a comparison by practitioners of delaware and cayman · in‐depth analysis of delaware and cayman...

________________ © 2011 Bloomberg Finance L.P. All rights reserved. This article was originally published by Bloomberg Finance L.P. and appeared in six parts in the Bloom‐berg Law Reports—Fund Management and Bloomberg Law Reports—Securities Law. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P. This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be ad‐dressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attor‐ney‐client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.

A Comparison by Practitioners of Delaware and Cayman Islands Limited Partnerships

Andrea R. Cohen, SharesPost, Inc.; and Caroline S. Williams, Walkers

In this series of six articles, the authors provide an in‐depth analysis of Delaware and Cayman Islands limited partnership laws as they apply to private equity funds. Despite increasing convergence, mea‐ningful differences between the two regimes re‐main. The articles are intended to explore certain of these differences, and to assist practitioners, as well as fund sponsors and investors, in appropriately structuring private equity funds as limited partner‐ships in either jurisdiction. This first installment in‐troduces the benefits of limited partnerships, pro‐vides an overview of each regime, and addresses related mutual fund and hedge fund points.

Part I

Overview of Limited Partnership Laws

Tax and Legal Efficiencies

Limited partnerships are the primary business struc‐ture used by private equity funds, including venture capital, real estate, buyout, and other fund vehicles for pooled capital. Limited partnerships are favored for their tax flow‐through treatment by the Internal Revenue Service, such that tax is not paid by both the entity and a person holding a beneficial interest in such fund. Further, the limited partnership form

is preferable to an "S" corporation, as it may be be‐neficially owned by more than 35 investors, by cor‐porate investors, and by non‐U.S. investors. While a typical private equity fund in the past was a rela‐tively straightforward tax‐efficient investment, cur‐rent investing trends have led to significant U.S. tax issues for private equity fund sponsors and their investors, regardless of investment type, industry, stage, or focus of the fund.

Many private equity funds that have traditionally invested solely in U.S. assets now routinely invest in non‐U.S. assets. As investments are made in new territories from which returns may be generated, fund sponsors must evaluate whether U.S. invest‐ment vehicles are suitable for particular transac‐tions and for the tax structuring needs of their li‐mited partners. As tax‐exempt and non‐U.S. inves‐tors have increasingly become limited partners in private equity investment vehicles, their needs have changed as well. Fund investments in certain types of portfolio companies can trigger complex tax ra‐mifications for them, including U.S. real property holding company issues, Foreign Investment Real Property Tax Act of 19801 issues, and "effectively connected income"2 for non‐U.S. investors, causing them to file income tax forms and pay U.S. income tax to which they may not have otherwise been subject. Fund investments in portfolio companies that are treated as partnerships and certain non‐

© 2011 Bloomberg Finance L.P. All rights reserved. This article was originally published by Bloomberg Finance L.P. and appeared in six parts in the Bloomberg Law Reports—Fund Management and Bloomberg Law Reports—Securities Law. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P.

U.S. entities can create "unrelated business taxable income" for U.S. tax‐exempt investors if the income is "effectively connected" to a U.S. trade or busi‐ness.3 In each case, a limited partner may be subject to significant withholding or direct tax liability. One method of maintaining the tax flow‐through nature of such investments is through the use of an off‐shore vehicle. Structuring a fund through an off‐shore vehicle is intended to isolate and neutralize the tax on investment income. Offshore vehicles may provide tax efficiency for the varied needs of a fund’s limited partners.

Delaware has long been the "gold standard" among jurisdictions for private equity limited partnerships investing primarily in U.S. companies. The Delaware Secretary of State’s office is renowned for the effi‐ciency of its filing process, facilitating both the for‐mation and amendment of limited partnership enti‐ties. Its courts offer superior jurisprudence in busi‐ness matters and provide predictability and ease of interpretation of law for practitioners. The Dela‐ware legislature has shown an unprecedented wil‐lingness to routinely update and clarify confusing or antiquated laws as the behaviors of entities domi‐ciled in Delaware change.

The Cayman Islands, like many other "offshore" ju‐risdictions, is a "tax neutral" jurisdiction. There is no direct taxation of any kind with respect to an in‐vestment entity formed there.4 The attractiveness of the Cayman Islands as a jurisdiction for establish‐ing private equity funds is not limited to the ab‐sence of direct taxation. The Cayman Islands have a sophisticated business and legal infrastructure. The "big 4" accountancy firms boast established busi‐nesses in the Cayman Islands, and a number of the law firms, like their onshore instructing counsel, have a global presence and high‐caliber lawyers. The Registrar of Exempted Limited Partnerships un‐derstands the importance that speed and efficiency play in the private equity fund formation arena and can therefore provide a 24‐hour processing time for the registration of new partnerships, where re‐quired.

Today, the Cayman Islands are the most frequently used offshore jurisdiction for private equity funds. The Cayman Islands are a British "overseas territo‐ry," under which foreign policy is handled in London while local matters are handled through the Cay‐man Islands’ legislature and judicial system. Finan‐cial services are the largest revenue generator in the Cayman Islands after tourism. As such, many of the advantages present in Delaware limited part‐nerships are also present in Cayman Islands ex‐empted limited partnerships. Cayman Islands law is derived from the same English common law that formed the background of U.S. common law. Local legislation ensures that Cayman Islands entities are structured as robust, internationally accepted in‐vestment vehicles.

Cayman Islands law and the related judicial system are well developed, allowing practitioners greater certainty when counseling and providing legal ad‐vice. When necessary, appeals of Cayman Islands judicial decisions ultimately go to the Privy Council of the House of Lords in London. English case law is seen as highly persuasive but not binding on Cay‐man Islands courts. As in Delaware, the government is amenable to working with the business communi‐ty to ensure that the regulatory and legal frame‐work of the Cayman Islands financial services sector reflects the operational realities of the funds domi‐ciled there. This commitment provides the legal flexibility necessary to permit modern finance to thrive with minimum bureaucracy.

Freedom of Contract and Evolution of Limited Partnership Laws

The Cayman Islands and Delaware partnership laws both trace their roots to the English Partnership Act of 1890 (Act). The Act, in nine pages, provided the essential legal framework permitting parties to come together, pool capital, share risk, and engage in a joint enterprise without the traditional formali‐ties of the corporate form.5 The Act was fundamen‐tally premised on the right of contract between par‐ties. Accordingly, the Act permitted substantial flex‐


ibility in the terms and conditions contained in a partnership agreement.

In the United States, the Act significantly influenced the Uniform Partnership Act of 1914, which was adopted by the Delaware legislature in 1947. Like‐wise, when the Delaware legislature modified its partnership laws in 1973 to allow for the creation of the modern limited partnership, its Revised Uniform Limited Partnership Act (DRULPA) retained the ex‐pressly stated policy of giving "maximum effect to the principle of freedom of contract and to the en‐forceability of partnership agreements."6 Indeed, the DRULPA, in its nearly 40 double‐columned pag‐es, thoroughly enumerates the rights and remedies associated with many of its provisions. Nonetheless, in keeping with freedom of contract principles, most provisions apply only in the event that the li‐mited partnership agreement is silent on the rele‐vant issue.

The Cayman Islands’ approach is minimalist in com‐parison. Its Partnership Law (as amended) (Partner‐ship Law), comprising 15 pages as initially enacted in 1983, is substantially identical to the Act. English common law did not recognize the limited partner‐ship until passage of the English Partnership Act of 1907. The essence of the later act is reflected in the Partnership Law, which permits the creation of li‐mited partnerships that are not exempted limited partnerships.

The English common law view of limited partner‐ships is more restrictive than the Delaware ap‐proach.7 Accordingly, to enhance flexibility in the formation of a limited partnership, the Cayman Isl‐ands legislature adopted the Exempted Limited Partnership Law of 1991 (Original EPL), based on the DRULPA. The Original EPL has been revised on a few occasions since its initial enactment and the current version is the Exempted Limited Partnership Law (2010 Revision) (EPL). Consistent with the Act, however, the EPL is not as extensive as its Delaware counterpart. Comprising 26 sections set forth in 20 pages, the EPL reflects a legal presumption that where the EPL is silent, the limited partnership

agreement itself controls. Although not explicit in its rules of construction, it is accepted practice that parties have the right to contract with respect to virtually anything not opposed to public policy (e.g., criminal activities), and provided not contrary to the express provisions of the EPL.

Although many provisions of the EPL and the DRUL‐PA align, the two laws still diverge, even in basic matters such as the nature of a limited partnership. As discussed in greater detail in the "Formalities" section of the second article in this series, under Delaware law, limited partnerships are independent legal entities akin to companies. In contrast, Cay‐man Islands limited partnerships are contracts be‐tween parties and lack independent legal existence. Consequently, property conveyed into or vested in the name of a Cayman Islands exempted limited partnership is deemed to be held by its general partner upon trust as an asset of the exempted li‐mited partnership pursuant to the terms of the re‐levant limited partnership agreement.

Applicability of The Mutual Funds Law

The Cayman Islands Mutual Funds Law (MFL) also may apply to private equity funds domiciled in the Cayman Islands in certain circumstances. Under that law, a "mutual fund" covers any company, unit trust, or partnership that issues equity interests, the purpose or effect of which is the pooling of investor funds with the aim of spreading investment risks and enabling investors in the mutual fund to receive profits or gains from the acquisition, holding, man‐agement, or disposal of investments.

At first glance, it would appear that all exempted limited partnerships about which this article is con‐cerned would be governed by the MFL. Yet, the law contains two key exceptions that excuse most pri‐vate equity funds from its requirements. First, in‐terests in a company or limited partnership are not considered "equity interests" unless they are re‐deemable or subject to repurchase at the option of the investor. Since most private equity limited part‐nership agreements do not give limited or general


partners such options, they generally are not consi‐dered to be mutual funds at all.

In the case that its limited partnership agreement does allow for redemption or repurchase at the in‐vestor’s option, an exempted limited partnership may still be exempt from the MFL’s requirements if its equity interests are held by not more than 15 investors, a majority in number of whom are capa‐ble of appointing or removing the general partner (Exemption).

Private equity funds that provide their investors with an ability to redeem or have their interest re‐purchased at the option of such investor, and that do not meet the requirements of the Exemption, must register as a mutual fund with the Cayman Islands Monetary Authority (CIMA). In order to reg‐ister with CIMA as a mutual fund, it is necessary for a fund to file with CIMA its offering document, its certificate of formation or incorporation, a docu‐ment known as a Form MF1 that summarizes cer‐tain key provisions in the offering document, a let‐ter from the fund’s auditor confirming its consent to act as the fund’s auditor, a letter from the fund’s administrator confirming its consent to act as the fund’s administrator, and a prescribed filing fee.

Following registration as a mutual fund with CIMA, a fund will be subject to ongoing filing obligations. These ongoing filing obligations include the re‐quirement to file audited financial statements on an annual basis and to also notify CIMA of any material changes to the fund’s offering document. The ratio‐nale behind the latter requirement is that CIMA, as regulator of the fund, seeks to ensure that investors are being provided with current information that materially affects their investment.

