The Privy Council has published its decision in an appeal as to whether redemption payments made by an insolvent company (“Weavering”) were preferences over other creditors of the company. Bedell Cristin acted in the case.
On 29 July 2019, the Judicial Committee of the Privy Council (“PC”) published its decision in an appeal as to whether redemption payments made by an insolvent company (“Weavering”) were preferences over other creditors of the company under s.145(1) of the Cayman Islands (“Cayman”) Companies Law (“Law”). The payments were made to a bare nominee (“SEB”), which had passed those payments on to its client principals before it received any request to either repay or hold on to the redemption payments. The case also looked at the position where the Net Asset Value (“NAV”) was set incorrectly as a result of internal fraud where the company was complicit in setting the incorrect value, as opposed to where the NAV was set incorrectly by external fraud (i.e. by an administrator). The PC concluded that the payments were preferences and that on policy grounds, a change of position defence was not available.
What happened in this case?
Weavering was incorporated in April 2003 as an open-ended investment company, established as an exempted company with limited liability under Cayman law. SEB held redeemable “Participating Shares” in Weavering as a nominee on behalf of two Swedish mutual funds. SEB gave two notices of redemption of its shares in accordance with the terms of Weavering’s offering memoranda. Weavering made three payments to SEB:
- on 19 December 2008, Weavering paid SEB in respect of the first notice; (First)
- on 2 January 2009 it paid 25% of the amount due in respect of the second notice; (Second)
- on 11 February 2009 it paid the remaining 75% due on the second notice. (Third)
How did that become an issue?
On 5 March 2009, Weavering’s directors became aware of issues which would affect the company’s solvency. They resolved with immediate effect to suspend determination of the net asset value (“NAV”) and the issue and redemption of shares. On 19 March 2009, Weavering entered liquidation. The Joint Official Liquidators (“JOL”) appointed to Weavering argued that the redemption payments made to SEB were preferences and invalid under s.145(1) of the Law. They applied to the Cayman Grand Court for an order that SEB repay to them all of the redemption payments: US$8,217,761.54 plus interest.
How did this get to the Privy Council?
At first instance, the Grand Court agreed with the JOLs and found the redemption payments to SEB were invalid as preferences over Weavering’s other creditors. SEB was ordered to repay the redemption payments to the JOLs together with interest and costs. SEB appealed to the Cayman Islands Court of Appeal (“CICA”), which dismissed the appeal. SEB then appealed to the PC on six points.
What were SEB’s six points of appeal?
(1) The fraud point
Weavering’s directors set a fraudulent value to its assets and therefor to its NAV. SEB argued that, as a result of this internal fraud, the published NAVs were not binding. There was authority to say that a NAV set as a result of external fraud would be binding, but this did not apply where the company was complicit in setting a fraudulent NAV. Without a valid NAV, none of the share redemption notices were valid. Because of this, no redemption payments were due and no shareholder had become a creditor. If no one was a creditor, then no payment to SEB could be regarded as a preference to one creditor over the others. Payments to SEB might be reclaimed as “money had and received”, but not as preference payments.
(2) The 30-Day point
At the time of the December 2008 payments to SEB, the 30 day grace period within which Weavering had to pay other redeeming shareholders had not expired. As those redemptions were not due and payable, Weavering was not insolvent at the time it made the December 2008 payment to SEB. SEB argued that in deciding to the contrary, CICA misinterpreted a case which established when shareholders became creditors. Even if it was right to say that those redeeming their shares were creditors, they were still not entitled to payment before the end of the grace period.
(3) The future debts point
In determining whether Weavering was cash flow insolvent within the meaning of s 93(c) of the Law, CICA took into account future debts. SEB argued that in deciding to do so, CICA wrongly followed a UK Supreme Court decision, which was based on the UK’s solvency test. SEB argued CICA should have applied the Cayman solvency test under s 93(c) of the Law, which turns solely upon the ability to pay existing debts.
(4) The intention to prefer point
For a payment to be a preference under s.145(1) of the Law, the debtor has to have had the intention to prefer one creditor over another. CICA found that Weavering made the Second and Third Payments “with a view” to giving SEB a preference over other creditors, because Weavering’s head, Magnus Peterson, “knew that the Company had no prospect of paying the January Redeemers and February Redeemers in full…”. SEB argued that CICA should have found the test for an intention to prefer involves substantially more than the debtor knowing that in paying “A” it could not pay “B”. Mere knowledge does not create an intention to prefer, there must be “something approaching dishonesty”: Re Kushler Ltd . Even if this means no more than a lack of commercial propriety, there was no evidence that Weavering’s lawful policy of paying December 2008 redeemers 25% immediately and the rest later (the “25/75 Policy”) was improper.
(5) The amendment point
SEB argued that if its appeal succeeds in respect of the Second and Third payments, the First payment would have been made in January/February 2009 in accordance with the 25/75 Policy and so could not be a preference.
(6) The repayment issues point
SEB argued that should the PC conclude that the payments were preferences, the proper claim for repayment is under common law for “unfair enrichment”. Section 145(1) of the Law does not create a statutory cause of action for the recovery of preferential payments, it provides only that a preference is “invalid”. As well as defences at common law, SEB was never enriched as it acted as a bare nominee for mutual investment funds. It paid the redemption proceeds to those funds. In doing so it suffered an irreversible change of position because it had no means to recover those payments if the redemption payment was ultimately set aside as invalid.
What did the Privy Council decide?
The PC decided that the payments SEB received were preferences. Although equitable defences were available to SEB, the policy of ensuring that all creditors were paid pari passu overrode the equitable principles that would allow a “change of position” defence. The PC recognised that this gave rise to a “harsh result” and commented that legislation in other jurisdictions has addressed this situation to mitigate against such a result. An interesting feature of the decision was a majority finding on the Fraud Point that internal fraud meant the NAV was not binding. This was on the basis that those setting the NAV were not doing so in good faith. The PC found that situation was distinguishable from that in Fairfield Sentry Ltd v Migani  where those within the company who were setting the NAV were completely unaware of the Madoff fraud that had affected the NAV.
What next for nominee shareholders in Cayman companies?
This decision means that all nominee shareholders in Cayman companies are vulnerable to preference claims. There are some aspects of the decision which suggest there may be ways to avoid this kind of result by constructing a contract which avoids a trustee relationship in regard to redemption payments. This will need careful attention, pending any of the legislative changes the PC suggested might be desirable.
Bedell Cristin acted for SEB in this case and has many years of experience in all forms of disputes arising from fund liquidations and receiverships. If you would like further information on how we can help, please contact partners Laura Hatfield or Kai McGriele, or managing associate Tom Wright.