The Lending and Secured Finance Review: Cayman Islands
i Introduction to the Cayman Islands
In terms of assets under management, the Cayman Islands is the largest offshore jurisdiction for investment funds and financing structures. One reason for this is a particular legal and regulatory framework that pays specific regard to the requirements of sophisticated institutions, fund managers, lenders and investors. Based on well-established English common law principles, the legal regime has been enhanced by specific statutory enactments, invariably driven by user input. The judicial system is reputable, highly efficient and well regarded. As the Cayman Islands is a British Overseas Territory and Crown Dependency, the Judicial Committee of the Privy Council comprised of UK Supreme Court and Commonwealth judges is the final court of appeal. This provides market participants with a full array of legal precedents and a high degree of certainty. The legal framework is described as creditor friendly with no Chapter 11 or equivalent procedures that might frustrate enforcement of security arrangements. The laws of the Cayman Islands provide certainty of execution and outcome to lenders and, as such, secured lending and fund financings to Cayman Islands borrowers are increasing in number and volume on a yearly basis.
ii Cayman borrowers
While Cayman Islands domiciled funds and their portfolio companies dominate the borrowing market, we increasingly see corporate borrowers, often using dedicated Cayman Islands special purpose vehicles. Given the absence of restrictions under Cayman Islands law and regulation as to investment objectives, Cayman Islands alternative investment funds are used for the full range of alternative strategies, including hedge, private equity, venture capital, infrastructure, real estate and private debt, as well as traditional long-only investing. Consequently, the variety of fund structures and underlying investment pools necessitates a broad range of bespoke financing solutions.
iii Flexible financing structures
A newly formed private equity fund with a large amount of uncalled capital will typically borrow against the capital commitments of the investors (known as subscription facilities) and secure such borrowings by assigning the rights over the capital calls by way of security. Midway through the fund's investment period, the borrowing base may also be formed by reference to the net asset value of the fund's assets (known as hybrid or net asset value/NAV facilities). Private debt and credit funds more often seek NAV-type facilities, borrowing against a portfolio of loans and securing such borrowings by way of share security over the portfolio companies. Secondaries funds that acquire and hold limited partnership and other equity interests in existing funds may secure their borrowings over those interests. There has also been recent growth in NAV facilities for real estate and infrastructure funds.
As for the more liquid hedge fund alternative strategies, their financing may involve traditional lending (e.g., to bridge subscriptions and redemptions with security over collateral assets, much like a traditional mutual fund bridge funding), although their principal financing of trading activity typically entails gearing through margin, repurchase agreements, derivatives and other synthetic structures. This often leads to quasi-security arrangements, including title transfer security and sophisticated netting arrangements.
Facility documentation is usually governed by New York or English law (largely based on the Loan Syndications and Trading Association (LSTA) and Loan Market Association (LMA) terms, respectively) and the terms vary depending on the framework of the fund and its investment structure. The documentation will need to be particularly tailored where the fund borrower has a single investor (known as a separately managed account) or there are multiple separately managed accounts in the structure (known as the umbrella structure). A Cayman Islands law governed security package is determined by the structure and investments of the fund. Cayman Islands law provides full flexibility as to the types of assets over which security can be validly created. In a multi-tiered 'master-feeder' structure, lenders might require cascading security in the security package and with 'parallel fund' structures, cross-collateralisation may be necessary. Corporate borrowers might also secure their financing over other assets such as ships, aircrafts, receivables or intellectual property.
Legal and regulatory developments
The Cayman Islands continues to meet international regulatory and transparency standards in respect of its financial industry. We have outlined below some of the most significant regulatory developments.
i Mutual Funds Law and Private Funds Law
The Cayman Islands Monetary Authority (CIMA) is the authority responsible for financial services regulation, covering Cayman Islands open-ended funds, which fall under the Mutual Funds Law (2020 Revision) (MFL) and closed-ended funds, which fall under the Private Funds Law, 2020 (PFL). Open-ended funds are defined as funds that offer redeemable interests to investors. Interest here means a share in a company, a unit in a unit trust or a partnership interest. Open-ended funds and their associated master funds must be regulated by CIMA to conduct their business.