CIMA has various supervisory and enforcement powers and duties that are conferred on it under the MFL. An important power is CIMA’s ability to compel a fund to have its accounts audited at any time and to submit them to CIMA within a specified timeframe. Such a request may be made at a time when the audited financial statements of a fund are

not yet due but may be required by CIMA because it has reason to believe that such an audit is necessary to provide a clearer picture of the current financial health of a particular fund.

CIMA may exercise the various enforcement powers that it has under the MFL in certain circumstances, including where it has concluded that (1) a regu‐lated mutual fund is or is likely to become unable to meet its obligations as they fall due; (2) a regulated mutual fund is carrying on or attempting to carry on business or is winding up its business voluntarily in a manner that is prejudicial to its investors or credi‐tors; (3) the direction and management of a regu‐lated mutual fund has not been conducted in a fit and proper manner; or (4) a person holding a posi‐tion as a director, manager, or officer of a regulated mutual fund is not a fit and proper person to hold such a position.

In exercising its supervisory or enforcement powers or its statutory duties, the overriding motivator for CIMA is to protect the interests of investors in the funds that it regulates, thereby simultaneously pro‐tecting and upholding the integrity and efficacy of the Cayman Islands as a leading jurisdiction for the establishment of hedge funds.

Much of the benefit of forming funds in the Cayman Islands derives from the relatively few restrictions the legal regime imposes on funds. While the MFL is not especially onerous compared to U.S. securities laws, it does require disclosure of information to CIMA as a regulator that a fund might prefer to keep private. Prospective investors in private equity funds structured as exempted limited partnerships should not be surprised, then, if their partners resist provisions in the limited partnership agreement that would grant redemption or repurchase rights. The MFL is intended to regulate hedge funds and not private equity funds.

Hedge Funds Paving the Way

Hedge funds, once a small, opaque sub‐set of in‐vestment funds dedicated to using sophisticated


mathematical "hedges" while trading in public equi‐ties, have become one of the driving forces of global finance. Today, hedge funds participate in nearly every market for every financial product worldwide. While private equity funds expanded use of Cayman Islands vehicles in the early 2000’s, hedge funds have long used the Cayman Islands. Though they may have offices in locations like Greenwich, Con‐necticut, New York City, or Mayfair, London, the vast majority of hedge funds operating worldwide are registered in the Cayman Islands.8

Hedge fund managers, due to their trading strate‐gies or investor bases, have long looked offshore for flexible, responsive regulation that also provides tax efficiency for their investors. An offshore domicile provides several advantages to the average hedge fund. A fund domiciled offshore will not pay taxes on the gains made by the portfolio (investors will still be taxed on such profits in their home jurisdic‐tion upon withdrawal or distribution). If a manager expects significant participation by non‐U.S. or U.S. tax exempt investors, an offshore domicile will pro‐vide tax efficiency since these investors will not be subject to U.S. tax on the profits generated off‐shore.

Most offshore hedge funds are formed using a "master‐feeder" structure. The "master" hedge fund itself is organized as a partnership or an off‐shore corporation (but treated as a partnership for U.S. tax purposes via a check‐the‐box election) in an offshore jurisdiction, such as the Cayman Islands, giving it foreign residence under the U.S. tax code. The master fund typically has two "feeders" that invest in the master fund: the domestic feeder for U.S. resident taxable investors; and the foreign feeder for non‐U.S. investors and U.S. tax‐exempt investors. The domestic feeder is a limited partner‐ship, usually organized in Delaware, so all of its items of income, gain, deduction, or loss pass through to its partners.

The Cayman Islands has become the domicile of choice for most offshore hedge funds. The flexible regulatory regime can accommodate a variety of

managers. For example, first time managers with a limited track record can start as an unregistered fund relying on the Exemption and then register under the MFL as they gain marketing momentum. The Cayman Islands is home to a notable number of sophisticated professional service providers, from lawyers and accountants to fund administrators that administer the funds. Also, the Cayman Islands is a brief plane ride away from the United States and situated in the same Eastern time zone as much of the U.S. financial services industry, aiding con‐venience of communication. These benefits have developed into a cumulative advantage that will likely continue to make the Cayman Islands the do‐micile of choice for offshore hedge funds for the foreseeable future.

Part II

Core Differences

Limited Partner Liability Status

A limited partnership provides limited liability for its limited partners in exchange for forfeiting rights to manage and otherwise make operating decisions concerning the limited partnership. The general partner, on the other hand, has decision‐making authority and assumes general liability for its acts or omissions.9 Accordingly, a limited partner is gener‐ally not responsible for the debts of a limited part‐nership above and beyond the amount of the li‐mited partner's contributions and unpaid capital commitment. Exceptions include amounts agreed to be paid by the limited partner pursuant to the li‐mited partnership agreement or subscription agreement (for example, a limited partner "claw‐back" in respect of partnership liabilities), and pay‐ments made to a limited partner in error or pay‐ments made to a limited partner in violation of the limited partnership agreement, the EPL,10 or the DRULPA, as applicable.11

In contrast, if the limited partnership's liabilities exceed its assets, the general partner's "general


liability" permits creditors of the limited partnership to seek redress from the general partner, to the extent of the general partner's available assets, re‐gardless of the general partner's capital commit‐ment to the limited partnership. In exchange for this assumption of general liability, and subject to the terms of the limited partnership agreement, the general partner retains the privilege (and responsi‐bility) of conducting business on behalf of the li‐mited partnership in its sole discretion pursuant to the relevant limited partnership law.

A limited partner who conducts the limited partner‐ship's business — or holds itself out as having the authority to conduct business — may also be sub‐ject to general liability, and may ultimately be held fully liable, in excess of its capital commitment, for debts or liabilities the limited partnership incurs as a result of such limited partner's activities. For ex‐ample, if the limited partner entered into a contract on behalf of the limited partnership with persons who are not partners and who reasonably believed such limited partner to be a general partner,12 the limited partner may itself ultimately be liable for the contract's payment, rather than the limited partnership. Under the EPL, a limited partner may lose its entire limited liability status by straying into the territory of conducting an exempted limited partnership's business.13 However, as demonstrated below, actual knowledge and reasonable belief re‐quirements make it relatively difficult, in practice, for such limited liability to be lost.

Both the DRULPA and the EPL contain "safe harbor" provisions enabling limited partners to participate in specified activities that might otherwise be treated as conducting business on behalf of the li‐mited partnership. Under either the DRULPA or the EPL, a limited partner will not lose its limited liability status for engaging in the activities respectively enumerated thereunder.

The EPL sets out a non‐exhaustive list of activities in which a limited partner may engage without losing the benefit of the safe harbor provisions in the EPL.

The test in respect of losing limited liability is quite specific and relatively difficult to breach. It requires the limited partner to have taken part in the con‐duct of the business of the limited partnership in relation to persons who are not partners who rea‐sonably believe the limited partner to be a general partner. If this occurs, in the event that the limited partnership should become insolvent, the limited partner becomes liable for all debts and obligations of the exempted limited partnership incurred dur‐ing the period when the limited partner masque‐raded as a general partner.

The DRULPA permits a broad set of activities by a limited partner with respect to its interactions with the limited partnership.14 A limited partner may be an employee or contractor, or otherwise transact business with the partnership, and may exercise its consent or voting rights with respect to the business of the limited partnership. Limited partners may also influence a wide range of administrative mat‐ters. For example, under the DRULPA they may call meetings of the partners, and serve or appoint someone to serve on committees of the limited partnership.15 The DRULPA further instructs courts not to presume that limited partners are "conduct‐ing business" merely because of their engagement in other activities not enumerated therein.16

The EPL also permits a limited partner to be em‐ployed by, consult with, contract with, or exercise voting rights with respect to the limited partner‐ship.17 Like the DRULPA, the failure to enumerate a particular activity does not imply that such activity constitutes "conducting business".18

Under either the DRULPA or the EPL, the activities of concern to most limited partners, such as partici‐pating on a limited partner advisory board, co‐investing with the limited partnership, providing strategic relationships, regulating deal flow, and advising the general partner regarding conflicts of interest and valuation of assets, do not generally threaten their limited liability.


Third‐party Beneficiaries

Limited partnership agreements often reference and provide rights to persons who are not technical‐ly parties to the agreement. For example, the indi‐vidual members of the limited partner advisory board, while representing limited partners, are not as individuals signatories to the limited partnership agreement. If the limited partner advisory board seeks to exercise rights granted to it in service to the limited partnership, each such participant claims those rights as a third‐party beneficiary un‐der the express terms of the limited partnership agreement. Under common law, the ability to assert third‐party claims under the limited partnership agreement is quite limited.19

The DRULPA explicitly recognizes the rights of third‐party beneficiaries, providing rights to "any person not a party to the partnership agreement, to the extent set forth therein".20 In contrast, the EPL does not recognize a person that is not a party to the li‐mited partnership agreement in question. However, there are practical ways to address this difference, for example the use of a "deed poll"21 or a separate agreement to extend certain provisions of the li‐mited partnership agreement, such as the benefit of an indemnity, to third parties.

Third‐party status may affect, among other rights, (1) enforcement of the general partner's obligation to return amounts in excess of the distribution to which it is properly entitled under the limited part‐nership agreement, (2) determination of eligibility for indemnification rights pursuant to the limited partnership agreement, and (3) the benefits of con‐fidentiality provisions under the limited partnership agreement.

Return of Distributions

A general partner is typically subject to "clawback" provisions, i.e., an obligation to return to the limited partnership distributions made to it in excess of the carried interest payment to which it is entitled pur‐suant to the limited partnership agreement. Be‐

cause the general partner is typically an entity with no assets of its own, formed exclusively to manage the investments of the fund, distributions of cash made to it are typically its only asset. Distributions by the fund to the general partner are subsequently distributed to the underlying individual members of the general partner entity (unless the limited part‐nership agreement provides for an escrow or other governor). Consequently, a clawback situation re‐quires either the limited partnership or its limited partners to look to members of the general partner to return excess distributions. In the event that the underlying members of the general partner, in each such person's individual capacity, have not agreed to execute a guarantee or have not otherwise es‐tablished a contractual basis for their obligation to return distributions to the fund, the limited part‐ners of a limited partnership formed under the EPL may have no basis for recourse if the general part‐ner entity itself is insolvent, and unable to return the over‐distribution, as the limited partnership has no direct contractual relationship to the members of the general partner.

Indemnification

The lack of recognition of third‐party beneficiaries further results in the inability of the limited partner‐ship to indemnify persons not a party to the limited partnership agreement.

Advisory Board Representatives

Limited partnerships indemnify certain of their li‐mited partners, as well as members of the general partner and the management company, from ac‐tions taken as a result of their activities promoting the business of the fund. Individuals representing institutional limited partners on limited partner ad‐visory boards expect indemnification for their role on the advisory board. Typically, the limited part‐nership agrees to pay any of the debts or obliga‐tions that such limited partners and their advisory board representatives incur as a result of such activ‐ities. Accordingly, individuals representing limited partners on a Cayman Islands limited partnership's


advisory board are advised to enter into a separate indemnity or a deed poll to provide the same in‐demnification as such person would have enjoyed under the limited partnership agreement if the enti‐ty were formed under the DRULPA.

