Aquapoint L.P. v Xiaohu Fan CICA (Civil) Appeal no. 0014 of 2022 (Grand Court cause no. FSD 0157 of 2021 (DDJ)), 4 October 2023
Overview
In an interesting recent judgment of the Cayman Islands Court of Appeal (CICA), whilst upholding the order of Justice Doyle winding up the appellant Cayman Islands exempted limited partnership (ELP), Aquapoint L.P. (the Fund) on the just and equitable basis, the CICA appears to have somewhat reluctantly set aside the second ground of the Judge’s decision for winding up – holding that to make out an irretrievable breakdown in trust and confidence in a quasi-partnership under the UK case law relied on by the parties, the Petitioner, a limited partner in the Fund, had to establish that he was a participant in running the business, which it was not possible for him to do as a limited partner specifically prohibited from playing an active role in the business of the Fund as an ELP under the Exempted Limited Partnership Act (the ELP Act). [1]
Notably, the CICA stated that it felt constrained in its decision making on this point by the fact that the parties and the Judge at first instance had proceeded on the basis that UK case-law was the primary source of authority for the scope of the just and equitable jurisdiction in the case of a Cayman Islands ELP, concluding that it would have been interested to have heard argument which took “…full account of the special nature of an ELP and less account of the overseas jurisprudence”[1].
This is the second recent decision by the CICA recognising the special nature of an ELP, which does not necessarily fit the mould in terms of developed principles in other contexts (such as companies, trusts and English limited partnerships)[2] or developed case law in other jurisdictions commonly looked to for guidance in the Cayman Islands, including the UK. This again highlights the importance of taking a nuanced and Cayman-focused approach to ELP disputes.
Background
ELPs
The Fund was formed as a Cayman Islands ELP on 16 February 2017.
In short summary[3], ELPs were first introduced in the Cayman Islands in 1991, partly inspired by, and designed to provide symmetry with, the equivalent Delaware legislation. ELPs are formed with at least one general partner and one limited partner, and like ordinary partnerships, the general rules of equity and common law apply, except where there is inconsistency with the ELP Act.
Unlike ordinary partnerships, however, ELP LPs owe no fiduciary duties either to the ELP itself or to fellow partners. As with company shareholders, limited partners benefit from limited liability capped up to the amount of their contribution. Unlike company shareholders, and to maintain that limited liability, limited partners can have no active involvement in the business of the ELP in their capacity as limited partners. Also, unlike companies, an ELP has no separate legal personality and cannot hold assets or pursue or defend claims in its own right. Instead, assets are held by the general partner(s) on statutory trust for the limited partners, in accordance with the terms of the relevant limited partnership agreement.
An ELP’s business activities are carried out by the general partner on behalf of the ELP. The general partner is liable for all debts and obligations of the ELP, and owes statutory, contractual and fiduciary duties to limited partners, including an express duty of good faith to act in the interests of the ELP.
Facts of the dispute
The Petitioner seeking the winding up of the Fund was Dr Xiaohu Fan (Dr. Fan), a limited partner (LP) in the Fund. The general partner of the Fund (the GP) was GenScript Corporation, which was controlled by its majority shareholder, Dr Fangliang Zhang (Dr Zhang).
Dr. Fan had been significantly involved in critical developments of several ground-breaking cancer therapies while working as part of the GenScript Group. In 2014, GenScript Group formed a subsidiary company in the PRC named “Legend Nanjing” to develop novel biological drugs. In 2016, Legend Nanjing entered into an agreement with Dr. Fan to incentivise his contribution to the business which, among other things, provided Dr. Fan with the right to have 10% of the shares in the company transferred into his ownership six months after its contemplated IPO, regardless of the effect on the overall share value if he decided to sell (the 2016 Agreement).
