Maintaining the status quo: How to ensure business continuity when presented with a winding up petition in the Cayman Islands

This article first appeared in Volume 22, Issue 6 of International Corporate Rescue, contributed to by partner Barnaby Gowrie, senior associate Michael Testori and associate Sam Hall. 

Synopsis

A recent judgment of the Grand Court of the Cayman Islands has reiterated the principles that the Cayman Islands Courts will consider in determining whether to grant a validation order in the context of winding up proceedings in the Cayman Islands. This article follows on from Walkers’ previous guidance published in this publication in May 2018,¹ by addressing the law as developed by, and following, the Cayman Islands Court of Appeal decision in Tianrui (International) Holding Company Limited v China Shanshui Cement Group Limited [2020] 1 CILR 417, and subsequent instructive authorities. This article provides practical evidentiary considerations and tips for parties that are considering making, or presented with, a validation application. 

Background: what is section 99?

Section 99 of the Companies Act provides that, ‘When a winding up order has been made, any disposition of the company’s property and any transfer of shares or alteration in the status of the company’s members made after the commencement of the winding up is, unless the Court otherwise orders, void’. Accordingly, any payments or dispositions made by a company after a winding up petition has been presented against it are at risk of being void if a winding up order is made, unless the company during this time seeks validation in respect of such payments from the Court under section 99.  The purpose of section 99 ‘is to preserve the status quo’ and has a ‘“conservational” function’.² It enables a liquidator to ‘unwind any transactions which may have taken place during the twilight period and return the assets and circumstances of the company and its contributors to those which were in place at the time the winding up commenced’.³

If section 99 did not exist, ‘persons seeking to wind-up companies would have the relief that they were seeking defeated, because unscrupulous directors would simply dispose of the company’s assets before a winding-up order was made. And so, this provision operates in the following way. Once a petition is presented, no assets of the respondent company can safely be disposed of without the Court granting a validation order under section 99, or until such time as the petition is dismissed’.⁴

When is validation required?

The scope of section 99 is very wide as it applies to any disposition of the company’s property and any transfer of shares or alteration in the status of the company’s members made after the winding up petition is presented. Where a winding up petition has been presented against a company, whether or not a validation order is sought or granted does not of itself prevent the company from continuing to carry out its normal business and does not prevent its directors from causing the company to enter into appropriate transactions. It simply has the result that such transactions may be susceptible to avoidance by the liquidator if a winding up order is made in due course.⁵

Accordingly, it is common for directors to seek prospective validation of dispositions of the company’s property, which may include:

– payments to suppliers or creditors in the ordinary course of business;

– settlement of liabilities critical to maintaining operations;

– transactions necessary for business continuity or restructuring; and

– asset sales essential for liquidity or commercial viability.

The legal test

When determining an application for validation under section 99, the Court will need to consider whether, if a winding up order were to be made, the applicant company and its contributories are unlikely to be worse off as a result of any particular validation order that the Court might make than if no validation order is made and the transaction is susceptible to avoidance.

The general principles underpinning section 99 were recently summarised by Justice Jalil Asif KC in AllFunds Bank S.A. v Rasmala Trade Finance Fund: ⁶

– Section 99 applies whether the company is solvent or not, whether it is a trading company or undertakes some other business, and whether the winding up is on the grounds of insolvency, on just and equitable grounds or on other grounds.

– The purpose of section 99 of the Act is to preserve the status quo during the twilight period between presentation and determination of the winding up petition. It enables a liquidator to unwind any transactions which may have taken place during that period and to return the assets and circumstances of the company and its contributors to those which were in place at the time the winding up commenced.

– The status quo in question is the position of the company and of those interested in any future winding up as at the date of the presentation of the petition, so that they are not prejudiced by the necessary time taken to determine the petition.

– The potentially deleterious effect of the ability to unwind transactions may be ameliorated by the process of validation. Particularly in the case of a trading company, validation may itself assist in preserving the status quo by enabling the company to continue to conduct its business and to survive notwithstanding the depressing effects which flow from the presentation of a winding up petition.

– However, the court’s power to make a validation order must not be exercised in a way which undermines the essential purpose of section 99, namely, to preserve the status quo pending determination of the petition. The court must keep at the forefront of its consideration of a validation application the need not to impede or undermine that statutory purpose. 

– The court must consider whether, if a winding up order were to be made, the company and those interested in the liquidation are likely to be worse off than if the action sought to be validated was not taken. If they are likely to be worse off, the status quo will not have been preserved.

