Cayman Islands: Guide To Directors' Duties In The Cayman Islands

PREFACE

This Guide provides a summary of duties and liabilities of directors of a company incorporated under Cayman Islands laws. It is not intended to be an exhaustive statement of the law but to be of assistance to persons who act as directors of one of the (approximately) 90,000 companies incorporated in the Cayman Islands.

The duties and liabilities of directors of a Cayman Islands company are governed by a mix of the Companies Law (2010 Revision) (the "Law") and the common law (insofar as it has not been amended by or incorporated into statute).

Whilst the Cayman Islands' courts regard decisions of the English Courts in relation to such matters as highly persuasive and largely adopt English common law principles, there are still significant differences of which directors of Cayman Islands companies need to be aware and which this Guide sets out.

Additionally, under Cayman law, there are statutory provisions which impose personal liability upon directors for their acts or omissions. This Guide discusses and gives an overview of areas such as fraudulent trading and fraud in anticipation of winding up. There are also provisions relating to misconduct and defrauding creditors.

Directors are not only agents but they are in some sense and to some extent trustees or in the position of trustees. However, their position differs considerably from that of ordinary trustees and this Guide summarises how and which of the strict rules do not apply in all respects to directors.

For most purposes it is sufficient to say that directors occupy a fiduciary position and all the powers entrusted to them are only exercisable in this fiduciary capacity.

In summary, directors are agents of the company to which they stand in a fiduciary relationship. The fiduciary relationship imposes upon directors duties of loyalty and good faith, which are similar to those imposed upon trustees so called. As agents, directors are also under duties of care, diligence and skill. As agents their duties are very different from the trustees' duties to be cautious and not to take risks.

It is recognised that this Guide will not completely answer detailed questions which clients and their advisers may have. It is intended to provide a sketch of the subject matter covered and is not a substitute for taking legal advice in the context of specific factual circumstances. This Guide is, therefore, designed as a starting-point for a more detailed and comprehensive discussion of the issues.

1. NATURE OF DIRECTORS' DUTIES TO THE COMPANY

Each company registered in the Cayman Islands has a set of constitutional documents which describe and delimit the duties and responsibilities of its directors. The company's constitutional documents are supplemented by common law and statute. In general, the duties described in this Guide are owed by the directors to the underlying company as a whole – that is, to the general body of shareholders, rather than to individual shareholders or to particular classes of shareholders. Where the company is on the brink of insolvency (i.e. where its solvency is in doubt), directors' duties also extend to the company's creditors, whose interests will become paramount if the company actually becomes insolvent.

Directors as Agents

As stated directors are, in the eyes of the Companies Law (2010 Revision) (the "Law"), agents of the company for which they act and the general principles of the law of principal and agent regulate in many respects the relationship between the company and its directors. This position has long been established and in Ferguson v. Wilson (1866) L.R. 2. Ch.77, Cairns LJ stated:

"What is the position of directors of a public company? They are merely agents of a company. The company itself cannot act in its own person, for it has no person; it can only act through directors, and the case is, as regards those directors, merely the ordinary case of principal and agent. Wherever an agent is liable those directors would be liable; and where the liability would attach to the principal, and the principal only, the liability is the liability of the company."

Therefore the general rule is that directors are considered to be acting as agents for the company and, as long as they make this fact clear to third parties, they should not incur any personal liability for breach of contract or any tortious act committed by the company. It follows that if a director fails to make it clear to a third party that he acts as a director of a company or, for instance, the director gives personal guarantees, then personal liability will result.

A director's duties of care, diligence and skill can be summarized as follows:-

a. Directors are not expected to be experts unless appointed as such

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. The test is partly objective (the standard of the reasonable man) and partly subjective (the reasonable man is deemed to have the knowledge and experience of the particular director). A director is therefore not expected to exercise skill which he does not possess.

