Oakwise - Creditors' Considerations for Receivership Orders in SPC Structures

SEGREGATED PORTFOLIO COMPANIES

In the Cayman Islands, SPCs are a creature of statute under the Act.[1] An SPC is a single legal entity containing various internal portfolios within the company umbrella.[2] It can issue shares and declare dividends on its own account, but also in relation to each segregated portfolio,[3] even though the latter do not have their own separate legal personality.[4] Importantly, the assets and liabilities of each portfolio are ring-fenced from the other portfolios and from the SPC itself.[5] This is known as the segregation principle.[6]

Accordingly, SPCs have value in circumstances where a group structure of various companies would have otherwise been necessary to give effect to a commercial venture. They are particularly popular for investment funds (particularly, master-feeder funds and multi-class funds), insurers (particularly, captive insurers and reinsurers) and structured finance vehicles. For insurers and investment managers, the segregation principle allows insurance risks, or liabilities arising from a particular investment, to be isolated from the risks (and assets) of the other portfolios.

TREATMENT DURING INSOLVENCY

Liquidation

The Act provides for the treatment of SPCs during insolvency. An SPC can be wound up voluntarily or by the order of the Grand Court.[7] However, it is the SPC, rather than a particular portfolio, over which an official liquidator is appointed.[8] Importantly, the liquidator must continue to observe the segregation principle during liquidation.[9] Therefore, they can only discharge claims from the assets of the relevant portfolio (and they have no right to claim against the general assets of the SPC).

Receivership

The Act also confers jurisdiction on the Court to make a receivership order over one or more segregated portfolios of an SPC.[10] A receiver can have wide-ranging powers, including any of the usual statutory powers of a liquidator with Court approval, if appropriate in the circumstances.[11] Such powers might include conducting investigations into the affairs of a portfolio and reversing transactions regarded as a voidable preference or fraudulent disposition. In addition, once a receiver is appointed, the directors of the SPC will cease to have power in respect of that portfolio,[12] the receivers will be able to attend and vote at SPC board meetings,[13] and they can bring proceedings in the name of the SPC on behalf of the portfolio[14] (and a statutory stay will be in place in respect of claims against the portfolio).[15]

OAKWISE

In Oakwise, a creditor unsuccessfully sought a receivership order in seeking recovery from a portfolio. Below we set out the legal test for appointing a receiver; the facts and decision of Oakwise; and our observations on the decision.

The test under the Companies Act

Receivership orders are made under section 224 of the Act. The Court needs to be satisfied of two grounds:

• first, that the assets attributable to the relevant segregated portfolio are or are likely to be insufficient to discharge the claims of creditors of that portfolio (the Insolvency Ground);[16] and
• second, that making the order furthers the purpose of (a) the orderly closing down of the business of the segregated portfolio; and (b) the distribution of the portfolio’s assets to those entitled to have recourse to the portfolio (the Purposes Ground).[17]

In Oakwise, the Court reaffirmed the following useful principles in relation to this test.[18]

• The Act confers jurisdiction on the Court where there is a deficiency in the assets relative to liabilities, or, more importantly, where there is likely to be a deficiency.[19] In this, the Cayman statute has preferred a “flexible” rather than “traditional” balance sheet approach.[20] This stems from the difficulties creditors would otherwise have in accessing the receivership jurisdiction if they were required to meet a traditional balance sheet test and positively prove a deficiency of assets, given they are unlikely to have access to full and current financial information about the portfolio.[21]
• Therefore, a creditor must prove either that (a) it is probable that a deficiency exists or (b) the evidence establishes a risk of deficiency so cogent and real that a receiver should prima facie be appointed in any event.[22]
• In practice, how the insolvency test will operate is a fact-sensitive matter, highly dependent upon both (a) the nature and extent of the creditors’ claims in relation to a particular portfolio, and (b) the extent to which the application is opposed by either the segregated account company or other stakeholders.[23]
• Even if the Insolvency Ground is made out, a petitioner is unlikely to succeed unless the relief sought is consistent with the express or implied wishes of the majority of creditors, and there is no room for serious doubt that the segregated portfolio is hopelessly insolvent.[24]

