IN THE MATTER OF THE CYBERVEST FUND 04-January-2006
[2006 CILR 80]
IN THE MATTER OF THE CYBERVEST FUND
GRAND COURT (Smellie, C.J.): January 4th, 2006
Civil Procedure—costs—security for costs—likely outcome of suit important consideration for ordering security if other side very likely to succeed—discretion normally to be exercised based on likelihood of unsuccessful plaintiff failing to meet award of costs against it from assets within jurisdiction—foreign state agency with good reputation and undoubted resources with valuable shares in Cayman company, unlikely to fail to pay
Companies—compulsory winding up—costs—security for costs—no bar to ordering security by petitioner in winding up—petitioner’s valuable shares in company being wound up, together with good reputation and other undoubted resources as foreign state agency, may make security unnecessary
Companies—dispositions and transfers during winding up—validation by court—no validation order for payment of fund management fees even when company solvent if alleged irregularities in management and company to be wound up within year
The petitioner sought the winding up of the Cybervest Fund.
The petitioner, an agency of the state of Kuwait, was a shareholder in the company and was supported in its petition by two other major investors, altogether controlling 70% of the participating shares in the company. The winding up was requested on the “just and equitable” ground because there had been various convoluted dealings with the assets of the company, about which the respondent (the manager of the fund) had failed to consult the shareholders. These dealings were alleged to be a deliberate attempt by the managers to divert the company’s assets for their own purposes and, by treating transferred capital as invested,
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claim management fees at a higher rate. Furthermore, the plaintiff argued that the substratum of the company had failed, it was now acting in breach of agreed investment strategy, and was no longer capable of making the investments for which it was set up.
The respondent (a) opposed the petition on the basis that the funds had been fully invested and it would be harmful to the returns due to the plaintiff and the other investors if the company were prematurely forced into liquidation; (b) sought security for costs, as it had incurred significant expense in preparing the case and, as the petitioner was based outside the Cayman Islands and had no liquid assets within the jurisdiction, was concerned that should it succeed, it would be unable to enforce an order for costs in its favour; and (c) sought a validation order under the Companies Law (2004 Revision), s.156 to enable it to make valid payments to third parties and pay management fees incurred in the ordinary course of business in order to keep the company running whilst the petition was being heard.
The respondent submitted that (a) it had a good chance of success and therefore it was important that security for costs was provided as it was reasonably likely that it would be awarded costs; (b) the plaintiff was ordinarily resident outside the Cayman Islands and on a reasonable construction of O.23, r.1(1)(a) of the Grand Court Rules foreign plaintiffs should usually be required to provide security for costs; (c) if the court would not automatically order security against a foreign petitioner, then it should do so in this case because the petitioner had no liquid funds within the jurisdiction and to enforce the order the respondent would therefore need to travel to Kuwait where, since the petitioner was a state agency, it might be met with a plea of state immunity; (d) if forced to resort to the plaintiff’s shares in the company to meet its costs, it would have to liquidise assets of the company which only notionally belonged to the plaintiff, to the detriment of other investors; and (e) in order to continue to run the company effectively, for the benefit of all investors, it needed a validation order to enable it to make payments in the ordinary course of business, both to third parties, such as audit or administration fees, and management fees to the respondent as agreed in the company’s memorandum and it ought to be allowed to continue to deal with the assets in the normal manner as the company was still liquid and there was not a risk of bankruptcy.
The petitioner submitted in reply that (a) it was irrelevant who was more likely to win the case unless the chance of one side winning appeared to be so low that the case was frivolous; (b) O.23, r.1(1)(a) of the Grand Court Rules gave the court a discretion to order security for costs if it thought it was necessary, and was not a blanket instruction that security should be ordered against any foreign plaintiff; (c) it was the very fact that it was an internationally well-respected state agency which meant that there was no risk of its failing to comply with an order for costs; (d) whilst it had no liquid assets here, its shares in the company would be worth enough to cover any order of costs which might be made
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and any further security for costs would therefore be unnecessary; and (e) it did not oppose the validation order regarding third party payments, but such validation should not apply to management fees as they were not necessary for the basic running of the company and, furthermore, s.156 was not intended just to apply to companies where there was a risk of bankruptcy, but also to liquid companies where there was a risk of transactions being made in bad faith, as here, considering the allegations in the petition regarding the calculation of management fees.
