Global Mutual Fund PCC Limited (In Administration) et al and Guernsey Financial Services Commission

An interesting Judgment concerning PCC cells, which appears to be a first of its kind in Guernsey, has recently been handed down by the local courts. The case arose from orders made by the Guernsey Court putting certain entities into administration management and/or liquidation based on regulatory concerns.

The background was that an international accounting firm were appointed as administration managers, not under the companies legislation but under a special statutory regime which only the Guernsey FSC could apply for and the purpose of which was the protection of investors. What interests me for purposes of this article is the dispute as to the allocation of costs.

The Judge in previously granting the order for the appointment of administration managers had made the following order as to the allocation of fees and expenses: 

“That the fees and expenses of the joint Administration Managers be payable from the assets of the Funds and the underlying cells in such proportions as there are assets available to meet such fees and expenses and as the joint Administration Managers deem appropriate.”

The Judge pointed out that the administration managers needed to be confident that their expenses would be paid and that at the time he took the view that he had the power to make an order in those terms and that nobody had subsequently challenged his power to do so. He also considered that in the exercise of his discretion it was an appropriate order to make as there was no better practical or pragmatic order that he could have made in those circumstances. Here lies the conundrum.

In the present application, the administration managers were applying for directions from the Court as to how to give effect to the cost allocation order above.

Briefly:

The approach proposed by the administration managers was first of all to allocate specific costs to the specific cells in respect of which those costs had been incurred where fund-specific costs could be identified. The administration managers had incurred further substantial costs that were general or common in nature and could not be allocated to a specific fund or cell. In relation to those expenses, the proposal was to allocate the further costs equally to all the funds concerned.

The administration managers had also looked at future costs, much of which had been paid. These represented their estimate of the costs required to liquidate or exit each fund, some central core costs, future legal fees and some specific service provider fees. The proposal was to allocate them on a similar basis: fund specific costs to the relevant fund; costs of a central nature across all funds; and a provision for recovery from the funds that could afford to pay a share of costs which the funds with a shortfall could not afford to pay.

Several objections were raised to the method of allocation of costs, all of which were considered but dismissed by the Court.

One objection was made on behalf of investors generally and related to the segregation of assets and liabilities within a protected cell structure, namely, to the proposed allocation to the funds with sufficient assets of a share of the shortfall of costs relating to funds that did not have sufficient assets.

The argument was put by counsel that the proposed allocation would defeat the object of PCC legislation. His submission was that the purpose of the PCC legislation was to protect the integrity of individual cells and their assets so that any one cell does not have to pay liabilities incurred by any other cell. Counsel referred to the potential reputational damage to Guernsey and its funds industry; he submitted that the proposal put forward could undermine confidence in its PCC legislation.

In its Judgment the Court noted that these concerns were not shared by the GFSC, with the counter-submission made that the purpose of the statute appointing the administrator was to give the Court the power to override legislation in exceptional circumstances such as the circumstances that had been identified in this case. This being such an exceptional case, the Judge stated that the costs order he made was the only practical pragmatic order that could have been made at the time and the only basis upon which the administrative managers or indeed any other person would have accepted the role that they were being asked to undertake.

Per the Judge: “There are well recognised instances of pooling of costs in the liquidation of group companies or related companies and although those instances are not directly relevant because we are not dealing with a liquidation or administration under the Companies Law, nevertheless they can be considered analogous. As I previously said I had the power to make the order that I made on 24th April 2015; that order has not been challenged; nobody has sought to set it aside; the order stands; and in my view what is being proposed by [the administration managers] is a practical way of giving effect to my order. I note in passing that as a matter of fact, the amount of fund specific costs having to be re-allocated to other funds is negligible in relation to the total costs incurred.”

The Judge further noted that if the order were not made as proposed one suggestion was that the administration managers could bear the costs themselves “but in my opinion that would be unreasonable when they have taken on the responsibilities on the understanding that their costs would be paid. I see no reason why [they] should have to bear the costs”. The alternative suggestion was that the GFSC should pay but as the Judged stated “this case is not an occasion for me to review the GFSC’s policies or the policies laid down by the States of Guernsey under which they operate as laid down both in legislation and in the State.”

This was undoubtedly a complex issue for the Court and it is not difficult to have sympathy for the situation the administration managers found themselves in. Admittedly, PCC regimes tend not to specifically address the issue of IP costs but in this case the Court applied non-PCC legislation to effectively override the PCC regime.

The Judge, however, was at pains to explain in his Judgment that his original order had not been previously challenged and that the proposed allocation was the only practical way of dealing with the matter.

COMMENT

Perhaps had the Court, at the earlier application stage, had the benefit of the argument raising the objection as to any allocation shortfall, as it had at the directions hearing, it may have reached a different decision, allowing the Guernsey legislature an opportunity to make such amendment to the PCC Act as was necessary before it considered the application again.

In my book “Protected Cell Companies: A Guide to Their Implementation and Use” (2010, 2nd edition, Spiramus Press), co-authored with Grant Jones, on the issue of IP costs we pointed out “A PCC’s raison d’être is cellular integrity and cellular integrity should even extend to IPs.” (p. 284).

Indeed, promoters, investors and contractual parties alike transact with a PCC on the basis that a cell is only liable to pay for liabilities incurred on its behalf. To do otherwise is to undermine the statutory ring-fencing which lies at the heart of the PCC regime. Worse still, this could send a contradictory message to foreign Courts who in any potential foreign proceedings would be asked to respect the ring-fence by applying PCC legislation, especially on insolvency, whilst ignoring their own domestic laws. If PCC legislation is to be treated as substantive law (as opposed to rules of procedure), the Courts in the PCC jurisdiction of incorporation have to apply the cellular firewall in accordance with the terms of the PCC legislation. If they do not (as appears to have been the case here), there is a danger that a foreign Court will also do the same and not abide by the cellular priority rules. In my view, it could therefore have a negative consequence if a foreign Court when reviewing the Guernsey PCC regime came to the conclusion that Guernsey judicial authorities introduce uncertainty as regards the statutory segregation of assets and liabilities between cells and/or blurred the distinction between substance and procedure. There is no reason, however, why the matter cannot be clarified by the introduction of an express provision in the Guernsey PCC Act itself in respect of the allocation of IP/administration managers costs.

Clearly, in a PCC to the extent that any costs are incurred for the benefit of all cells they should be allocated across the cells on a pro-rated basis. On the other hand, absent express provision in the PCC Act itself to the contrary, in my view any shortfall of assets in a cell to pay for costs attributable to that cell should not be met with the assets of other cells (including in respect of IP costs). The PCC regime, of course, may also expressly provide that where liabilities cannot be attributed to cellular assets or where cellular assets are insufficient, they shall be satisfied from the hub/core (non-cellular assets). But this assumes that the PCC has non-cellular assets to pay for such claims (at least in part). Therefore if there is no public funding available within the jurisdiction for cases of public interest, it must be incumbent upon regulators that authorise the establishment of a PCC with different economic interests/shareholders to ensure that the company’s hub/core is properly capitalised to meet not just the operational costs, but more importantly, the expense of unforeseen legal proceedings by or against the PCC (and not just a cell). This should be part of the capital commitment by the promoter when the PCC is set up.

Nigel Feetham is a senior partner at Gibraltar law firm Hassans and the co-author of “Protected Cell Companies: a Guide to their Implementation and Use” which was cited by the judge in PAC RE 5-AT v. AMTRUST NORTH AMERICA, INC., No. CV-14-131-BLG-CSO (D. Mont. May 13, 2015). He is also a Visiting Professor of law at Nottingham Trent University.