On 29 July 2019, the Judicial Committee of the Privy Council handed down its judgment in Skandinaviska Enskilda Banken AB v Conway & Shakespeare (as joint official liquidators of Weavering Macro Fixed Income Fund Ltd) (Cayman Islands)  UKPC 36. The Privy Council upheld the decisions of the Cayman Islands Grand Court and Court of Appeal in finding that certain redemption payments received by Skandinaviska Enskilda Banken AB (Publ) (“SEB”) from Weavering Macro Fixed Income Fund Ltd (the “Company”) shortly prior to the Company’s liquidation constituted voidable preferences and requiring SEB to repay those amounts to the Company’s joint official liquidators (“JOLs”).
The Company was an open-ended investment fund, trading mainly in interest rate derivatives. It went into liquidation on 19 March 2009, prompted by the discovery of fraud on the part of the principal of the Company’s investment manager, Magnus Peterson. In 2015 Mr Peterson was convicted and sentenced to 13 years’ imprisonment.
During the course of 2006 to 2008, SEB had subscribed for approximately US$9.5 million of redeemable participating shares in the Company as custodian and nominee for two clients.
Shortly after the collapse of Lehman Brothers in September 2008, many of the Company’s investors sought to redeem their shares. This included SEB, which in October 2008 issued redemption notices in respect of all of the shares it held as nominee for its clients, for a 1 December 2008 redemption day. As a result, redemptions totalling US$138.4 million became due to redeeming shareholders on 1 December 2008 (the “December Redeemers”). Redeeming shareholders with a 2 January 2009 redemption day (the “January Redeemers”) were owed US$54.7 million. Redeeming shareholders with a 2 February 2009 redemption day (the “February Redeemers”) were owed US$30 million.
The offering memorandum for the relevant shares stated that “Redemption payments are generally made within 30 calendar days after the Redemption Day”.
SEB was paid just over US$1 million by the Company on 19 December 2008. It received a second payment of 25% of the balance of the redemption amounts owing to it on 2 January 2009 and a third and final payment of the remaining 75% on 11 February 2009. In total, SEB received approximately US$8.2 million in redemption payments (the “SEB Redemption Payments”).
All but three large December Redeemers had been paid their redemption claims in full by the time the Company went into liquidation on 19 March 2009, with the balance owed to the unsatisfied December Redeemers being about US$50 million. The January Redeemers and the February Redeemers were never paid.
In August 2014, the JOLs issued proceedings against SEB seeking a declaration that the redemption payments were invalid as preferences under section 145(1) of the Companies Law (2013 Revision) (the “Law”) and an order that the monies be repaid with interest. Section 145(1) provides that:
“Every conveyance or transfer of property… made… by the company in favour of any creditor at a time when the company is unable to pay its debts… with a view to giving such a creditor a preference over the other creditors shall be invalid if made… within six months immediately preceding the commencement of the liquidation.”
The Lower Court Decisions
In December 2015, the Grand Court held that the SEB Redemption Payments were each invalid as a preference over the other creditors of the Company pursuant to section 145(1) of the Law and ordered that SEB repay those amounts to the JOLs.
SEB appealed the Grand Court’s decision to the Court of Appeal on several different grounds, none of which succeeded. Our client advisory on the Court of Appeal’s November 2016 decision can be found here.
SEB then appealed to the Privy Council on six issues. That appeal was heard in June 2018. The Privy Council’s approach to each of these issues and their conclusions are summarised below.
The Privy Council Decision
The six issues before the Privy Council were:
- The Fraud Point – was the result of the fraud of Mr Peterson, which caused the published NAVs of the Company to be inflated, that no valid redemptions had ever taken place and therefore the payments to SEB fell outside of the scope of section 145(1) as SEB was not a creditor at the time of the payments?
- The 30 Day Point – did the payment due to the December Redeemers only fall due 30 days after the 1 December 2008 redemption day, such that the Company was solvent at the time that the first redemption payment to SEB was made on 19 December 2008?
- The Future Debts Point – If the 30 Day Point is successful, does the cash flow test of insolvency applicable in the Cayman Islands permit consideration of debts that would become payable in the reasonably near future?
- The Intention to Prefer Point – was there any intention to prefer SEB over other creditors in respect of the second and third redemption payments in January and February 2009 (it was conceded by SEB that there was a specific intention to prefer SEB in respect of the first December 2008 SEB Redemption Payment)?
