Cell companies in Guernsey
10 June 2013
This briefing provides a summary of the main provisions of Guernsey law relating to protected and incorporated cell companies.
Guernsey was the first country in the world to introduce legislation permitting the formation of cell companies through the Protected Cell Companies Ordinance 1997. The concept of the incorporated cell company was introduced in Guernsey through the Incorporated Cell Companies Ordinance in 2006. Both of those ordinances have now been consolidated into the Companies (Guernsey) Law, 2008, as amended (the "Companies Law").
Protectected Cell Companies
A Guernsey Protected Cell Company ("PCC") is a single legal entity. It is one company with one board of directors, one share capital and one memorandum and articles of incorporation.
A PCC comprises a "core" and any number of cells. Those cells can be created simply by a resolution of the board of directors of the PCC.
The key issue which differentiates a PCC from a traditional (non-cellular) company is the segregation of its assets. A PCC is able to limit its liability in respect of a particular contract to a specified pool of assets rather than exposing all of the assets of the PCC, as would be the case with a non-cellular company.
When a PCC contracts, the directors must specify in the contract which particular pool of assets is to be bound by the obligations under that contract. That pool of assets may comprise a particular cell or the core of the PCC. By default, any liability not attributable to a particular cell of a PCC automatically attaches to the core. However, if the directors intend a transaction to be made in respect of a particular cell or the core but fail to specify that cell or the core in the relevant contractual documentation then the directors incur personal liability in respect of that transaction although there is a right of indemnity out of the core assets.
The crucial protection which the Companies Law affords creditors of a PCC is that losses in one cell of a PCC do not affect profits in another cell. If the PCC is unable to satisfy the liabilities it owes to a creditor, out of the assets of a particular cell, that creditor is not entitled to have recourse to the assets of other cells.
A PCC is a single legal entity, accordingly, each individual cell is not a separate legal entity. Therefore the cells of a PCC cannot contract with each other and a cell cannot contract with the core of the same PCC. These issues can be resolved by interposing a company (for example, a subsidiary of the PCC in question) which is able to contract with both cells or the cell and the core to achieve the same economic outcome as would have been the case were those cells able to contract with each other or were the cell in question able to contract with the core. Of course, cells of two different PCCs can contract with each other.
The Companies Law does not dictate how the share capital of a PCC must be structured. However, traditionally the share capital of a PCC would be divided into ordinary or management shares in respect of the core and unclassified shares in respect of the cells. The ordinary or management shares would often carry voting rights at general meetings and the unclassified shares would be available for issue as cell shares, often as redeemable shares with no voting rights.
The shares issued in respect of each cell of the PCC constitute a separate class of shares. Accordingly, although those cell shares may not have voting rights at general meetings they do have class rights which must be observed and can only be varied with the consent of the holders of that class of shares.
An insurance company structured as a PCC would usually issue at least £100,000 in core shares in order to meet the minimum capital requirement imposed on Guernsey licensed insurers under the Insurance Business (Bailiwick of Guernsey) Law, 2002 (the "Insurance Law"). Capitalising the core in this way saves having to individually capitalise each cell. Conversely, collective investment schemes structured as PCCs tend to have a very small issued share capital in their core, often comprising only two management shares of £1 each. Cell shares are issued to investors meaning that each cell may have an issued share capital of several million pounds.
Availability of PCCs
When originally introduced PCCs were only available to licensed insurance companies and collective investment schemes and, not surprisingly, these remain the two most popular uses for PCCs. Currently a closed-ended or open-ended collective investment scheme, a licensed insurer or any other company whose affairs are administered by a licensed person in Guernsey may be established as a PCC. However, a PCC may not be a licensed insurance manager or intermediary, a bank, a licensed fiduciary or a person licensed to conduct controlled investment business under the Protection of Investors (Bailiwick of Guernsey) Law, 1987. The consent of the Guernsey Financial Services Commission is required for the formation of or conversion into a PCC.
Changes to the law: 1 May 2006
On 1 May 2006 certain changes were made to the law applicable to PCCs in Guernsey which are worthy of note.
