Whilst there are no statutory requirements as to the type of legal entity that should be used in the establishment of a closed-ended fund pursuant to the Act, the type of entity most commonly used for this purpose is the Exempted Limited Partnership (“ELP”). Whilst other types of corporate vehicles can be used, such as a Cayman Islands Exempted Company, these are more commonly deployed in the context of an open-ended investment fund pursuant to the Mutual Funds Act (As Revised).

If a closed-ended fund (referred to under the Act as a private fund) is structured as an Exempted Company, it will be the directors of that company who operate it. However, as part of the registration of the fund with the Cayman Islands Monetary Authority (“CIMA”), it will be necessary to ensure that there are at least two directors appointed; this is known as the “four eyes principle” to ensure proper corporate governance and investor protection and is a prerequisite for registration as a private fund with CIMA.

If the fund is established as an ELP, the two-director rule does not apply directly to the ELP as ELPs do not have separate legal personality and therefore do not have directors. An ELP must, however, have a qualifying “general partner” who operates the ELP on behalf of the limited partners. It is at the general partner level that the “four eyes principle” will apply in this context and so a general partner must also have at least two directors.

Presently, it is not necessary for the directors of a private fund (or the directors of a general partner of an ELP which is registered as a private fund) to be registered pursuant to the Directors Registration and Licensing Act (As Revised).

Only closed-ended funds that fall within the definition of a “private fund”, as defined in the Act, will be required to register with CIMA under the Act as a private fund and will be regulated as such. The Act defines a “private fund” as:

“…a company, unit trust or partnership that offers or issues or has issued investment interests, the purpose of effect of which is the pooling of investor funds with the aim of enabling investors to receive profits or gains from such entity’s acquisition, holding, management or disposal of investments, where –

(a) the holders of investment interests do not have day-to-day control over the acquisition, holding, management or disposal of the investments; and

(b) the investments are managed as a whole by or on behalf of the operator of the private fund, directly or indirectly…”

The term “investment interest” is defined in the Act as an interest in the issuing vehicle which carries an entitlement to participate in the profits or gains of the vehicle and which interests are not redeemable or re-purchasable at the option of the investor.

Whether a particular structure will fall within this definition and be subject to regulation can be highly nuanced. We therefore recommend that you speak with an experienced Cayman Islands investment funds attorney to determine whether your proposed project would be regulated or whether an exemption from registration might be available.

For example, the Act itself contains a list of “non-fund arrangements” which are not considered to be “private funds”. The list of non-fund arrangements is extensive and quite broad in remit but we would specifically highlight the following non-fund arrangements:

• Joint ventures;
• Proprietary vehicles;
• Holding vehicles;
• Debt issues and debt issuing vehicles;
• Structured finance vehicles; and
• Sovereign wealth funds.

It should also be noted that single investor funds will also fall outside of the remit of the Act on the basis that where there is only one investor, there will not be any “pooling of investor funds” as required by the above quoted definition of “private fund”.

Where a particular project falls within the definition of a “private fund” and where it is not a “non-fund arrangement”, the corporate vehicle will be required to apply to CIMA for registration as a private fund under the Act.

In order to be registered under the Act, the fund will need to submit a completed application to CIMA via its online portal together with supporting documentation, including its offering document (which should contain, as a minimum, the information specified by CIMA in its Rules on Content of Offering Memorandum) and evidence of the appointment of an auditor and an administrator.

The application must (per section 5 of the Act) be submitted to CIMA (together with payment of the applicable registration fee) within 21 days after its acceptance of capital commitments from investors for the purposes of investments (although the application can be submitted at any time before capital commitments are received). The fund must be registered with CIMA as a private fund before it receives any capital contributions from investors.

In addition to the above, there are certain other key obligations with which private funds must comply.

Where the fund makes any change (or becomes aware of any change) which materially affects any information that was delivered to CIMA as part of the fund’s registration as a private fund, it must file details of the change with CIMA within 21 days of the change taking effect or of the fund becoming aware of the change. Whilst the Act only requires ‘material’ changes to be notified to CIMA, in practice CIMA tends to be notified of all changes given what is ‘material’ is open to interpretation.

