Commentary: Fund directors encouraged to raise questions before launch Loop Cayman Islands

Black Immigrant Daily News

Readers are asked to note that Op-eds do not necessarily reflect the opinions or beliefs of Loop Cayman.

by Alric Lindsay

I remember when my accountant friend first started acting as a director of Cayman-based funds. He often queried why I had so many questions on the fund’s draft documentation before the fund was launched. He asked because he felt that independent directors ought to place full reliance on the fund’s lawyer to get everything right.

Over time, however, my friend learned from his own experience that lawyers are not impervious to errors or omissions. In fact, after several fund launches, he observed that some lawyers missed important items related to redemptions, side pockets and liquidating trusts.

Redemptions

In the case of redemptions, in my role as a director, I’ve seen a corporate open-ended investment fund’s articles of association where the ability for investors to submit redemption requests was absent. Having enquired of the client what was intended, the client agreed that the provisions of the articles of association dealing with redemptions should amended to allow for voluntary redemption requests.

A similar thing is seen from time-to-time in the case of compulsory redemption clauses. The normal issue here is that there may not be enough flexibility to effect a compulsory redemption without notice, which can be useful in the case of FATCA, CRS and other regulatory non-compliance.

The importance of having such flexibility becomes apparent when the fund urgently needs to compulsorily redeem an investor from the fund and the fund provisions are severely limited to the circumstances where a compulsory redemption can be exercised without notice.

For this reason, it is often good to have some level of flexibility within compulsory redemption provisions, depending, of course, on what the client’s intention is (informed by past experience with a similar fund structure).

Side pockets

Speaking of flexibility, independent directors are also encouraged to consider in advance what their options will be if a position becomes illiquid or trading suddenly halts on a listed security.

Here, designated investment provisions or side pockets can be useful, if they are incorporated in the fund’s articles of association and offering document.

Notwithstanding the usefulness of side pocket provisions, I note from experience that, sometimes clients initially didn’t wish to have these provisions in the documents because they planned to invest solely in blue chip or listed securities where they did not expect liquidity issues. Fortunately, they later implemented the provisions, which they came to appreciate when circumstances changed in respect of a position.

Liquidating trusts or spvs

Similar to side pockets, directors are encouraged to consider early what options are available to transfer assets outside the fund during times of trouble.

In the Cayman case, for example, special purpose vehicles or liquidating trusts could have been very useful in the case of sanctioned Russian investors or investors controlled by such sanctioned persons.

Unfortunately, the general licence issued by the Governor for Cayman funds initially only allowed certain service provider fees to be paid out and for non-sanctioned persons to be redeemed, which left relevant Cayman investment funds somewhat at a standstill and frozen.

If the general licence issued by the Governor had, instead, initially allowed Cayman funds to compulsorily redeem out Russian sanctioned investors or investors controlled by them, such sanctioned persons and assets attributable to them could have been placed in a special purpose vehicle. The assets of the spv could have then been frozen and, perhaps, subject to further direction from the regulator. The other advantage of doing this, of course, would be to allow non-sanctioned investors to continue with their investment in the fund and to permit the fund to continue enjoying its track record.

Templates

Regarding the provisions discussed above, I do realise that some law firms have templates to minimize or prevent errors or omission in these instances.

These templates are sometimes divided into two sets- one for quick incorporation, often used to obtain official documents for the purpose of bank account opening and the other is for post-incorporation purposes, when the memorandum and articles of association are amended and restated and aligned with the terms of the offering document.

Even in these cases, however, there can be a slip up where a set of incorporation templates remains in place after the fund’s launch and someone forgot to amend and restate the relevant provisions of the memorandum and articles.

Risk of this happening can be exacerbated when a client is using a lawyer who does not have sufficient experience with fund structures or who is advising on fund structures for the first time or by using someone who is not registered in the Cayman Islands as a lawyer and who may have no Cayman Islands legal practice certificate (regarding this, the list of registered Cayman lawyers can easily be found on the Cayman court’s website at: https://www.judicial.ky/general-public/licensed-attorneys).

Summary

The foregoing shows why it is important for independent directors to raise questions in advance of the fund’s launch with the fund’s legal counsel and the investment manager. For the most part, this is not to challenge the lawyer’s competency, but to ensure that relevant provisions are included in the fund documentation to sufficiently incorporate what is contemplated for the fund and to provide flexibility for the fund and the directors that may be exercised in the future, if and when needed.

Disclaimer

The commentary herein is in Alric Lindsay’s sole capacity as a director of Cayman-based investment funds. None of the commentary herein is legal advice. The relevant entity must seek the advice of Cayman legal counsel registered in the Cayman Islands and possessing a Cayman Islands’ legal practice certificate for definitive advice related to specific circumstances of the relevant entity.

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