A Growing Trend for Cayman Islands Private Equity Structures? Further Developments in the Law and Practice of Claims Involving Cayman Exempted Limited Partnerships

In this article, we cover

1. the commercial and legal development of ELPs as a PE investment vehicle, and their basic features;
2. the most important take-aways from the now noticeable trend of decisions on the law and practice of ELP claims in the Cayman Islands over the last few years; and
3. how the Court deployed receivers to assist in managing complex issues which can arise where claims proliferate across all parts of an ELP structure – as they often will where allegations of fraud are made by investors – in its recent decisions in The Port Fund, L.P.

Exempted Limited Partnerships

The Cayman Islands is the leading offshore jurisdiction for establishing private equity funds, with ELPs long having been the vehicle of choice. The industry has been in a sustained period of growth since the global financial crisis in 2007-2009, and consistent with that, there has been an upward trend in the number of active ELPs registered in Cayman. The number of active ELPs registered with the Cayman Islands General Registry has increased rapidly since at least 2011 – from around 11,000, to almost 37,000 in 2022.[1]

Development of the ELP as an Investment Vehicle

Although the concept of a limited partnership has existed in civil law systems since the Italian middle-ages,[2] it was only as recently as 1907 that limited partnerships were first introduced into English law.[3] As with the civil law concept, the basis of the limited partnership model initially adopted in England was that certain partners’ liability was limited to the amount of their capital contribution, but they were restricted from participating in the partnership’s management which was left to the GP(s), who was in turn liable for all of the debts and obligations of the partnership.

Limited partnerships have existed in the Cayman Islands in some form since at least 1963 based on the English model of 1907.[4] Exempted limited partnerships, however, were first introduced as a new vehicle in 1991. Since then, there have been 21 revisions or amendments to the 1991 Law, with the version currently in force the Exempted Limited Partnerships Act 2021 (the ELPA).

The introduction of ELPs removed previous restrictions on the use of ordinary limited partnerships in the Cayman Islands, making those vehicles available for use by the global mutual fund and private equity markets. The ELP was designed to provide symmetry with the corresponding law in Delaware, which had already developed a modern limited partnership model,[5] and it is now generally accepted that the adoption of the 1991 Law in the Cayman Islands was at least partly inspired by the equivalent Delaware legislation.[6]

The creation of the ELP vehicle in Cayman followed the first private equity boom in the 1980s, where the trend towards the use of limited partnerships, in combination with numerous favorable regulatory and tax changes, saw the flow of capital to private equity deals increase.[7] ELPs continue to offer significant tax advantages to investors:

1. the Cayman Islands has no corporation, income, capital gains or any other taxes applicable to an ELP conducting offshore business, and
2. GPs standardly apply to the government for an undertaking that no law which may come into force imposing any tax will apply to that ELP, its assets, or the partnership interest of any of its partners for a period of up to 50 years.[8]

An ELP Structure and Its Key Characteristics

ELPs are formed by at least one GP entering into a partnership agreement with at least one LP.[9]

Like an ordinary partnership, the general rules of equity and common law applicable between partners apply to ELPs,[10] except where they are inconsistent with the ELPA.[11]  Unlike ordinary partnerships, however, ELP LPs owe no fiduciary duties either to the ELP itself or to fellow partners.[12]

As with shareholders in a company, LPs benefit from limited liability capped up to the amount of their contribution. But in order to maintain that limited liability, LPs can have no active involvement in the business of the ELP in their capacity as LPs.[13]

Unlike companies, however, an ELP has no separate legal personality and cannot hold assets or pursue or defend claims in its own right. Instead, those assets, including “any rights or property of every description… including choses in action…” are held by the GP(s) on statutory trust for the LPs, in accordance with the limited partnership agreement.[14] There are therefore aspects of

1. trust law,
2. company law,
3. ordinary partnership law, and
4. (non-exempted) limited partnership law, which either directly apply, or can be used to provide helpful analogies to new situations as they arise in the ELP context.

