There are various causes for parties becoming embroiled in fund litigation. Often disputes can centre on investment restriction breaches, perceived losses of assets held in custody, and fund financing breaches. In this article, we look at the factors which can precipitate litigation and some of the means for avoiding costly disputes.
Investment restriction breaches and other fund errors
One of the more common situations which can lead to litigation between investors and service providers to investment funds in Ireland is breaches of either regulatory or self-imposed investment restrictions.
UCITS
The European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations 2011, as amended – or UCITS Regulations – place a series of prescriptive diversification, counterparty and liquidity requirements on funds established as UCITS in Ireland. Often investment managers, with oversight from management companies, will have pre-trade compliance systems in place which are designed to minimise the possibility of investment breaches occurring. Where breaches do occur, the relevant depositary and board will need to be notified alongside the Central Bank of Ireland depending on the type of breach. Breaches involving concentration limits and ineligible assets can on occasion be resolved by disposing of assets in a timely manner while taking into account market conditions and the best interests of investors. However, where assets have become illiquid, or shareholders have suffered a loss, disputes can arise between the board of a fund, its shareholders and service providers. In these situations, it is important to consider the obligations placed on boards and all service providers under the UCITS Regulations and the Central Bank (Supervision and Enforcement) Act 2013 (Section 48(1)) (Undertakings for Collective Investment in Transferable Securities) Regulations 2019 alongside any other regulations and guidance which may be relevant depending on the circumstances.
Alternative investment funds
Alternative investment funds are generally subject to less prescriptive product requirements. The European Union (Alternative Investment Fund Managers) Regulations 2013, as amended (AIFM Regulations) place obligations primarily on alternative investment fund managers. Boards and service providers also need to comply with the Central Bank’s AIF Rulebook, any self-imposed investment restrictions included in offering and constitutional documents and other domestic and European regulations and guidance which may be relevant.
Other fund errors
Alongside investment restriction breaches, other common errors which can lead to disputes between service providers include:
- the incorrect charging of fund fees and expenses;
- net asset valuation calculation errors; and
- control breach errors such as the payment of redemption monies to an incorrect investor account.
Delegation is a common feature of Irish funds and is often used for portfolio management by engaging entities with specialist expertise. However, a party appointing a delegate is not released from its responsibilities and needs to carry out appropriate initial and ongoing due diligence alongside continued oversight.
Where a dispute between parties seems likely to become litigious, as a first port of call, examining the liability and indemnity provisions set out in the service provider agreements is prudent.
Safekeeping assets
Following the financial crisis, detailed regulatory frameworks were put in place which sought to clearly outline the role of depositaries in safeguarding investor assets. Both the UCITS Regulations and the AIFM Regulations impose a quasi-strict liability standard on depositaries for any loss of financial instruments held in custody. Depositaries also have an obligation to verify the ownership of assets not held in custody.
Disputes can arise between parties where there has been a perceived loss of assets held in custody either at the level of the depositary to a fund or one of its sub-custodians. In these situations, the depositary agreement should clearly reflect the corresponding safekeeping obligations included in the relevant regulatory framework. Identifying whether assets which have been lost were held in custody or not is crucial for determining the applicable liability standard for the depositary.
Fund financing breaches
Where leverage has been introduced into a fund platform through a subscription line or asset financing arrangement, disputes can arise between borrowers and lenders on repayment obligations, priorities and whether default events have occurred. In these situations, it is important to examine the security package and documents which were put in place at the time the facility was agreed.
Other common disputes
Management Companies |
Issues with the oversight of delegates including investment managers and distributors. |
Administrators |
Net asset value pricing or calculation errors. |
Administrators / MLROs |
Failures related to onboarding investors including anti-money laundering and know-your-customer obligations. |
Distributors |
Issues with marketing material not correctly matching a fund’s offering documents. Distributing a fund without appropriate marketing permissions. |
Conclusion
Navigating the intricacies of fund litigation requires a deep understanding of the relevant regulatory frameworks and the corresponding obligations of all fund service providers. With specialised legal expertise and a robust commercial court system, Ireland is well-equipped to handle all types of fund disputes. For those managing or servicing funds, staying ahead of potential issues can make the difference between the timely resolution of an issue and a costly legal battle.
For tailored advice, our Investment Funds and Commercial Disputes teams are ready to assist.
The content of this article is provided for information purposes only and does not constitute legal or other advice.
