Cayman Islands: Weavering - Cayman Islands Clawbacks And Investor Certainty

Last Updated: 12 August 2019
Article by Aristos Galatopoulos, James Eldridge and Nick Herrod

The Privy Council upheld the decisions of the lower courts that redemption payments to a Swedish bank made shortly prior to the collapse of the Weavering fund were voidable preferences that must be repaid. In doing so, the Privy Council has revisited the question of whether a fund's net asset value ("NAV") calculated in accordance with the fund's constitutional documents can be revised – holding that, in certain limited circumstances, it can. On the whole, though, any erosion to investor certainty will likely be around the margins. This is because it will only be possible to challenge NAV in circumstances where the fund itself has perpetrated a fraud (internal fraud), as opposed to having had a fraud perpetrated on it (external fraud, for example, in the case of the various Madoff feeder funds). Further, there is no automatic adjustment; legal proceedings must be brought to rectify the NAV.

The decision also stands as a reminder to custodians and nominees of claw-back risk.  The defendant, SEB, was held to be liable to return the payments, notwithstanding they were a bare trustee and they had paid the redemption proceeds many years ago to their own customers.

Background

The facts are now notorious. A Cayman Islands investment fund (Weavering) defrauded its investors by painting a picture of positive growth using worthless swaps with an affiliated company. This caused NAV to be calculated on fictitious unrealised gains from the swaps. The reality was that Weavering was making huge losses through options trading. The bogus swaps masked the losses. The guiding mind of the fund, and architect of the fraud, was Magnus Peterson (the UK based investment manager) whom the courts also found to be a de-facto director of Weavering. This was therefore internal fraud.

Swedish Bank, SEB, who was acting as custodian investor for third parties, redeemed its shares shortly before the fraud was uncovered and received redemption proceeds based on what turned out to be a fictitious NAV. Other redeeming shareholders were not so fortunate and lost out. Weavering's Cayman Islands liquidators sued SEB for the return of the payments on the basis that they were voidable preferences under the relevant Cayman Islands legislation.

Under such legislation a payment will be a voidable preference if a company transfers property to a creditor when the company is unable to pay its debts (a cash flow insolvency test taking into account future debts) with a view to giving such a creditor a preference over other creditors. Such a payment is invalid. It is settled law that "with a view" requires a dominant intention to prefer.

The Cayman Islands Grand Court and the Cayman Islands Court of Appeal ("CICA") held that the redemption payments to SEB were voidable preferences and ordered SEB to repay the sums received (approximately US$8.5 million). The Privy Council (the highest Cayman Islands Court) upheld these decisions; but, importantly, in some aspects, for different reasons. The Privy Council's reasoning differed both in respect of: (i) whether a contractually binding NAV can ever be revisited; and (ii) how the Cayman Islands voidable preference regime works.

Is NAV Always NAV?

It was held that where NAV has been misstated due to an internal, as opposed to an external, fraud it is possible to challenge the NAV. However, in order to do so legal proceedings will need to be commenced by a party who has suffered loss as a result of the fraud. Without such a successful challenge then the struck NAV remains the NAV and cannot be adjusted. As no proceedings had been brought to rectify NAV and SEB had no standing to do because it had not been defrauded, the Privy Council rejected the  argument that: (i) no redemptions had taken place in accordance with Weavering's articles: and (ii) therefore the redeemers were not creditors for the purpose of the voidable preference provisions.

The Privy Council's decision in Fairfield Sentry (that NAV determined in accordance with the articles was binding for all purposes and cannot be revisited) was distinguished. In Fairfield Sentry the fraud was external: the fraud was perpetrated not on the feeder funds, but on the fund those feeder funds invested in. In Weavering the fraud was internal – the fund (through its guiding mind Mr Peterson) knew the NAV was incorrect.

The message is internal fraud unravels all – but, in respect of NAV, it does not do so automatically. This gives rise to a number of questions.

First, when is a fraud internal as opposed to external? For example, where the fraud is initially external to the fund but there are allegations that the fund's directors were complicit in or turned a blind eye to the fraud; is this internal fraud? The lines may not always be bright. 

Secondly, if an internal fraud is present, NAV still needs to be rectified.  The Privy Council has made it clear that this is not automatic: "the NAV was and is binding on all parties until and unless successful proceedings are before the Grand Court by a party which has suffered loss to have the NAV in a transaction based upon it avoided for fraud".  Who has standing to bring such an action is unclear; for example, could a liquidator bring an action? If so, against whom?  Indeed, why should it be necessary to bring such a claim at all, in circumstances where (as was the case in Weavering) nobody was denying there had been an internal fraud which had resulted in misstated NAVs. 

