Monday 20 November Ritz-Carlton, Grand Cayman Welcome Hugh Dickson - - PowerPoint PPT Presentation

Monday 20 November Ritz-Carlton, Grand Cayman

Welcome

Hugh Dickson Chair, RISA

Introduction

Felicity Toube QC South Square

Programme

Panel 1: Redemption Claims in the winding up of funds

• Coffee Break-

Panel 2: Merger fair value appraisals: recent development Panel 3: Fund Structures: what can and should be expected from fund service providers

• Summing up and closing remarks-
• Drinks reception-

Redemption Claims

Matthew Goucke, Walkers Michael Pearson, FFP Peter Hayden, Mourant Ozannes Gordon MacRae, Kalo Tom Smith QC

“The path to redemption is not always smooth”

• Issues surrounding the timing and effectiveness of

redemptions are often critical

• At what point and how does a redemption take effect?
• And what is the position and status of a “redemption

creditor”?

• Priority of claims in a winding up and “scooping the pool”

Background

• Why had s.37(7) never been critically examined by Appellate

Courts?

• Procedure adopted by the Additional Liquidator
• First instance and CICA decisions
• Priorities, emergence of the “Late Redeemer” and “Later

Redeemer” classes, etc.

Section 37(7)

• Section 37(7)(a) –where a company is being wound up, and

there are shares which are or are liable to be redeemed, then the terms of redemption can be enforced against the company

• BUT – does not apply if the terms of redemption provided for

the redemption to take place after commencement of winding up

• Or if the company is insolvent so that it could not lawfully have

made a distribution equal to the amount of the redemption in the period between the intended date of redemption and commencement of the winding up

The Issues

Issue in Herald was whether s.37(7) applied to the claims of the December and KYC Redeemers AL’s case was:

• Accepted that the relevant shares had been “redeemed” within

the meaning of the Articles (Redemption Date had passed prior to Suspension)

• This did not mean the Shares had been “redeemed” within the

meaning of s.37(7)

• December and KYC Redeemers’ claims were subject to s.37(7)
• Those claims unenforceable due to the proviso in s.37(7)(a)(i)

The Issues (cont.)

• Primeo’s position was that:
• s.37(7) had no application to the December Redeemers
• it was entitled to prove in Herald’s liquidation as a contingent

creditor, ranking ahead of unredeemed equity

• Matters were complicated by the intervention of:
• Reichmuth as representative of the Late Redeemers; and
• Natixis as representative of the Later Redeemers

Lack of jurisprudence

• Strategic Turnaround dealt with when redemption occurred

under the relevant Articles, not the Statute

• Did not consider s.37(7)
• Related to issues of locus, rather than ranking of claims
• Those Articles did not permit a separate suspension of

payments

• Re Founding Partners Global Partners Ltd (In Liquidation)
• Unreported, Foster J, 21 September, 2010
• It was agreed that the wording of section 37(7) "…is not

as clear as it might be but that the words …'have not been redeemed' must mean ‘the redemption proceeds due have not been paid’.”

Lack of jurisprudence (cont.)

• Most fund articles provide Directors with broad defensive

powers to protect liquidity

• Lock ups, suspensions, gating provisions etc.
• Usually, a fund, properly advised, will be able to implement an

appropriate suspension of redemptions

• Stops conversion to deferred creditor
• Herald’s position (as well as that of the other Madoff feeder

funds quite unusual):

• Bi-monthly redemption dates
• History of high liquidity (even in the context of $100m+

redemptions)

– History and practice of permitting short-notice redemptions – 100% invested into a sole asset, BLMIS – Accordingly, no real possibility of suspending prior to discovery of Madoff Ponzi Scheme in mid-December 2008 – Not a case of multiple assets, where only a small proportion affected by a fraudulent or otherwise incorrect valuation – In Madoff, all NAVs were misstated from day 1 and cash commingled at BLMIS – On the facts of this case, a number of important and high- value class issues arose

Procedure adopted by the AL

• AL obtained advice (including from Leading Counsel) as to

enforceability of claims of December and KYC Redeemers

• Shared advice with all members of the LC pursuant to NDAs /

common interest privilege agreements

• Took a position
• Agreed with Primeo that the Court should be invited to make

“representative” orders pursuant to the CWR

• Close and ongoing consultation with non-conflicted members of

the LC

The Grand Court

• Pearson v Primeo Fund [2015 (1) CILR 482]
• December and KYC Redeemers had redeemed on or prior to 1

December 2008 and fell outside s.37(7)

• Had provable claims ranking pari passu with the claims of
• rdinary unsecured creditors
• Significant departure from prior common law position
• See also In re Palm Beach Offshore Ltd FSD 38 of 2009

(unreported, 25 November 2014, Jones J)

The CICA

• Affirmed the Grand Court’s decision that the December and

KYC Redeemers did not fall within s.37(7)

• Held that “redemption creditors” ranked after outside

creditors:

• Contingent creditors with provable claims under s.139(1)
• Claims founded on the statutory contract of membership

and subordinated by s.49(g)

• An “accrued right of redemption”?

