Cayman Islands laws and administrative arrangements are sufficiently flexible to facilitate, where appropriate and applicable, the domestic resolution of insolvency proceedings or the rendering of assistance for the resolution of such proceedings before foreign courts. This is the view of Chief Justice Anthony Smellie who recently spoke on the investment fund perspective on “forum shopping” to an international audience of fellow judges and related professionals.

An overview of this legal and judicial progression was detailed in his paper on the topic of “Forum Shopping is Bad; Choice of Forum is Good?” at an INSOL San Francisco judicial colloquium, 21 to 22 March. Forum Shopping is the informal name given to the practice of some litigants of having their cases heard in the court thought most likely to provide a favourable outcome.

Cayman’s Chief Justice was speaking at the Eleventh Joint Multinational Judicial Colloquium on Cross-Border Insolvency, part of a larger INSOL conference. The annual judicial colloquium, at which the Chief Justice has been a regular presenter, is an educational session open only to judges, judicial administrators, and senior civil servants from relevant government ministries globally.

The aim of the educational session was to prepare participants to understand developments in the handling of cross-border insolvency cases where there are assets in more than one jurisdiction. This is an increasing phenomenon with the growth of cross-border commerce.

In his presentation, the Chief Justice allowed that choice of forum or forum shopping is permissible essentially where it results in preserving value for shareholders and maximising returns for investors and creditors.

“The choice of forum is important to the investors’ decision to invest and reflects their expectation that [in the case of the Cayman Islands] Cayman Law will apply to the liquidation of their investments if things go wrong.”

However, the Chief Justice noted that forum shopping was unacceptable where the intent involves fraud or abuse of process.

Underpinning his discussion is the fact that the UNCITRAL (UN Convention on International Trade Law) Model Law, now widely adopted, is designed to allow courts of various jurisdictions to cooperate with each other in resolving cross-border insolvency cases, even while seeking to prevent improper forum shopping.

Another method of achieving cooperation and coordination between courts — one that has been successfully employed by the Cayman courts with foreign jurisdictions — is “Cross-Border Insolvency Agreements.” The Chief Justice said that the “landmark Pooling Agreement between the three major BCCI banking companies in 1992 still serves as a paradigm for cross-border cooperation.”

As a result of these mechanisms, insolvency judges are today well aware of the “flexibility and discretion” they hold in cooperating with foreign courts or foreign representatives.

Detailing this range of provisions, the Chief Justice said that many countries had also recognised from as far back as the 1990s that “there should be at least the minimal legislative underpinnings … to clarify and ensure the judges’ jurisdiction to provide cross-border cooperation.” He detailed for attendees the relevant provisions in the Cayman Islands Companies Law.

In addition, the Chief Justice pointed to the common law position: “… the common law power is alive and well and is available to be called upon in many circumstances.” This includes the power “to recognise the proper choice or change of forum, as well as, in the appropriate case, to disapprove or disallow improper forum shopping.”

The colloquium at which the Chief Justice spoke was jointly sponsored by INSOL International, UNCITRAL (The UN Commission on International Trade Law) and the World Bank. This was the fifth time the World Bank had joined with INSOL International and UNCITRAL,
which have jointly sponsored these colloquia since 1995.

INSOL is a world-wide federation of national associations for judges, accountants, lawyers and other insolvency professionals who specialize in corporate turnaround and insolvency, and is a global accrediting body for insolvency professionals. Supporting INSOL’s work is the Group of Thirty-Six, “some of the most prominent and influential firms within the insolvency and turnaround profession,” noted organisers, adding: “The aim of the Group of Thirty-Six is to work with INSOL to develop best practice guidelines to enhance the ability of practitioners globally to save businesses throughout the world.”

A Paper presented to the INSOL Judicial Colloquium, at San Francisco, 21-22 March 2015 (Abridged)

By Hon. Anthony Smellie, Chief Justice, The Cayman Islands.

To view and download the whole Paper go to: https://www.judicial.ky/wp-content/uploads/publications/speeches/2015-04-21-ChiefJusticesPresentationatSanFranciscoINSOLJudicialColloquium.pdf

THE ELEVENTH INSOL/UNCITRAL/ WORLD BANK JUDICIAL COLLOQUIUM SAN FRANCISCO, MARCH 2015.

FORUM SHOPPING IS BAD; CHOICE OF FORUM IS GOOD?
– THE INVESTMENT FUND PERSPECTIVE –

When the captioned question is asked in relation to imminent insolvency proceedings, we see from the research of Irit Mevorach1, that one could posit the answer: “…it depends on what are the motives or objectives of those who seek to change the forum of the insolvent or troubled entity”.

