The crossover between fraud and insolvency in my jurisdiction - Cayman Islands
10 March 2022
“Whoever commits a fraud is guilty not only of the particular injury to him who he deceives, but of the diminution of that confidence which constitutes not only the ease but the existence of society.” - Samuel Johnson
Fraud and insolvency are inextricably linked and have been since the introduction of the company, becoming particularly visible in times of financial crisis.
The archetype is all too familiar to all of those who practice in the insolvency arena: a fraud is committed, which ultimately leads to the financial status of a company being compromised; the company comes under scrutiny from regulators, investors, shareholders or other stakeholders; debts are ultimately not satisfied; an insolvency appointee takes control of the company.
As the global investment framework evolves, the legislature and the judiciary need to also evolve to deal with the cross-border nature of fraud and fraud involving new types of assets such as virtual assets if the remedies available to insolvency appointees are to be successful.
The Cayman Islands (“Cayman”), as a centre for international investment structures and whose products are often used for novel structures and purposes, is always working to address the needs of insolvency appointees in a fraud context. Old tools are dusted off and applied to new situations to provide certainty for the users. Lacunas in jurisprudence are resolved, taking account of jurisdictional needs. New laws are created to cover new remedies in new situations and new asset classes. The Cayman legislature, regulators, law enforcement agencies, judiciary and financial industry constantly focus on ensuring that the victims of fraud have the best chance possible of recovering the ill-gotten gains from a fraudster. This essay addresses just 3 of the ever-evolving tools which Cayman insolvency appointees dealing with fraud have available to them.
Virtual Assets are Property
Crucial to tackling fraud is the ability to recover assets fraudulently taken from the owner. Any insolvency appointee has statutory rights that work alongside civil remedies to enable them to hunt down and claim property belonging to the estate over which they are appointed. Essential to being able to do so is to show that what has been taken is property that belongs to the estate.
There have been myriad well publicised crypto-currency frauds recently and blockchain data firm, Chainanalysis, asserts there was US$14 billion worth of cryptocurrency subject to fraud in 2021. With fraud on this scale inevitably insolvency will result. In the context of cryptocurrency, non-fungible tokens and other virtual assets establishing that what has been the subject of fraud is property has had its challenges. Various jurisdictions such as England, BVI and Singapore have answered the question in case law for crypto currency but arguably that does not provide the certainty that ideally an insolvency appointee needs when embarking on a trace and recover exercise for a digital asset yet to be the subject of a case.
In the Cayman the Virtual Asset (Service Providers) Act 2020 (“VASP Act”) was passed in May 2020 and introduced a regulatory and licensing regime for the conduct of virtual assets business and those providing services for such business.
The VASP Act gives a definition as follows: “virtual asset” means a digital representation of value that can be digitally traded or transferred and can be used for payment or investment purposes but does not include a digital representation of fiat currencies”.
At the core of the definition are the aspects of transferability and exchangeability, intending to capture activities rather than asset types.
Whilst the definition in the VASP Act does not go so far as to determine that virtual assets are property or determine ownership the existence of a definition of what is a virtual asset under Cayman law, it does enable an insolvency appointee to at least provide a court with a clear indication that digital representations of value in the estate are virtual assets and that Cayman law allows for their identification, trading and transfer, which are hallmarks of something that is property.
Whether virtual assets are property has not yet come before the Cayman courts but much can be gleaned from the judicial development of the matter in England and Wales, which is accepted as persuasive authority in the Cayman courts. The English High Court determined in AA v Persons Unknown  EWCH 3556 that a crypto asset was capable of being classed as property, and, therefore, capable of being the subject of an interim remedy such as a Mareva injunction. This view was subsequently reinforced by ION Science v Persons Unknown (unreported, 21 December 2020).
On the basis of the principles from the cases from England and Wales, which establish the hallmarks of what is property and have been followed in Singapore and BVI, I consider that the VASP law definition of virtual assets will enable a Cayman Court to find the necessary hallmarks exist and virtual assets are property so that any digital representation of value will be able to be considered as property and traced and recovered as such.
Aiding Foreign Insolvency Appointees
Fraudsters do not respect borders; in fact they seek to exploit the existence of borders and the potential barriers they create for law enforcement agencies and insolvency appointees to chase stolen assets. In Cayman the legislature has recognized the need to limit fraudsters ability to hide behind jurisdictional barriers.
