The judgment of the Grand Court of the Cayman Islands in Weavering Macro Fixed Income Fund Limited (in Liquidation) v Stefan Peterson and Hans Ekstrom has been seized upon by the financial services industry in the Islands as invaluable guidance, albeit in fact specific circumstances, as to the standard of performance expected of the board of directors of a Cayman Islands domiciled fund.
The principal of the investment manager of Weavering Macro Fixed Income Fund Limited (“Weavering”) was the older brother of one of the directors, Mr. Peterson. The other director was their elderly stepfather. The day to day responsibility for the operations of Weavering had been delegated by the board to the investment manager and the administrator.
Weavering collapsed in mid 2009 when it became apparent that the supposedly profitable series of interest rate swap transactions to which the investment manager had heavily committed Weavering were found to be a fictitious scheme designed to falsely inflate the stated Net Asset Value (“NAV”) and to disguise the substantial losses that it was actually suffering.
In the face of a claim by Weavering’s liquidators that both of the directors had failed to properly discharge their respective legal duties to exercise skill, care and diligence in the management of Weavering’s affairs, the directors sought to rely upon the standard protections set out in the articles of association:
“Every Director, agent or officer of the Company shall be indemnified out of the assets of the Company against any liability incurred by him as a result of any act or failure to act in carrying out his functions other than such liability (if any) that he may incur by his own wilful neglect or default. No such Director, agent or officer shall be liable to the Company for any loss or damage in carrying out his functions unless that liability arises through the wilful neglect or default of such Director, agent or officer.”
The Grand Court applied the English authorities on wilful default and held that the two limbs of the test were (a) knowing and intentional breach of duty, or (b) acting recklessly, not caring whether or not the act or omission is a breach of duty. The case against the directors was put under the first limb of the test. The judge held that if the evidence established that the directors had completely and utterly ignored and made no serious attempt to perform their duty, in spite of being conscious of a duty to supervise, then their default must be wilful.
The director’s failings were narrated at length in the judgment and the main lessons to be taken appear to be:
- It is the directors’ duty to satisfy themselves that the overall structure of a fund is consistent with Cayman Islands industry standards and that the terms of the service providers’ contracts, in particular those relating to the determination of NAV, remuneration and limitation of liability, are reasonable and consistent with industry standards.
- The directors must satisfy themselves that the scope of the work intended to be performed by the investment manager and administrator in respect of the preparation of the financial statements and determination of monthly NAVs is properly understood.
- The directors cannot discharge their duty by reliance solely on the other service providers being reputable firms having experience in their respective fields nor that the articles of association and service providers’ contracts, which created the management structure and identified the responsibilities of those involved, were prepared by suitable professional advisers.
- An agenda should be prepared and circulated in advance of each meeting of the directors, reflecting input from the investment manager, the administrator and the directors themselves.
- The directors should request regular reports from the administrator, auditor and investment manager in order to inform themselves about the fund’s investment activities and have a proper understanding of its financial condition.
- The directors have an on-going duty to satisfy themselves that the investment manager is operating within the stated investment criteria and restrictions.
- It is the directors’ duty to ensure that someone who understands the investment criteria and restrictions performs a proper analysis. Directors of investment funds are expected to be able to read a balance sheet and have a basic understanding of the audit process.
- Directors are expected to assess and consider whether or not the execution of side letter agreements are in the best interests of the fund or could impact adversely on it.
The judge expressly noted that the way in which the directors behaved during the financial crisis suffered by Weavering was the most compelling evidence that they never intended to perform their duties as directors. There was no evidence that the directors assured themselves that Weavering was not exposed to financially weak counterparties, nor was there evidence that the directors took any steps at all, even after the liquidity crisis, to assure themselves that Weavering would be able to meet its obligations.
Stefan Peterson and Hans Ekstrom were ordered to pay Weavering US$111 million in damages for their role in the collapse. The judge had no hesitation in finding that the directors’ inactivity amounted to wilful neglect. The judgment is a sobering reminder to directors of fund companies that their legal duties are of the most serious nature and demand constant vigilance and the application of considerable professionalism, time and expertise in their discharge. Diligent directors of an investment fund should apply their minds and exercise independent judgment, not simply “rubber stamp” documents prepared by legal advisers or the investment manager.