The Comp Anies Law (2007 Revision) and The Sphinx Group of Companies (in Official Liquidation) as Consolidated by The Order this Court Dated 6th June 2007
| Jurisdiction | Cayman Islands |
| Judge | Hon. Anthony Smellie |
| Judgment Date | 04 December 2009 |
| Court | Grand Court (Cayman Islands) |
| Docket Number | CAUSE NO. 258 OF 2006 |
| Date | 04 December 2009 |
The Hon. Chief Justice
The SPhinX Group of Companies are investment fund entities now in official liquidation under the aegis of this Court. The Joint Official Liquidators (“the JOLs”) have applied to the Court for the setting of a monetary reserve to meet the contingent liabilities of the SPhinX Companies, as such contingent liabilities may arise from certain indemnities given by them. These are contractual indemnities given to persons in respect of various fiduciary relationships formerly held as between those persons and the SPhinX Companies and in respect of which those persons have filed or may yet file claims in the liquidations.
There are potentially 34 such Indemnity Claimants, 9 of whom have participated in the hearing of this, the JOLs' application. It is however accepted by the JOLs that the monetary reserve must also cover the contingent liabilities of the other 25.
The Indemnity Claimants are individuals who were in various capacities engaged as auditors, directors or other professional service providers to the SPhinX Companies and whose contracts of engagement contained the indemnities which are contemplated by this application.
Subject to their proper construction and to the admission by the JOLs of the contingent proofs of debts submitted by reliance on them, the contractual indemnities would protect the Indemnity Claimants from liability arising from their relationships with the SPhinX Companies and with related third parties; except for liability arising from gross negligence, fraud or other intentional wrong-doing. Thus, liability for negligence — non-intentional wrong-doing —would be covered by the indemnities, as well as liability for the legal costs of successfully defending against any claim whatsoever — whether of non-intentional or intentional wrong-doing. This contingent liability for the legal costs of the Indemnity Claimants became, in the course of these proceedings, the subject for which the JOLs, with the support of the Liquidation Committee (“the LC”), pressed most urgently for the setting of the reserve. However, legal costs aside, the Indemnity Claimants have identified at least three other heads of potential contingent liabilities for which they say provision must be made now and object to the monetary reserve being set for legal costs alone, unless some arrangement (monetary or otherwise) is made to provide for those other heads of contingent liabilities.
For their part, the JOLs and the LC contend that the reserve for legal costs should now be set so that a distribution of surplus assets can be made to the investors/shareholders of the SPhinX Companies.
The JOLs have reported that the SPhinX Funds are solvent, with some 535 million dollars' worth of assets realised over the course of the past three years of the liquidation and available for distribution.
While the Indemnity Claimants who are present on this application (“the ICs”) and the other 25 ICs, may properly be regarded as contingent creditors to the extent of their potential indemnity claims, the JOLs believe that indemnity claims could — even if they were all realised — come to represent but a fraction of the assets and so should not stand in the way of a timely distribution to the investors/shareholders now. In this the LC naturally joins in support. However, inthe view of the JOLs, no distribution scheme can be finally agreed or is likely to be appealing to the various classes of investors/shareholders, until the reserve for the contingent indemnity claims has been quantified. It is to resolve this issue that the JOLs apply now to the Court and in order to meet the contingent liabilities other than for legal costs (for which they seek the immediate setting of the reserve) they make other proposals about which more below.
By way of background, it is to be noted that the JOLs have been engaged for some time in two sets of proceedings being heard together in the Southern District of New York against, amongst others, the ICs who are present in these proceedings. The New York proceedings are complex consolidated proceedings in which the JOLs also seek to recover some 300 million dollars in damages, not only as against the ICs, but also as against others who had been closely involved in the management of the SPhinX Companies and of its fund managers — the ill- fated Refco Group of Companies — in claims of gross negligence and fraudulent mismanagement. These consolidated proceedings will be referred to as “the New York proceedings” or “the Refco MDL”, as the context requires. There are also on foot, proceedings brought by four of the ICs (Messrs. Kavanagh, Owens, DPM and Aaron) here in Cayman by way of appeals against the JOLs' rejection of their proofs of debt based on their indemnities, for legal costs already incurred in the New York proceedings.
