Offshore Hedge Fund Disputes: We're Not in New York Anymore Jonathan Sablone, Nixon Peabody LLP "Hedge Funds are sophisticated investment vehicles often strict adherence to the fund documents reminiscent of hedgehogs or sea urchins which tend regardless of the sale tactics utilized by the fund, to prick badly if not carefully handled . ." ― Judge and the difficulty encountered by onshore Joseph-Olivetti, Matter Between SV Special authorities looking to investigate, prosecute or seize Situations Fund Limited and Headstart Class F the assets of such funds. In many ways, offshore Holdings Limited, In the High Court of Justice, venues provide idyllic upsides to both fund British Virgin Islands (2008). managers and investors alike. These benefits may be outweighed by the downside of litigating a Introduction dispute offshore, however. Fund managers and investors often discount the offshore legal structure There is perhaps no better summation of the until a problem arises. It is only then that they may offshore legal philosophy, borrowed from English come to realize that offshore legal vehicles are not law, than the above statement by Judge Joseph- for everyone, and may provide insurmountable Olivetti in the SV case. Put simply, offshore problems when a loss of capital liquidity or a jurisdictions, following the lead of courts in the freezing of redemptions occurs. United Kingdom, are much more likely to apply a "buyer beware" standard to hedge fund investors Offshore Venues seeking redress in offshore courts. Both fund managers and institutional investors should Although there are many offshore jurisdictions understand the key differences in offshore law which have become havens for hedge funds and before forming, or investing in, an offshore fund. asset management, the two most important (especially with respect to the US financial markets) Over the past decade, there has been an explosion are the Cayman Islands (Cayman), specifically Grand of offshore hedge funds catering primarily to Cayman, and the British Virgin Islands (BVI), investors in the United States (US) and the United specifically Tortola. Cayman has long been the Kingdom (UK), but also the Middle East and Far favored offshore haven for US hedge funds. It is a East. Investors are attracted to such funds because large commercial and banking center (ranked fifth of the promise of tax avoidance, limited regulatory largest in the world). It is easily accessible from the regimes, and the privacy protections that such US mainland, highly developed, and home to many jurisdictions can offer. Fund managers, on the other top-notch banking, accounting, consulting and legal hand, are enamored of the limited liability offered firms principally staffed with US and UK ex-patriots. in such jurisdictions for single purpose funds, the BVI, while less a center of US financial transactions, ________________ © 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 4, No. 41 edition of the Bloomberg Law Reports—Securities Law. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P. The discussions set forth in this report are for informational purposes only. They do not take into account the qualifications, exceptions and other considerations that may be relevant to particular situations. These discussions should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Any tax information contained in this report is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. The opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities do not take responsibility for the content contained in this report and do not make any representation or warranty as to its completeness or accuracy. has attracted investors from around the world, and US litigants that offshore legal counsel (as well as has been a growing center for US funds. The Queen’s Counsel often imported from London in investment vehicle of choice in BVI has long been high stakes cases) cannot and will not frame claims the limited liability company (LLC) as opposed to in a manner that is consistent with US legal the limited partnership structure that is more principles. favored in Cayman. While less accessible and less developed than Grand Cayman, BVI is home to Even if a litigant can get past the pleading stage, approximately one million registered companies and commence a lawsuit, a roadblock is often (typically LLCs), most of which are financial funds. quickly encountered in the prosecution of the case. Discovery in Cayman and BVI generally follows the As noted above, while many US-based fund "disclosure" standards in the UK. Disclosure, as a managers and investors choose Cayman or BVI for concept, is much more narrowly defined than their perceived benefits over an onshore domicile, it discovery in the US. Parties are only allowed is only when problems arise that they realize they disclosure on specifically pled items in the need to contend with the offshore legal systems in complaint (on which they already have some both locales. The differences between those legal evidence or they could not have made the systems and that of US jurisdictions can be stark, allegations in the first place). Even then, the scope and vary greatly in both procedural and substantive of disclosure is extremely narrow and limited solely law. to information that is directly relevant to such claims (as opposed to the liberal "likely to lead to Procedural Challenges the discovery of admissible evidence" standard in the US). For US litigants who are used to Both the Eastern Caribbean Supreme Court, High voluminous discovery requests and production of Court of Justice, Commercial Division (Tortola, BVI) millions of pages of documents often encompassing and the Grand Court of the Cayman Islands (Grand terabytes of electronically stored information, it is a Cayman, the Cayman Islands) operate procedurally shock to discover that most "disclosure," even in like UK courts (which can be a shock to anyone very large, high stakes cases, can fit in a few familiar with US style litigation). Judges in both bankers boxes. US litigants are often even more jurisdictions are imported from the UK, or, at the shocked that the use and dissemination of such very least, are UK educated and trained. The disclosure is strictly regulated by the courts. For pleading, evidentiary, and discovery standards of example, court documents and disclosure are the courts are extremely narrow compared to the typically not available to the public or third parties US. Pleading in these systems is based upon (including other investors in a fund that is in personal knowledge and must have a factual basis litigation) without court order, and most offshore that can be supported. If evidence of a fact is not in judges are loath to require the court or the litigants the possession of the pleading party, it may not be to share any information with any third party. In pled, unlike the looser "information and belief" short, the offshore litigant who hopes to prove his standard applicable to most US jurisdictions. From a or her case through the document production of pleading standpoint, litigants often find that they the opposing party will, in almost all cases, fail. are in a "chicken and egg" scenario. They may firmly believe there has been some malfeasance by the Perhaps the biggest impediment to engaging in other side, but they cannot demonstrate it until offshore litigation, however, is the UK concept of they file suit and receive some information through shifting of legal fees. The UK follows a "losing party discovery. The lack of evidence of the claims, pays" standard with respect to legal fees and costs. however, precludes the bringing of the suit in the The same standard applies in Cayman and BVI, and first place. It is a continual source of frustration for often takes on a life of its own with respect to the way litigation is conducted. For example, it is not © 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 4, No. 41 edition of the Bloomberg Law Reports—Securities Law. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P. uncommon that every motion, and every move by might find an offshore court distinctly uninterested an opposing litigant, is met with a cost-shifting in his or her plight. Rather, an offshore court is petition as parties tally the ongoing costs associated more likely to credit language in the fund with winning or losing during the life of a case. The agreements that states the fund manager may fee shifting standard also makes for extremely invest in any asset class he or she desires, as well as cautious litigation because the costs associated with language that the fund manager does not owe the bringing a case to fruition and losing can be investor any transparency into the fund’s enormous. A typical large case offshore will often investments (i.e., a black box trading strategy). involve Queen’s Counsel whose rates are in the While such a construction might offend traditional $1,500 per hour range, as well as numerous local notions of justice and equity in the US, it would counsel whose rates exceed those charged in New likely not arouse such passions with an offshore York (typically getting close to or exceeding $1,000 judge. Furthermore, litigants who think they can per hour). Coupled with the need for onshore legal simply bring suit in the US to avoid such legal advice, experts, consultants and financial advisors, constructs are likely to find that the same the cost of litigating offshore can be enormous.