Multilaw Collateral Snapshot (Cayman Islands)

This Collateral Snapshot gives a high level overview of Cayman Islands law security taking, perfection, collateral types, and enforcement in financing transactions. The Collateral Snapshot intends to provide a general overview only and does not constitute a substitute for a case-by-case assessment.

This article first featured on the Multilaw website.

What types of collateral are common in the Cayman Islands?

Capital Call Security

• Assignment of Call Rights: An assignment by way of security (Assignment) of the rights and obligations of the general partner (GP) and the limited partners (LPs) contained in the limited partnership agreement (LPA) of a Cayman Islands exempted limited partnership (ELP). These rights include the ELP’s rights to make capital calls in respect of the unfunded capital commitments of the LPs and to receive the resulting proceeds from such capital calls, which are held on trust as an asset of the ELP by the GP in accordance with the terms of the LPA.
• Charge over the bank account: In connection with the above, it is common for a charge to be taken over the bank account into which the proceeds of capital calls are deposited (the Charged Account).
• The above collateral package would typically support a subscription credit facility, a popular financing product utilised by private equity investment funds.

Security over limited partnership interests

• An LP of an ELP may grant security over the whole or any part of its LP interests (the Secured LP Interest) with the written consent of the general partner under the Exempted Limited Partnership Act (as amended) of the Cayman Islands (the ELP Act), unless the LPA expressly provides otherwise (which may dispense with or modify the requirement for such consent).

Share Security

• Share Security: an equitable mortgage (Equitable Mortgage) is taken over the shares in a Cayman Islands exempted company (the Company). The mortgagor will remain the legal owner of the secured shares (the Secured Shares) pending enforcement of the Equitable Mortgage, to ensure that the mortgagee is not inadvertently treated as the parent of the Company under the Companies Act (as amended) and/or to avoid potentially consolidating the Company onto the mortgagee’s balance sheet.

Which Cayman Islands law particularities are to be considered in financing transactions?

Capital Call Security

• Fund document diligence should confirm the ELP and GP are authorised to incur the facility and grant security over the investor’s uncalled commitments, that the LPs waive rights of set-off and defences, and that the LPA/any side letters do not restrict borrowing terms or security over uncalled commitments. Where alternative investment vehicles or parallel funds are used, lenders will also expect confirmation these additional structures are permitted and, where relevant, included within the security package.
• In the event the LPA contains an ‘investment period’, it is important to confirm that capital calls may still be made after the end of the investment period (if that is earlier than the term of the facility) to repay borrowings, as this is fundamental to ensuring that the security remains capable of effective enforcement.

Security over LP Interests

• The LPA/side letters should be reviewed to confirm that the LP may grant and enforce security over the Secured LP Interest, the form of GP consent required, and whether any other conditions or restrictions apply. It is common for private fund LPAs to restrict the identity of a transferee to qualified investors, so the secured lender should be aware of these restrictions.
• The ELP’s statutory registers (or extracts) should be reviewed to confirm that the LP is the registered legal holder of the Secured LP Interest, to verify its capital commitments and contributions, and to check the register of security interests (the Register of Security Interests) for any existing security over that Secured LP Interest.

Share Security

• The Company’s memorandum and articles of association (the Articles) should be reviewed to determine whether the directors have discretion over the registration of transfers, whether there are any provisions prohibiting the creation of security, whether there are any provisions that may hinder or impair enforcement of the security, and whether the Company has a lien over the Secured Shares for any amounts due from a member that could take priority over any subsequent security interests.
• The Company’s register of members should also be inspected to confirm that the mortgagor is the registered holder of the Secured Shares, that there is no evidence of any existing security over the Secured Shares and that the Secured Shares are fully paid.
• Stamp duty is payable in the Cayman Islands on the creation or enforcement of security over the Secured Shares if the Equitable Mortgage or any ancillary document is executed in, or brought into, the Cayman Islands. In practice, this does not usually present an issue as most cross border financing transactions close virtually using PDF executed copies.
• Regulatory approvals are required to create or enforce security over the Secured Shares if the Company is a regulated entity in the Cayman Islands.

How is collateral typically established under Cayman Islands law?

