It seems to have fallen upon me to talk about all the things that can go wrong with your fund! As it happens, suspending NAV calculations, subscriptions and redemptions is not the end of the world that it was once considered. If you keep in mind a few key considerations, chances are you will survive this challenge.
Suspensions: The post-2008 context
Prior to September 2008, suspensions were pretty much never invoked. The general view was that to invoke a suspension would cause irreparable reputational damage to a manager. However, in the midst of the 2008 financial crisis, it was those managers that did suspend redemptions, waited for the storm to pass, limited the damage and then eventually lifted suspensions that survived. Those who failed to operate suspensions and gates were left with redeemed (but unpaid) investors whose claims as creditors for their redemption proceeds ranked above the remaining investors. It is because of this that, whilst liquidity is still absolutely key for investors, there is now an expectation that a responsible and well advised manager would invoke a suspension or gate when reasonably necessary in order to protect the investors’ interests.
Navigating a suspension scenario
So, the dreaded situation arises; your fund suffers a financial blow so severe that your investors start to withdraw their funds. What should you do? Firstly, call your lawyer! They will need to carefully review your fund documents to determine what you can and cannot do, and what the correct process is. Getting the right strategy from the start is crucial. Your lawyer should know their way around your fund documents, particularly if they drafted them, and they will know where to look for any potential pitfalls. Secondly, act quickly. You will need to suspend redemptions before the next redemption date. Otherwise, investors that have submitted redemption requests will become creditors of the fund and their redemption proceeds will become payable. So you called your lawyer straight away. What do you need to do next? Below are six key considerations or actions you will want to take.
1. Consult Your Board
You will need to call a board meeting, as there are various things to discuss. What has your lawyer advised and are you able to suspend redemptions? If not, are there other mechanisms that you can use such as imposing investor or fund level gates or transferring certain assets into side pockets or restructuring the fund in another way? Do you need to work out a liquidation plan or do you think you can ride this storm? Minutes will need to be taken at each meeting, as they may be required in future proceedings to prove that reasonable steps were agreed and followed by the board. Make sure to document everything. Whilst not pleasant, the investment manager and the board of direcors will need to consider whether there are any conflicts of interest that would, for example, prevent a director who is affiliated with the investment manager from attending and voting at any meetings. If there is a likely chance of a conflict of interest arising, you will need to consider whether the investment manager and board of directors need to instruct separate legal counsel.
2. Don't forget about redemptions and subscriptions
You need to make sure that as well as suspending the calculation of NAV, you also suspend redemptions and subscriptions. In some circumstances it may be possible to continue to calculate NAV and you may want to suspend redemptions and subscriptions without suspending the calculation of NAV. If there are investors who have submitted redemption requests and the redemption date has passed, you may also want to suspend the payment of redemption proceeds, if your fund documents permit this. You could also consider payments of redemption proceeds in kind (often referred to as “in specie”), ie by transferring assets worth the same amount as the redemption proceeds to the redeeming investor, if your fund documents allow this.
3. Consider the fitness of your independent directors
Your independent directors may want to resign from the board before any of these resolutions are passed, as they may not feel that they have the relevant experience to deal with this type of situation. You will still be required to have two directors on the board at any time if you’re a fund that’s regulated by the Cayman Islands Monetary Authority or the BVI Financial Services Commission (FSC) and will need to consider who to appoint in their place. There are independent directors with specific experience of acting on the board of distressed funds who can be appointed.
4. Communicate your plan
You will need to make a plan for informing the FSC or CIMA and your investors. An investor circular will need to be prepared and your lawyer should draft a letter to the FSC or CIMA, depending on where the fund’s regulated. Both the investors and the FSC/CIMA will expect regular updates throughout the process. Communication is key to a successful resolution.
5. Regular re-assessments
It will be important to constantly re-assess the situation to determine whether or when suspensions ought to be lifted. Your fund documents are likely to permit suspensions only for so long as the circumstances giving rise to the ability to suspend persist.
6. Keep your lawyers on speed dial
Keep in touch with your lawyer at all stages. If a period of suspension continues for a long time, the fund may be open to claims from investors to wind up the fund on the basis of “loss of substratum”, that the fund is no longer viable. This poses a greater risk in Cayman than it does in the BVI where the test is much higher and an investor would need to establish the impossibility of the fund continuing business. The drafting of your fund documents can also be a key factor in whether this is a risk for the fund. With careful management and good advice, a period of suspension does not have to damage your reputation or be the end of the fund. Get in touch if you would like to discuss any specific situation.
The author of this post is no longer with Harneys. For more information on this topic, please reach out to the author listed above.