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Distressed funds litigation in the BVI

Phillip Kite

The recently established Commercial Court in the British Virgin Islands has been busy with a number of important cases. One of the most interesting areas of distressed funds litigation continues to be the creditor/investor debate.

It can be important for a party to allege that it is a creditor, especially in liquidation proceedings. There have been various cases in other jurisdictions but this year the BVI Commercial Court handed down important decisions on the status of a redeemed shareholder and the application of section 197 of the Insolvency Act 2003.

One such case involved a fund (Reserve) that operated daily redemptions which were ceased following the collapse of Lehman Brothers. Western Union, as one of Reserve's shareholders (WU) had submitted redemption requests for its entire shareholding.

These requests were received and acknowledged on the same day. Reserve announced the NAV at $1 per share for that day. Redemptions were subsequently suspended. The redemption proceeds were not paid and WU petitioned as a creditor to wind up Reserve.

Reserve defended and denied WU had completed the redemption of its shares, denied that WU was a creditor of the fund by virtue of section 197 and argued that, even if WU was a creditor, the Court should exercise its discretion against appointing liquidators.

On the first issue raised by Reserve the Court held that, under Reserve's articles, the shares referred to in the redemption request were redeemed on the day of receipt.

The Court also examined the provisions of the articles and concluded there was no power to suspend redemptions nor was there a specific date by which Reserve was obliged to remit the redemption proceeds.

On the second issue raised by Reserve, the Court highlighted the difference it saw between a case where redemption was still in progress and one where it was completed, save for payment. In this case, the Court found that, on its interpretation of the Articles, the redemption had been completed and WU was a creditor of Reserve.

On the third issue, Reserve suggested it should not be wound up, so that the parallel proceedings regarding the distribution of Reserve's assets in the US could continue. The Court rejected this argument.

One critical point is that the Court did not see section 197 as a bar to the liquidation application. Section 197 provides:

"A member, and a past member, of a company may not claim in the liquidation of the company for a sum due to him in his character as a member, whether by way of dividend, profits, redemption proceeds or otherwise, but such sum is to be taken into account for the purposes of the final adjustment of the rights of members and, if appropriate, past members between themselves."

Another section 197 case was Westford Special Situations Fund v Barfield Nominees. At first instance the application to wind up was allowed on two grounds. However the fund appealed. The Court of Appeal recently upheld the appeal and dismissed the appointment of liquidators.

The written reasons remain pending and are awaited with great interest. The decision has potentially wide-ranging implications, including for some of the analysis in Reserve.

A third case shows that the Court will not always use its power to liquidate a fund even where a party has proper standing. In Citco Global v Y2K Finance a liquidation application was brought on two bases.

The first ground was based on alleged improper redemption payments made by the fund prior to the suspension of redemptions. The Court held that it would not permit minority shareholders to wind up a company on the basis that it had, or might have, claims against its directors as this would be inconsistent with the rule in Foss v Harbottle.

The second ground was based on a loss of substratum argument. By the time of the hearing the fund agreed that it should be wound up, but the directors wanted the opportunity to realise assets, repay investors and then enter into a voluntary liquidation procedure.

Although the Court preferred a wide definition of loss of substratum, it refused to make a compulsory winding up order as the directors were acting within the articles in making repayments and any investor would have the more appropriate unfair prejudice remedy.

This is very different from the Cayman line of cases such as Wyser-Pratt Eurovalue v UBS Fund where the Cayman High Court considered that a winding up order could be appropriate where directors were winding down a fund's affairs.

Important lessons have been learned by investors including being very careful about which fund to invest in and in ensuring that advice is taken to ensure their rights are preserved when they invest.

Phillip Kite

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