The PFL and associated regulations took full effect on 7 February 2020 and regulate closed-ended funds. A private fund, for the purposes of the PFL, is a fund in which investor funds are pooled for reward and professionally managed and where the investors do not have day-to-day control over the acquisition, holding, management or disposal of the fund's investments. The definition excludes funds regulated under the MFL, joint ventures, proprietary vehicles, incentive schemes, pension funds, debt-issuing vehicles, holding vehicles, preferred equity financing vehicles, single managed accounts, syndication companies and certain other arrangements.
From a lender's perspective, investigating the regulatory status of a Cayman Islands borrower and its compliance with any relevant statutory requirements imposed under the MFL or PFL regimes should form part of their due diligence and facility agreement documentation process. A failure to register with CIMA and the subsequent loss of such registration will represent a credit risk for the lender and it should therefore require a Cayman Islands borrower in the due diligence phase to provide evidence of compliance with all relevant requirements and undertakings in the finance documents to maintain its CIMA regulatory status and to comply with all other relevant regulatory obligations during the term of the financing.
In relation to Cayman Islands fund borrowers that are within the scope of the PFL, lenders need to be aware that a private fund cannot accept capital contributions without the fund first complying with the registration requirements imposed under the PFL. We expect that an approach may develop over time whereby (1) closed-ended fund borrowers will be required to register before finance is extended and provide evidence of continuing compliance with applicable PFL obligations and (2) contractual protections will be incorporated in the finance documents to serve as early warnings of non-compliance. However, robust and fully perfected security over capital call rights might further enhance a lender's right to demand an investor's capital contribution upon default by the fund borrower.
ii Securities Investment Business Law
Under the Securities Investment Business Law (2020 Revision) (SIBL), a Cayman Islands person who conducts securities investment business must be licensed by or registered with CIMA. Securities investment business includes the business of managing securities, advising on securities, arranging deals in securities or dealing in securities. Securities are widely defined to encompass shares, bonds, futures, options, contracts for differences and other typical investments. Accordingly, most fund managers, advisers and placement agents that are organised or have a place of business in the Cayman Islands fall within SIBL. Review of the status of a Cayman Islands fund manager under SIBL therefore forms part of the lender's due diligence, particularly when a closed-ended fund borrower has delegated to its manager the authority to exercise the power of the general partner to call capital contributions from the limited partners of the fund.
iii Economic Substance Law
Depending on the precise role and structure of the borrower and its service providers, other regulatory laws may also be relevant, such as the International Tax Cooperation (Economic Substance) Law, (2020 Revision) (ES Law) which implements the economic substance standards of Action Point 5 of the Organisation for Economic Co-operation and Development Base Erosion and Profit Shifting initiative. The ES Law requires a 'relevant entity' that carries on a 'relevant activity' to satisfy the 'economic substance test' and to make certain compliance-related filings with the Cayman Islands Tax Information Authority (TIA). Investment funds and the vehicles through which they invest are generally out of scope for the purposes of the ES Law; however, the service providers to a fund may be subject to the ES Law.
The relevant activities for the purposes of the ES Law are the businesses of banking, fund management, distribution and service centre, financing and leasing, headquarters, holding company, insurance, intellectual property and shipping. When a fund manager or a portfolio company (which might be a borrower, co-borrower or guarantor in the financing) is structured as a Cayman Islands company or limited liability partnership, it constitutes a relevant entity and, as such, its activity might fall within the scope of the ES Law.