Held, dismissing the applications:
(1) When refusing security for costs, it was not necessary to take into account who was likely to succeed in the case for the winding up unless there was
prima facie a high probability of success for one side or the other; in this case, the matter was not sufficiently one-sided for the strength of the arguments to be a relevant factor (
paras. 20–21).
(2) The court had the power to order security for costs against a foreign plaintiff under O.23, r.1(1)(a) of the Grand Court Rules, but, on a reasonable interpretation of the legislation, it had discretion over when to exercise this power and, having regard to all the circumstances of the case, it would not be reasonable to order security here because—
(a) whilst the petitioner did not have liquid assets in the jurisdiction, it did have its shares in the company, which were valuable and could be used if any costs remained unpaid by the petitioner. As the company would be used to fund the respondent’s case in the first place, its argument that it should not have to liquefy assets of the company that only notionally belonged to the petitioner failed, as it would merely be an accounting exercise to redeem the costs from any distributions which became due to the petitioner (
paras. 25–26); and
(b) the petitioner was a state agency of undoubted resources, which was well known and respected internationally and therefore had a financial interest in complying with court orders made against it in foreign jurisdictions. There was therefore little prospect that it would not meet any order for costs made against it. This also supported the court’s view that there was no real risk of the petitioner’s using state immunity as a defence against attempts to enforce the order in Kuwait (
para. 27).
(3) A validation order in respect of the management fees would not be made, because where there could be shown to be irregularities in the conduct of a company’s affairs, it by no means followed that because the company was solvent and able to pay its debts as they fell due the conduct of the company’s business should be continued, potentially at the expense of its investors (
paras. 29–30;
para. 32).
Cases cited:
(1) Aeronave SpA. v. Westland Charters Ltd., [1971] 1 W.L.R. 1445; [1971] 3 All E.R. 1074, applied.
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(2) Alipour v. Ary, [1997] 1 W.L.R. 534, followed.
(3) Apollinaris Co.’s Trade Mark, In re, [1891] 1 Ch. 1, followed.
(5) Burton & Deakin Ltd., In re, [1977] 1 W.L.R. 390; [1977] 1 All E.R. 631, followed.
(6) Company, In re a (007130 of 1998), [2000] 1 BCLC 582, followed.
(8) JN2 Ltd., In re, [1977] 1 W.L.R. 183; [1977] 3 All E.R. 1104, followed.
(9) Porzelack KG v. Porzelack (UK) Ltd., [1987] 1 W.L.R. 420; [1987] 1 All E.R. 1074, followed.
(10) Pretoria Pietersburg Ry. Co. (No. 2), In re, [1904] 2 Ch. 359, applied.
Legislation construed:
Grand Court Rules, O.23, r.1(1): The relevant terms of this sub-rule are set out at
para. 22.
Companies Law (2004 Revision), s.156: The relevant terms of this section are set out at
para. 28.
M.W. Imrie and J.P. Lagan for the petitioner;
K.J. Farrow for the second respondent.
1 SMELLIE, C.J.: The Public Institution for Social Security of the State of Kuwait (“PIFSS”) petitions for the winding up of the Cybervest Fund which is a Cayman company. In this petition it is supported by the Kuwait Investment Authority and the Kuwait Fund for Arab Economic Development which are also investors in the company. Together they have invested US$65m. in the company and own 70% of the participating shares. The petition is based on the “just and equitable” ground because PIFSS alleges that the substratum of the company has failed and that those in control of the company have acted unlawfully and in a manner which is oppressive to the participating shareholders.