Private funds must also file an annual return with CIMA and pay an annual registration fee in order to maintain its registration.

The Act requires that private funds have in place certain mechanisms and safeguards relating to an annual audit of the fund, the valuation of the fund’s assets, the safeguarding of the fund’s assets, cash monitoring and the identification of securities.

• Audit – the fund must engage an approved Cayman Islands auditor to prepare its audited financial statements annually. CIMA maintains a list of the approved auditor firms who are able to provide this service. Such audited financial statements must be filed with CIMA within six (6) months of the end of each financial year of the fund.
•  Valuation of fund assets – the assets of a private fund must be valued periodically. What is considered to be an appropriate period between valuations will depend on the asset class(es) in which the fund is invested. However, valuations should, as a minimum, be carried out at least annually. Each valuation must be carried out by an independent and suitably qualified professional valuer who is familiar with the relevant asset class. If the valuer is not independent, then CIMA reserves the right to have the valuation independently verified at the cost of the fund. Otherwise, if the valuation of assets is carried out by the fund itself or by its investment manager, the valuation function must be independent from the portfolio management function of the fund and any conflicts of interest are required to be identified, managed, monitored and disclosed to investors.
•  Safeguarding of the fund’s assets – private funds are, generally speaking, required to appoint a custodian to hold, in segregated accounts maintained in the name of the fund, the fund’s assets which are capable of physical delivery or capable of registration in a separate account except that the private fund shall not be required to appoint a custodian if it has notified CIMA and it is neither practical nor proportionate to do so, having regard to the nature of the private fund and the type of assets it holds. The duty of custodian appointed is to verify the fund’s title to its assets based on information provided by the fund together with any externally available information. If a custodian is not appointed, the verification of the fund’s title to its assets must be carried out either by the fund’s administrator or by the fund itself or its investment manager. In the case of title verification by the fund or its investment manager, the title verification function must be independent from the portfolio management of the fund and any conflicts of interest are required to be identified, managed, monitored and disclosed to investors in the fund.
• Cash monitoring – private funds are required to appoint any of an administrator, custodian or the investment manager to (1) monitor the cash flows of the fund; (2) ensure that all cash has been booked in cash accounts maintained in the name of the fund; and (3) ensure that payments made by investors to the fund for the purposes of investment have been received. If such monitoring is not undertaken by an independent third party, CIMA reserves the right to have the cash monitoring verified at the cost of the fund. In the case of cash monitoring undertaken by the fund or its investment manager, as above, the cash monitoring function must be independent from the portfolio management of the fund and any conflicts of interest are required to be identified, managed, monitored and disclosed to investors in the fund.
•  Identification of securities – if the private fund in question regularly trades securities or holds them on a consistent basis, it must keep records of the identification codes (such as ISIN codes or CUSIP codes) of those securities that it trades and holds, and such records must be made available to CIMA on request.

In addition to its obligations under the Act and guidance issued by CIMA, private funds are also subject to other obligations under the laws of the Cayman Islands in relation to matters such as FATCA / CRS compliance and, in respect of anti-money laundering legislation and regulations.

• FATCA / CRS – Private funds tend to be classified as ‘Reporting Financial Institutions” for the purposes of FATCA and CRS. Each private fund is therefore required to undertake detailed due diligence on each of its investors (which is typically undertaken on its behalf by its administrator). The fund must also provide information to the Tax Information Authority of the Cayman Islands in respect of each of its investors who constitute ‘reportable accounts’.
• Anti-money laundering – Private funds conduct “relevant financial business” for the purposes of the Proceeds of Crime Act (As Revised) and the Anti-Money Laundering Regulations (As Revised) (being together the “AML Requirements”). Private funds are therefore required to have robust policies and procedures in place to ensure that the AML Requirements are adhered to. The fund must have a detailed Anti-Money Laundering Compliance Manual which contains detailed guidance on the policies and procedures that must be followed in carrying out the fund’s activities, ranging from the onboarding process for investors, record-keeping, processes for the reporting of suspicious activity and other risk management matters.
• Beneficial ownership – The Beneficial Ownership Transparency Act (“BOTA”) requires Cayman Islands exempted companies, ELPs, and limited liability companies to maintain a beneficial ownership register unless an alternative route to compliance applies. Under the BOTA, alternative routes to compliance are available to categories of legal persons such as private funds and each private fund will be required to provide its corporate services provider in the Cayman Islands with:

1. written confirmation of the category into which it falls; and
2. the required particulars specific to it.

