Bear Stearns’ decision to liquidate two bankrupt hedge funds in the Cayman Islands — where disgruntled investors have weaker rights — could backfire, according to industry experts in New York.

The move — formalised with a bankruptcy filing on July 31 — could establish a precedent that will allow other failed hedge funds to seek bankruptcy refuge in the Cayman Islands, where judges are known for favouring managers over investors, Bloomberg reports.

“This is definitely going to be watched closely and other hedge funds might do the same thing,” Evan Flaschen, a bankruptcy lawyer at Bracewell & Giuliani in New York, told Bloomberg.

Investors in the two funds, which were heavily invested in sub-prime mortgages and collapsed on the back of rising defaults on home loans, are unlikely to take the news lying down.

Bill Brandt, the president of Development Specialists, a financial services consultancy, branded Bear’s move a “nice little stunt” and accused the bank of “trying to put a wall between themselves and the funds".

Mr Brandt told Bloomberg that he expected investors to attack Bear Stearns over the decision.

Jay Westbrook, a professor at the University of Texas Law School, said that it was “difficult to take legal action [in the Cayman Islands] and that as a jurisdiction it was “attractive to management.”

However Mark Andrews, a bankruptcy lawyer at Denton Wilde Sapte in London, defended the move.

“These are Cayman incorporated funds and so the Cayman Islands are the obvious place to file for bankruptcy, “ Mr Andrews said, adding that this was “not a stunt but a perfectly legitimate business decision.”

Another UK bankruptcy lawyer, who declined to be named, said: “Where a fund is incorporated and under which system it will be administered if things go bad is one of the most basic questions you ask before throwing your money in. It sounds like a desperate attempt.”

Bear Stearns could not be reached for comment. The bank declined to comment to Bloomberg.

Explore Law

• Columnists

• Law Panel

• Law Reports

• Student Law

Times Recommends

• The best legal yarns this Christmas
• Legal school 'earned £1m by exploiting bar course'
• Axe may fall on 5,000 more City lawyers