Shortly thereafter, Dr. Zhang set out to persuade Dr. Fan to relinquish his rights in Legend Nanjing and to become an LP in a Cayman Islands registered fund instead, which would in turn hold shares in a Cayman Islands exempted limited company to be listed on the NASDAQ, referred to as “Legend Cayman”. Dr. Zhang assured Dr. Fan that he would have the exact equivalent of his entitlement under the 2016 Agreement in respect of his shares in Legend Cayman, whereby 10% of the shares in the company would be transferred into his ownership six months after its planned IPO (the Assurances). In 2017, Dr. Fan did agree to relinquish his rights in Legend Nanjing and to become an LP in the Fund holding shares in Legend Cayman, and the parties entered into what was described throughout the proceedings as the “2017 Agreement”. Dr. Fan gave evidence that his understanding was that the 2017 Agreement reflected the 2016 Agreement, but with more technical and legal terms, but, crucially, the terms of the 2017 Agreement did not reflect the Assurances as to his ability to deal with 10% of the shares.
Legend Cayman was listed on the NASDAQ in June 2020 and Dr. Fan sought to have 10% of the shares in Legend Cayman transferred into his ownership six months after the IPO, per the Assurances. Dr. Zhang refused, mentioning instead that Dr. Fan may be able to sell a small percentage of his holdings which, as the CICA noted, “would have meant that it would have taken over 300 years for Dr. Fan’s total shares to be sold”.[4] Dr. Zhang’s stated rationale for the refusal was that Legend Cayman needed to raise funds, and Dr Fan’s sales plans would crash the share price. Ultimately, Dr. Zhang informed Dr. Fan that he had been instructed not to sell the shares, leading Dr. Fan to conclude that he had no reasonable alternative but to file a petition seeking to wind up the Fund on the just and equitable basis, which he duly did in June 2021.
The Judge’s four distinct grounds for winding up the Fund
At first instance, in a judgment dated 10 June 2022 , Justice Doyle ordered the Fund to be wound up on the just and equitable basis, finding that this was justified on four distinct grounds. These were summarised by the CICA as follows[5]:
1. Frustration of Dr Fan’s legitimate expectation that the GP would transfer 10% of the shares in Legend Cayman shares into his name as the beneficial owner thereof.[6]
2. Irretrievable breakdown in the relationship between Dr Fan and Dr Zhang that had begun as one of mutual trust and confidence.[7]
3. The justifiable loss of trust and confidence in the management of the Partnership judged to the requisite objective standards in the circumstances of this case.[8]
4. The GP’s conflict of interest and breach of the fiduciary duty to act in good faith.[9]
The CICA decision
The CICA found that the Judge was right to order the winding up of the Fund. In relation to the four specified grounds for winding up relied upon by the Judge:
1. On the first ground (frustration of Dr. Fan’s legitimate expectation), the CICA found that the GP’s actions were “an egregious act of bad faith”. The relationship between Dr. Fan and Dr. Zhang was held to be sufficiently akin to a partnership of the sort contemplated in the decision of Ebrahimi[10] for the Assurances to be of a character arising between one individual and another that it made it inequitable for the GP to insist on refusing to agree to Dr. Fan’s request. The existence of the Assurances made it unjust and inequitable for the GP to exercise the power conferred on it by the 2017 Agreement by refusing the request. It was also inconsistent with the GP’s free-standing duty to act in good faith, as well as the GP’s statutory duty of good faith provided for under the ELP Act,[11] for the GP to seek to rely on entire agreement clauses as a means of avoiding the Assurances. [12]
2. The CICA disagreed with the Judge’s second ground (irretrievable breakdown in the relationship that had begun as one of mutual trust and confidence) for granting the winding-up order. Due to authorities cited by the parties, the CICA felt constrained to follow Lord Briggs’ statement in Lau v Chu[13]: that: “where the company is a corporate quasi-partnership, an irretrievable breakdown in trust and confidence between participating members may justify a just and equitable winding up” [our emphasis]. The issue here for Dr Fan was that he could never have been involved in running the business of the partnership by reason of the effect of s. 14 (1) & (2)) ELP Act, which state that “A limited partner shall not take part in the conduct of the business of an exempted limited partnership in its capacity as a limited partner […]”. This ground was therefore rejected by the CICA.[14]
3. On the third ground (justifiable loss of trust and confidence in the management of the Fund), the CICA said that the establishment of this just and equitable ground was not dependent on there being a quasi-partnership relationship in accordance with Ebrahimi, and that the GP’s failure to honour the Assurances, which it was obliged to do in good faith, amounted to misconduct in the management and affairs of the Fund. It was a result of this misconduct that Dr. Fan had justifiably lost trust and confidence in the management of the affairs of the Fund to the requisite objective standards. This ground was therefore upheld.[15]
4. On the fourth ground (the GP’s conflict of interest and breach of fiduciary duty to act in good faith), the CICA said that the Judge was entitled to conclude that the GP (acting by Dr Zhang) was in breach of its fiduciary duties to act in good faith and avoid a conflict of interest in frustrating Dr Fan’s legitimate expectation regarding his shares. The CICA noted that the first and the fourth winding up grounds were substantively duplicitous, but went on to find that this was not a reason for rejecting the fourth ground, and therefore it was also upheld on appeal.[16]
In summary, notwithstanding the rejection of the Judge’s second ground, the CICA dismissed the appeal and upheld the winding up order on the just and equitable basis, expressly upholding the first, third and fourth grounds relied upon by the Judge below.
