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04 April 2013
On March 11 2013 the Court of Appeal of the Eastern Caribbean Supreme Court(1) handed down an important ruling on the question of where investors stand in the 'waterfall' of distributions in the liquidation of investment funds under BVI law. The court affirmed the widely held industry view that debts owed to former members for redemption proceeds confer on them deferred creditor status. Thus, they rank behind the company's external creditors, but their claims have priority over the interests of continuing members in the liquidation of a BVI company.
The decision brings certainty to the position and will be welcomed by investors, particularly those with secondary market positions, and insolvency practitioners which may now proceed to make distributions with clarity.
While conventional practice in insolvency law is for creditors to take priority over members, and that between themselves members rank pari passu (on equal footing) according to their shareholdings, the generality of these two maxims was called into question following a first instance commercial court decision in November 2012. At first instance it was held that an investor which had redeemed its shares in the fund and was owed redemption payments ranked alongside continuing investors which had not redeemed their positions.
Section 197 of the Insolvency Act 2003 provides only for an adjustment to be made between redeemed members and continuing members, but without particularising how this adjustment should be made. At first instance, the commercial court considered that this provision does not specifically stipulate that continuing members should be subordinated to redeemed members. Further, the court was reluctant to create an intermediary class of claims not expressly contemplated by the legislation, even where, as is customary, the fund's memorandum and articles of association clearly describe redeemed members as creditors and that their debts are liabilities owed to them by the company. Instead, it was held that redeemed members ranked pari passu with continuing members. Their respective rights to share in the surplus were valued by reference to the net asset value at the time of redemption (in the case of redeemed members) or their initial subscription price (in the case of continuing members).
However, the court of appeal found that the adjustment provisions of Section 197 provide for 'inside' creditors (eg, former fund members) to be given priority of distribution against continuing members after the payment of external creditors, but before distribution of the residual surplus. In addition, it was held that the application of the subscription price as a means for determining the rights of continuing members to share in any residual surplus was flawed as a matter of BVI law. Instead, the relevant provisions of the memorandum and articles of association or, in the absence of specific provisions, the default position in Section 34 of the Business Companies Act, should be applied in determining the rights of continuing members and redeemed members to participate in the distribution of the fund's surplus assets.
A number of liquidators were eagerly awaiting this judgment before making any distributions to ensure that a clearly defined route forward is in place. Therefore, this judgment provides welcome clarity for investors and liquidators by laying down a clear priority of distributions for vehicles in liquidation. It also realigns BVI insolvency law with the orthodox position found in most other fund domiciles.
For further information on this topic please contact Phillip Kite, Ross Munro or Andrew Thorp at Harney Westwood & Riegels by telephone (+1 284 494 2233), fax (+1 284 494 3547) or email (firstname.lastname@example.org, email@example.com or firstname.lastname@example.org).
(1) Somers Dublin Ltd A/C KBCS v Monarch Pointe Fund Limited (In Liquidation). The full judgment is available at www.harneys.com/files/Monarch-Pointe.pdf.
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