Segregation in the Liquidation of a Segregated Portfolio Company in the Cayman Islands: When Does It Matter?

A Segregated Portfolio Company (SPC) is a type of Cayman Islands entity, which consists of one legal entity containing one or more “segregated portfolios” (SPs) within its (overarching) structure. The SPs do not have legal personality separate from that of the SPC. Importantly, and despite the lack of legal personality, it is still possible for each SP to have assets and liabilities. The assets of each SP are absolutely segregated from those of other SPs and those of the SPC (Section 220 of the Cayman Islands Companies Act (2023 Revision) (the “Act”)). Creditors of an SP have recourse only to that SP’s assets (or potentially to the general assets of the SPC, if the SP’s assets are insufficient); they do not have recourse to the assets of any other SP Section 221 of the Act). As a matter of law, the directors of an SPC must follow these strict principles of segregation (the “Segregation Principle”) (Section 219(6) of the Act). The same treatment is given in an SPC’s liquidation, and liquidators are required to observe the Segregation Principle (Section 223(1) of the Act).

Recent judgments of the Grand Court of the Cayman Islands in the liquidation of Performance Insurance Company SPC (“Performance Insurance”) (FSD No 70 of 2021) have highlighted two areas in the liquidation of an SPC where liquidators will have to pay particular attention to the Segregation Principle, namely: (i) in relation to the interests of the individual SPs and conflicts which may arise; and (ii) in relation to fees, expenses and the liquidators’ remuneration. These will now be discussed briefly.

In the case of Performance Insurance, the company’s liquidation followed an alleged fraud in relation to at least one of the SPs of the SPC. Most of the other SPs within the company were solvent and unaffected by the alleged fraud, including Bottini Insurance SP (“Bottini SP”) and SSS Insurance SP (“SSS SP”). Performance Insurance entered voluntary liquidation which was later converted to an official liquidation, and joint official liquidators (JOLs) were appointed.

During the conduct of the liquidation, Bottini SP and SSS SP sought to be transferred into a new structure of their choosing, and to exit the liquidation process. This should have been a reasonably straightforward process. However, as the liquidation progressed, Bottini SP and SSS SP observed that the JOLs increasingly found themselves in a conflicted position as between the solvent and insolvent SPs of the company in dealing with competing interests. It also became apparent that the JOLs had been allocating a pro rata share of the general liquidation expenses to all of the SPs (including Bottini SP and SSS SP), and that Bottini SP and SSS SP were not going to be transferred until such fees were paid. A conflict ensued, and Bottini SP and SSS SP concluded that the JOLs were unable to properly regulate the competing interests, to the detriment of the solvent SPs generally, and Bottini SP and SSS SP in particular.

Mr Justice Parker found that there was “at least the reasonable perception of a conflict of interest”. To resolve the perceived conflict, he appointed an additional joint official liquidator (AJOL) to deal specifically (and exclusively) with Bottini SP and SSS SP, pursuant to Sections 105 and 106 of the Act from which it follows that two or more persons can be appointed as liquidator. Parker J recognised the importance of the liquidators acting in the interest of the economic stakeholders, and of the liquidators enjoying the confidence and support of the economic stakeholders (In re Asia Private Credit Fund Limited [2020 (1) CILR 134], and In re Alpha Re Limited, FSD No 15 of 2018, 2 March 2018 (unreported)).

It follows that liquidators of SPCs must be alive to possible conflicts of interest between the various SPs, and that they will have to navigate such conflicts carefully. Where conflicts cannot be overcome, they should consider whether the Court should be asked to appoint an AJOL to resolve any conflicts.

For the period that the JOLs had been appointed over Bottini SP and SSS SP, SSS SP continued to challenge the JOLs’ method of allocating fees and expenses to the SPs within the company. The JOLs had failed to separately record time and fees for each individual SP from the outset, which necessitated an “after-the-event” reallocation, and the JOLs had effectively allocated a portion of the general expenses of the liquidation pro rata among the SPs of the company. SSS SP contended that this was not appropriate in light of the Segregation Principle, and not compliant with the provisions of the Act. In addition, the JOLs had failed to seek directions from the Court as to the apportionment of fees, expenses and disbursements, despite having been expressly authorised to do so in the supervision order.

Mr Justice Parker agreed with SSS SP that only fees, expenses and disbursements which had been expressly “for the benefit of” SSS SP could be allocated to it. In addition, it was found to be obviously contradictory for legal expenses to be allocated to SSS SP which the JOLs claimed to be privileged, in circumstances where work done for the benefit of SSS SP could obviously not be privileged from its shareholders. SSS SP’s challenge of the JOLs’ method of fee allocation led to the JOLs’ fees and expenses being more than halved in respect of SSS SP.

The judgment should serve as a reminder that liquidators appointed over an SPC should immediately put an accounting system in place to record time and expenses separately in relation to each SP, in so far as such fees and expenses are incurred “for the benefit of” an individual SP. Furthermore, in so far as there is doubt about the correct allocation, directions should be sought from the Court immediately to resolve any issues in allocation.

Finally, the JOLs’ approach to conflicting interests (and challenges thereto) and fee allocation (and challenges thereto) will inevitably have consequences for subsequent costs awards. The costs judgment which followed the above two challenges reflected the reality that the JOLs had unjustifiably been resisting SSS SP’s challenges and had not been acting “on behalf of” or “for the benefit” of the SP. However, that costs judgment is currently the subject of a leave to appeal application.

SSS SP is represented by Paul Kennedy and Nienke Lillington of Campbells LLP.