Isle of Man: W(e)avering In Your Choice Of Domicile For Your Company Or Fund? Happy Ending Or Grimm Tale?

Last Updated: 15 October 2012
Article by John Spellman

Do you as a Non Executive Director or the appointed Non Executive Directors ("NEDs) of your client funds actually realise why they are in situ? Harsh? Fair? Irrelevant? For many years the role of the NED has, for some companies, been seen as a necessary evil rather than a necessity: NEDs being appointed by tax advisors for tax reasons or imposed by the parent or the relevant regulator.

Of course, the choice of NED is often left to the appointing entity and some companies took the view that they wanted passive NEDs and to this end paid them to attend 4 board meetings a year or so and subsequently entertained them for their trouble. The regulator and tax adviser's box was ticked and the company continued as it always had. Everyone lived happily ever after...or so they all thought...

The recent Weavering case demonstrated that it is all too easy to appoint a NED but the impact of getting it wrong can be devastating on both the professional advisers and the directors themselves. In that sorry tale, the damages awarded for negligence in their duties meant a nightmare ending for those involved.

Choosing the right NED is a difficult decision: the NED needs to display many skills and often a NED may not possess all the skills that the company may typically need over its lifecycle. Further, with a limited pool of NEDs, sometimes NEDs are appointed because they are 'friends' of the company and perhaps there only to make up the numbers to satisfy the tax advisers and appease investors.

Horror Story

In case you don't like full length horror stories, here is a quick precie.

On 26 August 2011 in the Grand Court of the Cayman Islands the honourable Mr Justice Andrew Jones QC handed down the decision in Weavering Macro Fixed Income Fund Limited (in liquidation) (the 'Fund') v Stefan Peterson ('Peterson') and Hans Ekstrom ('Ekstrom'). The case examined the role of the NED and what will hopefully grab your attention is that Peterson and Ekstrom were held liable to the Fund's losses of $111 million for wilful neglect or default of their duties.

The Fund was a typical offshore fund based in the Cayman Islands which was put into liquidation shortly after the directors and professional service providers discovered that a high proportion of the assets held by it were fictitious. Obviously not ideal. The Fund had been established in 2003 and was put into liquidation some 6 years later in 2009, after having made some redemptions during the credit crisis in 2008. As Warren Buffet would have said described as one who were not wearing trunks when the tide went out.

The Fund appointed a UK investment adviser which was itself owned by a Magnus Peterson (a relative of Peterson) and also appointed an unconnected Fund Administrator based in Dublin. The case determined that Peterson and Ekstrom failed to:

  1. Ensure the Offer Memorandum was correct (as to auditors and administrators);
  2. understand the roles and duties of the service providers;
  3. to read fully or analyse reports provided to them; and
  4. to verify what the Investment Manager told them.

In addition the directors:-

  1. signed anything the Investment Manager asked them to sign without review;
  2. did not hold meetings as stated;
  3. produced no agendas or board papers in advance of meetings;
  4. allowed proforma minutes to be drafted by lawyers rather than the minutes reflecting matters discussed;
  5. requested no independent reports; and
  6. did not require other parties other than the Investment Manager to attended meetings to report to the board.

The case examined the three phases of the Fund's life and coincidentally the case notes provide an excellent account of what a NED should do during the start-up phase, during the Fund's operation and when a crisis occurs. It is a salutary tale of what not to do but many aspects of the case are not uncommon in a lot of companies who appoint NEDs. The reason for this is simple: the role the NED is clear but companies still have to embrace that role.

Our Heroes

Typically the NED should make sure he or she understands the structure, understands where responsibilities lie and that those responsibilities are clearly defined, eg with service providers. Further, reliance should not simply be placed on the company's lawyers to make sure everything is drafted correctly. In addition the NED should make sure the company understands the scope of the NED's supervisory role and that the Offer Memorandum complies with the law and is accurate and complete.

The Plot Thickens

The directors must:

  1. hold regular meetings, have proper agendas circulated in advance with proper minutes being taken to reflect discussions. Some communication between meetings is to be expected if circumstances affecting the company change. If such circumstances arise then they should be considered promptly; Also board papers should be circulated sufficiently in advance to allow Directors to review them prior to the meeting
  2. require the appointed service providers to occasionally attend meetings and reports should periodically be requested of them where appropriate;
  3. review management accounts (eg ability to read a balance sheet) and ensure investment criteria are being met; and
  4. not rely on other directors to undertake a task without discussion (or without understanding their findings).

When Disaster Strikes

The directors must:

  1. meet promptly to consider internal and external events which might affect the company;
  2. request relevant reports to facilitate impact assessment; and
  3. take immediate appropriate action.

