In Kuwait Ports Authority & Another v. Port Link GP Ltd. & Ors (FSD 236 of 2020, unreported, 25 November 2021, Parker J) the Grand Court considered – for the first time in the Cayman Islands – the applicable test governing derivative claims by a limited partner on behalf of an exempted limited partnership (“ELP”) under section 33(3) of the Exempted Limited Partnership Act (2021 Revision) (the “ELPA”).
The Court dismissed applications by the Defendants seeking to strike out the derivative claims against them by the limited partner Plaintiffs on the grounds that the general partner had not, as required by section 33(3) of the ELPA, “without cause, failed or refused” to institute proceedings against the Defendants in respect of the claims sought to be brought derivatively by the Plaintiffs. To the contrary, the independent directors of the general partner had thoroughly investigated the Plaintiffs’ claims and positively determined, in the exercise of their commercial judgment, not to commence proceedings in respect of such claims.
As ELPs play a central role in Cayman’s investment landscape, and provide a widely-used vehicle allowing for passive investment with limited liability for investors (in exchange for not becoming involved in the management of the ELP), the judgment will have wide-reaching consequences. The Court has set a low bar for limited partners wishing to commence derivative claims on behalf of an ELP, whether against the ELP’s general partner or third parties.
Factual Background
The Plaintiffs, Kuwait Ports Authority (“KPA”) and The Public Institution for Social Security (“PIFSS”), are Kuwait state-owned entities that were two of eleven limited partners (“LPs”) in The Port Fund L.P. (the “Fund”). The Defendants are the Fund’s general partner, Port Link GP Ltd (the “GP”), and parties connected to the GP/service providers to the Fund (collectively “D2-D4”).
The Plaintiffs make a series of allegations against the Defendants, claiming that in excess of US$100 million of the Fund’s assets were misappropriated or paid away to various related entities and professional service providers in breach of the Defendants’ duties to the Fund and the LPs. The Plaintiffs have raised numerous causes of action against the GP and D2-D4 for breach of duty, unlawful means conspiracy, fraudulent dispositions, dishonest assistance and knowing receipt. Relevantly, these claims are principally pleaded as direct claims, and are pleaded derivatively on behalf of the Fund in the alternative (save in the case of D4, where claims are advanced solely on a derivative basis).
The Defendants strongly reject the entirety of the allegations, and maintain the Fund’s assets were managed and applied lawfully, and principally to settle legitimate debts owed to the Fund’s creditors, including its investment manager, and third parties who were engaged by the Fund.
Independent directors were appointed to the GP in place of the former directors prior to the commencement of the proceedings. Following their appointment, the independent directors undertook extensive investigations into the allegations of wrongdoing raised by the Plaintiffs against the GP and D2-D4. The GP determined that there was cause not to pursue the derivative claims advanced by the Plaintiffs on behalf of the Fund, either because the threatened claims lacked merit and/or they were otherwise not in the best interests of the Fund. The Defendants consequently applied to strike out the Plaintiffs derivative claims on the basis they did not satisfy the threshold test set down in the ELPA.[1]
The Statutory Test
Section 33(1) of the ELPA provides that legal proceedings by or against an ELP may be instituted by or against a general partner only, and a limited partner shall not be a party to or named in the proceedings. Section 33(1) is consistent with sections 14 and 16 of the ELPA, which respectively provide that limited partners shall not take part in the conduct of the business of an ELP, and that any choses in action are held or deemed to be held by the general partner(s) upon trust as an asset of the ELP.
Section 33(1) is, however, subject to the exception in section 33(3) of the ELPA permitting derivative claims by a limited partner, which provides that:
“[a] limited partner may bring an action on behalf of an exempted limited partnership if any one or more of the general partners with authority to do so have, without cause, failed or refused to institute proceedings.”
Consistent with the common law, GCR O.15, r. 12A provides a mandatory procedure for an application for leave of the Court to continue a derivative claim after its commencement, however the rule applies only to derivative claims brought by “shareholders of a company”.