Capital Call Security

• In order to establish a first ranking priority of the lender’s security interest over capital call rights under the LPA, it is necessary to notify the LPs that those rights have been assigned as part of the security package pursuant to the terms of the Assignment.
• The timing for the dispatch of such notices is variable, with lenders typically requiring dispatch on closing or within three to five business days after closing, together with evidence of receipt, and GPs often preferring later delivery, such as in a quarterly report. Ultimately, this will be determined by the negotiations between the parties.
• Although the sending of notices is commonly described as a perfection requirement, under Cayman Islands law a valid security interest is created on signing even if no notices are sent, but the order in time that notice is given determines priority as against competing interests in the secured assets.
• If the GP or the ultimate GP is an exempted company, it is necessary for the security interest created under the relevant security document to be recorded in its internal register of mortgages and charges. There is no strict deadline for making such an entry, but it should be done as soon as practicable post-closing. Failure to do so does not technically invalidate the security or its perfection, but would constitute a breach of statutory obligations under the Companies Act.

Security over LP Interests

• Under the ELP Act, notice of security over the Secured LP Interest (Notice of Security) must be given by the LP or lender to the ELP at its registered office. The notice should identify the security document, the LP and lender, and the Secured LP Interest. In practice, where notice is given by the LP, the lender would typically require a copy of the notice and an acknowledgement from the general partner.
• Any security interest over LP interest shall have priority according to the time that the Notice of Security is validly served at the registered office of the ELP.
• The lender should ensure that the Register of Security Interests is updated with the particulars of the security over the Secured LP Interest to ensure that third parties viewing the register are put on notice of such security. This is also a statutory obligation of the GP under the ELP Act.
• If the LP is itself an exempted company, it is necessary for the security interest created in respect of the Secured LP Interest to be recorded in its internal register of mortgages and charges.

Share Security

• If the mortgagor of the Secured Shares is a Cayman Islands exempted company or a Cayman Islands limited liability company, it is necessary for the security interest created under the Equitable Mortgage to be recorded in its internal register of mortgages and charges which must be maintained at its registered office in the Cayman Islands.
• If any changes are required to be made to the Articles to facilitate the creation or enforcement of the share security, the Company must pass a special resolution to approve the changes to the Articles and forward a copy of the special resolution within fifteen days to the Registrar of Companies in the Cayman Islands. Preferably, this should be done before the security document is signed. The changes to the Articles will be effective from the time the resolutions are passed.
• The Company should be required to include in its register of members a statement that security has been created over the Secured Shares pursuant to the Equitable Mortgage. Although noting the security created over the Secured Shares in the Company’s register of members is not a strict perfection requirement, it has the practical effect of putting third parties who view the register on notice of the existence of the security, and therefore can help establish the secured lender’s first ranking priority position.

How is collateral typically enforced under Cayman Islands law?

Capital Call Security

• If a default occurs, the lender is entitled to notify the LPs directly that a default has occurred and that payment of capital commitments must be paid directly into the Charged Account, or to such account as the lender directs.
• The right to issue calls are assigned by way of security so the lender may exercise the GP’s rights to issue capital calls or allow the GP to remain in situ but required to follow the lender’s instructions pursuant to the security enforcement provisions. The proceeds of the capital calls are then deposited into the Charged Account, where they can be used to pay down the outstanding obligations under the loan facility.
• If LPs refuse to pay capital contributions when called, the lender can exercise any defaulting investor remedies under the fund documents, acting in the name of the GP (and the lender will typically hold an irrevocable power of attorney to support such rights).

Security over LP Interests

• If a default occurs under a Cayman Islands law security document, the lender may, subject to the terms of the security document and the LPA, sell the Secured LP Interest or appoint a receiver in respect of it.
• A receiver may, subject to the terms of the security document and the LPA, receive distributions in respect of the Secured LP Interest and exercise any other rights and powers of the LP in respect of it.
• The lender may exercise the power of sale and appoint a receiver without obtaining a court order.

Share Security

• In practice, a mortgagee would typically appoint a receiver to take possession of, and potentially sell, the Secured Shares.
• Where a restrictions notice has been issued under the Beneficial Ownership Transparency Act (as amended) (the BOT Act) in respect of the Secured Shares, it will not take effect if the shares are subject to a pre-existing security interest granted to an unaffiliated third party.
• If the Company is in insolvent liquidation at the time of enforcement, the Secured Shares may only be transferred with the prior approval of the Grand Court.