In a ruling delivered on 22nd May and made public on 27th May, US District Judge Robert Sweet in Manhattan denied protection from creditors under Chapter 15 of the US Bankruptcy Code, which covers cross-border insolvencies, because the Cayman Islands weren't their "center of main interest", upholding a decision by a lower court on the case.

Chapter 15 protection would have allowed the hedge funds to liquidate in the Cayman Islands while giving the funds a higher degree of protection from creditors in the US.

Legal experts expect that the ruling will have a substantial impact on future bankruptcy cases where investment funds are based offshore, and there are fears that it could deter funds from registering in offshore jurisdictions such the Cayman Islands - which is home to about 8,000 hedge funds - and the British Virgin Islands.

"The process by which the financial problems of insolvent hedge funds are resolved appears to be of transcendent importance to the investment community and perhaps even to the society at large," Sweet wrote in the order.

While lawyers for the two hedge funds pointed out in the trial that they had two directors resident in the Cayman Islands, Judge Sweet argued that these directors "have not been shown to have had any substantial involvement in the business of the funds". Sweet added that furthermore, the investment manager for the funds was located in New York, as were its back office staff, its books and records, and all of the funds assets.

The two hedge funds in question, the Bear Stearns High-Grade Structured Credit Strategies Master Fund and the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund, invested heavily in collateralized loans backed by sub-prime mortgages.

A large percentage of the funds' assets, most of which are in the US, had been repossessed by secured creditors, including Merrill Lynch and Bear Sterns itself, during the period before their bankruptcy.

Bear Stearns is currently in the process of being acquired by JPMorgan Chase and Co., a transaction that is expected to complete by the second quarter of 2008.