It is clear from these remarks that directors of a specific company are not required to be experts of the type of business which the company promotes unless they are appointed because of their specialist qualifications. Many boards consist only partly of such experts and, for the rest, of persons who are specialists in business administration or in certain general aspects of business management such as legal, financial, accounting, banking or expert trade practice. Upon these principles a director would be entitled to rely upon the advice of his fellow directors and in matters in which they are, or should be, experts.

A number of English cases have accepted the distinction between the duty to be skilful, on the one hand and to take care on the other; the first being defined by reference to the particular director's skill and experience, and the latter by reference to the standard to be expected of the ordinary man.

b. A director must exercise reasonable care and diligence but is not liable for errors of judgement

The Cayman position is strongly influenced by English common law. Where a director takes part in the company's business, he must display reasonable care and diligence. Such reasonable care must be measured by the care that an ordinary man might be expected to take in the same circumstances on his own behalf. He is not responsible for damages occasioned by any errors of judgement. From this it falls that in appropriate circumstances the director may rely upon an opinion of an outsider. Of course the obtaining of outside advice does not absolve directors from the duty of exercising their business judgement upon such advice.

c. A director may reasonably rely on co-directors and officers of the company

When determining duties we must look to the nature of the company's business, and, provided the work is distributed in a reasonable way, to the manner in which the work is distributed between the directors themselves and the other officials in the company.

A director may reasonably rely on co-directors and other officers or managers of the company. Consideration must be given to the nature and demands of the company's business. Of course the reliance of the director upon his co-directors and the officers should not be unquestioning and the director must have no ground for suspicion that the other director, officer or manager on whom he is relying is performing his duties other than honestly. Even non-executive directors, when delegating responsibility to management, are under a duty to ensure that sufficient controls are in place to ensure that abuses can be quickly identified and the board is always in a position to guide and monitor the management.

This point is extremely important as in large companies the board cannot in fact manage the company. Extensive delegation to particular executive directors, to senior managers who are not directors and to senior employees of the company is inevitable in a large business organisation.

A director must give a reasonable amount of attention to the company's affairs but is not bound to give continuous attention. The amount of time to be given will depend largely upon the extent to which devolution of duties has been organised, and upon the number of directors.

It is not necessary for a director to attend every board meeting unless the articles specify this; but he ought to attend whenever he is reasonably able to do so and continuous non attendance of meetings may render the director guilty of the breaches of trust which are committed by others. It is not part of the duty of a director to take part in every transaction which is considered at a board meeting. It should be pointed out that even where a director has been shown to be negligent as a result of non-attendance at board meetings, it may nevertheless be very difficult to demonstrate that any particular loss has occurred to the company as a result of the non-attendance.

Directors' Fiduciary Duties

As previously mentioned, the test of whether the fiduciary duties of a director attached to a particular person is a functional one. Does the person in question perform the duties of a director, for example as a de facto or shadow director, even if he is not a director de jure? If the answer is in the positive, then the appropriate fiduciary duties will attach.

The fiduciary relationship of a director exists with a company: the director is not usually a trustee for individual shareholders. Thus a director may accept a shareholder's offer to sell shares in the company although he may have information which is not available to that shareholder and the contract cannot be upset even if the director knew of some fact which made the offer an attractive proposition.

In certain circumstances, however, the directors may by their actions have placed themselves in a relationship with the shareholders by virtue of which they owe fiduciary duties to the shareholders as well as to the company. The English courts have held directors to be under a duty to act in good faith when giving shareholders advice whether to accept a take-over offer for their shares or whether to sanction a scheme for the purchase of a large block of assets from another company. The directors have no obligation to give such advice but if they give it, the advice should not be given for their own improper reasons.

These duties apply at all times and not only when a company faces financial difficulty.

The Grand Court has recently provided a detailed analysis of the scope of an independent director's duties towards an offshore fund for the first time in Weavering Macro Fixed Income Fund Limited (In Liquidation) v Peterson & Ekstrom (2011).

