Side letters – Know your rights

A recent case in the Cayman Islands has once again raised the importance of understanding what rights side letters give fund investors, and how those rights can be lost.

Medley Opportunity Fund, Ltd v. Fintan Master Fund, Ltd and Nautical Nominees Limited involved a dispute arising from the terms of a side letter that Fintan and Medley had agreed when Fintan (through its nominee) invested in Medley. The court found that Fintan was not able to exercise its preferential redemption rights under the side letter because:

1. although Fintan had signed the side letter, it was not a shareholder in Medley; rather, Fintan's nominee was the shareholder;
2. the terms of Medley's restructuring made after the date of Fintan's investment and agreed by Fintan's nominee overrode the redemption provisions in Medley's articles – the restructurings were proposed after Medley encountered liquidity issues in 2008. Under the restructurings, investors' redemption rights were limited in return for quarterly distributions of excess cash pro rata to those investors who had agreed to the restructurings. Fintan's nominee was one of the investors that signed documents agreeing to the restructurings of Medley.

So, fund investors take note. Make sure the legal entity that will be registered as the investor signs the side letter. And, review fund restructuring proposals carefully against any preferential terms you have agreed in a side letter to ensure you don't inadvertently give up those rights.

Fund managers also need to be careful when entering into and amending side letters, to ensure that the terms reflect legal and regulatory requirements as well as commercial terms. Hong Kong's Securities and Futures Commission will generally ask fund managers to provide copies of side letters and the disclosures that have been made to fund investors about side letters when the Commission conducts routine inspections.

Key Contacts

Scott Carnachan

Consultant | Financial Services

Email or call +852 2825 9265