Accordingly, both the law and procedure applicable to derivative actions by limited partners in a Cayman Islands ELP were unclear. Neither section 33(3) of the ELPA nor its equivalent in other Commonwealth statutes had been the subject of any prior judicial consideration; the Grand Court was treading new ground.
The Parties’ Submissions
The Defendants’ strike out application in relation to the derivative claims relied upon the following arguments:
- This was not a typical strike out application in the sense of the Plaintiffs’ case presenting no cause of action or being abusive; the test was not about establishing an arguable case, but rather whether the section 33(3) gateway for derivative claims by a limited partner had been satisfied (akin to the requirement for leave in the context of derivative claims by shareholders of a company).
- The Plaintiffs were required (but failed) to plead a claim which satisfied the statutory threshold of section 33. In particular, it was argued that the Plaintiffs must plead and demonstrate that (i) the GP had failed or refused without cause to commence proceedings in respect of the threatened derivative claims and (ii) the GP’s decision not to itself pursue the derivative claims on behalf of the Fund, or the decision making-process, was inhibited in the sense of being bound up in the wrong-doing upon which the threatened claims are based, or which results from a conflict of interest that prevents an independent decision in relation to the claims. The Defendants argued that the independent directors of the GP were not so inhibited, as they could and would pursue claims which had merit on behalf of the Fund.
- Alternatively, the Plaintiffs must show that the decision of the GP was so unreasonable as effectively to be irrational, such that it could not have been taken in good faith in the interests of the Fund. The commercial decision of the GP not to pursue the threatened derivative claims should not be interfered with by the Court, absent exceptional circumstances.
- The GP had not failed or refused “without cause” to bring the threatened derivative claims; rather the independent directors of the GP had conducted extensive investigations and positively determined that there was cause not to bring such claims. This was set out in detail in lengthy affidavit evidence filed by the independent directors on behalf of the GP.
- The Plaintiffs had an alternative remedy in the form of their direct claims against the Defendants, and the derivative claims should accordingly be disallowed.
- The Plaintiffs were contractually and statutorily prohibited from involving themselves in the management of the Fund, and payment of compensation/damages to the limited partner Plaintiffs would usurp the management function of the GP.
- The “without cause” test in section 33(3) invokes common law and equitable principles applying to derivative actions in the case of companies and trusts, which is supported by section 3 of the ELPA. Unless derivative claims are reserved for exceptional circumstances (as is the case for companies and trusts), limited partners of an ELP could hold their fellow partners to ransom by pursuing a claim to trial simply because the GP has refused or failed to initiate a threatened claim on behalf of an ELP which the GP regards as unworthy.
The Plaintiffs argued in response that:
- The derivative claims are (at least) well maintainable as pleaded. The GP had a reasonable opportunity to bring the claims in question but has not done so. The GP has thus “failed” to bring them within the meaning of section 33(3).
- It is not necessary to plead the requirements of section 33(3) or to give the GP notice of the threatened derivative claims in advance of filing proceedings.
- The GP, distinct from its independent directors, is hopelessly conflicted and is prevented from reaching an independent view of the Plaintiffs’ claims. The GP cannot cure this conflict by appointing independent directors after the alleged wrongdoing occurred.
- The time for testing whether the GP has failed or refused without cause to bring the threatened derivative claims is at the time proceedings are filed; subsequent investigations by the independent directors are immaterial.
- The Court cannot grant a strike out application unless it is certain that the claim is bound to fail (e. a merits based argument), or where the claim raises serious issues of fact or developing areas of law.
The Court’s Decision on Section 33(3)
The Court dismissed the Defendants’ strike out applications based on section 33(3). It held that, unlike in the case of shareholder derivative claims in a company law context, there is no ‘leave stage’ for limited partners to overcome and no requirement to plead special circumstances. While Parker J further held that the principles of common law and equity for bringing derivative claims in the case of companies, trusts or English limited partnerships are not applicable in the case of Cayman ELPs, as section 33(3) ‘occupies the field’, he nonetheless concluded that whether to allow a derivative claim under section 33(3) was a question which engages the Court’s discretion (albeit, the point at which the Court’s discretion is engaged is unclear from the judgment).
