Anyone familiar with Cayman Islands mutual funds will be aware of the decision of the Cayman Islands Grand Court last year in Weavering Macro Fixed Income Fund Limited (In Liquidation) v. Stefan Peterson and Hans Ekstrom. It will be recalled that in Weavering the Fund was wound up following the discovery that it had been the victim of a fraud and had no assets, and that claims were brought by its official liquidators alleging that the directors had acted in breach of the duties they owed to the Fund to act in its interests, to exercise independent judgment, and to exercise reasonable care, skill and diligence. As Peterson and Ekstrom relied on a clause in the Fund's articles of association exonerating a director from liability for loss or damage caused to the Fund other than that arising through his own wilful neglect or default, the official liquidators had to prove that the directors were guilty of wilful neglect or default in order to succeed.
On the facts, the judge (Jones J) had no hesitation in holding that the directors of the Fund were guilty of wilful neglect or default, as they had intentionally failed to perform their duties to supervise their delegates (particularly the Fund's investment manager ("WCUK")) and to exercise independent judgment. They had subordinated themselves to the will of Magnus Peterson who, in addition to being Stefan's brother and Hans's step-son, was a director of WCUK and the author of the fraud. Peterson and Ekstrom had, according to the judge's findings, adopted a practice of signing whatever board minutes and documents Magnus put in front of them and saying what Magnus wanted them to say without giving those matters any or any proper consideration. Jones J also found that the directors had failed to properly consider the quarterly financial reports provided to them by the Fund's administrator, which, had they done so, would have informed them that WCUK was not complying with the Fund's investment restrictions and that Magnus was perpetrating a fraud on the Fund and its investors. In those circumstances, they could not be heard to say that they were simply doing their "incompetent best", which was what they needed to show in order to rely on the exemption clause in the Fund's articles.
The next episode in the saga was set in the English High Court. Entitled Weavering Capital (UK) Limited (In Liquidation) and Others v. Peterson and Others (in which judgment was handed down on 30 May 2012), this was an action brought by the liquidators of WCUK which comprised clawback claims against recipients of some of WCUK's assets and claims against WCUK's directors (Magnus Peterson, his wife Amanda and a Mr Chas Dabhia) for inter alia breaches of the fiduciary and statutory duties they owed to WCUK. If the action against the directors succeeded, WCUK's liquidators intended to admit (to an amount of US$450 million) a proof of debt the liquidators of the Fund had filed in WCUK's liquidation in respect of breaches by WCUK of the Investment Advisory Agreement (in particular failure to comply with its obligation to adhere to the Fund's investment restrictions), breaches of fiduciary duty, negligence, conspiracy and fraudulent/negligent misstatement in WCUK's purported performance of its duties.
As Magnus Peterson was the author of the fraud perpetrated on the Fund's investors, Proudman J had no difficulty in finding that he was liable for breach of the duties which he owed to WCUK as a director. The judge also found that Magnus effectively controlled WCUK. A greater degree of analysis was, however, devoted to the claims against the other two directors.
Amanda Peterson sought to resist the liquidators' claim on the bases that:
- she had a very limited and confined role at WCUK, having been involved only in the execution of exchange-trading as opposed to investment management strategy;
- she had acted reasonably in assuming that Magnus Peterson, Chas Dabhia and a senior employee were managing the Fund properly, in the absence of anything to alert her to the fraud; and
- she could not reasonably have done anything which would have led to any different result. All of these arguments were rejected: as a director, Amanda Peterson could not escape liability on any of these bases.
In relation to the first, the judge found that WCUK was a small firm in which all parties occasionally undertook the functions of the others and it was no answer to a claim in negligence against a director that Amanda only had a confined area of responsibility.
On the second point, the test was whether what Mrs Peterson did was that which a reasonable director of a hedge fund management company in her position, with her experience, actual knowledge and intelligence should have done, and whether she had acquired a sufficient knowledge of WCUK's business to discharge her duties. The directors of WCUK had accepted responsibility for the contents of the Fund's offering memorandum, Mrs Peterson had discussed and approved the Fund's entry into the interest rate swaps with her husband, she knew that her husband had a majority interest in the counterparty ("WCF") to the trades which the Fund was entering into, that WCF was ostensibly managed by WCUK but paid no fees for that service, that WCF had no external administrator and had no substantial assets of its own, and that WCUK was not conducting any trades on behalf of WCF for extended periods of time.
With regard to the question of causation, the judge held that the test was what a reasonable director would have done and found that, with the knowledge that Mrs Peterson actually possessed, she could not have reasonably approved the relevant trading in contravention of the Fund's offering memorandum nor could she have allowed that trading strategy to continue with a related party such as WCF. Amanda had in fact decided to subordinate herself to the will of her husband and blindly trusted that he was properly managing the Fund and would continue to do so, and that was no defence to the claims against her.
In relation to the liquidators' claims against Chas Dabhia (whose primary responsibility was to market the Fund to investors), Proudman J confirmed that it was no answer to a claim for a breach of his duties as a director of WCUK to say that he failed to apply his mind to the important question of who was the counterparty to the relevant trades. In the judge's opinion, he should have realised that "something was seriously amiss with the swaps and that the requirements of the OM were not being observed" and he "should have realised that the swaps were being concealed from the investors, he should have asked the identity of the counterparty ... and considered the issue of the 20% restriction and made inquiries as to how WCF could meet its obligations", but instead he participated in misrepresentations to the investors in inter alia the due diligence questionnaires. In the circumstances, Proudman J held that Mr Dabhia was in breach of his duties as a director as he failed to acquire a sufficient knowledge and understanding of WCUK's business and failed to satisfy himself as to the details and propriety of the relevant trades, and was liable in negligence for failing to act with reasonable care, skill and diligence and for negligently making false representations to investors. Importantly, the judge reached this conclusion notwithstanding that she had found as a fact that Mr Dabhia had only a limited understanding of what Magnus was doing and had followed his instructions unquestioningly, and that he did not realise (at least until a very late stage) that WCF was the counterparty to the trades the Fund had entered into.
The most important points for directors to take from Proudman J's decision in the WCUK case are that:
- a director does not escape liability for breach of his duties by relying on co-directors to properly perform their functions in circumstances where the director was wilfully blind to the fact that his co-directors were not properly performing their duties, or where he failed to acquire sufficient knowledge and understanding of his company's business so as to be able to appreciate when his co-directors were failing to perform their duties; and
- a director must exercise his own independent judgment and may not subordinate himself to the will of another.
The English decision echoes Jones J's forceful reminder in the Cayman proceedings that directors are inter alia duty-bound to exercise their own independent judgment, to properly supervise their delegates and to know the business which they are appointed to direct. The directors' appeal against Jones J's decision has been heard by the Cayman Islands Court of Appeal and judgment is awaited.
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.