Private Equity 2020

Last Updated August 05, 2020

Cayman Islands

Law and Practice

Author



Walkers is a leading international firm that provides legal, corporate, compliance and fiduciary services to global corporations, financial institutions, capital markets participants and investment fund managers. The firm is made up of highly qualified and experienced lawyers, many of whom have international experience in major global law firms. Walkers’ Global Investment Funds Group offers Bermuda, British Virgin Islands, Cayman Islands, Guernsey, Jersey and Irish law advice on investment funds on a global basis, and is one of the largest specialist International Financial Centre funds teams worldwide. The firm advises many of the world’s most prominent asset managers, fund promoters and institutional investors, and consistently applies an innovative and practical approach to solving complex commercial issues.

The use of Cayman Islands-incorporated entities in M&A structures by private equity fund sponsors is now well established. That is particularly so for fund sponsors based in North America and Asia, where Cayman is the default jurisdiction for international transaction structuring. There has also been encouraging growth in this area from European fund sponsors where there is an international element to the investor base or the underlying asset class: financial services, medical technology, property, mining and energy/infrastructure are noteworthy sectors.

The ever-more complex global M&A marketplace, in which most significant deals have multiple transacting parties and an international element, and the position of the Cayman Islands within that context, should ensure that this fastest-growing aspect of Cayman's legal economy continues to offer reasons for optimism. In a world of increasing uncertainty, the Cayman Islands offers certainty from a structuring perspective, and sensible outcomes to dispute resolution.

Sponsors are able to avail themselves of a flexible, commercially focused corporate governance regime that offers a variety of entity structuring options in a jurisdiction where familiarity of use lends itself to predictable outcomes. US-based sponsors used to dealing with LLCs and limited partnerships can use their Cayman equivalents to ensure that the fiduciary and economic matters are structured in familiar ways. Parties in the UK and Asia can exploit the certainty and commercial sensibility afforded by more than a century of English common law and its application to Cayman Islands companies. And because Cayman-incorporated entities are tax-neutral in the jurisdiction of incorporation, the use of the flexible, malleable and familiar corporate governance regime can be installed above a group of portfolio assets and operating companies without affecting the taxation of the structure.

Continued levels of robust activity in the public markets involving Cayman Islands entities has been of particular note.

Foreign issuers seeking access to the public markets in the United States will typically employ a Cayman holding company structure. From an Asian perspective, the ease of use of Cayman Islands structures and the familiarity of the SEC with such entities means that IPOs can be consummated quickly and efficiently.

For issuers based in Europe, the flexibility afforded by the use of Cayman entities means that sponsors and founders looking to raise public capital whilst retaining voting control are able to benefit from the acceptance in the US markets of bespoke and sophisticated multiple share class structures.

Recent years have seen a steady increase in the number of special-purpose acquisition companies (SPACs) formed by private equity sponsors in Cayman and listed in the United States. The last two years have been remarkable in terms of the consummation by Cayman-incorporated SPACs of substantive acquisitions and, in many cases, multiple acquisitions. The early signs are that these structures may have significant longevity: mid-market and smaller private equity sponsors are entering this market and the listing documents are being commoditised, both of which suggest sustained growth in the short to medium term.

Take-private transactions involving Cayman-incorporated companies listed in the USA and Hong Kong continue to keep corporate and dispute resolution counsel busy. There is a perception that foreign-managed companies are routinely undervalued in the US markets and this, coupled with pressure from sources such as the Chinese government to relist in markets in the PRC, continues to drive large volumes of work. These are often the transactions that give rise to the most complex Cayman legal questions, particularly in relation to the fiduciary position of board members and to questions of valuation in anticipation of action by aggrieved shareholders. The law in this regard is developing fast, with a number of matters currently before the Cayman courts, and it is an area where early engagement and the working relationship between Cayman counsel and onshore counsel is absolutely critical to successful outcomes.

Whilst it is a little foolish to make any predictions at all in the current environment, it is not unreasonable to envisage a scenario in the latter part of 2020/early 2021 where the markets correct and assets become more accessible to fund sponsors with dry powder to burn. When economies reset, private equity sponsors are usually in the avant garde.

As regards sector-specific activity, and in addition to the very broad spectrum of ordinary commercial M&A transactions that are consummated either using Cayman Islands acquisition vehicles or involving Cayman-incorporated targets, the following sectors are witnessing significant activity.

Financial Services

Cayman has long been a preferred jurisdiction for the establishment of acquisition structures intent on acquiring financial services assets. In the aftermath of the global financial crisis, trillions of dollars were raised using Cayman structures and deployed to assist in the stabilisation of the US banking system. The use by private equity fund sponsors of Cayman-registered companies, limited partnerships and trusts has afforded opportunities to achieve the sophisticated and highly bespoke transaction structuring that is often necessary for acquisitions on behalf of funds with multiple underlying investors of regulated financial assets.

More recently, the growth in the number of banks, insurance companies and corporate service providers registered and regulated in the Cayman Islands has translated into an encouraging stream of locally relevant M&A activity as such entities are bought and sold in the ordinary course. The growth of the Cayman-incorporated fintech industry – much of it located in the Special Economic Zone (SEZ) established by the Cayman Islands government to encourage the physical relocation of such businesses to the Cayman Islands – promises much in terms of Cayman-focused M&A activity in the future.

Specialist Funds

If the ten years following the global economic crisis saw the vast majority of specialist funds launched under the wing of much larger institutional fund sponsors, the last year or two has seen the coming of age of those specialist funds as they leave the nest in increasing numbers. This is interesting not only from a fundraising perspective, but also because the divestiture by fund sponsors of these structures gives rise to complex and unusual challenges from an M&A perspective. Working in tandem with investment funds and M&A transactional experts to realise significant value for outgoing institutional sponsors, and to generate exciting opportunities for the newly independent funds, has been especially rewarding.

Energy and Infrastructure

The employment of Cayman-incorporated structures to consummate oil and gas transactions is perhaps the longest-standing tradition in the Cayman Islands M&A industry. More latterly, that has translated into the robust infrastructure and renewables sectors. These are industries of critical importance to global security, stability and the macro economy, and they rely heavily on the long-term stability of Cayman as a jurisdiction of incorporation, on the ability to put in place robust and certain financing arrangements, and on the complete freedom from local political interference in these most sensitive of assets.

