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The treatment of segregated portfolio companies in onshore liquidations

Colin Riegels

Like most other developed offshore jurisdictions, the British Virgin Islands promotes a type of company which seeks to compartmentalise the assets and liabilities of various portfolios away from other portfolios and the company's general assets. In the British Virgin Islands these are known as segregated portfolio companies (SPCs). In other jurisdictions the equivalent type of company is often known as a protected cell company or segregated cell company.

SPCs compartmentalise their assets into designated portfolios. A creditor of one portfolio may only have recourse to the assets attributable to that portfolio and when exhausted, to the assets attributable to the company as general assets. A creditor will not have recourse to the assets of a different portfolio (which are similarly ring-fenced for the benefit of that portfolio's creditors). Despite the segregation of assets and liabilities into these different portfolios, the SPC is still regarded as a single legal entity.

In the rush to create new corporate structuring products, however, the draftsmen creating the legislation for SPCs were always left with one nagging doubt: what happens if a bankruptcy court in an onshore jurisdiction simply refuses to recognise the statutory segregation of assets and liabilities?

In the British Virgin Islands SPCs are regulated by the BVI Business Companies Act 2004. The Act broadly contains three methods by which the draftsmen hoped to secure the recognition of segregation of assets and liabilities.

Limited liability – the statute simply provides that as a matter of British Virgin Islands law creditors of one portfolio will not have recourse to the assets of another portfolio (sections 145 and 146 of the Act).

Implied terms – the Act specified that each agreement an SPC enters into will have implied into it certain terms, providing broadly that each party to the agreement accepts and will abide by the segregation of assets (section 144(2)(a) of the Act).

Constructive trust – the Act provides that if any property is taken by a creditor in breach of the segregation provisions, then that property will be held by the creditor on trust for the SPC (section 144(2)(c) of the Act).

The real danger in the approach employed by the draftsman of the Act is that the wide array of measures employed to protect the segregation of assets betrays something of a lack of confidence that any one of those measures would be sufficient on its own.

Taking the weakest of those points first, it seems highly unlikely that the implied terms argument would persuade any court in a common law jurisdiction that the recourse had been so limited. Firstly, the terms which are implied into an agreement are determined by the governing law of the agreement. Secondly, however, there is very clear common law authority that parties cannot by agreement reach a system of distribution which is different from that provided for by the bankruptcy legislation (see British Eagle v Air France).

The constructive trust argument is slightly stronger. Although the mechanics of this statutory trust seem rather sparse, there is at least clear precedent suggesting that a property transfer in one jurisdiction can be the subject of a constructive trust in another (AG for Hong Kong v Reid). But looked at more closely, similar problems seem to arise. Other cases of cross-border constructive trusts usually arise as a result of tracing claims (the trust asset is a derivative asset, rather than the original property), and they tend to involve a degree of moral turpitude which encourages the court to reach conclusions which strip wrongdoers of the gains from their crimes.

If the constructive trust argument was a stand-alone statutory provision imposing a trust, it might constitute a stronger argument. The British Virgin Islands legislation does not impose a standalone statutory trust – it provides for an implied term into any agreement that such a trust would arise.

It is highly improbable that any common law legal system would accept that the law of one party's domicile may imply terms into a contract governed by the laws of a different jurisdiction. But where the agreement is in fact governed by British Virgin Islands law, it may provide a basis for segregation.

Finally, British Virgin Islands law simply provides that, for this type of legal entity, there is no recourse against certain assets in certain circumstances. Although most onshore jurisdictions do not have a concept of segregated portfolio or protected cell companies, the idea of segregation of assets and liabilities is not an alien concept.

While it is not possible to state definitely how a foreign bankruptcy court will treat the segregation of assets and liabilities upon the liquidation of an SPC, at least in common law jurisdictions there are reasons for cautious optimism that these provisions should be respected. It does seem unfortunate, however, that the draftsman of the Act chose to diminish his strongest argument by seeking to bolster it with weaker ones.

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