2 The matter is before me now on a summons brought by CIC Advisors Ltd., a company incorporated in the British Virgin Islands, and the investment manager of the Cybervest Fund. CIC, as respondent to the petition, now applies by two summonses for separate forms of relief.
3 First, they seek an order that the petitioner and the supporting contributories, pay into court or provide a bank letter of credit for the amount of US$500,000, as security for CIC’s costs in these proceedings, in case the petition is unsuccessful and an order for costs is made against the petitioner. Ancillary to that, CIC also seeks a stay of the proceedings until the appropriate security is provided.
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4 By their second summons, termed a “validation summons,” CIC seeks an order that in the event the petition is successful and an order is made to wind-up the company, no payment made by the company in the ordinary course of business, from the date the petition was filed in court until the hearing of the petition, shall be avoided by virtue of the provisions of s.156 of the Companies Law (2004 Revision).
Security for costs
5 The petition, supported by affidavits of the relevant officers of PIFSS, raises allegations of the most serious kind. It will suffice, for present purposes, that I should form only a preliminary view of the relative strengths and weaknesses of the parties’ positions and thus of the allegations raised in the petition.
6 Mr Bader Al-Rezaihan is the founder and president of CIC Group Inc. (“CICG”), a Delaware corporation with which CIC is affiliated and which provides asset management and investment services to institutional investors. In about October 1999, PIFSS was solicited by CICG to invest in a closed-end investment vehicle, the sole objective of which was to make direct equity investments exclusively in early stage Internet start-up companies within the United States and internationally. This vehicle became the Cybervest Fund, which was incorporated as a Cayman exempt company on October 13th, 1999. An earlier investment of this kind by PIFSS with CICG had proved to be highly successful, and it is alleged that that success was the pivotal reason for PIFSS seeking to invest specifically in the proposed venture.
7 PIFSS was sent a memorandum confirming the investment strategy and appointing CIC to be manager of the company. The memorandum, which PIFSS accepted, permitted CIC to charge the following fees:
(i) a management fee equal to 0.5% per annum of the uninvested capital of the investment fund plus 2% of the invested portion of the fund; and
(ii) a performance fee equal to 20% of any amounts distributed to investors in the fund in excess of the return of their invested capital.
It also stipulated that participating shares were to be issued to investors and CIC would be issued all the management shares. While the participating shareholders provided all the capital for the company, the management shares acquired all the voting rights. The participating shares carried the right to dividends and to repayment of capital in the event of winding up.
8 It is alleged that without the knowledge of the petitioner, an entity called eColony was incorporated as a joint venture enterprise between the company and Internet Capital Group Inc. (“ICG”), a related CICG
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company involved in e-commerce and that, in breach of the agreed investment strategy, US$90,000 (virtually all its capital) was transferred away from the company to eColony to purchase stakes in selected emerging companies. In further breach of the memorandum, the money which the company had put into eColony was invested in enterprises not related to the Internet industries specified in the investment strategy.
9 In 2001, eColony was placed into liquidation with the objective of distributing its assets and investments to another Cayman company called Anthem/CIC Partners (“Anthem CIC”). While Anthem CIC is said to be owned 91.19% by the company, it is regarded by the petitioner as an artifice by which Mr. Al-Rezaihan and a Mr. Woodward (employed by him as CEO of eColony) seek to divest and misappropriate the investments in the company.
10 Mr. Woodward is also the founder and managing director of Anthem CIC’s partner group, Anthem/CIC Ventures Fund Limited Partnership (“the Limited Partnership”). Financial statements of the company reveal that Anthem CIC has committed to contribute US$87,118,516 (all of its assets) to the Limited Partnership, of which around half has already been paid. The remaining US$44,944,417 is said to be payable at the discretion of the General Partner.
11 It seems that as a consequence of all this, CIC has notified shareholders that the company has suffered losses of US$14m. through expenses and the breaking of contracts. The foregoing concatenation of events has led the petitioner to conclude that the company cannot carry out the sole object of its incorporation; all its funds have now been committed to the Limited Partnership, whose investment strategy is entirely different from that outlined in the memorandum.
