"Back-to-back" redemptions in master-feeder fund structures: a cautionary tale
In an important decision that will be of significant interest to the funds' industry, the Cayman Islands Court of Appeal has held that a redemption request submitted at the Feeder level did not take effect so as to constitute an automatic redemption request between Feeder and Master. This was the case notwithstanding the preponderance of evidence (adduced at first instance) to the effect that established market practice in the Cayman Islands was that a Feeder in receipt of a redemption request did not need to serve, in turn, a second redemption notice of its own on the Master.
Following a redemption request submitted to one of the Master’s two feeder funds (respectively, Dragon and Eagle) in 2014, it became clear that the Master (which was invested in illiquid assets) would be unable to redeem a redemption request from the relevant feeder (Dragon) even were it inclined or obliged to do so. Accordingly, commercial negotiations having failed, resolutions were passed for the voluntary winding up of both Dragon and the Master.
Dragon subsequently lodged a proof of debt in the liquidation of the Master Fund. That proof of debt was rejected by the liquidators of the Master Fund on the basis that although a redemption request had been submitted by the underlying investor to Dragon, Dragon had itself failed to submit a redemption request to the Master Fund.
Dragon subsequently appealed the rejection of its proof to the Grand Court. The appeal was treated as an inter partes proceeding between Dragon and Eagle (being the two parties with an economic interest in the outcome of the liquidation of the Master Fund). The Grand Court dismissed the appeal and upheld the liquidators’ decision. Dragon’s further appeal, to the Court of Appeal, has now also been dismissed.
The decision is worthy of more fulsome analysis and commentary, but the key points arising from the judgment are as follows:
- Construction Issue. The terms and manner of redemptions were governed by the Master Fund’s Articles of Association. The Court rejected Dragon’s arguments to the effect that the Articles could be construed as permitting the directors of the Master to determine that redemption of shares could be effected without the submission of a redemption notice by Dragon to the Master.
- Determination Issue. This did not strictly arise on the facts, on the basis that the Articles did not permit the directors (who were, notably, directors both of Dragon and the Master Fund) to make such a determination. Nevertheless, the Court of Appeal agreed with the first instance Judge that the contemporaneous documents (for example, the Master Fund launch resolutions) were inconsistent with the argument that a determination to that effect had in fact been made by the directors.
- Waiver issue. Dragon contended that the Master Fund represented by its conduct that there had been an effective redemption of shares in the Master Fund consequent on the service of a notice on Dragon, and that Dragon had acted in reliance on that representation by not serving a notice of its own or asking for a formal waiver of the notice requirement. This argument also failed, the Court of Appeal noting amongst other things the “obvious artificiality in the contention that the same individuals (in their capacity as directors of the Master Fund) made a representation to themselves (in their capacity as directors of Dragon) and then in the latter capacity relied on it.”
Harneys acted for representatives of Eagle, being the successful party to the appeals at both first instance and on further appeal.
The first instance decision can be found in our 2018 blog post "Industry Practice versus Articles of Association; Directors beware".