The private fund is required to appoint a principal point of contact (“PPoC”) who is responsible for responding to any request for beneficial ownership information received from the Cayman Islands Competent Authority (“Competent Authority”) in relation to the private fund. The PPoC must be licensed in the Cayman Islands and will be required to provide the requested beneficial ownership information to the Competent Authority within 24 hours of a request being made, or such other timeframe as may be stipulated in the request.

Each private fund must also appoint three (3) officers to assist with compliance with the AML Requirements; these are the anti-money laundering compliance officer, money laundering reporting officer, and deputy money laundering reporting officer.

On the basis that private funds are a form of investment fund, private funds that are registered under the Act are not ‘relevant entities’ for the purposes of the International Tax Co-operation (Economic Substance) Act (As Revised). Whilst, therefore, private funds will not be required to demonstrate the extent of their ‘substance’ in the Cayman Islands, they will nonetheless be required to make an annual notification under this legislation to confirm their status as an investment fund.

If you are considering establishing a private fund in the Cayman Islands, it is imperative that you have experienced Cayman Islands legal counsel by your side to assist you in navigating the legislative, regulatory, and compliance landscape. We have a strong reputation for our technical excellence, responsive, forward-thinking and insightful approach to advising clients on offshore Investment Funds and would be happy to be your trusted advisor on the formation, launch and ongoing advisory of your Cayman Islands private fund.

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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.

E: gary.smith@loebsmith.com
E: robert.farrell@loebsmith.com
E: elizabeth.kenny@loebsmith.com
E: vanisha.harjani@loebsmith.com
E: vivian.huang@loebsmith.com
E: faye.huang@loebsmith.com

The Companies Act (as Revised) of the Cayman Islands (the “Act”) does not contain any provisions with respect to the creation of security over Secured Shares in a Secured Company. Therefore, the security should adhere to the following principles derived from common law:

1. 1. it must be in writing;
   2. the security document must be signed by, or with the authority of, the security provider; and
   3. the security document must clearly indicate the intention to create security over the Secured Shares and the amount secured or how that amount is to be calculated.

Cayman Islands law recognizes various forms of security over assets, including equitable mortgages and charges which are most commonly taken over Secured Shares in a Secured Company.

Cayman Islands law does not prescribe a particular mode of execution with respect to security over Secured Shares in a Secured Company and it is not necessary for such security to be certified, notarized or apostilled to make the security valid or enforceable from a Cayman Islands law perspective. That being said, in practice, a security document with respect to Secured Shares in a Secured Company is customarily executed as a deed.

From an execution standpoint, it is important to review the memorandum of association and articles of association (the “M&A”) of the relevant security provider and the relevant Secured Company, to the extent it is a party to the security document, to ensure compliance with any applicable signing formalities.

Unless security is being taken in a Secured Company which is a “regulated person”, such as a bank or a mutual fund, no regulatory approvals are necessary to create valid and enforceable security as a matter of Cayman Islands law.

No stamp duty or taxes are payable with respect to the creation of security over Secured Shares in a Secured Company or upon any transfer thereof in an enforcement as a matter of Cayman Islands law so long as:

1. 1. the security document and any ancillary documents thereunder are not executed or delivered in, brought into, or produced before a court of, the Cayman Islands; and/or
   2. the Secured Company does not have an interest in land in the Cayman Islands, or shares in a subsidiary that has an interest in land in the Cayman Islands.

Cayman Islands law permits security over Secured Shares in a Secured Company to be governed by Cayman Islands law or foreign law.

In cross-border finance transactions, it is relatively common for the governing law of a security document over Secured Shares in a Secured Company to be aligned with the governing law of the principal finance documents. One advantage of adopting a foreign governing law clause in a security document is that it may make available certain additional remedies (such as appropriation) which are not available under Cayman Islands law. Care should however be taken to ensure that there are no conflicts of law issues where a security document is governed by foreign law. English, Hong Kong and Singapore law are frequently adopted to govern security over Secured Shares in a Secured Company and no major conflicts of law issues are likely to arise.

