Not A Wind Up: A Soft Wind Down of a Mutual Fund
The recent Cayman Islands Grand Court decision in Washington Special Opportunity Fund, Inc, stands as a useful reminder that the winding up of a Cayman Islands open-ended mutual fund is a drastic measure, which will not be too readily granted. In circumstances where a solvent fund had amended its articles of association so as to permit a "soft wind down", the Grand Court declined to wind the fund up on the basis that its substratum had failed or that it was otherwise just and equitable to do so.
Washington Special Opportunity Fund, Inc ("Washington") is an open-ended mutual fund. In 2008 Washington experienced financial difficulties and, pursuant to a special resolution of its shareholders, amended its articles of association to permit Washington to redeem its investors' interests on a "slow pay" basis as its assets were liquidated.
In September 2015, a winding-up petition was issued by an investor on the basis that it was just and equitable for Washington to be wound up primarily because:(i) Washington had "lost its substratum"; (ii) investors had justifiably lost trust and confidence in management; (iii) there had been a wilful disregard for and the undermining of investors' rights and interests; and (iv) there was a need for an independent investigation by official liquidators. There was no question as to Washington's solvency.
The Court dismissed the petition on the basis that the petitioner was unable to make out any of the grounds for a just and equitable winding up.
Loss of substratum
Loss of substratum is one of the traditional bases for seeking a winding up order on the just and equitable ground. A company will be considered to have lost its substratum when it can no longer perform the objects for which it was formed. In a fund context those objects will likely be derived from the articles of association and the offering memorandum.
Two different tests have been applied to determine what constitutes "loss of substratum" and the law in this regard continues to evolve. The "traditional" test is whether the business of the company has become impossible to pursue. In more recent years, however, in the context of open ended mutual funds, a series of judgments in the Cayman Islands Grand Court has developed a somewhat different (and broader) formulation, to the effect that a fund's substratum will be lost where its affairs are no longer being conducted in a way which is consistent with the reasonable expectations of its investors. This test has been applied in circumstances where funds have suspended redemptions with a view to conducting a "soft wind down", in circumstances where the Court did not consider that to be envisaged by the relevant governing documents.
The Judge found that, as neither of the above tests was satisfied, she did not need to resolve which was the correct legal test. The fact that Washington had an express provision in its articles permitting a soft wind-down, which had been validly agreed to by the investors in 2008, meant that Washington could not be said to have lost its substratum.
The decision reinforces that, if a fund's management determines that the fund needs to be wound down (outside of formal liquidation proceedings) and that this is not already contemplated in the fund's offering or governing documents then it would be prudent for the fund to seek shareholder approval to permit this.
Loss of trust and confidence in management (and other grounds)
As has been a hallmark of other winding up petitions before the Cayman Islands Courts in recent years, the petitioner also sought to draw out as many areas of disagreement and dissatisfaction with the fund manager as possible to support its petition.
These allegations were wide ranging and, in some cases, dated back many years before the presentation of the petition. Broadly, the petitioners asserted a failure by the manager to engage with investors, lack of transparency, conflicts of interest between the manager and the fund and disagreement with respect to the on-going payment of management fees.
The Judge considered that in these circumstances it was not the Court's function to "trawl" through the entire history of the fund and conduct an examination of these allegations where they were based on old matters, no complaints had been previously made against the manager and there was no evidence of the manger having engaged in a persistently wrong course of conduct over time. Where the manager's actions were reasonable, commercially defensible and had been explained to investors, merely showing that the alleged mismanagement caused investors subjective dissatisfaction or loss of confidence is not a sufficient ground to justify winding up the fund on a just and equitable basis.
The Court was also unmoved by the petitioners' submission that the Cayman Islands Court had expressed "clear judicial disapproval" for the concept of charging management fees based on a percentage of NAV during a "soft wind down". In this case, the structure of the management fees had been disclosed to and agreed by the investors. The Court found this was "not a case of something underhand or improper occurring with respect to the Manager's fees", such as cash-hoarding in an effort to artificially inflate fees.
Majority investor support
Slightly over 53% of shareholders (by value) supported the winding up petition. Nevertheless, the Court found that, where there are otherwise no grounds upon which to wind up a fund on the just and equitable basis, that even if the petition is supported by a majority of investors it will make no difference. However, where the petitioner is able to establish grounds for a just and equitable winding up, the level of investor support may be a factor relevant to the Court's ultimate discretion as to whether or not to make that order.