Scope of Indemnification Clauses

Under the DRULPA, parties have complete and ul‐timate authority to define the breadth and scope of indemnification in a limited partnership agreement, and Delaware courts have deferred greatly to in‐demnification clauses in limited partnership agree‐ments.22 Indemnification may be virtually unlimited under the DRULPA, except where the provision pur‐ports to indemnify breach of the implied covenants of good faith and fair dealing and actions taken against public policy.23 For example, a Delaware li‐mited partner's indemnification is generally upheld, subject to a showing of fairness, even when the li‐mited partnership agreement does not contain a clear indemnification provision of the limited part‐ner's status.24

Given the EPL's lack of statutory indemnification provisions, Cayman Islands practitioners are gener‐ally free to draft specific indemnity clauses for any limited partnership, as under the DRULPA, other than provisions contrary to equitable principles of public policy such as prohibitions on indemnifica‐tion for fraud and criminal acts. Unlike under the DRULPA, however, a limited partner of a limited partnership formed under the EPL, if not granted an express indemnity right under the limited partner‐ship agreement, may still be able to require reim‐bursement under the theory of contribution.

Limited partners investing in a limited partnership under either the DRULPA or the EPL should familiar‐ize themselves with the indemnification provisions contained in the limited partnership agreement. We have discussed above in connection with third‐party beneficiaries considerations and solutions for those not a party to the limited partnership agreement, including those purportedly indemnified by it.

Confidentiality

Finally, the terms of a limited partnership agree‐ment's confidentiality provisions often expressly name the limited partnership as a third‐party bene‐ficiary of the rights and obligations such provisions address. If a limited partner breaches its obligation to maintain the confidentiality of confidential li‐mited partnership information, the limited partner‐ship typically has recourse against the limited part‐ner, and also against such limited partner's agents, affiliates, or other related persons. For a limited partner to make a claim for damages against a breaching "third party," it must create its own con‐tractual obligation, separate from the limited part‐nership. Despite the possibility of substantial harm to the limited partnership, if a person not a party to the limited partnership agreement discloses confi‐dential information, there is little avenue for re‐dress by the limited partnership under the EPL. Use of an ancillary confidentiality agreement between the limited partnership and another party may be used to manage risk, particularly in cases involving limited partners subject to a "freedom of informa‐tion act".

Formalities

Delaware law requires that one or more persons (but not less than all of the general partners or their agents) execute a certificate of limited partnership that includes (1) the name of the limited partner‐ship, (2) the address of the registered office and the name and address of the registered agent for ser‐vice of process, (3) the name and the business resi‐dence or mailing address of each general partner, and (4) any other matters the partners determine to include. A limited partnership is formed at the time of the filing of the initial certificate of limited part‐nership in the Office of the Secretary of State or at any later date or time specified in the certificate of limited partnership. 25

Forming a Cayman Islands exempted limited part‐nership can present a small learning curve for a fund sponsor not familiar with Cayman Islands law.


The EPL requires that at least one general partner of the exempted limited partnership be an individual resident in the Cayman Islands, a company regis‐tered under the Companies Law (as amended) of the Cayman Islands (Companies Law), a foreign company registered in the Cayman Islands under the Companies Law, or an exempted limited part‐nership.26 Those forming a Cayman Islands ex‐empted limited partnership should be prepared in advance by having at least one qualifying general partner and one limited partner, as required, to form an exempted limited partnership. Where the sole general partner of an exempted limited part‐nership will not be a Cayman Islands exempted company, an exempted limited partnership, or a natural person resident in the Cayman Islands, a U.S. corporation, or a limited liability company that will be used as the general partner of an exempted limited partnership should be registered in the Cayman Islands before the limited partnership is formed. Where necessary, registration of the for‐eign entity, or the incorporation of a Cayman Isl‐ands exempted company to act as general partner, and formation of the exempted limited partnership can occur on the same day provided clear instruc‐tions are given to the Registrar of Exempted Limited Partnerships.

Under Delaware law, documents need only be ex‐ecuted by a person authorized to sign.27 Cayman Islands formalities require that certain documents be executed "as a deed" or "as an instrument under seal". Powers of attorney are the most common example. Deed execution is a common law concept customary to signed written agreements that con‐vey a right but are not directly supported by consid‐eration.28 Historically, a deed would be accompa‐nied by a heavy wax seal bearing the signet seal of the party executing the document. Today, the seal is not a literal wax seal, but a notional one referred to by a term of art, "signed, sealed and delivered," or "executed as a deed". The notional seal is deemed to be the consideration necessary to sup‐

port the contract between the parties to the deed. In the context of a power of attorney, common law historically required powers of attorney to be made under seal. The Cayman Islands continues this for‐mality under the Powers of Attorney Law (as amended) of the Cayman Islands, which requires that a document creating a power of attorney must be executed as a deed or as an instrument under seal.29

As mentioned in the first article of this series, an exempted limited partnership is more akin to a trust. Accordingly, an exempted limited partner‐ship's lack of legal personality can also create situa‐tions where a Cayman Islands fund cannot invest in the manner it is accustomed, particularly when in‐vesting in limited partnerships governed by the laws of other common law countries. As a technical mat‐ter a common law limited partnership generally cannot invest in another common law limited part‐nership, since neither are entities. However, as a practical matter, there are structuring solutions, such as interposing a blocker vehicle, that may be used to address this issue. While the EPL provides a statutory basis for a limited partner or a general partner of an exempted limited partnership to also itself be an exempted limited partnership,30 other common law jurisdictions generally do not. Invest‐ments by Cayman Islands limited partnerships into, for example, an English limited partnership must be structured in such a way that the Cayman Islands limited partnership does not sign on its own behalf.

A Delaware limited partnership is, upon formation, a separate legal entity. Its existence as such contin‐ues until cancellation of the limited partnership's certificate of limited partnership.31 Formalities in exempted limited partnerships may initially cause some consternation in those unfamiliar with them. However, the steps to be taken to comply with these formalities are straightforward once known and understood.


Part III

Limited Partner Protections

This third installment examines the protection of limited partners' interests, in particular with regard to derivative actions, negligence, the assignment of limited partner interests, and fiduciary duties of the general partner.

Derivative Actions

While limited partners may not generally engage in day‐to‐day management activities that would nullify their limited liability, they do have other sharehold‐er‐like rights that permit them to take action where the general partner has mismanaged the limited partnership. Under the Delaware Revised Uniform Limited Partnership Act (DRULPA), limited partners may invoke their right to bring derivative lawsuits (1) against the general partner directly for misma‐nagement; (2) to force a general partner to take certain actions; (3) to ensure the right to quit the limited partnership and transfer their interest when they find doing so economically advantageous; and (4) to contract with the limited partnership to re‐ceive indemnification for any activities they might undertake in the promotion of the limited partner‐ship’s business. Limited partners in a Cayman Isl‐ands exempted limited partnership also have the ability to bring a derivative action.

The limited partners’ right to bring a derivative ac‐tion or a cause of action by the limited partners on behalf of the limited partnership is an important check on the balance of power in a limited partner‐ship. Typically, derivative actions are brought when the general partner fails to bring a claim on behalf of, and for the benefit of, the limited partnership. The limited partners then bring an action to compel the general partner to make the claim or take alter‐native action. For example, limited partners might bring a derivative action where a third party de‐faults on a contract payment to the limited partner‐ship and the general partner does not bring an ac‐

tion for recovery. The general partner’s failure di‐minishes the value of the limited partnership and otherwise creates a burden on the interests of the limited partners. The limited partners’ right to bring an action is particularly important where the gener‐al partner has a conflict of interest or an improper motive for refusing to bring the claim itself. Deriva‐tive rights of limited partners under the DRULPA and the Cayman Islands Exempted Limited Partner‐ship Law (2010 Revision) (EPL), however, can be distinguished.

The DRULPA allows a limited partner to bring a de‐rivative action when the general partner refuses to do so, or if an effort to force the general partner to bring an action is unlikely to succeed.32 The "unlike‐liness" of the effort demanding the general partner bring the suit is interpreted by analogy to the Dela‐ware corporate laws of demand and demand futili‐ty, where conflicts between directors and the cor‐poration are the primary determinate of whether a derivative action may continue.33 More specifically, Delaware courts will consider: "(1) whether the general partner acted independently and not self‐interestedly; (2) whether the general partner rea‐sonably investigated the basis for the proposed liti‐gation; and (3) whether the general partner refused to act in good faith."34

For a limited partner to bring a derivative action under the EPL, it is prima facie necessary for the limited partner to show that the general partner failed to bring the action "without good cause". If the general partner properly discharges its statutory fiduciary duty to act at all times in good faith in the interests of the exempted limited partnership in electing not to proceed, the general partner may be able to establish, as a matter of fact, that it has acted "with good cause". Ultimately, it will be a question of fact whether or not the general partner has or has not properly exercised its fiduciary du‐ties. Where it has done so, it is difficult to conceive of a Cayman Islands court substituting the general partner’s judgment. Even if a limited partner sues on the bona fide premise of promoting the limited partnership’s best interest as a whole, which is the


standard traditionally required for a derivative ac‐tion under English common law, absent extraordi‐nary circumstances, limited partners of an ex‐empted limited partnership may find it difficult to succeed in any derivative action brought under the EPL.

Negligence

In addition to derivative suits — to force the general partner to take action on behalf of an exempted limited partnership, or the limited partnership to take action in the case of a Delaware partnership — limited partners may bring a claim against the gen‐eral partner for harm to the limited partnership as a result of other actions. In determining whether a general partner is liable, courts of both Delaware and the Cayman Islands will look first to the limited partnership agreement to determine the applicable standard of care under which to evaluate the gen‐eral partner’s conduct. Typically, limited partnership agreements hold the general partner liable for gross negligence, fraud and willful misconduct.35

In the Cayman Islands (and generally under com‐mon law interpretation), gross negligence is equiva‐lent to negligence. Accordingly, a fund sponsor may have unwittingly held itself to a much higher duty of care to the limited partnership,36 to the benefit of the limited partners.37

It has recently become fashionable for an exempted limited partnership agreement of limited partner‐ship to define gross negligence pursuant to Dela‐ware or New York law. The Cayman Islands courts have not passed judgment on the enforceability of applying Delaware’s or New York’s definition of gross negligence in a Cayman Islands limited part‐nership agreement.

It is anticipated that the Cayman Islands courts would respect the intentions of the contracting par‐ties in the event that the Cayman Islands courts should be called upon to consider the issue. As a practical matter, in reaching any determination, the Cayman Islands courts would look to an expert in

Delaware or New York, as applicable, to explain the meaning of "gross negligence" in that jurisdiction and would reach a decision in light of the expert submissions received.

Although the Cayman Islands courts routinely uphold rulings from other jurisdictions, there is no guarantee they would forego interpretational con‐trol with respect to a single phrase in a limited part‐nership agreement. However, in the context of pri‐vate equity funds, where investors are likely to be "sophisticated," the expectation is that the Cayman Islands courts would reflect and uphold the inten‐tions of the parties to the limited partnership agreement.

