In a recent decision of the Grand Court of the Cayman Islands, Smellie CJ has found that redeemed shareholders are entitled to retain redemption proceeds paid to them by a fund even though the fund was cash flow insolvent at the time of the payment. The Judge found that the Companies Law (2007 Revision) (the \u201cLaw\u201d) (applicable at the relevant time) did not prohibit the use of share premiums for the redemption of shares when permitted by\u00a0a fund\u2019s articles, even when insolvent, because by operation of section 34(2)(f) as it then stood, payments out of share premiums were not to be regarded as payments out of capital.<\/p>\n
In a lengthy judgment, the Judge set out an array of reasons for rejecting the liquidators\u2019 contention that the payments to RMF fell foul of section 37(6)(a) of the Law which, reflecting the common law preservation of capital rule which originally developed to protect creditors, stated that:<\/p>\n
\u201ca payment out of capital by a company for the redemption or purchase of its own shares is not lawful unless immediately following the date on which the payment out of capital is proposed to be made the company shall be able to pay its debts as they fall due in the ordinary course of business<\/em>.\u201d<\/p>\n The par value of the shares in the DD Growth Premium 2X Fund was US$0.001 and the Judge found that the redemption monies were, in substance, paid out of the share premium, the price of the shares having been calculated at the date of redemption to be US$118.88. The liquidators argued, on behalf of the fund, that a redemption payment out of share premium fell within s 37(6)(a), by virtue of the deemed meaning of the phrase \u201cpayment out of capital<\/em>\u201d under section 37(5)(a) and (b), which included payment \u201cotherwise than out of its profits or the proceeds of a fresh issue of shares<\/em>\u201d. It must, the liquidators submitted, therefore include payment out of share premium.<\/p>\n The Judge rejected this argument as a \u201ctortuous and strained<\/em>\u201d construction of the statute. He expressed the view that many Cayman investment companies operated on the basis that redemption payments were made in the ordinary course of business from profits, share premiums and the proceeds of fresh issues of shares.<\/p>\n He also found the liquidators\u2019 position to be inconsistent with section 34 of the Law, under which a sum equal to the total value of share premiums must be transferred into a share premium account. Subject to the fund\u2019s articles, the balance of the share premium account can be used as set out in subsection (2), including, in the Law as it then was, subsection (2)(f): \u201cproviding for the premium payable on redemption or purchase of any shares or debentures of the company<\/em>\u201d. The Judge found that section 34 was not subject to section 37 but was instead a separate regime dealing with payments out of share premium.<\/p>\n In support of his conclusion, the Judge pointed to the changes to the Law brought in by the 2011 Amendment Law, which included adding payments out of \u201cshare premiums<\/em>\u201d to the list of payments not to be deemed payments out of capital under section 37(5)(b). The 2011 Amendment Law\u00a0also removed the reference in section 34(2)(f) permitting the share premium account to be used to pay redemptions. The Judge regarded this as a natural consequence of the clarification of section 37.<\/p>\n The purpose of capital preservation requirements is to protect a company\u2019s creditors. At common law, the default position is that company assets cannot be distributed to shareholders, unless statute provides otherwise. Such a distribution is defined as a return of capital and is accordingly unlawful at common law (Progress Property Co Ltd v. Moore<\/em> [2010] UKSC 55). Thus, the definition of capital is potentially broad but is limited by statute.<\/p>\n On Smellie CJ\u2019s construction of the Companies Law, the common law rule has a very narrow application in the context of Cayman funds. He appears to have confined the asset-preserving effect of section 37 of the Law solely to the amount of paid up share capital. The effect is especially marked when, as is typical in funds, shares are issued at a substantial premium and have only a very small nominal value.\u00a0 In these cases, the capital preserved will likely be insufficient to benefit the fund\u2019s creditors in any meaningful way, should the fund become insolvent.<\/p>\n