Cayman Islands law governed security document

Where the security document is governed by Cayman Islands law, so long as it is in customary form, the secured party is entitled to the following remedies in the event of a default:

1. 1. the right to take possession of the Secured Shares in the Secured Company (subject to redemption by the security provider upon the settlement of the debt);
   2. the right to sell the Secured Shares in the Secured Company; and
   3. the right to appoint a receiver who may:
      1. 1. vote the Secured Shares in the Secured Company;
         2.  receive distributions in respect of the Secured Shares in the Secured Company; and
         3. exercise other rights and powers of the security provider in respect of the Secured Shares in the Secured Company.

If the secured party acquires legal title to the Secured Shares in the Secured Company, it also has a right of foreclosure. This remedy extinguishes the security provider’s legal and beneficial title to the Secured Shares in the Secured Company but not its obligation to pay any secured and unpaid sums. Foreclosure involves a time-consuming and costly court process and is not usually exercised in practice given its draconian nature.

For further details regarding the enforcement of security over Secured Shares in a Secured Company, please refer to our guide entitled “Enforcing security over shares in a Cayman Islands exempted company”.

Foreign law governed security document

Where the security document is governed by foreign law, the:

1. 1. security document should comply with the requirements of its governing law to be valid and binding; and
   2. remedies available to a secured party are governed by the governing law and the terms of the security document.

Subject to any provisions to the contrary in the security document, all amounts that accrue from the enforcement of the security document are applied in the following order of priority:

1. 1.  firstly, in paying the costs incurred in enforcing the security document;
   2. secondly, in discharging the sums secured by the security document; and
   3. thirdly, in paying any balance due to the security provider.

The terms of a well-drafted Cayman Islands law governed security document with respect to Secured Shares in a Secured Company and the principal finance document will usually require the security provider to deliver the following documents to the secured party to assist with an enforcement:

1. 1. any original share certificate(s) with respect to the Secured Shares in the Secured Company;
   2. an undated share transfer form with respect to the Secured Shares in the Secured Company;
   3. an undated resignation letter from each director of the Secured Company;
   4. a letter of authorization from each director of the Secured Company authorizing the secured party to date each undated letter of resignation upon the occurrence of a default under the security document;
   5. an irrevocable proxy with respect to the Secured Shares in the Secured Company in favor of the secured party;
   6. a letter of instruction to the Secured Company’s registered office service provider containing, among other things, directions to register a transfer of Secured Shares in the Secured Company upon the occurrence of a default under the security document;
   7. a letter of acknowledgement from the registered office service provider with respect to the instructions referenced in the letter of instruction;
   8. if the security provider is a Cayman Islands exempted company, a certified copy of its register of mortgages and charges showing the security created over the Secured Shares in the Secured Company (see further below);
   9. a certified copy of the Secured Company’s register of members annotated to show the security created over the Secured Shares in the Secured Company (if commercially agreed – see further below);
   10. if the security provider is a Cayman Islands exempted company, a copy of the board resolutions of its board of directors authorizing:
       1. 1. its entry into and execution of the security document; and
          2. the updates to its register of mortgages and charges;
   11. a copy of the board resolutions of the Secured Company authorizing:
       1. 1. its entry into and execution of the security document (if it is a party);
          2. its register of members to be annotated (if commercially agreed); and
          3. its register of members to be annotated (if commercially agreed); and
   12. special resolution passed by the Secured Company with respect to certain changes to its M&A, if required (see further below).

Register of mortgages and charges of a Cayman Islands security provider

Pursuant to section 54 of the Act, if the security provider is a Cayman Islands company, it must record particulars of the security created over any Secured Shares in the Secured Company in its register of mortgages and charges. The register of mortgages and charges must include:

1. 1. a short description of the property mortgaged or charged;
   2. the amount of charge created; and
   3. the names of the mortgagees or persons entitled to such charge.

There is no statutory timeframe within which the register needs to be updated. However, a well-advised secured party will request that the register is updated promptly so that third parties that inspect it are on notice of the security.

Any variations and releases of charge should also be reflected in the register of mortgages and charges.