Facts

CMB International Securities Limited (the Petitioner) was a creditor of a segregated portfolio (the SP)[25] of Oakwise. The Petitioner sent the SP a letter of demand seeking repayment of a “redemption debt”. The SP refused to pay on the grounds that it would have to liquidate its assets at a significantly low price. This was because its underlying investments in the PRC real estate market were experiencing a downturn. However, the SP also said that gradual market improvement was expected and payments would resume when appropriate to do so in the directors’ opinion. Accordingly, the SP suspended all redemptions. The Petitioner filed a petition for the appointment of joint receivers to the SP.

In addressing the Insolvency Ground, the Petitioner argued that it had “reason to believe” that the assets of the SP are or are likely to be insufficient to discharge its liabilities. This was primarily based on the following:

• despite repeated requests, Oakwise had failed to provide particulars of the SP’s latest asset and liability position;
• there had been a significant decline in the underlying investments of the SP (related to the PRC real estate market);
• letters from the SP announcing a suspension of all redemptions and explaining that liquidating the SP’s assets now would result in a great loss to all shareholders; and
• the SP had repeatedly failed to pay all redemption repayments in full since January 2022.[26]

The key evidence against the Petitioner was that: (i) the SP had positive net asset positions in each of its balance sheets for 2021 and 2022;[27] (ii) various statements from the SP directors that the PRC real estate market was expected to gather momentum, particularly given the lifting of COVID-19 restrictions and the introduction of government policy measures;[28] and (iii) evidence that other shareholders opposed the petition.[29] Accordingly, Oakwise argued that the Insolvency Ground was not satisfied and that, in any event, the appointment of a receiver would be contrary to the best interests of the SP.

Decision

On 26 May 2023, the Court dismissed the petition. As to the Insolvency Ground, it was not satisfied that the SP was insolvent.[30] The Court referred to the SP’s financial statements as at December 2022, which indicated a positive net asset position, and found that there was no cogent evidence that the financial position of the SP had significantly deteriorated since December 2022 to justify a conclusion that the assets are or are likely to be insufficient.[31]

As to the Purposes Ground, the Court noted that the closing down of the business in any event would not be in the best interests of the SP’s investors and creditors.[32]

COMMENT

The following observations may be made in light of Oakwise.

1.    Don’t be fooled by the “flexible” balance sheet approach

In order to obtain a receivership order, applicants must satisfy the Court that the portfolio is insolvent on a “flexible” balance sheet basis (i.e. that the assets are likely to be insufficient).[33] The Act propounds this flexible and functional approach to balance sheet insolvency because creditors do not ordinarily have full visibility of the portfolio’s financial status.[34] This is often exacerbated when a portfolio experiences “choppy financial waters” and the free flow of information is interrupted.[35]

However, as Oakwise illustrates, creditors should not be fooled into thinking that the “flexible” test is a low bar. The Petitioner was only able to access and rely on unaudited financial information as at December 2022 and it did not have any other cogent evidence to show that the SP’s financial condition had significantly deteriorated since. Even though the Petitioner’s debt remained unpaid after demand, the SPC had admitted that the SP’s underlying investments were significantly depressed[36] and thus it had suspended all redemptions.[37] This was insufficient to make out the Insolvency Ground.

Accordingly, creditors applying for a receivership order should assess whether they have enough evidence to demonstrate that the deficiency of assets is cogent and real. A current and audited financial statement indicating liabilities greater than assets might be the gold standard. However, even where this is adduced, if the portfolio can demonstrate sufficiency in the “reasonably near future”, this may be enough for the SPC to successfully resist the making of a receivership order over the SP.[38] If a creditor cannot access current financial information, or the current information indicates sufficiency to meet claims, it will need to cast the net wider for cogent evidence. For example, evidence of significant prospective and contingent liabilities from reliable sources would be particularly useful.[39]

A petitioning creditor should also be able to evidence that it has the support of the other creditors and shareholders of the portfolio.[40] This could support the Purposes Ground.