Lenders should therefore be aware of the requirements of the ES Law that might be imposed upon their borrowers and those borrowers' service providers and, where relevant, should obtain comfort from due diligence and contractual protections (such as representations with regard to compliance and undertakings to provide evidence of such compliance) in the finance documents.
iv Anti-money laundering
The Anti-Money Laundering and Combatting of Terrorist Financing (AML) regime of the Cayman Islands requires Cayman Islands entities conducting relevant financial business (e.g., funds regulated under the MFL and PFL) to designate an individual to act as their anti-money laundering compliance officer and to adopt written policies and procedures to meet the requirements of the AML regime. From a lender's perspective, a non-AML compliant Cayman Islands borrower could pose a reputational risk or even result in non-compliance with its own AML obligations. In serious cases of non-compliance with the Cayman Islands' AML regime by a borrower, CIMA has the power to apply to court to seek an order for its winding-up, something that would no doubt trigger a financing default under the finance documents. Therefore, as part of their due diligence, lenders should request evidence from prospective borrowers of compliance with their AML obligations and may also insert covenants in the finance documents requiring fund borrowers to maintain compliance with the requirements of applicable AML regimes.
The Cayman Islands does not have a direct taxation regime as a matter of centuries-old fiscal policy. Accordingly, no taxes are imposed under Cayman Islands law on the profits, income, gains or appreciations of Cayman Islands borrowers and there is no withholding in respect of any dividend, distribution or interest payment by a Cayman Islands borrower. Nominal stamp duties apply to documents executed or brought into the Cayman Islands. There are no exchange or currency controls in the Cayman Islands.
Notwithstanding the absence of direct taxation, a Cayman Islands borrower formed as an exempted company desiring additional comfort on this matter may obtain an undertaking from the Governor-in-Cabinet of the Cayman Islands that for a period of 20 years from the date of the undertaking certificate, no laws of the Cayman Islands imposing any tax on profits, income, gains or appreciation shall apply to such borrower and that no tax in the nature of estate duty or inheritance tax shall be payable on the equity interests of that borrower. A borrower formed as an exempted limited partnership may obtain a similar undertaking for a period of 50 years. A unit trust fund may also obtain a similar undertaking for a period of 50 years, provided it excludes investors resident or domiciled in the Cayman Islands (other than Cayman Islands exempted companies and non-resident companies).
The ongoing global initiatives to enhance anti-money laundering and counter terrorist financing practices and to establish Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standard (CRS) regimes have overall proved positive for Cayman Islands funds and corporate borrowers, in that the Cayman Islands applies the highest international standards of anti-money laundering and tax transparency. The required administrative functions and procedures are now routinely delegated to administrators as part of their agreed compliance processes. Cayman Islands fund structures are generally subject to FATCA/CRS reporting regimes of the Cayman Islands. FATCA requires foreign financial institutions (FFI) (Cayman Islands funds are largely in scope) to report information on accounts of US taxpayers to the US Internal Revenue Service. The conclusion of a Model 1B intergovernmental agreement between the US and the Cayman Islands facilitates compliance with FATCA reporting requirements. A Cayman FFI will report directly to the TIA and once it complies with the relevant reporting and procedural requirements, it will be treated as deemed compliant FFI and shall not be subject to automatic withholding on US source income. The Cayman Islands has also entered into and implemented similar multi-lateral arrangements with more than 100 jurisdictions as part of the CRS regime, which provides for the collection and automatic disclosure of information to the tax authorities in the jurisdiction of tax residence of the investor of the investment amount of that investor in a Cayman Islands fund and in respect of any distributions paid to that investor. There is a generally very high level of compliance with the FATCA/CRS regimes and their reporting requirements in the Cayman Islands and lenders can obtain comfort from ongoing compliance from tailored contractual protections in the finance documents.
Credit support and subordination
As in any common law jurisdiction, the purpose of any security created in favour of a lender is to recognise that the lender will be able to look to the particular asset or the sale proceeds obtained from that asset if the borrower fails to discharge its liabilities in accordance with the finance documents. Moreover, a secured lender will be protected on the borrower's insolvency and should be repaid in full and ahead of the borrower's other creditors subject to any rules of priority, provided its security is validly perfected and not capable of being set aside. Cayman Islands law governed security documents usually grant a power to the secured creditor to appoint a receiver under the terms of the security document to sell the secured asset on its behalf. Although this contractual power is typically exercisable upon a borrower default, the parties can freely agree how to govern their contractual relationship and, as such, a receiver could be appointed even before a default in circumstances where, for example, the secured creditor reasonably believes that its security is in jeopardy. A Cayman Islands chargor may grant security over any of its assets and the four main types of security recognised under Cayman Islands law are mortgages (legal and equitable), charges (fixed and floating), liens and pledges. This chapter does not cover the creation of security over Cayman Islands real estate, aircrafts, intellectual property and ships.