Assignment of Limited Partner Interests

A limited partnership interest is a substantial asset. Assignment of this asset can greatly benefit the li‐mited partner and have significant consequence to the limited partnership. For example, a limited partnership could be negatively affected if a limited partner were to transfer its interest to a person not creditworthy, to a person who caused the limited partnership to breach securities, anti‐money‐laundering or tax laws, or to a competitor of the limited partnership. Therefore, limited partnership agreements invariably restrict a limited partner’s ability to assign its interest to avoid detrimental consequences resulting from impractical assignees, securities law or anti‐money‐laundering violations, conversion to publicly traded partnerships, and for simple reasons of control (particularly in light of the ten‐year or longer term of the agreement between the parties). It is not uncommon for a limited part‐nership agreement to contain permissive provisions applicable to transfers between affiliates, trustees of benefit plans, and other similarly situated limited partners. When it comes to requirements and pre‐sumptions in the assignment of interests, the DRULPA and the EPL differ slightly.

The DRULPA permits a limited partner to assign an interest in a limited partnership without any refer‐ence to the authority of the general partner.38 In


the marketplace, however, the general partner vir‐tually always has the ability to restrict the terms and conditions of transfers by contract. The restric‐tions contained in limited partnership agreements under the DRULPA are frequently modified through side letter agreements, often establishing in ad‐vance the right to transfer to an affiliate or other specified party.

Until recent amendment, the EPL stipulated that any assignment of limited partnership rights re‐quired the prior written consent of the general partner, which could be withheld in its sole discre‐tion.39 The prior EPL formulation provided that con‐sents to transfer may not be waived, withheld, or prospectively given in the limited partnership agreement. Under that regime, as a matter of prac‐tice, a general partner might have entered into a side letter arrangement with an investor agreeing to consent to a transfer in certain circumstances (pro‐vided permitted to do so under the terms of the limited partnership agreement). While such a side letter may have been an effective contract, in the event that a general partner subsequently declined to honor its prior promise to agree to a transfer, the limited partner hoping to effect such transfer would have had no recourse apart from an action for dam‐ages for breach of contract. To the extent the side letter was governed by Cayman Islands law, such breach of contract claim would only be successful if the limited partner could demonstrate that it had suffered a loss. The effect of the amendment to the EPL is to bring to the forefront the ability of limited partners and the general partner of an exempted limited partnership to place greater reliance on the principles of freedom of contract. Limited partners and the general partner of an exempted limited partnership may now agree upon the procedures for the assignment of a limited partner’s interest in the limited partnership agreement.40

Fiduciary Duties of the General Partner

Fiduciary duties are historically based in the law of trust and agency.41 In general, fiduciary duties are imposed in any relationship where one party holds

property for the benefit of another. The holder of the property may be incentivised to use its control to enrich itself rather than those for whose benefit the property is held.42 From a Delaware perspective, a protection against this unwanted behavior is to subject the holder of the property to a general fidu‐ciary duty of "unselfishness".43 Under common law, the case law applicable to the fiduciary duties of directors is by extrapolation applicable to general partners. There are several duties that have been identified at common law as being applicable to fiduciaries. The key fiduciary duty at common law is to act in the best interests of the parties that have conferred their trust in the fiduciary. This duty is reflected as a statutory provision under both the DRULPA and the EPL, but the formulation is not the same.

The DRULPA and the EPL differ significantly in their treatment of a general partner’s fiduciary duties. The general "freedom of contract" approach guiding the DRULPA permits fiduciary duties to be "ex‐panded or restricted or eliminated" through the limited partnership agreement.44 In theory, the par‐ties may agree to the general partner’s requisite level of care pursuant to current business practices and allocations of risk among the parties. In prac‐tice, most fiduciary duties in a limited partnership agreement are eliminated, leaving only the implied contractual covenant of good faith and fair dealing deemed inherent in every Delaware contract.45 The EPL adheres to traditional notions of fiduciary du‐ties owed by the general partner to the limited partnership and the limited partners. This contin‐ues, in part, from the common law concept that the limited partnership is not a person in its own right but rather a trust relationship between the general partner and the limited partners. In addition to the common law framework, the general partner has a statutory duty under the EPL to act at all times in good faith in the interests of the limited partner‐ship.46 While there is no Cayman Islands case law interpreting this duty, it can be inferred from Eng‐lish case law to include a duty to act in the interests of the partnership, to use reasonable care and skill in managing the affairs of the partnership, avoid


secret profits, and avoid conflicts.47 In the event of an action brought by limited partners alleging the general partner has not performed its duties, it is anticipated that the Cayman Islands courts would look at English common law with respect to director fiduciary duties and extrapolate from this body of law.

Part IV

Privacy, Distributions, and Defaults

Privacy Concerns

Access to Information

Notwithstanding the restricted role in management that limited partners assume, they must take care to ensure meaningful access to information pertain‐ing to a limited partnership's business operations and financial condition, while simultaneously pro‐tecting the confidential information of the limited partnership and its underlying portfolio invest‐ments. Subject to standards of reasonableness, in‐cluding a limited partner's right to reasonably de‐mand for any purpose reasonably related to the limited partner's interest as a limited partner, the Delaware Revised Uniform Limited Partnership Act (DRULPA) enumerates a laundry list of the types of information a limited partner has the right to re‐ceive.48 Under the DRULPA, the limited partnership agreement trumps the provision under the statute.

In recent years, media organizations, competitors, and certain individuals have obtained financial and other information about private equity funds in which public entities invest through freedom of in‐formation acts (FOIAs). Public disclosure of informa‐tion about the limited partnership's underlying portfolio investments, as well as information con‐cerning the limited partnership's operations, can be devastating to a limited partnership and its underly‐ing portfolio investments.49 The disclosure of a gen‐eral partner's proprietary information may put it at a competitive disadvantage to funds that are able to

control the timing of disclosure of this information. In addition, the "J‐curve"50 return distribution of private equity funds can mean premature disclosure of a limited partnership's internal performance numbers will directly impact perception of the fund's success. Internal estimates of a limited part‐nership's investment performance are subject to investment valuations, which are time‐specific and highly subjective. The effect of such disclosure may cause a fund sponsor to experience difficulty raising money in the future, irrespective of the unrealized value of the fund's underlying portfolio, delaying the limited partnership's anticipated exit of the in‐vestment. This may ultimately harm the profitability of the limited partnership.

Since disclosure of fund information may cause many potential harms, fund sponsors have re‐sponded by including provisions in their limited partnership agreements dramatically limiting the breadth and scope of information disclosed to li‐mited partners in general and to limited partners subject to FOIAs. Delaware legislators, consistent with their freedom of contract philosophy, subse‐quently clarified that such provisions were enforce‐able, subject to a standard of reasonableness, under the DRULPA. Notably, the DRULPA gives the general partner the right to keep confidential from limited partners information it reasonably believes (1) is a trade secret, (2) is not in the best interests of the limited partnership to disclose, (3) could damage the limited partnership or its business, or (4) must be kept confidential as required by law or con‐tract.51

The Cayman Islands Exempted Limited Partnership Law (2010 Revision) (EPL) provides only that "sub‐ject to any express or implied term of the partner‐ship agreement," limited partners may demand and receive information regarding the state of the busi‐ness and financial condition of the limited partner‐ship.52 The EPL allows tremendous scope for con‐tracting parties to agree the extent of disclosure of proprietary information. Limited partnerships go‐verned by the EPL, like the DRULPA, typically pro‐vide specific terms enabling limited partners to re‐


ceive the information they require and language limiting applicable confidentiality provisions to those expressly contained in the agreement, exclud‐ing judicial application of implied terms.

If a limited partner has entered into a side letter enumerating rights to receive and disclose informa‐tion, and assuming such side letter is enforceable, the limited partner should be in a similar position to a limited partner of a limited partnership formed under the DRULPA. Because side letters that change the material terms or conditions of the original li‐mited partnership agreement may not be enforcea‐ble under Cayman Islands' law, practitioners must draft carefully to ensure that for example superior or different information rights granted under a side letter are validly granted.

Register of Limited Partnership Interests

The EPL was recently amended to more closely align the accessibility of an exempted limited partner‐ship's register of limited partnership interests with the accessibility of the register of shareholders of a Cayman Islands exempted company. Prior to the recent amendment, the register of limited partner‐ship interests was open to inspection by any person during all usual business hours. Following the recent amendment, the register of limited partnership in‐terests is only open to inspection during usual busi‐ness hours by all partners or by any other person with the consent of the general partner. Interesting‐ly, and by analogy, in the case of a Cayman Islands exempted company, there is no statutory right of inspection. Access to the register of shareholders is entirely at the discretion of the board of directors. Indeed, unlike in the case of an exempted limited partnership, the register of shareholders of a Cay‐man Islands exempted company does not have to be held in the Cayman Islands and may be held any‐where in the world as resolved by the directors.

Distributions and Default

Return of Distributions

The terms of the limited partnership agreement govern when distributions of capital are made to limited partners. Each of the DRULPA and the EPL govern when distributions must be returned to the partnership. The provisions within each regime are distinguishable.53

The DRULPA provides that a distribution may not be made to limited partners if liabilities exceed assets. In the event that a limited partner knowingly rece‐ives a distribution in violation of the foregoing, the distribution must be returned to the limited part‐nership.54 Under the DRULPA, unless otherwise pro‐vided in a limited partnership agreement, a limited partner is "obligated to perform any promise to contribute cash." Accordingly, such limited partner must also return payments or distributions made to it in error or in violation of the limited partnership agreement, but only if such limited partner knows the distribution was erroneous.55 Under the DRUL‐PA, a limited partner's liability to return an impro‐per distribution expires three years from the date of the distribution except as otherwise provided in the limited partnership agreement.56

A limited partner's obligation to contribute capital to a Cayman Islands exempted limited partnership is limited to its capital commitment unless the li‐mited partner has agreed in the limited partnership agreement or in its subscription agreement to be liable for a greater amount. Under the EPL, a limited partner shall not be liable for the debts or obliga‐tions of an exempted limited partnership save as provided in the limited partnership agreement and to the extent that a limited partner compromises its limited liability by taking part in the conduct of the business of the exempted limited partnership and


acts outside of the parameters of the "safe har‐bour" provisions in the EPL or receives a payment representing a return of any part of its capital con‐tribution in a six‐month period prior to the insol‐vency of the exempted limited partnership.57 Li‐mited partners must return erroneous distributions whether they knew the distributions were impro‐perly made or not. A limited partner's obligation to return an improper distribution applies to any dis‐tribution made in the six‐month period before in‐solvency, and is payable together with interest at the rate of 10 percent per annum (calculated on a daily basis) or as otherwise specified in the partner‐ship agreement, to the extent that such contribu‐tion or a part of such contribution is required to discharge a debt or obligation of the exempted li‐mited partnership incurred during the period that the contribution represented an asset of the ex‐empted limited partnership.58

In short, while the scienter requirement of the DRULPA is more friendly to limited partners, the statute of limitations on returns of distributions is more favorable under the EPL.