Prior to 1 May 2006 if the assets of a particular cell were exhausted, a creditor of that cell was entitled to recourse to the core assets of the PCC in order to meet any unsatisfied liabilities. It was common practice in Guernsey for creditors' rights of recourse to the core assets to be excluded by agreement in any relevant contractual documentation. However, it could also be useful for the PCC to be able to rely on the core assets in this way and many insurance companies relied upon this "default" liability provision in order to ensure that they met minimum capital and solvency requirements under the Insurance Law.
After 1 May 2006, as a result of changes to the PCC legislation brought into force on that date, the opposite presumption applied. That is to say, a creditor of a cell of a PCC could not have recourse to the assets of the core of the PCC unless this had been specifically agreed between the PCC and that creditor. In the absence of explicit agreement creditors' rights were limited to the assets of the relevant cell. The idea behind the changes was to strengthen the integrity of the limited liability of cells and to prevent any accidental leakage in the structure by unintentionally exposing the core to liability.
The amendments on 1 May 2006 also introduced a special arrangement known as a recourse agreement whereby assets of the PCC, other than the assets of the cell in respect of which a contract was made, could also be exposed to liability in respect of that contract. For example, if a creditor is contracting with Cell A it is possible under a recourse agreement for the assets of Cell B or the assets of the core to be exposed to liability to that creditor to the extent that the assets of Cell A are insufficient to discharge its liabilities. A recourse agreement requires a special resolution of the holders of shares of the relevant pool of assets i.e. cell shareholders where the assets of the cell are to be exposed or the core shareholders where the assets of the core are to be exposed. In addition, the directors of the PCC must make a declaration that no creditor would be prejudiced by the recourse agreement. The economic effect of these recourse agreements is almost as if cells were able to contract with each other and so the difficulties which have sometimes been encountered as a result of the cells inability to contract with each other have to some extent been overcome.
Incorporated Cell Company ("ICC")
The ICC is based on the same principles as the PCC: segregation of assets and limited recourse of creditors to those assets in respect of liabilities owed by the ICC. An ICC comprises the ICC itself and any number of incorporated cells. Unlike cells in a PCC, each incorporated cell of an ICC is a separately registered legal entity (as is the ICC itself). Each incorporated cell has its own board of directors (albeit that pursuant to the Companies Law the composition of the board of each incorporated cell must be identical to the composition of the board of the ICC), its own share capital, its own memorandum and articles of incorporation and its own accounts.
The rationale behind the creation of the ICC was to provide additional protection to creditors. Since each incorporated cell is a separately registered legal entity the segregation of assets within the ICC is strengthened. The fact that each incorporated cell is a separate legal entity also provides greater flexibility in relation to the ability to convert, migrate and amalgamate incorporated cells.
Like a PCC, the consent of the Guernsey Financial Services Commission is required for the formation of and conversion into an ICC. The formation of an incorporated cell requires a special resolution of the shareholders of the ICC of which that incorporated cell will form part.
When a contract is made with an ICC it may be made with the ICC itself or with the relevant incorporated cell. Unlike a PCC, contracts can be made directly with the incorporated cell itself. The ICC has no power to bind any of its incorporated cells. It is possible for the ICC to own shares in one of its incorporated cells, but an incorporated cell is prohibited by the Companies Law from owning shares in the ICC.
As a consequence of each incorporated cell being a separately registered legal entity, incorporated cells can contract with each other. Consequently there is no equivalent of the recourse agreement in respect of ICCs.
There are a range of conversions possible with PCCs and ICCs. The process to effect a conversion is the same regardless of the particular transaction being considered: the consent of the Guernsey Financial Services Commission is always required as well as a special resolution of the shareholders of the entity which wishes to convert.
The conversions which are possible are:
- a non-cellular company may convert into a PCC;
- a non-cellular company may convert into an ICC;
- a PCC may convert into an ICC;
- an incorporated cell may convert into a non-cellular company;
- an incorporated cell may transfer from one incorporated cell company to another;
- a non-cellular company may convert into an incorporated cell and transfer to an ICC;
- a PCC may convert into a non-cellular company; and
- incorporated cells of an ICC may be subsumed into their ICC and subsequently converted to a non-cellular company.
