JPLs, Directors and Arbitration: Grand Court Clarifies the Scope of Provisional Liquidators' Powers

As explained in our previous article, the dispute arose from a Cayman Islands joint venture. The minority shareholder alleged that profits had been improperly diverted by the majority shareholder and petitioned to wind up the general partner on the just and equitable ground, while also seeking the appointment of JPLs. The majority shareholder sought a stay in favour of HKIAC arbitration pursuant to the shareholders’ agreement.

In Energy Evolution 1, the Court granted the stay but nevertheless appointed JPLs to preserve assets and prevent misconduct pending the arbitration. Importantly, the Court emphasised that their powers should extend no further than necessary to achieve those objectives.

Energy Evolution 2 concerned the subsequent dispute over the effect of the order appointing the JPLs (the Order). The petitioner (minority shareholder) argued that the appointment displaced the directors and vested management control in the JPLs. The respondents (on the side of the majority shareholder) argued that the JPLs’ powers were confined to asset preservation and misconduct prevention, leaving all other management powers with the directors.

The petitioner subsequently sought directions on the effect of, and alternatively variations to, the Order, arguing that the JPLs should be able to participate more actively in the governance of the general partner and its subsidiaries and in matters connected with the arbitration. The JPLs also applied for approval of their instruction of BVI and Cayman counsel, and for their proposed funding arrangements.

DO PROVISIONAL LIQUIDATORS AUTOMATICALLY DISPLACE DIRECTORS?

The Court first considered the petitioner’s argument that the appointment of a provisional liquidator automatically displaces the directors and transfers management authority to the JPLs.

In support, the petitioner relied upon: (1) a line of English authorities suggesting automatic displacement of the directors in favour of the JPLs; and (2) the Companies Winding Up Rules (CWR), Order 4, Rule 4(3), which states an order appointing a provisional liquidator “shall specify the powers conferred upon the provisional liquidator, any limitations upon the specified powers and the powers, if any, remaining with the company’s directors”. The petitioner argued that the use of the words “if any” meant that all directors’ management powers vested in the JPLs except where expressly reserved to the directors.[1]

In opposition, the respondents relied upon:

(1) section 104(4) of the Companies Act, which provides that “[a] provisional liquidator shall carry out only such functions as the Court may confer on that person and that person’s powers may be limited by the order appointing that person”. On that basis, the respondents argued that a provisional liquidator possesses only those powers expressly conferred by the Court, and the directors retain any remaining powers; and

(2) the CWR, which draw a clear distinction between provisional and official liquidations. While CWR Order 3, Rule 22(4)[2] and CWR Order 15, Rule 8(3)[3] expressly provide that directors’ powers cease upon the appointment of official liquidators or the making of a supervision order, no equivalent provision appears in CWR Order 4 governing provisional liquidators. The respondents therefore argued that directors’ powers do not automatically cease upon the appointment of JPLs, given the absence of express wording to that effect in CWR Order 4.[4]

Ruling in favour of the respondents, the Court found: (1) the English authorities relied upon by the petitioner were inconsistent with section 104(4) of the Companies Act and CWR Order 4 and therefore did not reflect Cayman law; and (2) Cayman law adopts a fundamentally different approach. The appointment of provisional liquidators does not automatically transfer management powers from directors to provisional liquidators or otherwise displace the directors. Instead, JPLs possess only those powers expressly conferred by the appointment order.[5]

THE COURT’S APPROACH TO CONSTRUING ORDERS

As to the meaning of the specific wording of the Order, the Court found that Cayman law follows the same approach as England – namely: orders are interpreted objectively according to the natural and ordinary meaning of their wording, read in light of their context and background. Only if the order is ambiguous may the court look to the judge’s reasons. If those reasons do not resolve the ambiguity, the court may then consider discussions with the judge concerning the terms of the order and, more exceptionally, the parties’ submissions to identify the mischief the order was intended to address.[6]

The Court found that the Order did not confer management or shareholder rights on the JPLs, or strip the directors of their powers. This was based primarily on an objective reading of the Order. However, because the parties’ opposing interpretations indicated that the Order was arguably ambiguous, the Court also took into consideration the reasoning of the judge upon giving the Order and the Order’s drafting history.[7] As a result, the Court found that a number of the petitioner’s criticisms of the respondents having not complied with certain of the JPLs’ previous requests could not be sustained on a proper construction of the Order.[8]

DIRECTIONS, VARIATION AND THE COURT’S ONGOING SUPERVISORY ROLE

Opposing any variation of the Order, the respondents argued that there had been no material change in circumstances since the original appointment and that the petitioner was effectively seeking a second attempt to obtain powers previously refused by the Court.[9]