Legal mortgages are the most comprehensive and secure form of security. A legal mortgage is the transfer, by conveyance or assignment, of the legal ownership of an asset by way of security. This transfer is subject to an obligation to re-transfer ownership of the asset to the mortgagor if the mortgagor discharges its liabilities. Advice should always be obtained as to whether any such transfer triggers an onshore tax liability. A legal mortgage over debts or choses in action created by an absolute assignment in writing (which is not purported to be by way of charge only)2 can secure borrowings over capital commitments or provide security for borrowings of limited partners over their partnership interests.3 Additionally, in order for such an assignment to take effect as a legal assignment, express notice in writing must be given to the debtor, trustee or other person from whom the assignor would otherwise have been entitled to claim the debt or chose in action.4 In the case of security over capital commitments, the relevant limited partner or partners and, in the case of security over a partnership interest, the general partner (on behalf of the partnership), should receive the notice of assignment. Lenders should review the relevant partnership documentation to ensure that granting of security and its enforcement, or both, is permissible (or at least not prohibited or hindered thereunder) and, if it is not, should insist upon the removal of any prohibition of transfer or assignment in favour of the secured creditors prior to the financing being put in place.
An equitable mortgage is the transfer by the mortgagor of its beneficial interest in the relevant asset to the mortgagee while the legal interest remains with the mortgagor. An equitable mortgage is weaker than a legal mortgage because a bona fide purchaser for value of the legal estate without notice of an equitable mortgage will take free from the equitable mortgage. An assignment will be equitable if it relates to an equitable interest over a chose in action, relates to future rights,5 or does not satisfy the notification requirement of a legal assignment.
Charges are always equitable in nature. Chargors do not transfer legal or equitable interests in the asset to the chargee, nor do they confer a right of possession. Instead, the chargee has a right to resort to the asset in order to realise it and apply the sale proceeds towards payment of its debts. A fixed charge over a particular asset should give the chargee control of any dealing or disposal of the asset of the chargor as dealing or disposal of the secured asset will be prohibited under the security document. This prohibition is crucial as without sufficient control over the secured asset being granted in favour of the chargee, the fixed charge risks being re-characterised as a floating charge. In contrast to a fixed charge, a floating charge is floating over the charged asset prior to default, meaning that the chargor is free to deal with the asset without reference to the chargee until the occurrence of a default, which causes the floating charge to crystallise over the asset and become a fixed charge. The Exempted Limited Partnership Law (2018 Revision) (the ELP Law) expressly recognises that any asset of an exempted limited partnership may be subject to a floating charge.
Assignment by way of charge generally refers to the circumstances where the chargee and the chargor contractually agree that the chargee has a fixed or floating charge over the chose in action. The effect of the charge (being an encumbrance on the chose in action) is that the benefit of the chose in action is assigned to the chargee for the duration of that charge so it obtains the right to use the chose in action (and receive any proceeds obtained in respect of it) to discharge the debt.
Liens and pledges
Liens and pledges are dependent upon delivery of possession of the secured asset; thus, they are rarely used in Cayman law governed security structures.
There is no public system of registration of security in the Cayman Islands and therefore no basis for constructive knowledge of a registered charge. A Cayman Islands company security provider is required under the Companies Law (2020 Revision) (the Companies Law) to note a short description of the secured asset, the amount of the security and the name of the secured creditor on its internal register of mortgages and charges, which must be maintained at its registered office in the Cayman Islands. Failure to register leaves the mortgagor or chargor and its directors open to financial penalty but does not invalidate the security itself and unlike some jurisdictions (e.g., England and Wales), there is no statutory time limit within which registration must take place. It is nevertheless important for lenders to review a company's internal register of mortgages and charges as part of their initial due diligence and to ensure that their security is registered as soon as possible following its creation (although this will not by itself guarantee priority in ranking of such mortgage or charge over any mortgage or charge existing prior to its creation).
