The Privy Council decision (on appeal from the Court of Appeal, Grand Cayman) that Liquidators of an insolvent open-ended investment company were entitled to recover from a bank those share redemption payments which were unlawful preferences over other creditors pursuant to the Companies Law (2013 Revision) 2013 (Cayman Islands) s.145(1) notwithstanding that the bank had not been enriched but, as a bare trustee, had paid away the money to its beneficiaries.
David Lord Q.C. of ThreeStone appeared (along with Shaun Folpp of Mourants) for the successful Liquidators.
What was the background?
In short, Weavering collapsed in March 2009 when the directors uncovered the fraudulent activities of the Fund’s principal investment manager, Magnus Peterson. At the heart of his fraud, Mr Peterson used fictitious interest rate swaps to give the impression that the Fund was returning steady profits when in reality the swaps had the effect of masking huge trading losses. This was done by attributing significant value to the swaps notwithstanding the fact that they were worthless. Following the collapse of Lehman Brothers in September 2008, a significant number of Weavering’s investors sought to redeem their shares. As a consequence, redemptions totalling US$138.4m, US$54.7m and US$30m became due on each of the 1 December 2008, 2 January 2009 and 2 February 2009 redemption days. As a result of Mr Peterson’s fraud, Weavering was never in a position to meet these redemption obligations, and was rendered hopelessly insolvent. However, rather than suspending redemptions, or otherwise taking steps to cease the Fund’s business, Mr Peterson implemented a policy for the payment of redemptions – albeit only to those investors who redeemed their shares on 1 December 2008, leaving those investors who redeemed on 2 January and 2 February 2009 unpaid. The defendant in these proceedings, SEB, was one of the investors who redeemed their shares on 1 December and who was paid their redemption sums in full.
What did the court decide?
The Board confirmed both decisions below that the redemption sums received by SEB were preference payments, and ought to be repaid to the Fund’s liquidators. In doing so, the Board held:
- While Net Asset Values (NAVs) struck prior to a company’s liquidation ordinarily cannot be disturbed or set aside once a company is in liquidation (following the Privy Council’s decision in Fairfield Sentry v Migani  UKPC 9), where those NAVs have been struck as a result of an “internal” fraud they may not be binding and may be liable to be set aside. This is to be contrasted with the position of an “external fraud” where, even if the NAVs are affected by fraud, they will nonetheless be binding. Here, given Magnus Peterson was found to be the controlling mind of the Fund (although he was not a director), the fraud was found to be “internal”.
- Where a company’s articles provide that redemption sums are to be paid within a set period of time following a redemption day, the obligation to pay those sums still arises on the redemption day. Reference to a payment period (in this case, a period of 30 days from the relevant redemption day) is simply a reference to a supplementary procedure which does not affect the liability from accruing on the redemption day.
- In a preference action, the required “dominant intention to prefer” can be inferred from the evidence by applying general principles of inference.
- The relevant provision within the Cayman Island statute in relation to preference only has the effect of avoiding the relevant payment. The cause of action which then accrues is not based on the statute, but rather restitution on the ground of unjust enrichment. However, as a matter of public policy, there can be no change of position defence to a claim brought for the recovery of preference payments.
As an aside, in the Court of Appeal’s decision, below, it held that the cash flow test for insolvency in the Cayman Islands is not confined to consideration of debts that are immediately due and payable, and that it also permits consideration of debts that will become due in the reasonably near future. Given the Board’s conclusion in relation to issue 2 above it was not necessary for the Board to go on to consider this point. The Court of Appeal’s decision thus remains the position as a matter of Cayman Islands law.
What are the practical implications of this decision?
The Board’s decision deals with a number of important principles which have a far reaching affect beyond mere preference payments. However, the two most obvious implications are:
First, given the propensity for investors to invest in Cayman Islands investment funds via custodians or nominees, the lack of a change of position defence will require those who provide these services to ensure the arrangements they have in place with their underlying investors include an ability to recover redemption sums which they receive on behalf of those investors and, in turn, which they pay to them. The defendant in these proceedings, SEB, was itself a custodian. It received the redemption sums from the Fund and, in turn, paid them out to its investors. Unfortunately, the indemnities it had in place with those investors were worthless, meaning SEB, having paid the redemption sums away and being unable to now recover them, will need to re-pay these sums from its own monies.
Second, the Board’s decision to draw a distinction between “internal” and “external” fraud may result in aggrieved investors in funds which have been subject to an internal fraud taking steps to try and set aside previously binding NAVs, with a view to all investors, regardless of whether they sought to redeem their shares or not prior to liquidation, sharing equally in the fund’s available assets.
Ultimately, the decision reinforces the policy behind much of the Cayman Islands’ insolvency regime, which is to restore value to a company for the benefit of its creditors who, in turn, ought to share equally in the distribution of the company’s assets