0214-Formation and composition of liquidation

Global Legal Solutions
The Court’s power in relation to
the formation and composition
of liquidation committees
4 February 2014
A recent ruling (In Re Herald Fund SPC (In Official Liquidation) – FSD 27/13, Grand Court (unreported), Jones J, 28 January 2014)1 provides insolvency
practitioners in the Cayman Islands with helpful guidance and clarification about the Court’s power to make directions in relation to the formation and
composition of liquidation committees in light of recent (2013) amendments to the Companies Winding Up Rules 2008 (as amended) (the “CWR”)
and the underlying methodology to be adopted when making a determination about a company’s solvency for this purpose.
Formation of a Liquidation Committee
The CWR express a clear preference that a liquidation committee be formed in respect of every company being wound up by the Court. Its
composition is driven by the financial status of the liquidation at the time when the committee is established and the membership requirements
are expressly provided for in the CWR.
The official liquidator of a company is required to determine whether a company should be treated as solvent, insolvent or of doubtful solvency
for the limited purpose of determining (i) the composition of the meeting(s) by which the committee is elected and (ii) the composition of the
liquidation committee itself.
No Jurisdiction to Dispense with Composition Requirements
The rationale behind the composition requirements set out in the CWR is simple – stakeholders with no practical interest in the liquidation should
be excluded from influencing the conduct of the company’s affairs.
Previously, the CWR empowered the Court to make directions in certain circumstances “permitting the establishment of a liquidation committee
with a fewer number of members or a different combination of creditors and contributories”. This power had been interpreted quite broadly by the
Court as enabling it not only to make directions in relation to the composition of a committee, but also with respect to the powers of a liquidation
committee (see Re Saad Investment and Finance Company Limited #5 [2010] (2) CILR 63).2 However, this provision of the CWR was revoked by the
Companies Winding Up (Amendment) Rules 2013.3 All that remains in the current version of the CWR is Order 9, Rule 1(1) which states: “Unless the
Court otherwise directs, a liquidation committee shall be established in respect of every company being wound up by the Court.”
1 Walkers acted for the joint official liquidators.
2 In light of the recent amendments, it is unclear whether the Court would consider that it retains the power to expressly define the powers of a liquidation committee under any circum-
stances (including where, for example, there is a clear conflict of interest with respect to certain members of the committee). The better view may be that the Court could be expected to
have power to regulate the affairs of all Court-supervised liquidations under its general mandate of supervision of all official liquidations.
3 Which came into effect on 1 March 2013.
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The Court has now made it clear that it no longer has any ability (by way of its inherent jurisdiction or otherwise) to make directions with respect
to the composition of a liquidation committee (other than to dispense with a committee altogether in appropriate circumstances).
Dispensing with the Requirement to Establish a Liquidation Committee
The Court has indicated that, on an application to dispense with the requirement to establish a liquidation committee, it will look to the reasons
why a liquidation committee cannot be formed in compliance with the CWR. Importantly, where a liquidator’s determination with respect to
the solvency of a company is the sole reason why a CWR compliant committee cannot be formed, it appears that the Court may look behind
a liquidator’s summary determination and examine the methodology used to reach that determination. If the Court is not satisfied that the
methodology was appropriate in all of the circumstances, it is likely that the Court will refuse to dispense with the requirement to form a liquidation
committee and may also direct the official liquidator to reconsider his initial determination of solvency (or otherwise) with a view to then being able
to form a committee compliant with the CWR. Of course, regardless of the financial position of the relevant company, there will always be cases
where it is simply not possible to form a committee compliant with the CWR and it appears the only alternative in such circumstances will be for
a direction that there be no formal liquidation committee.4
How Should a Liquidator Determine Solvency?
The Court has also provided some additional clarity5 to liquidators by expressly endorsing the balance sheet test as the applicable test which they
should apply when making a determination as to the solvency of a company.6
The [Liquidators] have to ask themselves whether [the company] is, or is likely to become solvent or insolvent, applying a balance sheet test,
and making reasonable assumptions about assets and liabilities which are contingent or contingent in amount.
The Court has made it clear that a liquidator should undertake this exercise in a thorough and rigorous manner. Notwithstanding the
inherent difficulties of properly estimating the value of highly contingent assets and liabilities, a company should only be determined to be of
“doubtful solvency” where “if, at any given time, its official liquidator is of the opinion that the final outcome is no more or less likely to be
solvent or insolvent, having regard to the likely resolution of some particular contingency or the likely outcome of a combination of different
unrelated contingencies”.
Conclusion
The key points for insolvency practitioners to take away from this recent decision are that the Court:
>> No longer has jurisdiction to sanction a non-CWR compliant committee.
>> Will not inevitably dispense with the requirement to have a committee.7
>> May look behind the liquidators’ summary determination of solvency (or otherwise) in certain circumstances.
>> Has expressly endorsed the balance sheet test as the applicable methodology and stressed the need for official liquidators to make reasonable
and informed assumptions and estimates as to the likely ultimate financial position.
>> Has indicated that “doubtful solvency” will apply only in quite limited circumstances.
4 It is also possible to have an informal or ad hoc committee.
5 There being no specific guidance in the Companies Law or CWR as to whether a cash flow test (which applies when determining the solvency of a company in the context of a winding up
petition) or a balance sheet test (or a combination of both) applies to a company in liquidation.
6 Whilst the Court’s decision in Re Awal Finance Company Limited & Ors [2011] (1) CILR 487 (a decision under an earlier version of the CWR) is authority for the proposition that a liquidator
should have regard to contingent liabilities of a company in accordance with section 139(1) of the Companies Law when making a determination as to solvency for the limited purpose of
forming a liquidation committee, it was not necessary for the Court in that case to go beyond that.
7 The liquidators in that case were not seeking that a committee be dispensed with.
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Contacts
As always, please get in touch with your usual Walkers contact (or those below) should you require any further information.
Neil Lupton
Colette Wilkins
Partner - Cayman Islands
T: +1 345 914 4286
E: [email protected]
Partner - Cayman Islands
T: +1 345 914 4215
E: [email protected]
Matthew Goucke
Sandie Corbett
Partner - Cayman Islands
T: +1 345 914 6332
E: [email protected]
Partner - British Virgin Islands
T: +1 284 852 2203
E: [email protected]
John O’Driscoll
Fraser Hern
Senior Counsel - British Virgin Islands
T: +1 284 852 2247
E: [email protected]
Partner - Hong Kong
T: +852 2596 3348
E: [email protected]
Robert Foote
Senior Counsel - Singapore
T: +65 6603 1695
E: [email protected]
Disclaimer
The information contained in this advisory is necessarily brief and general in nature and does not constitute legal or taxation advice. Appropriate legal or other professional advice should
be sought for any specific matter.
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