Aircraft and Other Structured Asset Financings

It seems inevitable that there will be a significant amount of work to be done in the aircraft industry when the dust of 2020 settles. Restructuring existing arrangements, and the introduction of new players and new technologies to the marketplace, mean that this already most international of businesses will require the introduction of nimble and robust products to survive the next decade. Innovation of this kind has always been at the core of what the Cayman legal infrastructure provides.

Cannabis

The cannabis industry is just one high-profile example of how Cayman-incorporated structures are employed by private equity fund managers to raise international capital in an efficient way that enables them to exploit new opportunities quickly. Whilst not without regulatory challenges, the Cayman Islands is the jurisdiction of choice for fund sponsors who are keen to raise and deploy international and tax-exempt investment capital in the US market. Strong valuations and the ready availability of cash has also meant that the cannabis enterprises themselves are becoming meaningful players in the investment market, and consequently a source of exit options for private equity fund sponsors.

More detailed and specific law and regulation in relation to the formation of funds by private equity sponsors has been the story of the last few years, and the Cayman Islands has been no exception there. For the world’s most prominent financial institutions and international investors, it is critical to remain relevant and innovative in response to market reality, as well as being credible, and that is why most see Cayman as the favoured tax-neutral jurisdiction for private equity funds. Key to this market is the existence of architecture that allows fund sponsors to structure and manage entities with many investors, a variety of strategies and multiple layers of debt and equity efficiently and effectively in a multinational environment.

In this context, Cayman legislation and regulation continue to be responsive to trends and challenges in current market practice, and to embrace transparency and anti-avoidance initiatives.

Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standard (CRS) reporting processes, the broadening of practices and procedures in relation to anti-money laundering compliance and the like are all now well established. From an M&A perspective, it has meant that fund sponsors are required to be more conscious of such matters when engaging in due diligence on any target, and are required to include an anti-money laundering investigation as part of their due diligence: the material increase in the culture of compliance across the industry has been encouraging.

Economic Substance

The Economic Substance (ES) regime is now more than a year into its application and, as with most law and regulation introduced in Cayman, shows the expected signs of being applied in a sensible and proportionate manner. The ES regime was introduced as part of the Cayman Islands’ ongoing commitment to assisting global tax recovery efforts in combatting base erosion and profit shifting (BEPS). It is worth noting that BEPS relies for its effectiveness on the presence of two key elements:

  • a system of taxation (ideally at a very low rate); and
  • tax treaties that enable companies to exploit that system of taxation.

Being tax-neutral and without tax treaties, Cayman is not a jurisdiction that offers much succour to any multinational organisation that is pursuing a BEPS strategy to reduce its tax bill. For that reason, the ES regime has had little meaningful impact on Cayman as a jurisdiction for structuring M&A acquisition vehicles. That is particularly the case for Cayman Islands structures employed by private equity fund sponsors, so it is not surprising that such structures are typically out of scope for the purposes of such economic substance law and regulation.

In the limited circumstances where Cayman Islands-incorporated entities are subject to economic substance requirements, and required to comply with them, it has not proven especially onerous to comply. Again, understanding that such entities are not typically engaged in BEPS, it is not difficult to see why this might be the case. The application of the law and regulation in this regard is in the very nascent stages: guidance notes published by the Cayman Islands regulator are in a state of development and specific outcomes will not be apparent for almost two years, when the first examinations by the Cayman Islands regulator are due to be completed.

Registration of Private Equity Funds

Most recently, Cayman has introduced a regime for the registration and regulation of private funds formed in Cayman. The Private Funds Law (PFL) now sits alongside the long-established Mutual Funds Law and promises to offer the same level of sensible and proportionate oversight and regulation that the jurisdiction has brought to hedge funds for more than two decades. The legislation is in its most early stages, but in its first six months more than 10,000 private funds and alternative investment vehicles (AIVs) have been registered. This is a remarkable achievement that illustrates the strong working relationship between fund sponsors, Cayman lawyers and the Cayman Islands Monetary Authority.

It is not clear at this juncture what effect, if any, this registration requirement will have on M&A transactions involving Cayman entities, though they are not anticipated to materially affect cost or the efficiency of execution of M&A transactions in Cayman.

Cayman Islands entities are engaged in transactions in most active jurisdictions around the world, and in each case it will be the relevant local regulatory regime that is relevant to the transaction. It is extremely rare for any M&A transaction involving Cayman Islands entities to have a material Cayman regulatory element. There are no relevant antitrust or business combination rules and, unless securities are being offered to the public in Cayman (which would be highly unusual), no relevant foreign investment restrictions or local national security regime. However, there are some areas where Cayman Islands regulatory issues arise.

If the target of any M&A transaction is regulated in Cayman, then an application may be required to be made to the Cayman Islands Monetary Authority (CIMA) to approve a change of control. This process can take six to eight weeks to complete, and that timing should be factored into any completion schedule. Entities affected will usually be Cayman-regulated banks, insurance companies and corporate services businesses.

Investment in industries that are engaged in the manufacture of cannabis products can be difficult for Cayman Islands-incorporated fund sponsors. The obligation of the fund sponsor to ensure portfolio companies comply with anti-money laundering rules can present challenges if their income is generated by activity that is considered illegal. In the United States, the federal illegality of the cannabis industry, despite the state-by-state legality, means that it is important to tread carefully and to ensure that Cayman Islands advice is taken at an early stage.

Because it is rare for target companies to conduct material operational activity in the Cayman Islands, due diligence is ordinarily limited to relatively binary matters, such as examining statutory registers and constitutional documents, and, in relation to regulated targets, investigating compliance with registration and regulatory obligations in relation to the Cayman Islands regulator.

In relation to transactions with a broader Caribbean context that may involve collating advice from across the region, it is not unusual to engage Cayman counsel who are locally placed and experienced in the consummation of international M&A transactions to co-ordinate the due diligence process.

