The main fiduciary duty that a General Partner owes to the ELP and the ELP’s limited partners as a whole is the duty of loyalty and good faith. Under Cayman law this is expressed as requiring the General Partner to act in good faith in the interest of the ELP. There is no specific guidance in the ELP Act as to the full extent of this duty. There are no decisions of the Cayman Islands’ courts that have  determined the full scope of the duty. However, as in other areas of Cayman law, it is reasonable to assume that the Cayman courts would refer to the decisions in English and Commonwealth cases, which are of persuasive authority if not binding authority, for guidance.

Prior to July 2014, a General Partner was under an absolute duty to act in good faith in the interest of the ELP. This duty could not be restricted, limited or varied by the terms of the Partnership Agreement between the General Partner and the limited partners. The requirement to act in the interest of the ELP often raises the issue of conflicts of interest for the General Partner, particularly when it acts as General Partner to more than one ELP.

Examples of where conflicts of interests can arise for the General Partner include:

1. The General Partner causes the ELP to:
   • co-invest with other ELPs (in which it is also the general partner) in only certain transactions that benefit the General Partner; or
   • co-invest in disproportionate amounts, which causes its interests to be no longer directly aligned with those of the limited partners of the ELP.
2. The General Partner causes the ELP to invest in a portfolio company in which the person(s) who control and/or own the General Partner, for example, the director(s) and/or shareholder(s) of the General Partner, have a personal interest.
3. The General Partner causes the ELP to purchase securities from person(s) who control and/or own the General Partner, for example, the director(s) and/or shareholder(s) of the General Partner.
4. The General Partner is responsible for valuing assets of the ELP where carried interest payable to the General Partner are based on such valuations.
5. Treatment of limited partners: the General Partner owes a fiduciary duty to the limited partners of the ELP as a whole. Therefore the General Partner should treat each limited partner of the ELP in a similar manner. It should not benefit one at the expense of the others. Different treatment of limited partners sometimes arises in the context of default by a limited partner in performing its obligations under the Partnership Agreement. For example, where the limited partner fails to pay its contributions to the ELP when a call on its capital commitments has been made.

Often the Partnership Agreement provides that where a limited partner fails to perform any of its obligations under, or otherwise breaches the Partnership Agreement (for example, where a limited partner fails to commit additional capital when called on to do so), that limited partner may be subject to or suffer remedies for, or consequences of, the failure or breach specified in the Partnership Agreement. Such remedies or consequences can include, for example, reducing, eliminating or forfeiting the defaulting limited partner’s partnership interest in the ELP. The ELP Act confirms that those remedies or consequences in the Partnership Agreement will not be unenforceable solely on the basis that they are penal in nature. This confirmation by the ELP Act reduces significantly the risk of those remedies or consequences in the Partnership Agreement being subject to legal challenge in the Cayman courts on the basis that they are penalties (that is, remedies that go well beyond a reasonable assessment and measure of the loss suffered as a consequence of the default) and may be unenforceable as a matter of Cayman law generally.

However, there is a risk of legal challenge by a limited partner where a General Partner fails to apply a clear and consistent approach to implementing such remedies in the Partnership Agreement against defaulting limited partners. The challenge could be based on the ground that the inconsistent implementation of such default procedures benefits one limited partner at the expense of the others or vice versa.

The ELP Act modified the scope of the fiduciary duty of a General Partner to act in good faith in the interest of the ELP. There is still an absolute duty on the General Partner of an ELP to act in good faith on matters concerning the ELP. However, the duty to act in the interest of the ELP is now subject to any express provision in the Partnership Agreement to the contrary.

The Partnership Agreement can therefore stipulate the circumstances in which the General Partner may act in the interest of a party other than the ELP (for example, see above, Duty to act in good faith in the interest of the ELP). Including these circumstances in the Partnership Agreement should make it easier for the General Partner to manage interests that compete against the interests of the ELP.

