Platinum Plated Priority

Platinum Plated Priority: Litigation Funding for Cayman Liquidators Approved in Platinum Partners Judgment

Insolvency and litigation funding are a natural fit, and the Grand Court of the Cayman Islands has recently issued the first public judgment approving a liquidator’s application for permission to enter into a third party litigation funding agreement with a commercial funder. As a bonus, the In re Platinum Partners Value Arbitrage Fund L.P.¹ judgment also provides some welcome clarification as to when a liquidator’s fees, costs and expenses in realizing secured property will be payable in priority to secured debt. The judgment represents an important step forward for both the litigation funding industry in Cayman and the ability of liquidators to generate value for creditors from insolvent estates.

In this article, we highlight three key takeaways from the decision:

• Funders, liquidators and their advisors now have clear judicial guidance to rely on when seeking, considering, assessing, negotiating and seeking approval of a third party commercial litigation funding agreement in an insolvency context. We anticipate this judgment will be an extremely useful tool for bench testing almost every aspect of a proposed funding agreement in the future, considering the evidence highlighted in the judgment on both the commercial terms of the agreement and the process followed by the liquidators.
• A liquidator’s fees, costs and expenses incurred in realizing secured property can have priority over the claims of the secured creditor. While this case concerned litigation claims, the principle can apply to any secured asset and will capture the fees, costs and expenses incurred by the liquidator’s care, preservation and realization efforts. The recognition that this principle exists in Cayman law should give liquidators greater comfort when dealing with property in their possession or control that is or may be subject to a security interest.
• The full impact and utility of section 142(2) of the Companies Law remains unsettled. That section allows a liquidator to recover its remuneration from sale proceeds when it sells an asset on behalf of a secured creditor. The liquidators in this case did not ultimately rely on this section, nor did the Court think that it was of assistance given that the amounts payable under the funding agreement went well beyond remuneration payments. We suggest the section applies even where priority is non-statutory, to ensure that a liquidator’s remuneration, when paid from secured property, is in line with the prescribed fee structure in the Insolvency Practitioners’ Regulations.

Liquidators and Litigation Funding

Liquidators of Cayman Islands entities have increasingly turned to third party litigation funding in recent years to investigate and pursue claims against third parties but have suffered from a dearth of public guidance on when funding arrangements will be acceptable. Most applications are made under heavy seal to protect commercially sensitive information and judges have not tended to issue written decisions in support of their orders approving the funding. Maintenance and champerty still attract criminal and tortious consequences in Cayman and there is no legislation defining those ancient torts or regulating litigation funding. This environment has led to uncertainty in drawing bright lines around what terms and provisions in a funding arrangement will be acceptable.

The case law prior to Platinum Partners addressed some issues but was not definitive for liquidators. The In re DD Growth Premium 2X Fund² judgment considered conditional fee agreements between liquidators and Cayman law firms, not a third party commercial funding agreement. Similarly, In re ICP Strategic Credit³ dealt with a liquidator’s application for approval of a contingency fee agreement with US lawyers. Two decisions in 2017 and 2018 – A Company v A Funder⁴ and The Trustee v The Funder,⁵ respectively – approved third party commercial litigation funding agreements but were not made in the insolvency context, and so did not consider a liquidator’s specific duties or the competing interests involved between multiple stakeholders in the winding up estate.

The Court’s Decision

The Platinum Partners judgment fills the gaps in the prior case law. The application was brought by the joint official liquidators of the Platinum Partners Value Arbitrage master fund, a Cayman limited partnership that operated as part of a typical master-feeder hedge fund structure. The funding agreement at issue contemplated the funder establishing a credit facility for investigations and holding a right of first refusal to fund claims identified by the liquidators. In return, the funder would receive a 10% interest rate on funds advanced and a certain percentage of the litigation recoveries made by the estate, depending on whether the funder chose to fund the claim and when the recoveries were made.

Complicating matters, there were approximately $140 million worth of secured creditor claims against the fund. Prior to liquidation, the fund had purported to grant various security interests over its assets in favour of a large number of creditors. The validity and scope of the security interests remained an issue between the liquidators and the purported secured creditors, but at least some creditors suggest that their security covered the fund’s causes of action, or any recoveries from them, that are the subject of the funding agreement. One of these creditors objected to the liquidators’ application, in part because the repayments to the funder from any recoveries were intended to be in priority to the secured debt.

After considering the legal and commercial issues in play, the Court approved both the funding agreement and the priority of the borrowing costs over the purported security interests.