Section 11A of the Grand Court Act (2015 Revision) (“11A”) permits the Court to grant interim relief in relation to proceedings which have been or are to be commenced in a court outside of Cayman and which are capable of giving rise to a judgment which may be enforced in Cayman under any Act or at common law.
The ability to grant such interim relief is a vital weapon in any circumstances involving fraud, and is exceptionally useful to foreign insolvency appointees in the circumstances where time is of the essence. Often action is needed before all of the books and records have been found or fully digested or where the full circumstances surrounding the fraud haven’t come to light. Even without enough to fully set out and commence a claim in court these remedies are available and may be what enables the insolvency appointee to access the information needed to launch the claim. The early access also avoids the ready to be commenced claim from coming to the attention of the fraudster before everything has been done to try to prevent the assets which are being chased being moved by the fraudster as soon as it is realized their location is known.
The tools available under 11A are: Mareva Order (otherwise known as a Worldwide Freezing Order, which would otherwise prevent a respondent from dealing with the relevant assets); Norwich Pharmacal Order (or Disclosure Order which would allow the applicant to seek information from third parties in relation to the movement of particular assets) and Banker’s Trust Order (usually made against banks, exchanges or other entities which either hold the misappropriated or stolen assets or through whom such assets have passed).
The judiciary has also recently confirmed that in Cayman the Norwich Pharmacal Order is available to aid foreign proceedings and not excluded by statutes dealing with obtaining evidence for foreign proceedings thereby departing from cases from England and Wales but concurring with the BVI Judicial view (see Essar Global Fund & Essar Capital Fund v ArcelorMittal USA LLC (unreported, CICA (Civil) Appeal 15 of 2019).
Laws Governing Debts
Given the notable surge of recent cases involving the Gibbs rule (explained below) I felt a look at the key principles was germane to the subject of this essay as the venerable Gibbs rule is being questioned as to whether it is fit for purpose after 130 years.
Fraudsters know well the barriers that arise when a victim of fraud has to pursue the assets through multiple legal systems. An insolvency appointee dealing with a fraudster needs to be confident that any arguments over discharge of debts which can be a feature of fraud (e.g. it is argued that the ill-gotten gains legally belong to the fraudster as they were to satisfy a debt) will be determined under an easily ascertainable law. In Cayman, the Gibbs rule applies so the insolvency appointee can be confident that a Cayman law debt can only be analysed under Cayman law.
The Gibbs rule is named from the case in which it was formulated: Antony Gibbs & Sons v La Société Industrielle et Commerciale des Métaux (1890) LR 25 QBD 399) and states that, the proper law of a debt governs how it may be extinguished so that English law debt may only be discharged under English law.
In a recent ruling in the English Court of Appeal (Bakhshiyeva v Sberbank of Russia  EWCA Civ 2802) the Gibbs rule has come under some criticism. The case involved the OJSC International Bank of Azerbaijan (IBA) which was going through a voluntary restructuring in Azerbaijan, however some of the creditors’ debts were English law governed and those creditors had neither participated in the restructuring nor submitted to the jurisdiction of the Azerbaijani court. Pursuant to the Gibbs rule the claims governed by English law could not be discharged or altered by the Azerbaijani proceedings. The Court cited the Supreme Court’s ruling in Rubin v Eurofinance SA  UKSC 46 which held that the principle of universalism could not be used to justify the disregard of English law to assist a foreign insolvency process.
Although, courts have recently upheld the Gibbs rule in England and Hong Kong it was recently rejected in Singapore in Pacific Andes Resource Development ( SGHC 210).
The difficult thing about the Gibbs rule is that it is helpful for the insolvency appointee chasing a fraudster who has set up contracts and loans as a way to seek to justify the appropriation of assets but less helpful to the insolvency appointee trying to deal with an insolvency involving creditors from many jurisdictions whose claims are sought to be compromised.
Cayman, Insolvency and Fraud
As many will know ever since the making of the film ‘the Firm’ in Cayman, Hollywood has continued to portray Cayman as the place the bad guys send the money. If that were actually true then the victims of fraud would have a pretty easy time getting their money back! Having said that, Cayman, as an important part of the global financial system, is a jurisdiction that will, alongside all the other major financial hubs, see its share of entities and transactions that are connected to fraud. The highly sophisticated and ever developing insolvency resources and tools, as well as tools available to foreign insolvency appointees, in Cayman make the jurisdiction a leader in the fight against international fraudsters.
This article was first published with ThoughtLeaders4 FIRE Essay Competition Magazine. Read more here.