RMF Market Neutral Strategies (Master) Ltd v DD Growth Premium 2X Fund

• Jurisdiction: Cayman Islands
• Court: Grand Court (Cayman Islands)
• Judge: (Smellie, C.J.)
• Judgment Date: 17 November 2014
• Date: 17 November 2014

RMF MARKET NEUTRAL STRATEGIES (MASTER) LIMITED

and

DD GROWTH PREMIUM 2X FUND

(Smellie, C.J.)

Grand Court, Financial Services Division

Companies-capital-distribution of capital-under Companies Law (2007 Revision), s.37(5)(b), definition of ‘payment out of capital’ in s.37(6)–(9) as ‘any payment so made’ not to refer to payment to redeem or purchase company”s own shares other than out of profits or proceeds of fresh shares under s.37(5)(a)-clear that, under 2007 Law and 2010 Law (as amended by Companies (Amendment) Law 2011), redemption or purchase of company”s own shares using share premiums not capital payment

Companies-compulsory winding up-creditors-fraudulent preference-payment only recoverable under Companies Law (2007 Revision), s.168(1) if debtor”s motive for transaction to prefer particular creditor-insufficient that knew payment would result in preferential payment if not primary reason for making payment-unnecessary to show that transferor intended to avoid equal distribution of assets but must be aware that insolvent at time of transfer

Held, making the declaration sought:

(1) 2X was, at the relevant times of the payments to RMF, both cash-flow and balance-sheet insolvent. Although the NAV showed that 2X was solvent, it was clear that it did not have any available assets. It must, therefore, have been insolvent, notwithstanding that there had not been conclusive evidence of this fact at the time the redemption requests were made (para. 16; paras. 116–118).

Were the payments to RMF unlawful payments of capital?

(2) Any distribution of a company”s assets to a shareholder, except in accordance with specific statutory procedures, was unlawful. This rule was designed to protect creditors by preventing a company from transferring all of its assets to its shareholders and rendering them inaccessible. Whether a transaction violated this rule did not depend on the label attached by the parties-the court would consider the substance, not the form, of the transfer (although any distribution would prima facie be seen as a distribution of capital). The rule should not, however, be overstated as, in order to protect the shareholders” right to redeem their investments, certain types of transfers between a company and a shareholder must be necessary. Accordingly, the Companies Law (2007 Revision), s.37 enabled a company to purchase its own shares from a shareholder in certain circumstances-provided that the company was also authorized to do so by its articles of association (paras. 24–29; para. 41).

(3) Section 37(5) did not mean that any payments for the redemption or purchase of a company”s own shares not made from profits or the proceeds of a fresh issue of shares were unlawful payments of capital. 2X”s proposed construction would be strained and tortuous and would have an extensive impact by creating wide-ranging criminal liability. Further, 2X”s interpretation would require all such purchases using share premiums received from the sale of its shares over and above their par values to be regarded as capital payments. As investment funds like 2X usually operated by selling and redeeming shares at a huge margin over their par values and using the money from those sales to make investments and pay for the redemption of shares (and all parties were aware that this was how such funds operated), the proposed construction would have far-reaching consequences on the ordinary course of business for such funds (paras. 51–65).

(4) Further, 2X”s interpretation would conflict with the regime under s.34(2). This section stated that, where permitted by the company”s articles, share premiums could be used for the redemption or purchase of the shares in the company. It was clear that s.34 and s.37 were separate regimes within the statute and it must follow that share premiums were not to be regarded under the 2007 Law as becoming part of the paid-up share capital of a company for the purposes of capital preservation. Further, there were no prohibitions in s.34 against the use of share premiums to redeem shares when the company was insolvent-although it did restrict the use of share premiums for distributions and dividends in such a

situation-and 2X”s interpretation would artificially introduce this restriction into s.34. Such an interpretation would therefore be contrary to s.34(2) itself and the statutory regime as a whole. Accordingly, the court could not interpret s.37 as introducing the prohibition of use of capital for the redemption of shares when the company was insolvent under s.37(5)(a) (paras. 73–79).