While the Court was critical of aspects of the petitioner’s application, the Court confirmed that the supervisory jurisdiction over provisional liquidations remains flexible.[10] The Court held that the petitioner was entitled to seek clarification of the proper interpretation of the Order and could apply to vary it pursuant to CWR O.4, r.5(1) and the liberty to apply provision contained in the Order. The Court also accepted in principle that provisional liquidators, as officers of the Court, may seek directions (including directions that have the effect of varying an appointment order) whenever genuine uncertainty arises regarding the scope of their appointment. However, that particular basis did not assist the petitioner because the application had been brought by the petitioner rather than the JPLs themselves.[11] In any event, the Court held that the complaints regarding lack of cooperation with the JPLs constituted a sufficient change in circumstances to justify considering whether the Order should be varied.[12]

VARIATIONS MADE TO THE ORDER

Consistent with the limited purpose of the appointment, the Court declined to grant the JPLs: (1) director management powers; (2) authority to act in the interests of the EPL in the arbitration; (3) authority to exercise any shareholder rights and (4) power to call meetings and exercise voting powers of the general partner and its subsidiaries.[13] The Court was particularly concerned that varying the Order on the terms sought may confer powers on the JPLs which could override any contractual arrangements governing the relevant entities, including shareholders’ agreements, which was outside of the Court’s jurisdiction.[14]

The Court also declined to grant injunctive relief to prevent the diversion of dividends, holding that any such relief should ordinarily be sought from the arbitral tribunal or the courts of the seat of the arbitration unless urgent intervention by the Court was required.[15]

However, the Court did order that the JPLs be copied on arbitration correspondence and authorised them to communicate with third parties (including subsidiaries) and obtain relevant books and records. The Court considered those powers necessary to enable the JPLs to perform their preservation and monitoring functions without encroaching upon matters reserved to the arbitral tribunal.[16]

THE JPLS’ SANCTIONS APPLICATION

The Court was satisfied that the JPLs had appropriately obtained Cayman Islands and BVI legal advice.[17]

As to the funding arrangements, the Court rejected the JPLs’ submission that the Court should approve the funding in principle now, and deal with the reasonableness of any fees at a later date. In that respect, the Court expressed concern that the amount of proposed funding was in the region of US$700,000, relative to the limited scope of the JPLs’ appointment. The Court was unwilling to approve substantial funding in principle where the scope of the JPL appointment remained deliberately limited.[18]

The Court therefore refused to approve the JPLs’ proposed funding arrangements, instead encouraging the general partner’s directors to remove any impediments that may be preventing the JPLs from taking payment from the General Partner’s assets.[19]

KEY TAKEAWAYS

Energy Evolution No.2 provides important guidance for insolvency practitioners and commercial litigators alike:

• First, the appointment of Cayman provisional liquidators does not automatically displace directors. This is distinct from the appointment of official liquidators, which does automatically displace directors. In the context of a JPL application focused entirely on asset preservation, the Court’s judgment follows the well-established practice in the Cayman Islands of appointing provisional liquidators on a “soft touch” basis.
• Second, appointment orders need to be drafted carefully, as it is the order which dictates a provisional liquidator’s powers. The Court’s emphasis on section 104(4) of the Companies Act means that implied powers arguments are unlikely to succeed.
• Third, where JPLs are appointed alongside ongoing arbitration proceedings, their appointment should not be used as a mechanism for obtaining control of issues that properly belong before the arbitral tribunal.
• Fourth, the Court remains willing to consider applications for directions and variation of court orders where genuine uncertainty arises concerning the scope of an appointment, even absent a material change in circumstances.
• Finally, the judgment signals that funding applications by provisional liquidators will be scrutinised closely and must remain proportionate to the scope and purpose of the appointment. The Court may scrutinise proposed funding arrangements at an early stage.

[1] At [31] and [33-36].

[2] Which states: “On the appointment of an official liquidator all the powers of the directors cease, save that directors retain residual powers to allow them to initiate an appeal against the winding-up order.”

[3] Which states: “On the making of a supervision order all the powers of the directors cease, save that directors retain residual powers to allow them to initiate an appeal against the supervision order.”

[4] At [31-32].

[5] At [37-38].

[6] At [29].

[7] At [30] and [40-46].

[8] At [44].

[9] At [49].

[10] At [56].

[11] At [51].

[12] At [52].

[13] At [77-78, 81 and 86-87].

[14] At [88].

[15] At [86].

[16] At [89].

[17] At [97].

[18] At [107-108].

[19] At [109-110].