The New Face of the Insolvency Regime in the Cayman Islands

June 18, 2009

By Tim Le Cornu and Mathew Clingerman
ABI Journal , June 2009

Historically, insolvency procedures in the Cayman Islands have been governed through the application of the U.K.’s Insolvency Rules 1986, insofar as such rules were not inconsistent with Cayman Islands’ law. While this practice worked well for many years, the U.K.’s Insolvency Rules 1986 were not designed with Cayman Islands’ Law in mind and led to an ad hoc solution that was far from ideal.

In 2006, a committee of experienced Cayman Islands’ insolvency specialists and the country’s Law Reform Commission conducted an extensive review and released a report making three key recommendations: (1) the existing law on corporate insolvency was too complex and should be updated; (2) tailored rules relevant to the jurisdiction were needed; and (3) existing judicial co-operation in cross-border cases should be codified.

The recommendations led to the recent introductions of jurisdiction-specific insolvency rules and regulations, along with amendments to certain parts of the law that, given the increasingly active insolvency market, have come into effect at an opportune time. The improvements provide insolvency practitioners with clearly defined procedures and an increased ability to act with confidence.

On March 1, 2009, the Companies Amendment Law 2007, together with the Companies Winding-up Rules 2008, the Insolvency Practitioners Regulations 2008 and the Foreign Bankruptcy Proceedings (International Co-operation) Rules 2008, came into effect.1 While it is not possible to outline all of the differences, this article provides background on 10 areas where we found the law, rules and regulations to contain substantial changes.

International Protocols

Over the past 25 years, the Cayman Islands have become one of the largest offshore financial centers in the world, and a vast majority of liquidations involve multijurisdictional litigation and recovery. As a result, the Grand Court has seen a large volume of cross-border insolvency cases, and while case law and practice in the Cayman Islands has been largely viewed as open and cooperative in cross-border cases, the new insolvency regime seeks to codify the law consistent with the objectives of the UNCITRAL model law.

International proto-col agreements can generally be defined as an agree-ment between a liquidator and a for-eign counterpart when they are both appointed over the same company under dual insolvency proceedings, setting out how they will cooperate for the benefit of the estate. Although international protocol agreements have been used in practice in the Cayman Islands for a number of years, Order 21 Rule 2 now imposes a duty on official liquidators to consider whether it is appropriate to enter into one. In making that assessment, an official liquidator will likely consider the purpose of an international protocol which, by definition, is designed “to promote the orderly administration of the estate of a company in liquidation and avoid duplication of work and conflict between an official liquidator and the foreign officeholder.” Order 21 Rule 3 sets out the areas that an international protocol may cover, including:

who will pursue what assets and in which jurisdictions;
exchange of information and transfer of assets between the official liquidator and foreign officeholder;
responsibilities for communicating with the investors/creditors; and
procedures relating to the adjudication and payment of claims.

An international protocol arrangement must be agreed upon by both the Grand Court and the foreign court in order to be binding and effective.

International Cooperation

Representatives of foreign companies, under foreign insolvency proceedings in their home countries, may seek assistance from the Grand Court in their dealings in the Cayman Islands. This assistance is dealt with primarily under the new Part XVI of the law.

Section 253 provides that representatives may seek declaratory orders recognizing the rights to act in the Cayman Islands on behalf of the foreign company. Ancillary orders, such as enjoinment, staying proceedings, enforcement of judgments, examination or the delivery of property, may also be sought. While the Grand Court has significant discretion in considering whether to make these types of orders, §254 provides that it will be guided by matters that best assure an economic and expeditious administration of the foreign company’s estate consistent with:

the just treatment of all claims/interests in the foreign estate;
the protection of Cayman Islands claims from prejudice and inconvenience in the processing of claims;
the prevention of preferential and fraudulent dispositions;
distribution of the foreign estates’ assets in a manner substantially consistent with Cayman Islands’ law;
recognition and enforcement of security interests of the foreign company;
nonenforcement of foreign taxes, fines and penalties; and
comity.