The ELP’s business activities are carried out by the GP who enters into all contracts by or on behalf of the ELP, whether itself or through agents or delegates it has appointed. The GP is liable for all debts and obligations of the ELP,[15] and owes statutory, contractual and fiduciary duties to LPs, including an express duty of good faith to act in the interests of the ELP.[16] Unless varied by agreement in the LPA, the GP must provide the LPs with “true and full” information “regarding the state of the business and financial condition” of the ELP.[17]

The Recent Development of Important Areas of Law and Practice in ELP Claims

The sustained increase in ELP disputes in Cayman has now generated an increasing number of Court decisions addressing a number of important practical and legal questions relevant to private equity investors, and disputes involving Cayman ELP structures. We consider the questions addressed by other recent judgments forming part of this trend below, before turning to the matters raised by the most recent judgments involving The Port Fund, L.P. in more detail. Earlier decisions have addressed the following questions:

1. How broad is the investor’s right to obtain “true and full” information about an ELP and what are the limits to this right? See here.
2. Is the investor’s right to “true and full” information practically irrelevant where disclosure is to be given in existing legal proceedings in any event?  See here.
3. What are the main types of substantive claim available to limited partners in the context of an ELP, and in what circumstances can they sue on an ELP’s behalf? See here.
4. How do (i) investors in, and (ii) creditors of, an ELP, seek to wind up an ELP when it has no separate legal personality and operates through the GP?  See here.
5. How do the familiar corporate processes of voluntary liquidations, and court-supervised liquidations, work in an ELP context? See here.

In the recent decisions in The Port Fund, L.P., the Court has now addressed a yet further question:

• How should a battle for control of a GP be resolved, during the course of legal proceedings involving claims and crossclaims between investor LPs, the GP, the former controllers of the GP, and the ELP itself?

tHE USE OF RECEIVERS IN ELP CLAIMS – THE PORT FUND, L.P.

On 25 May 2023, and 16 June 2023, the Grand Court handed down two decisions dealing with that question.  The main protagonists were:

1. the investor LPs who had brought various claims in respect of the Fund, including in respect of fraud and misappropriation; and
2. the ultimate beneficial owner (UBO) of the GP who had been involved in promoting and managing the Fund in various capacities, and was himself a defendant to some of the investor LPs’ claims.

Background

The Port Fund L.P. (the Fund) is a private equity fund created to provide investors with the opportunity to invest in port-related assets around the world. The Fund was set up in the Cayman Islands as an ELP in 2007, raising around USD 188 million from a range of investors, including substantial commitments from prominent Middle Eastern state-owned entities.

Disputes have since arisen between a number of the Fund’s LPs and the former directors of its GP, among others.

Multiple sets of proceedings have been raised across a number of jurisdictions by LPs, including a claim in the Cayman Islands for sums in excess of USD 100 million brought by the Kuwait Ports Authority (the KPA) and the Public Institution for Social Security (PIFSS) in 2020,[18] against, among others:

1. Port Link GP Ltd (the General Partner, also referred to in the proceedings as D1) – a Cayman Islands exempted limited company;
2. Mr. Mark Williams (Mr. Williams, also referred to as D2) – a US citizen, former authorised representative and UBO of the General Partner/D1;
3. Wellspring Capital Group, INC (D3); and
4. KGL Investment Company Asia (D4), both entities related to Mr. Williams.[19]

The UBO of the General Partner/D1 (Mr. Williams/D2) was also involved in the running of the Fund in various capacities.

ELP arrangements with one or a few individuals wearing many different hats across the structure are standard in Cayman Islands PE funds. Such arrangements work well when relations between investors and those running the fund are good. However, and as the Port Fund proceedings demonstrate, matters can become significantly more complicated when those relationships begin to breakdown and claims begin to be asserted by investors.

In circumstances where complaints are made by LPs which then escalate to claims against the GP, often those in control of the GP will appoint independent directors to the GP’s board to try to provide some level of comfort to the complaining investors. Those directors are appointed to act independently of the existing or former management team, or other related individuals, including UBOs of the GP (albeit that they will often be funded by them).