However, where the Partnership Agreement has no express provision to state in whose interest the General Partner must act in given circumstances, then the default position is that the General Partner must act in good faith in the interest of the ELP (that is, in the collective interest of all limited partners of the ELP).

A General Partner’s powers derive from the ELP Act and the Partnership Agreement governing its relationship with the limited partners. The General Partner is under a fiduciary duty to exercise its powers for the purpose(s) for which they are conferred in the Partnership Agreement. The purposes in the Partnership Agreement can be stated in general terms, for example, to undertake any lawful activity under the ELP Act, or to act as an investment fund. They can also be expressed in specific terms, for example, to invest in a portfolio consisting primarily of securities of companies in the renewable energy, renewables, clean technology, environment regeneration sectors and to engage in all activities and transactions as may be necessary, advisable, or desirable to carry out these activities. Where the Partnership Agreement of an ELP is, for example, negotiated with a large institutional investor or seed capital investor, the investor will more than likely seek to have the purpose(s) of the ELP stated in more specific terms.

The ELP Act states that all “rights or property of every description of the [ELP], including all choses in action and any right to make capital calls and receive the proceeds thereof that is conveyed to or vested in or held on behalf of any one or more of the general partners or which is conveyed into or vested in the name of the [ELP] shall be held or deemed to be held by the general partner and if more than one then by the general partners jointly, upon trust as an asset of the [ELP] in accordance with the terms of the partnership agreement” (section 16(1), ELP Act).

As the General Partner holds the ELP’s assets on trust, it follows that it should:

• Not make any secret profits from such assets or, without express authorisation, appropriate any benefits or opportunities that derive from such assets for itself.

• Disclose personal interest in contracts involving the ELP.

• Apply the ELP’s assets for the purpose of the ELP.

A General Partner can minimise the risk of breaching its fiduciary duties to the ELP and thereby the risk of being sued by one or more limited partners by adopting some or all of the following:

1. Avoid conflict transactions or establish advisory committees (LPACs) or votes of limited partners to approve conflict transactions or waive conflicts. An ELP’s Partnership Agreement often provides for the establishment of an advisory committee of persons nominated by certain limited partners (LPAC) to adjudicate on, among other things, conflict situations involving the General Partner. The use of advisory committees is a good way of mitigating the risk of the General Partner being found to be in breach of its fiduciary duties for failing to deal with conflicts or dealing with them inadequately. The ELP Act confirms that, subject to any terms of the Partnership Agreement to the contrary, a member of the LPAC does not owe any fiduciary duty to the ELP or to the General Partner or to any of the ELP’s limited partners, in exercising any of its rights or otherwise in performing any of its obligations as a member of the advisory committee (section 24(2), ELP Act).
2. Clear and consistent policies. The General Partner should ensure that the ELP, where possible, adopts clear and consistent valuation policies approved by the ELP’s advisory committee. The General Partner should also ensure that the ELP, where possible, adopts clear and consistent policies for dealing with circumstances where limited partners default on their obligations in the Partnership Agreement (for example, failing to make contributions when a capital call has been made). An ELP which operates as a regulated investment fund registered with the Cayman Islands Monetary Authority is required to have policies and procedures for implementing and effecting good corporate governance. This can also help to mitigate risks of liability.
3. Internal compliance. The General Partner should establish clear internal procedures for identifying potential conflicts and dealing with them (for example, referral to the LPAC for consideration).
4. Restrict the scope of fiduciary duties by agreement. The Partnership Agreement can be drafted in such a way as to minimise or restrict the scope of certain fiduciary duties. For example, the ELP Act now permits the Partnership Agreement to set out circumstances in which the General Partner may act in the interests of parties other than the ELP (see above, Modification of duty to act in good faith in the interest of the ELP). The Partnership Agreement can also be used to clearly exclude fiduciary duty obligations of the General Partner in other areas but this will depend on the relative bargaining power between the General Partner and incoming limited partners and the degree of negotiation of the Partnership Agreement. However, the absolute duty on the General Partner to act in good faith in respect of the ELP cannot be excluded or eliminated.