Privy Council: the Cast of Parties

• The AL of Herald
• The December and KYC Redeemers (represented by Primeo)
• The Late Redeemers (represented by Reichmuth)
• The Later Redeemers (represented by Natixis)

The AL’s arguments

• Redemption has a specific meaning in the context of

section 37(7)

• Primeo falls within section 37(7)
• Any other redeemers also fall within section 37(7)
• Claims fall foul of both provisos, such that they cannot be

enforced in the liquidation, and redeemers rank alongside the remaining investors

The Suspension

• Took effect from 12 or 24 December 2008
• Validity not disputed
• Issue as to when terms of redemption provided for

redemption to take place and whether terms were varied by suspension

Section 37(7)

• Does not apply to shares which have been

redeemed

• Whether shares have been redeemed is

determined by the Fund’s constitutional documents

• Freedom of contract and commercial certainty

Purpose of section 37(7)

• Allows a redeeming investor, whose

redemption has not taken place, to enforce the terms of that redemption in certain circumstances

• Circumstances are set out in the provisos –

timing and solvency requirements

Priority

• Ordinary creditors e.g. leverage providers etc
• Redemption creditors – section 49(g)
• Creditors claiming under section 37(7)(a)
• Remaining investors

Key Takeaways

• Redemption is the moment when the investor turns

from shareholder to creditor

• Depends on what the Articles say
• Does not depend on the fund paying the

redemption proceeds (unless Articles say so)

• Unpaid redemption creditor will rank behind leverage

and third party creditors but ahead of remaining investors

• Potential to scoop the pool

Key Takeaways

• Incentive to make early redemption requests
• Gating and suspension provisions in the Articles

therefore key

• Effect of suspension of redemptions will typically be to

prevent a section 37(7) claim from arising

• Difficult to see section 37(7) claims arising in practice

Questions/Comments?

Contact details

Peter Hayden Peter.Hayden@mourantozannes.com T +(345) 814 9108 Gordon MacRae GMacrae@kaloadvisors.com T+(345) 814 4007 Tom Smith QC tomsmith@southsquare.com T+44 (0)20 7696 9900 Matthew Goucke Matthew.goucke@walkersglobal.com T +(345) 914 6332 Michael Pearson Michael.pearson@ffp.ky +(345) 640 5860

Coffee break

Merger fair value appraisals: recent developments

 Barry Isaacs QC, South Square  Nick Hoffman, Harneys  Andrew Jackson, Appleby  Rupert Bell, Walkers

Why has there been an increase in Cayman dissenter actions?

• Since Q4, 2010 – major increase in China-based, US-listed companies going

private – most are Cayman incorporated. Returning to the PRC having raised capital they needed through the US listing.

• Loser pays jurisdiction – covers significant portion of costs
• High interest rate payable on awards
• Interim payment – immediate access to merger price - reduces risk of getting

nothing

• Range of interim remedies available – injunctions, provisional liquidator

appointments

Cayman Islands Fair Value Proceedings – What to Know

Section 238, Companies Law (introduced 2009): s.238(1) “A member of a constituent company incorporated under this Law shall be entitled to payment of the fair value of his shares upon dissenting from a merger or consolidation” s.238(11) “At the hearing of a petition, the Court shall determine the fair value of the shares of such dissenting members as it finds are involved, together with a fair rate of interest, if any, to be paid by the company upon the amount determined to be the fair value.”

Re Integra, 2015 - Background

• Cayman Islands incorporated company with a business as an oil field services

provider and equipment manufacturer operating in Russia. As at 31 December 2012 Integra had a market capitalisation of US$76 million.

• Dissenters three investment funds managed by East Capital International AB

which concentrated on public and private securities in emerging markets.

• Transaction was a management buyout by way of merger.
• The experts could not agree on the most appropriate valuation methodology

– Court preferred one over the other (discounted cash flow combined with market approach).

• The dissenters obtained an order for fair value higher than the merger price,

plus interests and an order for costs in their favour.