In addition to updating the register of mortgages and charges with details of security created by the company itself, when a mortgagor or chargor grants security over its shares in a Cayman Islands incorporated company, it is common practice to enter a notation in the register of members of that company to give notice of the security to third parties. However, the memorandum and articles of association of a Cayman Islands company and the register of members of a Cayman Islands exempted company are not publicly available documents. As such, not only is there no principle of constructive knowledge in relation to the contents of those documents, but it also follows that appropriate specific consents to inspect them must be obtained. In the case of a security interest granted over a partnership interest in a Cayman Islands exempted limited partnership, the general partner is required under the ELP Law to note security interests in respect of which it has received valid notice in the register of security interests of the partnership and under the ELP Law, such register may be inspected by any person during usual business hours.
iii Guarantees and other forms of credit support
Under a guarantee, the guarantor guarantees the payment obligations of one party to a contract to another party thereto. Subject to the terms of the guarantee document, lenders do not necessarily obtain any security solely by virtue of the guarantee. The provision of a guarantee by a company is subject to any limitations contained in the guarantor's constitutional documents and will also be subject to corporate benefit limitations. In a 'master-feeder' financing, when lenders request that the feeder entity guarantees the borrowings of the master fund (instead of entering into cascading security over the uncalled capital or other assets of the feeder entity), it is advisable to apportion the guarantee of the feeder entity to its capital commitment in the master fund. Otherwise the feeder guarantor might 'over-collateralise' the borrowings of the master fund and perhaps be left, at best, with a deferred subrogated claim on the master fund.
Certain financing structures involving, for example, sale and leaseback or repurchase of securities, factoring, retention of title, netting (including multi-lateral set-offs) and other structures involving the transfer of ownership of securities are all common in the Cayman Islands. The inclusion of netting, set-off, limited recourse and non-petition provisions in contracts is a well-established practice and recognised under Cayman Islands law and such provisions are crucial building blocks in certain SPV and synthetic financing structures. Segregated portfolio companies offer structural segregation by ring-fencing assets and liabilities on a segregated portfolio basis. Negative pledges included in security documents have proved useful in preventing the creation of subsequent charges ranking in priority or pari passu with the security interest that they purport to protect.
iv Priorities and subordination
Cayman Islands law recognises both contractual and structural subordination and the Companies Law specifically provides that an otherwise enforceable agreement to contractually subordinate claims shall be recognised in a liquidation of a Cayman Islands company. The corporate veil may only be pierced in very narrow circumstances6 and there is no general principle of substantive consolidation upon insolvency.
The priority of competing security interests (when a number of creditors have taken security over the same asset) is determined by reference to established English common law rules, which Cayman Islands law generally follows. In practice, however, secured creditors often avoid the issue by putting in place a deed of priority or subordination. Absent such an arrangement and subject to perfection requirements, the following rules apply:
- a fixed security interest will have priority over a floating charge even if that fixed security interest is created after the floating charge (unless the subsequent fixed chargee has actual or constructive notice of a negative pledge included in the security document preventing such fixed charge from being created);
- a fixed charge and mortgage rank in priority according to the date of their creation (although this principle can be circumvented by tacking7 and a bona fide purchaser for value of a legal estate without notice will override equitable interests, including the interest of a charge);
- floating charges over the whole undertaking of a company rank in priority according to the date of their creation;8 and
- security over choses in action rank in priority according to the date of notification of debtors (Dearle v. Hall).