Claims and proceedings by LPs can escalate further and begin to be asserted across, against, and between all parts of the ELP structure including in the form of counterclaims and crossclaims between multiple parties, within the same proceedings, such as:

1. direct claims by the investor LPs, against the GP;
2. derivative claims by LPs on behalf of the ELP against the UBO of the GP, and others;
3. the UBO of the GP, against the GP; and
4. the GP, against the LPs.

Two potential consequences of this highly complex scenario which have played out in The Port Fund, L.P., are

1. a lack of funding of the GP’s independent directors, and legal counsel, leaving the GP with a governance void despite its involvement as claimant and defendant to many of the claims being asserted in the proceedings; and
2. an urgent need to ensure that all claims are asserted and defended fairly and appropriately, including by being controlled by appropriate parties.

In The Port Fund, L.P., Mr. Williams had appointed independent directors to the board of the GP in 2020. The independent directors took over conduct of all relevant litigation since that point, and were funded by a corporate entity which previously owned 100% of the GP.  However, in February 2023, the independent directors and their Cayman Islands attorneys resigned, apparently because the GP was not able to pay their professional fees.

These circumstances created a significant and novel challenge for both:

1. the Plaintiffs; in having to bring applications to deal with the issues arising from the General Partner’s lack of decision-makers; and
2. the Court; in considering the best approach in light of all of the applications which followed, as explained below, to ensure that all claims and defences were being asserted and defended fairly and appropriately, by the right parties.

The Receivership and Joinder Applications

The situation which arose at the General Partner/D1 in February 2023, leaving the company without directors or officeholders, was said by the Plaintiffs to be concerning because:

a)   the General Partner/D1 was left unable to prosecute or defend the claims involving it either (i) in its own right, or (ii) in its capacity as General Partner of the Fund, and, therefore, statutory trustee of the Fund’s assets; and

b)   the General Partner/D1 was incapable of acting independently of Mr. Williams/D2 as its UBO.[20]

The GP’s ability to defend the claim being brought against it by Mr. Williams/D2 as its UBO was of particular concern to the Plaintiffs, who each considered themselves to have significant individual economic interests in its outcome; and which, if successful, had the potential to significantly reduce or completely extinguish the investor LPs’ own claims against D2-4. In those circumstances, and in light of the Plaintiffs’ significant majority interest in the Fund, the Plaintiffs took the view that they had the primary economic interest in the outcome of Mr. Williams’ claim against the GP, and for that reason should be allowed to defend it alongside the GP by being formally joined as co-defendants. The Plaintiffs also took the view that independent office holders should be put in place to ensure that the General Partner/D1 could act independently of Mr. Williams/D2, particularly in conducting its defence to the claim brought against it by him, but also in its conduct of the proceedings more broadly.

The Applications

In order to address these concerns, the Plaintiffs filed applications novel in an ELP context seeking:

1. to appoint Receivers/Managers over the assets of the General Partner/D1 with broad powers to preserve the General Partner/D1 and manage the litigation on its behalf as they see fit, with funding to be provided by the Plaintiffs (the Receiver Application); and
2. for the Plaintiffs to be joined as defendants to the Crossclaim brought by D2-4 against the General Partner/D1 pursuant to Grand Court Rule (GCR) Order 15, r.6(2)(b) (the Joinder Application) (together, the Applications).

Mr. Williams/D2, D3 and D4 strongly opposed the Applications, expressing concern that the Plaintiffs’ true motivation was to take control of the General Partner/D1, the Fund and the proceedings overall, and that the appointment of receivers was not necessary in circumstances where the alternative, and more conventional, remedy of appointing independent liquidators was available, including because the GP appeared to be cash-flow insolvent. As to the application for the investor LPs’ joinder as co-defendants to their claim against the GP to ensure that was properly defended, Mr. Williams/D2 and D3-4 asserted that this was not permitted by section 14 or section 33 of the ELPA (as impermissible management of the Fund (s14), and impermissible defence of claims against the ELP by those other than the GP (s33)).

The crux of the two Applications was obviously a battle for control of the GP, with each side keen to install their own preferred choice of officeholder to fill the governance void, and each accusing the other of having control of the GP as an ulterior motive.

