The Offshore Perspective: Five Fundamental Questions for a Liquidator

The Journal of Corporate Renewal:

The Offshore Perspective: Five Fundamental Questions for a Liquidator

By Margot MacInnis, Managing Director, KRyS Global & Mark Forte, Partner, Conyers Dill & Pearman

Once he has control of an entity and the investigations into what went wrong are underway, a liquidator and his advisors turn their attention to determining their litigation strategy. When a financial collapse occurs, there are often wrongdoers, if not fraudsters, and the liquidator must determine the best way to recover assets or generate recoveries through litigation.

With the benefit of legal advice, a liquidator must first determine, “Can I sue?” and if so, move on to the next question, “Where do I sue?” Among the factors to consider are:

• The potential recoveries from litigation. Do the defendants have assets, and are the assets realizable?
• Should the proceedings be commenced offshore or onshore?
• What likely defenses will be raised?
• How will the litigation be paid for? A liquidation costs money, and assets with ready cash value are often not available, not ascertainable, or nonexistent.

A liquidator must always keep in mind that any contemplated steps are likely to require permission of the court in the jurisdiction governing his appointment. The court also will want to know the reasons for the liquidator’s decisions.

There can be no doubt of the emergence in recent years of the offshore liquidator in the onshore market, particularly in the United States. If there is one thing for which offshore bankruptcy practitioners can be grateful, it is the incremental increase in awareness over the past five years of onshore practitioners of the offshore model and its related jurisdictions, particularly the Cayman Islands and British Virgin Islands (BVI).

Assets

One of a liquidator’s primary objectives is to achieve meaningful recoveries for an estate for the benefit of its creditors and, in an ideal world, its shareholders, too. A liquidator considers where he may have the best chance of achieving a successful recovery in this regard. But first, the liquidator must determine that there are assets and that they can be recovered.

It may be pointless, for example, for a BVI liquidator to sue in BVI if, in fact, there are no recoverable assets in that jurisdiction. It also may be pointless to commence an action against an entity that is in liquidation and has little prospect of meeting its obligation to creditors or, worse still, when there are competing creditors and priorities in the target estate. As such, the litigation strategy should take into account where the assets of the company might be and the tactics available in that jurisdiction that may provide for an effective recovery.

Jurisdiction

Various factors may influence a liquidator’s choice of jurisdiction in which to pursue litigation, should options be open to him. As a starting point, the liquidator looks to the contracts and arrangements that govern the legal relationships. The usual conflict of law principles apply to establishing jurisdiction to bring common law claims, but sometimes specific statutory provisions for matters such as clawback claims can confer jurisdiction.

From a liquidator’s perspective, consideration of where to bring a matter, particularly in the U.S., takes into account the nature of the jurisdiction and the court’s conduct in similar matters. This applies as much to where within the U.S. to bring a claim as to the federal jurisdiction itself.

For example, a liquidator often considers bringing causes of action against former service providers, to which a common defense, such as in pari delicto, may be raised. Because New York courts have historically upheld such defenses, a liquidator may consider bringing the claim in another jurisdiction, such as Canada, Cayman, BVI, the U.K., or even in another U.S. federal circuit where it is less likely that the company will need to overcome this hurdle.

Funding

When a liquidator is appointed in any jurisdiction, establishing a cash flow for the work to be done is second in priority only to the emergency steps taken to secure the assets. It is relatively easy to predict cost liability for bringing an action as liquidator to recover assets or obtain damages in the U.S. legal system, because as a general rule everyone pays his own way. In BVI, Cayman, and most other English-based common law jurisdictions, however, the general rule in contentious matters is that the loser pays.

Thus, possible double exposure for an unsuccessful action may prove unpalatable for many officials when there is an option to take action in the U.S. under a risk-related fee structure. This is especially true when the liquidator is potentially on the hook personally for such cost exposure, even if there is an indemnity against the company’s assets or a funding arrangement in place. Without the security of a retainer sum on account, there is always a risk of exposure.

There is a dearth of case law in England and offshore on the question of whether a petitioning and funding creditor can be held liable for losses to the company or the liquidators arising directly from setting aside the appointment of the liquidator on appeal. The BVI Court of Appeal did rule, however, that when an appointment of a liquidator has been set aside, the petitioning creditor could be made liable for the costs and fees of the liquidator being in office during the period of the misconceived appointment.

