Re Herald Fund SPC (in official liquidation)

• Jurisdiction: Cayman Islands
• Judge: (Jones, J.)
• Judgment Date: 02 September 2016
• Court: Grand Court (Cayman Islands)
• Date: 02 September 2016

Grand Court, Financial Services Division

(Jones, J.)

IN THE MATTER OF HERALD FUND SPC (IN OFFICIAL LIQUIDATION)

PEARSON (AS ADDITIONAL LIQUIDATOR OF HERALD FUND SPC)

and

PRIMEO FUND (IN OFFICIAL LIQUIDATION)

Attorneys: Walkers for the plaintiff; Mourant Ozannes for the defendant.

Cases cited:

(1) Barrell Enterprises, In re, [1973] 1 W.L.R. 19; [1972] 3 All E.R. 631, considered.

(2) L & B (Children), In re, [2013] UKSC 8; [2013] 1 W.L.R. 634; [2013] 2 All E.R. 294; [2013] 2 FLR 859; [2013] 2 F.C.R. 19, considered.

(3) Nilon Ltd. v. Royal Westminster Invs. S.A., [2015] UKPC 2; [2015] 3 All E.R. 372; [2015] 2 BCLC 1; [2015] BCC 521, referred to.

(4) Pilmer v. Duke Group Ltd., [2001] 2 BCLC 773; [2001] 5 L.R.C. 417, referred to.

Legislation construed:

Companies Law (2013 Revision), s.112:

“(1) The liquidator shall settle a list of contributories, if any, for which purpose he shall have power to adjust the rights of contributories amongst themselves.

(2) In the case of a solvent liquidation of a company which has issued redeemable shares at prices based upon its net asset value from time to time, the liquidator shall have power to settle and, if necessary rectify the company's register of members, thereby adjusting the rights of members amongst themselves.”

s.140(1): “Subject to subsection (2), the property of the company shall be applied in satisfaction of its liabilities pari passu and subjectthereto shall be distributed amongst the members according to their rights and interests in the company.”

Companies Winding Up Rules 2008, O.12, r.2:

“(1) The official liquidator shall exercise his power to rectify the company's register of members under section 112(2) if he is satisfied that-

(a) the company is or will become solvent;

(b) the company has from time to time issued redeemable shares at prices based upon a mis-stated net asset value which is not binding upon the company and its members by reason of fraud or default, with the result that the company has issued an excessive or inadequate number of shares in consideration for the prices paid by one or more subscribers; and/or

(c) the company has redeemed shares at prices based upon a mis-stated net asset value which is not binding upon the company and its members by reason of fraud or default, with the result that the company has paid out excessive or inadequate amounts to former members in consideration for the redemption of their shares.

(2) For the purposes of rectifying the register of members in accordance with this Rule, the official liquidator shall determine the true net asset value of the company as at each relevant redemption date.

(3) The true net asset value of the company shall be determined in accordance with the accounting principles specified for this purpose in its articles of association or, if none are specified, in accordance with whatever generally accepted accounting principles are adopted by the official liquidator.”

Rt. Hon. Lord Goldsmith, Q.C., F. Tregear, Q.C., M. Goucke and C. Keefe for the plaintiff;

T. Smith, Q.C., P. Hayden, R. Cecere and C. Levers for the defendant.

Companies — register of shareholders — rectification — power under Companies Law (2013 Revision), s.112(2) and Companies Winding Up Rules, O.12, r.2 to rectify register if open-ended fund collapses because shares issued and redeemed at misstated NAVs (often by third party fraud) — rectification under s.112(2) to restore register as if transactions at true NAVs — cannot give effect to scheme of distribution different from s.140

Companies — register of shareholders — rectification — investment fund (claiming as creditor in bankruptcy of Bernard L. Madoff Investment Securities LLC) cannot rectify register against shareholder who initially invested approximately US$150m. directly in BLMIS and later transferred balance in scheme (fraudulently misstated at approximately US$465m.) for in specie subscription in investment fund (being allocated shares based on misstated balance)

The court considered whether a register of shareholders should be rectified.

Herald Fund SPC (“Herald”) had been established as an open-ended investment fund which placed its funds with Bernard L. Madoff Investment Securities LLC (“BLMIS”). During the initial offer period, Herald had offered shares at US$1,000 or ââہ¡¬1,000 per share. Thereafter, shares had been issued and redeemed on each subscription or redemption day at the NAV determined in respect of the portfolio. Unknown to Herald, BLMIS had been an elaborate fraudulent scheme and the NAVs reported during Herald's trading life had all been misstated by reason of BLMIS's fraud.

