Cayman Court clarifies the test for the appointment of provisional liquidators

In two unrelated judgments handed down in the same week, the Grand Court has dismissed applications to appoint provisional liquidators pursuant to section 104(2) of the Companies Act due to a failure by the applicants to jump the “necessity” and “prima facie case” hurdles.

In both cases, the applications were made following the presentation of a contributory’s winding up petition on just and equitable grounds alleging a justifiable loss of trust and confidence in the company’s management due to alleged fraudulent conduct. In summarily dismissing the applications, the Court has confirmed that it is a serious step to appoint provisional liquidators and that there is a heavy and onerous burden on those that seek such orders.

We set out below an overview of the legal principles arising out of the judgments of Doyle J in In the matter of ICG I[1] and Parker J in in the matter of Al Najah Education Limited[2] which are of general application to those seeking to appoint provisional liquidators.

Liam Faulkner of Campbells appeared for the respondents in successfully opposing the application in ICG I.

The Four Hurdles

Under section 104(2) of the Companies Act an application to appoint provisional liquidators may be made by a creditor, contributory or (in certain cases) the Cayman Islands Monetary Authority at any time between the presentation of a winding up petition and the making of a winding up order on the grounds that:

• there is a prima facie case for making a winding up order; and
• the appointment of a provisional liquidator is necessary in order to prevent –
  • the dissipation or misuse of the company’s assets;
  • the oppression of minority shareholders; or
  • mismanagement or misconduct on the part of the company’s directors.

In ICG I, Justice Doyle confirmed that on a plain reading of section 104(2) an applicant seeking the appointment of a provisional liquidator has four main hurdles to jump:

• the presentation of the winding up petition hurdle: the applicant must satisfy the court that a winding up petition has been duly presented and a winding up order has not yet been made;
• the standing hurdle: the applicant must satisfy the court that the applicant has standing to make the application to appoint a provisional liquidator, i.e. the applicant is a creditor or contributory of the company;
• the prima-facie case hurdle: the applicant must satisfy the court that there is a prima-facie case for making a winding up order on the petition; and
• the necessity hurdle: the applicant must satisfy the court that the appointment of the provisional liquidator is necessary in order to prevent the dissipation or misuse of the company’s assets; and/or the oppression of minority shareholders; and/or mismanagement or misconduct on the part of the company’s directors.

The two hurdles which will often be the hardest to clear are the prima facie case hurdle and the necessity hurdle.

The prima facie case hurdle

On the prima-facie case hurdle, Doyle J commented that there has been much debate over the years as to the test to be applied in the Cayman Islands and whether the applicant was required to show a good prima facie case or merely a prima facie case and the meaning of those phrases.

Doyle J referred to the decisions of Parker J in Grand State Investments Limited[3] and Segal J in Re Asia Strategic Capital Fund LP[4] as authority for the proposition that it was not necessary for the applicant to demonstrate that a winding up order will be granted; a prima facie case is established where it is likely, on the basis of a case established by allegations supported by evidence which have not been disproved at the interim stage, that the petitioner would obtain a winding up order on the hearing of the petition.

Doyle J ultimately concluded in ICG I that it was not necessary for him to determine the standing and prima facie case hurdles as it was clear to him that the applicant had failed to jump the necessity hurdle.

The issue was, however, determined in Al Najah Education Limited with Parker J adopting a consistent position to the authorities cited by Doyle J in ICG I.

The necessity hurdle

In Al Najah Education, Parker J confirmed that there must be clear or strong evidence to show that there is a serious risk that one or more of the wrongs identified in section 104(2)(b) of the Companies Act may well occur if provisional liquidators are not appointed.

In ICG I, Doyle J considered the tests to be applied where it is alleged that the appointment of provisional liquidators is necessary in order to prevent (i) the dissipation or misuse of the company’s assets and/or (ii) mismanagement or misconduct on the part of the company’s directors and held that[5]:

• The risk of dissipation test: there is a heavy burden on the applicant, requiring clear or strong evidence as to necessity, to show that the assets of the company are being, or are likely to be, dissipated to the detriment of the petitioner and that there is a serious risk that the assets may not continue to be available to the company unless provisional liquidators are appointed; and
• The test for mismanagement or misconduct on the part of the company’s directors: mismanagement or misconduct on the part of the directors connotes culpable behavior involving a breach of duty or improper behavior that involves a breach of the governing documents and governance regime.

Decision on the evidence in ICG I

In ICG I the petitioner claimed to be a contributory of the company alleging that he had been issued with 99 out of 100 shares in the company as security for a loan advanced to an entity affiliated with the company’s sole shareholder, LC Capital Limited.

The applicant also asserted that he had been issued with 99 shares in a separate legal entity established by LC Capital with a similar name called ICG 1, that he had only recently become aware that ICG I and ICG 1 were not the same legal entity and that he had serious concerns over the conduct of the company’s management.  ICG I held two properties of value in Japan whilst ICG 1 had no known assets.

