Two Firms Offer Reassurance on Chapter 15 Fall-Out

Date: Thursday, September 20, 2007
Author: Christopher Faille, Senior Financial Correspondent, Hedgeworld.com

GRAND CAYMAN, Cayman Islands (HedgeWorld.com)—A company that provides independent directors for hedge funds has joined the list of industry service providers that have issued cautions about reliance on Chapter 15 bankruptcy proceedings in the United States.

In a recent decision two hedge funds bearing the Bear Stearns name, both exempted limited liability companies organized and registered under the laws of the Caymans, filed wind-up petitions with the Grand Court there. The court then appointed joint provisional liquidators which sought relief from the bankruptcy court in Manhattan pursuant to Chapter 15 of the U.S. Bankruptcy Code Previous HedgeWorld Story, hoping to protect the funds against the seizure of assets located in the United States.

The hedge funds involved in this decision incurred portfolio losses in the crash of subprime lending markets this summer and couldn't meet the margin calls from counterparties.

The court in Manhattan refused to recognize the Cayman Islands proceedings under Chapter 15 and gave the Bear Stearns funds 30 days to file either a Chapter 7 or Chapter 11 petition to protect their U.S. assets.

Last week dms Management Ltd., which has been doing business in the Caymans since 2000, commented on the case. dms' web site boasts of "catalyzing positive changes in the industry, reinventing … outmoded governance practices, and creating the modern-day hedge fund directorship firm."

On Sept. 12, dms posted on that web site an article titled "Back to the Ten Commandments?" by two of its principals. The reference is neither to Moses nor to Cecil B. Demille. The "ten commandments" were rules that once determined for income tax purposes whether certain foreign corporations or partnerships trading in stocks and securities were engaged in a U.S. trade or business.

Those 10 commandments have fallen into disuse in the tax context since 1997, when President Bill Clinton signed a tax reform bill that removed the requirement that a foreign entity trading in securities have its principal office outside the United States. As dms explained in its article, "There was a perception that offshore jurisdictions were ‘taking jobs' that rightfully belonged in the United States and, in this respect, the legislation was successful as many of the previously prohibited activities began to be performed in the United States."

The old tablets might well need dusting off. The dms article's authors—Roger Hanson and Ronan Guilfoyle—suggested that the same broad principles might now assist partnerships—i.e., hedge funds—in assuring themselves that they have their center of main interest (COMI) outside of the United States, in some such place as the Cayman Islands for example, so that they might rely upon a Chapter 15 filing in the United States with confidence.

Items of consideration might be:

Ensuring that the full board of directors is located outside of the United States and that the directors hold regular board meetings, indicating that mind and management are not located in the United States;

maintaining an offshore operational bank account, and using this for receipt of subscriptions, payment of redemptions and payment of expenses;

accepting subscriptions and maintaining the share registration services outside the United States;

establishing the investment manager as an offshore entity, who oversees or approves the actions of the U.S.-based investment adviser; and

the fund establishing a physical presence in an offshore location from where an employee or delegate of the fund performs functions, particularly those of an investor relationship nature, expense approval and other tasks currently performed in the United States by the investment manager.

The day before the dms article was posted, a U.S.-based law firm and a service provider to many hedge funds put out its own memorandum on the subject of Chapter 15.

Bingham McCutcheon LLP, New York, reassured its clients that the Bear Stearns decision did not turn Chapter 15 upside down. "Bankruptcy judges," the firm said, "will continue to recognize Chapter 15 cases and provide foreign representatives with access to and cooperation from the bankruptcy courts where debtors have sufficient connections with the foreign jurisdictions."

Meanwhile, the counsel for the JPLs, Akin Gump Strauss Hauer & Feld LLP, New York, has appealed the bankruptcy court's decision to the U.S. District Court in Manhattan.

CFaille@HedgeWorld.com