Jones J at para 27 “… the Court is therefore required to determine the fair value

• f Integra’s business as a going concern as at the Valuation

Date, meaning the point immediately before the merger was

• approved. The fair value of the Respondent’s shares is their

proportionate share of this amount without any minority discount or any premium for the forcible taking of their

• shares. There is no presumption that the fair value offer made

by Integra … in accordance with section 238(8) constitutes a minimum price and it is open to the Court to determine that a fair value is less than [the amount of the offer]”

Re Integra – Interesting Aspects

• Stands apart from subsequent section 238 which have been almost exclusively between Cayman

companies with substantial operations in the PRC and funds engaging in “appraisal arbitrage”.

• Jones J’s judgment has informed the subsequent practice and procedure in 238 proceedings

particularly with disclosure: “It goes without saying that the information contained in [the Company’s] own books and records is highly relevant to any appraisal of its fair value” (at [11]) and “The experts are the best judge of what information is or is not relevant for their purposes” (at [11]):

• So far: no dissenter discovery and expert driven discovery: current Qunar appeal may see

changes to that. Regardless, discovery will remain a key battleground in 238 cases.

• Integra gave no prescribed methodology – appropriate valuation method will depend on the
• circumstances. Court applied DCF in this case and, in our experience, this appears to be the

favoured method among valuers in these matters. As the Cayman jurisprudence grows, expect different valuation methods to emerge.

• Accepted relevance of the Canadian and Delaware jurisprudence on share valuation concepts.

Shanda Games, 2016 - Background

• On 25 November 2009, the Company completed an IPO of its American Depository

Shares ("ADS") on the NASDAQ at an offering price of US$12.50 per ADS

• Taken private on 18 November 2015 at a price of US$3.55 per share (US$7.10 per

ADS)

• Unable to reach an agreement on the fair price to be paid, the Company sought the

Court's determination of the fair value of the Dissenting Shareholders shareholding under section 238

• The Court drew inferences against the Company on factual issues where it failed to

meet its disclosure obligations

• After determining the manner by which the Company's shares were to be valued,

Segal J. held that the as at the Effective Date the Company's fair value was US$8.34 per share (US$16.68 per ADS).

Shanda, 2016 – Interesting Aspects

• Significance of Delaware and Canadian Jurisprudence to the Dissent Regime. In

Shanda the Court only referred to the Delaware cases noting that it is preferable, where possible, to ensure consistency of approach by focusing on one rather than a multiplicity of jurisdictions.

• Segal J. gave the merger price no special preference concluding that it is for the

court to conduct a fresh assessment of all factors relevant to value rather than to start from the position of the final merger consideration as being the best evidence of fair value - consistent with Delaware

• Shanda took the analysis of Jones J in Integra further by considering two

fundamental valuation points:

• (a) Whether a Minority Discount should apply to the “fair value” of the

Dissenting Shareholders' shares in the Company

• (b) The inputs and analysis used in constructing the DCF analysis

Shanda, 2016 – Minority Discount

• In Integra, Jones J had regard to the principles established by

Delaware and Canadian law and agreed that when determining fair value, it is not appropriate or permissible to apply a minority discount. This point also not argued before him

• In Shanda, the Company argued that a minority discount

should apply to the Dissenting Shareholders' interest using authorities dealing with unfair prejudice under the English Companies Act.

• Segal J distinguished appraisal cases from unfair prejudice cases
• n the basis of the difference in the statutory language in the

English Companies Act and because the Cayman regime imposes a fairness requirement.

• Affirming Integra, Segal J determined that a minority discount

would not apply. Significant, as it = 23% difference in value

Shanda, 2016 – DCF

• In Shanda the experts agreed that DCF was the correct

methodology to value the Company

• The experts did not agree on how to apply each of the main

components: cash flow projections; the discount rate and terminal value (a) On Cash Flow the Court concluded the Company was unreliable and preferred the shareholders’ experts; (b) On Discount Rate adopted the average of the experts' betas because "the data derived during the relevant period has been subject to exceptional and distorting effects such that it might be unreliable and result in an error in the beta estimate“ (c) On Terminal Growth, the Court ruling reducing the length of the transition period from 10 to 5

Appraisal Arbitrage – Does it pay?

Interlocutory Issues in Appraisal Proceedings

Types of Orders in Appraisal Proceedings

• Electronic data room for maintaining documents
• Discovery of documents relevant to fair value
• Provision of lay factual evidence
• Provision of expert evidence (including exchange of

evidence and meetings of experts)

• Meetings by experts with members of management
• Requests for information by experts
• How evidence to be given and cross-examination – video-

link?

