On June 8, 2016, the Cayman Islands published a new Limited Liability Companies Law. With this enactment, the Cayman Islands is yet another offshore jurisdiction to offer state-styled LLCs for business planning.
Promoters have described the Cayman Islands LLC law as “closely aligned” with Delaware’s popular LLC act. However, careful analysis shows that there is nothing “closely aligned” between the Cayman Islands and Delaware LLC laws.
The Cayman Islands LLC Law is so deficient as to raise red flags for any lawyer considering this jurisdiction for their client. One would be far better off forming an LLC under the laws of Delaware or Wyoming, or an offshore jurisdiction such as Belize or Nevis.
Problems with the Cayman Islands LLC Law
Members of Linhart Seuss Ivsan LLP advised the Cayman Islands Registrar of Companies about problems with the LLC law when an earlier draft of the legislation was circulated last year. At the time, the author identified a number of deficiencies in the legislation that required correction. Unfortunately, the Cayman Islands legislature enacted the law as initially drafted and without any corrections whatsoever. Below is a summary of the deficiencies the author identified last year.
Problem #1 – Transfers of Membership Interests: Most LLC statutes provide a default rule governing when an assignee of an LLC interest may be accepted as, and exercise the rights of, a member. Most often, the default rule requires consent of all the members absent some other threshold stipulated in the operating agreement.
Section 10(2)(b) of the CI LLC Law does not provide a default rule but merely provides that the assignee becomes a member “as provided in this Law” and upon compliance with the operating agreement, if any. Section 12(1) governs the rights of assignees to become members (which is probably what is intended by “as provided in this Law”); this provision contains a default rule requiring consent of all the members before the assignee may become a member, similar to Delaware law. However, Section 11(3)(d) separately provides that a creditor holding a security interest in all of a member’s LLC interest automatically becomes a substituted member, albeit without defining when this occurs. Could this be used by an involuntary creditor or any assignee generally? The CI LLC Law on this point is unclear.
Problem #2 – LLC Certificates: Paragraphs (7) and (8) of Section 10 permit LLC membership interests to be certificated, but there is no guidance as to how this operates in conjunction with the transfer provisions. Is assignment of the certificate sufficient to effect a transfer of a membership interest? Do security interests reside with the holder of such a certificate? Section 10(11)-(12) disclaims any use of bearer certificates, but Section 11(3)(d) permits a security interest to effect change in membership, so it is unclear what purpose is fulfilled by enabling certificates to be used in Section 10(7)-(8). The drafters did not seem to think this one through and should have considered UCC Article 8 for guidance on this.
Problem #3 – No Restrictions on Rights of Creditors: Section 10(9) makes clear that an LLC membership interest is personal property. Beyond the provisions governing assignments generally, however, there is no mention of creditor remedies. In fact, a number of provisions in the CI LLC Law suggests that the full range of creditor remedies are available at common law in the Cayman Islands. More specifically:
- There is no sunset provision on charging orders.
- There is no requirement that the creditor be limited to a charging order.
- There is no other protection for the LLC and its members under the CI LLC Law.
Section 11(3)(a) permits a member to assign all rights to allocations and distributions. Based on this, a creditor may compel such an assignment as one possible collection remedy, without having to bother going to a Cayman Islands court to seek a charging order.
Problem #4 – No Protection Against Foreclosure: Section 11(3)(c) provides by default that an assignment of all of a member’s interest constitutes an automatic cessation of membership rights with respect to the assignor. This applies whether the LLC has one member or several members. While this provision can be modified in the operating agreement, does it still have effect if there is only one member? This provision suggests a route by which a creditor may foreclose upon an LLC membership interest and gain control of a single-member LLC. At a minimum, a lawyer drafting a Cayman Islands LLC operating agreement should counsel the client on the risk of uncertainty on this point.
Problem #5 – No Protection for Foreign LLCs: Most jurisdictions that enact an LLC law provide for the accommodation of foreign LLCs. Typically, this entails integration of the “internal affairs doctrine,” a set of rules by which the jurisdiction determines which local statutes govern a foreign LLC, and to what extent the foreign LLC is to be governed by the laws of its jurisdiction of formation. The Cayman Islands bill is utterly silent on this. If your client is a foreign LLC with a bank or brokerage account in the Cayman Islands, how certain are you that the Cayman Islands won’t apply its own dubious LLC law to your client’s foreign LLC? Failure to address this basic principle of conflicts of laws raises serious doubts about the integrity of business transactions conducted by foreign LLCs in the Cayman Islands.
Analysis
The Cayman Islands LLC Law suffers from a number of lapses owing to what was an opaque drafting process. At the time the draft legislation was first circulated, we failed to gain comfort that anyone working on the draft possessed substantive U.S.-based experience in drafting LLC legislation. Naturally, what emerged from the process was what you would expect from foreign lawyers with no practical experience in American LLC law.
LLCs are not corporations, but the Cayman Islands LLC Law treats them as such. There is no practical bearing to Delaware LLC law much less the original LLC law first enacted in Wyoming back in the late 1970s. Failure to understand and address fundamental concepts under LLC law – such as charging orders, assignments, certification of membership interests, foreclosure, and the internal affairs doctrine – is destined to lead to much unnecessary litigation in the Cayman Islands and elsewhere. I
The best advice would be to avoid LLC planning in the Cayman Islands. If Wyoming or Delaware are not viable options, and the lawyer needs to consider offshore LLC planning, then both Belize and Nevis would be far superior alternatives.