Extracting value from your Cayman Islands company: returning capital and sharing profits

March 2014 | EXPERT BRIEFING | BANKING & FINANCE

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Whilst investors are clear as to the benefits of using a Cayman Islands Exempted Company (‘Company’) as an investment vehicle, they are not always aware of the options available to them for taking money out. As the Company is a legal entity there are formalities to follow and established legal rules about getting both income (profits) and capital out of a Company. Failure to follow the rules could in certain circumstances result in criminal proceedings for the Company and/or its directors, so it is important to know the rules and to follow them. Here we look at what options are available to directors on distributions, dividends and repayment of capital to shareholders.

Why can’t I just declare a dividend of capital?

Under common law rules in the Cayman Islands, a Company’s capital may not be returned to its shareholders except under procedures which safeguard the interest of creditors. This ‘capital maintenance rule’ provides, broadly, that share capital of a Company cannot be returned to shareholders except on a winding up of the Company or pursuant to a lawful repurchase or redemption of shares.

So what do I need to do?

Provided the Company is solvent, there are four ways available for directors to return funds to shareholders: a dividend out of profits; a share repurchase or redemption; a distribution out of a share premium account; and a Court approved share capital reduction. In every case directors need to be certain that once capital has been returned to shareholders, the Company is solvent on a cash flow basis (i.e., able to pay debts as they fall due in the ordinary course of business). If the directors breach the requirement for solvency they and the Company may face criminal proceedings and personal liability.

Dividend out of profit

The Cayman Islands Companies Law (2013 Revision) (‘Companies Law’) does not provide a definition of ‘profit’, nor does it set out rules on how to calculate profit to pay a dividend. Instead, Cayman directors have a great deal of flexibility in deciding if and when to pay a dividend, and in setting its amount. The common law rules which they need to follow allow a company to pay dividends out of profits available for the purpose. Directors still need to take practical and prudent steps, such as checking the Articles of Association (‘Articles’) for any limits on or rules governing the board’s power to declare and pay dividends. Most importantly, directors also need to be certain that the Company does not need the money being used to fund the dividend payments to meet its obligations and pay its debts. Directors could be personally liable if they declare and pay a dividend when they should not.

Share repurchase

Under the Companies Law, a Company can buy back its own fully paid-up shares provided that: it has sufficient funding available; the buy-back leaves at least one remaining member; and the purchase and the manner in which the purchase is conducted are authorised by the Company (either by the Articles or a shareholder’s resolution). Once again, the directors must be satisfied that the Company will be able to pay its debts as they fall due in the ordinary course of business immediately after it pays for the share repurchase.

A buy-back has no effect on the authorised share capital of the company, but shares which are bought back are generally treated as cancelled, and once the repurchase is complete, the Company’s issued share capital is reduced by an amount equal to the par value of the repurchased shares.

A buy-back may be funded out of profits, the proceeds of a new share issue, out of share premium account or out of capital (provided always that the Company will remain able to meet its debts as they fall due) or a combination of these funding methods.

Very similar rules to those outlined above also apply to a redemption of shares by a Company.

Distribution out of share premium account

‘Share premium’ is the amount a shareholder pays in excess of the share’s par value. So, if a shareholder subscribes for one share having a nominal or par value of US$1 at a subscription price of US$100, US$1 represents share capital and the remaining US$99 represents the share premium. This premium element must be credited to the Company’s share premium account. Subject to the provisions, if any, of the Company’s Memorandum and Articles, a Company is able to apply its share premium account to pay distributions or dividends to shareholders under the Companies Law. As with the other methods of returning funds to shareholders, directors need to be prudent and have a good level of certainty that the Company will be solvent, on a cash flow basis, immediately following the payment of the distribution or dividend, as there are significant criminal sanctions for directors who knowingly and wilfully make a distribution or pay a dividend in contravention of that restriction.

Court sanctioned share capital reduction

Provided the Articles allow, the amount of capital held by a Company can be reduced by returning capital pursuant to the authority of a special resolution of its shareholders. Once the special resolution is passed the Company petitions the Court to ask it to confirm the resolution. That starts a process which allows creditors identified by the Court to object to the capital reduction, and for the Court to make directions as it sees fit. This is a rarely used option given that it involves Court time and the associated expense.

Directors could be personally liable if they declare and pay a dividend when they should not. They must also take reasonable steps to ensure that they do not deliberately or knowingly misuse capital, as this can give rise to criminal liability for them and the Company. Directors should adopt a prudent approach to assessing the general financial condition of the Company, its solvency, working capital requirements and actual and prospective expenses and liabilities.

Overall, it is always important to remember that a shareholder’s capital in a Company is nothing like holding funds in a bank deposit account and cannot be returned without going through certain legal steps which are principally designed for the protection of creditors. Directors ignore these steps at their peril.

Paul Scrivener is a partner and Simone Proctor is a senior associate at Solomon Harris. Mr Scrivener can be contacted on +1 345 949 0488 or by email: pscrivener@solomonharris.com. Ms Proctor can be contacted on +1 345 949 0488 or by email: sproctor@solomonharris.com.

Paul Scrivener and Simone Proctor

Solomon Harris