Corporate subscription financings – a sheep in wolves’ clothing
July 2015 | PROFESSIONAL INSIGHT | BANKING & FINANCE
Financier Worldwide Magazine
Convention dictates that a Cayman Islands exempted limited partnership (ELP) be utilised for offshore private equity fund subscription financings. The process is relatively straightforward. A limited partner commits to pay capital up to an agreed amount into an ELP as and when capital calls are made. The subscription agreement usually sets out the payment obligations and terms while the limited partnership agreement (LPA) empowers, at least, the general partner to make the capital calls. The LPA typically allows an ELP to grant security over the rights to make capital calls as well as the proceeds thereof to support or guarantee borrowing obligations of itself or a third party. On occasions, however, such financings may not involve an ELP but instead a Cayman Islands exempted company with limited liability (Cayco). An inconspicuous change maybe – but a distinction with a difference.
This article highlights how taking subscription finance security in respect of a Cayco is different from an ELP, and offers some options for lenders and borrowers to consider. While different considerations apply, it is possible with proper Cayman Islands legal advice to get lenders comfortable.
A tale of two entities
The genesis for the different approach lies with the remedies available to a secured party upon an event of default. With an ELP, the secured party would usually be entitled to make capital calls on the limited partners of the ELP, collect the proceeds and update the books and records of the ELP accordingly. It is perfection in practice – a self-help remedy with no need to seek court consent prior to enforcement.
With a Cayco, however, section 99 of the Companies Law (2013 Revision) of the Cayman Islands (section 99) must be considered. Section 99 provides that any transfer of shares or alteration in the status of the Cayco’s shareholders made after the commencement of its winding up is void unless approved by an order of the Grand Court of the Cayman Islands. If a winding-up order has been made in respect of a Cayco, thereby triggering an event of default under the loan documents, it may not be possible to update the register of shareholders of the Cayco to issue shares to investors in return for capital payments made. The argument runs that since the Cayco cannot fulfil its part of the subscription agreement, namely the issuance of shares in return for cash, the shareholder may argue the subscription agreement is ‘frustrated’ (although one may not view such an argument as likely to be sustainable). This does not mean the security is invalid, but simply that the self-help remedy may not be available. The approval of the Grand Court of the Cayman Islands can be sought to update the register of shareholders, however the process is not automated as compared with an ELP.
How can section 99 be overcome to get lenders comfortable? Prevention is better than the cure and so, if at the outset it is anticipated that a Cayco may undertake a subscription financing during its lifetime, its subscription agreement and the articles of association should provide that shares are not required to be issued where section 99 applies. But what if one does not have the luxury of being at inception of a Cayco’s lifecycle? A Cayco is fully committed and its shareholders expect to be issued with shares in return for paying their capital commitments. If so, one or more of the following is worth considering. First, issue all shares in advance. If the Cayco’s shares are issued at the outset, they thereby avoid the issues caused by section 99. Second, seek consent of the shareholders for the proposed financing. This is unlikely to be attractive and is impractical where Cayco has many shareholders. Third, amend the articles of association. It may, depending on the provisions of the subscription agreement and the voting rights of the shares in Cayco, be possible to amend the articles of association without consent from all shareholders. The amendments are aimed at providing that shares need not be issued where section 99 applies. Fourth, consider springing rights. This is a variation on the option above whereby all the shares are issued at the outset, the terms of which provide an automatic springing right to the economic entitlements upon payment of the relevant subscription amounts. Finally, it may not be palatable to issue all the shares at the outset to the shareholders, and so instead the shares may be issued to a trustee. As and when capital payments are made, the appropriate number of shares in the name of the trustee are transferred to the relevant shareholder. Where section 99 applies, the shares remain with the trustee but are held for the benefit of the relevant investor until such time as the share transfer can be made.
In a subscription financing involving an ELP, the LPA must be governed by Cayman Islands law; however, the subscription agreement can be governed by any law. As a consequence, the right to call capital is a Cayman Islands situated chose in action or right and for Cayman Islands perfection purposes, a notice of the security granted in favour of a secured lender should be given to each limited partner. Under Cayman Islands law, and subject to certain exceptions, priority between successive assignees of the right to make capital calls is decided according to the timing with which notice is given to the relevant debtor or obligor; here, the shareholder (the so called ‘rule in Dearle v Hall’). Under the rule in Dearle v Hall, giving notice first obtains priority.
In a subscription financing involving a Cayco, the subscription agreement may not be Cayman Islands law governed, and depending on the specifics of the relevant transaction, the right to make capital calls may not be set out in the articles of association of Cayco. If so, since there is no Cayman Islands situated chose in action or right, then arguably it is not strictly necessary for any Dearle v Hall notice of the security to be given to each shareholder. This will need to be considered on a case by case basis as other factors, such as the location of the register of shareholders, are relevant. Where the right to make capital calls is set out in the articles of association of Cayco, such right is likely to be a Cayman Islands situated chose in action or right and therefore notice should be given to shareholders of Cayco in accordance with the rule in Dearle v Hall.
On the face of it, a creature of statute in section 99 is a roadblock (no matter how remote the possibility) and even a showstopper. Too often, law firms are informed of advice received that a secured lender cannot be adequately protected in a subscription financing involving a Cayco; that is not correct. Careful analysis of the operations of the relevant Cayco, its articles of association and subscription documents, coupled with proper Cayman Islands legal advice, usually reveals a pathway to achieve a subscription financing for Cayco.
Ramesh Maharaj is a partner and Alexandra Woodcock is senior counsel at Walkers. Mr Maharaj can be contacted on +1 (345) 914 4222 or by email: firstname.lastname@example.org. Ms Woodcock can be contacted on +1 (345) 814 4588 or by email: email@example.com.
© Financier Worldwide
Ramesh Maharaj and Alexandra Woodcock