In this case the directors were found guilty of wilful default in the discharge of their duties and they were ordered to pay significant damages to the fund's liquidators, representing the losses suffered due to their default.

The facts of the case are quite extreme and based on these the trial judge made a number of stern statements of principle about the duties of hedge fund directors. These statements are important in that the Court took long standing principles concerning the duties of non-executive directors in a conventional company structure and adapted them for the unique structure of a hedge fund.

Where directors have the benefit of an indemnity for all loss causing conduct other than that consisting of "willful neglect or default" (the current industry standard), liability can only accrue where they know that they are committing, and intend to commit, a breach of duty; or are recklessly careless in the sense of not caring whether their act or omission is a breach of duty.

In this case, the Court held that directors who effectively do nothing for a period of years, knowing that they had a duty to supervise, will be found to have intentionally neglected their duties and thus liable; on the other hand, directors who make a serious attempt to perform their duty but fail as a result of carelessness or incompetence, no matter how gross, will be relieved from liability by virtue of the standard indemnity.

a. Good Faith

The directors are under a duty to act bona fide in the best interests of the company. This duty is a subjective one and it is generally left to the business judgement of the directors to decide how the interests of the company may best be promoted. The company is defined in equity usually by reference to the shareholders as a whole and not by reference to the company as an entity as distinct from its members. The company does not mean the sectional interest of some (it may be a majority) of the present members, but of present and future members of the company and that on the basis that the company is to continue as a going concern. The directors should balance a long term view against the short term interest of present members.

There is now a growing body of dicta in the English Courts to the effect that, when the company becomes insolvent or is nearly so, then the interest to which directors must have regard when acting in the interests of the company include the interest of the creditors as well, perhaps in some cases instead of, those of the shareholders. An important consequence of this change in the definition of the company for the purposes of directors' duties is that actions of the directors which have adversely affected the value of the company's assets of which, whilst the company was solvent, could have been ratified by the shareholders may no longer be so ratified.

The courts will interfere only if no reasonable director could have concluded that a particular course of action was in the interests of the company.

It should be noted that the interests of employees are not recognised in their own right as an object of the directors' concerns.

b. Proper Purpose

The directors must exercise their powers for a proper purpose. Where directors have a discretion and are, bona fide, acting in the exercise of it, the courts will not interfere with their acts unless the particular purpose for which the discretion is being exercised is not one of the purposes for which it is conferred. A common example is the exercise by directors of their power to issue shares for purposes of maintaining their control over the affairs of the company. However, an exercise by the directors of their powers for a proper purpose which has the identical and desired result, for example, of diluting a voting majority of shareholders would not be sufficient to make the purpose improper.

c. Conflict of Duty and Interest

Like other fiduciaries, directors are required not to put themselves in a position where there is a conflict (actual or potential) between their personal interests and their duties to the company or between their duty to the company and the duty owed to another person.

At common law, however, and therefore in Cayman, the company is at liberty to waive completely the rules protecting it as principal in dealings in which the directors have an interest. Most Cayman companies have Articles which allow directors to attend, be counted in the quorum and usually also to vote on transactions in which they are interested as long as their interest is disclosed. Generally, however, directors should not use for their own profit the company's assets, opportunities or information.

d. Unfettered Discretion

It is a logical extension of the principle that a director must act in the company's best interests that a director is not permitted to contract with other directors or with third parties in such a way as to fetter his future discretion, although there is little judicial authority on the point. This is so even though there is no improper motive or purpose and no personal advantage to the directors under the voting agreement. This does not prevent the directors, having determined to enter into a transaction, from voting to take all further action necessary to complete the transaction.

e. Nominee Directors

The concept of nominee directors will often involve a breach of fiduciary duties, conceivably on the basis of a fettering of their discretion and also on the basis that they have an inherent conflict of interest. However, so long as the director is left free to exercise his best business judgement in the interests of the company, there is nothing to prevent the appointment of nominee directors.