An asset in respect of which a valid security interest exists at the time of liquidation of a Cayman Islands company or exempted limited partnership falls outside the scope of its liquidation and the secured creditor is generally free to enforce its security at any time in accordance with its terms. Upon insolvency, the assets of a company or exempted limited partnership are to be distributed in the following order of priorities (and always subject to the priority of competing security interests):
- in satisfaction of the rights of fixed charge creditors;
- in satisfaction of the expenses and costs of the liquidation (including the liquidator's remuneration);
- in satisfaction of the rights of preferred creditors (e.g., taxes, wages and certain sums due to employees);9
- in satisfaction of the rights of floating charge creditors;
- in satisfaction of the provable debts of the unsecured creditors of the company or exempted limited partnership (but having regard to priority where a creditor is subordinated to other creditors);
- in paying statutory interest on any proved debt; and
- distribution of any surplus assets to the shareholders of the company or limited partners of an exempted limited partnership, in accordance with their shareholdings or partnership interests, respectively.
v Foreign law considerations
Where a combination of jurisdictions are involved in the structure, there is an added level of complexity as different governing laws may govern different aspects of the contractual arrangements. In complex, cross-jurisdictional fund structures, while the governing law of the financing documents is usually English or New York law, the governing law of an exempted limited partnership agreement in respect of a Cayman Islands exempted limited partnership, for example, would be the laws of the Cayman Islands. In some cases, the general partner could be formed outside the Cayman Islands and in those circumstances, generally, we would expect that security over the capital call rights of the general partner will follow the governing law of the partnership agreement, although due diligence of the documentation is certainly required.
Similar issues should be considered in light of the situs of other security assets. The Cayman Islands do not generally have any mandatory provisions of law that would require Cayman Islands security to be taken over assets with their situs within the jurisdiction and courts will generally respect and give effect to valid foreign law security interests. Consideration should, however, be given to the applicable governing law and situs in the event of enforcement.
Regardless of the governing law of the security, in respect of any security taken over an asset with a Cayman Islands situs, any Cayman Islands law perfection requirements should be followed. Moreover, where the mortgagor or chargor is a Cayman Islands company or a limited partner of a Cayman Islands exempted limited partnership, the foreign law security should be noted in the register of mortgages and charges, in case of a company and in the register of security interests, in case of a security interest created over a partnership interest in a Cayman Islands exempted limited partnership.
The priority of foreign law security granted by a Cayman Islands security provider over Cayman Islands or foreign assets (assuming such security is validly created and fully perfected under foreign law), will, as a matter of Cayman Islands law, depend upon the subject matter of the security. In the case of tangible movables (e.g., a bearer bond), the question will be decided according to the situs of such tangible movable. In the case of intangible movables (e.g., debts and other choses in action), the governing law of the intangible movable or in some cases (for example, financial instruments), the lex situs will determine priority. In some cases (provided the relevant laws allow), the lender may require two carefully formulated security documents to take security over the same asset, one governed by the law of the location of the asset and one governed by the law of the finance documents. This may afford the lender flexibility to choose the most convenient jurisdiction for enforcement or insolvency proceedings.
Legal reservations and opinions practice
i Corporate benefit
The directors of a Cayman Islands company proposing to grant a guarantee or security over its assets or to guarantee or secure the obligations of another entity must ensure that this is in the best interests of the guarantor or security provider as a whole. If the guarantor or security provider does not derive commercial benefit from the transaction, the corporate benefit to the company could be called into question. In those circumstances a shareholder, creditor or liquidator of the guarantor or security provider could bring an action against the company before a Cayman Islands court, which could order that the guarantee or security be set aside.10 In addition, the directors could incur personal liability where they have breached their fiduciary duty to act in the best interests of the company, although collateral contractual provisions usually provide for broad director exculpation and indemnification.
ii Financial assistance
There are no statutory financial assistance rules under Cayman Islands law equivalent to those existing under English law.
Upon commencement of a formal insolvency process, certain transactions of an insolvent company are susceptible to challenge, pursuant to provisions of the Companies Law, as outlined below. These legislative measures derive from the common law principle that a court will not allow an entity to arrange its affairs to frustrate the legitimate interest of its creditors in the event of its insolvency.