While the law has been amended to primarily deal with the scope of cooperation, the Foreign Bankruptcy Proceedings (International Cooperation) Rules 2008 stipulate the necessary applications and required contents of petitions and originating summons.

Powers and Duties of Official Liquidators

An official liquidator is an officer of the court whose function it is to collect, realize, maintain, manage and distribute the company’s assets. To carry out his or her duties and functions, an official liquidator relies on specific powers granted to him or her. Section 110 and Part II of the Third Schedule provide certain powers to be automatically granted to the official liquidator, including, inter alia, the power to: (1) take possession and collect the company’s property, including taking any necessary proceedings; (2) promote a scheme of arrangement; and (3) do all acts and execute deeds, receipts and other documents on behalf of the company. Part I of the Third Schedule also holds that certain powers will be granted to an official liquidator with the sanction of the Grand Court. Among these are the powers to: (1) bring/defend any action or legal proceeding on behalf of the company; (2) carry on the business of the company; (3) dispose/sell company property to any related party; (4) pay any class of creditors in full; and (5) engage staff and attorneys to assist the official liquidator.

Traditionally, many of the powers available only with Grand Court sanction have been granted to an official liquidator in the order of appointment. We expect that such powers will be included in the draft order submitted at the winding-up hearing and will become powers of the liquidator from the date of appointment, rather than a subsequent application having to be made. This is particularly relevant for the appointment of attorneys who provide necessary legal support and advice for a liquidator in carrying out his or her duties.

Investigations and Examinations

Official liquidators have always enjoyed the ability to apply to the Grand Court for examination of various parties in relation to the affairs of a company in liquidation. Section 103 provides official liquidators with an ability to apply to the Grand Court for examination of:

persons having sworn a statement of affairs;
directors and officers;
professional service providers;
controllers, advisors, liquidators and receivers; and
anyone who has been concerned with or taken part in the promotion or management of the company.

The examinations may be in the form of sworn affidavits in response to written interrogatories and/or oral examination. The predecessor language provided that official liquidators could apply to the Grand Court to examine “anyone” who was (1) known or suspected to have company effects, (2) a debtor of the company or (3) capable of giving information on the company’s trade, dealings, estate or effects.

While the new provision replaces “anyone” with those parties specified above, in most circumstances the specified parties cover the most likely candidates for an examination. However, the liquidator may wish to examine other parties, such as creditors or bankers, for which he may be required to seek directions from the Grand Court.

In addition to the liquidator applying for an examination of a party, the creditors and contributories of a company now have the ability to require a liquidator to make such an application by resolution of at least 50 percent in value. The law provides liquidators with greater powers to investigate and report to the Grand Court on the affairs of the company, including (in an official liquidation) the causes of the company’s failure and the company’s promotion, business dealings and affairs. Section 102 allows the liquidator to obtain directions from the Grand Court to either assist the Royal Cayman Islands Police Service to investigate the conduct of directors, management and professional-service providers or to institute and conduct a criminal prosecution of either of these persons.

Section 102 also strengthens the capacity to investigate and prosecute fraudulent activity. It demonstrates the Cayman government’s and the regulators’ desire to update legislation to create a financial industry with both a level playing field and a regulatory and legal system that is competitive on the global stage.

Companies can reach the end of their natural lives for any number of noncontentious reasons. When this happens, the shareholders often pass a resolution appointing a voluntary liquidator. The rules and law are now clear that voluntary liquidations are only appropriate where the company is solvent.

Criminal prosecution in fraud and other financial crimes are lengthy, costly and require significant resources over extended periods. While the law provides for the costs of a prosecution pursued by the liquidator to be paid from the assets of the company, we believe this would only occur where the liquidator is able to demonstrate a potential benefit to the estate of assisting the prosecution of the wrongdoers. The Grand Court is likely to take into account the views of creditors prior to issuing directions for a liquidator to pursue a criminal prosecution, particularly where there may be limited assets available to fund such an exercise and, in these cases, may direct the regulatory bodies to pursue the action.