If their objective is to benefit from advantages which a different legal regime would offer for the restructuring of the entity to preserve value for shareholders, or as in the case of the United States Chapter 11 debtor-in-possession regime, to get “breathing space” for re-financing; then a change of forum or “forum shopping” may be both necessary and permissible. So also, if the objective is to maximize returns for investors or creditors because a different legal regime has more modern provisions for schemes of arrangement and compromise.

However, as the antithesis, forum shopping will be deemed unacceptable where the objective is fraudulent or abusive, including where the objective is to “steal a march” on other creditors or investors by obtaining an undue preference over assets of the insolvent entity.

All such objectives, whether good or bad, will however be informed by the nature of the business of the entity involved. Although this is axiomatic, examples which come readily to mind can be illustrative.

In the European Union context, there are a number of reported examples of relocations to the UK on the brink of insolvency from elsewhere within the European Union, apparently because of the attractiveness of the UK‟s voluntary arrangement procedures and pre-pack administrations for the restructuring of failing enterprises.

I am asked to address a gathering of fellow insolvency judges on this subject, it being understood, of course, that my perspective is that of a Cayman Islands judge, informed by the kind of insolvency or restructuring business coming before the Cayman court.

These days, a company carrying on international business from within the Islands would typically be one of four kinds:

1. a holding company having subsidiaries in other places such as the BVI, owning and carrying on enterprises of different kinds in still other places, such as the PRC or Latin America;

2. an SPV set up for the purposes of a joint venture or to hold assets such as aircrafts or ships or to conduct business as a captive insurer;

3. an asset holding company underlying a large family discretionary settlement; or

4. a hedge fund company serving as the corporate vehicle for a feeder or master fund structure and whose assets are invested in markets around the world;

There are of course, other kinds or categories of companies to be identified by reference to their use but for present purposes, these four broad categories will serve as a fair summary of the use of Cayman companies.

Of these four categories of companies I will discuss the fourth in particular – that which has involved the most significant body of insolvency litigation – the hedge fund or investment fund company. There are some 10,000 investment fund companies registered in the Cayman Islands. They hold something in the order of 70% of all assets invested worldwide in hedge funds. They are established in Cayman as the choice of forum for a number of good reasons. These include the availability of competent legal, accounting and other professional services; direct access to capital markets through the banks and other financial houses located in Cayman; the well- established, predictable and independent legal and judicial systems based on British Law; and of course, the absence of corporate profit or capital gains taxes.

Despite such well known and acceptable reasons for choice of forum, there have been cases in which hedge fund liquidators appointed by the Cayman courts have been refused recognition in the United States by the strict – some would say too strict – application of the COMI principles4, such that the rights and expectations of investors are not consistently addressed by the grant of recognition under the United States Bankruptcy Code (“USBC”); and despite Chapter 15‟s lineage from the UNCITRAL Model Law (“the Model Law”).

Article 17 of the Model Law is designed to enable the courts of different countries to render assistance to each other, even while addressing the problems presented by improper forum shopping and by the conflict of laws challenges posed by choice and change of forum. Towards those ends, for the purposes of granting recognition to a foreign proceeding as a “main” or “non- main” proceeding, the determination of the center of main interest (“COMI”) or the requirement of an “establishment” in the foreign jurisdiction in which the debtor is the subject of the proceedings, is of the essence of the Model Law.

The objective of this paper is not to argue other than that the Model Law provides a rational basis and practicable basis for the grant of recognition.

However, in the case of an investment or hedge fund company, too strict an application of the “COMI” or the “establishment” test can operate to deny recognition and assistance to foreign representatives on entirely artificial bases and such that the interests of those who are entitled upon insolvency can be unfairly hampered or even denied.

As originally drafted, it must be doubtful that the Model Law was intended to be applied as a strict code so as to deny recognition in cases where the application of comity would have readily resulted in the grant of recognition. As the Guide to the Enactment of the Model Law explains, the purpose of Article 17 is to indicate that, if recognition is not contrary to the public policy of
the enacting State and if the application meets the requirements set out in the article, recognition will be granted as a matter of course (emphasis added). This philosophy of the Model Law is hardly consistent with an overly strict view of the requirements either of the “COMI” or the “establishment” test of Article 175.

A central theme of my discussion will be to examine the concerns which arise for the liquidation of investment/hedge fund companies and of course, for their investors; where an overly strict application of the COMI test operates to deny recognition to a foreign liquidation of such a company.

I begin with the well-known Bear Stearns case. Certain Bear Stearns funds were established using Cayman Islands companies as a master/feeder hedge fund structure. Investors from around the world were invited to invest on the basis, apparent from the Funds‟ constitutional documents, that the Funds were domiciled in the Cayman Islands and so that Cayman Law would govern them. Having been hugely successful in attracting investors, the funds became over-exposed to collateralized mortgage debt and collapsed with the rest of that market during the 2008 financial crisis. There were allegations of fraud and breach of fiduciary duties against the promoters and investment managers of the Funds. They had carried on the management and control of the assets, not from within the Cayman Islands but from New York; where the real base of operations was maintained and the bulk of the records were kept.

