The liquidators of Weavering Macro Fixed Income Fund Limited have a result in the Grand Court of the Cayman Islands. On the 26th of August 2011 in a 37 page judgement Mr Justice Andrew Jones QC gave judgement against each of the two directors of the fund in the sum of US$ 111 million plus costs – to be taxed if not agreed.
The judgement is important because it places a spot light on 4 fundamental principles in relation to hedge fund directors that need to be carefully considered by both investors and fund directors alike.
The first important point of principle is that fund directors need to be independent and should not act simply as an extension of the will of the investment manager. They need to discharge their duties in a manner that is in the interests of investors. Clearly directors cannot ignore the commercial realities that give the investment manager the power to influence decisions, but directors should not act blindly on the instructions of an investment manager. The judgement should cause investors to reflect on nominating their own boards of directors to ensure that there is independence from the will of the investment manager.
The second principle is that the range of duties and the manner in which they are discharged by directors should reflect the arrangements of the fund and the directors general fiduciary duties. There are many professional directors of offshore hedge funds that would fail to meet a number of the standards articulated by Mr Justice Jones QC in his judgement. The failings will often arise due to a reluctance on the part of directors to challenge the will of the investment manager who ultimately control appointments to and removal from the board. Professional directors who rely on the income stream from multiple appointments by a manager will wish to accommodate the wishes of an investment manager to protect that income stream. In my view this is another reason for investors to be involved in the appointment of fund directors. I was both amused and appalled by the reference in the judgement to the resolution appointing PriceWaterhouseCoopers as auditors and Fortis Fund Services (Isle of Man) Ltd as already having been appointed administrator to the fund when in fact subsequently, the Cayman and Irish firms of Ernst & Young were appointed as auditors and PFPC International Ltd was appointed the administrator. It does happen, because in reality it is the investment manager that drives these decisions. The directors more often than not, simply go along with these appointments.
The third principle is that the indemnities given to directors on hedge funds need careful examination by investors. The Weavering fund indemnity was worded so that the indemnity carved out wilful neglect or default. The judge was therefore required to determine whether the actions of the directors constituted wilful neglect or default in order to determine whether they were (1) liable and therefore (2) in being liable were not able to rely on the indemnity. In doing so the judge relied on the test adopted by Harre J (in Prospect Properties Limited (in Liquidation) v McNeill [1990-91] CILR 171 ) based on the 1925 decision by Romer J in Re City Equitable Fire Insurance to set out two limbs to determine what was wilful neglect or default:
(a) knowing and intentional breach of duty or
(b) acting recklessly, not caring whether or not the omission is a breach of duty.
The case against the directors according to the judge was “fairly and squarely” under the first limb of the test and the judge found against them on the grounds that “they did nothing”. However there are many funds with indemnities that do not have such carve outs or where the exculpatory clauses and carve outs do not match the carve outs of the indemnity clauses. The judgement is quite clear in accepting “that these directors are entitled to rely upon the exculpatory provision[s]”. In my experience these clauses are rarely given enough attention by investors.
The fourth and final principle is to reflect on the extent to which investors will recover any money even though an action is successful. The liquidators have succeeded in an action against the directors but whether the directors are in a position to meet the judgement against them of US$ 111 million plus costs will depend on their personal worth and the existence of insurance or other assets.
The judgement itself should be compulsory reading for all directors of funds.
©Jaitly LLP