The purpose of this memorandum is to give a brief summary of some of the issues which may be faced by a director of a Cayman Islands investment fund. It is provided by Ogier to directors of companies maintained by Ogier Fiduciary Services (Cayman) Limited and/or advised by Ogier.
This memorandum is intended to provide a general summary of the position in law as at the date shown on the cover, and is not to be taken as specific legal advice applicable to particular issues or circumstances. If such advice is required, please contact one of the Ogier partners listed on the last page.
Sources of legal duties of directors
Cayman statutes impose penalties on directors and officers of a company who fail to comply with those statutes, but there is no statutory codification under Cayman Islands law of the duties of the directors and officers of a Cayman Islands company. General duties derive from case law, and the principles set out below ultimately derive from English common (i.e. non-statutory) law, which have been imported into Cayman Islands law by decisions of the Cayman Islands courts.
For the purposes of this Note, we assume that the existence, extent and breach of a duty will fall to be considered on an application of Cayman Islands law, either before a Cayman Islands court or before a foreign court applying Cayman Islands law. The laws of foreign jurisdictions may apply in the courts of those jurisdictions and may be significantly different from Cayman Islands law with regard to the existence, extent, breach and consequences of the breach of duties owed by directors, or with regard to other relevant issues. In such a case, advice must always be sought from legal practitioners within the particular foreign jurisdiction.
DIRECTORS AND OFFICERS
Who is a director?
There is no precise legal definition of a director under Cayman Islands law. In essence, directors are those who have the ultimate responsibility for the conduct of the company’s affairs. Directors share features similar to those of general partners of limited partnerships and trustees, but they also possess distinct attributes and duties. It is not always easy to identify who is a director, save in the case of those appointed in accordance with the company’s articles of association. Directors, as such, are not employees of the company - they may enter into service contracts, and these may impose further duties on them.
The following expressions are sometimes applied to the term ‘director’:
- an ‘executive’ or ‘non-executive’ director
There is no substantial difference between the responsibilities in law of an executive or a non-executive director. The extent to which a non-executive director may rely on the executive directors is an uncertain area of the law. Reliance may not be unquestioning, and there is a residual duty of supervision and control (please see paragraph 2.2.2 below).
- a ‘de jure’ director or ‘de facto’ director
A de jure director is a validly appointed director. A person who undertakes the functions of a director, but is not validly appointed may be treated as a de facto director, with the consequent duties of a director.
- a ‘shadow director’
A shadow director, in relation to a company, means a person in accordance with whose directions or instructions the directors are accustomed to act. Unlike a de jure or a de facto director, a shadow director does not claim or purport to act as a director. On the contrary, he claims not to be a director, but nonetheless directs the actions of the other directors. A person is not deemed to be a shadow director merely because the directors act on advice given by him in a professional capacity. A shadow director has the same duties as those imposed on a director.
- a ‘nominee director’
As the term itself implies, a nominee director acts on behalf of another party. The term is also used in respect of persons who act as directors of a number of investment funds for an annual fee. However, the duties owed by a director are personal to him, and it is immaterial that he acts for another person.
Who is an ‘officer’?
1.3.1 The company’s officers (other than directors) who are authorised to act on its behalf in a senior management capacity, are subject to the same duties as those imposed on a director.
1.3.2 The term ‘officer’ is defined in the Cayman Islands Companies Law (2004 Revision) as including a ‘manager or secretary’ [of the company]; the definition is not exhaustive.
THE DUTIES OWED BY DIRECTORS
2.1 The duties of a director owed under Cayman Islands law to his company can, for the purposes of this Note, be conveniently divided into duties at common law, being those of skill, care and diligence, on the one hand, and fiduciary duties, on the other. However, directors also owe statutory duties under various statutes, and, in certain circumstances, may owe duties to third parties such as creditors and individual shareholders. A director may also owe duties as a trustee, insofar as any company property is in his hands or under his control. Directors are also agents in relation to transactions they enter into on behalf of the company.