As there is no statutory regime for registering security interests under Cayman Islands law, the common law rules of priority continue to apply. In general terms, these rules specify that priority between competing security interests is determined by the dates on which the relevant security interests were created. It is important to note that inserting details of mortgages and charges in the register of mortgages and charges of a Cayman Islands company does not confer priority on a charge in respect of the relevant secured asset.

Register of members of the Secured Company

A Secured Company may annotate its register of members to include:

1. 1. a statement that security has been created over the Secured Shares;
   2. the name of the secured party; and
   3. the date on which the statement and the secured party’s name are entered in its register of members.

Although it is optional to annotate a Secured Company’s register of members with details of any security that has been created, this puts third parties that inspect the register on notice of the security. Therefore, a secured party usually insists on this.

M&A of the Secured Company

A secured party will usually request the Secured Company to make certain changes to its M&A to ensure, among other things, that there are no restrictions on the transfer of Secured Shares in the Secured Company which may impede enforcement action. Any changes to the Secured Company’s M&A must be made by passing special resolutions. Although such resolutions need to be filed with the Registrar of Companies of the Cayman Islands within 15 days of being passed, they take effect upon signing.

This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific advice on the matters covered in this Legal Insight, please contact your usual Loeb Smith attorney or any of the following: 

E: vanisha.harjani@loebsmith.com
E: max.lee@loebsmith.com

This article was first published in the Hong Kong Lawyer: https://law.asia/cayman-digital-asset-law/Granting and Protecting Security Over Shares in a Cayman Islands Exempted Company | Hong Kong Lawyer.

Firstly, the Letter of Wishes is a document separate from the Trust Instrument. Unlike the Trust Instrument, the Letter of Wishes does not have binding legal force. It is more akin to a guiding document, providing advisory guidance to the Trustee in administering the Trust. This means the Trustee has the discretion to decide whether or not to adopt the contents of the Letter of Wishes. Settlors might ask the question: if the Letter of Wishes lacks enforceability, isn’t creating one meaningless?

In practical application, if a Trustee’s failure to follow the Letter of Wishes results in harm to a beneficiary’s interests, the beneficiary may sue the Trustee in court. If the Trustees cannot provide sufficient evidence to prove that their decision-making process and purpose complied with the law and the provisions of the Trust Instrument, the court may assume the Trustees’ decision is invalid. For further details, see the section below on the validity of Trustee decisions contrary to the Letter of Wishes.

Typically, settlors do not include excessive detail within the Trust Instrument itself. Instead, specific wishes for trust administration will be placed in the Letter of Wishes. The main contents of a Letter of Wishes usually cover the following points:

1. 1. Trust/Beneficiary Arrangements. These often include prioritizing children’s education and medical needs. Additionally, conditions for beneficiaries to receive benefits can be set, such as age thresholds or educational requirements. Specific scenarios for excluding beneficiaries can also be stipulated. For example, distribution may be suspended or a beneficiary may be excluded if they are involved in drug-related crimes.
   2. Principles for Trust Asset Distribution. The Letter of Wishes can specify methods for distributing Trust assets, such as regular distributions, emergency distributions, and distributions upon the occurrence of significant events.
   3. Explanation of Trust Purpose. Elaborating on the Trust’s purpose within the Letter of Wishes is also a key measure to prevent Trust disputes. For instance, stating that the Trust aims to safeguard the livelihood of family members and their descendants. The Trustee must then weigh these purposes when making decisions.
   4. Stipulation of Special Clauses. For example, sometimes, while the law grants Trustees discretionary power to invest the Trust assets, the Letter of Wishes could state a recommendation to limit the proportion of assets invested in high-risk financial products to a specific range.
   5. Confidentiality Requirements. The settlor may state in the Letter of Wishes that its contents will not be disclosed to minor beneficiaries.

A settlor can usually sign multiple Letters of Wishes, reflecting the flexibility of Trusts. The settlor can update and adjust such non-binding guidance to the Trustee over time, based on changes in their circumstances (e.g., family situation, financial status, tax environment). It is generally understood that the most recently signed Letter of Wishes takes precedence, as it better reflects the settlor’s current situation and intentions. To avoid conflicts between multiple Letters of Wishes, a new Letter of Wishes should clearly and explicitly state that it revokes and replaces all prior Letters of Wishes or specified prior Letters of Wishes.