The jurisdiction for winding-up ELPs remains unresolved
At first instance, referring to the decisions of Parker J in Padma Fund LP[17] and Kawaley J in Formation Group (Cayman) Fund I[18], the Judge noted that there is an unresolved issue as to whether the jurisdiction of the Grand Court to hear a petition presented by an LP to wind up an exempted limited partnership on the just and equitable basis is derived from s.35 of the Partnership Act, pursuant to s.3 of the ELP Act, and/or Part V of the Companies Act pursuant to s.36(3) of the ELP Act[19], the question being whether such petition should be presented against the ELP itself, or against the ELP’s general partner. It was however common ground between the parties in this case that the Court had jurisdiction to wind up the Fund on either or both grounds, and so no submissions were made on the matter.
Field JA, giving the judgment of the CICA, noted that “I would have been disposed to this Court deciding the issue if we had received written and oral submissions on the point. However, perhaps unsurprisingly, neither side advanced any submissions before us on the point and in these circumstances it would plainly be inappropriate to decide the question.”[20] The matter therefore remains unresolved, requiring an authoritative CICA judgment to clarify it. The opportunity for this of course relies on a party taking the point, and it may be that, for pragmatic commercial reasons, the opportunity is unlikely to arise.
The correct interpretation of s.36(3) ELP Act, and the reliance on UK case-law as ‘authority’
The CICA concluded its judgment with a “closing observation” that, both at first instance and on appeal, the litigation had been conducted on the basis that English and Welsh and Commonwealth jurisprudence was applicable to petitions to wind up on just and equitable grounds Cayman Islands ELPs.[21] Field JA noted that this approach had been adopted “notwithstanding marked differences between an ELP and a partnership governed by the Partnership Act and a company incorporated under the Companies Act” and that he would have “been very interested to have heard a “further and in the alternative” case that the expression “just and equitable” in section 36 (3) (g) ELP Act was to be construed in an expansive and flexible way, taking full account of the special nature of an ELP and less account of the overseas jurisprudence”.
This more bespoke approach in the context of ELPs is also consistent with the earlier recent CICA decision in Kuwait Ports Authority where it was held that, when considering the statutory test to apply under s.33(3) of the ELP Act, although assistance could be derived from developed principles in other contexts, such considerations are not conclusive of themselves and are “simply a step on the road to determining the statutory test” under the ELP Act. That test is not the same as the equivalent tests in companies, trusts or partnership contexts, but an ELP’s own sui generis, or unique, test provided by the statute itself. [22]
The extent to which English and other decisions, particularly at an appellate level, are treated as persuasive and followed by the Cayman courts, was recently the subject of detailed consideration by Justice Doyle in Re HQP Corporation Ltd (in Official Liquidation) FSD 190 of 2021, Unreported, 7 July 2023.[23] Whilst the judgment considers this important issue in considerable depth and is not the subject of this article, the key takeaway points for present purposes are perhaps that: (a) the ratio of a judgment of the Judicial Committee of the Privy Council on an appeal from the Cayman Islands is binding on all Cayman Islands judges[24]; (b) English decisions, even of the House of Lords (now the Supreme Court), are not binding but they may be persuasive[25]; and (c) a Cayman Islands judge may decline to follow an English decision if, inter alia, there is some provision to the contrary in a statute of the Cayman Islands, there has been some compelling change of circumstance since the delivery of the English decision, the underlying conditions in the respective jurisdictions are not truly comparable, or by reason of statute peculiar to Cayman[26].
