Segregated portfolio companies, or SPCs, were introduced to the Companies Law of the Cayman Islands in 1998.
Demand for this type of structure by hedge fund investment managers has been growing significantly in the past few years. The complexities involved, however, are not always clearly understood.
An SPC is an exempted company that seeks to segregate separate pools of assets and liabilities to specified shareholders or creditors. Such segregation protects investors and creditors from assuming losses incurred by a separate share class or investor group. An investor may otherwise be exposed to the liabilities of other classes when, for example, a fund enters into side arrangements on behalf of another investor, or when individual cells have different levels of risk.
An SPC is designed so that a creditor or investor will only have recourse to the assets attributable to the specific segregated portfolio, or ” cell ” with which it is a creditor or investor. To the extent that such assets are insufficient to satisfy the obligation, and unless prohibited by its Articles, the creditor or investor may seek settlement from the balance of the SPC’s general assets less any minimum capital amount lawfully required. The creditor or investor may not look to the assets of any other segregated portfolio to satisfy its obligation, as is the case in a multi-class fund, or an umbrella trust.
A second attraction to the SPC structure is that it may, through board resolution, redesignate its share capital to authorize the creation of distinct cells. This allows for timely creation of a product tailored for the investment strategy needs of existing and prospective investors. The SPC structure therefore becomes an excellent selling tool for investment managers to create customized products with minimal cost and in a timely manner. An SPC may have unlimited segregated portfolios, however must furnish to the Registrar of Companies an annual notice containing the names of each segregated portfolio it has created.
There are interesting complexities inherent to this unique structure and care must be taken in the launch and ongoing operation of an SPC. Because an SPC is a single legal entity, as specified under the Law, in order for a cell to achieve the advantage of maintaining its separate legal status in liquidation, it is crucial that the assets and liabilities are legally segregated between cells. This may be achieved through the SPC entering into contracts for and on behalf of a specific identified cell and not in the name of the SPC. This includes establishing separate bank, custody and brokerage accounts, derivative contracts, loan agreements, service provider agreements, etc. If not separately identifiable, the assets and liabilities may be considered general assets of the SPC and may not be available to settle obligations of creditors of the intended cell when called upon to do so.
A creditor, shareholder or third-party entering into a contract with a specific cell should ensure that the contract specifies the name of the intended cell of the SPC. If in breach of this requirement, the structure may fail to provide the protection it was created to provide. Directors should in turn scrutinize all executed arrangements to ensure they are in compliance as the Law explicitly holds a director responsible for proper application of the structure. It is also the directors’ responsibility to ensure that any transfer of assets or liabilities between segregated portfolios be at full value.
Other elements to consider are the preparation of either separate audited financial statements for each cell, or one set of financial statements for the SPC disclosing the results of each cell in columnar format, without a consolidated column. The latter option essentially provides stand-alone financial statements for each segregated portfolio presented in one document. Thought should also be given to the implications of having separate service providers (auditors, administrators, investment advisors) for the individual cells of one regulated SPC. Caution must be taken to ensure that one segregated portfolio does not invest in a second segregated portfolio, as this is prohibited under the Law. Involvement of industry professionals in the structuring of these entities would help to ensure that the product meets the needs of its intended users.
Finally, the ultimate success of the structure has not been tested in court to date. Accordingly, some question both the strength of the product’s features in the event of litigation, and the validity of isolating litigation to one cell without tainting the SPC as a whole.
Odette is a Canadian Chartered Accountant specializing in the area of investment companies and special purpose entities. Odette is a Senior Manager in the Assurance & Advisory Services practice in the Cayman Islands firm.
Odette has over nine years public accounting experience, including three years with the Saint John office of our Canadian firm and six years in the Cayman Islands office.