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— Analysis —
Conceptually unique, PCCs jettison accepted concepts of limited liability and pari passu whereby creditors enjoy a rateable distribution upon insolvency. Although emphatically (all PCC statutes emphasize this) a single legal person, a PCC consists of a hub and an infinite number of cells. The hub and each cell has "attributed" to it assets and liabilities. Because the cells are statutorily firewalled, the liabilities of "cell A" cannot be met by the assets of "cell B," despite the PCC's single legal person status.
Self-insurance has been the PCC's driving force. Today, some jurisdictions, notably the U.S., still limit PCC usage to self-insurance. For instance, a mega-corporation can create and maintain its own dedicated captive self-insurer. But lesser organizations cannot, so they mutualize by ganging together. This economy of scale creates risk: your risk-bearing captive may be brought down by others' risk and inevitably you must share information with your co-insureds. The solution is a PCC, economy of scale with a firewalling of risk and information. Once one accepts the trinity logic of a PCC -- a single entity but with entity parts appearing as entities in their own right -- the concept can be applied outside of insurance. Fund management has taken to the idea with alacrity: compliance costs could be shared among differing investor appetites. Others in the Gulf saw it as an opportunity to mix Sharia and non-Sharia. Project financiers then saw it as an alternative to multilateral joint-venture contracts. Bond issuers created different classes within an issue and a cell could become a bankruptcy-remote SPV. Bankers saw the priority right to cellular assets as a new form of security. Accountants pondered, "could a cell be incorporated into the group accounts of its beneficiary?" Off-balance-sheet structures could thus be created. Internationally, three hub-cell structure types exist, in downstream, upstream and no cross-stream accounting models. Under the downstream accounting model, any hub deficiency (hub creditors exceeding hub assets) is met by the cells. Thus the hub insolvency could create a cellular insolvency. Conversely, in upstream accounting, jurisdictions' cellular deficiencies are met by the hub. Thus a cellular insolvency could create a hub insolvency. Finally, in no cross-stream accounting jurisdictions, even hub capital is firewalled. Each sub-entity (the hub and its various cells) represents a different priority structure for the payment of creditors in an insolvency. Consequently, in a two-cell PCC, four potential insolvencies exist: the two cells, the hub and the PCC itself. Given the PCCs raison d'être, that of "insolvency protection," there have been remarkably few PCC insolvencies internationally from which to judge the concept's efficacy. The most notable case was that of SPhinX Ltd. (SDNY 2007). This involved the collapse of a Cayman Islands ("CI") Bear Stearns hedge fund, one of the biggest U.S. insolvencies of last year. What was scarcely reported is that SPhinX Ltd. was a CI SPC: its very size and complexity indicates how the PCC concept has mushroomed. What then are the potential PCCs pitfalls? Most likely they will be revealed in insolvency issues and probably in a jurisdiction antithetical to the PCC concept. So the first pitfall is for the PCC to travel outside of its home jurisdiction. This should be avoided at all costs, especially with a PCC antithetical jurisdiction. Modern international insolvency law (the UNCITRAL and EU insolvency regimes to which the majority of the world's trading nations adhere), as applied in both the U.S. and the EU, revolves around the notion of an insolvent entity having a self-explanatory "center of main interest" ("COMI"). Many offshore financial centers (OFCs) have useful structured PCC legislation. Unfortunately, as with SPhinX Ltd., the OFC PCC often merely becomes a letterbox company for activity (its main interest) outside of the OFC PCC jurisdiction. In short, the PCC COMI falls outside its home OFC jurisdiction. With SPhinX Ltd., the U.S. Court was seized of the COMI issue only. It was not seized of the issue of whether the very notion of a CI PCC, which differs greatly to the standard US PCC, was acceptable. If the court was seized of the latter question, the SPhinX creditor outcome may well have differed considerably. Modern international insolvency law states the COMI jurisdiction insolvency law is paramount. If the COMI jurisdiction is antithetical to the PCC novel abandonment of pari passu, then the COMI jurisdiction may simply ignore the PCC structure as a sham. It should be remembered that it is not just the PCC itself that can travel; it's possible that a cell does business outside of its incorporation jurisdiction. This raises the very novel concept of a cell having a different COMI as the rest of the PCC. Obviously, this is to be avoided. A PCC's Achilles heel is the involuntary creditor. All PCC jurisdictions require, upon pain of directorial sanction, that creditors are made aware (if not that they positively agree) that their liability can only be met from a designated pot. An involuntary creditor, such as the taxman who often claims moral or legal authority to priority payment or the sympathy inducing tort claimant, cannot be so forewarned. The default position of most PCC statutes is that the involuntary creditor fails to be paid from the hub. This may not be to the liking of the involuntary creditor. Trite as it may be, PCC directors are warned to "avoid incurring involuntary creditors." A PCC could face all of the traditional "piercing of the corporate veil" threats that any corporation might confront, especially an attack on the basis that "holdco" should not let "subsid" fail. Hence the individual corporate veil associated with each group company should be pierced: case law around the world often supports such an attack. A hub and its cells are a quasi-group. Some PCC jurisdictions even allow for cell directors different from hub directors, thus enhancing the quasi-group appearance of the structure. A PCC is created primarily to firewall risk. Most group companies are created for operational reasons, not for limited liability risk reduction purposes. There is therefore prima facie evidence to attack the PCC's quasi-group structure. But given that PCC jurisdictions may allow for upstream and downstream liability accounting, such cross-support augurs against such a piercing attack. But this "defense" is subject to one caveat. If an ordinary company morphs into a PCC with "good" and "bad" cells, separating out the dross, then an attack can be easily leveled. PCCs in their various forms represent the evolution of the limited
liability concept which has driven economic development. But as in any
evolutionary race, there are winners and losers. Some jurisdiction PCC
structures will wither; others dominate. Lawyers, corporate, finance or
restructuring should familiarize themselves with the PCC concept to
stay in the race. Grant Jones is an English solicitor, New York attorney and English CPA with Squire Sanders & Dempsey London. He is the author of "Protected Cell Companies: A Guide To Implementation And Use" (published by Spiramus Press Ltd.), the first book worldwide on PCCs. |
Protected Cell Companies, sometimes referred to as Segregated Portfolio Companies (SPCs), are a recent phenomenon. Introduced into Guernsey in 1997, they now exist in different forms in the U.S., the Gulf, the EU and various offshore financial centers. They are the fastest-growing vehicle for umbrella funds, self-insurance and -- with the demise of structured investment vehicles -- structured investments. 
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