Cayman fund companies gain merger flexibility

Until recently, a Cayman fund company could only combine with another fund company by way of “arrangement”, which required the parties involved to petition the Court for approval, or via a somewhat cumbersome asset transfer process. The latter was used more commonly to avoid the potentially more costly and time consuming court-approval process.
 
The Companies (Amendment) Law, 2009 (“New Law”) allows a “merger” whereby one company remains as the surviving company, having in effect absorbed the other merging/terminating company that is then struck off and ceases to exist.  By comparison, the New Law also allows a “consolidation” whereby a new company is formed from the combination of each participating company. The participating companies, as a consequence, cease to exist and are each struck off by the Registrar of Companies (Registrar).
 
Appleby recently advised on the “merger” of two mutual funds registered with the Cayman Islands Monetary Authority. The client wanted one of its larger mutual funds (Surviving Fund) to absorb one of its smaller mutual funds (Terminating Fund) in order to make the Surviving Fund (which had quite similar investment objectives and restrictions as the Terminating Fund) even more substantial in size.
 
The old options
 
In the past, the lawyer would have advised the client to follow the asset transfer process mentioned above, but the New Law presented another option.  Naturally, a client would query the advantages and disadvantages of both options.
 
The transfer process has its advantages. Firstly, there is no mandatory level of shareholder approval to obtain. Shareholders in the Terminating Fund would be asked to consider transferring their investment to the Surviving Fund by subscribing “in-kind” by way of their shares in the Terminating Fund. The Surviving Fund would then become the sole shareholder of the Terminating Fund by means of share transfers from the Terminating Fund’s shareholders. Thereafter, the Surviving Fund can submit a redemption request to the Terminating Fund in respect of the shares it holds in the Terminating Fund. Such redemption requests could then be satisfied “in-kind” by way of the transfer of the assets of the Terminating Fund to the Surviving Fund.
 
Secondly, creditor approval is not required (unless the assets in question are subject to a charge or mortgage).  Thirdly, there is no need to seek the approval of any Cayman Islands authority.
 
There are however notable disadvantages. For example, if any of the shareholders of the Terminating Fund do not opt to subscribe for shares in the Surviving Fund, the Terminating Fund would need to exercise its right to compulsorily redeem non-consenting shareholders which some may find displeasing.
 
In addition, once all shareholders exit the Terminating Fund (excluding the client which held the non-participating management shares); the Terminating Fund ends up as a shell which should be terminated by entering into voluntary liquidation. The client will therefore incur additional expense and the process takes at least four weeks. Indeed, the Terminating Fund could apply to be struck-off by the Registrar, which is less expensive. However, for a fund that operated, even if it was relatively small, a strike off does not ensure finality as a director, shareholder or creditor could apply for a fund company to be reinstated.
 
Further, from a practical standpoint, the transfer of the assets from the Terminating Fund to the Surviving Fund could be a tedious process, may involve adverse tax consequences and may not be practical depending on the nature of the relevant assets.
 
Alternatively, there is also a compulsory liquidation method that is used from time to time.  In this option the Terminating Fund transfers its assets to the Surviving Fund in consideration for shares in the Surviving Fund.  The Terminating Fund then compulsorily redeems its shares in kind or liquidates in kind, pursuant to which the shareholders in the Terminating Fund become shareholders in the Surviving Fund.  If this option is used it is not necessary to seek the investors’ agreement to transfer their shares to the Surviving Fund.  Also, it should not be necessary to seek their consent to this process, provided the redemption terms, investment objectives and service providers for the Surviving Fund are the same as those for the Terminating Fund. However, in order to use the compulsory liquidation method, the fund documents would need to be flexible enough to allow for compulsory redemptions in such circumstances.
 
The new option
 
The New Law offers a more streamline procedure. It specifically provides that the effect of the merger is that all property and debts/liabilities (which is key for any creditors) of the Terminating Fund shall immediately vest in the Surviving Fund.  Additionally, upon the merger becoming effective, the Registrar arranges for the Terminating Fund to be struck off.
 
The New Law requires certain procedural steps to be undertaken before the Registrar will issue a Certificate of Merger.  This may be viewed as a disadvantage.  Namely, the directors of both funds must approve a written merger plan setting out certain details, including any proposed amendments to the existing constitutional documents, the terms and conditions of the merger, and the names of any secured creditors and the nature of the secured interests.
 
The plan must be approved by the shareholders, regardless of whether their shares carry voting rights or not, either: (i) by a resolution of the majority in number representing 75% in value of the shareholders voting together as one class; or, (ii) if the shares to be issued to each shareholder in a surviving company will have the same rights and economic value as the shares held in a terminating company, then by special resolution of the shareholders voting together as one class.
 
The consent of each secured creditor of the Terminating Fund and the Surviving Fund must also be obtained, provided that if such consent is not granted, the relevant fund could apply to the Court to have the requirement for secured creditor consent waived.
 
Once approved by shareholders and creditors, the plan must be submitted to the Registrar together with, for each fund: (i) a certificate of good standing; (ii) a director’s declaration that: (a) the Surviving Fund is and the Terminating Fund will be, immediately after the merger, able to pay its debts as they fall due, (b) the position of the unsecured creditors will not be prejudiced by the merger; (c) a statement of the assets and liabilities made up to the latest practicable date prior to such declaration (which could be satisfied by submitting the most recent audited financial statements of each fund); and (iii) an undertaking that a copy of the Certificate of Merger will be given to all shareholders and creditors and published in the Gazette.
 
Deciding which way to go
 
Despite the requirement for shareholder and secured creditor approval, many may prefer to follow the merger option under the New Law, not viewing shareholder or secured creditor approval as an onerous obstacle. Some parties may see benefits from an investment in the Surviving Fund and no material change in their positions.
 
Moreover, a merger under the New Law can be carried out quicker.  If director and shareholder approval can be arranged in a couple of weeks and secured creditor consent be obtained in short order, then the termination of the Terminating Fund would be dealt with automatically by the Registrar, and they could avoid the need for additional shares to be issued to investors or for investors’ shares to be redeemed.
 
Regulatory requirements
 
In either case, the Terminating Fund will need to de-register from CIMA.  To successfully de-register the Terminating Fund, the usual documents required by CIMA for de-registration of a fund must be submitted together with a copy of a Director’s affidavit regarding the merger, which exhibited the merger plan filed with the Registrar.  It is believed that CIMA intends to issue an updated Statement of Guidance to confirm the requirements for de-registering a fund that has merger with another fund.  The Terminating Fund should also be up-to-date with the payment of its annual CIMA fees and the filing of its audited financials.
 
In summary
 
All in all, the New Law serves to fill a significant ‘gap’ in Cayman corporate law and provides another viable option for combing two funds. The particular facts of each case will dictate whether funds will follow the merger option under the New Law or the more traditional asset transfer process.
 
Disclaimer: This article consists of general information only and is not intended to be legal advice. Whilst every effort is made to ensure the accuracy of this information, legal advice should be obtained from a qualified lawyer on any legal matter.

legallyspek

Legally Speaking by (L to R) Appleby Associate Andre Ebanks and Partner Bryan Hunter

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