FIA Leveraged Fund: The Cayman Court Takes a Strict ... - Appleby

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unable to make payment by the final agreed extension of 15 December 2011. The Plans thereforepresented the winding-up petition at the end of January 2012, alleging that no payment had been made tothem in satisfaction of their outstanding redemption requests. The petitioners also alleged that it was justand equitable that the Fund should be wound up for reasons which it was not necessary for the Court ofAppeal to consider and which will not be considered further here.In defence of the petition the Fund contended that it had in fact paid the amounts due to the Plans by wayof distributions in kind, comprising, first, the promissory notes and assignments, and secondly, the issueon 13 February 2012 (some two weeks after the presentation of the petition) to the Plans of shares in anew special purpose vehicle (“SPV”), which held investments formerly held by affiliates of the Master Fundand which had been created for the purpose of acting as a vehicle to facilitate a distribution in kind to thePlans. The mechanics of the transaction by which the redemptions in kind were purportedly made were setout by the director of the Fund in his evidence opposing the petition. As he explained, the Master Fund didnot in fact make direct investments itself but invested in other funds in the same Fletcher group of funds,which then invested in other funds in that group, and these affiliates had contributed assets which theyheld to the SPV in order to ensure that the assets held by the SPV were sufficient to satisfy the balanceowed to the Plans by the Fund. The relevant resolutions of the Master Fund and the Fund were producedin evidence and showed the chain of decisions pursuant to which the directors of the funds transferredcertain underlying assets of one fund in the Fletcher group into the SPV, ascribed a value to those assets,and a resolution of the Fund that the transfer of shares was to effected to satisfy in kind 90.15% of thevalue of the petitioners’ redemption requests.The assets transferred to the SPV, the shares of which were issued to the Plans, were examined duringthe trial of the petition. They comprised a right – acquired by one of the Fletcher group funds – to investUS$65 million in the series C convertible preference shares of a publicly traded US bank (“UCBI”). Theright to invest carried with it a potential perpetual right to income which might be called by UCBI 5 yearsfrom the date of the investment which, if called, would be converted to a right to common stock and afurther US$35m of warrants in the common stock in UCBI. However, in the period since the right wasacquired UCBI had announced a reverse stock split under which each 5 preferred shares in UCBI would becancelled and replaced with one share. That led to uncertainty as to just what the right comprised anduncertainty as to its value, although the directors of the Fund had adopted the higher of the possiblevalues when valuing the asset for the purposes of the transaction.The JudgmentThere were two questions for the Court of Appeal to decide on the appeal. The first was whether the Fundwas entitled to make a distribution of the shares in the SPV to the Plans in order to redeem the Plans’investments in kind. If the answer to the first question was yes, the second question was whether thedirectors had properly exercised their discretion in adopting the higher valuation of the asset held by theSPV when valuing the SPV for the purposes of the redemption.In relation to the first question, the Court of Appeal held that the answer to it depended on theconstruction of the investment agreement (comprised by the articles of association of the Fund and therelevant offering documents) between the Fund and its investors. The Court noted that clause 11F of thearticles of association provided that:“Subject to the next paragraph of this article, amounts due on redemption for participating sharesredeemed will be sent … as follows: At least 90% of the amount estimated by the directors to bedue on redemption shall be paid by the company generally within 35 days of the date that theshares were redeemed and the remaining amount shall be paid when the company has finallydetermined the redemption price for the participating share. If the initial payment made by thecompany exceeds the finally determined redemption amount, that holder shall repay to thecompany on demand the amount of any such excess.
With respect to series N shares, the company will pay at least 90% of the redeemed amounts incash or in kind without interest within 15 days of the date that the shares were redeemed and thecompany, subject to the discretion of the directors, will retain up to 10% of such redemption untilno later than 30 days after the completion of the audit of the financial statements relating to thefiscal year of the company in which the redemption occurred.”This was supplemented by a clause in the offering documents which stated:“An investment in the fund provides limited liquidity since the shares are not freely transferableand investors generally may redeem their shares only at the end of a calendar week. There can beno [assurance] that the fund will have sufficient cash to satisfy redemption requests or that it willbe open to liquidate investments at the time of such redemption request at favourable prices.Under the foregoing circumstances and under other circumstances deemed appropriate by theboard of directors, investors may receive in kind distributions from the fund's portfolio. Suchinvestments so distributed will not be readily marketable or saleable and may have to be held bysuch investors for an indefinite period of time. As a result, the investment is suitable only forsophisticated investors.”By reference to these provisions, and provisions in the offering documents which contained provisions thatwere nearly identical to the second part of clause 11F quoted above, the Court of Appeal held that “theintention is that, if an investor seeks to redeem at a time when the Fund is illiquid, his request can besatisfied by transferring to him an asset which is held in the Fund and is available for distribution.” As at15 September 2011, that being the date on which the Plans were entitled to be paid (that date being 15days after the right to be paid out crystallized) the assets which were distributed to the Plans were notassets belonging to the Fund; in fact they did not exist at all because the SPV had not been incorporatedas at that date.Having decided that the distribution in kind was not a valid distribution under the terms of the investmentagreement, it followed that the Plans were creditors of the Fund which had not been paid and that theGrand Court was right to have ordered the winding up of the Fund.In light of that, it was not strictly necessary for the Court of Appeal to decide the second question, but itwent on to consider the point in the event that its answer to the first question was incorrect. The secondquestion was whether the directors had properly exercised their discretion to ascribe the value which theyhad to the asset transferred to the SPV. As mentioned above, there was uncertainty about what the rightentitled the holder to receive, which lead to two widely different valuations, the higher of which thedirectors had adopted for the purposes of the redemption in kind.The Court of Appeal held, first, that there was no evidence that the directors of the Fund actually appliedtheir minds to the question of value as at the time the transfer of the asset to the SPV was effected. Thedirectors simply adopted an internal valuation which had been arrived at by parties within the Fletcherfunds group. Secondly, the only formal valuation that was before the Court was dated two weeks followingthe purported in kind distribution. Thirdly, there was a subsequent report that showed the very greatvariance in the value of the asset, depending on the view one took of the UCBI reverse share split, but noevidence that the directors had taken that issue into account when arriving at their valuation, such thattheir exercise of discretion could not be said to have been rational. And fourthly, it was no answer for thedirectors to say, in relation to the third issue, that they had a complete discretion in ascribing the valuewhich they did to the asset – in this context the Court of Appeal applied the English Court of Appeal’sdecision in Zuckerman International Bank v Standard Bank (London) Limited (2008), in which it had beenheld that “a decision maker’s discretion in circumstances of this nature is limited as a matter of necessaryimplication by concepts of honesty, good faith and genuineness and a need for the absence ofarbitrariness, capriciousness, perversity and irrationality”.
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FIA Leveraged Fund: The Cayman Court Takes a Strict ... - Appleby

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