Introduction
The Cayman Islands Segregated Portfolio Company ("SPC"), a justifiably popular vehicle since its introduction in 1998, continues to be a catalyst of judicial guidance, with cases now necessitating the input of the Islands' appellate courts.
In very simplistic terms, an SPC is a limited company which by statute has the ability to "contain" segregated portfolios in which the shareholders, assets and liabilities are separate and distinct from each other. The SPC can also hold general assets and liabilities which are not attributable to any of its segregated portfolios. It can be appreciated that insolvency issues could occur at SPC level or in one or more segregated portfolios.
Whilst it is possible for liquidators and, per the relatively recent decision in Re Holt Fund SPC (Unreported, 26 January 2024, FSD 0309 of 2023 (IKJ)), restructuring officers to be appointed over insolvent SPCs, it is not possible to seek the appointment of liquidators over individual insolvent segregated portfolios.
Which leaves creditors with section 224 of the Companies Act (2023 Revision) (the "Act"), which provides that only receivers, who have similar powers to those a liquidator has, may be appointed over individual insolvent segregated portfolios.
Summary
In June 2024, the Court of Appeal of the Cayman Islands published its judgment in CMB International Securities Limited v Oakwise Value Fund SPC (Unreported, 13 June 2024, CICA (Civil) Appeal No. 0009 of 2023) (per Field JA, with whom Moses JA and Goldring (President) agreed) ("Oakwise"). It provides helpful guidance on several aspects of applications for the appointment of receivers over insolvent segregated portfolios, but particularly in the following regards:
- It settles the position that the cash-flow test to establish the insolvency of companies governed by Part V of the Act (i.e. is the company in question able to satisfy its debts as they fall due?) does not apply to segregated portfolios.
- It clarifies what is meant by "flexible" in the expression "flexible balance sheet test", which has been applied to determine solvency of segregated portfolios, and explains why flexibility is needed in the particular case of Cayman Islands segregated portfolios.
- It emphasizes the fact that, even if insolvency were established on the "flexible balance sheet test", a petitioner seeking appointment of receivers is still far from the finish line, given that it must also:
‒ satisfy the court that the statutory purposes of the receivership (detailed further below) will be achieved; and
‒ persuade the court that there is no reason for it to exercise residual discretion and refuse to appoint receivers.
How "flexible"?
A petitioning creditor is tasked with demonstrating that the assets attributable to a segregated portfolio are, or are likely to be, insufficient to discharge the claims of creditors in respect of that segregated portfolio; the test must be satisfied on the balance of probabilities (i.e. more likely than not).
The Court of Appeal, referring to:
- the type of assets which are commonly held on behalf of Cayman Islands segregated portfolios; and
- the uneven playing field encountered by a creditor (a redeemed shareholder in Oakwise) when having to analyse the accuracy of values attributed by companies to assets on their balance sheets;
supported the views expressed by Parker J in Re Obelisk Global Fund SPC (Unreported, 12 August 2021, FSD 87 of 2021 (RPJ)) and by Kawaley J in Re Green Asia Restructure SPC (Unreported, 3 August 2022, FSD 112 and 113 of 2022 (IKJ)), that a simple balance sheet test, entailing "a simple assessment of the relative sides of a balance sheet", would not be sufficient.
Rather, the court should apply a test which:
"involves determining on the available evidence, applying the civil standard of proof, whether the assets, taking into account the actual, contingent and prospective liabilities, are now or are likely to be insufficient in the reasonably near future [an expression which may prove to be a fertile ground for dispute] to pay the claims of creditors".
The Court of Appeal, in recognition of the potential disadvantage creditors might face when presented with asset values promulgated by companies intent on resisting petitions, added that when assessing these values, the court "should carefully examine what the evidence reveals as to how the value of the assets has been arrived at" and that:
"where the assets are financial instruments, the Court should be concerned to be shown the auditors' notes [in the audited financial statements] … and those sections of the SPC's Articles and Private Placement Memorandums dealing with how the instruments are valued in the financial statements and for NAV purposes".
Indeed, in Oakwise, it was upon the Court of Appeal's scrutiny of the unaudited financial statements that it found that there were "substantial grounds" for doubting the values therein.
Statutory purposes
The Court of Appeal also clarified that the requirement to demonstrate that the appointment of receivers would lead to the orderly closing down of the business of, or attributable to, the segregated portfolio (being one of the statutory purposes, the other being "the distribution of the segregated portfolio assets attributable to the segregated portfolio to those entitled to have recourse thereto") was a criterion distinct from, and preferable to, the test the Judge in the court below applied, which was whether "the closing down of the business under receivers would not … be in the best interests of the investors/creditors".
A matter of discretion
As noted above, even after jumping through the dual hoops of the flexible balance sheet test and satisfying the court that the statutory purposes would be achieved by the receivership, the petitioner must still ensure that the court exercises its discretion in favour of the appointment.
In Oakwise, the Court of Appeal explained that this would entail the judge having regard:
"to all relevant considerations including the superiority of the interests of creditors owed undisputed debts over the interests of participating shareholders which will invariably be subordinate to those of the creditors".
Conclusion
The Court of Appeal's decision will give comfort to SPCs looking to stave off the threat of having receivers appointed over their allegedly insolvent portfolios, because it affirms the application of the flexible balance sheet test, meaning that creditors with undisputed, unpaid debts are not entitled to an order for receivership of a segregated portfolio as of right, as they would be so entitled to an order for liquidation of any other type of company, but need to provide substantive information on assets and liabilities of the segregated portfolio and to show the statutory purposes would be achieved.
The flipside of the coin is that SPCs will have to keep in mind that the court is going to adopt an investigatory approach to the evidence of the SPC submitted in support of the contention that the segregated portfolio is, or is likely to be, balance sheet solvent. Those SPCs would do well to ensure that the values attributed to assets in particular are capable of withstanding such judicial scrutiny.
If you find yourself wrestling with the issue of whether a Cayman segregated portfolio is insolvent, please do not hesitate to ask us for help with that analysis.