Statement of Affairs

Section 101 provides that a liquidator “may” require a statement of affairs (SoA), outlining the financial position of the company at the date of liquidation, the details of any person in possession of any company assets (and the nature of those assets), the nature of any security held by creditors, details of all creditors of the company and any other information the liquidator may specify. A SoA may be required from (1) a director or officer, (2) a professional-service provider or (3) a person who was an employee of the company within one year preceding the date of liquidation. A professional-service provider is defined in §89 as “a person who contracts to provide general managerial or administrative services to a company on an annual or continuing basis.” Previously, there was no requirement for a liquidator to require a formal SoA from any relevant person, although we note that the new provision does allow the liquidator some discretion if he requires one.

It is unlikely that a liquidator will not require a SoA, but with the discretion available to him, the liquidator may select the person or persons he believes are in the best position to provide an accurate and meaningful statement. He may also choose to request specific information from specific parties; for example, a liquidator would want to fully understand an investment company’s portfolio before making any decisions regarding its liquidation. In this regard, the investment manager may have valuable information on hedged positions that should be viewed mutually rather than independently, or information on markets for illiquid positions.

Interestingly, where a liquidator does require a SoA from one of the parties nominated above, his notice requesting the SoA must be delivered personally. In many commonwealth jurisdictions, it is sufficient for the demand for a SoA to be delivered by registered mail. This may present the liquidator with some logistical obstacles in cases where the nominated person resides in another jurisdiction, although these should not be insurmountable in the majority of cases.

The SoA must be verified by affidavit and lodged with the liquidator within 21 days, beginning the day after he is delivered the notice requiring the SoA. The penalty for noncompliance is a fine of CI$10,000 (US$12,195).

Provided that the SoA is filled out completely and accurately, it may be a useful aid to the liquidator in helping him to assess the company’s financial position, locate and realize assets and ensure that he or she has all the required details of company’s creditors.

Fraudulent Trading Provisions and Antecedent Transactions

Section 134 contemplates fraud “in anticipation” of the winding up of the company and includes the concealment or removal of company property and the destruction or falsification of documents. Such actions are now codified as an offense, carrying penalties of fines and/or up to five years in jail. This section allows the liquidator to review fraudulent actions for the 12-month period prior to the commencement of the winding-up.

In addition, §147 now allows the liquidator to apply to the Grand Court for a declaration of fraudulent trading, and any persons that are knowingly a party to such conduct may be ordered to make a contribution to the assets of the company as the Court thinks is proper.

Provisions relating to voidable preferences now introduce the concept of “related parties,” defined as those that control or exert significant influence over the company’s affairs. Section 145 holds that payments made to related parties will have been automatically deemed to have been with made with a “view to prefer” if made at a time when the company was insolvent and within six months preceding its winding-up.
Alternatives to Winding-up

Shareholders have always had the ability to petition for the winding up of a company in the Cayman Islands; however, the law now provides that the Grand Court may make specific alternative for petitions presented on “just and equitable grounds.” The alternative orders include the following remedies:

the company refraining from doing or continuing an act complained of by the petitioner;
regulating the conduct of the company’s affairs in future;
allowing civil proceedings to be brought on behalf of the company by the petitioner; and
the purchase of shares of some members by other members, or the company itself.

We anticipate that these changes will provide options where there may be dispute between shareholders or oppressed minority shareholders, providing an avenue previously unavailable in these circumstances. How the process would be implemented is not clear: presumably the concerned shareholders must petition to wind up the company first and then seek the alternative remedies available under §95(3) at the hearing of that application.