Because the vendor due diligence questions in Cayman can be rather binary, and not particularly controversial, it is not uncommon for a buyer to rely on vendor due diligence. Where more complex local regulatory or financial matters arise, buyers will prefer the comfort of a due diligence report prepared with their particular interests in mind.

The process for the acquisition of shares in a Cayman company will depend to a significant degree on whether the target's shares are closely held. If they are, then a private treaty executed by all affected parties (or using drag-along provisions) is the usual approach for such transactions.

Where shares are widely held so as to preclude the specific execution of a sale and purchase agreement by or on behalf of each seller, it is usual for such transactions to be prosecuted using the statutory merger process prescribed by the Cayman Islands Companies Law. The Cayman merger statute is procedurally familiar to contracting parties located in the USA and, increasingly, in Asia. Moreover, the adjudication by the Cayman courts of the principal area of dispute in Cayman statutory mergers – the valuation of claims for fair value by dissenting shareholders – borrows materially from the jurisprudence of the Delaware courts.

In certain limited circumstances, it may be advisable to proceed instead by means of a court-sanctioned scheme of arrangement. The process for a scheme of arrangement under Cayman Islands law derives from English law, and standards for judicial approval and shareholder consent are as they would be in the English courts. Circumstances that tend to suggest a court-driven scheme rather than a statutory merger may include the following:

  • where the buyer is offering its shares as consideration – because a court opines on fairness, the shares are exempt from registration with the US Securities and Exchange Commission;
  • where the target company is insolvent and so cannot give the "going concern" confirmation necessary for a merger, or where the offer includes a compromise, particularly with the creditors of the target company;
  • where there are concerns about significant disruption or post-merger litigation by dissenting shareholders (a scheme affords no process for dissent on value by minority shareholders); or
  • where the consent necessary to be obtained from secured creditors in relation to a merger cannot be obtained.

It is typical for a separate private equity-backed acquisition structure to be established in relation to each transaction undertaken by the fund. Cayman entities really prove their worth in relation to such transactions, particularly where multiple fund entities and/or co-investors are to be aggregated, or where a coalition of a joint venture or club deal partners is to be assembled. The usual acquisition structure will involve a Cayman-incorporated holding company containing the corporate governance and funding agreements. Beneath that entity there may be one or more entities established in jurisdictions that lend tax, regulatory or financing efficiency to the structure.

The only circumstance in which it is usual for the private equity fund itself to be party to the acquisition documents is where a guarantee to lenders for transaction finance or an undertaking for the vendor to ascertain that the acquisition structure is duly-funded (an "equity commitment" undertaking) is required.

There is no particular form of transaction finance or ownership structure that is typical in a Cayman context. It is precisely because Cayman-incorporated structures are able to be adapted to the specific requirements of any given transaction that such structures are so ubiquitous. Rather, it will be the commercial custom and practice of the relevant jurisdiction in which the Cayman-incorporated structure is to be deployed that will determine the approach adopted.

From the perspective of persons charged with the fiduciary responsibility of directing the actions of the Cayman-relevant entities, compliance with the customs and practices of relevance to the context of the particular transaction will often constitute the discharge of those responsibilities.

Consortium transactions and other aggregator arrangements are, in many respects, the raison d'etre for the Cayman Islands M&A industry.

It is typical for co-investors to participate in aggregator structures established by fund sponsors. It is usual for such investors to be entirely passive in a legal and economic sense, though it is increasingly apparent that persons co-investing alongside private equity funds into which they are invested are making use of the opportunity to learn from private equity fund sponsors with a view to making their own direct investments at a later stage.

There is no meaningful response from a Cayman perspective.

There is no meaningful response from a Cayman perspective.

There is no meaningful response from a Cayman perspective.

There is no meaningful response from a Cayman perspective.

There is no meaningful response from a Cayman perspective.

See 7.5 Conditions in Takeovers for a discussion on break fees.

There is no meaningful response from a Cayman perspective.

There is no meaningful response from a Cayman perspective.

There is no meaningful response from a Cayman perspective.

There is no meaningful response from a Cayman perspective.

Other than in respect of minority dissention rights exercised in the context of statutory mergers, private equity transactions are very rarely litigated in Cayman. Any such litigation would tend to involve deadlock between joint venture partners, and would ordinarily be pursued as a petition to wind up the relevant company on the basis that it is just and equitable to do so.

Take-private transactions of Cayman companies listed in the USA and in Asia continue to generate significant levels of activity. There is a perception that Asian-managed companies are routinely undervalued in the US markets and this, coupled with pressure from the Chinese government to relist in markets in the PRC, has driven large volumes of work. Each of these transactions typically involves private equity fund sponsors – often as a plaintiff in dissenting shareholder proceedings.

Other than in respect of the small number of entities listed on the Cayman Islands Stock Exchange, there are no material shareholding or disclosure thresholds relevant under Cayman Islands law.

Other than in respect of the small number of entities listed on the Cayman Islands Stock Exchange, there are no material offer thresholds relevant under Cayman Islands law.

Whilst cash continues to be the most common consideration of Cayman entities, there has been a small increase in the number of transactions that have shares as consideration. In most instances, that has tended to arise where a company has exploited a high valuation-to-revenue ratio to make strategic acquisitions.

Share-for-share transactions have the effect of excluding minority shareholder dissention rights in a merger context, so shares are sometimes offered as an alternative to cash.

Where a public company employs a Cayman Islands scheme of arrangement to offer shares as consideration, because a court opines on fairness the shares so offered will be excluded from certain registration requirements in the USA. This is the most common reason for employing a scheme of arrangement in Cayman.

Conditions

The conditions associated with an offer involving a Cayman Islands entity will be determined by the jurisdiction in which the Cayman entity operates. Apart from entities listed on the Cayman Islands Stock Exchange (and there is only a small handful of those), no additional Cayman rules apply.

It is not uncommon for a Cayman entity listed on a UK stock exchange to include in its constitutional documents compliance with the provisions relating to the Code on Takeovers and Mergers applicable to companies incorporated in the UK.

