The Privy Council recently upheld a decision that a hedge fund manager had not acted dishonestly or improperly when it failed to accurately describe to its client, the structure of its fund, and the way in which their client’s investments were being leveraged (Al Sadik v Investcor Bank (“Investcorp”).
In March 2018, at the onset of the global financial crisis, Mr Sadik invested approximately US$130 million with Investcorp in one of their Cayman Island hedge funds. The investments were leveraged by transferring Mr Sadik’s funds to a special purpose vehicle (“SPV”) in accordance with the share purchase agreement (the “SPA”), that provided for broad administrative steps in how the investments were managed. Unfortunately, the leveraging increased the losses Mr Sadik incurred and when he redeemed his investment in December 2009, he had sustained a heavy loss of over 40% from his original investment.
In light of these substantial losses, Mr Sadik sued Investcorp alleging a number of claims, amongst them:
- fraudulent misrepresentation;
- unauthorised leveraging; and
- breach of trust.
All of the claims were rejected by the Cayman Islands Court of Appeal and Grand Court. Nevertheless, Mr Sadik appealed to the English Privy Council claiming breach of contract in relation to the SPA governing the terms of his investments with Investcorp, in particular arguing;
- that the transfer of his shares to the SPV was not permitted under the SPA; and
- that the permitted method of leveraging his funds under the SPA had been breached.
Despite Mr Sadik alleging that he was not made aware that his portfolio would be leveraged, the Privy Council held that Investcorp’s initial proposal to Mr Sadik and the terms under the SPA made it clear that leveraging could be used, even though the exact method of leveraging was not specified.
Mr Sadik argued that while the SPA did provide for leveraging it did not permit Investcorp to transfer the funds to the SPV by way of share purchase, as this was not a permitted method of leveraging under the SPA. Mr Sadik explained that the payment to the SPV by way of a share purchase was an investment, and as the SPV was not a hedge fund within the SPA, the investment was unauthorised. The Privy Council disagreed, holding that the terms of the SPA were general enough to allow Investcorp to transfer the funds in that way, with the SPA containing the following wording:
“the Company’s board of directors will authorise or otherwise cause the Company to take any actions that the board believes are necessary or desirable in order to effectuate the purposes of this investment.”
The Privy Council therefore held that:
- the powers of Investcorp were described broadly by reference to the purpose of the fund, and therefore, the way they were invested was not relevant; and
- leveraging the shares and transferring the funds to the SPV was considered an authorised administrative step, rather than an investment for the achievement of the purposes of the leveraging.
This will provide some relief to investment managers as the courts have shown that they will not entertain attempts to recover losses as a result of poor investment performance, rather than negligent or wrongful conduct by the manager.
Nevertheless, investment managers are reminded to ensure that the terms of their relationship with their clients are clearly set out in their investment management agreements, and any other relevant documents and/or policies. The details of specific fund structures should be provided for to reduce the risk of future misunderstanding. Where any changes to the fund structure are required, this should be communicated effectively and clearly to your clients to ensure they are kept sufficiently informed, and that your duties as a manager are maintained.
For more information on drafting and negotiating your fund documentation and/or investment management agreements, Cleveland & Co external in-house counsel, your specialist outsourced legal team are here to help.