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The Protected Cell Companies in a Nutshell

By:

Francisco Pérez Ferreira

fperez@pmalawyers.com

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I. Introduction
II. The Protected Cell Company in a Nutshell
2.1 The Captive Insurance Companies and the "Rent-a-Captive" Schemes: a background
2.2 The Protected Cell Company Explained

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III. The Protected Cell Company: a new form of investment fund
IV. The Protected Cell Company as Conduit for Structured Finance
4.1 Protected Cell Companies and Securitization Corporations: Twin Conduits

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V. Conclusion

 

 I. Introduction

Among the different factors that contribute to economic growth are the roles played by "offshore" jurisdictionsi, which in many ways assist or ease different business activities (of commercial, financial or patrimonial nature) around the globe, an aspect often forgotten by many. The operational and business flexibility offered by these jurisdictions is achieved by means of the use of their various legal vehicles or instruments, which in many circumstances facilitate trade, capital flows, legitimately help reduce high/prohibitive tax burdens on business or even assist in fulfilling people's natural and legitimate desires for asset planning and protection. The spectrum of instruments may include -inter alia- the well-known International Business Corporationsii, the traditional common law trusts and captive insurance companiesiii. Authoritative and specialized publications on the subjectiv report a rapid improvement and innovation exemplified by the adoption of laws and regulations giving rise to -among others- private interests foundationsv, the British Nominee Companies, International Headquarters Company, Dual Resident Company and the Open-ended Investment Companies (OEIC)vi, the international corporations from Manx and Jersey, the Irish Non-Resident Company, the American limited liability companies (LLCs) and the Cayman Islands STAR Trustsvii. One of the relatively recent tools available for corporate, tax planning and financial services law practitioners in the comparative legal context is the Protected Cell Company (hereinafter "PCC"), an innovative corporate instrument whose concept, characteristics and uses in the international financial arena are briefly explained in the following paragraphs.

II. The Protected Cell Company in a Nutshell

These entities originated in Guernsey, specifically by means of The Protected Cell Companies Ordinance 1997 (as amended by "The Protected Cell Companies (Amendment) Ordinance, 1998")viii. Other offshore jurisdictions have followed the path of Guernsey, including the Cayman Islands with its Segregated Portfolio Companies; Bermuda (which passed the New Providence Mutual Ltd. Private Act allowing a PCC structure for this entity); Mauritius (which approved The Protected Cell Companies Act of 1999 [amended in 2000]); and St. Vincent and The Grenadines with their International Insurance (Amendments and Consolidation) Act of 1998 which allows "protected premium accounts" introducing elements of the PCCix. These regulatory schemes constitute a response to claims and heavy lobby from the captive insurance industry and come to resolve structural inefficiencies of the "rent-a-captive" concept. Before describing the intricacies of the PCC it is necessary to briefly express the background which gave rise to this new corporate structure.

2.1 The Captive Insurance Companies and the "Rent-a-Captive" Schemes: a background

As expressed in the Introduction, one of the "products"x available in the competitive offshore industry is the captive insurance company. A captive is a corporate entity created and controlled by a parent company (or a group of corporate entities) whose main purpose is to provide insurance for determined risks of such parent company (or of the corporate group), as an alternative to the traditional insurance coverage provided by the insurance industryxi. In short terms, it is an in-house self-insurance vehicle. Captives may take the form of a "pure" entity (which is a 100% a subsidiary of the self-insured parent company); of a "mutual" captive (which insures the collective risks of industry members) and of an "association" captive (which self-insures individual risks of the members of a professional, commercial or industrial association). Captives represent commercial, economic and tax advantages to their sponsors due to the reductions on costs they help create, the ease for insurance risk management and the flexibility for cash flows they generate. Additionally, they may provide coverage of risks which are neither available nor offered in the traditional insurance market at reasonable prices.

In cases in which a company is not financially capable to self-insure itself it may still obtain self-coverage through the use of a "rent-a-captive" scheme. In this case, such company would share the services of a captive with other companies of relatively similar size, by "renting" part of the capital of the rented captive. Unrelated companies would use then the same captive to insure their risks. The patrimony of the captive would thus cover the underwritten risks of the sponsoring entities in the case a triggering event occurs, as described in the respective policy.

 Although the rent-a-captive structure represents advantages for the insurance industry, because -among others- it provides for economies of scale (is a costs-savings instrument), it has a major flaw: it constitutes a single entity vis-à-vis third parties, whose single patrimony is thus exposed to unjustified third-party claims, which risks the assets allocated to cover claims for other companies participating in the sponsored captive structure. There is no guarantee nor assurance that the funds provided by one participant-enterprise to the rented captive would not be used to cover any unjustified claims unrelated to the risks such participant wanted to insure through the rented captive. No asset protection is provided for the participants of a rent-a-captive program on an individual basis. In order to circumvent such patrimonial risk-fencing deficiency the insurance industry developed the concept of the PCC.

2.2 The Protected Cell Company Explained

What is a PCC and which are its uses? How does it work?

In simple terms, the PCC is a corporation structured with different patrimonies, all segregated through "cells", which are independent and separate from each other and from a "core" patrimony of the entity. The segregation of patrimonies helps avoid commingling of funds and assets of the different sponsoring participants, ensuring thus that no claim against one participant-beneficiary of the captive-insurance entity would be covered by funds or assets furnished by another participating/sponsoring enterprise. Based on the aforementioned, a PCC may be defined thus as:

A corporation whose patrimony is composed of assets contained in structurally separate parts named "cells" [cellular assets], which are legally and functionally separate, distinct and independent among each other, and of assets not constituting "cells" [non-cellular assets], also structurally and legally independent, that has as main legal characteristic the fact that the portion of capital designated to a specific cell is neither liable for the general obligations, commitments or liabilities of the corporation nor for the specific liabilities of the other cells.

It is possible to extract the main characteristics of these entities from the above, as follows:

a) Legal Entity: the PCC has its own juridical personality, thus is capable of owning rights and assuming obligations on its own. The "cells", although being separate individual patrimonies, do not constitute separate entities themselves;

b) "Cellular" Patrimonies: the patrimony of the entity is divided in different "protected cells", which allows segregation of funds, thus enabling ring-fencing among the distinct cells and the core patrimony;

c) "Core" Patrimony: a portion of the PCC's patrimony is composed of general assets ("non-cellular" assets), which are separate and distinct from each of the assets composing the protected cells, creating what is commonly known as the "core cell";

d) Segregation of Assets and Liabilities: the assets allocated to each specific cell may only be liable for liabilities incurred by such cell and thus should not be attached by creditors of the other company's cells. The liabilities unrelated to a specific cell are covered by the non-cellular assets or the core cell. The core assets respond -on subsidiary grounds- once the specific cellular assets are depleted.

In summary, a PCC -structurally speaking- involves a core capital, cellular capital, cellular assets and liabilities, and core assets and liabilities. The ring-fencing rules are also applicable to any liquidator or receiver of the entity. Thus the insolvency of a cell should not affect the business of the whole entity or the performance of the other cells.

For each business, activity or agreement contracted, the PCC must disclose which cell is contracting or if the entity is committing its core assets or both, core and specific cell assets. The PCC must have a name and each and every cell must also be clearly identified in the formation documents of the entity. Once formed, these entities may issue shares ("cellular" or "non-cellular" shares, depending on whether they represent an equity interest in a specific cell or in the core assets) or other types of securities. The entity must keep accounting books showing the corresponding patrimonial divisions among the segregated cells and the core cell within the entity.