The Judgment – Receivers Appointed; Joinder Permitted

The Court granted both Applications, first, by appointing the Plaintiffs’ choice of Receivers with powers restricted to the conduct of litigation involving the General Partner and/or the Fund only, commenting: “The crux… is control of the General Partner…”,[21] and secondly, by joining the investor LP Plaintiffs as Co-Defendants to the claim brought by Mr. Williams/D2 and D3-4 against the GP (the Receivership Judgment).

Joinder

As to joinder, the Court held that neither section 14(1) nor section 33 of the ELPA bar LPs from defending counterclaims or crossclaims brought in the context of derivative claims on behalf of the Fund:

1. defending claims in their personal capacities did not constitute the LPs impermissibly managing the Fund for the purposes of section 14(1); the Plaintiffs were already litigating derivative claims on behalf of the Fund, having been permitted to do so by the CICA under s.33(3) of the ELPA;
2. the permission the Plaintiffs have already obtained from the CICA to bring derivative claims under s.33(3) must include the ability to defend any counterclaims or crossclaims within those derivative proceedings, where those counterclaims and cross-claims were “inextricably linked” with the claims themselves:[22] “it would be illogical and unfair if that derivative claim could be pursued on behalf of the partnership, but the limited partner not be permitted to defend a counterclaim or a crossclaim…[that] could stymie the derivative claims from properly proceeding.”[23]

The Court also held in this context:

1. there is a wide and flexible jurisdiction to permit joinder in the interests of justice, and a wide discretion to do so when appropriate;[24] and
2. it would not be in the interests of justice for Mr. Williams/D2 to be permitted to both advance the Crossclaim against the General Partner/D1, and to control the General Partner’s/D1’s defence of that same Counterclaim.[25]

Receivers

Taking a cautious approach, the Court was persuaded that it was just and convenient to appoint Receivers with powers restricted to the conduct of litigation involving the General Partner and/or the Fund, notwithstanding D2-4’s resistance and their suggestion of liquidation as the more natural and appropriate alternative remedy.

It was held that

1. the purpose of the appointment of the Receivers is “for an independent professional to manage the complex litigation on behalf of the General Partner reasonably and efficiently”[26];
2. it was just and convenient to appoint Receivers “for the purpose of ensuring that there is a professional, independent, and impartial office holder in place who will regularly report to the Court and… ensure the interests of the General Partner in the litigation are monitored, protected, and advanced appropriately”[27];
3. “the General Partner’s interests will be advanced on an objective, reasonable, and independent basis free from the improper influence by any of the protagonists in the litigation”[28]; and
4. “An independent, court-appointed Receiver would be the most appropriate means by which to manage the litigation concerning the [General Partner] and therefore, in this regard, the business and assets of the [Fund].”[29]

The Court preferred the appointment of receivers over the suggested preferable alternative of liquidators as

1. liquidation is not the natural or obvious remedy to the incapacity issue at the General Partner/D1 in circumstances where was no evidence of any creditor’s petition against the General Partner, or that it is cash flow insolvent;[30]
2. a liquidation would result in a statutory stay of all proceedings concerning the General Partner/D1;[31]
3. in instances where the Court must choose between liquidation and receivership, liquidation would be the more invasive remedy;[32]
4. liquidation would sound the ‘death knell’ for the General Partner/D1, and liquidators would assume full control going forward;[33]
5. “A liquidator is a remedy of last resort and the Court has formed the view that it is not appropriate, necessary or desirable at present”;[34] and
6. the issue which concerned the Court was the incapacity of the General Partner/D1 in the context of claims and crossclaims in litigation, not, “at least on presently available evidence” insolvency.[35]

Subsequent events

Shortly after the hearing of the Applications, but before the Receivership Judgment was handed down, Mr. Williams in his capacity as UBO of the General Partner/D1 chose to place the General Partner/D1 into voluntary liquidation and appoint his own choice of joint voluntary liquidators (JVLs), an action which had been somewhat foreshadowed in D2-4’s submissions.