- The Amendment Point – If the Court held that there was no specific intention to prefer SEB in respect of the second and third redemption payments, should the first redemption payment not be set aside as, if it had not been made in December 2008, it would have been made together with the second or third redemption payments and therefore cannot constitute a preference?
- The Repayment Issues – Are common law defences available to SEB (such as the absence of unjust enrichment and change of position) or is the JOLs’ claim against SEB contrary to public policy due to being founded on illegality, such that SEB should not be required to repay the claimed amounts?
The first three issues concern the question of whether the SEB Redemption Payments were made at a time when the Company was insolvent. The fourth and fifth issues concern the question of whether the SEB Redemption Payments were made with the intention to prefer SEB. The sixth issue concerns the consequences of the application of section 145(1).
In the end, the Privy Council did not need to deal with the third issue (the future debts point) as it was expressly contingent on SEB succeeding on the second issue (the 30 day Point), which it did not. Similarly, the fifth issue (the Amendment Point) did not arise, as SEB did not succeed on the fourth issue (the Intention to Prefer Point).
1) The Fraud Point
SEB contended that the published NAVs, which had assumed that certain swaps had the value fraudulently attributed to them by Mr Peterson, were not valuations within the meaning of the Company’s Articles and that in the absence of any alternative figures stating the Company’s true asset value, there was no material before the Court on which it could conclude that the Company was insolvent at the relevant times.
The Court of Appeal rejected that contention, favouring instead the JOLs’ submission that the reasoning in the Privy Council’s decision in Fairfield Sentry was applicable to this case. In the Court of Appeal’s view, the published NAVs were binding in favour of redeemers and conclusive at the time of the SEB Redemption Payments notwithstanding that, because of Mr Peterson’s fraud, the NAVs were, in fact, incorrect.
The Privy Council disagreed. It considered the decision in Fairfield Sentry to be distinguishable, as in that case the fraud which operated on the assessment of the NAV was external to the fund whereas in Weavering the fraud was internal to the Company, having been perpetuated by the Company’s controlling mind, Mr Peterson.
The Privy Council concluded that because of the ‘internal’ fraud, the NAV was not binding on all persons and could therefore be avoided. However, and fatally here, to effect such an avoidance, proceedings would need to be brought against the JOLs by a party which had suffered loss as a result of the fraud. As SEB had not been defrauded in this case – it had, in fact, received payments based on the inflated NAV substantially in excess of the amounts to which it would have been entitled had the NAV calculation been accurate and honest – the fraud point was of no assistance to SEB.
2) The 30 Day Point
SEB contended that the 30 day window for payment post-Redemption Day, as stated in the relevant offering memorandum, meant that the Company was not in breach of contract until that 30 day window had passed without payment so the First SEB Redemption Payment, received within that 30 day window, was not preferring SEB over anyone else when made, as other December redeemers were not owed their money until the end of the 30 days.
The lower courts rejected that contention, holding that this issue had been concluded by the Privy Council in Culross Global SPC Ltd v Strategic Turnaround Master Partnership Ltd. On this point the Privy Council agreed. The proposition advanced by SEB, that a statement in an offering memorandum or similar document indicating when payment of a redemption price would be made prevents an immediate liability from arising on the relevant redemption day, was soundly rejected. The court held that the redemption payments due to SEB and the other December Redeemers became liabilities of the Company on 1 December 2008.
3) The Intention to Prefer Point
A condition of the application of section 145(1) of the Law is that the payment said to be a preference must be made to a creditor “with a view to giving such creditor a preference over other creditors”. The Privy Council accepted that, on the authorities, ‘with a view’ in the context of that section requires a ‘dominant intention to prefer’.
The Privy Council concluded that the Court of Appeal was entitled to reach its conclusion that the second and third SEB Redemption Payments had been made with a dominant intention to prefer SEB (as one of the class of December Redeemers). The fact that the second and third SEB Redemption Payments had fully discharged SEB’s redemption claim, whereas the three largest December Redeemers received only 25% of their claims, was, in the view of the court, itself sufficient to demonstrate a dominant intention to prefer SEB over those partially-paid December Redeemers. Further, the fact that the Company had a policy in place designed to allow December Redeemers to be paid before January Redeemers and February Redeemers, all of whom were to the knowledge of the Company unlikely to be paid, was also held to be a sufficient indication of a dominant intention to prefer SEB by the Company.
This does not change the established principle that if a preference defendant can establish that the impugned payment was made with a different intention (e.g. in capitulation to pressure exerted by the preference defendant or threats of litigation), then the inference of a dominant intention by the insolvent company to prefer that defendant can be displaced.