Similarly, there is some increase in the appetite for Cayman entities listed in the USA to introduce into their constitutional documents the regime under Delaware law for the governance and management of substantial business combination transactions.

Break Fees

It is now common practice to employ break fees in relation to takeovers of public companies incorporated in Cayman. The concern that arises in relation to inducement fee arrangements and other deal protection measures is that they act to inhibit competing offers, and may preclude directors from recommending such offers. There are several issues that the board of a target should consider before agreeing to pay a break fee.

An agreement to pay a break fee must not be outside the scope of the target's express or implied powers, as set out in its constitutional documents.

At common law, the directors are required to exercise their power and authority in an informed and independent fashion, in what they consider to be in good faith in the interests of the company. Any agreement that conflicts with the duty of good faith, as perceived by the directors judged by reference to the circumstances at the time when the agreement is entered into, may be unenforceable.

Any decision to agree to a break fee must be predicated on the grounds that the directors believe that the arrangement is likely to promote the success of the target for the benefit of its members as a whole. It may be legitimate to agree to pay a break fee if doing so is necessary to induce the offeror to make his offer, or to secure a strategic benefit for the target (such as a reverse break fee). The board of the target must be able to conclude, and should record in its meeting minutes, that the directors believe on reasonable grounds that the offer would not have been forthcoming if the arrangement were not entered into.

An agreement to pay a break fee should not be entered into for a collateral purpose. Where the purpose of the break fee is simply to discourage a competing bid, agreeing to its payment in those circumstances would be an improper exercise of the directors' powers.

Level of the Break Fee

Whilst the point has never been considered by a court of relevant jurisdiction, considered wisdom is that the level of the break fee will be determined by reference to market practice in the jurisdiction of operation. In relation to a UK-listed company, that may be 1%; in relation to a US-listed company, 4% of the value of the offer may not be objectionable.

Match Rights, Force-the-Vote Provisions, Non-solicitation Provisions and the Like

As with break fees, there is no specific prohibition in Cayman with regard to the use of any of these deal mechanisms, and the same principles apply. It is recognised in Cayman that such provisions can be meaningful or necessary to ensure certainty in the conduct of commercial transactions. In all instances, the board of the target should be satisfied that the provisions are beneficial to the interests of the company and are reasonably consistent with common market practice in the relevant jurisdiction.

There are no Cayman restrictions on what shareholders might agree when establishing governance rights for shareholders that hold less than 100% of a company. In addition to what the parties might otherwise agree, a shareholder acquiring sufficient shares to control a special resolution of a target Cayman Islands company will be able to:

  • authorise a plan of merger, subject to any separately entrenched class rights (though it will also need the approval of the board in order to be consummated);
  • amend the memorandum and articles of association of the Cayman company (the constitutional documents), subject to any separately entrenched class rights; and
  • resolve to wind up the company.

It is usual that a special resolution requires the consent of two thirds of the votes cast at a quorate meeting, though the constitutional documents may raise this threshold.

Squeeze-Out of Minority Shareholders

The Cayman Islands Companies Law permits an offeror for all of a target's capital who has received acceptances in respect of 90% of the issued and outstanding shares to acquire the remaining 10% by a compulsory acquisition procedure (a "squeeze-out"). Where an offer to acquire all of the shares of the target not held by the offeror has been approved by the holders of not less than 90% in value of the shares in the capital of the target, within four months of the making of the offer, then:

  • the offeror may, at any time within two months of the expiry of said four-month period, give notice to any dissenting shareholder that it shall (subject to the following paragraph) be entitled and bound to acquire those shares on the terms on which under the contract the shares are to be acquired from approving shareholders;
  • within one month from the date on which such notice is given, a dissenting shareholder may apply to court for an order excluding it from the compulsory acquisition procedure;
  • within one month of the notice being given to a dissenting or non-accepting shareholder (if no application has been made to court for an order under the preceding paragraph, or if an application has been made and an order is pending, following such order being disposed of), the offeror shall transmit a copy of the notice to the target and pay the target (or transfer to the target) the amount in cash or other consideration representing the price for the dissenting shares, and the target shall be bound to reflect the offeror as the holder of the relevant shares; and
  • the target is then required to hold the consideration in a separate bank account on trust for the various dissenting shareholders.

Alternative Squeeze-Out by Statutory Merger

The Companies Law provides that a resolution of shareholders shall not be required to authorise a plan of merger in circumstances where a parent company seeks to merge with a subsidiary company (ie, a company in which it owns 90% of the issued and outstanding shares). In that event, provided that the remaining requirements for a merger have been met, once the offeror has acquired 90% of the target, it will be able to effectively “squeeze out” the remaining minority shareholders without having to wait out the four-month period described above.

There are a few relevant considerations.

  • It is not certain in the context of a parent/subsidiary merger whether the provisions relating to appraisal rights described below would apply. It is likely that they will not, but it may be advisable for an offeror to make such rights available in order to resist any suggestion by a minority shareholder that in invoking the statutory merger, parties have sought to commit a fraud on the minority by denying it the dissenting rights that it would otherwise have had under the squeeze-out process described above.
  • Invoking the statutory merger rules gives rise to the need to obtain the prior consent of secured creditors, which would not otherwise be the case in the context of a tender offer.

Of course, a buyer acquiring sufficient shares by tender offer to control the adoption of a special resolution in respect of the target company will then be able to control the outcome of a meeting convened to authorise a plan of merger. In that instance, though, dealing with dissenting shareholder rights may be a relevant consideration.

In the context of both a tender offer and a statutory merger, shares that are the subject of an irrevocable undertaking to accept such offer will normally count towards the relevant threshold necessary to consummate the relevant transaction. Moreover, neither the tender offer nor the statutory merger provisions of the Companies Law require a consideration that persons may be regarded as acting in concert. In both of those contexts, the existence of an irrevocable undertaking should have no adverse legal consequences.