f. Acting in other capacities

A director is not prohibited from acting as an officer or an employee of the company (except as an auditor), as a director of another company, or from representing the interests of a member or other third parties, as long as the company consents and the director is able to continue to act in the best interests of the company. If a conflict situation arises, the director must not subordinate the interests of the company to those of another company or third party in order to resolve such conflict.

g. Group Benefit

The English case of Charterbridge Corporation v. Lloyds Bank Ltd determined that a director must not be guided by the interests of the group of companies as a whole if this might be detrimental to the interests of his own company, particularly if his company has separate creditors. If, however, the intended measure does not conflict with the interests of his company, it is not a breach of duty to his own company that he has taken into account the benefit of the group as a whole. Further a director cannot be compelled to take into account the interests of the group of companies.

Statutory Duties

In addition to the common law duties discussed above, the Law sets down certain specific duties, some of which carry both civil and criminal penalties for the company and the "officer" in default.

Examples of some of the requirements with which directors must comply are:-

• Maintenance of Registers. The Registers of Members, of Directors and Officers and of Mortgages and Charges must be maintained and kept at the company's registered office (wilful omissions in the Mortgage Register carries a fine of CI$100);
  
• The directors must ensure that the company complies with reporting requirements under the Law such as filing of the annual return, notifying of changes to directors and officers or changes to the registered office address;
  
• The directors are responsible for ensuring that the company complies with accounting requirements. Any company that knowingly contravenes such requirements is liable to be fined;
  
• No distribution or dividend may be paid to members out of the share premium account unless immediately following the date on which it is paid the company shall be able to pay its debts as they fall due. A company and any director who knowingly and wilfully authorises or permits any distribution or dividend which contravenes this provision is liable on conviction to a fine of CI$15,000 and imprisonment;
  
• A payment out of capital by a company for the redemption or purchase of its own shares is not lawful unless immediately following such the company is able to pay its debts as they fall due. Again wilful contravention of this provision carries a CI$15,000 fine and imprisonment.
  
  Other insolvency related provisions in addition to the general requirement for directors of Cayman companies to cooperate with the liquidator (sections 101 to 103 of the Law) were brought into force via Section 3 of the Companies (Amendment) Law, 2007 in March 2009, see below.
  

a. Fraudulent trading

Section 147 of the Law provides that where any person (being a director or an officer) was knowingly a party to the carrying on of business by the company with the intent of defrauding creditors of the company or of any other person, or for any fraudulent purpose, a liquidator may apply to the court for an order requiring that person to contribute to the company's assets.

b. Fraud in anticipation of winding up

Section 134 of the Law provides that where any person, being an officer (including a shadow director), professional service provider, voluntary liquidator or controller of the company, within 12 months preceding the commencement of winding up has, with the intent to defraud creditors or contributories:

Then such person is guilty of an offence and liable on conviction to a fine and to imprisonment for five years.

c. Transactions in fraud of creditors

Section 135 of the Law introduced a criminal offence, similarly punishable by fine or imprisonment, where in the case of a company being wound up by the court or voluntarily, an officer of the company, a professional service provider to the company has either (a) made a gift of, or has charged the company's property, or has connived in levying execution against it or (b) has concealed or removed the company's property, in each case with the intent to defraud the company's creditors or contributories.

d. Misconduct in winding up

Section 136 of the Law states inter alia that where a company is being wound up by the court or voluntarily, any person who is or was a director, officer or professional service provider of the company who does not make full disclosure to the liquidator of all company documents or property within his control (except where disposed of in the ordinary course of business) or who permits a false debt to be proved in the liquidation is punishable by a fine and to imprisonment for five years.

e. Material omission in statement of affairs

Section 137 authorises a liquidator to require directors, officers, employees and professional service advisors of the company to submit a statement of affairs to the liquidator setting out their knowledge of the assets and liabilities of the company. Any material omission in such a statement is punishable again by a fine and to imprisonment for five years.

f. Shadow directors

Shadow directors are defined as persons in accordance with whose directions or instructions the directors are accustomed to act. This must amount to a pattern of conduct as opposed to an isolated occurrence. Further, a person will not be a shadow director just because directors act on advice given by him in a professional capacity.