Priority of Funding Agreement

The Court dealt first with the priority issue. Relying on a series of English and Australian cases, the judge determined that a liquidator’s fees, costs and expenses incurred in preserving and realizing a secured asset are payable in priority to the secured debt. He termed this the “Universal Distributing Principle”, based on the Australian case In re Universal Distributing Co Ltd,⁶ as further articulated by the High Court of Australia in Stewart v Atco Controls Pty Ltd:⁷

...a secured creditor may not have the benefit of a fund created by a liquidator’s efforts in the winding up without the liquidator’s costs and expenses, including remuneration, of creating that fund being first met. To that end, equity will create a charge over the fund in priority to that of the secured creditor.

The circumstances in which the principle will apply are where: there is an insolvent company in liquidation; the liquidator has incurred expenses and rendered services in the realisation of an asset; the resulting fund is insufficient to meet both the liquidator’s costs and expenses of realisation and the debt due to a secured creditor; and the creditor claims the fund. In these circumstances, it is just that the liquidator be recompensed.

Applying that principle to the funding agreement, the liquidator’s fees, costs and expenses incurred in investigating and prosecuting the claims – including the borrowing costs payable to the funder out of recoveries – could be granted priority over the existing security interests. The Court specifically considered two ways in which the liquidator’s application raised issues about whether it would be appropriate to apply the Universal Distributing Principle:

• Firstly, the liquidators sought an order confirming priority in advance of incurring the fees, costs and expenses in the face of an objection from a secured creditor. In the cases establishing the Universal Distributing Principle, the liquidators had already incurred costs for protecting and realizing the secured assets and the secured creditors had not interfered or objected to the liquidators’ activities at the time. The Court did not consider that these differences changed the analysis or approach, particularly where no creditors had taken any steps in Cayman or the US to enforce the purported security. Additionally, the funding agreement set out the nature and extent of the costs and expenses for which priority was sought.
• Secondly, the funding agreement required recoveries from potentially secured causes of action to be used to pay costs and expenses incurred in connection with unsecured causes of action. Despite admitting to being “troubled” by this issue, the Court focused on the commercial reality that funding was required and being made available to investigate the entire universe of the fund’s claims. That costs might become payable out of secured recoveries was the price to obtain funding for investigations of the secured claims. The alternative would be no funding, no investigation and no recoveries.

In reaching this decision, the Court identified an important restriction on the application of the Universal Distributing Principle: only the fees, costs and expenses that the secured creditor would have to bear if it took enforcement proceedings itself will have priority over the secured debt. The corollary of that restriction is that costs for the benefit of the general winding up estate cannot be recovered from secured property. It is helpful to think of these limitations in terms of what fees, costs and expenses the liquidator would incur if it was appointed receiver over the secured property. Generally, only those costs will be covered by the Universal Distributing Principle.⁸

The recognition of the Universal Distributing Principle in Cayman law provides a mechanism for liquidators to protect their winding up estates and themselves from the risk of incurring unrecoverable costs and expense when dealing with potentially secured property in their possession or control. As in Platinum Partners, the principle will significantly assist where the validity or scope of security interests are at issue and the commercial urgency is to protect or realize assets.

A Role for Statutory Priority?

The Court briefly addressed the role of section 142(2) of the Companies Law and its intersection with the Universal Distributing Principle. The statutory provision provides that:

Where a liquidator sells assets on behalf of a secured creditor, he is entitled to deduct from the proceeds of sale a sum by way of remuneration equivalent to that which is or would be payable under section 109.

The liquidators did not rely on section 142(2). Counsel and the Court agreed that only remuneration, not costs and expenses, are covered by the provision. Unsurprisingly then, the Court did not have much to say about the operation of section 142(2) except that:

• The statutory provision did not limit the Court’s jurisdiction to recognize priority under the equitable Universal Distributing Principle.
• The principles applicable to determining priority under the Universal Distributing Principle and section 142(2) are likely to be similar.
• Section 142(2) is likely engaged where the secured creditor consents to the liquidator’s realization efforts or, at a minimum, there is a realization for the secured creditor.

Cayman courts will hopefully have opportunity in the future to expand on these observations. In the meantime, the full impact and utility of section 142(2), and its interaction with the non-statutory jurisdiction, remain unsettled. It seems clear, given the linkage in section 142(2) to section 109 through to the Insolvency Practitioners’ Regulations (the IPR), that a liquidator’s remuneration payable from secured property must be within the bands prescribed by the IPR. We suggest that this restriction or protection, depending on your perspective, makes sense even where the priority is granted under the Universal Distributing Principle. Such an application would provide some amount of commercial certainty for both liquidators and secured creditors, while also giving a meaningful effect to the statutory provision.