Investor Default

Enforceability of limited partner default provisions under the EPL is distinguishable from that under the DRULPA. The DRULPA permits a limited partnership agreement to provide for virtually any specified pe‐nalty or consequence in the event of a limited part‐ner's default, including forfeiture.59 Further, the DRULPA allows virtually any legal remedy to be en‐forced against a defaulting limited partner, and the default provisions under the DRULPA may be enfor‐ceable despite punitive characteristics.60

Historically, for reasons of reputation on both sides, general partners have typically facilitated the expe‐dient sale of a limited partner's defaulting interest, keeping the default as quiet as possible. Recently, however, CapGen Capital Group LLC (CapGen), a New York‐based private equity firm focused on the financial services industry, brought suit in Delaware against two of its limited partners for failure to

make capital contributions. CapGen sought pay‐ment of the outstanding capital contributions with interest, and a court order compelling the limited partners to make all future capital contributions (plus payment of the funds' litigation expenses). Industry observers awaited an avalanche of lawsuits once this step was taken by CapGen. The court‐house rush failed to materialize as fund sponsors, preparing for the long haul, negotiated with their investors to reduce capital calls or fund size or facili‐tate secondary sales until market liquidity im‐proved. Once the smoke cleared, CapGen appeared to be a notable departure from traditional quiet handling of defaulting limited partners.

Typically, bringing a lawsuit is but one of the varied remedies in a general partner's arsenal, which may also include forced sale of the interest, forced with‐drawal from the limited partnership, or the forfei‐ture of all or part of a limited partner's interest. While it is unclear the extent to which a claim against a limited partner may become a trend, it is an interesting departure from traditional handling of defaulting limited partners.

Under Cayman Islands' laws of equity and public policy, however, default provisions must reflect a reasonable pre‐estimate of damages, rather than a penalty or general amount not tied to such analysis. Provisions with respect to limited partnership agreements and defaulting limited partners have not as yet been tested in the Cayman Islands' courts. As such, there remains a risk that Cayman Islands' courts may find punitive default provisions, in whole or in part, unenforceable. On the other hand, from a Cayman Islands practitioner's perspec‐tive, Cayman Islands' courts have become less will‐ing to interfere with freedom of contract, and so in addition to considering a clause's "oppressiveness", a court may also consider such factors as whether the provision was negotiated by parties with equal bargaining power or commercial justification.

In practice, default provisions of limited partnership agreements governed by the EPL typically state the same default remedies as those governed under the


DRULPA. At such time as general partners of ex‐empted limited partnerships institute proceedings against defaulting limited partners, or defaulting limited partners seek to challenge the validity of default provisions in the limited partnership agree‐ment of an exempted limited partnership, Cayman Islands' courts may provide greater certainty in such matters.

A general partner may resist applying previously negotiated default provisions, a position that may or may not be aligned with the interests of the non‐defaulting limited partners. If default provisions were drafted in an economic climate different than today's, the general partner may be more sensitive to defaulting limited partners. However, it was evi‐dent during the recent financial crisis that, instead of applying punitive provisions to limited partners unwilling to uphold their capital commitments, general partners may wish to reduce, excuse, or terminate contributions of limited partners unable to meet their commitments. In particular, where limited partners are able to meet capital calls but, as a result of the current economic climate, are re‐luctant to do so, a general partner may wish to con‐sider restructuring the exempted limited partner‐ship in reliance on the amendment provisions in the limited partnership agreement. Pursuant to such restructuring, the general partner may then make an offer to all limited partners that reflects an ac‐ceptable commercial compromise, as compared to a potentially more draconian approach of imple‐menting all or some of the default remedies availa‐ble to the general partner under the limited part‐nership agreement. Limited partners may seek to bring a derivative action against the general partner to bring claims against the defaulting limited part‐ners. Those bringing a derivative action may obtain different results under the DRULPA and the EPL as discussed in the "Return of Distributions" section, above.

Part V

Side Letters and Anti‐money Laun‐dering Compliance

The growing use of Cayman Islands entities in pri‐vate equity has sharpened the focus on more than just the differences between Cayman Islands and Delaware limited partnership law. Practitioners are increasingly drafting individual provisions to be con‐strued under law different from the law governing the limited partnership agreement as a whole.

What Constitutes the Agreement? Side Letters, Ancillary, and Amending Agreements

Side agreements between the general partner of a fund and its limited partners have become an in‐creasingly common occurrence. Many limited part‐ners enter into individual side letter agreements with the limited partnership to address regulatory, policy, tax, and other matters that may or may not apply to the other limited partners. Certain side let‐ter provisions may affect the economic relationship between the particular limited partner and the li‐mited partnership by, for example, reducing the management fee, extending enhanced information rights, or granting the limited partner a seat on the limited partner advisory board in exchange for its substantial commitment.

Each of Delaware and Cayman Islands common law recognizes the integration of ancillary or amending agreements to form the entire limited partnership agreement. Delaware's Revised Uniform Limited Partnership Act (DRULPA) goes so far as to allow amendments without the vote or approval of cer‐tain limited or general partners.61 Unless the limited partnership agreement provides otherwise, which it


usually will do, Cayman Islands law does not permit the general partner and one or more of the limited partners to change the material terms and condi‐tions of the limited partnership agreement without the consent of all other partners.

The principle that a limited partnership agreement of an exempted limited partnership may not be un‐ilaterally varied is encapsulated in the Partnership Law which states that:

The mutual rights and duties of partners whether ascertained by agreement or de‐fined by this Law, may be varied by the con‐sent of all partners, and such consent may be either express or inferred from a course of dealing.62

The Partnership Law (with the exception of certain sections) is applicable to exempted limited partner‐ships in addition to the Cayman Islands Exempted Limited Partnership Law (2010 Revision) (EPL).

However, as a matter of practice, a limited partner‐ship agreement for a private equity fund will usually contain an amendment provision that permits the general partner to make minor or ministerial amendments to the limited partnership agreement without limited partner consent in certain circums‐tances. In addition, a limited partnership agreement will usually contain an amendment provision that permits substantive amendments to be made upon the receipt of the consent of a specified percentage of limited partners to such amendments, as stipu‐lated in the amendment procedure prescribed in the limited partnership agreement. Any amend‐ments effected pursuant to the amendment me‐chanism stipulated in the limited partnership agreement may then be implemented subject to compliance with the terms of the limited partner‐ship agreement and any necessary formalities, such as an amendment and restatement of the limited partnership agreement or the execution of a deed of amendment.

When a general partner of an exempted limited partnership suggests or facilitates amendments to a limited partnership agreement, the general partner must, and notwithstanding the language of the li‐mited partnership agreement, have regard to its fiduciary duties in causing or facilitating any amendments. In addition to the statutory fiduciary duty that a general partner has to act at all times in good faith in the interests of the partnership, there is English common law authority for the notion that where a power of unilateral variation of a contract is exercised, the power should not be exercised in a manner that is dishonest, for an improper purpose, capricious or arbitrary, or in a way that no reasona‐bly acting person would exercise.63 Accordingly, a general partner should still think before it acts, even where there is license in the limited partnership agreement to make changes without investor con‐sent. This includes entering into a side letter with a limited partner that varies, alters, or supplements the limited partnership agreement solely with re‐spect to that particular limited partner.

The key focus of any analysis regarding the enfor‐ceability of a side letter between the general part‐ner of an exempted limited partnership and a li‐mited partner is whether there is express authority in the limited partnership agreement permitting the general partner or the exempted limited partner‐ship to enter into side letters with individual limited partners, which will have the effect of establishing rights under, or altering or supplementing the terms of, the limited partnership agreement.

In practice, limited partnership agreements in the context of private equity will typically include a pro‐vision empowering the general partner to enter into such side letters and also include an acknowledge‐ment by all partners that any such side letter, if en‐tered into by the general partner with a limited partner, shall bind the general partner and the ex‐empted limited partnership and be applicable to such limited partner notwithstanding any provisions in the limited partnership agreement to the con‐


trary. The inclusion of such a provision in the limited partnership agreement, carefully drafted so that the general partner does not have to solicit the consent of any limited partner to enter into such a side let‐ter, will enable the general partner to agree to terms with a particular investor that are applicable solely to that investor without having to go through a process of amending the entire limited partner‐ship agreement. The inclusion of such a provision in the limited partnership agreement will not in any way abrogate the general partner’s overriding sta‐tutory fiduciary duty to act in good faith in the in‐terests of the limited partnership as a whole, and such fiduciary duty must be borne in mind by the general partner in agreeing to alternative terms or amending or supplementing provisions of a limited partnership agreement for a specific limited part‐ner.

In some cases, the limited partnership agreement for an exempted limited partnership will incorpo‐rate side letters by reference and stipulate that they form part of the limited partnership agreement. Caution must be exercised in this regard in that if such side letter is not governed by Cayman Islands law, this may give rise to uncertainty as to whether the contracting parties are therefore purporting to have the exempted limited partnership governed by a law other than Cayman Islands law. As the limited partnership agreement is the constituting instru‐ment for an exempted limited partnership, by defi‐nition it must be governed by Cayman Islands law.

Even where a side letter is entered into by a general partner with a limited partner and is not incorpo‐rated into the limited partnership agreement by reference, and whether governed by Cayman Isl‐ands law or not, the general partner should ensure that it has authority under the limited partnership agreement to enter into such side letter.

To the extent that a limited partnership agreement does not give the general partner or the exempted limited partnership express authority to enter into side letters, then the general partner should ensure that any side letter entered into is entered into by

the general partner in its personal capacity, rather than in its capacity as general partner of the ex‐empted limited partnership. In addition, the general partner should ensure that the side letter in ques‐tion is not inconsistent with, or is not designed to attempt to amend or alter, any provision of the li‐mited partnership agreement and, quite fundamen‐tally, that by contracting on the terms contem‐plated by the side letter, the general partner will not violate its statutory fiduciary duty to act in good faith in the interests of the exempted limited part‐nership.

There have been no rulings by the Cayman Islands courts on the enforceability of side letters. They are frequently used in the context of private equity fund formation and this is why it is important for the requisite authority for a general partner to en‐ter into side letters to be built into the limited part‐nership agreement from the start. Such forward planning should enable a general partner to avoid potential breaches of contract and/or unenforcea‐bility issues and should also ensure that it acts with‐in parameters that will not give rise to a breach of contract and a breach of its fiduciary duties.

An option increasingly seen in the marketplace is the use of U.S. state (i.e., New York‐ or Delaware‐governed) side letter agreements coupled with li‐mited partnership agreements governed by the EPL. Such agreements have not, to the authors’ know‐ledge, been judicially challenged. It is not clear that a Cayman Islands court would agree to interpret a particular portion of the overall agreement under one jurisdiction and the remainder under another in particular since, as the constituting document for an exempted limited partnership, the limited partner‐ship agreement for an exempted limited partner‐ship must be governed by Cayman Islands law. This is a question that can only be resolved through the final determination by a court of competent juris‐diction. Until that time, use of this approach may leave the parties with some uncertainty and risk, in particular where side letters governed by foreign law are incorporated by reference into the ex‐


empted limited partnership’s limited partnership agreement.