Provisional Liquidation

While provisional liquidation has long been viewed as a flexible and timely alternative to official liquidation, §104(3) contains a new provision allowing the Grand Court to make orders allowing a company to pursue a compromise with its creditors. A company may petition the Grand Court for a provisional winding-up order on an ex-parte basis if it is, or is likely to become, unable to pay debts and intends to present a compromise to its creditors. In making a provisional winding-up order, the Grand Court may grant the company certain relief, such as a stay of proceedings, while it works toward a compromise. Pursuing a compromise or scheme of arrangement in this manner allows the company protection from creditors during reorganization from which it may emerge as a going-concern. Applications for provisional winding-up orders can be made by a creditor or contributory on grounds to prevent (1) the assets of the company from being dissipated or misused, (2) the oppression of minority shareholders or (3) mismanagement or misconduct of the directors. Order 4, Rule 1 allows the application for provisional winding-up to be heard on an expedited basis, requiring four days’ notice to the company, or in exceptional circumstances, the application can be heard on an ex parte basis.

Liquidators’ Remuneration and Qualifications

The regulations introduce, for the first time, provisions that allow Cayman Islands’ liquidators to be remunerated on the basis of realizations and distributions. Remunerating liquidators in this manner provides a system that can more closely align creditors’ and investors’ economic interests with that of a company’s liquidators. Concerns over excessive compensation are addressed through a progressive schedule that caps the amount a liquidator can be paid under these types of arrangements at between 2 1/2 and 10 percent.

The rules and regulations now contain language aimed at strengthening who may be appointed to act as an official liquidator in the Cayman Islands. Order 5 Rule 2 holds that the Grand Court will not make a winding-up order or supervision order without also appointing a qualified insolvency practitioner, as defined by Part II of the regulations as someone who meets the professional-qualification, insurance, residency and independence requirements.

The professional-qualification requirement will be met by insolvency practitioners who are licensed to practice in several major commonwealth countries, as well as by qualified professional accountants having a minimum of five years of experience in restructuring/liquidations and a minimum of 2,500 relevant chargeable hours. With respect to insurance, the regulations require a qualified insolvency practitioner and his firm to have professional indemnity insurance with a minimum coverage of at least US$20 million in aggregate, US$10 million for each individual claim and deductibles of no more than US$100,000.

The subject of independence is also now covered by the regulations, which hold that an official liquidator shall not be appointed unless he can be properly regarded as independent. The definition of “independent” is largely left open to interpretation, save for the specific reference, to anyone having served in relation to a company as its auditor in the preceding three years and that is not regarded as independent.

The residency requirement requires an official liquidator to be resident in the Cayman Islands and to hold or be employed by a firm that holds a relevant trade and business license. It should be noted that this does not preclude a foreign practitioner from being appointed as an official liquidator. While the regulations specifically exclude foreign practitioners from having to meet the residency requirement, they must be appointed jointly with a resident-qualified insolvency practitioner and meet the insurance and independence requirements. The regulations are silent with respect to a foreign practitioner’s qualifications; however, Order 3, Rule 4 provides that a foreign practitioner seeking appointment must submit an affidavit stating the country in which he or she is qualified to perform functions equivalent to those performed by official liquidators in the Cayman Islands, along with details of his or her experience and professional qualifications.

Voluntary Liquidations

Section 124 now requires that voluntary liquidators file with the Register of Companies (ROC), a declaration of the company’s solvency signed by all of the directors, failing which, voluntary liquidators must apply to the Grand Court for a supervision order. It should be noted that §124 also makes it an offense for any director to complete a statement of solvency without having reasonable grounds or basis for confirming that the company can pay its debts in full. Penalties for this offense include fines of CI$10,000 (US$12,195) and possible imprisonment of up to two years.

The declaration of solvency must be completed and filed with the ROC in order for the liquidation to continue as a voluntary liquidation. This may impact who is authorized to conduct the liquidation, as liquidations under court supervision must have qualified insolvency practitioners pursuant to the regulations, whereas anyone, including a director or an officer of the company, may be appointed as a voluntary liquidator. The impact of the declaration of solvency is clearly significant and may be something a liquidator considering appointment would want assurances of prior to the company being placed into liquidation.

Reprinted with permission from the ABI Journal, Vol. XXVIII, No. 6, June 2009.
The American Bankruptcy Institute is a multi-disciplinary, nonpartisan organization devoted to bankruptcy issues. ABI has more than 12,000 members, representing all facets of the insolvency field. For more information, visit ABI World at www.abiworld.org.