Under a scheme of arrangement, on the other hand, there is some concern that the existence of an irrevocable undertaking may be sufficient to differentiate the interests of such shareholders from others, such that they would form a separate class of shareholders for the purpose of approving the scheme (and consequently be required to vote separately on the matter, not counting toward the majorities necessary for the approval of the scheme by the general body of shareholders). The terms of any irrevocable undertaking given in the context of a scheme of arrangement would therefore require particular attention and may require a "fiduciary out", in the event of a competitive offer arising (a so-called soft irrevocable).

The Cayman Islands courts are likely to exclude any shareholders that it deems to be acting in concert with the offeror from voting on a scheme of arrangement.

Hostile acquisitions are extremely rare in relation to Cayman Islands companies. The process can be extremely time-consuming and almost never concludes in an effective hostile acquisition. There are very few instances, if any, of Cayman companies being subject to protracted hostile bids, and transactions that may start out in that manner are usually concluded with a degree of amicability. That is not to say that target companies have not been adept at exploiting the takeover protections described below to improve their respective bargaining positions. Apart from in respect of a general tender offer, the acquisition of a Cayman Islands company will invariably require the support of the board of directors of the target company. For that reason, it is typical for any hostile bid to be predicated on an attempt to procure the appointment of persons sympathetic to the bid to the board of directors.

Obtaining the consent of sufficient numbers of shareholders to alter the composition of the board of directors is a hurdle not easily overcome. In relation to private companies, it is only overcome with the support of significant shareholders. Where the shares are public or otherwise widely held, constitutional barriers such as staggered boards or limited rights on the part of shareholders to convene meetings will often frustrate a hostile bidder. Because the register of members of a Cayman company is not a public document, the battle for proxies is extremely difficult, unless the rules of the exchange on which shares are listed require disclosure of the beneficial holders.

The protections generally available to Cayman companies to prevent hostile takeovers are likely to be determined to a significant degree by the rules and conventions that apply to entities listed upon the exchange upon which its shares may be listed. Because their structure contains so much flexibility, Cayman companies are able to adapt their constitutional documents to incorporate provisions that investors in a variety of jurisdictions may expect to see.

Particularly in recent years, it has become common for public Cayman companies to adopt takeover protections that closely mirror the protections adopted by companies incorporated in Delaware and elsewhere in the United States. In the final analysis, these protections act to a greater or lesser extent as a deterrent.

The most common protections included in the memoranda and articles of public Cayman companies are:

  • a prohibition on business combinations with any “interested” shareholder unless (i) there is advance approval by the board, (ii) the interested shareholder owns at least 85% of the voting shares of the company at the time the business combination commences, or (iii) the combination is approved by at least two thirds of the voting shares that are not held by the interested shareholder;
  • blank cheque preferred shares;
  • a staggered board (where directors are appointed in three separate classes for fixed terms that expire at different times);
  • the entrenchment of directors' appointment providing for removal only for cause or by supermajority vote; and
  • prohibitions, or at least severe restrictions, on the ability of shareholders to call special meetings and/or to have matters added to meeting agendas.

There are a number of more aggressive provisions that have not often been included in the constitutional documents of Cayman companies. Chief amongst these is the traditional "poison pill" arrangement permitting existing shareholders to subscribe additional shares, or to acquire the shares of the offeror, in each case at a discount to their value. For the directors of a Cayman company, the employment of a poison pill mechanism as a defence to a hostile bid poses substantial challenges to the discharge of their fiduciary duties.

The nature and extent of equity incentivisation is determined by reference to the jurisdiction of the relevant entity's operation and management. There is no Cayman-specific approach that informs the outcome here.

See 8.1 Equity Incentivisation and Ownership.

See 8.1 Equity Incentivisation and Ownership.

See 8.1 Equity Incentivisation and Ownership.

As regards the enforceability of restrictions on manager shareholders, and assuming such arrangements are to be governed by Cayman Islands law (which would be unusual), the general principle (on the basis that the Cayman courts would follow the English common law authorities) is that restrictions should be no wider than is necessary to protect the legitimate business interests of the contractual counterparty. The key aspects to consider in the context of enforceability are the geographic scope, the length of the restriction, and the business activities that the restrictions cover. In order to maximise enforceability, the beneficiary should draw each of these as narrowly as it feels is reasonably necessary to protect its interests.

See 8.1 Equity Incentivisation and Ownership.

The level of control to be exercised by a private equity fund holding shares in a portfolio company is determined entirely by reference to the corporate and commercial practices of the jurisdiction and industry in which the relevant entity operates. This is rarely a Cayman-relevant question.

It is ordinarily possible, though, to include the full gamut of commercial and governance arrangements that may be considered necessary or desirable by the transacting parties in the agreement between shareholders and the constitutional documents of the relevant Cayman entity. Shares with weighted voting rights or preferential economic rights, the ability to veto certain transactions of the portfolio company and the right to appoint and remove directors at will are all available to shareholders. Moreover, in the exercise of its rights, the shareholders of a Cayman company owe no fiduciary duties to their fellow (including minority) shareholders.

The principle of corporate personality was firmly established by the English House of Lords, which held more than a century ago that however large the proportion of the shares and debentures of a company owned by an individual and even if all other shares of such company were also held in trust for him, the acts of such company are not the acts of such individual, and its liabilities are not his liabilities. This principle is accepted under Cayman Islands law.

The relevant English law authorities broadly illustrate that only in exceptional circumstances can the basic principle of the separate legal personality of a company be ignored and the "corporate veil" be "lifted" – for instance, where the device of incorporation is used for some illegal or immoral purpose, or is a sham, or where the company is otherwise party to some form of fraud, or where public interest concerns must prevail.

The small number of reported Cayman Islands cases that have examined the principle that a company has a separate legal personality from that of its members have closely followed the English authorities.

The obligation of the manager of a Cayman-incorporated private equity fund to ensure compliance with the applicable anti-money laundering rules extends to portfolio companies of that fund, so it is necessary and usual for a private equity fund sponsor to insist on the existence of practices and procedures for such compliance.

It is also common for investors – and particularly investors in funds established to invest in emerging markets – to insist that both the fund and its portfolio companies undertake to comply with prescribed policies on environmental, social and governance (ESG) issues.