2.    Shortcomings of the receivership jurisdiction

Oakwise demonstrates the following shortcomings with the receivership jurisdiction.

• First, there is no deeming provision under the Act as regards insolvency in the context of receivership orders. Ordinarily, the insolvency of a Cayman Islands company is determined by the traditional cash flow test – i.e. whether the company can pay its debts when they fall due.[41] Accordingly, if a company fails to meet a statutory demand, it will be deemed insolvent and has the statutory burden of proving its solvency. However, Oakwise illustrates that this avenue is not available for creditors seeking receivership orders. The failure of the SP to meet the Petitioner’s statutory demand did not entitle it to the appointment of a receiver. The Petitioner still had to prove the Insolvency Ground and the Purposes Ground. This raises questions as to whether the Act inadvertently encourages late payment or non-payment of debts by portfolios, which was illustrated in Oakwise.
• Second, the well-recognised categories of winding up a company on a just and equitable basis are not relevant to the making of a receivership order:[42] such categories include a loss of confidence in management, or a loss of substratum. Therefore, in Oakwise, the Court expressly disregarded evidence of the Petitioner’s complaints about the management of the SP, as such considerations were held to be irrelevant to sections 224 and 225 of the Act.[43]
• Third, a creditor cannot have a liquidator appointed over a portfolio, but only over the entire SPC.[44]  As the segregation principle normally means that the creditor’s recovery is against the portfolio’s assets rather than those of the company,[45] recourse to the suite of recovery measures under liquidation will not be available. This potentially leaves a creditor in a rather undesirable situation where a letter of demand for a significant sum remains unpaid for an extended period with no further recourse available. Indeed, this might well be the case for the Petitioner in Oakwise, who sought recovery of over USD 91 million.[46]

CONCLUSION

Although the flexible balance sheet approach is designed to assist creditors who lack full visibility of a portfolio’s financial status, satisfying the requirements of the Act can be challenging. However, the rewards for doing so are considerable. This was illustrated in In the Matter of JP SPC 1 and JP SPC 4,[47] in which the Court conferred a wide-suite of powers on the receivers (which are ordinarily available to liquidators) including the power to carry on the business of the portfolio, to obtain credit, to engage staff and other professional advisors, and to compromise any claims with creditors or shareholders.[48] The value of receivership to a creditor of a financially distressed SP should not be understated.

If the receivership test under the Act appears insurmountable, a creditor may also have recourse to the Court’s general jurisdiction to appoint a receiver if just and convenient.[49] However, the Courts are yet to determine whether this inherent jurisdiction continues to exist in parallel to the statutory jurisdiction, or whether in fact the former has been usurped.[50] Therefore, tread this path with caution.

Creditors should be fully aware of their recovery options under Cayman Islands law against a segregated portfolio before entering into any contract. If recovery is subsequently necessary, the creditor should be aware of the difficulties it may face in obtaining a receivership order and seek to obtain as much financial information about the portfolio as early as possible.