The answers to the above are likely to be highly fact sensitive; but the settled position that a contractually binding NAV is NAV and cannot be revisited is no longer always the case. However, practically the impact is likely to be small. If there is no internal fraud then NAV remains NAV; so investor certainty remains for properly run funds. Secondly, even if there is internal fraud a party (and it will not always be clear who can do so) needs to bring a successful action to rectify NAV – NAV still remains NAV absent a challenge.

Voidable Preferences

A dominant intention to prefer can be inferred

Upholding the CICA's decision, a dominant intention may be inferred by the court in accordance with the general principles of inference from the available evidence. This does not change the established principle that if a different intention for the payment can be demonstrated (such as to ward off threats of litigation) then the payment will not be a preference. However, SEB had not, after giving notice of redemption, put pressure on Weavering to pay (or even requested payment). Accordingly, there was nothing to displace the inference derived from board minutes and emails that SEB was paid pursuant to an intention to prefer.

It remains the case that proving a dominant intention to prefer will often be a challenge and inferring such intention is not necessarily made easier by Weavering. It is usual for there to be a cogent alternative explanation for payment and in many cases payment will be made to ward off threats of litigation.  Accordingly, as has always been the case, generally speaking the more a creditor agitates for payment, the less likely such payment is to be a voidable preference.

Basis for recovery of a voidable preference

The statutory provisions render a payment voidable (not void ab initio). However, as there is no statutory method to recover the payment, it was held that recovery is governed by the common law. Specifically, restitution (based on the concept of a party being unjustly enriched). The usual defences to a restitutionary claim are that the party receiving the payment has: (i) not been enriched; or (ii) that it has changed its position so that it would be inequitable to require repayment.

SEB was a mere custodian – but it was still enriched

SEB had argued that, as custodian, it held the shares as bare trustee for other funds. As trustee, SEB did not have any beneficial interest in the proceeds of redemption and so was not enriched by the receipt of the money. The Privy Council disagreed. SEB dealt with Weavering as principal and not agent and received payments as registered shareholder. It did not matter that SEB was only a custodian for the funds and was obligated to pass them on to the beneficial owners (or that the Weavering knew this). Weavering was entitled and obliged under the articles to deal with SEB as the legal owner of its shares and had no legal relationship with the underlying funds or with the investors in them. SEB, as registered owner of the shares, was entitled to receive, and did in fact receive, the redemption proceeds - it was SEB who was enriched. 

"Change of position" defence contrary to public policy in insolvency

In the context of a claim by a liquidator for the restitution of money paid to a preferred creditor, the change of position defence is not available. It was held that the common law should not undermine the operation of the statutory scheme of pari passu distribution, which voidable preferences are intended to support.  A contrary conclusion would undermine public policy.

The failure of these two defences, while perhaps not surprising, serves to re-inforce a risk inherent in acting as a custodian investor and the importance of robust and enduring indemnification arrangements with the underlying investors.

Where does this leave investors in Cayman Islands funds?

At its heart Weavering was a battle of conflicting public policy objectives. Certainty of transactions (investor certainty) v. pari passu distribution to unsecured creditors. While pari passu comprehensively trumped; the result in practice is likely to be little actual erosion for investor certainty. While NAV may now, where there is shown to be an internal fraud, be more susceptible to a challenge; without any express challenge NAV remains NAV. Where there is an internal fraud the law will need to develop as to who has standing to bring a challenge to NAV and what matters the court may take into account. Further (and importantly) the bar has not been lowered for a voidable preference action to be successful. This minimises the impact of the change of position defence not being available in the insolvency context to custodian/nominees/trustees (and it is not unusual for the redemption creditor, as was the case here, to be under an obligation as trustee, nominee or custodian to pay on the redemption proceeds to underlying third parties).

This is not the last word on whether NAV really is NAV in all circumstances. In solvent liquidations, where NAV is not binding on the company and its shareholders because of fraud, Cayman Islands law allows the register of shareholders to be rectified. The CICA held in Pearson v Primeo that these provisions grant no power to calculate a correct NAV and substitute it for a misstated NAV, which despite the misstatement has been calculated in accordance with the articles. An appeal to the Privy Council is due to be heard in October 2019 and the decision is keenly awaited.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions