Insolvency and litigation funding are a natural fit, and the Grand Court of the Cayman Islands has recently issued the first public judgment approving a liquidator’s application for permission to enter into a third party litigation funding agreement with a commercial funder. As a bonus, the In re Platinum Partners Value Arbitrage Fund L.P.1 judgment also provides some welcome clarification as to when a liquidator’s fees, costs and expenses in realizing secured property will be payable in priority to secured debt. The judgment represents an important step forward for both the litigation funding industry in Cayman and the ability of liquidators to generate value for creditors from insolvent estates.
In this article, we highlight three key takeaways from the decision:
Liquidators and Litigation Funding
Liquidators of Cayman Islands entities have increasingly turned to third party litigation funding in recent years to investigate and pursue claims against third parties but have suffered from a dearth of public guidance on when funding arrangements will be acceptable. Most applications are made under heavy seal to protect commercially sensitive information and judges have not tended to issue written decisions in support of their orders approving the funding. Maintenance and champerty still attract criminal and tortious consequences in Cayman and there is no legislation defining those ancient torts or regulating litigation funding. This environment has led to uncertainty in drawing bright lines around what terms and provisions in a funding arrangement will be acceptable.
The case law prior to Platinum Partners addressed some issues but was not definitive for liquidators. The In re DD Growth Premium 2X Fund2 judgment considered conditional fee agreements between liquidators and Cayman law firms, not a third party commercial funding agreement. Similarly, In re ICP Strategic Credit3 dealt with a liquidator’s application for approval of a contingency fee agreement with US lawyers. Two decisions in 2017 and 2018 – A Company v A Funder4 and The Trustee v The Funder,5 respectively – approved third party commercial litigation funding agreements but were not made in the insolvency context, and so did not consider a liquidator’s specific duties or the competing interests involved between multiple stakeholders in the winding up estate.
The Court’s Decision
The Platinum Partners judgment fills the gaps in the prior case law. The application was brought by the joint official liquidators of the Platinum Partners Value Arbitrage master fund, a Cayman limited partnership that operated as part of a typical master-feeder hedge fund structure. The funding agreement at issue contemplated the funder establishing a credit facility for investigations and holding a right of first refusal to fund claims identified by the liquidators. In return, the funder would receive a 10% interest rate on funds advanced and a certain percentage of the litigation recoveries made by the estate, depending on whether the funder chose to fund the claim and when the recoveries were made.
Complicating matters, there were approximately $140 million worth of secured creditor claims against the fund. Prior to liquidation, the fund had purported to grant various security interests over its assets in favour of a large number of creditors. The validity and scope of the security interests remained an issue between the liquidators and the purported secured creditors, but at least some creditors suggest that their security covered the fund’s causes of action, or any recoveries from them, that are the subject of the funding agreement. One of these creditors objected to the liquidators’ application, in part because the repayments to the funder from any recoveries were intended to be in priority to the secured debt.
After considering the legal and commercial issues in play, the Court approved both the funding agreement and the priority of the borrowing costs over the purported security interests.
Priority of Funding Agreement
The Court dealt first with the priority issue. Relying on a series of English and Australian cases, the judge determined that a liquidator’s fees, costs and expenses incurred in preserving and realizing a secured asset are payable in priority to the secured debt. He termed this the “Universal Distributing Principle”, based on the Australian case In re Universal Distributing Co Ltd,6 as further articulated by the High Court of Australia in Stewart v Atco Controls Pty Ltd:7
...a secured creditor may not have the benefit of a fund created by a liquidator’s efforts in the winding up without the liquidator’s costs and expenses, including remuneration, of creating that fund being first met. To that end, equity will create a charge over the fund in priority to that of the secured creditor.
The circumstances in which the principle will apply are where: there is an insolvent company in liquidation; the liquidator has incurred expenses and rendered services in the realisation of an asset; the resulting fund is insufficient to meet both the liquidator’s costs and expenses of realisation and the debt due to a secured creditor; and the creditor claims the fund. In these circumstances, it is just that the liquidator be recompensed.
Applying that principle to the funding agreement, the liquidator’s fees, costs and expenses incurred in investigating and prosecuting the claims – including the borrowing costs payable to the funder out of recoveries – could be granted priority over the existing security interests. The Court specifically considered two ways in which the liquidator’s application raised issues about whether it would be appropriate to apply the Universal Distributing Principle:
In reaching this decision, the Court identified an important restriction on the application of the Universal Distributing Principle: only the fees, costs and expenses that the secured creditor would have to bear if it took enforcement proceedings itself will have priority over the secured debt. The corollary of that restriction is that costs for the benefit of the general winding up estate cannot be recovered from secured property. It is helpful to think of these limitations in terms of what fees, costs and expenses the liquidator would incur if it was appointed receiver over the secured property. Generally, only those costs will be covered by the Universal Distributing Principle.8
The recognition of the Universal Distributing Principle in Cayman law provides a mechanism for liquidators to protect their winding up estates and themselves from the risk of incurring unrecoverable costs and expense when dealing with potentially secured property in their possession or control. As in Platinum Partners, the principle will significantly assist where the validity or scope of security interests are at issue and the commercial urgency is to protect or realize assets.
A Role for Statutory Priority?
The Court briefly addressed the role of section 142(2) of the Companies Law and its intersection with the Universal Distributing Principle. The statutory provision provides that:
Where a liquidator sells assets on behalf of a secured creditor, he is entitled to deduct from the proceeds of sale a sum by way of remuneration equivalent to that which is or would be payable under section 109.
The liquidators did not rely on section 142(2). Counsel and the Court agreed that only remuneration, not costs and expenses, are covered by the provision. Unsurprisingly then, the Court did not have much to say about the operation of section 142(2) except that:
Cayman courts will hopefully have opportunity in the future to expand on these observations. In the meantime, the full impact and utility of section 142(2), and its interaction with the non-statutory jurisdiction, remain unsettled. It seems clear, given the linkage in section 142(2) to section 109 through to the Insolvency Practitioners’ Regulations (the IPR), that a liquidator’s remuneration payable from secured property must be within the bands prescribed by the IPR. We suggest that this restriction or protection, depending on your perspective, makes sense even where the priority is granted under the Universal Distributing Principle. Such an application would provide some amount of commercial certainty for both liquidators and secured creditors, while also giving a meaningful effect to the statutory provision.
Approval of Funding Agreement
After determining that it had jurisdiction to approve the funding agreement with the required priority over secured creditors, the Court turned to the question of whether it should approve the funding. There were two elements to the Court’s analysis: (a) the established test for sanctioning a liquidator’s exercise of its powers, which defers heavily to the commercial judgment of the liquidator, and (b) the criteria set out in ICP Strategic Credit Fund, A Company v A Funder and The Trustee v The Funder to ensure that a litigation funding agreement does not stray into unlawful maintenance or champerty.
On the sanction test, the Court accepted the liquidators’ judgment that the funding agreement was in the best interests of the fund. Some of the factors cited by counsel and relied upon by the Court included:
The Court was slightly critical, however, of the failure to involve the purported secured creditors more fully in the process. The judge noted that where funding arrangements will affect secured creditors, liquidators should have regard to those interests and ensure that on balance the funding terms properly protect all stakeholders. The liquidators’ approach in this case ultimately passed muster on the evidence, but the Court’s comments highlight an area where liquidators could proactively cut off a potential area of criticism with an appropriate consultation process.
On the maintenance and champerty issue, the Court returned to its decision in A Company v A Funder and the features identified as having significance in determining whether a funding agreement is consistent with Cayman public policy. The Court accepted that the terms negotiated by the liquidators and the funder adequately addressed any champerty concerns:
Accordingly, the Court granted permission for the liquidators to enter into the funding agreement.
The Future of Litigation Funding in Cayman
It is not uncommon in Cayman liquidations for the most valuable assets to be legal claims. External funding is often needed for liquidators to investigate and pursue those claims. Local law firms are hampered by common law restrictions on contingency and conditional fee arrangements, making third party litigation funding an especially useful and attractive alternative.
But the litigation funding industry will only grow and thrive when the regulatory environment is clear and predictable. In that light, the Platinum Partners decision should serve as an important judicial precedent going forward. Insolvency practitioners, litigation funders and their advisors can use the details included in the judgment on commercial terms and the liquidators’ process to design, implement and defend their own efforts. It is the latest sign that the Cayman Islands are open for business in this area, even while needed legislative reform remains outstanding.Mark A. Russell is the Head of Insolvency & Restructuring at KSG Attorneys.
1 Grand Ct, 13 December 2018, unreported.
2 2013 (2) CILR 361.
3 2014 (1) CILR 314.
4 2017 (2) CILR 710.
5 Grand Ct, 26 July 2018, unreported.
6 (1933) 48 CLR 171.
7 (2014) 252 CLR 307.
8Although in the right commercial circumstances the priority may be broader than that as demonstrated by the Platinum Partners decision itself.