From Mourant Ozannes

Private equity funds are set to benefit from updates to the Cayman Islands Exempted Limited Partnership Law (the ELP Law). The Cayman Islands has once again shown itself to be an innovative and responsive jurisdiction in terms of providing user-friendly and practical legislation. This will come as a welcome relief to an industry post-global financial crisis otherwise suffering from a severe case of “regulatory fatigue”.

Background

The Cayman Islands has for some time been the jurisdiction of choice for fund managers looking to establish their private equity funds offshore. The combination of a tax neutral environment for fundraising, practical laws and sophisticated service providers have led to Cayman’s popularity as a domicile for private equity funds. In addition, exempted limited partnerships (ELPs) in Cayman complement onshore fund structures and particularly those in the US due to the symmetry of the ELP Law with the corresponding Delaware statutory regime.

Legislators in Cayman are keen to ensure that the structuring opportunities available in Cayman are, at all times, considered both world class and user-friendly. They have, in concert with the private sector, been seeking industry feedback to this effect.

Recent changes to the ELP Law enacted by the Cayman Islands Government on 2 July 2014 are set to make the ELP Law even better. Set out below are some of the ways that private equity funds will benefit from these updates.

Easier for investors

Investors in private equity funds structured as limited partnerships, wherever in the world those limited partnerships are domiciled, share a common concern that the actions permitted by, or the rights granted under, the limited partnership agreement (LPA) governing the fund might jeopardise their right to enjoy limited liability in respect of their investment in the partnership. In particular, limited partners are keen to ensure that the participation by such limited partner or their representative on an advisory board or other committee of the partnership will not give rise to liability concerns for such limited partner (or, indeed, their representative).

In addition, limited partners are often keen to understand the extent to which they owe a duty (if at all) to their fellow limited partners, the general partner or the partnership as a whole.

The changes to the ELP Law clarify that in respect of an ELP:

• serving on such boards or committees by such limited partner or their representative will be a “safe harbour” such that it shall not constitute taking part in the conduct of the business of the partnership (so as to make the limited partner liable as if they were a general partner);
• a limited partner’s representative on any board or committee of the partnership (i) will be entitled to rely on the provisions of the LPA governing such committee (where previously they could not since they are not typically party to the LPA) and (ii) subject to the express provisions of the LPA, owes no fiduciary duty to the partnership or any partner; and
• subject to any contrary provisions of the LPA, a limited partner (acting in that capacity) owes no fiduciary duty to the partnership or any partner.

Easier for managers

Various changes to the ELP Law have simplified matters for the general partner of an ELP, from the outset as the fund holds its first closing, throughout the life of the fund and on to the winding up of the fund.

Previously, third parties who were not party to the LPA (and reluctant to sign up to it for fear that they may be deemed to be a partner), whether a private equity firm’s investment principals or the private equity firm itself, had to find some way to rely on the rights granted to them under the LPA (for example, the indemnification provisions). Solutions either involved some form of back-to-back indemnity arrangement or the general partner holding the benefit of those provisions on trust for such third parties. The changes to the ELP Law clarify that third parties may sign up to the LPA to benefit from certain rights or to assume certain obligations without being deemed to be partners.

The ability of a general partner to obtain financing in respect of a private equity fund has been assisted by the addition of provisions to the ELP Law which clarify that a floating charge (previously considered to be the preserve of bodies corporate) may be granted over the assets of the ELP. In addition, where there was previously uncertainty as to whether the right to call capital was an asset of the general partner or the ELP, the new ELP Law clarifies that this is an asset of the ELP.

General partners have historically had to find ways to accommodate the desire of certain limited partners to keep their investment in the private equity fund confidential (for example, family offices with legitimate security concerns or sovereign wealth funds linked to royal families desiring to keep their investment programmes confidential). Whilst previously the register of limited partnership interests, including the name, address, amount and date of any contribution of each limited partner, was open to inspection by all limited partners (and anyone else with the general partner’s consent), the new ELP Law provides flexibility for general partners to respect the privacy of their investors such that details of limited partner contributions and, if provided by the LPA, details of the names and addresses of limited partners will be subject to inspection, even by other investors, only with the general partner’s consent.

Dealing with default now easier

Default provisions in private equity fund LPAs, which sometimes contemplate forfeiture of some or all of a defaulting investor’s interest, have been subject to a degree of scrutiny (or at very least uncertainty) as to whether such provisions could constitute unenforceable “penalty clauses”.

This is because Cayman Islands law imports the English law treatment of “penalty clauses”. This analysis dictates that contractual remedies for breach must represent a genuine pre-estimate of likely loss.

As corresponding default provisions of this kind are invariably found in offshore and onshore LPAs and are market standard, the revised ELP Law provides clarity that such provisions will not be unenforceable solely because they are penal in nature.