AML Compliance

AML and the control of the flow of money from ill‐gotten gains is an ever‐increasing focus of the regu‐latory regimes of the world’s financial centers. After September 11, 2001, it became increasingly impor‐tant to stop the flow of money to groups supporting terrorism. This drew the focus of the international community to offshore financial centers as the pre‐sumed locus of money laundering activity.

The Cayman Islands has been continuously streng‐thening its AML regime, culminating with The Proceeds of Crime Law, 2008 (PCL) and the accom‐panying Money Laundering Regulations (2010 Revi‐sion) (Regulations). The PCL and the Regulations are supported by the Guidance Notes on the Prevention and Detection of Money Laundering and Terrorist Financing in the Cayman Islands (Guidance Notes), issued by the Cayman Islands Monetary Authority (CIMA). The Guidance Notes do not have the force of law but, further to recent amendments to the Regulations, the Cayman Islands courts will take into account the provisions of the Guidance Notes in determining whether a person has complied with the PCL and the Regulations. With the PCL and the Regulations at the center of its AML regime, the Cayman Islands moved to the forefront of com‐pliance with international AML standards. Com‐pliance with the PCL and the Regulations can create additional hurdles for the U.S.‐based fund manager accustomed to compliance with U.S. AML practice, but such hurdles are not insurmountable.

The PCL applies to all businesses and individuals resident in the Cayman Islands. The Regulations ap‐ply to most financial services entities, including funds not registered under the Mutual Funds Law, on the basis that any person conducting "relevant financial business" must take steps to ensure sys‐tems are in place and are adhered to, to prevent money laundering. The definition of "relevant fi‐nancial business" covers a number of activities. The

activity that will tend to capture both open‐ended funds registered under the Mutual Funds Law and closed‐ended funds such as Cayman Islands private equity funds is the activity of "participation in secur‐ities issues and the provision of services related to such issues." Persons that carry on "relevant finan‐cial business" are referred to in the Guidance Notes as "financial services providers."64 Accordingly, the PCL captures under its purview Cayman Islands do‐miciled private equity funds. The Regulations re‐quire client identification and verification proce‐dures (KYC), recordkeeping procedures, internal reporting procedures, and internal controls.65 The Cayman Islands' AML legislation recognizes that some financial services providers, such as private equity funds, may have to delegate their AML com‐pliance functions to a third party. Such delegation is permissible under Cayman Islands AML legislation, provided that the financial service provider ensures that (1) details of such delegation and written evi‐dence of the suitability of the delegate to perform the relevant compliance functions on behalf of the financial services provider are made available to CIMA on request; (2) there is a clear understanding between the financial services provider and the delegate as to the functions to be performed; (3) the relevant KYC information collected by the dele‐gate will be readily available to CIMA, the financial reporting authority, and law enforcement authori‐ties in accordance with prescribed procedures, on request; and (4) the financial services provider satis‐fies itself on a regular basis as to the reliability of the delegate systems and procedures.

It is very important to note that where the person or institution to whom a financial services provider has delegated its AML compliance functions is lo‐cated in a "schedule 3 country"66 and is subject to the AML regime of that schedule 3 country, CIMA will regard compliance with the AML legislation of such schedule 3 jurisdiction as compliance with the Regulations and Guidance Notes. This ability of a financial services provider, such as a Cayman Islands private equity fund, to delegate to a third party and permit such third party to rely on the AML regime of a country other than the Cayman Islands, pro‐


vided that such country is a schedule 3 country, is critical. However, where a financial services provid‐er is relying on a delegate complying with the AML regime of its own jurisdiction, for the purposes of compiling KYC information on behalf of a Cayman Islands fund, the fund will nonetheless retain ulti‐mate responsibility for ensuring that the fund’s ob‐ligations under the Regulations (and by definition under the PCL and the Guidance Notes) are com‐plied with. Accordingly, a financial services provider that delegates compliance to a third party must en‐sure that it is satisfied that the AML systems and procedures being followed by the delegate (for ex‐ample the investment manager or the general part‐ner on behalf of a partnership) meet the standards prescribed by the legislation of the schedule 3 juris‐diction in question. Failure to do so may cause the fund to breach its obligations under the Regula‐tions.

It should also be noted that even where a Cayman Islands fund has delegated its AML compliance functions to a third party in a schedule 3 jurisdic‐tion, such as the United States, such fund will also need to have a registered office in the Cayman Isl‐ands, and such registered office is also a financial services provider.

As a financial services provider located in the Cay‐man Islands, the registered office of a Cayman Isl‐ands fund, such as a private equity fund formed as an exempted limited partnership, has no option but to comply with the AML legislation of the Cayman Islands. A financial services provider located in the Cayman Islands and having a staff in the Cayman Islands, such as the registered office of a Cayman Islands fund, will be expected to comply with the Cayman Islands' AML regime and will not be able to rely on compliance with the legislation of a sche‐dule 3 country (notwithstanding that the fund for which it is providing registered office may do so).

There can be occasions where the registered office of a Cayman Islands fund is requested by CIMA or another regulatory authority in the Cayman Islands to produce evidence of compliance with its AML

obligations in relation to a fund for which it pro‐vides the registered office. Where, in relation to such a request, the fund in question has delegated its AML compliance function to a third party located in a schedule 3 country and such third party has been complying with the AML legislation in its own country in order to fulfill its responsibility to collate AML due diligence information on behalf of the fund, on occasions, although the relevant systems and procedures adopted by the delegate may be completely satisfactory for the purposes of the AML laws of the delegate’s schedule 3 jurisdiction, such systems and procedures may not be as comprehen‐sive as those prescribed under the Regulations and the Guidance Notes. In such circumstances, the reg‐istered office may need to ask the general partner or directors, as applicable, of the relevant fund to provide the registered office with further AML compliance information, in order to enable the reg‐istered office, in its capacity as a financial services provider falling solely under the ambit of the Cay‐man Islands' AML legislation, to fulfill its obligations.

A solution to any potential mismatch in the extent and nature of document compilation requirements under the Cayman Islands' AML regime and sche‐dule 3 countries such as the United States, is to en‐sure that even where a delegate located in a sche‐dule 3 country is complying with the AML legislation of its own jurisdiction, the fund documentation con‐tains an express agreement by investors to provide additional KYC information where this may be ne‐cessary to enable a financial services provider to the fund, such as its registered office, to comply with AML obligations.

Alternatively, to avoid having to revert to investors for additional KYC information as a result of such requests received by a Cayman Islands financial ser‐vices provider, delegates in a schedule 3 jurisdiction relying on their own AML legislation may wish to bolster their own systems and procedures to bring them in line with the requirements under the Regu‐lations and the Guidance Notes. This will mean that such delegates are essentially complying with the Regulations and the Guidance Notes, to the extent


that there are significant differences between the requirements of their own AML regime and that of the Cayman Islands.

It could be argued that, as a matter of best practice, a fund’s investment manager, general partner, or other delegate conducting AML compliance func‐tions on behalf of a Cayman Islands fund should en‐deavor to ensure that its systems and procedures do not fall short of the requirements under the Regulations and the Guidance Notes.

It should also be noted that in the case of an ex‐empted limited partnership, the general partner is ultimately responsible for ensuring that the ex‐empted limited partnership complies with its obli‐gations under the PCL, the Regulations, and the Guidance Notes. It is therefore in the general part‐ner’s interest to monitor and review the nature and implementation of the exempted limited partner‐ship’s AML policy and systems.

Part VI

Confidentiality

Delaware Confidentiality Law

As discussed earlier in this series, subject to stan‐dards of reasonableness, including a limited part‐ner's right to reasonably demand information for any purpose reasonably related to the limited part‐ner's interest as a limited partner, Delaware's Re‐vised Uniform Limited Partnership Act (DRULPA) enumerates a laundry list of the types of informa‐tion a limited partner has the right to receive.67 The language of a specific limited partnership agree‐ment trumps the statutory provision.

Public disclosure of information about the limited partnership's underlying portfolio investments, as well as information concerning the limited partner‐ship's operations, can be devastating to a limited partnership and its underlying portfolio invest‐ments.

Since disclosure of fund information may cause many potential harms, private equity fund sponsors dramatically limit information required to be dis‐closed to limited partners. If the general partner reasonably believes that (1) information is a trade secret, (2) it is not in the best interests of the li‐mited partnership to disclose information, (3) dis‐closure of information could damage the limited partnership or its business, or (4) information must be kept confidential as required by law or con‐tract,68 the Delaware courts will uphold the confi‐dentiality of such information as between the gen‐eral partner and the limited partner.

Caymans Islands Confidentiality Law

As a general principle, under Cayman Islands law, the disclosure of confidential information by a per‐son pursuant to a right that has been conferred on that person, whether by contract or by statute, or the disclosure of confidential information pursuant to a duty imposed upon a person, for example a statutory obligation of disclosure under the Cayman Islands' AML legislation, will not constitute a breach of duty owed to the party that imparted such confi‐dential information and will not therefore expose the person that has made disclosure to liability.

Criminal Offences Under the CRPL

The key Cayman Islands statute that governs the circumstances in which confidential information may be disclosed is the Confidential Relationships (Preservation) Law (as amended) (CRPL).

The scope of the CRPL is not as wide as may be thought at first blush. The CRPL only applies to "confidential information" relating to "business of a professional nature" that arises in or is brought into the Cayman Islands and further applies to all per‐sons that gain possession of such confidential in‐formation at any time after such confidential infor‐mation came into being, whether such persons are within the Cayman Islands or outside of the Cayman Islands.69


The CRPL provides that "confidential information" includes information concerning any property70 which the recipient of such information is not, oth‐erwise than in the normal course of business, au‐thorized by the person who has provided such in‐formation to divulge.71

The CRPL gives a wide definition to "business of a professional nature" specifying that it "includes the relationship between a professional person and a principal, however the latter may be described."72 The CRPL defines "principal" as a "person who has imparted to another confidential information in the course of the transaction of business of a profes‐sional nature."73 The CRPL gives a very broad defini‐tion to "professional person" and so in addition to capturing, as would be expected, lawyers and ac‐countants, it also covers every type of commercial agent and adviser.74 As the CRPL applies a broad definition to "professional person" and "business of a professional nature", a general partner of an ex‐empted limited partnership will almost certainly fall within the definition of a "professional person" and the CRPL will apply to certain information ex‐changed between the general partner of an ex‐empted limited partnership and its investors. Simi‐larly, an investor in an exempted limited partner‐ship may fall within the definition of "professional person." Accordingly, depending on the circums‐tances, either the general partner or an investor could be the principal who has revealed confidential information to the other party (the general partner or the investor, as applicable) in the course of transacting business of a professional nature.