Penal Code

The Penal Code (Revised) provides for offences of theft and fraud and includes: publishing false or misleading statements with an intent to deceive members or creditors and false accounting. A director if found guilty can be criminally liable for up to seven years imprisonment.

2. DIRECTORS' LIABILITY

Generally speaking, directors do not incur personal liability for the debts, obligations or liabilities of a company except for those specified by statute and which arise out of negligence, fraud or breach of fiduciary duty on the part of an individual director, or due to an action not within his authority and not ratified by the company.

Statutory liability

In a number of cases already discussed above legislation now provides that directors who are in default shall be personally liable to persons without the company. Such liability may arise for example: by order of the court on the winding up of the company or under the fraudulent trading provisions.

Furthermore, where directors act outside the scope of their authority they may be liable to compensate a contractual counterparty for breach of their implied authority.

Tortious liability

There are two potential situations to be distinguished with regard to liability for torts. The first is where a tort is committed by the company through one of its servants or officers and the question is whether a director, although not the officer in question, is liable for the tort committed by the company. The second is where the director is the person whose acts have caused the company to be liable in tort and the question is whether the plaintiff can sue the director personally.

Where the tort is committed by the company, a director does not make himself liable merely because of the fact of his directorship. Nevertheless, a director who, whilst not committing a tort himself, has authorised, directed and procured the commission of a tort by his company may be personally liable to the victim of the tort even though he was not aware that the acts he authorised were tortious or did not care whether the acts where tortious or not. Whether a director has authorised a tort will depend on the facts of each case.

Equally a director is not held responsible for the fraud of his co-directors, unless he has expressly or impliedly authorised it.

Where it is the acts of the director in question which give rise to the liability of the company, there are two competing approaches to the issue of the personal liability of the director. One approach is to say that the principles applicable are exactly the same as in the cases where the principal is not a company and the agent is not a director. The normal rules of agency would apply and a director acting as agent who commits a tort in the course of his functions as a director is always personally liable and the company will be liable as well on the basis of the doctrine of vicarious liability.

The alternative approach, which the English and Commonwealth Courts appear to lean towards, proceeds from the premise that the separate legal personality of the company requires directors to be to some degree shielded from liability which would otherwise apply to them in the same way that the doctrine of limited liability protects the shareholders. On this approach, the director is not made personally liable unless he has made it clear to the third party that he has assumed personal responsibility as opposed to assuming responsibility on behalf of the company.

3. INDEMNIFICATION

Cayman law does not prohibit or restrict a company from indemnifying its directors and officers against personal liability for any loss they may incur arising out of the company's business. A company's articles may provide for the indemnification of a director or an officer for breach of duty, save in circumstances where there has been wilful neglect, wilful default, fraud or dishonesty in the carrying out of fiduciary duties. Such indemnities have been considered by the courts many times and it is clear that the "irreducible core" [that is the duty to act in honesty and good faith] of a fiduciary's obligations remains despite the terms of any indemnity (In re Bristol Fund Ltd. (4.) 2008 CILR 317).

If there is an indemnity clause it will have the effect of an exculpatory clause, because there is no cause of action against a person whom you are liable to indemnify in respect of the same matter (Viscount of the Royal Court of Jersey v Shelton [1986] 1WLR 985 following In re City Equitable Fire Insurance Co. [1925] Ch 407).

The company will commonly obtain directors and officers' insurance.

4. CONCLUSION

Directors of companies must be fully aware of their powers and duties so that they can avoid personal liability to the company and third parties. In addition to their duties under common law and the statutory regime in the Cayman Islands, directors must have regard to the company's memorandum and articles, shareholder resolutions and board minutes. Company's constitutional documents and any contract for services or contract of employment are in fact the starting point in determining directors' responsibilities.

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.