Regardless of whether or not investors insist upon the adoption of such policies, most private equity fund sponsors will adopt ESG policies and procedures as part of the ordinary course of their business as good corporate citizens, and will encourage portfolio companies to do the same.

Cayman Islands private equity funds are established with a large variety of strategies that will determine the holding period for relevant assets.

It is far less common for dual track listing and sale processes to be pursued than historically was the case, although this experience is entirely anecdotal.

Drag rights for arm's-length third-party offers are entirely usual for Cayman-established entities with multiple shareholders. The terms of any drag provision, however, will be determined by the commercial and geographic context in which the transaction is negotiated, rather than by any Cayman-specific factors.

As with drag rights, tag rights are entirely usual for Cayman-established entities with multiple shareholders. However, the specific commercial terms are not determined by reference to Cayman-relevant factors.

Cayman entities are utilised to pursue IPOs on a variety of exchanges around the world. The terms of any lock-up or other continuing relationship between the private equity sponsor seeking to exit an investment by an IPO and the issuer company or its underwriters will be determined by the practices, conventions and expectations of the relevant exchange.

Walkers

190 Elgin Avenue
George Town
Grand Cayman KY1-9001
Cayman Islands

+1 345 949 0100

+1 345 949 7886

info@walkersglobal.com www.walkersglobal.com
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Trends and Developments


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Maples Group, through its leading international law firm, Maples and Calder, advises global financial, institutional, business and private clients on the laws of the British Virgin Islands, the Cayman Islands, Ireland, Jersey and Luxembourg. With offices in key jurisdictions around the world, the Maples Group has specific strengths in the areas of corporate commercial, finance, investment funds, litigation and trusts. Maintaining relationships with leading legal counsel, the Group leverages this local expertise to deliver an integrated service offering for global business initiatives. The authors would like to thank Tim Dawson for his contribution to the chapter.

Introduction

Private equity activity in the Cayman Islands has been robust in 2020, notwithstanding volatile markets and the broader challenges presented by various events, most notably COVID-19.

Investors appear to have retained a healthy appetite for alternative assets as they seek more attractive returns and longer maturity periods than many other asset classes offer, particularly in a likely prolonged period of low or negative interest rates and bond yields.

Sponsors have been responsive to this environment, structuring and offering certain products that offer strategies tailored to the current environment, such as market dislocation and special situations opportunities, or leverage time limited Government-led initiatives such as the Federal Reserve's TALF program.

The Cayman Islands has been well-positioned to respond to this volatile and challenging global environment and retain its preeminent offshore position due to its legislative and regulatory framework, tax neutral status, flexible structuring options, respected legal system developed from English common law and experienced and responsive service providers.

The Private Funds Law

The most notable development in the Cayman Islands in the last 12 months has been the introduction and implementation of the Private Funds Law that provides for registration of closed-ended collective investment vehicles with the Cayman Islands Monetary Authority (CIMA). Approximately 12,000 private funds have registered under this new regime during a short transitional period that concluded in August 2020. The Private Funds Law introduces a proportionate regulatory overlay for closed-ended funds and has several benefits that include:

  • allowing Cayman Islands private funds to be distributed more broadly to investors who are required to invest in regulated products (eg, whether due to internal policies or the securities laws applicable in their jurisdiction of domicile);
  • streamlining set up and registration formalities for Cayman Islands private funds by way of simplified compliance procedures and wider marketing opportunities to investors in various jurisdictions;
  • facilitating more efficient regulator-to-regulator confirmations where appropriate; and
  • broadening the types of vehicles that sponsors or investors look to establish in the Cayman Islands, notably where there is a requirement for an entity to be regulated for trading purposes or for the purposes of making a specific portfolio investment.

Cayman Islands regulation

Cayman Islands regulation is, generally, fund-level focused and there is no requirement for a non-Cayman Islands manager of a private fund domiciled in the Cayman Islands to be regulated in the Cayman Islands. Most managers of private funds are not domiciled in the Cayman Islands and are regulated by various onshore regulators such as the US Securities and Exchange Commission, the UK's Financial Conduct Authority, the Hong Kong Monetary Authority or the Japanese Financial Services Agency. A Cayman Islands-registered manager would be subject to oversight by CIMA.

This framework enables sponsors, allocators and investors alike to legislate freely their contractual arrangements, which is particularly helpful as strategic investors seek alternatives to traditional co-mingled fund structures and vehicle types.

The Cayman Islands' offering is also well-positioned for alternative structures; ranging from separate accounts, funds of one through "permanent capital" strategic transactions, end-of-life liquidity options and GP minority equity stake deals.

Transactional context

While the Cayman Islands is most commonly associated with private equity fund establishment, whether main, feeder/blocker, parallel, alternative investment or co-investment vehicles, there continues to be increasing demand for Cayman Islands structures in transactional contexts, particularly buy-out and secondary transactions, including as management holding vehicles.

The nature, scope and volume of work being undertaken in the Cayman Islands gives rise to a number of trends and developments which reflect emerging technologies and work practices, a mature funds industry and the multi-jurisdictional dimension of offshore practice.

Fund Structuring

A key reason for the jurisdiction's success is the range of Cayman Islands vehicles which are available to sponsors/managers, enabling them to structure closed-ended fund products in a manner which meets the diverse profile of investors domiciled in geographically disparate regions.

The most popular Cayman Islands-domiciled vehicles for structuring investment vehicles are:

exempted limited partnerships (ELPs);

exempted companies; and

limited liability companies (LLCs).

There has also been increased interest from Japan in unit trusts that are tailored for private equity purposes. The Cayman Islands has also enacted legislation for a limited liability partnership vehicle that is anticipated to be available for use in late-2020.

The Cayman Islands limited liability company, similar to the Delaware variant, was introduced in mid-2016. There have been in excess of 3,000 Cayman Islands LLCs registered since then.

The popularity of exempted companies and ELPs has been unaffected by the introduction of LLCs. By way of illustration, there has been consistent year-on-year growth in the number of ELPs registered, averaging over 10% per annum.

Regional differences

There are nuanced regional differences in the types of vehicles being used for private equity mandates. In the North American and European markets, most primary, feeder, parallel, alternative investment and co-investment vehicles are typically formed as an exempted limited partnership unless a tax blocker is required.