Notably, an ICC cannot convert directly into a PCC and a non-cellular company cannot convert directly into a cell of a PCC.
Since incorporated cells are separately registered legal entities they are able to take advantage of Guernsey's migration and amalgamation legislation giving them the freedom to become registered in other jurisdictions and to amalgamate with other entities within and beyond Guernsey. This would not be possible with cells of a PCC because they are not separately registered legal entities.
Common uses for PCCs and ICCs
The PCC is often used and indeed, was originally introduced, to enable Guernsey licensed insurance managers to offer cells to third parties as rent-a-captives. In those circumstances, the core of the PCC is owned by and capitalised by the local insurance manager. The cell can be offered to a client to write an insurance contract for that client's benefit. Shares in the cell are issued to that client in order that the client has an economic interest in the cell and can benefit from any profits accruing from the business written. The cell will often reinsure its liabilities into the reinsurance market.
Both PCCs and ICCs are commonly used as umbrella investment funds with each cell being used as an investment vehicle for different asset classes.
The PCC is also often used in insurance transformer transactions whereby the cell of a PCC writes a derivative contract such as a credit default swap and the liability of the cell under that derivative contract is insured by an insurance company. The transformer provides the insurance company with exposure to a more varied form of investment product (the derivative) but through its traditional business method, the writing of an insurance policy.
The general insolvency provisions under the Companies Law apply equally to PCCs and ICCs. A PCC can be wound up in the same way as a non-cellular Guernsey company. However, on the winding up of a PCC the liquidator must observe the special nature of the PCC. Since each cell of the PCC is not a separate company it cannot be independently wound up. Consequently, there are two other insolvency procedures applicable to cells of a PCC:
Administration: administration is available to non-cellular companies, PCCs, cells of PCCs, ICCs and incorporated cells. This process is only available if the company or cell is insolvent and the court considers that the making of an administration order may achieve the survival of the company or cell or the more advantageous realisation of its assets.
Receivership: receivership is only available in respect of cells of a PCC. This process is only available where the assets of a cell are likely to be insufficient to discharge the claims of creditors of the cell and the making of a receivership order by the court will result in the more orderly winding-up of the business of the cell and the distribution of its assets to those entitled to have recourse thereto.
Notably, both of these processes are only available where the body in question is or is likely to become insolvent. A solvent entity cannot avail itself of these processes. It is for this reason that most cells of a PCC issue redeemable shares so that, upon the conclusion of the business written by the cell, a solvent cell can be wound up through the redemption or repurchase of the issued redeemable shares.
Unlike a cell of a PCC, an incorporated cell can be wound-up just like a non-cellular Guernsey company.
If a cell of a PCC is unable to pay its debts, technically the PCC as a whole is unable to pay its debts and a creditor of that cell could apply to wind up the entire PCC because the PCC is a single legal entity. However, on any application to the Guernsey court to wind up a PCC on the basis that one of its cells is unable to pay its debts the Guernsey court would refuse to order the winding up of the PCC as a whole in recognition of the nature of a PCC.
Nonetheless, it is common for contractual documentation relating to PCCs to provide that in the event that the assets of a particular cell become exhausted any rights of the creditors against that cell are extinguished and any right of that creditor to petition for the winding up of the PCC is excluded.
Proposed amendments to the Companies Law
On 28 November 2012, following consultation, the States of Guernsey approved a report setting out proposed amendments to the Companies Law and directed the preparation of legislation to effect such changes.
Proposed changes potentially affecting PCCs and ICCs include:
- removal of the restriction on types of bodies corporate that can amalgamate (currently a PCC can only amalgamate with another PCC);
- that individual cells of PCCs or ICCs should be able to be audit exempt;
- that a PCC need not prepare consolidated accounts for its core and its cells and may prepare them individually;
- that section 437(1)(a) be amended to confirm that registered (in addition to authorised) collective investment schemes are eligible to be PCCs; and
- permitting conversion of a PCC cell to a stand-alone company.
It is not yet known when the revised legislation will come into force.