2.1.2 We set out below the general duties: service contracts entered into by directors may impose other obligations.
Duties at common law
2.2.1 Directors owe duties to the company of skill, care and diligence in the exercise of their powers and in the conduct of the company’s affairs. A director of a company is normally only obliged to exhibit such skill as he actually possesses and such care and diligence as would be displayed by a reasonable man in the circumstances. The three main criteria expounded in the (1925) leading English case are:
- a director need not exhibit, in the performance of his duties, a greater degree of skill than may reasonably be expected from a person of his knowledge and experience; he is not liable for mere errors of judgment; he is not required to be an expert in the business of the company, or to possess any particular skill, unless he is appointed as an expert or to exercise such skill;
- a director is not bound to give continuous attention to the affairs of the company. He is not bound to attend all meetings but should attend such meetings as he ought to attend whenever, in the circumstances, he is reasonably able to do so; and
- in respect of all duties that, having regard to the exigencies of business and the Articles of Association, may properly be left to some other official, a director is, in the absence of grounds of suspicion, justified in trusting such an official to perform such duties honestly.
2.2.2 These criteria were expounded over seventy-five years ago and the standard of care now required of a director is probably higher, and more objective i.e. he must act as a reasonable person in his position and that standard may increase if his subjective skills enable him to meet a higher standard than a director without those skills. A director must be diligent and careful in his selection of the persons to whom he delegates any functions and those persons must not only be reasonably believed to be honest but also to be competent to carry out the functions in question. Any delegation and the delegates should be re-evaluated on a regular basis. The directors who delegate must ensure there is in place a system of checking on the performance of the delegated functions, and ensure they are sufficiently informed about the nature and condition of the company’s business to appreciate any warning signals which the supervisory system may generate.
2.2.3 Directors may rely on the advice of an independent outsider, and may be considered negligent if they reach a decision without first obtaining appropriate expert (e.g. legal) advice.
Directors must take reasonable care to select an adviser who is qualified to give the advice, and, having received it, the directors must then exercise their own judgment in the light of that advice.
2.3 Fiduciary Duties owed by the Directors to the Company
2.3.1 These are four main duties.
(a) Bona fides. A director must act loyally, honestly and in good faith in what he considers (and not necessarily what a court might consider) is in the best interests of the company. The test is subjective.
(b) Proper purpose. A director must exercise the powers that are vested in him for the purpose for which they were conferred and not for some personal or collateral, or some other improper purpose.
(c) Unfettered discretion. A director must not fetter the future exercise of his powers, for example by agreeing to exercise his powers in accordance with the instructions of some third party. This will be of particular relevance to a nominee director or one who represents a particular shareholder.
(d) Conflict of interest. This is the duty that is most frequently varied by a company’s Articles of Association. As a fiduciary, a director must not put himself in a position where there is an actual or potential conflict between his duty to the company and a duty owed to another person, including a shareholder whom the director represents on the board. It is open to the company, as beneficiary of the fiduciary power, to waive a particular conflict. Under the general common law, such waiver can only be given by the company in general meeting (i.e. the shareholders by a majority vote, once the director has made full disclosure of the conflict or potential conflict). However, it is now the almost invariable practice for the company’s Articles of Association to provide that, if a director discloses his interest to the board at or before the meeting at which a particular matter is to be considered, he may vote in respect of that matter, notwithstanding that he is interested in it.
2.4.1 The Cayman Islands Companies Law (2007 Revision) imposes various specific statutory duties in relation to the internal administration of the company and the registration and filing of the company. These are outside the scope of this general Note.
2.4.2 Although not a duty imposed on directors per se, the Law also prohibits fraudulent trading. Specifically, if in the course of the winding up of a company, it appears that any of its business has been carried on with intent to defraud the company’s creditors or creditors of any other person or for any fraudulent purpose, the court may declare that any persons who were knowingly parties to carrying on the business in that way are liable to make contributions to the company’s assets. Usually, each director will be knowingly a party to ways in which the business of the company is carried on and therefore potentially liable if that business is carried on for fraudulent trading.
2.4.3 There are specific Cayman Islands statutes and regulations dealing, for example, with investments and mutual funds, which impose specific duties on directors. Again, these are outside the scope of this general Note.
Duties to third parties
Directors are agents of their company and, on basic agency principles, are not personally liable on contracts purporting to bind the company, and will bind only the company provided that the making of the contract was within the authority of the directors. However, if there is in fact no such authority, directors may be liable to compensate the other party to the contract for breach of the implied warranty of their authority. Directors of a company can make themselves liable in contract to third parties, for example by giving personal guarantees to banks and others for the performance of the company’s obligations.