• CMC/Trial

Discovery Issues

• How to undertake discovery – search for relevant documents

vs certain categories of documents and requests by experts

• Discovery by way of list of documents (or electronic data

room index)

• Specific discovery/general discovery orders
• Types of experts
• Expert requests?
• Justification for expert requests? Experts are the best judges
• f relevance

Discovery Issues (cont’d)

• Number of experts to be appointed where multiple

dissenters

• Timing of lay evidence
• Management meetings – jurisdiction
• Dissenter discovery

(See In the matter of Qunar Cayman Islands Limited (Parker J), In the matter of Homeinns Hotel Group (Mangatal J), In the matter of Trina Solar Limited (Segal J) and In the matter of E-House (China) Holdings Limited (Mangatal J))

Discovery Issues (cont’d)

• Inadequate discovery and remedies
• Appointment of forensic expert (In the matter of Qihoo 360

Technology Co. Ltd. (Mangatal J and Court of Appeal))

• Leave to submit expert evidence at trial revoked (In the matter
• f Bona Film Group Limited (McMillan J))

Interim Payments

• Order 29, rules 10 and 12 of the Grand Court Rules
• In the matter of Qihoo 360 Technology Co. Ltd. (Quin J)
• In the matter of Qunar Cayman Islands Limited (Mangatal

J)

• jurisdiction – money judgment vs declaration/self-

contained code?

• lack of carve-out in the Grand Court Rules
• substantial sum
• what is a just sum – public statements by the

company/reliance on expert evidence?

Interim Payments (cont’d)

• discretion
• interim payments in excess of merger price?
• In the matter of Qunar Cayman Islands Limited (Court of

Appeal)

Cross-Over with Winding Up Proceedings

• Winding Up Petition/Provisional Liquidation Application in

the context of appraisal proceedings

• In the matter of Bona Film Group Limited (McMillan J)
• dissenters served expert evidence valuing shares at higher than

merger price

• company’s leave to submit expert evidence at trial had been

revoked as a result of an ‘unless’ order

• restructuring of company’s subsidiaries

Cross-Over with Winding Up Proceedings (cont’d)

• just and equitable winding up petition presented by dissenters as

contingent creditors – justified apprehension that the debt (in the form of the judgment in the appraisal proceeding) will not be paid

• application seeking appointment of provisional liquidators/strike
• ut application
• Court had urged the company to provide transparency as to its

financial circumstances

• was there a bona fide dispute on substantial grounds?
• were the dissenters contingent creditors?
• were grounds made out for the appointment of provisional

liquidators?

Cross-Over with Winding Up Proceedings (cont’d)

• In the matter of Trina Solar Limited (Segal J)
• consent order entered into by the parties providing for the

payment of interim payments within 14 days

• extension of time requested for payment
• demand for payment made by dissenters/company states that it

will not be making payment for a number of reasons

• winding up petition presented by dissenters on the basis of

insolvency

• company made applications to set aside the consent order and

strike out the winding up petition

Cross-Over with Winding Up Proceedings (cont’d)

• application to set aside consent order was dismissed
• extension of time granted to make payment of interim

payments

• outcome of winding up petition
• dissenters awarded costs of the winding up petition and strike
• ut application

Appraisal Actions following Management Buyouts: a couple of problems

• Management’s self-interest: how do we address and avoid the

expert evidence on fair value being tainted by it?

• Hindsight evidence: the extent of the general prohibition

against relying on post-merger material?

Addressing Managerial Self-Interest

Merion Capital v 3M Cogent (8 July 2013): “Generally, this Court prefers valuations based on contemporaneously prepared management projections because management ordinarily has the best first-hand knowledge of a company‘s operations. …projections prepared by management are not entitled to the same deference usually afforded to contemporaneously prepared management projections where management had never prepared projections beyond the current fiscal year, the possibility of litigation, such as an appraisal proceeding, was likely, and the projections were made outside of the ordinary course of business. I also considered it relevant in Gearreald that the projections at issue there were prepared by directors and officers of the target company who risked losing their positions if the bid succeeded and were involved in trying to convince the Board to pursue a different strategic alternative in which they were involved”.

The Rule Against Hindsight

Cavalier Oil Corp v Hartnett (1989): “…the Court of Chancery’s task here was to value what has been taken from the shareholder: “viz. his proportionate interest in a going concern”. To this end the company must first be valued as an operating entity by application of traditional value factors, weighted as required, but without regard to post- merger events or other possible business combinations”.

A Practical Rejection of Hindsight-Driven Evidence

Agranoff v Miller (15 May 2001): “Although Lee also believed that EMS’s projections were unreliable, he purported to base a DCF analysis on a substantial negative revision of those projections that he came up with after discussions with EMS managers after the valuation date. That is, Lee discussed the projections for the years following 1998 with managers who knew what the actual results of those later years were. Based on these conversations, Lee developed revised projections that he plugged into a DCF model. I refuse to give any weight to this technique and therefore to Lee’s DCF

• analysis. The possibility of hindsight bias and other cognitive distortions

seems untenably high”.

