Adjusting Shareholder Rights in the Winding Up of a Cayman Islands Investment Fund

A recent judgment of the Cayman Islands Court of Appeal1 (CICA) has over-turned an earlier decision of the Grand Court of the Cayman Islands (Grand Court) which had conferred the power on an official liquidator to adjust the rights of shareholders, in the winding up of a Cayman Islands investment fund, where the rights of shareholders have been distorted by the effects of a pervasive, but external fraud. Unfortunately for shareholders whose net asset values (NAVs) have been adversely affected by such a fraud, based on the current state of the law (as referenced in the CICA’s judgment) it would appear that the toolbox is bare, despite the best intentions of the draftsman.

The CICA decision is the most recent in the ongoing liquidation proceedings of Herald Fund SPC (in Official Liquidation) (Herald), a segregated portfolio company incorporated in the Cayman Islands which was one of the largest so-called feeder funds into the Madoff Ponzi scheme.

This aspect of the proceedings involved an important point of statutory construction, namely whether an official liquidator has a statutory power under section 112(2) of the Companies Law and its subordinate legislation to rectify (or, in other words, adjust) a share register so as to override the contractual rights of investors in the winding up of a Cayman Islands investment fund. Notwithstanding that this power has been exercised previously by official liquidators on at least one occasion (of which we are aware) in very similar factual circumstances without opposition, this was the first time the question of its scope and application had confronted the Grand Court and the CICA.

Herald was incorporated in the Cayman Islands in 2004 as a segregated portfolio company and was one of the largest so-called feeder funds into the Madoff Ponzi scheme (having invested all or substantially all of its assets in the Madoff Ponzi scheme since its inception in 2004). When Madoff was arrested on 11 December 2008, Herald’s business effectively collapsed overnight and its directors focused their attention, with the assistance of lawyers in various jurisdictions, on recovering its assets through litigation. Some years later, following the presentation of a winding up petition by Herald’s largest investor, Primeo Fund (in Official Liquidation) (Primeo), Herald was placed into official liquidation in July 2013.

Herald’s principal asset is its claim in the United States bankruptcy of Bernard L. Madoff Investment Securities LLC (BLMIS), which has been admitted in the amount of approximately US$1.6 billion (less a substantive “clawback” payment) – significantly less than the circa US$2 billion recorded as being held in Herald’s managed account with BLMIS prior to the discovery of the Madoff fraud. Given the hopelessly co-mingled nature of the fictitious managed account purportedly operated by BLMIS (which was, in effect, the world’s largest Ponzi scheme), the Trustee of the BLMIS bankruptcy has, in accordance with US legal principles, determined claims in the bankruptcy by reference to the investors’ individual net cash investment in BLMIS using what has been termed the “Net Investment Method” (that is, total cash invested less total amounts withdrawn prior to the collapse of BLMIS). The real value of Herald’s claim in the bankruptcy of BLMIS is currently estimated to be in the vicinity of US$750 million - US$800 million.

Further complicating matters, in May 2007 Primeo, which was already a shareholder of Herald, subscribed for further shares in Herald, the consideration for which was the in specie transfer to Herald of the assets purportedly held in Primeo’s managed account with BLMIS. At the time, those assets had a notional value of approximately US$463 million. Pursuant to that subscription, Primeo was duly issued shares in Herald at the prevailing NAV per share based on the value of its managed account with BLMIS (approximately US$463 million). However, as a result of the application of the Net Investment Method by the BLMIS Trustee, the component of Herald’s claim in the BLMIS bankruptcy attributable to the in specie transfer from Primeo has been valued at approximately US$149 million (i.e. approximately one third of the notional or face value). It was the substantially lower $149 million figure which was used by the BLMIS Trustee in calculating Herald’s admitted claim which, in turn, formed the basis of distributions received by the Liquidators for onward distribution to investors.


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1Primeo Fund (in Official Liquidation) v Michael Pearson (in his capacity as Additional Liquidator of Herald Fund SPC (in Official Liquidation)), unreported, 27 February 2018.

Matthew GouckePartnerT +1 345 914
Chris KeefeSenior CounselT +1 345 814 4574