Back-to-back redemptions in Cayman master-feeder fund structures
A “master-feeder” fund structure is often used by Asian-based hedge fund managers who wish to target a broader investor base. Such a structure is commonly used to ultimately pool investments by US taxable, US tax-exempt and non-US investors into one single vehicle – the master fund. This happens when investors invest into the feeder fund(s) which will then invest into the master fund; the master fund invests in the underlying investments and all the market trading occurs at the master fund level.
The Grand Court of the Cayman Islands (the “Court”) has recently handed down a decision on the issue of redemption process that has significance for Cayman Islands’ master-feeder structures.
In the matter of Ardon Maroon Asia Master Fund (in official liquidation)1 , the Court considered the requirements for a valid redemption of the feeder fund’s shares in the master fund where there had been no separate redemption request by the feeder fund.
The liquidators of the feeder fund contended that the receipt of a redemption notice by the feeder fund from the investor triggered an “automatic” back-to-back redemption in the master fund. However, the master fund rejected the feeder fund’s so-called ‘back-to-back’ proof of debt on the basis that the feeder fund had not submitted a written notice to redeem shares in the master fund. The said redemption process was set out in the constitutional documents of the master fund.
A second related issue was whether the directors of the fund were able to make a determination as to the method of redemption and by implication waive the requirements set out in the constitutional documents. The directors of the funds argued that a ‘back-to-back’ redemption at the master fund level is normal industry practice in the Cayman Islands to avoid misalignment of the liquidity profiles between the master fund and feeder fund.
The Court rejected the arguments in favour of a “back-to-back” redemption process. It concluded the feeder fund’s redemption was ineffective on the basis that it had not completed the redemption process by submitting a written notice of redemption, which was required by the constitutional documents of the master fund.
In principle, the Court recognised that redemption at the feeder fund level can amount to a simultaneous redemption at the master fund level without having to serve a separate redemption notice - provided that this was authorised in the master fund’s constitutional documents. However, the Court was unwilling to depart from the agreed contractual terms stated in the constitutional documents on the basis that industry practice was different. Given the redemption procedure set out in the constitutional documents, the Court was unable to accept that the redemption process could be disregarded by the directors without the express power for such a change.
Ardon has highlighted two important points for master-feeder structure funds. First, the importance of ensuring the redemption procedure set out in the master-feeder structure’s constitutional documents is strictly followed in order for a valid and enforceable redemption to take place. Second, it is clear that the Court will not allow industry practice to trump what the parties have contractually agreed. At a minimum, directors would need to be contractually entitled to waive any requirements within the redemption process irrespective of what is reflected in industry practice. The case should encourage fund managers to ensure that the contractual redemption processes are being implemented and carefully documented.
1Ardon Maroon Asia Master Fund (in official liquidation), unreported 17 July 2018