There are two potential situations: The first is where the company commits a tort (e.g. negligence) through a servant or agent, and the question is whether a director, not being the servant or agent responsible, is liable to the victim. The second is whether a director, who acts so as to cause the company to be liable in tort, can be sued personally by the victim.
- In the first instance, a director is not liable for the torts committed by a company simply by virtue of his being a director, but he may be personally liable if he has authorised, directed or procured the commission of the tort, even if he did not know, or did not care, whether the acts so authorised were tortious. It will be a question of fact in each case, and the court will examine what part the director played personally in the commission of the tortious act.
- In the second instance, the test for personal liability is whether the relevant director has assumed responsibility, either on an actual or imputed basis.
Contempt of Court
- Where a company is ordered by the court either to do or to refrain from doing something, or if it gives an undertaking to the court to do or to refrain from doing something, then a director who is aware of the order or undertaking is under a duty to take reasonable steps to ensure that the order or undertaking is complied with, and if he willfully fails to do so, with the result that the order or undertaking is breached, he can be punished for contempt of court. Thus, a director may be liable for contempt even though he has not actively participated in the breach of the order or undertaking. The failure to supervise or investigate, or willful blindness on his part, will be enough.
- The sanction for contempt of court is a fine or imprisonment, or both.
To whom are a director’s duties owed?
2.6.1 As regards a director’s common law duties and his fiduciary duties:
As a general rule, a fiduciary relationship will exist between the director and the company, and his fiduciary duties are owed only to, and can only be enforced by, the company. Similarly, his common law duties are generally owed only to the company, and can only be enforced by the company. In certain circumstances, the shareholders can enforce duties owed to the Company (by derivative action).
- In certain circumstances, directors may, by their actions, place themselves in a relationship with the shareholders by virtue of which they owe fiduciary duties to the shareholders as well as to the company. However, such fiduciary duties to shareholders arise under another fiduciary relationship, namely that of principal and agent.
- However, modern cases suggest that directors owe fiduciary duties to shareholders, in addition to those which they owe to the company, in respect of any advice given and action taken by the directors in relation to the shareholders’ decisions whether to dispose of their shares. Two points should be noted: first, such a fiduciary duty to shareholders is very limited in scope and, secondly, compensation available to a shareholder in an action for breach of this fiduciary duty will be limited to the loss suffered personally by the shareholder.
- Directors may also, by their actions, place themselves in a position where they owe a separate duty at common law to individual shareholders.
ENFORCEMENT AND REMEDIES FOR BREACH OF DIRECTORS’ DUTIES
Duties may, depending on the duty and the circumstances, be enforced, or the breach of duty prohibited, by court injunction. Breach of the injunction would constitute a contempt of court (paragraph 2.5.3 above).
RemediesBreach of Statutory Duty
- Specific Cayman Islands statutes provide for the imposition of penalties (usually fines or imprisonment, or both), for breaches of statutory duties by directors.
- In a company liquidation, personal liability may be imposed on a director by statute (s.169 of the Cayman Companies Law) for misapplication of company money, misfeasance or breach of trust.
- Also, in company liquidation, personal liability may be imposed on any person, including a director, who is knowingly party to the carrying on of the company’s business for fraudulent trading. Any such person may be held liable to make such contribution to the company’s assets as the court directs.
Breach of Common Law and Fiduciary Duty
- Remedies for breach of common law and fiduciary duties include compensation, restoration of company property, or an account and payment to the company of profits made in breach of duty.
- In all cases, it must be remembered that, in general, in order to succeed in a common law claim and in a claim for breach of fiduciary duty, it will be necessary for the company, shareholder or outsider, to prove (1) the duty (2) breach of the duty and (3) the amount and causation of loss. The degree of proof required is the balance of probabilities.