12 It is further alleged that in breach of the fee structure set out in the memorandum, CIC has charged the company a management fee of US$1.8m. on the basis that it represents 2% of the US$90m. transferred to eColony, which it treated as invested capital of the company.
13 For all the foregoing reasons, the petitioner alleges that the company has lost its substratum and has merely become a device by which the managers seek to extract management fees unlawfully by transferring away its assets to related entities owned by CICG or Mr. Woodward.
14 In opposition to the petition, Mr. Al-Rezaihan’s affidavit asserts that the petitioner was made aware of the proposal to use eColony as the vehicle for the investment after the initial proposal to use another vehicle called GarageBank was not approved. He exhibits copies of the presentation made to the investors under the title of GarageBank.com which provided an overview of the proposed strategy. He asserts that it was in direct response to this presentation that the petitioner invested in the
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company. Mr Al-Rezaihan asserts that the amount invested by the company in eColony represented the entire share capital of the company, and that there were no deductions made for management fees at that time.
15 In short, he asserts that the petitioner’s statement that they were unaware that the entire capital of the company was to be re-invested in another entity is false. He then proceeds to explain how, on the advice of Mr. Woodward, the decision was taken to liquidate eColony. It had been determined that the window of opportunity to take eColony public as an early stage Internet technology company had passed, in the context of the market as it then existed. That being so, there was no longer any advantage in maintaining eColony, with the disadvantage of double taxation it attracted as a US entity.
16 Then, of particular significance to the breakdown in relationships, Mr. Al-Rezaihan describes how it was determined that a partnership structure would be formed to take eColony’s assets, but makes no reference to any efforts made to advise the petitioner, in advance, of the reasons for this development. A presentation was later sent to the investors with details of the new legal structure and business model being pursued by the company. This, to an objective observer, would reveal the ex post facto nature of this communication, occurring, as it did, six months after eColony was put into liquidation.
17 Mr. Al-Rezaihan asserts that the core investment strategy outlined in the presentation is still being used. Finally, he submits that far from there having been a loss of substratum, the consolidated financial statements for the company in 2004 show net assets of US$60,767,288 of which US$20,335,017 is held in cash or equivalents. He states that the assets of the company, invested as they are, are very likely to increase in value, in keeping with the investment strategy.
18 Many of the portfolio companies are said to be fully invested now and generating strong revenues. Any attempt at liquidating the company’s investment portfolio now would likely, he asserts, have a very damaging effect on its value and ultimately the level of returns to investors. There would also be significant issues of liability regarding the other parties who have vested legal interests in the fund, such as ICG, Mr. Woodward and the employees of the management company. Allowing the investment team now in place to continue the strategy being pursued will be, ultimately, he concludes, in the best interests of the investors.
19 These, by means of the rather detailed examination of the opposing positions, are the juxtaposed arguments for and against the grant of the petition.
20 For present purposes, the question is whether, despite Mr. Al-Rezaihan’s explanation, it can be said that the petitioner shows, prima
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facie, a good arguable basis for its petition. In other words, is either the plaintiff or petitioner very likely to succeed? That, on the case authorities, is an important factor to be considered upon an application for security for costs:
Banco Economico SA v. Allied Leasing & Fin. Corp. (4) and
Porzelack KG v.
Porzelack (UK) Ltd. (9). In
In re Pretoria Pietersburg (No. 2) (10), it was confirmed that security for costs can be ordered against a petitioner for winding up as it can be against a plaintiff in a writ or other action.
21 On the basis of these case authorities, I note that the relative merits of the litigation are only relevant at this stage if it can be clearly demonstrated that there is a high probability of success for either party. Only on that basis would it be appropriate to take the merits into account in deciding for or against the grant of security for costs.
