Vol 7 (2010) - Issue 2

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Hedgehogs and Sea Urchins: Offshore Hedge Fund Litigation – A Review

The spring and summer of 2008 were difficult times for the hedge fund industry, and in particular those that operated as 'funds of funds', i.e., funds whose investment lay itself in hedge funds. The funds were exposed to illiquidity and volatility in the world markets, and funds of funds were turn exposed to delays, 'gating' and NAV suspensions by the administrators of the investee funds. Some investors saw the writing on the wall and wanted out. They served notices of redemption. What followed was a small explosion of litigation across the ‘blue water’ jurisdictions where the companies who had issued the redeemable shares to investors were incorporated.
The latter part of 2008 and 2009 saw a number of insolvency cases come to court in Cayman, the British Virgin Islands and Bermuda in which these courts had to resolve questions such as the legal nature of redemption, the status of the redeeming shareholder as having standing to serve a statutory demand or to present a petition, and the effect of NAV or redemption suspensions. The outcomes of these cases differed widely. There is no end of hedge fund litigation in sight, and so, as the new litigation year dawns, it is a good time to stand back and take stock.

Re Strategic Turnaround Master Partnership Ltd (Cayman Court of Appeal, 12 December 2008)

This is the most important of the clutch of recent cases. The company was a 'fund of funds', in which it would act as one of two 'feeders', investing its assets into an underlying Cayman-based Master Fund. There was also on-shore feeder into the Master Fund, in the shape of a Delaware limited partnership. The hedge fund investor had subscribed for shares in the fund. It made a request for redemption of their shares in the fund (i.e. the company) and elected 31 March 2008 as the redemption date, which would require the fund to calculate and make payment on 30 April 2008. On 17 April 2008, between the date on which the redemption request was served and the due date for calculation and payment, the fund suspended redemptions, purporting to exercise a contractual right under its articles to do so.
The fund did not pay and the investor petitioned to wind up the fund. The fund applied to strike out the petition. The Chief Justice refused the application. He held, among other things, (i) that the investor had effectively redeemed on 31 March 2008, (ii) that the fund became a debtor at that date in respect of the amount of the value of the shares redeemed (i.e., the redemption proceeds), (iii) until payment of the redemption proceeds, the investor remained a member of the fund, (iv) on 31 March 2008, the investor became a creditor in respect of the redemption proceeds in its capacity as a member, ranking ahead of other shareholders but after unsecured creditors, and (v) the exercise by the directors of the power of suspension of the redemption was ultra vires the article of association of the company and the Confidential Explanatory Memorandum (CEM) which together contained the terms on which the shares in the fund were acquired and could be redeemed.