OFFSHORE INVESTMENT STRUCTURES: DO YOUR DUE DILIGENCE BEFORE MAKING AN INVESTMENT

On 11 March 2009, in mCubed International (Pty) Ltd and another v Leon John Singer and others (Case number 118/08-11 March 2009) the Supreme Court of Appeal (“SCA”) delivered a judgment which highlights the importance for investors to diligently examine both the nature and the terms and conditions of any investment structure before making an investment.

Mr Singer was the founder and a trustee of the Singer Family Trust (“the Trust”). The Trust entered into an investment agreement with mCubed pursuant to advice given by an employee of mCubed regarding the investment structure. However, mCubed failed to implement the agreed investment structure. When the Trust found out that its investment had not been made in the agreed manner, it cancelled the agreement and demanded a refund of the R10 million which had been invested. The Trust instituted an action for damages (for the R10 million) against mCubed in the Cape High Court.

The Trust relied for its claim, on two different misrepresentations allegedly committed by mCubed’s employees. The misrepresentations were that: (1) mCubed had the necessary approvals to implement the proposed investment structure which included exchange control approval; and (2) mCubed had implemented the investment structure as proposed and agreed to by Mr Singer, in particular; a) Special Purpose Vehicle ("SPV") had been created; b) the SPV had then purchased the SelectLife Policy denominated in US dollars; and c) the policy or special Purpose Vehicle ("SPV") had been ceded to the Trust.

The main claim, based on the mispresentation in (1) was a loss of capital in an amount of R3 884 958.53 and damages resulting from interest paid by it on money borrowed to make the investment, in the sum of R3 881 017.47.

The alternative claim, based on a misrepresentation subsequent to the conclusion of the investment contract again comprised of the above two elements but for a lesser amount. In this instance the Trust claimed R2 547 122.80 for loss of capital and R3 558 435.69 for interest as damages.

The Cape High Court dismissed the Trust’s main claim but granted and alternative claim. mCubed appealed to the SCA against granting of the alternative claim and the Trust cross appealed against the dismissal of the main claim as well as the dismissal of claims for interest and damages on the alternative basis.

The SCA considered that Mr Singer, a high net worth individual acting on the advice of his accountant, had decided to divert some of his assets offshore. Mr Singer raised the possibility of offshore investments with mCubed, and an initial amount of R1 million was invested offshore by mCubed in the name of the Trust. With a view to investing larger amounts, Mr Singer consulted further with representatives of mCubed specializing in offshore investments, the result of which was that mCubed, acting through its representatives proposed a structure which was presented to Mr Singer and his accountant. In terms of the structure, mCubed utilsing its asset swop capacity, would assist Mr Singer in making an investment through a Rand denominated linked endowment policy issued by mCubed by converting Rand amounts received from Mr Singer into US dollars which would then be used by mCubed to purchase an offshore life policy issued by an offshore company, which offshore company would in turn invest the money offshore.

Mr Singer was not satisfied with the first proposal for the investment arrangement, leading to the introduction of an SPV into the investment structure that constituted the first proposal. Instead of mCubed acquiring the policy as in the first proposal, mCubed would invest the US dollars in an SPV. The SPV would then acquire the policy which would then be ceded to Mr Singer or an entity nominated by him thereby giving Mr Singer protection against the loss of any investment in the event of mCubed’s insolvency. Mr Singer accepted the revised investment structure and made the investment.

At all times following the investment of the money, mCubed through its representatives represented to the Trust that a cession of the policy was in place, which the Court on the facts subsequently found that was not the case. Furthermore, it was later discovered that the implementation of the investment structure would contravene South Africa’s exchange control regulations. This meant that the investment structure incorporating the protective mechanism of the cession and the SPV could not be implemented.

When mCubed failed to produce proof relating to the deed of cession or the SPV, Mr Singer instituted legal proceedings alleging that mCubed had acted recklessly making incorrect representations about the legality of the investment structure. The Court held that mCubed had through its representative held itself out as an expert in the field of offshore investments thereby inducing Mr Singer’s participation in the investment process.

However, the SCA found that although there was a misrepresentation, there was no factual causation as the Trust would still have lost money even if mCubed had implemented the structure as agreed because the actual cause of the loss was the strengthening of the Rand. The SCA held that had the Trust known about the misrepresentation at an earlier date, it would most likely still have invested money offshore through a different investment management entity.

The SCA went on to say that Mr Singer had at all times intended to invest offshore. He adopted a position on the future of the Rand/Dollar exchange rate and there was no reason to think that that position would have been any different had he not decided to invest with mCubed. Furthermore, the SCA held that there was no difference between the capital loss and the loss of interest as the Trust would probably have availed itself of the same borrowing structure in making a similar investment.

Therefore, the misrepresentations were not the cause of the loss suffered by the Trust. Rather, it was the unpredicted strengthening of the Rand against the US Dollar between March 2002 and June 2005. The SCA found that the loss suffered by the Trust was too remote from the misrepresentations for it to be said that it was caused by the misrepresentations. Therefore, the Trust failed on the legal causation test as well.

What lessons can investors learn from this case?

• Investors should always investigate and confirm that an investment structure is legal. Where the investment relates to an offshore investment structure, an investor should consider the implications of exchange control regulations.

• The investment structure should be documented and the investment manager/promoter should be required to make necessary representations and give indemnities regarding the investment structure and fulfilment of its obligations.

• Timelines must be agreed for the implementation of the investment structure and protection of the investor’s position should be agreed in the event that the timelines are not met.

• There is risk in all investment arrangements. However, such risk can be mitigated by the investor insisting on disclosures regarding the inherent risks (e.g. currency fluctuation) and considering whether, in light of the risks, the investment is appropriate to make.

 
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