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. If you require further advice relating to the matters discussed in this Briefing, please contact us.  We would be delighted to assist.

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What rules and restrictions govern the exchange of fiat currency and cryptoassets?

Assuming the subject cryptoassets fall within the definition of virtual assets under the Virtual Asset (Service Providers) Act (As Revised) (VASP Act), the exchange of fiat currency and cryptoassets will likely constitute a virtual asset service under the VASP Act and hence any person providing the service of exchange of fiat currency and cryptoassets in the course of their business will be a virtual asset service provider regulated by the VASP Act.

Furthermore, if the exchange of fiat currency and cryptoassets falls within one of the relevant financial businesses under the Proceeds of Crime Act, the relevant service provider will be required to comply with the AML and KYC requirements under the AML Regulations, which include, among other things, implementing client identification and verification, record-keeping, and internal reporting and control procedures.

Where are investors allowed to trade cryptoassets? How are exchanges, alternative trading systems and secondary markets for cryptoassets regulated?

There are generally no legal requirements or restrictions on where investors are allowed to trade cryptoassets in the Cayman Islands, so investors are usually free to trade cryptoassets wherever they desire.

Assuming the subject cryptoassets that are traded on the exchanges, alternative trading systems and secondary markets qualify as virtual assets under the VASP Act, such exchanges, alternative trading systems and secondary markets will have to apply for a licence with the Cayman Islands Monetary Authority (CIMA) if either of them qualifies as a virtual asset trading platform under the VASP Act, which is defined as: a centralised or decentralised digital platform — (a) which facilitates the exchange of virtual assets for fiat currency or other virtual assets on behalf of third parties for a fee, commission, spread or other benefit; and (b) which — (i) holds custody of or controls virtual assets on behalf of its clients to facilitate an exchange; or (ii) purchases virtual assets from a seller when transactions or bids and offers are matched in order to sell them to a buyer, and includes its owner or operator, but does not include a platform that only provides a forum where sellers and buyers may post bids and offers and a forum where the parties trade in a separate platform or in a peer-to-peer manner.

If the exchanges, alternative trading systems or secondary markets are licensed with CIMA as virtual asset trading platforms, each of them would be subject to various restrictions and obligations stipulated, among other things, under section 11 of the VASP Act, such as being restricted from providing financing to its clients for the purchase of virtual assets unless disclosures are made to clients regarding the terms of, and the risk of, the financing, and being obligated to carry out reasonable due diligence procedures on virtual assets and their issuers that are listed on the platform.

Alternatively, the exchanges, alternative trading systems and secondary markets for cryptoassets may otherwise have to be registered or licensed with CIMA if its business activity constitutes any virtual asset service under the VASP Act.

At the same time, the exchanges, alternative trading systems and secondary markets for cryptoassets may be regulated by the Securities Investment Business Act (SIBA) if the subject cryptoassets fall within the definition of securities under the SIBA, and if they are engaged in certain securities investment business, which would mandate the registration or licensing with CIMA.

Furthermore, if the business of exchanges, alternative trading systems and secondary markets for cryptoassets falls within one of the relevant financial businesses under the Proceeds of Crime Act, they will be required to comply with the AML and KYC requirements under the AML Regulations, which include, among other things, implementing client identification and verification, record-keeping, and internal reporting and control procedures.

How are cryptoasset custodians regulated?

