Introduction
The rule in Houldsworth, as it has been known since the decision of the House of Lords in Houldsworth v City of Glasgow Bank (1880) 5 App Cas 317, served to preclude a shareholder of a company from proving as a creditor in its liquidation for any loss caused by misrepresentations the company had made that induced them to subscribe for their shares, when they could not rescind the subscription contract after the liquidation had commenced. The rule was absolute: the shareholder that had fallen victim to the misrepresentation had no right to be compensated in priority to other shareholders in such circumstances, even where the company was solvent and all of its external creditors had been fully paid or provided for.
Perhaps unsurprisingly, that was quite controversial. The rule was heavily criticised by academics, abolished in England by statute in 1989, and Australian and Bermudan courts had declined to follow it. However, the question as to whether it formed part of Cayman Islands common law had not been substantively considered by the Cayman Islands courts until May 2023, when that issue came before Justices Doyle and Segal respectively in Re HQP Corporation Limited (in Official Liquidation) (HQP) and Re Direct Lending Income Feeder Fund Ltd. (in Official Liquidation) (Direct Lending).
Doyle J delivered his judgment in HQP on 7 July 2023, concluding that the rule was not part of Cayman Islands common law and that Houldsworth should not be followed. Accordingly, any shareholder could prove for such compensation as a misrepresentation plaintiff from the outset, ranking equally with external unsecured creditors. However, Segal J took the opposite view, concluding in his judgment in Direct Lending, delivered on 13 March 2024, that the Houldsworth rule did indeed form part of Cayman Islands common law; albeit that, properly understood, it only precluded a shareholder from proving for such a claim before all creditors external to the company had been fully paid or suitably provided for (i.e. the rule was not an absolute bar on proof in respect of such claims) – since its purpose and intent was to apply the maintenance of capital principle to protect the interests of those external creditors.
With each of those judgments effectively being irreconcilable with the other, in each case an appeal was made to the Cayman Islands Court of Appeal (CICA), and the CICA ultimately heard both as a conjoined appeal in November 2024. It recently delivered its eagerly awaited judgment on 7 November 2025,[1] effectively upholding the conclusions that Segal J had reached in Direct Lending: whilst the CICA acknowledged that Houldsworth and its progeny had indeed treated the rule as being absolute, it nonetheless accepted that the purpose and intent of the rule, once properly understood, was as Segal J had explained in Direct Lending at first instance. Moreover, the CICA considered that this revised formulation of the rule – and the decision not to follow Houldsworth and subsequent cases in treating the rule as being absolute – was justified by differences in local circumstances, namely:
“the large number of open ended investment funds incorporated in the Cayman Islands in which investors purchase their investment by subscribing for redeemable shares and where, in a liquidation, it is to be expected that the total debts owed by the company to external creditors will be much smaller than the total of the claims made by shareholders who had served dishonoured pre-liquidation redemption notices”.[2]
The rule in Houldsworth will therefore apply in the modified form which Segal J explained in Direct Lending in relation to liquidations of Cayman Islands companies, at least absent a reversal of the CICA’s judgment on any further appeal to the Judicial Committee of the Privy Council in due course.
The authors discuss the first instance and appellate judgments in further detail below.
[1] [2025] CICA (Civ) 19
[2] Id. at [212].
The Judgments at First Instance
The first instance judgments in HQP and Direct Lending were made on applications for directions by the two companies’ respective joint official liquidators (JOLs). The JOLs in each case sought directions regarding the proper treatment of claims made in the liquidation by investors who claimed they were induced to subscribe for redeemable shares by misrepresentations that the subject company had made.
In HQP, Doyle J held inter alia that:
- the rule in Houldsworth does not form part of Cayman Islands common law, and there were several reasons why the Grand Court ought not to follow the authorities from which it was derived;
- accordingly, the rule did not operate to bar claims by shareholders who had fallen victim to misrepresentations by their company which had induced them to subscribe for their shares;
- the foundation of such claims is a pre-contractual tort rather than the shareholders’ contractual agreements or the statutory contract with the company in question; and
- the sums due to such shareholders are not due to them in their capacity as members and thus fall outside the scope of s.49(g) of the Cayman Islands Companies Act (Act),[1] such that they would rank pari passu with external creditors’ claims.
In Direct Lending, Segal J conversely held that:
- the rule in Houldsworth applies in the Cayman Islands, alongside the statutory regime for subordination;
- shareholders’ claims for such misrepresentations could only be considered after claims by external unsecured creditors had been adjudicated and satisfied; and
- such shareholders’ claims would rank pari passu with redemption shareholder claims.
The CICA’s Judgment
Whilst the facts of each case were substantially different, the CICA was effectively tasked with deciding the same two questions in the appeals from each of those judgments:
- Whether, after the presentation of a winding up petition, claims for damages for misrepresentation, including a subscription for shares in a company, can be admitted to proof in a liquidation or whether such claims are barred by the decision of the House of Lords in Houldsworth (Bar on Proof Issue)?