But not everything was done from New York. In addition to the registered offices of the Fund companies being in Cayman as their place of incorporation, certain directorship services, certain basic administrative services and the annual audits were conducted form Cayman and by the time of the liquidation, significant amounts of assets had been relocated to Cayman. Requests from investors for redemption of their shares were, as with the typical Cayman fund, submitted to the Cayman based administration but most important of all though, as one might think, the Funds had been placed in liquidation and were under the supervision of the Cayman court as the court of their place of incorporation.

It may be regarded as surprising given those circumstances, and when viewed from the point of view of private international law as now embodied in the principle of “modified universalism”6, that the New York bankruptcy Court refused to grant not only recognition of main proceedings, but also of its own motion7, refused to find that the Funds had an “establishment” in the Cayman Islands and so refused also to grant the Cayman liquidation proceedings recognition as foreign non-main proceedings.

In coming to its decision, the New York Court reversed the presumption in section 1516 Company of Chapter 15 [reflecting Articles 2 and 17 of the Model Law] that the debtor’s registered office is its center of main interests. The Court declared, as a matter of American Law, that the presumption should be applied only in cases where there is no serious controversy (especially in order to permit and encourage fast action in clear cases) and that the burden of proof was upon the foreign representative, in controversial cases, to demonstrate COMI or to show that there was an establishment. As expressed in the judgment of the Court, even if raised from no other source, that “controversy” could be raised by the Court itself.

Having thus raised its own concerns, the Court held that principles of comity as hitherto understood, had been replaced by the concept of “recognition” as required by Chapter 15 and that recognition had to be distinguished from relief, although the latter could not be obtained without the former. Further, that it is at the stage of considering whether and if so, what kind of relief should be given, that comity would guide the exercise of judicial discretion.

In arriving at its decision, the New York District Court also discussed the European case in Re Eurofood IFSC Ltd 2006 E.C.R. 1-3813 and the English case in Re Daisytek-Isa Ltd [2003] All E.R. (d) 312; and concluded that both those cases were consistent with its analysis and application of the COMI test as one requiring the Court itself to be satisfied that the test is met even in the absence of any partisan objection.

This analysis presents stark difficulties for investment fund companies which conduct their different functions in different places. The difficulty with the overly-strict application of the COMI test is that it does not reflect the objectives for which investment funds are properly established and operated and the fact that their liquidators applying for recognition from a place not readily regarded as their COMI will not necessarily involve improper forum shopping. In order to maximize returns as one of the benefits obtained from being established in a jurisdiction like the Cayman Islands,investment funds are established in the Cayman Islands as a matter of choice of forum for the advantages only briefly mentioned in passing above. The choice of forum is important to the investors‟ decision to invest and reflects their expectation that Cayman law will apply to the liquidation of their investments if things go wrong.

In order to achieve these objectives, it is often neither necessary nor desirable that the Funds should have to establish a center of main interest in the traditional sense defined in Chapter 15 or the Model Law, within the Cayman Islands. What is necessary is that the transactional documents, like the Fund itself, are compliant with and governed by Cayman Law and that investments and returns to investors are properly booked as rendered in Cayman in keeping with its laws. Hence, for instance, the requirement that the Funds must be audited by the established
accounting firms in keeping with generally accepted accounting standards, within the Islands. To the extent the books and records are not all kept or available within the Islands, what this requires in practice is that the auditors must be given access to them wherever they may be.

And there is no lack of transparency in any of this. Not only are there well-established tax information exchange agreements (“TIEAs”) with all the major jurisdictions in which the Funds operate or invest, but when returns are maximized due to the absence of corporate and capital gains tax and dividends paid to investors, their obligation to declare and pay taxes which are due in their countries of domicile are in no way diminished.

These are obligations moreover, which the TIEAs will help to enforce. But all that aside, what is crucial for the success of the Funds, is that they are regarded internationally by all the markets in which they operate, as domiciled in and so as being able to acquire the benefits of investing through the Cayman Islands.

For these purposes, Cayman hedge funds are also fully and transparently regulated. They are required, at minimum, to maintain registered offices and certain functions must be undertaken here, such as legal, audit (already mentioned) and directorship services. This regulatory presence allows the funds to maximize other economies of scale available by the carrying out of the more substantial operations of management, and investment of assets from offices in the larger onshore financial centers, like London and New York. But there can be no denying the fact that they must maintain a real presence in the Cayman as described above, far more substantial than the mere “letterbox” presence of yore.

Such was the situation with the Bear Stearns funds, as indeed was the situation with other Cayman Islands funds which were placed in liquidation by the Cayman court as a consequence of the global collapse of the markets in 20089.