22 The respondent’s application for security for costs is made under Grand Court Rules, O.23, r.1 which provides:
“(1) Where, on the application of a defendant to an action or other proceedings it appears to the Court—
(a) that the plaintiff is ordinarily resident out of the jurisdiction;
. . .
then if, having regard to all the circumstances of the case, the Court thinks it just to do so, it may order the plaintiff to give such security for the defendant’s costs of the action or other proceedings as it thinks just.”
Sir Nicholas Browne-Wilkinson, V.-C. in Porzelack KG v. Porzelack (UK) Ltd. (9) stated the purpose of an order for security for costs in these concise terms ([1987] 1 All E.R. at 1076):
“The purpose of ordering security for costs against a plaintiff ordinarily resident outside the jurisdiction is to ensure that a successful defendant will have a fund available within the jurisdiction of this court against which it can enforce the judgment for costs.”
The wording of the rule—“if, having regard to all the circumstances of the case, the Court thinks it just to do so”—plainly reveals the wide discretion to be exercised in the making of an order.
23 The wording does not admit any judicial policy that would mandate the making of an order simply because the plaintiff is a foreign plaintiff; the requirement that the plaintiff is ordinarily resident outside the jurisdiction is simply a pre-condition to the making of an order under the particular O.23, r.1(1)(a). It is a precondition just like those stipulated in (b)–(d), the other sub-rules, which are aimed at plaintiffs who may not
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ordinarily reside out of the jurisdiction. I must therefore proceed by explaining that I do not accept Mr. Farrow’s submissions to the effect that the court would ordinarily require a foreign plaintiff to give security for costs because it will ordinarily be just to do so, following
Porzelack KG v.
Porzelack (UK) Ltd. (9) and
Aeronave SpA. v.
Westland Charters Ltd. (1).
24 In the latter case, the following passage from the judgment of the court delivered by Lord Denning puts the case law in context and makes it plain that such an approach would be misconceived ([1971] 1 W.L.R. at 1449):
“I agree with the note in the Supreme Court Practice (1971) that the [English equivalent] rule does give a discretion to the court. In 1894 in Crozat v. Brogden [1894] 2 Q.B. 30, Lopes, L.J. said, at p. 35, that there was an inflexible rule that if a foreigner sued he should give security for costs. But that is putting it too high. It is the usual practice of the courts to make a foreign plaintiff give security for costs. But it does so as a matter of discretion, because it is just to do so. After all, if the defendant succeeds and gets an order for his costs, it is not right that he should have to go to a foreign country to enforce the order. It is to be noted that Italy [the domicile of the plaintiff Aeronave] is not within the provisions as to the recognition of foreign judgments. But even if it were, Kohn v. Rinson & Stafford (Brod.) Ltd. shows that is not a ground for refusing security. The ordinary rule still remains, that it is a matter of discretion.”
I would simply add that discretion is to be exercised on a case-by-case basis, as the rule states, having regard to all the circumstances of the case.
25 One circumstance, and perhaps the most compelling here, is that the petitioner has immensely valuable assets to be regarded as being within the jurisdiction in the form of its shares in the company. This is so even on the respondent’s case and even if the petitioner ultimately proves unsuccessful with its petition to wind-up the company. Indeed, in that event and if the petitioner fails to pay an order for costs, it will be open to the respondent to seek recourse, if necessary through these courts, against the petitioner’s assets in the company. There is a principle in the case law, from In re Apollinaris Co.’s Trade Mark (3), that security will not be required of a foreign plaintiff who has substantial assets within the jurisdiction.
26 I do not accept the objection that the respondent should not be put in the position of having to realize investments in the company which only notionally belong to the petitioner in order to satisfy an order for costs in its favour. The costs of successfully defending the petition would certainly be borne by the company in the first instance. It would therefore eventually become an accounting exercise to redeem those costs fully, if remaining unpaid by the petitioner in the meantime, from any distributions to be ultimately made to the petitioner. Viewed in that way, this is
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not a case where there is a real risk that a successful defendant will not be able to enforce its judgment for costs.