Assuming the cryptoassets that are the subject of the custody service of the relevant cryptoasset custodians qualify as virtual assets under the VASP Act, such custodians will have to apply for a licence with CIMA if either of them provides virtual asset custody service under the VASP Act, which is defined as ‘the business of safekeeping or administration of virtual assets or the instruments that enable the holder to exercise control over virtual assets’. If the custodians are licensed with CIMA to provide virtual asset custody service, each of them would be subject to various restrictions and obligations stipulated, inter alia, under section 10 of the VASP Act, such as being obligated to:

• maintain best technology practices relating to virtual assets held in custody;
• not encumber or cause any virtual asset to be encumbered, unless specifically agreed to by the beneficial owners of the virtual assets;
• ensure that all proceeds relating to virtual assets held in custody shall accrue for the benefit of the owner, unless otherwise agreed in writing;
• take such steps as may be necessary to safeguard the virtual assets held;
• have adequate safeguards against theft and loss; and
• enter into a custodial arrangement with the owner of a virtual asset, which includes the prescribed details set out in the VASP Act.

Furthermore, if the business of such cryptoasset custodians falls within one of the ‘relevant financial businesses’ under the Proceeds of Crime Act, they will be required to comply with the AML and KYC requirements under the AML Regulations, which include, among other things, implementing client identification and verification, record-keeping and internal reporting and control procedures.

How are cryptoasset broker-dealers regulated?

Assuming the broker-dealer business of the relevant cryptoasset broker-dealers involves cryptoassets that qualify as virtual assets under the VASP Act, it is likely that such broker-dealers will have to be registered with CIMA and be regulated accordingly because such broker-dealer business typically involves either one or a combination of the following virtual asset services: transfer of virtual assets, virtual asset custody service, or participation in and provision of financial services related to a virtual asset issuance or the sale of a virtual asset.

At the same time, the cryptoasset broker-dealers may be regulated by the SIBA if the subject cryptoassets fall within the definition of securities under the SIBA, and if they are engaged in certain securities investment business (which would be likely in terms of dealing in securities and/or arranging deals in securities), which would mandate the registration or licensing with CIMA.

Furthermore, if the business of such cryptoasset broker-dealers falls within one of the relevant financial businesses under the Proceeds of Crime Act, they will be required to comply with the AML and KYC requirements under the AML Regulations, which include, among other things, implementing client identification and verification, record-keeping and internal reporting and control procedures.

What is the legal status of decentralised cryptoasset exchanges?

Since the definition of ‘virtual asset trading platform’ under the VASP Act also covers those trading platforms with a decentralised nature, certain pieces of legislation and regulations, such as the VASP Act, the SIBA and the AML Regulations, may similarly apply to decentralised cryptoasset exchanges so long as the subject cryptoasset and business activities fall within the corresponding scopes.

What is the legal status of peer-to-peer (person-to-person) transfers of cryptoassets?

Assuming the cryptoassets that are the subject of the peer-to-peer transfers qualify as virtual assets under the VASP Act, if such peer-to-peer transfers are conducted in the course of the relevant party’s business, such peer-to-peer transfers may constitute a virtual asset service with respect to transfer of virtual assets under the VASP Act, which renders the need to be registered with CIMA.

Similarly, a party of peer-to-peer transfers of cryptoassets may be regulated by the SIBA if the subject cryptoassets fall within the definition of securities under the SIBA, and if that party is engaged in certain ‘securities investment business’ (which would be likely in terms of dealing in securities), which would mandate the registration or licensing with CIMA.

Furthermore, if such peer-to-peer transfers fall within one of the relevant financial businesses under the Proceeds of Crime Act, the relevant party will be required to comply with the AML and KYC requirements under the AML Regulations, which include, among other things, implementing client identification and verification, record-keeping, and internal reporting and control procedures.

Does the law permit trading cryptoassets with anonymous parties?

In general, there are no legal restrictions on trading cryptoassets with anonymous parties, unless such trades are considered to be conducted in the course of business of the relevant party and the relevant party is considered to be providing the services of transfer of virtual asset under the VASP Act, and/or carrying out the relevant financial business under the AML Regulations, in which the relevant party will then be subject to certain due diligence requirements of the transaction parties and/or customers, hence making it difficult for a party to keep itself anonymous.

Are foreign cryptocurrency exchanges subject to your jurisdiction’s laws and regulations governing cryptoasset exchanges?