- If such claims are provable, where do they rank in a liquidation in relation to other claims by members, former members and external unsecured creditors. Do they fall within section 49(g) of the Act so that the claims of members are subordinated to the claims of unsecured creditors (Priority Question)?
It thus heard the appeals as a conjoined appeal, in the interests of efficiency and avoiding the risk of further inconsistent judgments, delivering a single judgment on the two appeals on 7 November 2025.
Bar on Proof Issue
In respect of the Bar on Proof Issue, the CICA effectively upheld Segal J’s decision in Direct Lending, finding that:
- The long-standing English common law rule in Houldsworth[2] was and remains part of Cayman Islands common law, having been developed on the basis of statutory provisions which were common to both jurisdictions and confirmed by the House of Lords (now the Supreme Court) in Houldsworth, i.e., a judgment of the highest persuasive authority. Although the rule had been abrogated in England by statute in 1989, the Cayman Islands legislature must be taken to have chosen not to do so: indeed, Smellie CJ (as he was then) had proceeded on the basis that the Houldsworth rule applied in his 2010 judgment in Re SPhinX Group[3].
- The rule is premised on the basis of the maintenance of capital principle[4], operating alongside the statutory winding up regime, and serves to prevent shareholders from proving for misrepresentation claims in a liquidation.
- Notwithstanding this, where a company’s external creditors have been paid or the liquidator has suitably provided for them, the Houldsworth rule should not prevent such shareholders from proving in the liquidation thereafter, in competition with other shareholders. The CICA accepted that such an absolute restriction was not the purpose or intent of the rule in Houldsworth, and was consistent with ss. 49(g) and 37(7)[5] of the Act.
- In the CICA’s view, the large number of open ended investment funds in Cayman in which investors purchase the investment by subscribing for redeemable shares, combined with the fact that the debts owed to external creditors in a liquidation scenario with respect to such funds
will typically be much less than the value of the claims made by those shareholders, were “very good reason[s] for limiting the application of the Houldsworth rule to situations where there are insufficient assets to pay the external creditors…”.
Priority Question
On the priority question, the CICA necessarily determined the cases differently: this was because the shareholders in HQP were subject to a contractual liquidation waterfall (dictated by the class of shares for which they had subscribed) under HQP’s articles of association, whereas, in Direct Lending, there was nothing that provided for a difference in status as between the redeeming shareholders and shareholders claiming on the basis of misrepresentation.
- In general terms, redeeming shareholders[6] and shareholders claiming for misrepresentation in the “character of a member” would rank equally under section 49(g) of the Act, which provides that their claims are subordinated to so-called external creditors.
- The claims of the redeeming shareholders and shareholders claiming for misrepresentation in Direct Lending were made in the capacity of creditors and ranked pari passu with each other, whilst having priority over the claims of other shareholders.
- The claims of shareholders based on misrepresentation in HQP rank pari passu with claims of redeeming shareholders, but only those holding the same class or classes of shares, by reason of the contractual liquidation waterfall.
The CICA recognised that its decision may appear “unfair” to the shareholders claiming for misrepresentation in HQP that held lower ranking shares (such that they were unlikely to be paid), but concluded that “[i]n the absence of a perfect solution, we are satisfied that the outcome is at least consistent with the applicable law”.
Conclusions
Whilst the CICA recognised the Cayman Islands’ status as a centre for the formation and operation of open-ended investment funds and modified the Houldsworth rule accordingly, the judgment highlights the stark reality that shareholders with misrepresentation claims are unlikely to be paid any damages, unless the liquidation is solvent.
The CICA particularly observed that the wider impact of the decisions “on liquidations generally in the Cayman Islands is likely to be limited because we expect there will be a great many where there are insufficient assets to pay external creditors or ensure they are dealt with, in consequence of which Houldsworth rule will apply in its full rigour”. Further, as was the case in HQP, such shareholders will also be bound by the contracts they entered into on subscription, which may further impact their ability to be admitted to proof and receive any distribution.
It remains to be seen whether the CICA’s judgment marks the end of the debate, or will be appealed to the Privy Council, with the issues discussed above having been highly contested in each of the two proceedings.
For further information, please contact:
Andrew Jackson, Partner, Appleby
ajackson@applebyglobal.com
[1] This section is concerned with the liability of present and past members of a company. Section 49(g) qualifies the position that unsecured creditors are paid pari passu ahead of shareholders, by providing for further subordination.
[2] As developed in Re Addlestone Linoleum Company (1887) 37 Ch D 191, In Re Hull and County Bank (1880 15 CH. D. 507 (Burgess’s Case) and explained in Webb Distributors (Aust) Pty Ltd and Another v State of Victoria and Another (1993 179 CLR 15)
[3] [2010 (2) CILR 1]
[4] Confirmed in Trevor v Whitworth (1887) 12 App Cas 409 and Ooregum Gold Mining Co of India v Roper [1892] AC 125
[5] Section 37(7) of the Act relates to the order of priority afforded to the claims of redeeming shareholders on the winding up of a company.
[6] Including those who have completed the steps to redeem and so have become creditors, but have not been paid.
