On 12 February 2015 the Cayman Islands Court of Appeal handed down its long-awaited judgment in Weavering Macro Fixed Income Fund Ltd v Peterson and Ekstrom. The case, which measured the liability of directors, sent shock-waves through the funds industry in Cayman and the offshore world when it was decided at first instance. The Court of Appeal's long-awaited judgment allowed the appeal and set aside the order of the trial judge which had ordered the directors to pay damages of $111 million.
The case against the directors was that they breached their duty of supervision by failing to identify, by the latest in November 2008, that a substantial proportion of the fund's investments were interest rate swaps the counterparty to which was a related fund (WCF). The judge at first instance (Jones J) found that, if the directors had identified this fact (which was set out in a report which had been produced for the board following the end of the third quarter of 2008) they would have appreciated that the values attributed to those investments in the fund's financial statements could not be justified and that the fund was in fact insolvent and should be (and would have been) wound up. Following the collapse of Lehman Brothers there had been a large number of redemption requests which had then been paid by the fund. The liquidators alleged that, if the directors had performed their duty of supervision, the fund would have been placed into liquidation sooner and the redemption requests would not have been satisfied. The allegations were much broader than this but the essential causative breach of duty that was complained of was the failure of the directors to pick up on the fact that WCF was the counterparty when it was stated in the quarterly report and to act accordingly in light of that knowledge.
The directors disputed that they breached their duty, but said that, even if they did breach their duty, they were entitled to rely on the exculpation clause in the fund's articles of association, which excluded the directors from liability for their conduct except where they were guilty of "wilful neglect or default". Jones J found that the directors did breach their duty and were guilty of wilful neglect or default.
The President of the Court of Appeal (with whom the other two judges agreed) agreed with the judge that the directors did breach their duty to supervise the fund's business, which, as in most Cayman investment structures, is carried on by delegates such as investment managers, administrators, custodians and so forth (such that the duty essentially consists of selecting appropriate delegates, ensuring that the terms on which they are appointed give effect to the investment objectives and restrictions set out in the offering documents of the fund and ensuring that they perform properly the functions which are delegated to them).
Jones J had held that the directors were guilty of wilful neglect or default and that they could not therefore rely on the exculpation clause in the articles of association. The judge directed himself that in order to amount to "wilful neglect or default" the directors must have either known that they were committing, and intended to commit, a breach of duty, or were recklessly careless in the sense of not caring whether an act or failure to act is or is not a breach of duty. The judge said that the case against the directors was that "'they did nothing' and carried on doing nothing for almost six years. If they knew that they had a duty to supervise – and they both claim to have been aware of this duty – but did nothing, then it seems to me that their neglect must be intentional. If the evidence establishes that directors have completely and utterly ignored their duty and made no serious attempt to perform their duty, in spite of being conscious of a duty to supervise, as I think it does in this case, then their default must be regarded as wilful. The purpose and effect of [the exculpation clause] is to protect directors who do their incompetent best. Those who attempt to perform their duty, but fail as a result of their carelessness, no matter how gross, are relieved from liability. Those who have an appreciation of their duty, but make no attempt, or at least no serious attempt, to perform the duty are not relieved from liability." The judge went on to hold later in his judgment that the directors were "guilty of wilful neglect or default because they consciously chose not to perform their duties to the [Fund], or at least not in any meaningful way." And for good measure, later still he held that "If they had applied their minds for a moment, they would have appreciated that their behaviour was wrong. In my judgment their behaviour ... when Mr Ekstrom signed fictitious minutes of two meetings which never took place, leads unequivocally to the conclusion that they knew perfectly well that their behaviour was wrong."
The Court of Appeal disagreed with the reasoning of the judge. It could find nothing in the evidence to support the findings the judge had made and the inferences which he had drawn which led him to conclude that the directors were guilty of wilful neglect or default.
As to the law, the Court of Appeal held that in order to show wilful neglect or default it was necessary for the fund to prove that the directors made a deliberate and conscious decision to act or to fail to act in knowing breach of duty, or necessary for the court to be satisfied that the director appreciated (at the least) that his conduct might be a breach of duty and made a conscious decision that, nevertheless, he would do or omit to do the act complained of without regard to the consequences.
The Court of Appeal's disagreement with the judge as to the findings he had made and inferences which he had drawn from the evidence was extensive. In summary:
- the judge was wrong to conclude that the directors had sought to falsify minutes of board meetings said to have been held in July and October 2008 when the evidence pointed to the conclusion that the directors had annotated the minutes (which were dated July and October 2008) to identify them as minutes of a meeting which had actually been held on a later date;
- the judge had been wrong to conclude that the directors' failure to keep accurate minutes of meetings (pro forma minutes recorded the decisions taken) was evidence of a conscious decision to disregard their duty;
- the judge was wrong to find that because the directors never summoned delegates to meetings to be questioned this was evidence of a decision not to perform their duties. The directors were entitled to take the view that they could rely on the written reports that were produced to them by the administrator;
- the judge was wrong to find that the directors' decision to sign documents which they had not read was evidence of wilful neglect. Directors who sign documents which on their face appear to be documents which the directors can properly be advised to sign, and which they are advised to sign by those who may be taken to have considered whether it is in the fund's interests for the documents to be signed, are not to be held in breach of a high-level supervisory duty;
- the judge identified, said the directors, the scope of the high-level supervisory duty by reference to the judge's own expectations of what the directors should have done without reference to authority and on a rigid and overly prescriptive view. The President observed that "these submissions cannot be dismissed as fanciful. It may be said that the conduct of the directors which the judge criticised ... is consistent with the judge's conclusion that neither of the directors ever intended to perform his duties; but it is equally consistent with an understanding on the part of the director concerned as to what the high-level supervisory duty required which differed from that of the judge; and, as it seems to me, it is equally consistent with negligence or gross negligence in the performance of whatever the directors believed the high-level supervisory duty required of them."
Even though the Court of Appeal has disagreed with Jones J as to the findings he made at first instance and allowed the directors' appeal, and even though it was on any view an extreme case, there is little doubt that when it was published the judgment at first instance in Weavering served an important and useful purpose in that those operating in all corners of the Cayman funds industry sat up and took serious notice of what had been said by the Cayman court. Many Cayman service providers reviewed their governance models and their standard documentation to make sure that roles and responsibilities were more clearly defined and delineated. Weavering has also generated a public consultation concerning fund governance issues and has led to legislation regulating certain providers of professional directorships. In short, while it may ultimately have been shown to have been wrong, it is unlikely that the changes which has brought about will be forgotten or reversed.
The Court of Appeal's reiteration of the test for wilful neglect and default reminds us that the bar for liability is set very high and that professional service providers can escape liability even where they have been responsible for the grossest default, as long as it was not wilful. The question which may now become the focus of debate is whether wilful default remains the appropriate standard for the Cayman Islands' sophisticated professional funds industry in the 21st century.
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