A legal specialist in captives and, specifically, protected cell companies (PCC), has suggested that a recent landmark ruling by the Montana District Court is not as detrimental to the way these structures operate and their exposure to risk as has been suggested by some including rating agency Fitch.
Nigel Feetham, partner at law firm Hassans International notes that many jurisdictions have tweaked their legislation to overcome this exact concern.
To recap, the Montana ruling related to the Pac Re 5-AT v. AmTrust case. The judgement concluded that it should be the PCC, rather than an individual cell, that is the proper legal entity that can sue and be sued.
Fitch said it believes the court decision demonstrates the link between individual cells and the PCC and exposes protected cells to additional risk as a result.
It said the decision suggests to Fitch that the failure of a protected cell's PCC could potentially cause disruption or financial stress for the protected cells in that PCC; therefore, prospective cell sponsors should consider the creditworthiness of the PCC when forming a protected cell.
“Fitch believes the primary credit focus when the PCC structure was designed was the protection of each protected cell's assets from the creditors of the other protected cells,” said Donald Thorpe, senior director, Insurance.
“There are many linkages to be considered in a credit analysis of a protected cell besides the segregation between the individual protected cells. The weakest link often determines the final credit rating of an entity, and the weakest link in a PCC structure may not be the risk that individual protected cells pose to each other.
“The ruling concludes protected cells are not separate entities from their PCCs. Additionally, the PCC is the actual holder of the insurance license. To Fitch, the case raises the question as to how the protected cell continues in the event its PCC fails.”
Previously, there has been a dearth of court cases on this or other aspects of the PCC structure. Therefore, Fitch said it believes this case makes a significant contribution to the history of PCCs.
The report highlighted the fact the case only addressed PCCs rather than incorporated cell companies (ICCs) as well, while Montana’s PCC legislation is different from the National Association of Insurance Commissioners’ (NAIC) Protected Cell Company Model Act, which many states are in line with.
In regards to rating implications, Fitch said this decision reinforced its view that it would be difficult for a protected cell “to have a credit profile stronger than the credit profile of the PCC sponsor”.
However, Feetham at law firm Hassans International, pointed out that the specific concern that Fitch highlights has already been addressed in the PCC legislation of a number of jurisdictions around the world by making provision for the liquidation of a cell as if it was a separate legal entity in the event of insolvency of that cell.
He notes that he recently lobbied for amendment to Gibraltar legislation to also achieve this and helped in the drafting of it.
He continues: “So the ‘weakest link’ concern raised by Fitch therefore does not necessarily arise in the sense that an individual cell can be liquidated separate from the entity as a whole and therefore it is 'deemed' to be a separate legal entity for the purposes of cell liquidation only.
“In essence it reinforces the ring-fencing and the insolvency of one cell would not necessarily disrupt the whole (core) or other cells which is what Fitch are suggesting. That is why I lobbied to amend the PCC legislation in Gibraltar. Indeed, numerous jurisdictions have also already introduced amendments to their PCC legislation to specifically provide for cells to be treated as if they were separate companies in relation to taxation matters. In both cases (liquidation and taxation), this is despite the fact that it is the PCC that still carries on business as a single legal person and that does not change.”
“The argument in the Pac Re 5-AT v. AmTrust case that the proper party to the arbitration could be anyone other than the PCC itself was, in my view, doomed to failure from the outset”, concludes Feetham.
Nigel Feetham is the co-author of the book “Protected Cell Companies: A Guide to Their Implementation and Use (2d ed. Spiramus Press 2010) and the book was cited in the Montana Court judgment.
Montana District Court, Fitch, Nigel Feetham, Hassans International, North America