27 Another circumstance, of some weight, is the fact that the petitioner is a state agency of a foreign government of undoubted resources and enjoying a high reputation in the global financial and commercial community. This is relevant insofar as it would tend to negate any concern that the plaintiff would be unlikely to obey an order for costs made in favour of the respondent. To my mind, it also addresses the concern raised by Mr. Farrow, that efforts to enforce an order in Kuwait, if it ever came to that, could be met with a plea of state immunity.
The s.156 validation summons
28 Section 156 of the Companies Law (2004 Revision) provides:
“Where any company is being wound up by the Court or subject to the supervision of the Court all dispositions of the property, effects and things in action of the company, and every transfer of shares, or alteration in the status of the members of the company made between the commencement of the winding up and the order for winding up shall, unless the Court otherwise orders, be void.”
29 In In re Burton & Deakin Ltd. (5), Slade, J. formulated statements of principle to guide the court in deciding whether dispositions made pending the winding up of a solvent company under the analogous English statutory provisions, should be validated. His
dictum was cited and agreed in
In re JN2 Ltd. (8) and mentioned with approval by the English Court of Appeal in
Alipour v.
Ary (3). Moreover, it was adopted by this court as accurately stating the law in the Cayman Islands in
In re Fortuna Dev. Corp. (7). I agree with and adopt the summary of the principle (
2004–05 CILR 533, at para. 5):
“. . . Thus there are four elements which must be established before an applicant is entitled to a validation order. First, the proposed disposition must appear to be within the powers of the directors … Secondly, the evidence must show that the directors believe the disposition is necessary or expedient in the interests of the company … Thirdly, it must appear that in reaching the decision the directors have acted in good faith. The burden of establishing bad faith is on the party opposing the application. Fourthly, the reasons for the disposition must be shown to be ones which an intelligent and honest director could reasonably hold.”
There is another consideration to add to this list, in light of the concerns raised in this matter, although arguably it is subsumed within the third and fourth elements. This would be whether irregularities in the conduct of the affairs of the company can be shown, even if the company is
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clearly solvent, as is alleged here.
30 In Re a Company (No. 007130 of 1998) (6), such concerns motivated the Secretary of State to petition to wind up. Partly, the concerns were for the lack of honesty in the conduct of the affairs of the company and above all, for concern for the interests of the members who had been persuaded to part with their money on the basis of a false prospectus, not unlike the allegations here. It was held, among other things, that it by no means followed that because the company was solvent and able to pay its debts as they fell due, the conduct of the company’s business should be at the expense of the members. The application for the validation of payments to be made was dismissed.
31 The payments in respect of which validation is sought here may be regarded as coming within two categories: first, third party professional or other fees (e.g. audit fees or administration fees) or miscellaneous fees and, secondly, management fees. The petitioner raises no objections to the validation of the first category, subject to there being properly documented records of the transactions.
32 The objection raised is in respect of the management fees— chargeable, as explained above, at a high rate of 2% and low rate of 0.5% per annum. At the time of the arguments before me, in September of this year, Mr. Al-Rezaihan’s second affidavit stated these at US$100,000 due and owing or likely to be made in the ensuing six months from the company. These are the fees for which validation is now sought, said to be paid in the ordinary course of business on behalf of the company. Given the nature of the allegations, the history of this matter and the evidence which I have seen, I need only state that I do not consider the making of such an order to be appropriate at this time.
33 I do not consider that the directors could properly hold that these dispositions are necessary or expedient in the interests of the company at this time. It is said that the fund is likely to be wound up and its capital somehow redistributed to contributories in 2006, in any event.
34 If the petition is to be heard and dismissed before that happens, these payments may then, ex post facto if needs be, be validated by the court. Or else, if the petition is granted, it will become a matter for the liquidation whether these fees or such fees already paid are to be paid or have been properly paid and the appropriate steps accordingly taken. For those reasons I refuse to make the validation order.
Application dismissed.
Attorneys: Maples & Calder for the petitioner; Quin & Hampson for the second respondent.