JP Morgan v Finter Bank

• Jurisdiction: Cayman Islands
• Judge: (Jones, J.)
• Judgment Date: 13 July 2012
• Court: Grand Court (Cayman Islands)
• Date: 13 July 2012

Grand Court, Financial Services Division

(Jones, J.)

J.P. MORGAN MARKETS LIMITED

and

FINTER BANK ZURICH LIMITED

R. Handyside, Q.C. and A.J. Bolton for the applicant;

F. Hughes for the respondent;

S. Dickson for the JOLs.

Cases cited:

(1) Att. Gen. (Belize) v. Belize Telecom Ltd., [2009] 1 W.L.R. 1988; [2009] 2 All E.R. 1127; [2009] UKPC 10, dicta of Lord Hoffmann considered.

(2) Investors” Compensation Scheme Ltd. v. West Bromwich Bldg. Socy., [1998] 1 W.L.R. 896; [1998] 1 All E.R. 98; [1998] 1 BCLC 531; [1997] CLC 1243, dicta of Lord Hoffmann applied.

(3) Rainy Sky SA v. Kookmin Bank, [2011] 1 W.L.R. 2900; [2012] Bus. L.R. 313; [2012] 1 All E.R. 1137; [2012] 1 Lloyd”s Rep. 34; [2011] 2 CLC 923; [2012] B.L.R. 132; (2001), 138 Con. L.R. 1; [2011] UKSC 50, referred to.

(4) Reilly v. National Ins. & Guarantee Corp. Ltd., [2009] 1 All E.R. (Comm) 1166; [2009] Lloyd”s Rep. I.R. 488; [2008] EWCA Civ 1460, referred to.

(5) Schuler (L.) A.G. v. Wickman Machine Tool Sales Ltd., [1974] A.C. 235; [1973] 2 W.L.R. 683; [1973] 2 All E.R. 39; [1973] 2 Lloyd”s Rep. 53, referred to.

Companies-shares-redemption-if credit provider subscribes for shares and company given option to compel redemption and, after reducing strike price to zero, receive payment of excess proceeds, achieves economically equivalent result to limited recourse loan-if parties intended that effect, e.g. to protect other classes of shareholders from liability, not to imply obligation to pay strike if redemption proceeds insufficient-cannot re-write transaction by turning into actual loan

Joint official liquidators were appointed to wind up a fund on the ‘just and equitable’ ground (the winding-up proceedings are reported in 2010 (1) CILR 83).

The fund was incorporated as a Cayman company in 2003 to carry on business as an open-ended investment fund. Its offering document provided, inter alia, that (a) leveraging was permitted up to a maximum of 150% of the fund”s NAV; (b) a credit facility could be established to achieve this; and (c) whilst efforts would be made to contract with parties on a ‘limited recourse’ basis, if such a result were not possible, liabilities sustained by a share class in excess of the assets attributable to such class could be apportioned to the other share classes.

The fund”s memorandum and articles of association were amended in 2007 to provide for the issue of new leveraged and non-leveraged share classes, and the creation of a Class F which could only be issued to a credit provider. The fund”s offering document was additionally amended to provide, inter alia, that (a) leveraging in respect of the leveraged share classes was permitted up to a maximum of 150% of the relevant classes” NAVs; and (b) leveraging in respect of the non-leveraged share classes was permitted up to a maximum of only 50% of the relevant classes” NAVs.

The applicant creditor provider subsequently entered into an option agreement with the fund to subscribe for Class F shares. The agreement granted the fund an option to bring about the transfer to it of the Class F shares either through (a) redemption and payment by the applicant of the amount (if any) by which the proceeds exceeded the strike (‘the cash

settlement amount’); or (b) physical delivery of the shares against payment by the fund of the strike. It provided for cash settlement unless the fund elected for physical settlement.

In 2008, the fall in Class F”s NAV entitled the applicant to terminate the option agreement at a specified expiration date, on which, pursuant to its terms, the option was deemed to have been exercised; accordingly, the cash settlement provision became applicable. The applicant consequently redeemed its shares but the proceeds were less than the value of the strike. It obtained an order to wind up the fund and submitted to the JOLs a proof of debt in respect of the strike. In the present proceedings, the JOLs sought directions on whether to admit this proof.

The applicant submitted that (i) its subscription pursuant to the option agreement was the economic equivalent of making a loan to the fund under a credit facility; (ii) it was inherently unlikely that the parties viewed it as the economic equivalent of a limited recourse loan, because it did not provide for the applicant to have any ‘upside’ participation in any increase in the NAV of the shares over its term; and (iii) accordingly, an obligation to pay the strike should be implied.