However, if the settlor fails to explicitly revoke prior versions in the new Letter of Wishes and conflicts arise between the old and new documents, the Trustee can face difficulties in decision-making. In such cases, the Trustee needs to consider all the Trust documents and make decisions based on the settlor’s overall intent. If the conflict is irreconcilable, the Trustee should seek legal advice to determine the course of action that best serves the interests of the Trust and aligns with the settlor’s true intentions, while avoiding liability for breaching fiduciary duties.

As mentioned, the Letter of Wishes itself lacks binding force. This means that, under specific circumstances, the Trustee has the right to make decisions that deviate from or even contradict the instructions in the Letter of Wishes. However, this does not mean the Trustee can arbitrarily disregard the settlor’s wishes. The Trustee’s power to deviate is strictly limited by the core requirement that the Trustee must fulfill his/her/its fiduciary duties, particularly the duties of loyalty, prudence, and adherence to the Trust’s purpose and terms.

Referencing a classic case, the Wong Case (Grand View Private Trust Company v Wong & Others [2022] UKPC 17), the UK Privy Council (whose judgment is persuasive authority in the Cayman Islands and the BVI) issued a number of guiding principles.

Based on the facts stated in the UK Privy Council’s judgment, the Wong brothers co-founded the large Taiwanese conglomerate Formosa Plastics Group (FPG) in the 1950s. In 2001, the brothers established two Bermuda trusts. The first was a discretionary family trust named the Global Resource Trust No. 1 (GRT), holding approximately US$560 million worth of FPG shares, with the beneficiaries being the settlors’ children and descendants. This discretionary family trust also granted the Trustee the discretionary power to add or remove “any person or class or description of persons” to the beneficial class of the Trust. The second Trust was a purpose trust named the Wang Family Trust (WFT), serving both charitable and non-charitable purposes. In 2005, The Trustee of the GRT exercised its powers of addition and exclusion to exclude all family members of the founders from the beneficial class of the Trust, and to add the Trustee of the WFT as the sole beneficiary. The dispute accordingly focused on the GRT trust deed, which granted the Trustee the power to add or exclude beneficiaries. Further, as early as 2001, the founding brothers had signed a memorandum of wishes before establishing the Trusts. This memorandum stated their intention in establishing the family trust was for the benefit of their children. The UK Privy Council admitted this memorandum as evidence, concluding that the purpose of the GRT discretionary trust was for the benefit of the founder’s family members. According to the Letter of Wishes, if the family Trust was established to benefit the family, how could excluding the family members to benefit another Trust serve a proper purpose? Consequently, the UK Privy Council found that the Trustee’s exercise of its power to exclude the existing beneficiaries and add the purpose Trust as a beneficiary was invalid.

Although the above case is an extreme and unusual example, it illustrates that a Trustee cannot ignore the settlor’s wishes and purposes when exercising their administrative powers. However, when dealing with such cases, courts will not automatically find a Trustee in breach simply for not following the Letter of Wishes. The reasonableness of the Trustees’ decision-making process and basis, and whether they have complied with their fiduciary duties, are also crucial factors. The court will consider the Letter of Wishes as significant evidence for understanding the settlor’s intent.

The Letter of Wishes, as a key non-binding document within a Trust, plays an indispensable role in family wealth succession planning. Its core value lies in providing guiding principles for the Trustee regarding the management of Trust assets, distribution of gains or profits, and addition or removal of beneficiaries, thereby significantly compensating for the potential lack of detailed execution provisions in the Trust Instrument, which prioritizes flexibility.

Although the Letter of Wishes itself lacks binding legal force, its practical influence and risk management value in practice of Trust administration cannot be overlooked. When making discretionary trust administration decisions, Trustees should fully understand the settlor’s Trust intentions to avoid dispute.

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific advice on the matters covered in this Legal Insight, please contact your usual Loeb Smith attorney or any of the following: 

E: gary.smith@loebsmith.com
E: robert.farrell@loebsmith.com
E: elizabeth.kenny@loebsmith.com
E: vanisha.harjani@loebsmith.com