While the vast majority of Cayman Islands fund finance deals concern funds formed as exempted limited partnerships (ELPs), the ELP is not the only show in town! Every year we see a handful of Cayman Islands unit trusts popping up in fund finance transactions as feeders or main borrowers. Unit trusts have always been popular with certain Japanese investors, but they are not a regional curiosity: sponsors use them in other circumstances where investors prefer a trust to a partnership, and lenders are now regularly asked to lend against investors’ capital commitments to them.
A lender or lawyer brought up on limited partnerships alone may be tempted simply to change a few names in the usual checklist and move on – but unfortunately it isn’t quite that simple! Like any good relationship, a subscription finance deal depends on trust and commitment, but when dealing with a unit trust each of those words means something slightly different!
This article focuses on the role of the trustee, where call rights sit and how the security package is built around them.
What is a unit trust?
A unit trust is a trust under which a trustee holds a pool of assets for investors whose beneficial interests are divided into units. It has no separate legal personality: the trustee holds legal title and contracts for the trust, and a manager usually runs the investment programme. The terms are set out in a trust deed, typically entered into unilaterally by the trustee.
Unit trusts and ELPs: similarities and differences
The two structures share a starting point. Neither an ELP nor a unit trust has separate legal personality, and each acts through a person in a particular capacity (the general partner or the trustee), who must sign in that capacity. The structures differ, however, in two critical respects.
Unitholders are not parties to the trust deed
The first is that unitholders are usually not parties to the trust deed. An LPA is a contract among the partners, so a limited partner's obligation to contribute capital arises under the LPA. A trust deed sets the terms on which the trustee holds the trust property, and unitholders are its beneficiaries rather than counterparties. The unitholder's obligation to fund comes from its subscription agreement, which will usually cross-refer to the terms of the trust deed.
The trustee is not a general partner
The second difference is less visible in the documents but just as important in practise: who (or what) the trustee actually is. In a partnership, the general partner is usually a sponsor affiliate with an economic stake in the fund and a commercial interest in making the financing work. The trustee of a Cayman unit trust, however, is typically an independent, licensed trust company, paid a fee to hold legal title and act on proper instructions. Understandably, in these circumstances, trustees are very particular about including their limited-recourse wording in every transaction document, confining the lender's claims to the trust assets.
Who holds the call?
Because the trustee does not want to run the fund, trust deeds typically delegate widely to the manager, and the trustee acts on the manager's direction. The lender's diligence must follow that delegation: what has been delegated and on what terms.
In an ELP, the general partner is typically the source of both the right to receive called capital and the power to issue calls, even when it delegates the day-to-day work. A unit trust often separates the two:
- the right to receive called amounts: a contractual right against each investor, which vests in the trustee as trust property if the trustee is the counterparty to the subscription agreement; and
- the right to make a call: a power conferred by the trust deed, which is usually vested in the trustee but, for the reasons above, is frequently delegated to the manager.
Where the right to call has been delegated, the manager should normally join the security agreement and grant the lender a power of attorney to issue calls in its name or, at a minimum, acknowledge the security agreement and undertake not to exercise its call rights other than as the lender directs once the security has become enforceable.
Notices to investors
No Cayman fund finance article would be complete without a word on investor notices. As with a partnership facility, notices of the security will need to be given to investors as a post-closing deliverable.
Concluding Thoughts
In a unit trust, each of the elements a lender relies on sits somewhere slightly different from where it would sit in an ELP, but none of this prevents a Cayman unit trust from supporting a subscription facility, and unit trusts remain a workable basis for fund finance, in Japan-nexus deals and well beyond them. The issues are largely documentary, and where the key points are properly addressed in the facility documents, investor commitments to a unit trust can give a lender the same comfort as those in a limited partnership.