[1] See Part XIV of the Act. The concept of the “protected cell company” originated in Guernsey on the passing of The Protected Cell Companies Ordinance, 1997.  Since then, various offshore jurisdictions now allow for the formation of cell companies (also known as SPCs) including the British Virgin Islands, Jersey and the Isle of Man.
[2] Section 216(2) of the Act.
[3] Section 217 of the Act.
[4] Section 216(2) of the Act.
[5] See generally sections 219 to 222 of the Act. Section 220(b) also provides that segregated portfolio assets are “absolutely protected”.
[6] Sections 219 to 222 of the Act. The directors of the SPC also have a duty to establish and maintain the segregation: section 219(6) of the Act.
[7] Leave is required to appoint a liquidator to a SPC where a receivership order is already in place in respect of any one segregated portfolio.
[8] See generally ABC Company (SPC) v J & Company [2012 (1) CILR 300] (Cayman Islands Court of Appeal) (ABC Company).
[9] Section 223 of the Act.
[10] See generally section 224 of the Act. Section 225 provides that such an application may be made by the company, its directors, any creditor or shareholder or the Cayman Islands Monetary Authority (for a regulated fund or other regulated entity only).
[11] See for example In the Matter of JP SPC 1 and JP SPC 4 [2013 (1) CILR 330] (JP SPC) in which the Court conferred the wide powers usually available to liquidators to the applicant receivers. Section 226(2) of the Act confers discretion on the Court to determine what directions to give “as to the extent or exercise of any function   or power” of a receiver of a segregated   portfolio.
[12] Section 226(6)(a) of the Act.
[13] Section 226(6)(b) of the Act.
[14] JP SPC at [14]-[16].
[15] Except where leave of the Court is obtained to commence an action. See section 226(5) of the Act.
[16] Section 224(1)(a) of the Act.
[17] Section 224(1)(b) and 224(3) of the Act.
[18] The Court referred to two previous leading cases: Obelisk Global Fund SPC, FSD 87 of 2021 (RPJ), 12 August 2021 (Obelisk) and Green Asia Restructure Fund SPC, FSD 112 and 113 of 2022 (IKJ), 3 August 2022 (Green Asia).
[19] Oakwise at [18] quoting Green Asia at [13].
[20] Oakwise at [15], [18] and [26], confirming the approach in Obelisk and Green Asia. In Green Asia, the test was also referred to as “the somewhat fluid balance sheet test” at [12] (Oakwise at [17]). For more on the traditional balance sheet test, see the UK Supreme Court decision of BNY Corporate Trustee Services Limited v Eurosail-UK [2013] UKSC 28 cited in Obelisk at [24].
[21] Oakwise at [18] quoting Green Asia at [15]-[16].
[22] Oakwise at [18] quoting Green Asia at [14]. See also Oakwise at [27].
[23] Oakwise at [20] quoting Green Asia at [20].
[24] Oakwise at [20] quoting Green Asia at [20].
[25] The segregated portfolio was called Oakwise Value Fund SPC – Enhanced Fixed Income SP.
[26] Oakwise at [12].
[27] The audited financial statements for the year ended 31 December 2021 disclosed net assets of US$759,377,462; the balance sheet as at December 2022 disclosed net assets of US$284,550,606.25: Oakwise at [26].
[28] For example, Oakwise at [32].
[29] Oakwise at [25] and [29].
[30] Oakwise at [26] and [37].
[31] Oakwise at [27].
[32] Oakwise at [37].
[33] Oakwise at [18] quoting Green Asia at [16].
[34] Oakwise at [18] quoting Green Asia at [14].
[35] Oakwise at [18] quoting Green Asia at [15].
[36] Oakwise at [30].
[37] Oakwise at [9] and [10].
[38] Oakwise at [15] quoting Obelisk at [40].
[39] Oakwise at [15] quoting Obelisk at [36].
[40] Oakwise at [20] quoting Green Asia at [20].
[41] See generally section 92(d) and 93 of the Act. See also Obelisk at [17], referring to Re Weavering Macro Fixed Income Fund Limited [2016(2) CILR 514].
[42] Oakwise at [40]-[42]. See also ABC Company at [19].
[43] Oakwise at [42].
[44] This also applies where relief is sought on the just and equitable ground – the Court can only order that the SPC is wound up “as a whole”:  see ABC Company at [38].
[45] As was the case in Oakwise: see [11].
[46] Oakwise at [6].
[47] [2013 (1) CILR 330].
[48] JP SPC at [13]. See also Schedule 3 of the Act.
[49] Section 11(1) of the Grand Court Act (2015 Revision). See Jian Ying Ourgame High Growth Investment Fund (In Provisional Liquidation) v Powerful Warrior Limited, FSD 258 of 2021 (DDJ), 15 September 2021, at [24-[29].
[50] Oakwise at [39].