4) The Repayment Issues
The repayment issues arise from the fact that, unlike the equivalent preference provisions in English statute, the Cayman Law does not explicitly direct that payments found to be preferential be repaid to the insolvent company; it only declares such payments to be ‘invalid’.
SEB contended that, in the absence of any specific statutory right to claim repayment of preference amounts, liquidators must rely on a restitutionary remedy or a common law claim in unjust enrichment. If that is the case, SEB contended that common law defences, such as the absence of unjust enrichment and change of position must be able to be pleaded in defence to preference claims under section 145(1) of the Law.
The Privy Council agreed (contrary to the view expressed by the Court of Appeal) that section 145 does not create a statutory right to recover the property or payment which were the subject of the preference, but merely renders the relevant transfer or payment voidable.
In this case, the JOLs based their claim to repayment on a statutory entitlement impliedly created by section 145. The Privy Council did not accept that any claim lay on that basis. The court accepted, however, that the JOLs were entitled to restitution of a payment avoided under section 145 at common law on the grounds of unjust enrichment – subject to any defences available to SEB.
The Privy Council held that restitution in this circumstance was necessary to undo the unfair advantage that SEB had obtained at the expense of the other creditors of the Company. The common law therefore imposed an obligation on SEB to repay the SEB Redemption Payments, with a corresponding right for SEB to rank as a creditor in the Company’s liquidation for the amount owed to it (following repayment).
The defences raised by SEB to the restitution claim were (1) that it had not been enriched by the SEB Redemption Payments due to the fact that it had only ever held the relevant shares in the Company as a bare trustee for its clients and had therefore never had any beneficial interest in the shares and could not be said to have been enriched by the SEB Redemption Payments; and (2) that it had changed its position by paying away the SEB Redemption Payments to its clients in circumstances where it now has no ability to recover them.
On the first of these defences, the Privy Council rejected SEB’s assertion that it had not been enriched by the SEB Redemption Payments, drawing a distinction between the position of an agent (where a claim in restitution could properly be made against its principal) and SEB’s position as a trustee, acting as a principal in respect of its dealings with the Company. The Privy Council concluded that a trustee who acts as principal should be regarded as having been enriched by a payment which it receives in that capacity, even if it has fiduciary obligations to account to its clients for any funds received.
On the second of SEB’s defences, change of position, the Privy Council first weighed the question of whether, in the context of a claim by a liquidator for the restitution of money paid to a preferred creditor following the avoidance of the payment under section 145, the common law gives priority to the operation of the statutory scheme of distribution in a liquidation over the detrimental impact which recovery may have on a creditor against whom the claim is made. It concluded that it did and that, as a matter of principle, in the Cayman Islands ‘change of position’ will not be recognised as a defence to a preference claim. The court acknowledged that this finding could lead to harsh results, but concluded that addressing the question of whether it would be desirable for a measure of protection to be given to creditors in this situation was a matter for legislation and not for the courts. Having found that the defence of change of position is not available in the circumstances of SEB, it was not necessary for the court to reach any conclusions as to whether the defence might otherwise have been available to SEB in this case.
The greatest interest in this decision is likely to come out of its discussion of the ability of a fund to recalculate NAV in insolvency and on the position of custodians and other professional nominees who receive redemption funds from a company which later becomes insolvent.
In overturning the Court of Appeal’s conclusion that the Company’s published NAV was binding and conclusive despite the NAV being incorrect due to Mr Peterson’s fraud, the Privy Council has drawn a clear distinction between the binding nature of a NAV calculated in circumstances where there has been an internal fraud, as was the case here, and a NAV calculated where there has been an external fraud, as was the case in Fairfield Sentry. As also shown here, however, while an internal fraud may expose the NAV to a risk of recalculation, until there has been a successful legal challenge to the NAV by a party which has suffered loss as a result of the fraud (which will not be the case for a preference defendant), the NAV will remain the NAV.
The Privy Council’s finding that no ‘change of position’ defence is available to a preference claim in the Cayman Islands will be of concern to custodians who receive redemption payments on behalf of their clients from financially distressed funds. It is now extremely clear that the fact that a custodian has paid out the proceeds of any redemption payment to or on behalf of its customer will not, in itself, provide it with any defence to a preference claim made by a liquidator for the return of the redemption payment. A custodian may therefore find itself ‘out of pocket’ (subject to any potential recovery from the liquidation) if it does not take steps to protect itself against that risk, whether through adequate indemnity arrangements with its clients or by other means.