The fund submitted in reply that (i) the option agreement was intended to produce a result which was the economic equivalent of a limited recourse loan; (ii) it would have made no commercial sense if those opting for unleveraged shares were exposed to the risk of leverage, but not the benefit; and (iii) accordingly, no payment obligation should be implied.

Held, directing the JOLs to reject the applicant”s proof of debt:

The court would not imply an obligation to pay the strike. The option agreement would be interpreted by reference to what a reasonable person, having all the background knowledge reasonably available to the parties at the time of the contract, would have understood them to have meant; further, insofar as the language was ambiguous, the court would generally prefer the construction most consistent with business common sense. Properly construed, the agreement did not provide for payment of the strike on exercise of the option because the parties had intended to achieve an economically equivalent result by a different mechanism, viz. the redemption of the shares and-after reducing the strike to zero-payment of the cash settlement amount (if any). Its commercial purpose was to provide the fund with credit for the leveraged investments, without exposing the non-leveraged investments to liability for the strike, achieving a result economically equivalent to a limited recourse loan. It was not, therefore, open to the court to re-write the transaction by turning it into an actual loan agreement (paras. 40–53).

1 JONES, J.:

Introduction

On August 5th, 2011, the joint official liquidators (‘the JOLs’) of Belmont Asset Based Lending Ltd. (‘the fund’) issued a summons seeking directions that they may admit to proof a claim of Bear Stearns Alternative Assets International Ltd. (‘BSAAIL’) in the amount of US$59,947,747 plus interest, in respect of the strike under an option agreement entered into between J.P. Morgan Markets Ltd. (formerly known as Bear Stearns International Ltd.) (‘BSIL’) and the fund, dated April 27th, 2007 (‘the option agreement’). On November 24th, 2011, I directed that the summons be treated as an application by BSAAIL, as applicant, against Finter Bank Zurich Ltd. (‘Finter’), as representative respondent, to determine whether, upon the true construction of the option agreement, BSAAIL is a creditor for that amount.

2 At the time the JOLs” summons was issued, neither BSIL nor its affiliate BSAAIL had actually submitted any proof of debt. However, the JOLs had taken legal advice from specialist London counsel, Mr. Iain Milligan, Q.C., as to the interpretation of the option agreement. In his written opinion, which has since been disclosed to the parties, Mr. Milligan advised, on the assumption that Cayman law is the same as English law in the relevant respects, that the fund was obliged to treat Bear Stearns as a creditor.

3 BSIL has now submitted a proof of debt dated March 7th, 2012, by which it claims the sum of US$61,208,180.21, being the amount of the strike allegedly due and owing under the terms of the option agreement as at that date. It was agreed that I should make an order for substitution to

reflect that the claimant is BSIL (rather than BSAAIL) and that the claim is for US$61,208,180.21 (rather than US$59,947,747), thus bringing the application into line with the proof of debt. It follows that the issue to be decided is whether, upon a true construction of the option agreement, BSIL is a creditor for the amount of its proof of debt. Having determined this issue, I shall direct the JOLs to admit or reject the proof of debt as the case may be. These amendments have no bearing upon the substance of the matter in issue which is a pure point of law to be determined upon the basis of an agreed statement of facts filed with the court on January 16th, 2012 (and agreed on February 13th, 2012).

The fund

4 The fund was incorporated and registered under the Companies Law as an exempted company on October 24th, 2003. It carried on business as an open-ended investment fund and was registered with the Cayman Islands Monetary Authority pursuant to s.4(3)(c) of the Mutual Funds Law. Upon its incorporation, the fund”s authorized share capital was the aggregate of US$29,000 and €20,000, comprising 100 voting shares of US$100 each (held by the fund”s management) and four classes of redeemable non-voting participating shares. The Class A and Class B shares are denominated in US dollars and the Class C and Class D shares are denominated in euros. At this stage, the only other distinction between the classes is that no management or performance fees were charged to the Class A shares which could only be issued to funds of hedge funds under the same management as the fund.

5 The fund was established as a fund of hedge funds. The investment objective, described in the confidential information memorandum dated July 10th, 2006, was as follows:

‘The investment objective of the [fund] in each of its classes is to maximize long-term returns to shareholders by investing in a diversified portfolio of fixed income related hedge fund strategies. The [fund] will allocate its assets to various fund managers employing various fixed income strategies, including relative value hedge fund strategies such as fixed income arbitrage, mortgage-backed securities arbitrage and capital structure arbitrage, as well as directional hedge fund strategies such as distressed securities...