This article was first published in Tolley's Company Law and Insolvency Newsletter, Volume 8, Bulletin 9, March 2009.
Introduction
Offshore jurisdictions are traditionally associated with tax avoidance for wealthy individuals. Banking secrecy, relaxed residency and directorship requirements for registering companies, and a friendly judiciary have combined to make many tax-shelters household names (the Cayman Islands, the British Virgin Islands, and the Channel Islands come to mind). In addition to servicing the wealth retention needs of those who can afford it, offshore jurisdictions have played a key role in enabling securitisations and the issue of derivative securities. Legislation friendly to the issuance of significant volumes of debt have enabled offshore jurisdictions both old and new to lure the capital markets to their doorstep, with consequences for the investor attempting to collect on defaulted financial instruments.
The liquidity crisis and consequent recession is the first of the 'global economy', arriving after two decades of loosening regulations on cross-border capital movements and the emergence of new markets for investment and trade. English investors, banks and brokerages may find structural barriers to recovery and litigation in offshore jurisdictions whose regulatory regime enabled the explosion of derivatives issuances for the past twenty years. For the first time, insolvency proceedings in English courts (with English solicitors and insolvency practitioners) will grapple with limited recourse vehicles and cellular corporate structures.
Structure Of The Vehicle
The 'limited recourse vehicle' is a corporate form apparently originating in Guernsey with the enactment of the Guernsey Protected Cell Companies Ordinance in 1997. The July 2008 enactment of the Guernsey Companies Law preserves the existence of protected cell companies The Guernsey structure is typical of limited recourse vehicles in other jurisdictions: a company consists of a 'core' and a number of 'cells', to which corporate assets can be allocated. Any non-allocated assets are part of the core, with the core and cells administered together with one board and sharing a common legal personality. Cells have their own members and notional share capital. Cellular assets are 'ring-fenced', meaning they can only be liquidated in the event of insolvency to the benefit of those creditors having a claim on the relevant cell (in practice, the investors in the assets allocated to that cell). If the cellular assets are insufficient to satisfy the creditor, it can turn to the non-cellular 'core' assets of the company, but cannot recover from any assets allocated to other cells. Each cell, typically, has minimal assets: receivables from the security the cell has issued, and from a swap used to facilitate the cell's payment obligations, plus any amount of paid-up share capital generally constitute the whole of a cell's assets.
In a normal insolvency situation, all or substantially all of the insolvent company's assets are available to the liquidator or administrator for satisfaction of the creditors, in order of preference. In a cellular structure, only the relevant cell's assets, and possibly the non-cellular assets, are within the reach of a bankruptcy creditor, severely limiting its prospect of recovery.
Judicial Consideration
The protected cell company, or its equivalents in other jurisdictions, has not yet been considered by the English courts. This is unsurprising: holders of asset-backed securities have not, until recently, had much reason to litigate, and there are other barriers to successfully participating in the insolvency of an investment bank's offshore vehicles. The Royal Court in Guernsey, however, had its first opportunity to consider the protected cell statute in Messenger Insurance PCC Limited v Cable & Wireless plc and others, a 2005 decision of the Ordinary Division. Although the Bailiff (judge) in Messenger does not comment directly on the nature of a protected cell, he treats the assets of that cell as segregated from the rest of the company, for the purposes of both an administration and a proprietary claim against the company by Cable & Wireless.
Involving the English courts in the insolvency of an offshore vehicle is a difficult task. If the vehicle is (1) located in an jurisdiction within the European Union; (2) deemed to be part of a corporate group (with an investment bank, for instance) and (3) the corporate group has England as its primary centre of business interests, any insolvency proceedings should be within the gift of the English courts pursuant to EU Regulation 1346/2000 (the 'Insolvency Regulation'). The English court has demonstrated an enthusiasm for administering the insolvencies of foreign corporate entities (as in Re BRAC Rent-a-Car International Inc [2003] 2 All ER 201, which concerned the insolvency of a Delaware corporation). The question of whether the English court would apply, without question, the local companies law insofar as it affects the rights of creditors is as yet unanswered, particularly with respect to a statutory device specifically designed to achieve 'bankruptcy remoteness' and separate creditors from assets.
The Insolvency Regulation does not assist in this regard: its presumption for choice of law is that of the forum where the insolvent entity (or group) has its primary centre of business, but makes a number of exceptions to this general rule: these include rules of payment and financial markets (which may not apply) and rules related to the treatment of rights in rem (which may apply: it can be argued that the proprietary rights of other creditors to the cells with which they have transacted would be negatively effected by the court's disregard of the cellular structure). Whether rights in rem accrue with respect to any cellular asset is a question to be decided on the particular facts.
Piercing The 'Corporate Wall'
The English court may be open to certain policy arguments as a basis for overlooking the offshore statutory regime with respect to limited recourse vehicles.
- The cell does not have legal personality, and cannot therefore be rendered insolvent independent of the other cells or the core (to borrow the Guernsey nomenclature). The same is true in Luxembourg. Article 32 requires the 'securitisation undertaking' (i.e. the company) to be deemed to exist, after dissolution, for the purposes of a liquidation.
- The structure is plainly designed to restrict the normal course of creditors' recovery, and could be said to undermine a fundamental principle of corporate borrowing. In response, most regulators in the relevant offshore jurisdictions require the companies to disclose to counterparties the consequences of dealing with a cellular structure.
- The English insolvency regime could be said to be wholly incompatible with this kind of ring-fencing. For instance, administrators and liquidators have general duties to the company's creditors. Without the usual system of secured and unsecured creditors positioned in a 'waterfall' of all the company's assets, how could an insolvency professional better the collective interests of creditors when each has recourse to varying pools of assets? Favouring one creditor by enabling it to collect from another cell's assets prejudices the position of the parties transacting with that cell.
The most prominent offshore jurisdiction which may be vulnerable to an English insolvency treatment in this manner is Luxembourg, an EU member state subject to the Insolvency Regulation and a major participant in the offshore market for derivatives issuances. Article 33 of Luxembourg's law of 22 March 2004 on securitisation states that 'each compartment [i.e. cell] of a securitisation undertaking may be separately liquidated without such liquidation resulting in the liquidation of another compartment.' If an English court made a judgment as to the disposition of a company's assets without regard to the cellular structure, the Insolvency Regulation may operate to compel Luxembourg's enforcement of that order.
The innovation of Guernsey's legislators has been taken up by a multitude of tax-shelters near (the Isle of Man) and far (the Seychelles). Limited recourse vehicles offer unique protection to arrangers of derivatives transactions, and saves on the operating costs of the special purpose vehicle (SPV) itself. Arguably, creditors are protected from the bad bargains of others and have an achievable, if small, recovery against the SPV should it become insolvent. If the principles of ring-fencing assets remain commonplace for asset-backed securities issuances, the standard principles of English insolvency law and civil recovery may need to evolve in step.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.