Approval of Funding Agreement

After determining that it had jurisdiction to approve the funding agreement with the required priority over secured creditors, the Court turned to the question of whether it should approve the funding. There were two elements to the Court’s analysis: (a) the established test for sanctioning a liquidator’s exercise of its powers, which defers heavily to the commercial judgment of the liquidator, and (b) the criteria set out in ICP Strategic Credit Fund, A Company v A Funder and The Trustee v The Funder to ensure that a litigation funding agreement does not stray into unlawful maintenance or champerty.

On the sanction test, the Court accepted the liquidators’ judgment that the funding agreement was in the best interests of the fund. Some of the factors cited by counsel and relied upon by the Court included:

• There were insufficient funds in the winding up estate and no other funding sources available to pursue claims.
• The liquidators conducted an extensive solicitation and negotiation process to obtain the funding commitment. They contacted 17 potential funders, held over 35 meetings with potential funders, received 12 expressions of interests, entered into non-disclosure agreements with 8 potential funders and ultimately received 4 proposals.
• The liquidators solicited advice and recommendations from their advisors and conducted their own research to glean further information on the selected funder.
• The liquidators consulted with the liquidation committee about the solicitation and negotiation process throughout, and a majority of the committee supported the funding agreement negotiated.
• Limitation periods for some claims were rapidly approaching and urgent funding was needed to investigate and commence those claims.

The Court was slightly critical, however, of the failure to involve the purported secured creditors more fully in the process. The judge noted that where funding arrangements will affect secured creditors, liquidators should have regard to those interests and ensure that on balance the funding terms properly protect all stakeholders. The liquidators’ approach in this case ultimately passed muster on the evidence, but the Court’s comments highlight an area where liquidators could proactively cut off a potential area of criticism with an appropriate consultation process.

On the maintenance and champerty issue, the Court returned to its decision in A Company v A Funder and the features identified as having significance in determining whether a funding agreement is consistent with Cayman public policy. The Court accepted that the terms negotiated by the liquidators and the funder adequately addressed any champerty concerns:

• The liquidators remained solely responsible for the conduct of claims and proceedings and the funder was prohibited from seeking to influence the liquidators. The funder only had limited rights to attend consultations with advisors, court hearings, mediations, arbitrations and settlement meetings.
• The funder could only terminate the agreement for reasonable cause, and the termination would only be effective if agreed to by the liquidators or with the approval of the Court.
• The agreement contemplated funding being made available for adverse costs orders, security for costs and ATE insurance premiums, so there would be limited prejudice to a defendant if a liquidator’s claim against it failed.
• The returns to the funder – 10% compound interest per year and a share of recoveries ranging from 5% for unfunded claims to 30% for certain funded claims – were significant but favourable compared to the other proposals received. The Court accepted that these returns also left the fund with a substantial interest in recoveries.

Accordingly, the Court granted permission for the liquidators to enter into the funding agreement.

The Future of Litigation Funding in Cayman

It is not uncommon in Cayman liquidations for the most valuable assets to be legal claims. External funding is often needed for liquidators to investigate and pursue those claims. Local law firms are hampered by common law restrictions on contingency and conditional fee arrangements, making third party litigation funding an especially useful and attractive alternative.

But the litigation funding industry will only grow and thrive when the regulatory environment is clear and predictable. In that light, the Platinum Partners decision should serve as an important judicial precedent going forward. Insolvency practitioners, litigation funders and their advisors can use the details included in the judgment on commercial terms and the liquidators’ process to design, implement and defend their own efforts. It is the latest sign that the Cayman Islands are open for business in this area, even while needed legislative reform remains outstanding.

Mark A. Russell is the Head of Insolvency & Restructuring at KSG Attorneys.

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¹ Grand Ct, 13 December 2018, unreported.
² 2013 (2) CILR 361.
³ 2014 (1) CILR 314.
⁴ 2017 (2) CILR 710.
⁵ Grand Ct, 26 July 2018, unreported.
⁶ (1933) 48 CLR 171.
⁷ (2014) 252 CLR 307.
⁸Although in the right commercial circumstances the priority may be broader than that as demonstrated by the Platinum Partners decision itself.