In determining whether the statutory test was satisfied, the Court held that there was “a good arguable case” that the GP has failed or refused without cause to bring the claims, and that there was also a good arguable case that the GP had and still has a relevant inhibition as (i) the GP’s independent directors, acting in the GP’s best interests, would not sue the GP, and (ii) the decision not to pursue the claims is insufficiently distinct from the wrongdoing upon which the claims are founded.
The Court further held that the GP should take a neutral position with regard to the claims sought to be advanced derivatively by the LPs, as the GP (distinct from its directors) was incapable of exercising an impartial decision-making function. The Court also recognised that it has a role to ensure that the process followed by directors when assessing whether or not there is “cause” under section 33(3) is fair and the decision is taken impartially.
Finally, on the question of when in time the section 33(3) test is to be assessed, the Court held that this is to be judged on the relevant facts as they were at the time the proceedings were commenced. Section 33(3) is expressed in the past tense. Consequently, changed circumstances following the commencement of a derivative claim will not be relevant to the determination of the threshold issue of whether there has been a failure or refusal without cause; it will not matter if the claims are later proved to be materially flawed or unlikely to result in recoveries for the fund (i.e. because the defendant goes insolvent).
Accordingly, the strike out applications fall to be dismissed with the question as to whether the section 33(3) test has been met to be determined at trial.
Analysis
While this case did not concern a strike out or summary dismissal application in the traditional sense, and notwithstanding that section 33(3) appears on its face to operate as a gateway provision to be definitively overcome at the outset of the proceedings before a derivative claim can proceed to trial, the Court introduced and applied a summary judgment test by invoking an “arguable case” analysis throughout the judgment. Accordingly, the effect of the judgment is that a LP does not need to establish that there has, in fact, been a requisite failure or refusal, but rather a LP will be able to satisfy the statutory threshold and pursue derivative claims to trial by merely establishing that it is arguable that the section 33(3) test is met.
The practical consequence of the judgment is that a limited partner (even a minority limited partner) would need only to surpass the summary judgment test to force an ELP investment fund and its GP to litigate derivative claims at trial, and this may occur against the wishes of not only the GP but all other limited partners. This would also appear to be the case even though a limited partner has an alternative remedy in the form of direct claims.
The existence of an alternative remedy, such as a direct claim, provides grounds for the refusal of leave to continue a derivative claims in the context of companies or trusts. However, in the Court’s judgment, the fact that the direct claims concerning the same subject matter were already proceeding to trial provided a justification for why the Court should exercise its discretion in favour of allowing the derivative claims to continue. Accordingly, this represented a significant departure from the common law principles applicable to companies and trusts.
The Court’s finding that the GP cannot be the arbiter of claims against itself, or which arise from its own alleged breach, also raises a dilemma, as it follows that a conflict of interest – and therefore a relevant inhibition – will arise in every case where the subject of the derivative claims concerns the alleged wrongdoing of the GP. The weight given by the Court to the GP’s relevant inhibition is also curious as it is a principle which arises from authorities dealing with derivative claims in the company context, which the Court expressly disapplied, instead holding that section 33(3) occupies the field. It is also not clear from the judgment when (or whether) such discretionary considerations are to be weighed when testing section 33(3).
While it remains to be seen how this judgment will be applied in practice, the judgment appears to set a low bar which may result in LPs too readily forcing an investment fund into litigation against the wishes of the majority of its general and limited partners, thus subordinating the GP’s management function.
Andrew Pullinger, Harry Shaw and Katie Logan of Campbells represent the Second – Fourth Defendants.
[1] The GP also applied to strike out the Plaintiffs’ direct claims on separate grounds.