In onshore-offshore fund structures, the ability to provide symmetry between the offshore fund vehicles and their equivalent onshore counterparts (notably Delaware and Luxembourg limited partnerships) can lead to greater ease and cost efficiency of fund administration, pass-through tax treatment and has helped to better align the rights of investors between the different vehicles in a fund structure.

The exempted company is less regularly employed as a fund vehicle other than with respect to certain types of target investors and with reference to certain assets. Its key feature - being a corporate vehicle with separate legal personality - lends these vehicles to being most commonly used as general partner, manager, blocker or holding vehicles (although one of the exempted company variants, the segregated portfolio company, can be an attractive option for managers targeting certain Middle Eastern-based or family office investors).

The LLC has been an appealing alternative for general partner, upper tier, manager and co-investment vehicles. The absence of share capital (and the absence of the need to maintain a share register), combined with the ability to intuitively track and record the capitalisation of an LLC and its distributions, has also led to LLCs being attractive for blocker, aggregator and holding vehicle applications. Because a member is not required to make a contribution but may benefit from profit allocations, the LLC has been adopted for certain employee award and grant schemes.

Japan

In a Japanese context, a unit trust structure may offer tax and other regulatory related benefits to certain types of investors when compared to a limited partnership vehicle. The unit trust is familiar to Japanese investors and can be customised to incorporate characteristics of a traditional private equity fund, including capital call features, clawbacks and defaulting investor provisions.

This development is in response to traditionally risk-averse Japanese institutions recalibrating their investment portfolios and allocating to private equity in a search for yield. As with many western states, Japanese Government bond yields have been stuck at, or near, zero per cent.

There is continued interest from Japanese institutional investors in private equity as an asset class. Some of the largest institutional investors, such as Japan Post Bank, are now in their fifth year of their private equity investment program in which they are allocating significant capital each year to global private equity funds. In addition, five major Japanese trading houses recently attracted a combined USD6 billion investment from Warren Buffet's Berkshire Hathaway, who are also reportedly shifting their attention from commodities to venture capital and private equity. Private equity is also proving popular with Japanese life insurers and, more recently, a number of the regional banks who are similarly rebalancing portfolios and shifting assets into private equity in the search for higher yields.

Parallel fund vehicles

A number of managers will utilise a mix of parallel fund vehicles to maximise the global distribution of their funds and manage downstream assets. By way of example, managers targeting investors in multiple regions, including Europe, may look to offer parallel Cayman Islands, Delaware and Luxembourg fund options or a variation on that arrangement, such as a master-feeder fund structure with a Cayman Islands closed-ended fund vehicle operating as a feeder fund into a European (such as an Irish or Luxembourg) master fund. Similarly, a Cayman Islands closed-ended fund vehicle may set up holding or trading vehicles in various European jurisdictions (such as Ireland or Luxembourg) to facilitate its investment objectives.

Regulatory

A sophisticated legislative and regulatory framework has enabled the Cayman Islands to respond to the challenges and opportunities arising out of evolving, and often conflicting, regulatory developments. The key regulatory developments in the recent years include:

  • Implementation of the Private Funds Law in 2020, a new regime that requires closed-ended funds to register with CIMA. The Private Funds Law introduces a proportionate regulatory overlay for closed-ended funds with several benefits, is responsive to recommendations by international partners and reflects the Cayman Islands' commitment as a co-operative jurisdiction as affirmed by various international organisations, including by the EU in early-October 2020 when removing the Cayman Islands from its Annex I list of non-cooperative jurisdictions for tax purposes. It covers similar ground to existing or proposed legislation in a number of other jurisdictions.
  • The Cayman Islands has implemented the comprehensive automatic exchange of information (AEOI) regimes of both the Organisation for Economic Co-operation and Development’s Common Reporting Standard (OECD) and the US Foreign Account Tax Compliance Act (FATCA). Reporting financial institutions have customer due diligence and annual reporting obligations in the Cayman Islands. Reports are made to the Cayman Islands Tax Information Authority (TIA) administered by the Government’s Department for International Tax Cooperation. The TIA in turn provides account information automatically to the tax authorities of over 100 jurisdictions.
  • The maintenance of beneficial ownership information and, since 2017, a requirement for a beneficial ownership register. Subject to any available exemptions, exempted companies and LLCs are now required to complete and maintain a beneficial ownership register at their Cayman Islands registered office with a licensed corporate service provider with information made available by the Cayman Islands Government to certain law enforcement agencies upon legitimate request.
  • The Cayman Islands introduced the Tax Information Authority (International Tax Compliance) (Country-by-Country Reporting) Regulations in 2017. In summary, these regulations implement in the jurisdiction the model legislation published under the OECD's Base Erosion and Profit Shifting Action 13 Report (Transfer Pricing Documentation and Country-By-Country Reporting).
  • The Cayman Islands continue to revise and update its AML Regulations and related guidance to ensure they remain in line with current Financial Action Task Force (FATF) recommendations and global practice from time to time. The requirements of the AML Regulations include the appointment of natural persons as AML officers to entities carrying on "relevant financial business" (which includes Cayman Islands investment funds vehicles) to oversee the effective implementation of AML programmes carried out by or on behalf of such entities.
  • In further response to and compliance with OECD base erosion and profit shifting standards, in December 2018, the Cayman Islands brought into force the International Tax Co-Operation (Economic Substance) Law (2020 Revision) and associated regulations and guidance. This law introduced reporting and economic substance requirements for certain Cayman Islands-domiciled entities, with reporting made to the TIA.
  • The Data Protection Law, 2017 (DPL) came into force in late-2019. This law imposes certain obligations on Cayman Islands vehicles which handle personal information relating to an individual with respect to that information. The DPL data protection principles are equivalent to those in force under other comparative legislation, such as GDPR in Europe.
  • The Cayman Islands continues its dialogue with a number of international partners and governing regulatory bodies, including the OECD and the FATF, to ensure the jurisdiction maintains a robust and proportionate regulatory framework which meets internationally accepted best practice standards.

