By Nicholas Butcher, Maples and Calder – Cayman Islands exempted limited partnerships (“ELPs”) are currently riding the crest of a wave. Consistently a popular form of investment vehicle for hedge and especially private equity funds, 2013 saw a record 2,368 ELPs formed and registered in the Cayman Islands, and with the tally of new registrations in the calendar year to November 2014 already standing at 2,580, that record is set to be eclipsed this year.
In degree this popularity is explained by strong demand for Cayman Islands vehicles for use in offshore transactions as a result of a combination of Cayman’s robust regulatory laws, neutral tax status and well established and understood commercial jurisprudence rooted in English common law principles, but that is only part of the real story. Cayman partnerships are popular because of their unique potential to combine freedom of contract with a statutory framework which provides key investor protections, most notably limited liability.
First, a few basics: a Cayman ELP is a creature of contract and agency principles, it does not have separate legal personality and must act through a general partner (“GP”). With an ELP, limited partners (“LPs”) have limited liability provided they do not become involved with the conduct or management of the business of the partnership.
A Cayman partnership, like a company, can have perpetual duration, but unlike a company a partnership is not bound by corporate maintenance of capital rules which operate to restrict the circumstances in which capital can be returned to investors. Subject only to solvency, the limited partnership agreement (“LPA”) governs how much, when and how capital can be distributed. It is this contractual flexibility which allows the complicated waterfall distributions common to modern private equity deals to be easily accommodated within a Cayman ELP structure.
Provided LPs do not intermeddle in the business or management of the ELP, they will have limited liability, meaning in general terms the risk for the LP is limited to the amount it has agreed to invest.
Even so, the Exempted Limited Partnership Law, 2014 (the “ELP Law”) sets out “safe harbours” which provides that the carrying on of certain activities, such as consulting with the GP, will be deemed not to amount to carrying on the business of the ELP and limited liability is therefore preserved. Better yet, the ELP Law provides that even if an LP acts outside one of the extensive list of safe harbours and, to that extent, takes part in the conduct of the business its limited liability will only be lost if a third party reasonably believes that LP in fact to be the GP.
In practical terms this means that it is highly unlikely limited liability would be lost provided an LP does not deal with third parties on behalf of the ELP or its GP. Further, the LP can ask for such protections internal to the ELP it believes are necessary to safeguard its investment and those can be reflected in the LPA. This feature allows for the use of investor populated panels or committees, often called limited partner advisory committees, to balance the management powers of the GP.
Investor protection is also provided through the GP’s statutory standard of behaviour. The GP is required at all times to act in good faith and, subject only to the express provisions of the LPA, in the interests of the ELP (for which read the LPs). This anchors the GP, and the conduct of the management and the business of the ELP, to a fiduciary foundation whilst allowing the partners to settle through the terms of the LPA exactly how that duty should be acquitted. This, for example, permits the issue of side letters (good for the management of the ELP) with confidence with respect to their enforceability (good for the investor receiving the side letter).
Since the introduction of the ELP Law this year, for the first time the statute now confirms that, again subject to the express terms of the LPA, neither LPs nor the members of LP committees owe fiduciary duties.
The statutory clawback provisions under the ELP Law also offer certainty and security to LPs. These govern the circumstances in which an LP may be required to return capital to the ELP in the case of its insolvency.
Since the revisions to the ELP Law this year, an LP will only be subject to clawback if a payment of capital was made at the time the ELP was insolvent and the LP had actual knowledge of that insolvency. The jeopardy period runs for six months from the date of the original payment. This is another example of robust investor protection under Cayman’s ELP regime.
The new ELP Law has embraced principles of freedom of contract. For example, the mechanics for the admission of new partners and the transfer of partnership interests have been simplified in that, provided the admission or transfer takes place in accordance with the terms of the LPA, it will be valid without the need for further formalities.
Similarly, sanction provisions, for example for failure to honour capital call commitments, will be enforceable in accordance with their terms regardless of common law principles with respect to striking down penalty provisions.
Another example of freedom of contract, also introduced this year into Cayman Islands law through the Contracts (Rights of Third Parties) Law, is the ability in the LPA to provide for enforceable third party rights even if that third party is not a party to the LPA. All these illustrate the ability of the partners to write their own commercial deal with minimal prescriptions from the general law.
An ELP is also a very flexible structure in its own right: it can be transferred into or out of the jurisdiction; overseas companies and partnerships can act as the GP; it can be tax transparent and serve as a flow-through entity; or a check-the-box election (form 8832) can be made to treat the partnership as a corporation for tax purposes in the United States.
In addition to LP committees, corporate governance structures, including independent directors and split boards can be incorporated at the level of the GP (if a corporate GP is used).
Cayman ELPs provide the flexibility to combine the parties’ required deal terms with robust limited liability and other statutory investor protections and at the same time with minimal additional overlay mandated by Cayman Islands law. This creates the ability easily and efficiently to translate contractual documentation used in onshore partnership arrangements for use with Cayman Islands partnership structures, which in turns gives the sponsor the best of both worlds in planning international transactions. Against this background, we can expect further records for the use of Cayman ELPs to be broken in years to come.
Nicholas Butcher is a partner at Maples and Calder and head of the firm’s Cayman Islands Investment Funds group. He advises on all aspects of investment funds, specialising in both hedge fund and private equity transactions. Nicholas has extensive experience of corporate, partnership and trust structures (including Japan focused retail funds) and also advises with respect to securities investment business law as well as listings on the Cayman Islands and other worldwide exchanges.
December 2014
© MAPLES AND CALDER
This article is intended to provide only general information for clients and professional contacts of Maples and Calder. It does not purport to be comprehensive or to render legal advice.