This development was known to the Judge before the Receivership Judgment also appointing the Receivers was delivered, as a result of a related injunction application by the Plaintiffs which was refused at the time it was heard (the Injunction Application).[36]

The judgment giving reasons for the refusal of the Injunction Application was published on 16 June 2023 (the Injunction Judgment).  By that decision, the Court held that that Mr. Williams/D2 had not breached an undertaking given to the Plaintiffs by appointing the JVLs when he did, because the undertaking in question had expired by the time of the appointment, and there was therefore no serious issue to be tried – one of the key principles for granting injunctive relief.[37]

There are therefore now both JVLs and Receivers in place at the General Partner/D1 at the same time, with the same Judge reserving any matters arising from the appointment of the JVLs to himself.[38]

The Receivers are appointed to conduct legal proceedings involving the Fund or General Partner, and the effect of the voluntary liquidation is to set the Cayman Islands corporate winding up regime in motion in parallel.

Therefore, and despite all of the Court’s best efforts to react effectively to and help manage the legal complexities arising from a proliferated set of disputes which have arisen across this standard private equity structure, the issues arising from the resignation of the General Partner’s independent directors remain unresolved.

A key factor is clearly the power which can be wielded by UBOs in these structures, as Mr. Williams’ decision to place the General Partner/D1 into voluntary liquidation presents the Court with yet another layer of complexity to grapple with, likely in the context of a contested application by the JVLs to bring the liquidation under court supervision.

Conclusion

Given the structure in The Port Fund, L.P. is relatively standard across Cayman Islands private equity funds, the current increase in ELP related-disputes, and the potential for aggressive complaints/litigation by investor LPs then leading to a proliferation of claims and crossclaims across an ELP structure; the practical approach taken by the Court in these decisions in The Port Fund, L.P. now form an important part of what is a rapidly-growing Cayman Islands tool-kit for future complex ELP disputes.

[1] Partnerships Statistics – Cayman Islands General Registry | An official website of the Cayman Islands Government (ciregistry.ky).
[2] According to the leading text of Lindley & Banks on Partnership ([1.04] – [1.13]), as a means for the nobility to engage in trade, without ‘disgracing’ themselves by direct involvement (and allowing indirect investment in a commercial enterprise with, trusted merchants, sharing profits, but without liability beyond their contributions).
[3] By the enactment of the English Limited Partnerships Act 1907.
[4] When the Revised Edition (Laws of the Cayman Islands) Law included at Chapter 118 a law passed in Jamaica in 1853 named “The Partnerships (Limited) Law.”
[5] Via the Delaware Revised Uniform Limited Partnership Act.
[6] A Cohen and C Williams: “A Comparison by Practitioners of Delaware and Cayman Islands Limited Partnerships” (2011, Bloomberg Law Reports) at page 3.
[7] The Economics of the Private Equity Market, Board of Governors of the Federal Reserve System (1995), pg. 11.
[8] Section 38, ELPA.
[9] Section 4(2), ELPA.
[10] As modified by the Partnership Act (2013 Revision) but excluding sections 31, 45 to 54 and 56 to 57.
[11] Section 3, ELPA.
[12] Section 19(2), ELPA.
[13] Section 14(1), ELPA.
[14] Section 16(1), ELPA.
[15] Section 4(2) and 20, ELPA.
[16] Section 19(1), ELPA.
[17] Section 22, ELPA.
[18] Kuwait Ports Authority et al v Port Link GP et al (FSD 236 of 2020 (RPJ)).
[19] Note that the Plaintiffs have since amended their pleadings to add further Defendants D5 – 9, but it is not necessary to consider those amendments for present purposes.
[20] This is because, in the absence of directors, any decisions by the General Partner had to be made by its sole shareholder, a US entity controlled by Mr. Williams/D2.
[21] [110] of the Receivership Judgment.
[22] [77], ibid.
[23] [79], ibid.
[24] [84] ibid.
[25] [90], ibid.
[26] [110], ibid.
[27] [111], ibid.
[28] [111], ibid.
[29] [112], ibid.
[30] [124], ibid.
[31] Section 97, Companies Act (2023 Revision).
[32] [126] of the Receivership Judgment.
[33] [126], ibid.
[34] [128], ibid.
[35] [129] – [130], ibid.
[36] [137], ibid.
[37] [24] – [25] of the Injunction Judgment.
[38] [141] of the Receivership Judgment.