At the establishment stage, these regulatory matters are being reflected in more detailed disclosures in offering and subscription documents. By way of example, investors are being required to make disclosures which pertain to AML and tax transparency considerations and sponsors are addressing data protection and sanctions obligations together with economic considerations, such as pertaining to the costs which will be allocated to the fund as fund expenses as opposed to incurred by the manager.

These are dynamic and ongoing obligations, the nature of which is reflected in fund documents and Cayman Islands notification and reporting obligations of the nature described above.

Fair disclosure

There is also an emphasis on fair disclosure. During a fund's lifecycle, as in key onshore jurisdictions, sponsors engage in ongoing dialogue with investors and advisory boards to ensure key matters, notably conflicts, are fairly disclosed, including in the context of fees (which has been an area subject to well-publicised onshore regulatory enforcement actions).

The scope for conflicts can be particularly acute at the end of a fund's life, for example where liquidity is sought, or value optimised, by way of a general partner-led secondary transaction or a term extension. In those instances, a sponsor may receive new material information in the midst of an all-partner consent process, or prior to a deal being consummated, which the sponsor (and/or general partner) must disclose so that investors are able to make an informed decision with reference to those revised particulars.

Given that the regulatory framework is evolving quickly and becoming more complex and multi-layered, an increasing number of sponsors look to outsource compliance functions, such as AML/KYC verification and tax transparency reporting obligations, to third-party specialists. This allows management companies to dedicate more resources to their core investment-focused activities and more clearly delineate between fund and house expenses.

Geographic Factors Impacting Cayman Islands Private Equity Trends

The Cayman Islands product has broad global appeal although several trends are dictated by geographic factors.

North America

The North American fundraising market remains active with a range of vehicles from small bespoke sidecar funds to mega-funds being established in the Cayman Islands. The broad flexibility of the Cayman Islands' offering ensures there is wide appeal among mid-market and start-up managers as well as allocators and investors to establish Cayman Islands vehicles intended to fulfil a wide range of purposes.

Europe

The European private equity market, including new fund formations, buyouts and exits, has continued to grow within the last few years, despite the noticeable uncertainty that has prevailed in the UK private equity market since the Brexit referendum. Against this backdrop of continued growth in European private equity markets, demand for Cayman Islands private equity fund structures by European sponsors has also continued to increase, in particular, where targeting non-European money.

There is also consistent demand to structure downstream investments through Cayman Islands aggregator, alternative investment vehicles and holding vehicles as sponsors look to deploy capital in what has been, until the onset of the global pandemic, a highly competitive deal market.

Aside from the continuing uncertainty surrounding Brexit and the future relationship between the UK and the EU, COVID-19 has notably impacted the number of fund launches by European managers in 2020 as a result of the disruption caused to businesses and market uncertainty and there is a trend of adapting products and strategies to reflect the current environment, in particular in the distressed credit space.

Secondary activity has also been effected as deals have been delayed due to concerns over valuations. However, given the capital available from new fundraising and, if anything, increased investor appetite, it is anticipated that deal activity will pick up in the final quarter and into Q1 2021.

UK

Notwithstanding the challenges facing the UK private equity market, the Cayman Islands continues to be a popular jurisdiction for UK managers looking to establish offshore private equity funds. Increased fund oversight and investor protection through the implementation of the Private Funds Law will, together with certain other recent legal and regulatory developments, enhance the standing of Cayman Islands funds to European private equity fund managers and investors alike who are already operating within the AIFMD environment.

Asia

The sharp slowdown of Chinese investment during 2019 has continued into 2020. The consequences of COVID-19 and economic downturn, the ongoing US-China trade tensions, together with the 2020 US elections, have made the environment for fundraising particularly difficult, especially for new managers. As a result, a number of major fund launches have been put on hold due to the uncertainty in the markets.

Against this backdrop, investor confidence has taken an inevitable hit with investors becoming far more cautious and discerning. As a result, GPs appear to be more flexible and willing to accept investor requests by way of side letters in order to receive commitments from investors. Notwithstanding, these considerable headwinds, the Chinese State Owned sector and certain strategic funds have maintained their interest in real estate investment through Cayman Islands structures.

As noted above, there is increasing appetite in Japan for exposure to private equity and a number of managers are expanding into the asset class.

Looking Ahead

It is anticipated that, given deflationary pressures and low to negative interest rates and bond yields, investors will continue to allocate a significant portion of their investment capital to alternatives.

Against this backdrop, and notwithstanding a volatile macro-economic landscape, the Cayman Islands remains well placed to maintain its position as the principal offshore jurisdiction for private equity given the flexible structuring options and proportionate regulatory framework that continues to adapt in a robust and responsive manner to the needs and expectations of sponsors, investors and international partners.

Maples Group

Ugland House
South Church Street
PO Box 309
Grand Cayman KY1-1104
Cayman Islands

+1 345 949 8066

+1 345 949 8080

info@maples.com www.maples.com
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Law and Practice

Author



Walkers is a leading international firm that provides legal, corporate, compliance and fiduciary services to global corporations, financial institutions, capital markets participants and investment fund managers. The firm is made up of highly qualified and experienced lawyers, many of whom have international experience in major global law firms. Walkers’ Global Investment Funds Group offers Bermuda, British Virgin Islands, Cayman Islands, Guernsey, Jersey and Irish law advice on investment funds on a global basis, and is one of the largest specialist International Financial Centre funds teams worldwide. The firm advises many of the world’s most prominent asset managers, fund promoters and institutional investors, and consistently applies an innovative and practical approach to solving complex commercial issues.

Trends and Development

Authors



Maples Group, through its leading international law firm, Maples and Calder, advises global financial, institutional, business and private clients on the laws of the British Virgin Islands, the Cayman Islands, Ireland, Jersey and Luxembourg. With offices in key jurisdictions around the world, the Maples Group has specific strengths in the areas of corporate commercial, finance, investment funds, litigation and trusts. Maintaining relationships with leading legal counsel, the Group leverages this local expertise to deliver an integrated service offering for global business initiatives. The authors would like to thank Tim Dawson for his contribution to the chapter.

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