Issues and solutions of commercial trusts

Ingrid Pierce, Partner, Walkers discusses her presentation to the STEP Caribbean Conference which took place last month titled ‘Leading in Turbulent Times’.

Trustees of commercial trusts are facing unprecedented market turmoil, downturn in performance and illiquidity. Trustees and managers of unit trusts have employed various techniques to manage distress, including imposing gates, side pockets, meeting redemptions in-kind or suspending redemptions. Trustees who control the voting shares of funds or special purpose vehicles must determine whether to use their power to amend the terms of the structure or to terminate it. The action or inaction of trustees could trigger events of default under certain documents and put the entire structure at risk. How should trustees approach these options in order to manage risk and properly discharge their fiduciary obligations?

Trustees are being called on more than ever to exercise their discretion to limit or suspend redemptions and to determine the proportion of cash and assets that may be used to return capital to investors. Trustees routinely take advice and rely on recommendations from fund managers, pricing agents and other service providers. However, the spotlight is clearly on the trustees themselves, who are usually the ultimate decision makers. Trustees therefore need to be able to demonstrate that they have taken into account all relevant matters and be prepared to defend their actions. The whole process can be difficult and stressful. Some may have little sympathy for professionals paid to act in this capacity but unless the trustees were only recently appointed, they could not have anticipated the global economic crisis and its impact on the funds under their control.

Investors are becoming increasingly active in their discussions with fund operators, seeking greater levels of disclosure and ventilating their complaints in the media or the courtroom. Recent cases have highlighted the importance of carefully reviewing the fund’s investment objectives and restrictions and properly determining the redemption price, in particular, if the underlying assets have fallen in value since the redemption date.

Certain investors feel strongly that if a fund is winding down its operations, the fund manager should not be entitled to receive an investment management fee, or at the very least, should receive a substantially reduced fee. There may be cases where this is appropriate but it tends to ignore the fact that as a general matter, fund managers, trustees and other service providers continue to manage and administer the vehicle even if its units or shares are not actively being offered for

A few observations about managing funds in distress: the liquidity terms of many funds no longer match the nature of the underlying investments. Placing assets into a side pocket (or segregated account) may be an option, but the documents must authorise the trustee to do so. Side pockets have traditionally been used for assets that were, on acquisition, illiquid. Investors would be issued non-redeemable units representing their interest in the illiquid assets but once the assets were deemed liquid, investors’ non-redeemable units would be converted into redeemable units, enabling them to realise capital. However, as underlying investments in funds have become less liquid, trustees have sought to hive off those assets into a side-pocket. This may or may not be permissible: investors who subscribe for redeemable units in a fund cannot simply be issued non-redeemable units without their consent. Accordingly, careful consideration needs to be given to the trust documents to ensure that trustees have the power to side pocket these types of securities and trustees should only exercise their discretion to do so if it is in the best interests of unitholders.

Suspending unitholders’ rights to redeem their units is usually permitted in certain circumstances. However it is a drastic step and one that is not lightly taken. Many trusts have been unable to lift suspensions imposed due to liquidity issues and have been forced to wind down operations and terminate. Some trustees have sought to avoid a suspension by transferring the trust assets to unitholders in order to satisfy redemptions. However it may be difficult or impossible to divide the trust assets in an equitable manner. Worse still, the transfer of assets may jeopardise the trust’s
financing arrangements.

Trustees of a charitable or STAR trust holding voting shares of a fund structure which is operated by different trustees or directors need to ensure they act in accordance with the terms of the trust instrument. This may require the trustees to carry out a particular purpose or vote their shares in a
particular way.

It is therefore crucial that trustees take appropriate advice and become fully informed about the trust’s portfolio and the effects of their actions on the interest holders in the trust.

Many investors are themselves funds and are therefore experiencing similar pressures. Trustees are therefore well advised to keep investors regularly informed of the fund’s financial position and of the major decisions taken to manage liquidity issues.

Moving forward, we anticipate that trusts will adopt modified investment strategies and seek to match liquidity terms with the underlying assets. This inevitably means that newer funds will tend to offer less liquidity or may even be structured as closed-ended vehicles. There is a trend towards broader flexibility in the trust documents although this can be something of a double-edged sword for trustees who must then exercise their discretion without the comfort of express limits within which they must operate. We have already seen an increase in the level of disclosure relating to investment risk, trustees’ ability to manage liquidity, to restructure the trust and to satisfy redemptions other than in cash, including by the transfer of interests in special
purpose vehicles.