Epilogue

It is not the level of remuneration that is key here, it is the responsibility of the appointment and effectively undertaking the role. Those who refer to NED as NLE's (or Nice Little Earners) are sadly ignorant of the real world. In the Weavering case it was clear that:

  1. The level of remuneration paid to NEDs or directors generally does not reduce the level of responsibility. In Weavering the directors were not paid at all.
  2. No indemnity if you don't try your best.
  3. The indemnity clause contained in the articles only applied if the directors tried their best (even if they were incompetent). In Weavering the directors were found to have known what they should have done but failed to do it. One can imagine a position where a strong board could seek to frustrate a NED's role: this can happen if the NED is not sufficiently independent of the company. In such circumstances, the NED may take the option of an easy life and take the fees rather than carrying out that role.

Happy Ever After?

It is clear the NED has an (increasingly) important role and a role that cannot be taken lightly. It is clear from Weavering that it is likely that it will be the NED that will carry the responsibility and be answerable to investors if the executive directors fail to perform their duties diligently and independently.

In the UK the role of the NED is regarded as very important and is a highly respected factor in maintaining and enhancing a high level of corporate governance, whereas in the offshore environment a different view is often taken. Arguably the reason for this is probably tax: believing that the main reason why companies are likely to be offshore is for tax purposes. This does make a difference and often requires the appointment of NEDs who are independent of the investors to make the strategic decisions. This can lead to some stresses, strains and governance concerns between those who promote and invest offshore companies and the appointed directors.

There is a natural desire to interfere because to the average investor have every right to ask, 'Who are these people in the X location and what do they know about the proposed company's business?' Also revenue authorities are sceptical. As such there is a real burden on the appointed director to ensure good governance and also secure tax residence.

It is also essential to overcome the old perceptions. The only way one can achieve this, it appears, is by educating 'clients' (i.e. those who set up such structures) assisted by some level of regulation. Weavering teaches us that by choosing the wrong NED, things can go wrong but it also teaches that the executive board need to embrace the role of the NED and allow the NED to do his or her job, as set out earlier. The international community is now demanding that NEDs in overseas territories actually do their job, are accountable and are capable of standing up to scrutiny. Not before time many will say.

Their overriding role assists in ensuring tax residence remains offshore, not by throwing numbers of directors at the problem but by good and robust decision making and ensures that investors and other stakeholders are protected by ensuring the highest standards of governance.

It is only when a crisis occurs that the finger pointing starts and this affects not only the company involved itself but also could affect the jurisdiction from a reputational perspective and this is something any can ill afford.

Choosing the Right Jurisdiction

The Isle of Man has shown its foresight and already regulates the appointment of directorships so "jumbo directors" (individuals acting in a non-executive director capacity to over 100 companies) are not allowed unlike places like the Cayman Islands. Since 2000, individual non-executive directors within this jurisdiction, who hold more than 10 directorships of independent entities, are subject to regulation as "Professional Officers".

The application to the Isle of Man Financial Supervision Commission ("FSC") for a license, assesses amongst other things fitness, propriety and experience. Indeed there is a Code of Conduct contained within the Financial Services Rulebook 2011.

It should be noted that some persons are exempt, such as those who already hold a position of registration with the FSC or if you are employed within industry as an executive director as the individual will have already gone through the rigorous vetting process.

Emphasis is also given to a requirement of ensuring continuing professional development is gained and recorded as such. The FSC is now working on a comprehensive code of corporate governance for governing bodies that will consolidate the various Isle of Man statutory and regulatory provisions as a best practice guide. This will be supported by codifying the criminal and enforcement regime for breach of current statutory obligations for governing bodies of Isle of Man companies. The FSC also maintains "Guidance on the responsibilities and duties of directors under the laws of the Isle of Man". This is mandatory reading for everyone acting as a Director in the Isle of Man.

Choosing the Right NED

A company needs to be able to demonstrate for tax reasons that real decisions are made by the Board but this is one of many decision making responsibilities. These need to be based on facts and evidenced properly. The NED plays and integral role hereand tax is only part of the story, investor protection is paramount and hence the NED is there, in part, to ensure the required level of governance is in place. The NEDs role is not only becoming more important to give comfort to investors but companies and other stakeholders (such as tax authorities) are demanding higher standards.

The perception of role the NED needs to change. Many companies still have to embrace that role and it really is at their and their investors peril.

So the parable of this tale is a warning to all current NEDs, professional indemnity insurance does not protect against wilful neglect!

Let's all live happily ever after....

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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