Given the statutory lien a liquidator has over a company’s assets, that is a second layer of protection for the liquidator in the event the company has no assets.[1] More recently, however,[2] the English Court of Appeal has seemingly relaxed the rather rigid approach pursuant to which a bankrupt company in liquidation always paid for the trustee’s fees in favor of a more fault-based approach that protects the innocent victim, which is the entity over whose assets the liquidator has a lien.

Thus, suing professional service providers in the Caribbean could prove an expensive proposition, as a professional negligence suit could run into the tens of millions of dollars. Conditional fee structures are generally not available offshore, their legality called into question. As a result, unless a liquidator can find counsel to act while waiving its fees until after the event and not requiring funding during the event, the liquidator will need to pay its counsel a retainer and the interim bills.

A liquidator must seek court approval for engaging counsel. When the arrangement is on a contingency fee basis, he is likely to face inquiries from the court on the merits and strength of the claims, how termination of the arrangement will be handled, out-of-pocket costs, and whether the contingency fee attorney is amenable to providing the necessary input to facilitate reporting to the court.

In practical terms, the beneficiary of an adverse costs order that applies to the liquidator does not worry much about whether the liquidator can recover from the estate. Depending on who brought the action, it may well be against the administrator. Carving out assets within a bankruptcy estate to meet the indemnity to which a liquidator may turn for backing is now a relatively common practice, particularly in Cayman. A court can ring-fence money that is untouchable by others for such purposes, the calculation of which is based on an assessment of possible exposure.

Litigation funding is also an option rarely explored by liquidators as a means of financing possible claims for recovery of assets. Given that premiums for such service are significant—in the range of 30-40 percent—that is almost certainly something a liquidator will want the creditors and preferably a creditors’ committee to approve. Until recently, therein lay a problem if the company in liquidation was a fund.

In the BVI, case law developed to define a redeemed member as a creditor, but not one with locus to bring liquidation proceedings. Without creditors with standing, there was no creditors’ committee, and almost all business for which the liquidator legitimately wanted pre-approval required him to go to court for direction. Thankfully, this issue has been addressed on appeal, and redeemed but unsatisfied members are now granted standing as creditors.[3]

Another issue is a Catch 22 in which a liquidator may find himself, given that litigation funding is costly and requires court approval, in addition to creditor sign-off the liquidator will want. In considering whether to approve the funding arrangement, a court may want more details and particularized advice on the claim. Such details often are not available at this stage of the litigation and can only to be obtained once discovery commences. How can a liquidator advance to discovery to obtain advice on the merits without litigation funding first being sanctioned by the court?

Funding of liquidations therefore remains somewhat diverse, depending on the purpose for the funding and the jurisdiction in which the liquidator is operating. More case law is expected to evolve, and possible statutory intervention may address some of these issues in due course.

Limitation

U.S. statutes on time allowances to perform certain actions may not translate well into offshore law. A good example is the time allowed in which to bring a claim in fraud or mistake, two causes of action seen in clawback arguments made in recent collapsed fund litigation. In BVI, Section 25 of the Limitation Act allows for six years from the date of discovery or when such fraud or mistake ought to have been discovered, based on a test of reasonable diligence. There are similar limitations in Cayman.

No such tolerance is permitted under U.S. bankruptcy law. As such, claims arising from a Ponzi scheme may have a limited clawback period if the fraud has been running for years before it is discovered, as is often the case.

This, however, must be weighed against the fact that a U.S. bankruptcy trustee has two years from the date of his appointment in which to file a claim. An offshore liquidator has no such tolling period. To the extent the offshore liquidator needs to investigate a claim and take steps to file it, he does not have the luxury of time and may need to file a protective writ to protect the claim.

There could be a very real advantage in relying on the tolling provisions of the English-based offshore limitation laws to open the door to claims significantly in excess of equivalent causes of action onshore. This determination is heavily fact-dependent, but the difference could be exponentially greater than the difference between the cost of running a more traditionally funded offshore litigation and a cash flow friendly onshore model.

