Interesting times for hedge fund litigators

Insolvency professionals from around the globe convened at the Marriott Hotel in Grand Cayman late last year to attend the one day INSOL International Seminar. One of the highlights of the conference programme was the panel discussion on hedge fund litigation.  The Journal reports.

Moderated by Ross McDonough (Campbells partner and World Finance’s Cayman Islands Insolvency and Restructuring Lawyer of the Year for 2009), the illustrious panel comprised Chief Justice Anthony Smellie, David K. Momborquette (a partner at Schulte Roth & Zabel LLP in New York) and David Allison (an English barrister and member of 3-4 South Square Chambers in London).
McDonough opened the session and commented that as a result of recent global financial turmoil there had been a marked increase in hedge fund litigation in 2009 much of it being conducted before the court in the Cayman Islands. This had led to the courts having to regularly deal with novel issues which head never previously been addressed but upon which his panel were going to attempt to throw some light.
The Chief Justice was unable to attend on the day due to urgent official business.  In his absence, McDonough delivered the Chief Justice’s presentation on the topical questions of when winding up procedures are available to investors in funds which have suspended redemptions of their shares, and how long a fund can avoid formal liquidation proceedings by remaining in suspension. 
His presentation discussed the difficulties which a shareholder faces in having a fund wound up voluntarily in circumstances where either his shares carry no voting rights or, even if he does have the right to vote, he does not know the identity of the fund’s other shareholders and may lack sufficient shares himself to requisition a shareholders’ meeting or to ensure that a winding up resolution is passed at that meeting. 
The presentation then turned to the question of whether a disgruntled investor could resort to the remedy of presenting a winding up petition on just and equitable grounds against a fund which is solvent and a going concern, but which nevertheless remains in suspension.  The Chief Justice expressed the view that the Court of Appeal may have settled this issue by upholding the Grand Court’s decision to refuse to strike out an investor’s just and equitable petition against the fund in the Matter of Strategic Turnaround Master Partnership Limited.  However, his presentation drew the delegates’ attention to the recent and as yet unresolved appeal in the Matter of Camulos Partners Offshore Limited, in which the fund is arguing that a just and equitable petition is inappropriate in a situation where the fund has none of the characteristics of a quasi partnership.
The Chief Justice’s presentation concluded by considering a question which has not yet been determined by the Cayman Courts, namely how long a fund can stay in suspension and avoid a formal liquidation.  The answer depends on the facts of every case, but the Chief Justice was of the view that the Court could clearly exercise its discretion to make a winding up order if the fund’s management were giving no indication of when the suspension might be lifted.  He tentatively suggested that factors such as the length of the suspension, management’s reasons for it remaining in place, management proposals to permit redemptions and the views of investors would all weigh heavily in the balancing exercise to be performed by the Court.
Momborquette then spoke on the New York law principles applicable to resolving the problems of conflicting provisions in poorly drafted constitutional documents of a fund. 
He also addressed the delegates on claims which might be made by the trustees of a fund operated as a ponzi type scheme to claw back redemption proceeds paid to investors based on artificially inflated net asset values, and on the defences which might be available to such claims under New York law, including good faith, in pari delicto, the legitimacy of the trades, statute of limitations and venue and choice of law arguments. 
Momborquette’s presentation concluded with an analysis of state fiduciary law, state common law and federal and state fraudulent transfer law claims which might lie against a fund’s service providers in circumstances where its net asset values have been fraudulently inflated by management.
Allison then considered claims based on artificially inflated net asset values from the defendant service providers’ perspective, and in particular the scope and status of their contractual rights of indemnity against the fund, and the approach which liquidators of a fund must take in considering and dealing with service providers’ indemnity claims.
He then gave an interesting and topical analysis of the question of when a redeeming investor becomes a creditor of an investment fund, and reviewed the well publicised ruling of the Cayman Islands Court of Appeal in the Strategic Turnaround case (which is currently on appeal to the Privy Council), the Grand Court’s subsequent decision in the Matter of Matador Investments Limited, and the judgment of the British Virgin Islands High Court in SV Special Situations Fund Ltd v Headstart Class F Holdings Limited.  
McDonough concluded by thanking his panel and noting that these were indeed interesting times for hedge fund litigators.


Ross McDonough