Cayman Islands – The Focal Point of Cross Border Insolvency
By Neil Lupton
Posted: 8th November 2012 10:21
When examining the key issues and trends dominating cross-border insolvency work, the Cayman Islands is as good as any place to start. Virtually every case we come across in the Cayman Islands has at least one cross border element (if not several) which means that the international aspect is interwoven into our everyday work, in dealing with courts, office holders and legal counsel in various jurisdictions. In many circumstances, one should appreciate that companies may be involved in more than one insolvency process and the courts in the Cayman Islands, as well as the BVI are very flexible in this regard, with the ability to hold joint hearings with courts in the US and elsewhere by video or teleconference where appropriate. Insolvency practitioners in the Cayman Islands are also well used to companies that are registered here but operate elsewhere, so the international dynamic is an important part of everything we do.
In terms of the objectives we are trying to achieve, the primary legal issues in an insolvency situation often reflect the commercial considerations. When a company is in distress there will usually be a number of different stakeholder groups who are all looking for different outcomes and have different priorities. With all of these stakeholders having their own legal rights (which may differ considerably amongst one another), typically alongside a substantial financial interest, these rights must be examined in a commercial context. At Walkers, we regularly advise all of the major insolvency practitioners (who act as official liquidators) in the Cayman Islands and the BVI with respect to such issues. We regularly advise all forms of Cayman Islands and BVI domiciled vehicles (including hedge funds, exempted limited partnerships and other special purpose vehicles) and their directors and managers in connection with complex insolvency issues, particularly in the grey area as to whether a company may not be insolvent on a pure cash flow basis (the applicable legal test in the Cayman Islands), but may have serious balance sheet issues due to increasingly illiquid investments and/or high levels of unmet redemption requests. The sheer number of hedge fund and private equity clients in our Corporate department means that we tend to be involved in the lion's share of the largest (by value) and most interesting work.
In addition, we have widespread experience acting for companies, funds and other investors in disputes relating to their investments with other funds. We have continued to see elevated levels of winding up petitions (both creditor and shareholder) in the Courts and one must always be mindful that – in contrast with bipartite litigation – these are class action remedies which requires consideration of their effect not just on the petitioner, but on all relevant stakeholders. For example, whilst a client may be very keen to initiate proceedings in order to either protect or enforce their legal rights or otherwise obtain maximum leverage (within the confines of applicable legal and equitable rules), taking pre-emptive action may sometimes be counter-productive if that step then triggers defaults under the relevant company or fund's underlying external contracts which, in turn, may cause value destruction for all stakeholders.
Dynamic Work Flow
Clearly the impact of the global financial crisis on the insolvency sector has been profound and workflow in the Cayman Islands and the British Virgin Islands has been consistently busy from the initial spike over the past four years. The first wave of work following the crisis featured a range of problems from hedge fund insolvencies to more traditional restructuring work, which was followed by a jump in bank and bondholder-led enforcement work. Now we are seeing litigation coming out of these insolvency proceedings, for example the litigation in the Weavering directors' duties case which made the headlines in 2011 was from a 2009 bankruptcy. Another evident trend is that of investors beginning losing patience with funds which sought to restructure, suspend or side-pocket their illiquid portfolios over the past few years and we anticipate a further uptick in contentious work of this nature.
Another form of litigation taking centre stage has been the emergence of clawback claims, involving the recovery of money that has been paid out to investors by a fund in the period leading up to a formal insolvency filing, usually because of improperly calculated net asset values ("NAV"). Typically these claims are harder to achieve in the Cayman Islands or BVI than in the US where a specific and detailed statutory regime is in place under the US Bankruptcy Code. We have also seen first-hand the interplay between the US and Caribbean approaches by the actions taken by Mr Irving Picard, the SIPC Trustee of the Madoff estate, in seeking to enforce such avoidance claims against funds in the Cayman Islands and the BVI. This will certainly be an area to watch as participants in Cayman and BVI continue to examine ways to achieve clawbacks, especially as we now have a specific regime in the Cayman Islands under our Companies Winding Up Rules which provide liquidators with some guidance in terms of restating NAV where fraud has occurred and rectifying the register of members accordingly (although such claims often involve complex issues which are very likely to be tested before the courts in the short to medium term).
Elsewhere, we are seeing claims made against service providers, such as directors, just like with the Weavering case, as well as auditors and administrators. I have no doubt that we will continue to see more claims along these lines. Lately we have not seen as many of the so-called "loss of substratum" just and equitable winding up petitions whereby a minority investor alleges that a permanent or indefinite suspension of redemptions by a fund with a view to returning assets through a "soft wind-down" is inappropriate and the fund ought to be wound up by the court instead. However, given the present divergence in the law of the Cayman Islands and the BVI in this regard, I would be surprised if we do not see some further cases which are then taken to appellate level.
For most of our clients, typical challenges include dealing with a lack of working capital, a sharp fall in profitability, unsustainable costs and the likely breach of loan covenants. Often events in a restructuring process can move extremely quickly with assets being dissipated. It is crucial to avoid the destruction of value and the underlying assets in the restructuring process, underlining the need for specialist assistance at an early stage.
For Walkers, we are certainly operating in mature markets, which bring its own challenges. Walkers has a dedicated Insolvency and Corporate Recovery Group which is well resourced with specialist Cayman Islands and British Virgin Islands attorneys. We have also considerably expanded our ICR practice in Hong Kong over the past 12 months, where the team have been extremely active. The flexibility of the courts in Cayman and BVI is another important factor and in particular the introduction of the Financial Services Division in the Cayman Islands with a number of specialist judges that are experienced in fast paced cross border insolvency disputes. The jurisdiction is also pleased to have the presence of specialist and experienced insolvency practitioners acting as liquidators who perform this role day-in, day-out. With an international aspect never far from the centre of every important insolvency case, this cross-border expertise will ensure that Cayman and BVI remain at the heart of the restructuring universe.
Neil Lupton is based in Walkers' Cayman Islands office and is a partner in the Global Insolvency and Corporate Recovery Group. Neil specialises in complex restructurings, contentious and non-contentious insolvencies and distressed situations, advising existing stakeholders and creditors, debtors, private equity and hedge funds, insolvency practitioners and other advisors. Neil also has broad experience in general contentious matters.
Mr. Lupton can be contacted by phone on +1 345 914 4286 or alternatively via email at firstname.lastname@example.org