To properly appreciate whether a particular authority of a foreign court should be followed in relation to ELPs, questions of statutory differences and the underlying conditions in the respective jurisdictions must therefore be considered.
Given the unique background to the ELP regime and the multitude of differences between ELPs and corporate entities in other commonwealth jurisdictions, it is easy to see why the CICA spoke of “taking full account of the special nature of an ELP” and that there may be arguments that s.36(3)(g) ELP Act should be “construed in an expansive and flexible way” on a more Cayman-specific basis.
Future parties to ELP disputes should ensure to carefully consider the bespoke nature of the Cayman ELP regime and the potential arguments that may be made to seek relief in circumstances where English authority would suggest this should be denied. In Aquapoint, nothing turned on the CICA’s rejection of the second ground[27] given that the winding up order was upheld on the Judge’s three other grounds. This may not be the case in a future matter, with a different factual matrix, where the quasi-partnership breakdown of trust and confidence ground may play a central role as grounding the winding up petition, therefore bringing into sharp focus the need to consider carefully how “expansive and flexible” Cayman law should be.
For further information, please contact:
David Lee, Partner, Appleby
dlee@applebyglobal.com
[1] CICA judgment, [77].
[2] As in the earlier case of CICA (Civil) Appeal Nos 2 and 3 of 2022 Kuwait Ports Authority et al v. Port Link GP Ltd et al where it was held that, when considering the statutory test to apply under s.33(3) of the ELP Act, although assistance could be derived from developed principles in other contexts, such considerations are not conclusive of themselves and “simply a step on the road to determining the statutory test” under the ELP Act. That test is not the same as the equivalent tests in companies, trusts or partnership contexts, but an ELP’s own sui generis test in the form of section 33(3), see [44] – [46].
[3] For an in-depth review of the background to ELPs, and a detailed analysis of the law in this area, please see Appleby’s recent ELP article linked to in footnote 5.
[4] CICA judgment, [15].
[5] CICA judgment, [18].
[6] Grand Court judgment, [167] – [170]
[7] Grand Court judgment, [182] – [184]
[8] Grand Court judgment, [166]
[9] Grand Court judgment, [171] – [179]
[10] Ebrahimi v Westbourne Galleries [1973] AC 360.
[11] ELP Act s. 19(1).
[12] CICA judgment, [60] – [68]
[13] [2020] UKPC 24 at [15]
[14] CICA judgment, [69] – [71]
[15] CICA judgment, [72] – [73]
[16] CICA judgment, [74] – [75]
[17] Unreported FSD judgment 8 October 2021.
[18] Unreported FSD judgment 21 April 2022.
[19] First instance judgment, [157]. Appleby has covered this recently in our detailed article on ELPs: A Growing Trend for Cayman Islands Private Equity Structures? Further Developments in the Law and Practice of Claims Involving Cayman ELPs, dated 10 July 2023, www.applebyglobal.com/news/a-growing-trend-for-cayman-islands-private-equity-structures-further-developments-in-the-law-and-practice-of-claims-involving-cayman-exempted-limited-partnerships
[20] CICA judgment, [20] – [21].
[21] CICA judgment, [77].
[22] CICA (Civil) Appeal Nos 2 and 3 of 2022 Kuwait Ports Authority et al v. Port Link GP Ltd et al at [44] – [46]
[23] At [6]-[74]. On 11 August 2023, Doyle J granted leave to appeal his judgment in HQP, inter alia because he considered that the status of foreign (including English) authorities in Cayman Islands law is a matter of public interest which should be examined by the Court of Appeal. It may therefore be that in due course, Doyle J’s analysis will receive appellate imprimatur.
[24] HQP judgment, [70(1)].
[25] HQP judgment, [70(2)].
[26] HQP judgment, [70(3)].
[27] Save, perhaps, for potential costs arguments.