Chapter 15 of the U.S. Bankruptcy Code has proven to be a useful tool for a liquidator in a number of respects, including pursuing clawback claims. The benefit of a stay on any actions, the two-year tolling period, and the discovery process based on Rule 2004 of the Federal Rules of Bankruptcy Procedure can all assist in determining the beneficial owners that may need to be pursued.

Chapter 15 allows foreign representatives to benefit from the U.S. bankruptcy trustee’s two-year toll. However, if only discovery is needed, it may be faster and less costly to apply under 28 U.S.C. § 1782(a), which provides for discovery for foreign proceedings and is available outside of Chapter 15.

Is There Even an Insolvency Law?

In a rather surprising development in late 2011, the Eastern Caribbean Court of Appeal handed down a judgment in Veda Doyle.[4] Of the nine states that comprise the Eastern Caribbean judicial circuit, perhaps five of them deal with international work, heavily skewed, of course, to the dominant offshore corporate center of the BVI. However, Anguilla, St. Kitts, Nevis, and Antigua all deal with some international work.

In such a market, insolvency or bankruptcy law is needed to accomplish such work and address the cross border nature of the work. Except for the BVI, these states have no specific insolvency legislation beyond the most basic of provisions usually enshrined in their company’s legislation.

Each state, however, has always reverted to a provision of its respective Supreme Court Acts that allowed, as they saw it, for the law of England to be imported into local law if the local law did not address an issue. There is evidence this power was somewhat loosely adopted over many years, but it was clearly in need of some closer scrutiny.

In Veda, the Court of Appeal clearly defined the parameters of the importation provision. In short, the importation can occur when there is a need for English procedural law, not substantive law. The result of such a finding is that whereas before, the provisions of voidable transactions or set aside actions could be lifted from the English Insolvency Act of 1986, for example, that no longer is permissible. Insolvency-related offences are simply not provided for in companies’ legislation and, as such, there is now considerable confusion as to whether there even exists a judicially sound basis for considering clawback actions in the insolvency context.

It is readily apparent to these other offshore jurisdictions that this is a problem, and considerable efforts are being brought to bear for legislative reform in each. Until that happens, however, there remains the very practical difficulty of securing a sound legislative infrastructure for such bankruptcy matters to provide predictability and reassurance to liquidators seeking to recover assets and taking other steps to further their cross border interests.

All in all, the world of cross border offshore bankruptcy law remains a minefield through which careful navigation can reap considerable advantages, but which also presents dangerous hazards to the role of the liquidator and the interests of the creditors, whether secured or unsecured. However, retaining good local counsel and giving strategic consideration to where the bankruptcy erupts with where the bankruptcy needs to operate should still allow for effective recovery and distribution.

Avoiding Accidents

Whether a liquidator is suing a single wrongdoer in a single jurisdiction or running a multi-defendant cross border litigation strategy, there are a number of important elements to consider. It is important not to create traffic accidents in the process of a coordinated cross border strategy, such as making arguments in one case with respect of one group of defendants that run counter to the arguments made in another jurisdiction for similar claims. A focused litigation strategy will go a long way toward assisting a liquidator in avoiding inconsistencies in the arguments and claims brought against the parties.

Margot MacInnis is a managing director and leads the Cayman Island practice of KRyS Global, and Mark Forte is a partner and head of Litigation and Restructuring in the British Virgin Islands office of Conyers Dill & Pearman. MacInnis is an experienced insolvency practitioner and acts as a liquidator in compulsory and voluntary insolvencies, and directs specialized engagements involving asset tracing, forensic analysis, and valuation assignments. She is experienced in cross border insolvency projects in Asia, Europe, and Africa involving multijurisdictional issues and regulations. Forte specializes in cross border litigation of a commercial and company nature, along with all aspects of international insolvency. He regularly assists liquidators in asset tracing claims and advises in restructuring through plans and schemes of arrangement.

[1] See Pacific China Holdings Ltd v Grand Pacific Holdings Ltd HCVAP 2010-007.

[2] Oraki v Dead & Dean [2013] EWCA Civ 1629.

[3] See Monarch Pointe Fund Limited; HCVAP 2011/040.

[4] Veda Doyle v Agnes Deane HCVAP 2011/020.

http://www.tmajcr.org/journalofcorporaterenewal/may_2014#pg16