Why is it important for a person who has received confidential information in a business context to maintain the confidentiality of that information, unless there is a contractual or statutory basis that permits disclosure? The revealing of confidential information contrary to the CRPL constitutes a crim‐inal offence.75

Safe Harbors

The scope of the CRPL is softened by the existence of various circumstances in which confidential in‐formation may be sought, divulged, or attained without committing a criminal offence (each, a safe harbor).76 In particular, the CRPL will not apply to the seeking, divulging, or obtaining of confidential information in compliance with directions of the Grand Court of the Cayman Islands.77

Additionally, the seeking, divulging, or obtaining of confidential information by or to "any professional person acting in the normal course of business78 or with the consent, express or implied, of the relevant principal" will not violate the provisions of the CRPL.79 This safe harbor is particularly important in a private equity context. Ideally, the limited part‐nership agreement and the subscription agreement, and any side letters to the extent relevant, should contain provisions addressing and permitting the disclosure of confidential information by the gener‐al partner and/or the investor in specified circums‐tances. This is important not only to avoid an inad‐vertent violation of the CRPL but also to prevent the necessity of having to seek the consent of a princip‐al at a future point, where the recipient of confiden‐tial information needs to reveal such confidential information but in doing so will not have the pro‐tection of a safe harbor in the CRPL or some other statutory provision under Cayman Islands law.

The CRPL also provides a safe harbor where a per‐son seeks, divulges, or obtains confidential informa‐tion in accordance with any other Cayman Islands law.80

In circumstances where the relevant contract does not confer on a professional person the authority to reveal confidential information that has been im‐parted by a principal, and where a subsequent re‐quest for consent to divulge such information is not


forthcoming, a person who intends or is required to deliver confidential information in evidence in, or in connection with, any proceedings must apply to the Cayman Islands' courts for directions before reveal‐ing such confidential information.81

Recent Developments

There has recently been a significant amount of ac‐tivity in the Cayman Islands in relation to the intro‐duction of new legislation and the amending and updating of existing legislation. The CRPL has not escaped the attention of the lawmakers and there are moves afoot to repeal the CRPL and replace it with a new law governing the disclosure of confi‐dential information.

It is anticipated that new disclosure law will, like the CRPL, regulate the disclosure of confidential infor‐mation and will restate the circumstances in which a person may be required or authorized to disclose confidential information without the express con‐sent of the person to whom a duty of confidentiality is owed. However, it is expected that the new law will differ from the CRPL in that it will not impose criminal sanctions for breach but will instead im‐pose civil sanctions.

In addition, it is anticipated that the new disclosure law will not be limited to "professional persons" as defined in the CRPL and referred to above but will have broader scope and apply to "persons" general‐ly. This will ensure the protection of confidential information of parties that impart such information to another person in circumstances that do not fall within the strict parameters of "business of a pro‐fessional nature" but which still merit confidentiali‐ty. Similarly, any party holding or in pursuit of such confidential information, but who is not a "profes‐sional person," will be able to rely on an applicable safe harbor provision permitting the seeking, divulg‐ing, or obtaining of confidential information in the normal course of business with the express or im‐plied consent of the relevant principal, which would not be permissible under the CRPL given that it only confers protection on a "professional person."

Conclusion

Interpretation of limited partnership agreements governed by the Cayman Islands Exempted Limited Partnership Law (2010 Revision) (EPL) remains grounded in the English common law. Recent revi‐sions to the EPL indicate the Cayman Islands legisla‐ture's willingness to move closer to its roots and the provisions of the DRULPA. In particular, recent revi‐sions to the EPL have enhanced the ability of part‐ners to control their affairs and reflect the commer‐cial terms of their relationship contractually, by placing more reliance on the agreed provisions in the limited partnership agreement. Both the DRUL‐PA and the EPL will continue to provide robust and reliable frameworks for the formation of limited partnerships in a private equity context.

Andrea Cohen is Vice President of Legal Affairs in the San Bruno office of SharesPost, Inc. and Caroline Williams is a partner in, and co‐head of the private equity group of, the Cayman Islands office of Walk‐ers. Matthew Phelan, a former associate in the San Francisco office of Morrison & Foerster LLP, pro‐vided invaluable assistance in the preparation of the article.

1 Section 897 of the Internal Revenue Code of

1986, as amended (Code). 2 See Code § 882. 3 See Code § 514. 4 The Cayman Islands government website

(http://www.gov.ky) states that it does not have a me‐thod of collecting direct tax. Cayman Islands exempted companies may also apply for and receive a certificate from the Governor in Cabinet of the Cayman Islands ex‐empting them from future tax for a period not exceeding 30 years from the date of such certificate, should any direct‐taxation be introduced in the Cayman Islands (§ 6 Tax Concessions Law (1999 Revision)).

5 Under the Joint Stock Companies Act of 1856, a corporation could not, inter alia, alter its organizational documents once they had been enacted apart from changing its name in very limited circumstances and is‐suing new shares, or perform any business that was not


specifically mentioned in its organizational documents (the ultra vires doctrine).

6 6 Del. C. § 17‐1101(c). 7 Prohibitions on limited partner involvement are

much stricter in English common law limited partner‐ships. A limited partner’s ability to withdraw capital and share in profits are restricted, and the number of limited partners is capped at 20. All of these limitations are wa‐tered down or removed under both the U.S. and Cayman Islands models of limited partnership. See Joseph A. McCahery and Erik P.M. Vermeulen, Limited Partnership Reform in the United Kingdom: A Competitive, Venture Capital Oriented Business Form, European Business Or‐ganization Law Review 5, 61‐85 (2004).

8 It has been estimated that currently, between 60 and 80 percent of all hedge funds formed are estab‐lished in the Cayman Islands (most traditional hedge funds will register as mutual funds in the Cayman Islands, see "Applicability of The Mutual Funds Law" above). Data from the CIMA indicates that from 2003 to 2010, the number of mutual funds registered in the Cayman Islands increased by 97 percent, with 9,438 registered as of De‐cember 2010.

9 "(a) A limited partner is not liable for the obliga‐tions of a limited partnership unless he or she is also a general partner or, in addition to the exercise of the rights and powers of a limited partner, he or she partici‐pates in the control of the business. However, if the li‐mited partner does participate in the control of the busi‐ness, he or she is liable only to persons who transact business with the limited partnership reasonably believ‐ing, based upon the limited partner's conduct, that the limited partner is a general partner". 6 Del. C. § 17‐303(a).

10 EPL § 14. 11 6 Del. C. § 17‐607. 12 6 Del. C. § 17‐303(b); EPL § 7(2). 13 EPL § 7(2). 14 6 Del. C. § 17‐303(b). 15 6 Del. C. § 17‐303(b)(10). 16 See id. 17 EPL § 7(3). The Exempted Limited Partnership

(Amendment) Law (2009) added additional safe harbor language relating to limited partners that have existing relationships with the general partner and for limited partners serving on the partnership advisory committee.

18 EPL § 7(4). 19 Under common law, privity was required to en‐

force all contractual claims. England did not allow third parties to enforce contractual claims until the passage of

Contracts (Rights of Third Parties) Act 1999 (UK) and no such act has been passed in the Cayman Islands.

20 6 Del. C. § 17‐101(12). These rights are mirrored in the laws respecting Delaware limited liability compa‐nies and other alternative entities.

21 From John Bouvier's Law Dictionary Revised Sixth Edition (1856): "A deed poll is not, strictly speaking, an agreement between two persons; but a declaration of some one particular person, respecting an agreement made by him with some other person. For example, a feoffment from A to B by deed poll, is not an agreement between A and B, but rather a declaration by A ad‐dressed to all mankind, informing them that he thereby gives and enfeoffs B of certain land therein described". In the case of third‐party indemnity in the Cayman Islands, the deed poll represents the unilateral obligation of the partnership or the general partner, as applicable, to in‐demnify the named persons or entities.

22 Delphi Easter Partners Limited Partnership v. Spectacular Partners, Inc., C.A. No. 12409 (Del. Ch. Aug. 6, 1993), slip op. at 3. (Section 17‐108 defers completely to the contracting parties to create and delimit rights and obligations with respect to indemnification and ad‐vancement of expenses).

23 6 Del. C. § 17‐108. Extreme cases, such as fraud, however, may not be subject to indemnification.

24 Active Asset Recovery, Inc. v. Real Estate Asset Recovery Services, Inc., C.A. No. 15478 (Del. Ch. Sept. 10, 1999), slip op. at 42‐43.

25 6 Del. C. §§ 17‐201(a), (b). 26 EPL § 4(5). A U.S. corporation or limited liability

company (but not a U.S. partnership) can be registered as a foreign company in the Cayman Islands, and thereby qualify to serve as the general partner. This process can take a few days and should ideally be done in advance.

27 6 Del. C. § 17‐204(b). 28 Transferring title to real property is the most

common example but by the general definition, powers of attorney, commissions, patents, and diplomas confer‐ring academic degrees are also deeds.

29 Typically the power of attorney contained in the subscription agreement grants the general partner the power of attorney required to execute the limited part‐nership agreement on behalf of the limited partners; this is why such document is executed as a deed and often called a "deed of adherence". If the power of attorney is contained in the partnership agreement that document must also be signed directly by the limited partner as a deed.

30 EPL § 4 (5). See comment above. 31 6 Del. C. § 17‐201(b).


32 6 Del. C. § 17‐1001. 33 See Litman v. Prudential‐Bache Properties, Inc.,

C.A. No. 12137 (Del. Ch. Jan. 4, 1993) aff'd, 642 A.2d 837 (Del. 1994). For a discussion of the law surrounding the demand requirement of derivative actions, see Levine v. Smith, 591 A.2d 194 (Del. 1991) and Grobow v. Perot, 539 A.2d 180 (Del. 1988).

34 Seaford Funding L.P. v. M & M Assocs. II, L.P., 672 A.2d 66, 70 (Del. Ch. 1995).

35 The meaning of gross negligence in Delaware is well established. See In re Lear Corp. Shareholder Litiga‐tion, 967 A.2d 640, 652 (Del. Ch. 2008) (which in turn cites: Tomczak v. Morton Thiokol, Inc., C.A. No. 7861, 1990 BL 20, at *31 (Del. Ch. Apr. 5, 1990); ("[G]ross negli‐gence means reckless indifference to or a deliberate dis‐regard of the whole body of stockholders or actions which are without the bounds of reason.") (internal quo‐tations omitted); Solash v. Telex Corp., Nos. C.P.A. 9518, 9525, 9528, 1988 BL 27, at *22‐23 (Del. Ch. Jan. 19, 1988) (to be grossly negligent, a "decision has to be so grossly off‐the‐mark as to amount to 'reckless indifference' or a 'gross abuse of discretion'"). (internal citations omitted).

36 The traditional view of British common law, fol‐lowed in the Cayman Islands, can be found in Wilson v. Brett (1843) 11 M&W, 113 ("gross negligence is ordinary negligence with a vituperative epithet"). This was recent‐ly affirmed by the English Court of Appeal in Tradigrain S.A. v. Intertek Testing Services (ITS) Canada Limited [2007] EWCA CIV 154 ("The term gross negligence, al‐though often found in commercial documents, has never been accepted by English law as a concept distinct from simple negligence").