(5) The changes to the Companies Law under the Companies (Amendment) Law 2011 supported the court”s interpretation. Under s.37(5)(a) (as amended by s.8 of the Companies (Amendment) Law), a company was entitled to make a payment to redeem or purchase its own shares otherwise than out of its profits, share premium account, or the proceeds of a fresh issue of shares. Even if the definition of a payment out of capital as ‘a payment so made’ referred to a payment under s.37(5)(a), a payment out of capital could not include a payment out of share premiums. Such a payment would not, therefore, be unlawful under s.37(6)(a), even if the company were insolvent at the time that it was made. Additionally, the proposition that the s.37 regime was not intended to affect the s.34 regime was supported by the fact that, under the Companies (Amendment) Law 2011, s.7, the reference to share premiums was removed from s.34(2) so as not to conflict with the new language in s.37(5)(a). Further, under s.37(5)(c) (as amended by the Companies (Amendment) Law 2011, s.8), the use of a company”s capital and the use of its share premiums for the purposes of payment were clearly distinguished. There were no policy reasons for the amendment Law to have changed the substantive law in this area and the legislative history indicated that the amendments were simply intended to provide certainty. The amendment was therefore properly regarded as clarifying the existing state of the law rather than changing it and could be used to support the interpretation of the 2007 Law (paras. 80–92).

(6) It was clear that the money was a share premium. Although the shares were described as ‘ordinary shares’ and the articles and offering memorandum stated that the money invested with the master fund was capital, the substance of the transactions-particularly the difference between the par value and the value at which the shares were sold-made it clear that the majority of the money was a share premium. Further, whilst s.34(1) stated that share premiums would be transferred into a specific account, it was accepted by all parties (and stated in the offering memorandum) that all money would be invested with the master fund and that 2X”s main asset was a contractual claim for a return of that investment. In the ordinary course of business, 2X”s assets were therefore to be regarded as a share premium and appreciations from investments of that premium and it was clear that the use of these profits in the redemption of shares was in the ordinary course of business. Although 2X was insolvent at the time of the transfers, it was not in the process of winding up. Whether it was operating in the ordinary course of business was therefore defined by its constitutional documents. 2X”s directors had

not exercised any powers which could cause 2X to be regarded as not operating in the ordinary course of business-although it was regrettable that its directors had not done so and had instead created a Ponzi scheme to the detriment of the other shareholders. 2X had therefore clearly been acting in line with its normal practices and RMF had fully complied with the procedure for redeeming investments under its articles of association. As the transactions involved share premiums and had not been in violation of either the statute or 2X”s articles of association, 2X should not, therefore, be entitled to reverse the payments based on reliance of the capital preservation rule (paras. 53–69; paras. 94–108).

(7) Even if the payments had been out of capital, they would not have been unlawful. As a matter of law, and under 2X”s constitutional documents, the payments were made (in substance, if not form) as payments for debts owed to RMF as a creditor, rather than as a payment for the purchase of RMF”s shares. The transaction would not, therefore, be unlawful (although fraudulent preference claims might be possible) (paras. 114–115).

Were the payments to RMF preferential payments?

(8) The mere fact that a particular creditor was paid ahead of others was insufficient to avoid the payment. For the liquidators to recover the payments under s.168(1), they had to be able to show that 2X”s dominant motive for the particular transaction was to prefer RMF over its other creditors-although they did not need to show that 2X actually intended to disturb the operation of the bankruptcy laws by avoiding an equal distribution of assets. 2X must therefore have known that it was insolvent at the time of the transfer, although that was not, by itself, sufficient to show the necessary intention. The court was entitled to consider all of the circumstances surrounding the transfer and infer the necessary intention from indirect evidence. It would not, however, return a payment which was lawfully made simply because the debtor had intended to repay his debt. There was therefore a distinction between a situation in which the dominant motive was to prefer a creditor and a situation in which the debtor was aware that the payment would prefer a particular creditor but the dominant motive was different (e.g. if the creditor in question had threatened the debtor or offered an immediate benefit if it paid the debt). Accordingly, as the focus was on the creditor”s dominant intention (rather than whether a desire to prefer influenced the creditor), this was distinct from the...