It is well established that the articles of a fund[1] will dictate the timing and mechanics of redemptions. The articles of association (the Articles) will be construed in a manner that is consistent with the fundamental rules of construction of contractual documents – ie what the parties intended and what accords with business common sense.

Under Cayman Islands law, the issues of redemption and the payment of redemption proceeds are distinct. The essence of redemption is the surrender by the shareholder of its status as shareholder. Once a redemption takes place and shareholder status is surrendered, the redeemer becomes an unsecured creditor for the redemption proceeds. The deferral of payment of the redemption proceeds has been held by the Judicial Committee of the Privy Council (being the highest Appellate Court of the Cayman Islands) to be the grant of a short period of credit to the company in question (Pearson v Primeo Fund (Cayman Islands)  [2017] UKPC 19).

Where funds face a run-on redemptions, be it triggered by external global events or a loss of confidence in the underlying investment, this can lead to a terminal event as the fund tries to maintain liquidity by exiting its positions which only leads to worse performance and greater number of redemptions (the negative feedback loop). The liquidity and value of a fund’s underlying assets will inevitably dictate the level of risk associated with investor runs. The speed at which the fund manages the run, seeks professional assistance and deploys the appropriate tools available to it to manage the run will dictate the severity of the run. The options open to the fund, in the form of temporary relief or otherwise, will be subject to the explicit terms of the constitutional documents.

There are currently no authorities, in the Cayman Islands or elsewhere (that we have identified), that address the precise moment in time at which a share is redeemed. The current approach is therefore highly fact specific and ultimately depends on the wording of a fund’s documentation. Similarly, the mechanics and timing of calculation of net asset value (NAV), payment of proceeds thereafter and/or what is to happen in the interim will be determined by the fund’s constitutional documents (Culross Global SPC Limited v Strategic Turnaround Master Partnership Limited [2010] UKPC 33).

The threat of insolvency, if the underlying assets of a fund decrease in value whilst there is a parallel increase in investors seeking to redeem, is an inevitable risk. However, formal restructuring and litigation generally remains a rarity, with funds keen to protect reputations and settle disputes out of court wherever possible.

In circumstances where funds are insolvent or are facing insolvency, it is important to note that the law distinguishes between investors who have redeemed pursuant to the fund’s Articles prior to the commencement of the liquidation (who will rank as redemption creditors behind the company’s external unsecured creditors, but ahead of the company’s unredeemed shareholders) and those investors who have not redeemed as at the commencement of the liquidation (who will remain an unredeemed shareholder of the fund). This approach to ranking of rights highlights an important consideration for investors - the timing of when shares are regarded to be “redeemed” as governed by the Articles.

[1] Redemptions are relevant in the context of open-ended funds. In the Cayman Islands, exempted companies and segregated portfolio companies are the vehicles of choice for open-ended funds whereas close-ended funds are typically structured as exempted limited partnerships thereby explaining why we reference a fund’s articles of association.