Expert Adjustments Permitted

In re ISN Software Corp. Appraisal Litigation (11 August 2016): “Complicating the issue, ISN itself did not regularly create long-term financial

• projections. The experts, therefore, were required to project future cash flows

using various assumptions regarding growth and efficiency. While that approach is inherently less reliable than using long-term management projections, I note the reliability of the experts’ projections is bolstered by ISN’s subscription-based business model, its ability to retain customers, and the inelastic demand for its product. Nonetheless, projections out more than a few years owe more to hope than reason. Balancing those considerations, I find the use of a standard 5-year projection period appropriate here”.

Conclusion

• The Cayman courts, consistent with Delaware authority, have demonstrated

a willingness to provide dissenting shareholders and their appointed experts with the practical tools they need to address the problem of self-interest which arises in the management buyout context.

• Whilst hindsight evidence is generally impermissible where the objective is

to value the company concerned at a particular point in time, where management projections are unreliable and a discounted cash flow is the

• nly appropriate valuation methodology, it should be permissible for the

valuation experts to make corrections and adjustments to the projections which reflect what would reasonably have been expected to be the operative reality of the Company at the time of the merger.

Contact us

Barry Isaacs QC barryisaacs@southsquare.com Nick Hoffman nick.Hoffman@harneys.com Andrew Jackson ajackson@applebyglobal.com Rupert Bell rupert.bell@walkersglobal.com

Fund Structures: what can and should be expected from fund service providers and who carries the can when it goes wrong?

 David Allison QC, South Square  Richard Fisher, South Square  Ronan Guilfoyle, Calderwood  Rachael Reynolds, Ogier  Russell Smith, BDO CRI

SNOW WHITE

The Usual Suspects

BASHFUL SLEEPY

HAPPY DOC GRUMPY DOPEY SLEEZY

LIQUIDATOR SP

SNOW WHITE

The Usual Suspects

BASHFUL SLEEPY HAPPY DOC GRUMPY DOPEY SLEEZY

Director Negligence Indemnity Director Negligence Indemnity Custodian Breach of Contract Auditor Negligence Investment Manager Fraud 3 x Fee Cap

Bernard L. Madoff

 Arrested - 11 December 2008  Pleaded guilty - 12 March 2009  Sentenced to 150 years - 29 June 2009

• To be distinguished from duty of care
• “I find nothing surprising in the proposition that crass

incompetence might give rise to a claim for breach of a duty

• f care, or breach of contract, but not for a breach of

fiduciary duty.“

• One is about competence, the other about loyalty

Carlyle Capital Corporation Limited Fiduciary Duties

• Duty to act in good faith
• Objective element?
• Charterbridge principle - yes
• Wednesbury test - no
• Duty to act for proper purpose – subjective by reference to
• bjective
• Duty to exercise independent judgment - may defer to others
• Duty to avoid conflicts of interest – no rule of exclusivity

Carlyle Fiduciary Duties

• Subjective / objective test
• Gross negligence – “jaw dropping negligence”
• Delegation – no obligation to take legal advice (but helps

evidentially)

• Board meetings – no per se obligation – may even be a

distraction and self serving

• Meeting notes – no prescription, may be amended by

advisors

Carlyle Duty of Care

 “zone” not the English test – suggests more distant that “brink” or “verge”  “I hold that the duty to have regard to the interests of creditors arises

when it can be seen that decisions about the company's actions could prejudice the creditors' prospects of recovering their debts in a potential liquidation”

 Proper regard to creditors (not exclusive or even paramount) –

precedence

 Does not mean automatic cessation of trading  Subjective approach  Avoid hindsight judgments

Carlyle Brink of Insolvency

• Assemble team – forensic, legal
• Asset review and insulation
• Information gathering from service providers
• Consistently monitor: suspension? Liquidation?
• Communicate – investors, creditors, regulator
• Document

Carlyle When on the verge…

Custodian criticism

TYPICAL?

PRIMEO

Custody confirmations

Gross negligence

Contact us

David Allison QC davidallison@southsquare.com Richard Fisher richardfisher@southsquare.com Ronan Guilfoyle rguilfoyle@Calderwood.ky Rachael Reynolds rachaelreynolds@ogier.com Mark Goodman mgoodman@campbellslegal.com Russell Smith rsmith@bdo.ky

Summing up and closing remarks

Drinks reception