Despite the fact that the Bear Stearns Funds carried out the regulatory activities required as well as the economic activities discussed above, the liquidators were denied both main and non-main recognition by the S.DN.Y Bankruptcy Court10.

An obvious and reasonable, albeit rhetorical, question arises by way of response to this denial of recognition of the Cayman liquidation: why does the physical location overseas of most of an investment Fund‟s assets and management activities suffice to outweigh the presumption in the Model Law11, that the Fund‟s COMI (and thus its establishment as well), are at the place of registration where no less important and necessary economic and regulatory activities, essential to its business as an investment fund, are carried out?

Fortunately, the case law has progressed in the United States as I will come to discuss below, and recent pronouncements of the United Kingdom Privy Council
(“ UKPC”), are also helpful on the point.

The presumption in favour of the place of incorporation as the forum for the liquidation of an investment fund was authoritatively affirmed by the UKPC in its judgment in the Shell Pension Fund case (above) in its rejection of Shell‟s blatant attempt at improper forum shopping declaring that [43]:

“There appears to the Board to be nothing to suggest that allowing Shell an advantage over other comparable claimants would be consistent with the ends of justice. Nor, in the circumstances, should Shell find this surprising. It invested in a company incorporated it the British Virgin Islands and must, as a reasonable investor, have expected that, if that company became insolvent, it would be wound up under the law of that jurisdiction.”

Contrary to that plainly correct dictum, an overly strict application not only of the COMI but also of the “establishment” tests, will likely result in investors having to petition the courts, not only at the place of incorporation but also at the place or places where the assets are located, for commencement of insolvency proceedings and so for the appointment of multiple trustees or liquidators – the very outcome that the Model Law and the principles of universalism are themselves aimed at preventing.

In the case of an insolvent hedge fund, a more flexible and pragmatic application certainly of the “establishment” test should be taken – the approach eventually taken, for instance, in the SPhinX case. There the S.D.N.Y. Bankruptcy Court opined that the granting of non-main proceedings was a “better choice”, emphasizing the importance of flexibility and concluding that recognition of non-main proceedings was a “pragmatic resolution”.

And for these purposes, investors can note with a sense of optimism, the reasonable and pragmatic approach more recently taken by the New York Courts, to the grant of recognition as foreign main proceedings to the liquidation of the Madoff related Fairfield Sentry Liquidation in the BVI, on the basis, inter alia, that post-liquidation, the COMI of that fund had been established in the BVI by the liquidators establishment of an office there and by the collection of assets there.

But to return to my basic proposition, demonstration of the existence of a “non-main proceeding” should require proof of a lesser connection, namely that the debtor has an “establishment” within the State where the foreign proceeding is taking place. The term “establishment” is defined as “any place of operations where the debtor carries out a non-transitory economic activity with human means and goods or services”. There is a legal issue whether the term “non-transitory” refers to the duration of a relevant economic activity or to the specific location at which the activity or to the specific location at which the activity, is carried on. But whichever of those two views is taken, emphasis should be laid on the fact that the non-transitory economic activity does not have to be carried out by “employees” at a place of operation owned or occupied exclusively by the debtor; it should suffice that the activity is carried out by agents or professional service providers at premises owned or occupied by them.

On that view, there should be no doubt that the typical Cayman investment fund incorporated in and having a registered office in the Cayman Islands, with independent directors, legal advisors, administrators and auditors, maintain at least an “establishment” within the Cayman Islands.

Conclusion

The foregoing discussion of the cases reveals an encouraging move by Courts internationally towards acceptance of the principle of (modified) universalism in bankruptcy or insolvency proceedings. This is evident notwithstanding the sometimes overly-strict application of the COMI or “establishment” test and notwithstanding the revision of the Model Law in July 2013 to set the date for the identification of COMI or proof of an “establishment”, at the date of commencement of the foreign proceeding and not after. This would preclude reliance on a COMI which was changed or the setting up of an establishment, post-liquidation. But this revision to the Model Law is yet to be adopted in many States that follow the Model Law, notably among them, the U.S.A. As we have seen from Fairfield Sentry (above); where COMI was deemed to have developed post-liquidation, the revised Model Law approach would be contrary to the pragmatic approach taken by the bankruptcy court S.D.N.Y, in circumstances which will be very similar to those in which the liquidation proceedings of many investment funds will need to seek recognition abroad.

And, despite what may be regarded as the Privy Council’s policy driven limitation upon the common law power to render assistance, we see from the Singularis decision, that the common law power is alive and well and is available to be called upon in many circumstances. Thus, the cases illustrate that the power exists to recognise the proper choice or change of forum as well as, in the appropriate case, to disapprove or disallow improper forum shopping.

EDITOR: iNews Cayman has only republished 14 of the 28 pages of this Paper.