Structuring made easier

Additional changes have been made to the ELP Law in order to provide additional flexibility in structuring private equity funds (which frequently (i) have multiple international investors each with different tax and regulatory considerations, (ii) invest in multiple jurisdictions, often in cross-border transactions, and (iii) have carried interest and management fees paid to multiple recipients, themselves in a variety of jurisdictions).

The old ELP Law required at least one general partner to be a Cayman company, a foreign company registered in Cayman, an ELP, or a Cayman resident individual. Where a foreign limited partnership was considered necessary as a general partner of a private equity fund structure, since it could not act as the sole general partner because of this requirement, two general partners were necessary: one Cayman general partner and the foreign limited partnership acting alongside the Cayman general partner.

Under the new ELP Law, further choice has been added to structuring discussions by allowing the registration of a foreign limited partnership (similar to the existing Companies Law regime that allows registration of a foreign company) to act as general partner of a Cayman ELP. Regulations are expected to prescribe exactly which jurisdictions’ limited partnership regimes will qualify, but it is expected that limited partnerships in the likes of Delaware, Jersey, Guernsey, BVI, Scotland and England will be able to be registered to act as a general partner of an ELP in Cayman.

Parallel funds, co-invest vehicles and side car funds made easier

Complications have often arisen when the arrangements between the partners of an ELP are considered alongside the sometimes competing or conflicting arrangements between other limited partnerships which, together, constitute a private equity fund structure. These issues most commonly arise where a number of parallel fund vehicles are established for different classes of investor or investment or where a co-investment or side car vehicle is set up for investors to co-invest alongside the main fund.

In particular, two complications arise where (i) a general partner needs to consider the interests of a number of ELPs and not just one ELP (particularly where it is general partner of more than one ELP in a structure), and (ii) where investor votes or consents are to be sought across a fund platform as a whole and not on a per-ELP basis.

In relation to the duties of a general partner, the old ELP Law imposed a duty upon a general partner to act “at all times in good faith in the interests of the exempted limited partnership”. Under the new ELP Law, the duty has been modified so that the second limb (“in the interests of the exempted limited partnership”) may be varied and will be subject to “any express provisions of the partnership agreement to the contrary”. So, for example, a general partner acting in such capacity in respect of more than one limited partnership may now take the interests of another limited partnership or the fund structure as a whole into consideration when exercising its duties in respect of any one ELP if so provided in the LPA. Such provisions of the LPA need not specifically refer to the relevant provision of the ELP Law but will nonetheless modify the duty to act in the interests of the ELP. This change brings the Cayman ELP regime more in line with the Delaware Revised Uniform Limited Partnership Act pursuant to which a general partner’s fiduciary duties may be reduced or restricted where the intention to do so is explicitly stated in the LPA.

The ELP Law definition of “majority of partners” has been given flexibility such that now the votes of non-partners (such as investors in a parallel vehicle) may be included in the calculation of a vote if so desired.

Conclusion

In addition to the changes outlined above, there are numerous other changes to the ELP Law, each designed as with those changes set out above, to make the establishment, ongoing operation and final winding up of an ELP easier, clearer, more accommodating and less complicated for those involved in the process, whether investors, managers or service providers.

Such additional improvements include:

• simplification of the formalities surrounding execution of documents upon a first or subsequent closing of a private equity fund;
• the introduction of foreign script names (allowing a dual name for an ELP not using the Roman alphabet which may be of particular interest to Russian or Chinese managers or investors);
• simplified mechanisms in relation to partnership transfers and winding up;
• a simple abbreviated strike off procedure equivalent to that which already exists

for Cayman Islands companies whereby a formal liquidation can be avoided;

• the ability to deregister an ELP with a view to migrating it to another jurisdiction; and
• the preservation of limited liability of the limited partners in the event of an ELP ceasing to have a qualifying general partner.

Should you have any questions in relation to any of these changes, please speak with your usual contact at Mourant Ozannes.

Contacts:

Simon Thomas, Senior Associate, Cayman Islands

+1 345 814 9202 [email protected]

Alex Last, Partner, Hong Kong

+852 3995 5703 [email protected]

Hayden Isbister, Partner, Cayman Islands

+1 345 814 9125 [email protected]

James Wauchope, Partner, Cayman Islands

+1 345 814 9117 [email protected]

Julian Fletcher, Partner, Cayman Islands

+1 345 814 9122 [email protected]

Neal Lomax, Partner, Cayman Islands

+1 345 814 9131 [email protected]

Robert Duggan, Partner, London

+44 20 7796 7622 [email protected]

This briefing is only intended to give a summary and general overview of the subject matter. It is not intended to be comprehensive and does not constitute, and should not be taken to be, legal advice. If you would like legal advice or further information on any issue raised by this briefing, please contact one of your usual Mourant Ozannes contacts.

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