In an unanticipated development, the Cayman Islands Court of Appeal handed down judgment on 12 February 2015 and has reversed the decision of Jones J1 who had held that the Directors of the Weavering Macro Fixed Income Fund (the "Fund") were liable for wilful neglect or default, and has set aside the US$111 million judgment which had been obtained by the liquidators of the Fund against them.
The Fund collapsed into insolvency when it was discovered that its Net Asset Value ("NAV") comprised fictitious interest rate swaps with the related Weavering Capital Fund based in BVI and which were designed to conceal the fact, that the Fund had in fact suffered substantial losses. The allegation against the Directors was that they ought to have discovered the identity of the counterparty to the IRS contracts, and if they had, then they would have appreciated that the values attributed to those contracts could not be justified and the Fund would have been put into liquidation in November 2008 and would not have paid out US$111 million to redeemed investors which was irrecoverable.
Jones J concluded at the end of the trial at which both Directors gave evidence that they were in breach of their duty of care and skill in failing to discover who the counterparty was in November 2008 as the name of the counterparty appeared in a quarterly report which they had both read. The Court of Appeal agreed.
However, the Articles of Association of the Fund provided an exclusion of liability unless the Fund could prove that the Directors had been guilty of "wilful neglect or default". Jones J had inferred from the evidence that they had indeed been guilty and held them liable. The Court of Appeal disagreed and held that the Judge had been wrong to draw such an inference from the facts.
The Court of Appeal re-affirmed that a Director could not be guilty of wilful neglect or default unless he either (i) knows that he is committing and intends to commit a breach of his duty or (ii) is recklessly careless in the sense of not caring whether his act or omission is or is not a breach of duty (applying the test of Romer J in Re City Equitable Fire Insurance [1925] Ch.407). This was the same test that Jones J had applied.
Jones J had found that this test had been satisfied on the evidence. He inferred that the Directors consciously chose not to read the 2008 report with sufficient care to satisfy himself that there had been no breach of the investment restrictions, knowing that failure to do so was in breach of his duty. The Court of Appeal held that this inference was improper on the evidence. The Court of Appeal said that the evidence was equally consistent with the Directors having a different view from the Judge as to what their high level supervisory duties required of them, and equally consistent with negligence or gross negligence which was not enough. The Directors' evidence that they each genuinely believed that they were complying with their high level duty to supervise, was clear and unchallenged in cross-examination and so the Judge was wrong to have inferred that they had consciously chosen generally not to perform their duties to the Fund.
Jones J had not considered the second limb of "recklessly careless" and in particular had left open the question of whether in order to be held liable under this limb it was necessary to prove that the Director had appreciated that his conduct might be a breach of duty and had continued regardless of the consequences. The Court of Appeal examined the authorities which had been relied upon by Romer J in City Equitable and concluded that the Director must at least be shown to have suspected that his conduct might constitute a breach of duty in order to be found liable under the second limb. There was no evidence that these Directors appreciated that their conduct might be a breach of duty and so they could not be liable for reckless carelessness.
The judgment applies well known principles and authorities relating to the legal test of wilful neglect or default, indeed Jones J had applied the same principles. The significance of the judgment lies in the criticism by the Court of Appeal of the inferences which had been drawn by the Judge, and their emphasis on the fact that these Directors had not understood what their high level supervisory duties required of them, having delegated all important functions to the Investment Manager, the Administrator and the Auditors.
The conclusion to be reached from the approach of the Court of Appeal to the evidence is that if liability for negligence and gross negligence are excluded, the prospects of finding liability on the part of Directors, Administrators or Auditors of funds are very slim indeed.
Footnote
1 (Weavering Macro Fixed Income Fund Limited -v- Peterson and Ekstrom [2011] (2) CILR 203)
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