First developed in the Cayman Islands, SPCs offer a wide range of uses, says Alan Craig.
The Segregated Portfolio Company (SPC), which was first introduced in the Cayman Islands in 1998, continues to evolve to meet business needs.
When first introduced, the use of the SPC structure was restricted to licensed insurers. An amendment to the Companies Law in late 2001 removed this restriction on the use of SPCs and we are now seeing their use in various other sectors, most notably mutual funds, where the protection afforded by the use of segregated portfolios is being applied to class shares with different investment objectives, and consequently risk profiles, in much the same way as we have seen it applied to different insureds and different lines of business within insurance SPCs.
The insurance sector, however, is where the SPC cut its teeth and is still at the forefront in their use. The use of SPCs in other sectors however increases their familiarity with third parties and the comfort level of such third parties when dealing with what is still a relatively new beast.
The SPC concept, under a variety of different names, is now familiar in offshore, and some onshore, jurisdictions. The SPC is a single legal entity within which may be established various segregated portfolios. The Cayman Islands' statute provides that assets and liabilities of each segregated portfolio are legally separate from those of the other segregated portfolios. If a segregated portfolio becomes insolvent its creditors only have recourse to the assets of the segregated portfolio and to any general assets of the company (being assets not comprised with any segregated portfolio) to the extent, if any, that such general assets exceed any minimum capital amounts required by any regulatory body in the Cayman Islands.
Normally an SPC will be arranged such that the general assets do not exceed the specified regulatory minimum, with the result that each segregated portfolio stands or falls on its own merits, having recourse neither to the assets of other segregated portfolios or to any general assets. For this reason, the formation of each segregated portfolio requires the approval of the Cayman Islands Monetary Authority (CIMA). This involves a review of the sustainability of the segregated portfolio's business model.
Existing operators of captive insurance companies have not been slow to realise the potential of the SPC structure where, when properly constituted, they have the ability to add additional participants without risk of cross-liability. Likewise, those new to the captive market have identified benefits in being associated with others with specific experience of operating a captive insurance business and the additional benefits of faster establishment of their programme and reduced costs where they participate in an existing vehicle. For the operators, the payment received from `renting' segregated portfolios in their existing SPC directly contributes to their bottom line by offsetting costs. For this reason we have seen a large proportion of those proceeding with captive formation electing to use the SPC structure, in many cases not to introduce other insureds at the time of initial formation, but to provide the flexibility to do so at a later date. In addition, a number of the insurance managers have established SPCs to ensure ready availability of `rental' segregated portfolios as a facility for their customers.
The SPC structure however is not restricted to use as a new form of group or rent-a captive. The legal segregation is also being used by single insured to segregated. different insurance lines by coverage type, geographical location or other basis.
The two key SPC legal documents are the Memorandum & Articles of Association of the SPC and a Subscription and Shareholders Agreement.
The Memorandum & Articles of Association are akin to the Issuer Charter of a US corporation. They establish the legal segregation and provide specific regulations concerning the SPC's operation and the rights of shareholders.
Where multiple participants are involved, close consideration has to be given to the `rental' terms. These will normally be set out in a Subscription & Shareholders Agreement, which will regulate the contribution of capital to the segregated portfolio, distributions from the segregated portfolio, the winding up of the segregated portfolio at the end of its term and the consideration to be paid for the `rental' of the segregated portfolio.
In most, but not all cases participants will be issued one or more segregated portfolio shares carrying rights to the segregated portfolio in which their business is placed. Where specific tax advice prefers that there not be a direct shareholding link, the Shareholders Agreement can be supplemented to address all relevant issues on a purely contractual basis.
The Cayman Islands' statute places specific additional requirements on the directors of SPCs in relation to their management of the SPC to reinforce the statutory segregation of assets and liabilities. It is important that the directors adhere to these to preserve the statutory segregation and to ensure that they do not incur personal liability.
The SPC is undoubtedly an extremely useful vehicle for those considering captive insurance, both as a means for existing captive owners to supplement income or offset costs and for the increased speed, flexibility and lower costs it provides for those who choose segregated portfolio `rental' as their introduction to the captive market. Many of those utilising a `rental' segregated portfolio are likely to graduate to a separate captive later, or, given that the same logic applies, establish their own SPC and introduce other participants.
There is wide flexibility of application of the SPC structure and each new SPC sees new application of the structure, whether to provide risk sharing whilst preserving segregation or to address ownership restrictions affecting tax deductibility or the economics of the specific transactions for which it is being established.
Walkers, which is one of the largest insurance practice in the Cayman Islands, works closely with the insurance managers in the jurisdiction with respect to Cayman Islands' regulatory matters, and with leading overseas counsel to ensure appropriate treatment in the home jurisdiction. Whilst having the benefit of having worked on a wide range of SPC structures, we are particularly pleased when we have the opportunity to work with clients to apply it to their specific needs and in the process further develop the use and application of the SPC.
By Alan Craig
Alan Craig is a partner in the Cayman Islands' law firm of Walkers.