For the second time, a U.S. court has rejected a request from a hedge fund to recognise the Cayman Islands as the proper jurisdiction for insolvency proceedings. Under Chapter 15 of the U.S. Bankruptcy Code, companies based abroad can get protection from U.S. creditors while being wound up. Without this protection, the fund remains liable to lawsuits from U.S. creditors.
The fund in question, Basis Yield Alpha Fund, is domiciled in Cayman but has operations elsewhere including Australia, where its parent company is based; most of its creditors, which include JP Morgan Chase, Goldman Sachs and Citigroup are based in the United States. The fund filed for insolvency in Cayman in August 2007 after being hit by subprime losses.
Refusing Basis Yield’s petition for U.S. bankruptcy protection, Judge Robert Gerber said that the fund had failed to show that Cayman was its economic base – or “Center of Main Interest (COMI).” In fact, Judge Gerber said that the petition was “strikingly silent” on the “nature or extent” of its business activity in Cayman and had failed to include key facts such as whether Basis Yield had any employees in Cayman or whether any of its assets were based in Cayman. However, he did note that the fund’s administrator, investment manager and auditor are based in Cayman.
The Cayman liquidators argued that because the fund was registered in Cayman, then according to the U.S. Bankruptcy Code, in the absence of other evidence, this could be presumed to be COMI. However, the judge rejected this argument saying there was some evidence to the contrary. He also strongly criticised the failure of the fund to respond to the court’s request for detailed information about the assets, creditors and employees of the fund.
Discussing which factors should be taken into account by a U.S. court when defining COMI, Judge Gerber suggested the location of a debtor’s headquarters, its managers, primary assets and majority of its creditors could all be relevant.
The judge also referred to a previous ruling of the same court (U.S. Bankruptcy Court, Southern District of New York) involving two collapsed Bear Stearns’ funds, where a similar petition had been rejected. This ruling has been appealed by Bear Stearns.
Both rulings suggest that in future Cayman-domiciled funds may find it difficult to escape the U.S. bankruptcy regime where they have U.S. creditors. Another message from the Basis Yield ruling is that funds must be transparent about the location of their assets, investors and employees if they want to qualify for protection under the Chapter 15 regime.
Although not specified in either case, one reason why funds may prefer a Cayman-based insolvency to U.S. bankruptcy proceedings is because it is regarded as less costly. There is also less scope for class actions than in U.S. courts.
To read the full judgment, click here: Re: Basis Yield Alpha Fund, Debtor in a Foreign Proceeding.