A disposition of property made at an undervalue by or on behalf of a company with an intent to defraud its creditors shall be voidable by the liquidator. Such action must be bought within six years from the date of the relevant disposition. The burden of proof in establishing the intent to defraud lies with the liquidator. Note that creditors may in some circumstances bring fraudulent disposition claims themselves, outside of the liquidation process, in accordance with the provisions of the Fraudulent Dispositions Law.11
If in the course of the winding up of a company, it appears that any business of the company has been carried out with an intent to defraud its creditors or the creditors of any other person or for any fraudulent purposes, the liquidator may apply to court for a declaration that any persons who were knowingly parties to such fraudulent trading shall be liable to make such contributions (if any) to the company's assets as the court thinks proper. There is no prescribed time under the Companies Law prior to the winding up of the company during which the contested trading must have taken place.
Every conveyance or transfer of property or charge thereon and every payment obligation and judicial proceeding made, incurred, taken or suffered by a company at a time when it was unable to pay its debts (as defined in the Companies Law) and made or granted in favour of a creditor with a view to giving that creditor a preference over the other creditors of the company shall be invalid if it occurred within six months immediately preceding the commencement of liquidation of the company.
Clawback claims are quite rare in the Cayman Islands. Bringing a successful claim would be challenging, given the difficulty to satisfy requirements of fraudulent intent or an intent to prefer. Many of the above provisions are based on historic legislation from England and Wales, which have since been updated to lower the threshold to bring a claim. A lender with valid first ranking security is unlikely to be affected by a clawback claim in any event because the assets that are the subject of their security interest will fall outside the scope of the liquidation of the company, provided the original grant of security is not the subject of the clawback challenge.
Exempted limited partnerships
Pursuant to the ELP Law, many of the rules regulating the winding up and insolvency of Cayman Islands companies apply to the winding up of exempted limited partnerships. For instance, in principle, a liquidator of an insolvent limited partnership could bring a clawback claim. Partnership assets in respect of which valid security has been created also fall outside the scope of the dissolution of an insolvent limited partnership in the same manner as a company.
iv Recognition of foreign law and foreign judgments
The courts of the Cayman Islands will recognise and give effect to the choice of the parties to a contract of a particular governing law, if the selection was made in good faith and would be upheld as a matter of that governing law by the courts of that jurisdiction.
Where the parties have agreed to submit disputes arising out of or in connection with their contract to the courts of a particular jurisdiction, a judgment obtained in such jurisdiction (other than certain judgments of a superior court of any state of the Commonwealth of Australia) will be recognised and enforced in the Cayman Islands at common law without any re-examination of the merits of the underlying dispute, by an action commenced on the basis of the foreign judgment debt. This is provided that such judgment is given by a foreign court of competent jurisdiction and is final, for a liquidated sum, not in respect of taxes or a fine or a penalty and was not obtained in a manner and is not of a kind, the enforcement of which would be contrary to the public policy of the Cayman Islands.
As mentioned above, New York or English law tends to be selected as the governing law in financing transactions in which Cayman Islands borrowers or obligors are involved. When those facility agreements are based on LSTA/LMA forms, they are designed to be freely transferable by the lenders. Funds borrowers in particular heavily negotiate loan transfers and attempt to regulate potential eligible transferees by way of white lists, black lists or explicit transfer restrictions in the facility agreements. In addition to the provisions of the applicable facility agreement, one must also have regard to any applicable provisions of the relevant governing law to ascertain any rules regulating loan-trading transactions.
In terms of any Cayman Islands law governed security interest that has been created to secure the obligations arising under a tradable loan, the transfer or assignment provisions in the relevant security document or documents typically follow those of the facility documentation. If the loan is validly transferred to a new lender, the Cayman Islands law-governed security should also transfer upon execution of the relevant documentation.
