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Lost at sea

Christopher Russell, partner at Appleby Global, guides insolvency professionals in handling litigation involving failed offshore funds.

Christopher Russell
partner, Appleby Global

Co-authored with Rupert Coe, also partner at Appleby Global

Newly appointed liquidators will immediately seek to identify assets of the company. Usually, the company will be holding money: an important issue is whether money forms part of the liquidation estate or is held on trust and so falls outside the estate, and unavailable for payment of liquidation costs or distribution to stakeholders. Misuse of trust money would render the liquidators liable to the beneficiaries of the trust.

In the offshore funds industry, investors typically pay their subscription monies prior to the issue of their shares. It is common for a fund to have, at any one time, prospective investors who have paid for shares but are waiting for the next subscription date, when the fund’s NAV is calculated, before their shares can be issued. When a fund fails there will often be would-be shareholders in exactly that position. The question arises as to who owns the cash paid by those investors: the investors, or the fund? Are the would-be shareholders entitled to their money back, or can they only prove as unsecured creditors in the liquidation?

The issue is a topical one. In Bellis v Challinor (1) the English Court of Appeal (whose decisions are almost always followed in the British offshore world where the relevant legislation is materially similar) has considered the ownership of subscription monies paid to a firm of solicitors for onward investment into an ultimately unsuccessful property scheme. Although not a funds case, the principles are of wider relevance.

In Bellis investors advanced funds on the basis that loan notes would be issued in return, with the later possibility of acquiring equity. The property scheme failed before the loan notes were issued. The investors argued that their entire investment should be returned on the basis that the solicitors held the monies on a Quistclose-type trust (2). In other words the monies were provided to the solicitors on trust for the investors themselves, pending the satisfaction of certain conditions. The investors contended that those conditions went unfulfilled following the failure of the scheme, and the investment monies should be returned.

The Court of Appeal rejected the investors’ analysis due to the absence of an intention to create a trust. Bellis turned on its own facts, but the judgment clarifies and restates important principles. Briggs LJ, with whom the other judges agreed, noted that “A person creates a trust by his words or conduct, not by his innermost thoughts.” There must be evidence of an intention to enter into an arrangement which, as a matter of law, creates a Quistclose trust. This will typically mean that the transferor intended to restrict how the transferee could use the funds. On the facts of Bellis the investors made no attempt to place any restrictions on the solicitors as to how the monies were used. Accordingly the transfer of the investment monies was found to be an immediate loan to the solicitors’ client.

In the offshore funds context, there is typically a more formal process for subscription for shares than was the case for the investments in the Bellis case. Most commonly, investors will submit a subscription form with subscription monies to the fund’s administrator where they are held pending the next subscription day. Then, on the subscription day, shares will be issued and the investors entered onto the register of shareholders, at which point they legally become shareholders (this process might be delayed pending the calculation of the NAV for that subscription day). Usually this process will be clearly set out in the fund’s constitutional documents. Nevertheless, and unsurprisingly given the potential negative connotations such provisions might carry, it is rare to see provisions which detail who owns the subscription monies, and on what basis, in the event that the fund fails before a particular subscription day, leaving would-be subscribers in the unfortunate position of having paid for shares which cannot be issued.

As Bellis makes clear, should those would-be subscribers seek to assert that the subscription monies were held on trust, they must discharge the burden of proof that there was a trust. It is likely to be necessary to show evidence of an agreement that there was some special arrangement in place creating a trust, such that the monies were not at the fund’s free disposal (3).

From the perspective of liquidators of insolvent funds in the British offshore world, faced with prospective investors awaiting the issue of their shares at the start of the liquidation, regard should first be had to local legislation. Typically liquidators may not simply issue the shares. That being the case a careful factual analysis must be done to determine whether at law the subscription monies were paid on trust, such that they must be returned, or whether those monies fall into the liquidation estate, with the investors in no better a position than other creditors. As Bellis illustrates, the courts will be reluctant to find the existence of a trust absent clear evidence that a trust was intended.

(1) [2015] EWCA Civ 59
(2) Barclays Bank v Quistclose Investments [1970] AC 567: the so-called “purpose trusts”.
(3) For example in the case of Nanwa Gold Mines Ltd. [1955] 1 WLR 1080 a trust was found to exist because subscription monies were held in a separate account and never formed part of the company’s general assets. The Court of Appeal in Bellis considered Nanwa among other cases and simply concluded that it turned on its own facts.

Posted on 17th September 2015 by Fred Crawley



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