37 There is some debate among local practitioners. While it is universally acknowledged that, from a tort law perspective, there is only one standard of care and the adjective "gross" adds nothing to alter that standard; some feel it is unnecessary and inconsistent to equate "negligence" in indemnification and exculpation clauses with the tort of negligence. If one regards the term "neg‐ligence" as meaning lack of reasonable care, in the ordi‐nary non‐tortious sense, the difficulty of giving meaning to the word "gross", in conjunction with "negligence", disappears. See Hellespont Ardent [1997] 2 Lloyds Rep. 547 ("gross negligence is clearly intended to represent something more fundamental than failure to exercise proper skill and/or care constituting negligence, but as matter of ordinary language and general impression, the concept of gross negligence seems to be capable of em‐bracing not only conduct undertaken with actual apprec‐iation of the risk involved, but also serious disregard or indifference to an obvious risk"). Despite this disagree‐

ment, U.S. practitioners expressly recommend using a Delaware or New York gross negligence standard when drafting a limited partnership agreement governed by the EPL as the safest course of action.

38 6 Del. C. § 17‐702. 39 EPL § 7(7). The following quoted provision re‐

flects the EPL prior to its recent amendment. "No limited partner may, save with the prior written consent of at least one general partner which may be withheld in the sole discretion of such general partner notwithstanding any express or implied term of the partnership agree‐ment to the contrary, assign either absolutely or by way of mortgage the whole or any part of his partnership interest[.]"

40 EPL § 7(7)(a). 41 See, e.g., Salomons v. Laing (1850) 12 Beav 377,

382; 50 ER 1105, 1107; Kalb v. Kantorowicz (1857) 3 K & J 203, 250‐51; 69 ER 1093, 1101‐2; Ferguson v. Wilson (1866) 2 Ch App 77, 90; Russell v. Wakefield Waterworks Co. (1875) LR 20 Eq 474, 477.

42 See generally Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. Fin. Econ. 305 (1976).

43 See In re USACafes, L.P. Litig., 600 A.2d 43, 48 (Del. Ch 1991) ("the principle of fiduciary duty, stated most generally, [is] that one who controls property of another may not, without implied or express agreement, intentionally use that property in a way that benefits the holder of the control to the detriment of the property or its beneficial owner").

44 6 Del. C. § 17‐1101(d). "To the extent that, at law or in equity, a partner or other person has duties (including fiduciary duties) to a limited partnership or to another partner or to another person that is a party to or is otherwise bound by a partnership agreement, the partner's or other person's duties may be expanded or restricted or eliminated by provisions in the partnership agreement; provided that the partnership agreement may not eliminate the implied contractual covenant of good faith and fair dealing". This cuts both ways as well, see Cantor Fitzgerald, L.P. v. Cantor, No. 16297 (Del. Ch. Mar. 13, 2000) (holding that the agreement could impose fiduciary duties on limited partners, and noting the need to instill commitment and discourage competition within a closely held limited partnership in a highly competitive industry).

45 Delaware courts have adopted the Restatement (Second) of Contracts § 205 definition: "[t]he phrase good faith is used in a variety of contexts, and its meaning va‐ries somewhat with [its use]. Good faith performance or


enforcement of a contract emphasizes faithfulness to an agreed common purpose and consistency with the justi‐fied expectations of the other party; it excludes a variety of types of conduct characterized as involving 'bad faith' because they violate community standards of decency, fairness or reasonableness".

46 EPL § 4(3). 47 For the common law fiduciary duties see, e.g.,

Lister v. Stubbs (1890) 45 Ch D 1, Attorney General (Hong Kong) v. Reid [1993] 3 WLR 1143.

48 6 Del. C. § 17‐305. It provides: (a) Each limited partner has the right, subject to such

reasonable standards (including standards governing what information and documents are to be furnished, at what time and location and at whose expense) as may be set forth in the partnership agreement or otherwise es‐tablished by the general partners, to obtain from the general partners from time to time upon reasonable de‐mand for any purpose reasonably related to the limited partner’s interest as a limited partner:

(1) True and full information regarding the status of the business and financial condition of the limited part‐nership;

(2) Promptly after becoming available, a copy of the limited partnership’s federal, state and local income tax returns for each year;

(3) A current list of the name and last known busi‐ness, residence or mailing address of each partner;

(4) A copy of any written partnership agreement and certificate of limited partnership and all amendments thereto, together with executed copies of any written powers of attorney pursuant to which the partnership agreement and any certificate and all amendments the‐reto have been executed;

(5) True and full information regarding the amount of cash and a description and statement of the agreed value of any other property or services contributed by each partner and which each partner has agreed to con‐tribute in the future, and the date on which each became a partner; and

(6) Other information regarding the affairs of the li‐mited partnership as is just and reasonable.

49 For an example of a recent FOIA related inci‐dent, please see Private Equity Wants To Stay That Way, BusinessWeek, Feb. 13, 2006.

50 The J‐curve is used to illustrate the historical tendency of private equity funds to deliver negative re‐turns in early years and investment gains in the outlying years as the portfolios of companies mature. For this reason a fund’s return level is not truly known until the

completion of its investment cycle, often 10 years or more.

51 6 Del. C. § 17‐305(b). It provides: A general partner shall have the right to keep confi‐

dential from limited partners for such period of time as the general partner deems reasonable, any information which the general partner reasonably believes to be in the nature of trade secrets or other information the dis‐closure of which the general partner in good faith be‐lieves is not in the best interest of the limited partnership or could damage the limited partnership or its business or which the limited partnership is required by law or by agreement with a third party to keep confidential.

52 EPL § 12. 53 A general partner is liable for the debts of the

limited partnership regardless of cause. If a general part‐ner has received an improper distribution, creditors may claim such distributions irrespective of the provisions governing limited partners.

54 6 Del. C. § 17‐607(b). 55 6 Del. C. § 17‐502(a). 56 6 Del. C. § 17‐607(c). 57 EPL §§ 4(2), 7(2), and 14. 58 The term "solvent" is not defined in the EPL.

However, the EPL provides in section 2 that "insolvency" of an exempted limited partnership "means that the general partner is unable to pay the debts and obliga‐tions of the exempted limited partnership (otherwise than in respect of liabilities to partners on account of their partnership interest) in the ordinary course of busi‐ness as they fall due out of the assets of the exempted limited partnership (without recourse to the separate assets of the general partner not contributed to the ex‐empted limited partnership)."

59 A partnership agreement may provide that the interest of any partner who fails to make any contribu‐tion that he or she is obligated to make shall be subject to specified penalties for, or specified consequences of, such failure. Such penalty or consequence may take the form of reducing or eliminating the defaulting partner’s proportionate interest in the limited partnership, subor‐dinating the partnership interest to that of nondefaulting partners, a forced sale of his or her partnership interest, forfeiture of that partnership interest, the lending by other partners of the amount necessary to meet his or her commitment, a fixing of the value of that partnership interest by appraisal or by formula and redemption or sale of the partnership interest at such value, or other penalty or consequence. 6 Del. C. § 17‐502(c).

60 Partnership agreements and side letters cannot agree to violate the law. 6 Del. C. § 17‐106(a).


61 "Unless otherwise provided in the partnership agreement, any person may sign any certificate or amendment thereof or enter into a partnership agree‐ment or amendment thereof by an agent, including an attorney‐in‐fact. An authorization, including a power of attorney, to sign any certificate or amendment thereof or to enter into a partnership agreement or amendment thereof need not be in writing, need not be sworn to, verified or acknowledged, and need not be filed in the Office of the Secretary of State, but if in writing, must be retained by a general partner." 6 Del. C. § 17‐204(b).

62 Section 20 of the Partnership Law. 63 Nash and Staunton v. Paragon Finance plc

[2001] EWCA Civ 1466; [2002] 1 WLR 685. 64 Section (1) of the Regulations. 65 Section (1) of the Regulations. 66 Schedule 3 countries are those countries listed

in the Third Schedule of the Regulations, and which are deemed to have AML laws equivalent to the Cayman Islands. A list of such schedule 3 countries may be found on the website for CIMA at http://www.cimoney.com.ky/.

67 6 Del. C. § 17‐305. It provides: "(a) Each limited partner has the right, subject to

such reasonable standards (including standards govern‐ing what information and documents are to be furnished, at what time and location and at whose expense) as may be set forth in the partnership agreement or otherwise established by the general partners, to obtain from the general partners from time to time upon reasonable de‐mand for any purpose reasonably related to the limited partner’s interest as a limited partner:

(1) True and full information regarding the status of the business and financial condition of the limited part‐nership;

(2) Promptly after becoming available, a copy of the limited partnership’s federal, state and local income tax returns for each year;

(3) A current list of the name and last known busi‐ness, residence or mailing address of each partner;

(4) A copy of any written partnership agreement and certificate of limited partnership and all amendments thereto, together with executed copies of any written powers of attorney pursuant to which the partnership agreement and any certificate and all amendments the‐reto have been executed;

(5) True and full information regarding the amount of cash and a description and statement of the agreed value of any other property or services contributed by each partner and which each partner has agreed to con‐

tribute in the future, and the date on which each became a partner; and

(6) Other information regarding the affairs of the li‐mited partnership as is just and reasonable."

68 6 Del. C. § 17‐305(b). It provides: "A general partner shall have the right to keep confi‐

dential from limited partners for such period of time as the general partner deems reasonable, any information which the general partner reasonably believes to be in the nature of trade secrets or other information the dis‐closure of which the general partner in good faith be‐lieves is not in the best interest of the limited partnership or could damage the limited partnership or its business or which the limited partnership is required by law or by agreement with a third party to keep confidential."

69 CRPL § 3(1). 70 Under Section 2 of the CRPL, "property" includes

"every present, contingent and future interest or claim direct or indirect, legal or equitable, positive or negative, in any money, moneys worth, realty or personalty, mo‐veable or immoveable, rights and securities thereover and all documents and things evidencing or relating the‐reto."

71 CRPL § 2. 72 Id. 73 Id. 74 Section 2 of the CRPL provides that "profession‐

al person" includes "a public or government official, a bank, trust company, an attorney‐at‐law, an accountant, an estate agent, an insurer, a broker and every kind of commercial agent and adviser whether or not answering to the above descriptions and whether or not licensed or authorised to act in that capacity and every person sub‐ordinate to or in the employ or control of such person for the purpose of his professional activities."

75 Section 5(1) of the CRPL provides that: "Subject to section 3(2), whoever‐ (a) being in possession of confidential information

however obtained‐ (i) divulges it; or (ii) attempts, offers or threatens to divulge it; or (b) wilfully obtains or attempts to obtain confidential

information, is guilty of an offence and liable on summary convic‐

tion to a fine of five thousand dollars and to imprison‐ment for two years."

76 CRPL § 3(2). 77 CRPL § 3(2)(a). 78 Section 2 of the CRPL defines "normal course of

business" as meaning "the ordinary and necessary rou‐tine involved in the efficient carrying out of the instruc‐


tions of a principal including compliance with such laws and legal process as arises out of and in connection the‐rewith and the routine exchange of information between licensees."

79 CRPL § 3(2)(b)(i). 80 CRPL § 3(2)(c). 81 Section 4(1) of the CRPL provides "Whenever a

person intends or is required to give in evidence in, or in connection with, any proceeding being tried, inquired into or determined by any court, tribunal or other au‐thority (whether within or without the Islands) any confi‐dential information within the meaning of this Law, he shall before so doing apply for directions and any ad‐journment necessary for that purpose may be granted."

a comparison by practitioners of delaware and cayman · in‐depth analysis of delaware and cayman...

Documents