3.2.3 In the particular context of shareholder investment, directors may be liable to compensate those who acquire any of the company’s shares and suffer loss as a result of any untrue or misleading statement or the omission of any matters stated in the offering documentation. However a director will have a defence to this liability if he satisfies the court that at the time the offer document was submitted he reasonably believed, having made such enquiries as were reasonable, that the statement was true and not misleading (or that the matter omitted which caused the loss was properly omitted) and that he continued in that belief up until the time when the shares were acquired or that they were acquired before it was reasonably practicable to bring a correction to the attention of persons likely to acquire the shares, or that before the shares were acquired, he had taken all such steps as were reasonable for him to take to secure that a correction was brought to the attention of those persons.
3.2.4 A director would not be liable for any statement made by an expert which is included in the offering documentation with the expert’s consent, if at the relevant time the director believed, on reasonable grounds, that the expert was competent to make the statement (see paragraph 2.2.3 above).
Defences available to Directors
3.3.1 Apart from defences of ‘no breach’, ‘no Causation’ and ‘no loss’, there may be, depending on the claim, various defences - the claim may be time barred, the Plaintiff may have been contributorily negligent, there may be a claim for indemnity, or the liability of a director to the company or to shareholders may be excluded or limited by the articles of association (please see paragraph 4.3.1(a) below).
RELIEF FROM LIABILITY
Relief by Statute
Unlike English law, there is no express provision in the Cayman Companies legislation for the relief, by the court, of company directors from liability. However, it is considered that such an application may be made under the Cayman Court’s inherent jurisdiction, and/or under the Cayman Trusts law, insofar as the breaches of duty amount to a breach of trust. Relief, if granted, would only be afforded in cases where a director had acted honestly and reasonably and ought fairly to be excused.
3.4.2 Relief by resolution of the shareholdersCertain breaches of duty by a director can be ratified (and so absolve the directors) by ordinary resolution, so long as all material facts have been disclosed prior to the passing of the resolution. Breaches of duty involving illegality, fraud or other dishonesty are not capable of ratification in this way.
4.1 It is desirable, but often difficult in practice, for directors to convert general principles applicable to their duties into an overall practical approach to limit their potential liabilities. Some guidance is set out below.
4.2.1 No director should accept an appointment unless he has sufficient awareness of the company and its business. As explained above, he is not required to be an expert in the type of business carried on by the company, or to possess any particular skill, unless appointed as an expert or to exercise that skill.
4.2.2 He should familiarize himself with the memorandum and articles of association and, in the case of investment funds, the offering documentation. He should enquire into the fund structure - who is the adviser, the administrator, the registrar and the investment manager - and he should familiarise himself with the contracts under which they perform their services. He should understand the provisions relating to the NAV and to redemptions.
4.2.3 He should ensure that he has sufficient knowledge of the regulatory and similar requirements which affect the company.
4.2.4 He should carefully examine the minute book of past directors’, meetings, and all other books of record maintained by the company.
4.2.5 If the director is uncertain of his duties and responsibilities in law with regard to the company, or of the terms of any service contract he proposes to enter into, he should obtain advice from the company’s legal representatives.
4.3 Operational Considerations
4.3.1 In relation to investment funds, the best way for a director to avoid liability is, of course, to take practical steps to ensure that he acts in accordance with his duties to the fund. There are operational considerations that can help achieve this objective. Please note this list is not exhaustive but we have tried to highlight the main areas of relevance to investment funds.
Prior to appointment, an intending director should carry out checks, including:
- independent due diligence on the fund’s sponsor, the investment manager and its principals.
- ensuring that the track record for reliability, honesty and competence of the services providers has been adequately checked.
- giving careful consideration to the competence, honesty and expertise of his co-directors.
- familiarizing himself with all operational considerations including investment strategies, major investors (existing or sought), NAV calculation procedures (including suspension of NAV), redemption, gates, suspension of redemptions and all other such considerations applicable to the particular fund.
- ensuring that appropriate indemnities and exclusions or limitations of liability are provided for him, in the Articles of Association. It is extremely important that appointments of directors are made subject to, and with the benefit of, the provisions of the Company’s Articles of Association. If the appointment is not made on these terms, it is possible that a director will not be able to rely on such provisions.
- ensuring there is (or will be) in place an adequate directors’ and officers’ liability insurance policy, to the benefit of which he will be entitled.