The defendant (“Primeo”) was an open-ended investment fund which had initially invested directly with BLMIS (it invested approximately US$150m.). In May 2007, the balance standing to Primeo's credit with BLMIS, namely US$463,353,186.26, which was adjusted to US$465,418,349.08, had been assigned to Herald in consideration for 373,260.3648 shares at the then NAV of US$1,246.90 per share (“the Primeo in specie subscription”). Thereafter, Primeo became, in effect, a feeder fund for Herald, which in turn was a feeder fund for BLMIS.

When BLMIS collapsed in 2008, Primeo was placed into immediate liquidation. A winding up order was subsequently made in respect of Herald. Joint official liquidators were appointed. The plaintiff was appointed as additional liquidator whose task was to settle the list of contributories pursuant to s.112 of the Companies Law (2013 Revision) and determine related issues, including whether Herald's register of members should be restated pursuant to s.112(2) and whether Primeo's shareholding in Herald should be adjusted on the ground that the consideration for the issue of its shares had been the transfer of the portfolio with BLMIS, the value of which had been fraudulently overstated. Primeo was a member of Herald's liquidation committee.

Section 112(2) provided that-

“in the case of a solvent liquidation of a company which has issued redeemable shares at prices based upon its net asset value from time to time, the liquidator shall have power to settle and, if necessary rectify the company's register of members, thereby adjusting the rights of members amongst themselves.”

Herald filed a customer claim in the BLMIS bankruptcy based on the amount recorded in its last statement of account, which included the final recorded value of the Primeo in specie subscription. The US Bankruptcy Court determined, however, that customer claims would be dealt with by the net equity method, i.e. a customer could claim for the total cash invested, less the amount withdrawn. It was agreed that the net cash value attributable to the Primeo in specie subscription for the purposes of Herald's customer claim was US$149,780,967.

In June 2015, the court held that the misstated NAVs were binding as a matter of contract between Herald and its shareholders, with the result that unpaid redeemed shareholders were entitled to prove in the liquidation as creditors (that decision is reported at 2015 (1) CILR 482). The court leftopen the question whether the register of members should be restated and rectified pursuant to s.112(2).

The outstanding issues were therefore whether Herald's register should be restated and rectified, as amongst its shareholders, because of the misstated NAVs and, if so, on what basis or by which method? The additional liquidator considered that Herald's shareholders should be treated equally in the sense that the adverse impact upon Herald of the Madoff fraud should be passed on in the same way to all shareholders. He argued that the Primeo in specie subscription should not be allowed to stand to the extent that it was based on fictitious profits that were not recoverable by Herald (and would not have been recoverable by Primeo) in the BLMIS bankruptcy. He argued that, notwithstanding that the court had held that the Primeo in specie subscription was not void for mistake, he had power to rectify Herald's share register under s.112(2) and that he should do so to achieve substantive justice between the shareholders. He considered that the register should be rectified using the “net investment” or “rising tide” method.

Primeo submitted inter alia that, as a matter of construction, s.112(2) did not create a freestanding power of rectification, and that the relevant part of the June judgment was wrong and should be revisited.

Held, ordering the rectification of the share register:

(1) The court would not revisit its earlier decision that s.112(2) of the Companies Law (2013 Revision) (“the Law”) created a freestanding power of rectification. It was not disputed that a judge had power to change his decision unless and until a written order had been drawn up, signed, sealed and filed. The overriding objective in the exercise of that power was simply to deal with matters justly. The issue of the construction of s.112(2) would not be revisited, however, as it had been fully argued at the previous hearing, a reasoned judgment had been delivered and it had been reported in The Cayman Islands Law Reports (paras. 18-20).

(2) Section 112(2) of the Law and O.12, r.2 of the Companies Winding Up Rules (“CWR”) were intended to deal with issues arising in connection with open-ended mutual funds that had collapsed (and were consequently put into compulsory liquidation) because shares had been issued and redeemed at NAVs that were materially misstated, often as a result of fraud or default by a third party that was not imputed to the company. Unlike the court's rectification power under s.46, this power applied only to a limited class of companies and only when such a company was the subject of an official liquidation and certified to be solvent. The power was expressed in very general terms but, because its exercise was dependent upon the company having issued redeemable shares at prices based upon its NAV, the legislature must have intended that this...