If the JOLs are successful in the New York proceedings on grounds of intentional wrong-doing, they would also expect to establish that the exclusionary provisions of the indemnities apply. But if the JOLs fail to establish such liability against theICs or succeed only on grounds of negligence, then the ICs (and potentially the other 25 ICs who may yet be joined in the New York proceedings) will seek to rely on the indemnities for the recovery of all their costs.
It is therefore accepted by the JOLs, that the reserve for costs must be calculated on the footing that the JOLs lose; both in the New York and the Cayman proceedings.
The directions and orders which the JOLs seek are, against the background of the contingent liabilities which may arise on the indemnities, of personal importance to them as well. Were it not for the protection which the sanction of the Court will afford them, the JOLs — being on notice of the full extent of the potential contingent liabilities — would be at risk of themselves having to meet any shortfall which might arise from keeping too small a reserve.
The Court must therefore be alive to the risk of prejudice to the ICs and the other 25 ICs, which may arise from it setting too small a reserve to meet the costs which may be indemnified. The same risk of prejudice would arise from too small a reserve for meeting any other liabilities which may be owed arising under the indemnities.
It is in this respect that the ICs assert correctly that as contingent creditors of the SPhinX liquidation estate, they are entitled to priority over the investors/shareholders. The Companies Law (2009 Revision) (“the Law”) in section 140 (1) provides that in a winding-up“…the property of the companyshall be applied in satisfaction of its liabilities pari passu and subject thereto shall be distributed amongst the members according to their rights and interests in the company.”
The statutory priority andpari passu principles are reflected in the winding up rules and for present purposes the important rule is Companies Winding-up Rules (“CWR'y 0. 18 R.4 which provides:
“In the calculation and distribution of the dividend the official liquidator shall make provisions for—
(a) any debts which appear to him to be due to persons who for whatever reason, may not have had sufficient time in which to tender or establish their proofs;
(b) any debts which are the subject of claims which have not yet been determined;
(c) disputed proofs and claims; and
(d) expenses of the liquidation which are anticipated but not yet incurred.”
The contingent liabilities here contemplated would come within sub rule (d) and the disputed proofs of ICs Kavanagh, Owens, DPM and Aaron already the subject of appeals before this Court; within sub rule (c).
The purpose of CWR 0. 18 R.4 is clear: provision must be made by a liquidator for the matters there identified in order that the priority of creditors over shareholders and the pari passu principle can be honoured, before a liquidator calculates and distributes a dividend. If no or inadequate provision is made for the matters identified in Rule 4, claimants whose proofs have been admitted mayreceive a greater dividend than they should at the expense and to the prejudice of claimants (including contingent creditors) who subsequently establish their claims. In this case, a failure to make provision as required would allow investors/shareholders to receive assets which may turn out not to be surplus assets and so to which they have no entitlement.
The amount of the provision which is required to be made for the types of claim identified in CWR 0. 18 R.4 is the full amount of the potential liability:Gooch v London Banking Association [1885] 32 Ch. 41; Oppenheimer v British and Foreign Exchanse and Investment Bank [1886] 6 Ch.D. 744 at 747; and Midland Coal, Coke and Iron Company [1895] 1 Ch. 267. The principle that full provision must be made for the contingent liabilities of companies in liquidation is well established also in the local case law (See: In Re Transnational Ins. Co. Ltd. 2001 CILR 34 and In Re Bristol Fund 2008 CILR 317.)
If the Court errs in setting a reserve that is too small, the ICs will suffer irremediable prejudice because — absent some provisions for “claw back” from recipients or insurance provision to cover any shortfall — once a distribution has been made, a creditor who could have proved his debt in the liquidation has no claim against those to whom a distribution has been made and the distribution cannot be reopened to let in such a creditor. In the words of Sir Robert Megarry VC inRe R-R Realisations Ltd. [1980] 1 All E.R. 1019 at 1024A:
“What has gone has gone”.
Thus,...
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