The director should ensure that, in relation to the launch of the fund, he has reviewed and signed off on the final form of the fund documentation. This is particularly important in respect of the offering documentation. The directors must ensure that the offering documentation of the fund includes all such information as investors and their professional advisers would reasonably require and reasonably expect to find, for the purposes of making an informed assessment of the assets and liabilities, financial position, profits and losses and prospects of the fund, and the rights attaching to shares, and also as to the provision of side letters: please see, in this context, the separate Ogier note on side letters.
Particular attention should be paid to:
- whether all statements in the offering documentation are verifiable (e.g. relating to the past performance of the fund or the investment manager), and realistic (e.g. as to future returns).
- whether the risk factors are comprehensive, relevant and appropriate to the fund; and
- whether any conflicts of interest are sufficiently disclosed, particularly if the investment manager provides directors or if the investment manager calculates the NAV. The directors should also ensure that the launch resolutions are comprehensive and deal adequately with all relevant delegations, including full delegation of the fund’s AML responsibility to the administrator.
- The directors must ensure that all changes to the offering documentation are disclosed by notice to the shareholders and, if appropriate, that the offering documentation is republished. Whenever an offering document is updated or re-published, it must be sent to all existing shareholders and not just to potential investors.
- Each director and service provider and the company’s legal representatives should be provided with a file containing copies of all major documents relating to the fund - in particular the memorandum and articles of association, special resolutions, the offering documentation, and contracts with service providers. This should be updated as a matter of course with amendments or new documentation. The file should contain contact information for all important persons and entities connected with the organisation and operation of the fund.
- Once the fund is launched, a director should ensure that a number of operational procedures are established.
(1) clear procedures must be put in place for the provision of regular periodic reports to the directors from:-
These reports should include comprehensive accounting information for the relevant period, comprising, in particular:
- the NAV
- profit and loss accounts
- details of assets held by the fund
- details of sale and purchase transactions, showing gains and losses
- subscriptions and redemptions
- capital movement reports
These reports should include comprehensive details of investments made and sold during the relevant period, and of future proposed investments and sales. The directors should ensure that these comply with the fund’s policies and strategies as set out in the offering documentation.
- The directors should ensure that regular reports are sent to the shareholders by the administrator and that they are provided with copies of all such reports.
- The directors must provide the administrator and the investment manager with written instructions to the effect that they must immediately inform the directors of any breach of investment policy or instructions, or any breach of the provisions of the offering documentation or the articles of association.
- The directors must ensure that the administrator and the investment manager have instructed their senior staff that the directors may communicate with them directly on any matter concerning the fund and its performance, and that such staff are instructed to co-operate fully with the directors.
- The directors should not hesitate to press the administrator and the investment manager and their senior staff for relevant information and for full explanations. The directors must be alert to detect, and to insist on explanations for, apparent diversions from the fund’s investment policy and inaccuracies or inconsistencies in the reports prepared for them, and in the reports to the shareholders.
- The directors should, by general instruction, instruct the fund’s legal representatives to report immediately, and to advise on, all applicable regulatory requirements and changes, in particular under the Cayman Companies and Mutual Fund legislation. Stock Exchange requirements should be investigated and updated for the directors by the fund’s secretary or by the investment manager.
- Meetings of the board directors should be held as circumstances require, and in any event not less than once in any company financial year, for the purpose of approving the annual audited accounts. If approval of other accounts is required (e.g. under stock exchange requirements), then meetings should be held for that purpose. In addition to the directors:-
- the administrator should be required to attend to report on the accounts, changes by the auditors to the accounts and to explain unusual items and to answer such questions as the board may raise. A comprehensive list of the areas of reporting and of questions which might be raised, is outside the scope of this Note, but can be provided on request.
- The investment manager should be required to attend and report on performance and future investment plans, target investors, and all other matters within his remit.
- Neither the administrator nor the investment manager should remain at the meeting for any period other than their reporting and responding to questions raised.
In addition to matters raised in the reporting and questioning of the administrator and the investment manager, and the consideration and approval of accounts, it will generally be necessary to consider matters such as proposed dividends (and auditor’s approval thereof and any required stock exchange notifications), performance of service providers, adherence to fund strategy, reports to shareholders, exercising discretionary waivers, approving side letters and determining whether to impose a redemption gate.
The secretary of the meeting must draw up and circulate to the directors clear and detailed minutes, which must be approved and included in the company’s books.