Key legal considerations where you are seeking validation

Before issuing an application under section 99, the applicant should have regard to the following guidance which was recently established in Rasmala:

Evidentiary threshold:

The applicant’s evidence must identify, explain and justify (with sufficient specificity) the transactions for which validation is sought so as to enable the Court to consider whether if a winding up order were to be made, the applicant and its contributories / creditors are unlikely to be worse off as a result of any particular validation order that might be made than if no validated order is made and the transaction is susceptible to avoidance.⁷ In particular:

1. Financial Information: Up to date financial information regarding the applicant’s financial condition must be included in evidence. Without this, the Court will be handicapped in its ability to consider whether validation is appropriate under section 99 as it will be unable to determine the current status quo and whether validation will impact it.
2. Operation of the applicant: The applicant should include any evidence that demonstrates that the applicant has been unable to operate normally or nearly normally so as to justify payments that address the paralysis or risk of paralysis.⁸
3. Payments to service providers: If service providers are not accepting payment or unwilling to deal with the applicant given the risk that such payments may be unwound, this should be addressed in the evidence. Importantly, the Court will not infer that this is the case,⁹ and generalities will not suffice. Therefore, where validation is sought over payments to service providers, the applicant may consider whether it is possible to engage in correspondence with the service provider so as to evidence any concerns the service provider may have.
4.  Investments and new transactions: If the applicant would like validation over new investments or transactions, the applicant needs to provide a detailed assessment of the commercial terms and associated risk of both entering and not entering into the transaction so as to enable to the Court to determine if it impacts the status quo. ¹⁰

Solvency: 

The fact that the applicant appears to be solvent does not lessen the Court’s caution in determining whether or not to make a general validation order or to validate some or all of the specific categories of expenditure identified by the applicant. However, it may affect the Court’s assessment of whether validation of transactions is likely to risk a significant adverse impact on the status quo.

Retrospective validation is possible: 

There is no difference in the principles to be applied where validation is sought retrospectively, but it should be possible for the evidence presented to the court in support of the application for retrospective validation more directly to address the impact of the transaction on the statutory requirement under section 99 of maintaining the status quo.¹¹

Timing of the application: 

Where it is not demonstrated that validation is necessary at the time that the application is made, then the Court may consider that it may be better to await the outcome of the hearing of the petition, when the position is likely to be much clearer, rather than trying to assess the likely effect of the transactions in question on the status quo, particularly where, as was the case in Rasmala, the petition was due to be heard in the near future (i.e. in approximately two to three months).¹² Accordingly, if the applicant considers validation may be required, it is important that it does not delay in seeking it as any material delay may well prejudice the applicant’s ability to argue that validation is required.

General validation not permissible: 

In Rasmala, the applicant sought general validation of all transactions in the ordinary course of the applicant’s business. This was held to be too wide as the Court requires evidence which demonstrates that there will be no adverse impact on the status quo of making the general validation sought, which is difficult to do unless you go through all proposed dispositions in detail.¹³

Responding to a validation application

Before a petitioner is served with a validation application, it is common for the applicant to foreshadow the validation in correspondence so that the applicant can canvass the views of the petitioner with respect to the dispositions that validation is sought over.

In circumstances where the petitioner is not provided with sufficient information to determine whether the validation of dispositions will affect the status quo, it is important that the inadequacy of the information provided is highlighted and that the required information is requested. The petitioner should be cautious to object to dispositions as this may be construed as obstructive to the operations of the applicant and could cause the petitioner to be penalised with costs if the applicant is forced to make a contested validation application. Instead, if the petitioner has any concerns with the dispositions, such concerns should be ventilated in detail and the petitioner should describe what information and explanation it would expect to see in respect of each disposition before providing consent. Presenting the petitioner’s views in this manner portrays the petitioner as providing assistance to the applicant (and further, to the Court) rather than providing blanket objections without explanation. 

In the same vein, where the petitioner is responding to a validation application and does not consent to some or all of the dispositions validation is sought over, the petitioner should ensure that its responsive evidence and skeleton argument responds in a manner which seeks to assist the Court in its adjudication of the application and highlights how the evidence of the applicant is not sufficient to enable to the Court to undertake the analysis required under section 99. Adopting this approach may assist by providing the petitioner with costs protection. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Notes 

1. ‘Shining A Light On Validation Orders In Cayman Insolvency Proceedings’ (24 May 2018).
2. Paragraph 14 of Tianrui (International) Holding Company Limited v China Shanshui Cement Group Limited [2020] 1 CILR 417.
3. Paragraph 15 of Tianrui (International) Holding Company Limited v China Shanshui Cement Group Limited [2020] 1 CILR 417.
4. 241011 In the matter of LVII Investment Management Ltd (in Official Liquidation) & Ors -v- Floreat Private Ltd & Ors FSD 316 of 2024 (IKJ)- Ex Tempore Ruling at [11].
5. Paragraph 54 of Allfunds Bank S.A. v Rasmala Trade Finance Fund [2025] CIGC (FSD) 22 (‘Rasmala’).
6. Paragraph 14 of Rasmala.
7. Paragraph 67 of Rasmala.
8. Paragraph 65 of Rasmala.
9. Paragraph 65.4 of Rasmala.
10.  Paragraph 70 of Rasmala.
11. Paragraph 17 of Rasmala. 
12. Paragraph 57 of Rasmala. 
13. Paragraph 65 of Rasmala.