LSTA/LMA form facilities tend to be designed as syndicated structures whereby the security interest is granted in favour of a security trustee who holds it on trust for the benefit of the secured creditors. Cayman Islands law applies common law trust principles and therefore recognises trust mechanics. Assuming that the security trustee remains in place following a loan transfer, no further registration requirements need to be completed. In other circumstances (e.g., in respect of bilateral loans, where no security agent has been appointed or if there is a change of security agent), the details of the new creditor (and security agent, if applicable), following a loan and security transfer, should be noted on the register of mortgages and charges of the borrower.
Outlook and conclusions
At the time of writing, global markets have been severely disrupted by the covid-19 pandemic, which is likely to have a material adverse impact on the global economy as cross-border commercial activity and market sentiment may be increasingly negatively impacted. These developments may produce similarly adverse consequences for underlying portfolio investments of funds, may impact fundraising or other financing activities and could materially affect funds' ability to source, manage and divest their investments and to fulfil their investment objectives or meet their loan covenants.
Lenders may also face difficulties, including pricing products beyond 12 months because of market uncertainties and experience increased pressure on liquidity and rising funding costs. It seems likely that banks' lending criteria will become stricter. This could result in smaller players falling away and non-bank lenders or banks with a focus on fund financing further increasing their market share.
Despite the continued economic uncertainty, the Funds Finance Association reported active markets in its Covid-19 Report of April 2020.12 According to the report, many funds are looking to add portfolio companies as 'qualified borrowers' in their financing to obtain liquidity at company level. The subscription facilities market recently reported no defaults by funds in respect of their financing arrangements or by investors in meeting their capital commitments. Some funds are currently pursuing new financing opportunities and considerable interest in NAV facilities has been reported.
As of April 2020, the level of undeployed capital in the private equity industry stands at a record US$1.48 trillion. As such, firms have a huge amount of capital to put to work. We expect that fund managers should be able to continue to source promising opportunities, which will require financing to close investments on short notice or to meet IRR targets as they capitalise on market volatility, notwithstanding the difficulties and disruptions caused by the pandemic. In a downturn, alternative assets and related fund finance products (in particular, NAV facilities and loan-on loan-financings) can play a critical role in creating liquidity.
We expect that, in the next 12 months, special situations funds and distressed assets investments will grow and hedge and derivatives products across the market will increase. We have also witnessed a recent shift from asset lending to portfolio financing where leveraged, real estate and project financing transactions are structured as lending to a diversified portfolio of assets instead of financing at the specific asset level. In these cases, security is taken over the portfolio or over the shares of the portfolio company holding those assets instead of at the asset level. Such structures may provide more flexibility to funds, as they are able to invest and divest assets without the need to obtain lenders' consent or modify specific security documentation, while still affording lenders an acceptable level of security.
1 Agnes Molnar and Richard Mansi are both partners at Travers Thorp Alberga.
2 See Section IV.i Charges. Charges do not transfer an interest in the secured asset but rather create an encumbrance over the secured asset that would entitle the chargor to exercise the power of sale and satisfy outstanding payment obligations out of the sale proceeds.
3 See Sections 31 and 32 of the Exempted Limited Partnership Law (2018 Revision).
4 See Section 5(2) of the Property (Miscellaneous Provisions) Law (2017 Revision).
5 See Holroyd v. Marshall (1862) 11 ER 999.
6 See Prest v. Petrodel Resources Ltd (2013) UKSC 34.
7 See Hopkinson v. Rolt (1861) 9 HL Cas 514.
8 See Benjamin Cope & Sons Ltd (1914) 1 Ch 800.
9 See Section 141 of the Companies Law (2020 Revision). Preferential debt includes wages, certain other sums to due to employees, taxes and sums due to depositors of an insolvent bank holding an 'A' licence issued under the Banks and Trust Companies Law (2020 Revision).
10 See Prospect Properties Ltd v. McNeill (1990–1991) CILR 171.
11 See Fraudulent Disposition Law (1996 Revision).
12 See Fund Finance Association – Covid-19 Response at www.fundfinanceassociation.com/wp-content/uploads/2020/04/FFA-Statement-on-Market-Conditions.pdf (9 April 2020).