In general, the location of domicile of a foreign cryptocurrency exchange does not affect whether Cayman Islands’ laws and regulations may govern such exchange.

For the VASP Act, what matters is whether any virtual asset service is provided in or from within the Cayman Islands in the course of business, the affirmation of which will render the foreign cryptocurrency exchange to register or be licensed with CIMA.

In addition, the SIBA also does not differentiate between the treatment for varying locations of domicile of a foreign cryptocurrency, and what matters is the actual business activity conducted by the relevant exchanges and whether it is being conducted in or from within the Cayman Islands.

From the perspective of Cayman Islands laws, there is generally no legal restriction or requirement on how a citizen of the Cayman Islands is required to exchange cryptoassets on a foreign exchange.

There is generally no Cayman Islands tax liability for the exchange of cryptoassets.

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Parallel funds are investment vehicles structured to co-invest and divest alongside a main fund, with each structure being similar in many ways to the main fund in terms of strategy, investment policy, investment target, asset classes, risk management, etc. The major distinction between the different funds in the structure are typically the tax framework (capital gains, dividend, interest, etc.) or the intention of the investment manager to differentiate each fund vehicle based on their investor group.

For example, parallel funds may include an onshore fund or mid-shore (established in any jurisdiction, e.g. Singapore or Hong Kong) and a standalone Cayman fund, both being managed by the same investment manager, with similar investment objectives and strategies, making identical investments but having different structures and a different pool of investors (e.g. US investors in one Cayman structure or Delaware structure, Japanese investors in a Singapore domiciled fund structure, and other non-US investors based in Asia in another Cayman-domiciled fund structure), in order to cater for a tax efficient framework or regulatory requirements based on investors’ jurisdiction of domicile.

Parallel funds are often established by private equity (PE) fund managers to complement the main fund and address legal, tax, regulatory, accounting or other considerations from specific investors who are interested in the investment objective and strategy.

Parallel funds versus master-feeder funds. Parallel funds are distinguishable from master-feeder structures in that the feeder funds invest directly into the master fund, thereby pooling all investments in the master fund. With parallel funds, separate investment funds invest directly in the same investment deals or asset classes, but they are kept as distinct entities with no pooling of capital into a master fund.

What are the key benefits and advantages offered by parallel fund structures?

Using parallel funds provides a number of benefits to investment managers, including:

1. Flexibility, allowing investment managers to tailor investment strategies and structures based on investor profiles, offering different fee structures or liquidity terms;
2. Tax efficiency, providing a tax efficient way to invest without triggering adverse tax consequences in jurisdictions with stringent regulations; and
3. Regulatory compliance, allowing investment managers to adapt to varying regulatory environments, ensuring compliance.

However, it would be wise to note that parallel fund structures do not come without risks, including:

1. Operational issues – the investment manager may need to manage multiple funds across jurisdictions;
2. Different regulatory requirements – creating more administrative responsibility and complexities in terms of operations and compliance, increasing cost; and
3. Investor relations and fees – managing communications and reporting between different investor classes, and dealing with different structures and fees can cause confusion and increase the administrative burden.

When structuring parallel funds, consideration needs to be given to:

1. Investment strategy alignment to ensure that funds can invest in the same underlying assets without conflicts of interest;
2. Fund documentation, drafted to address the specific needs of each fund while ensuring consistency;
3. Management and fees, ensuring transparency; and
4. Legal and tax advice to ensure compliance with all relevant laws and regulations, and optimise the tax impact for investors.

When considering the Cayman Islands for a parallel fund structure, its robust legal framework, absence of taxes on investment funds and their investors, and flexible regulatory environment make it attractive for investment managers and investors alike.

This article was first published with Asia Business Law Journal. https://law.asia/cayman-islands-parallel-funds-growth-benefits/

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. If you require further advice relating to the matters discussed in this Article, please contact us. We would be delighted to assist.

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