On the morning of the hearing, the applicant was informed that a secured creditor had enforced its security by the appointment of receivers over the issued shares in ICG I and had voted on those shares to replace the Board with an independent director. The position of the receivers was that the documents relied upon by the applicant to evidence his shareholding in ICG I were at best incomplete and/or inconsistent such that it was far from clear whether he was in fact a shareholder of ICG I (as opposed to ICG 1) and that the appointment of the receivers and the independent director negated the need to appoint provisional liquidators.

Leaving aside the standing and prima facie case hurdles, Doyle J held that it was clear that the applicant had not cleared the “necessity” hurdle and had failed to persuade the Court that the appointment of provisional liquidators was necessary to prevent the dissipation or misuse of the company’s assets and/or prevent mismanagement or misconduct on the part of the company’s directors.

Decision on the evidence in Al Najah Education

In Al Najah Education the petitioners held 7.87{92e447aa5ae4509d19f58c4a2ed7ec0dbb286610ae15b33d823e9409689b2d4a} of the issued shares in the company and were supported by other shareholders holding a further 15{92e447aa5ae4509d19f58c4a2ed7ec0dbb286610ae15b33d823e9409689b2d4a} of the issued shares. The petitioners alleged that there had been a proven fraud by certain key members of the company’s management which involved (in effect) theft from the company and forgery of company documents in an effort to cover up that fraud, and which the current members of the Board had intentionally sought to conceal from shareholders.

It was said that these facts gave rise to a justifiable loss of trust and confidence in the Board. In essence, the alleged fraud involved the improper taking of placement fees by the former investment manager (which was owned and controlled by individuals who continued to act as directors of the company) which was the subject of adverse findings by the Dubai Financial Services Authority (“DFSA”) at first instance and the DFSA’s Financial Markets Tribunal on appeal.

The Court found that the regulatory decisions of the DFSA and the Financial Markets Tribunal showed that it was the company’s former investment manager, and not the company itself, which had been engaged in fraudulent promotion. The company was not a party to those regulatory decisions.

Parker J held that the company was a separate legal entity to its former investment manager and that the fraudulent conduct of the investment manager was not attributable to the company and could not be said to be fraud in the conduct of the affairs of the company. The impugned directors made up a minority of the company’s current Board and there was no evidence before the court at the interim stage that the company’s Board connived or were complicit in the conduct of the former investment manager or that it had any knowledge of the fraud at the relevant time. Rather the company could properly be characterized as a victim of the fraud.

The facts which gave rise to the regulatory decisions had occurred prior to 2015 and the Court held that there was no evidence of any on-going mismanagement at the company or risk of future mismanagement.

Parker J held that his provisional view based on the evidence before him was that the court was unlikely to conclude that it is just and equitable to wind up the company. The alleged loss of trust and confidence in the company’s management must be based upon the conduct of the directors regarding the company’s business and in his view there was no objectively justifiable evidence before him to demonstrate a lack of probity in the conduct of the company’s affairs.

Costs

Doyle J handed down a separate judgment in ICG I dealing with the costs of the failed application and confirmed that the general rule that costs should follow the event applies on an unsuccessful application to appoint provisional liquidators.

In doing so, Doyle J rejected the argument advanced by the applicant, citing the decision of McMillan J in Abraaj Holdings,[6] that the general rule that costs follow the event is a principle of limited application in insolvency proceedings in view of the underlying policy rationale to encourage open debate and the reasonable expression of views which stakeholders consider to be important or relevant to the liquidation.

Doyle J dismissed this argument and held that the circumstances of the case were “many miles away” from the circumstances which confronted McMillan J in Abraaj Holdings. Instead, Doyle J held that the unsuccessful applicant should pay the respondents’ costs of and incidental to the failed application and stated that a potential liability in costs should in future focus the minds of those thinking of taking the serious step of applying for the appointment of provisional liquidators before a petition has been determined.

About Campbells

Campbells has one of the largest insolvency and restructuring teams in the Cayman Islands and has had a lead or major role on almost all significant Cayman insolvency and restructuring cases in recent years. We act for financial institutions, investment funds, creditors, shareholders, provisional and official liquidators, directors, managers and other professional service providers in relation to the restructuring and liquidation of Cayman Islands companies and partnerships.

Notable recent instructions include:

• Advising the joint provisional liquidators of Luckin Coffee Inc. in connection with the restructuring of approximately US$1bn of debt, following a widely publicised fraud and delisting.
• Acting for the joint provisional and official liquidators of ABRAAJ Investment Management Limited, the investment manager of the Abraaj group.  Prior to its collapse in 2018, Abraaj had been the largest private equity firm operating in emerging markets, with some 40 underlying funds, over 600 investors, and $14bn of AUM at its peak.
• Advising the Liquidation Committee of SAAD Investments Company Limited, a liquidation involving the longest trial in Cayman legal history.

Should you have any queries or require advice on issues relating to litigation, insolvency or restructuring in the Cayman Islands then please contact us directly.

Liam Faulkner

Partner

+1 345 914 5866

lfaulkner@campbellslegal.com

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