14 May, 2015
Weavering Macro Fixed Income Fund Limited (In Liquidation) v Peterson & Ekstrom (12 February 2015) is a case from the Cayman Islands where the directors (“Directors”) of a hedge fund company (“Company”), Weavering Macro Fixed Income Fund Limited, failed to exercise proper supervision of the Company thereby allowing the investment manager to perpetrate a fraud on the Company. However, the Cayman Islands Court of Appeal found that the Directors had acted in the belief that they were complying with their duties, and accordingly held that while they had been negligent in the performance of their duties, they had not acted in “wilful neglect or default”. This was important because the constitutional documents of the Company provided an indemnity for the Directors which covered liability for any wrongful or negligent acts or omissions unless it was due to “wilful neglect or default”.
Facts
The Company was founded by Magnus Peterson (“Peterson”). The Directors were his brother and step-father. The Company carried on investment activities, in particular, in derivative-type transactions. Its investment activities were contracted out to an investment manager, an entity owned by Peterson. While the Company appeared to be doing well, in reality, it was making huge losses. The losses were masked through the booking of fictitious gains on a basket of interest rate swaps entered into with Weavering Capital Fund (“WCF”), a shell company controlled by Peterson with very little material assets.
The Directors were unaware of the fraud being perpetrated by Peterson. Both left the day-to-day management of the Company to the investment manager. They were also unaware that the interest rate swaps were being entered into with WCF. Indeed, it was found by the first instance court, that they exercised no supervision over the running of the Company whatsoever:
- They would sign minutes of board meetings that never took place when told to do so by Peterson.
- When board meetings did occur, the minutes took a standard form with the directors merely noting a number of matters and points.
- They never looked into or asked about the Company’s performance or its business.
- They would sign whatever documents were put in front of them by Peterson, for example, the Company’s annual accounts, side letters, and waiver forms.
There was no question that the Directors had been negligent in their exercise of their directors’ duties. The issue before the Cayman Islands Court of Appeal was whether this negligence had also amounted to “wilful neglect or default”. The Cayman Islands Grand Court had found, as the court of first instance, that it had and so held that the Directors could not avail themselves of the indemnity.
Decision
The Court of Appeal agreed with the Grand Court that the Directors had not met the required standard of care in performing their duties as directors of the Company. However, it disagreed that their actions (or lack thereof) had amounted to “wilful neglect or default”.
The Court of Appeal first noted that a director would only be guilty of “wilful neglect or default” if he either:
- knows he is committing and intends to commit a breach of duty; or
- is recklessly careless in that he does not care whether or not his act or omission is a breach of duty.
In this case, the Directors had testified that they had honestly believed that they were complying with their duties, and there was no evidence that this was not the truth. Accordingly, it could not be shown that the first limb of the test was satisfied.
As for the second limb, the Court noted that, in order to establish recklessness, it was necessary to show that a director appreciated that his conduct might be a breach of duty and nevertheless continued with such conduct. As with the first limb, no evidence had been brought to counter the Directors’ testimony that they had honestly believed that they were complying with their duties. Accordingly, it could not be shown that the second limb of the test was satisfied.
As neither the first nor second limb could be satisfied, it could not be established that the Directors had acted in wilful neglect or default of their duties and accordingly they were entitled to rely on the indemnity provided by the Company.
Our Analysis / Comment
The use of the phrase “wilful neglect or default” is often found in indemnity clauses in trust deeds of funds. While the decision of the Cayman Islands Court of Appeal as to what constitutes wilful default of fiduciary duty was made in the context of directors’ duties, it might be useful in a construction of similar indemnity or limitation of liability clauses in a different legal and commercial context. Whether this case may be persuasive to the Singapore courts remains to be seen.
For further information, please contact:
Annabelle Yip, Partner, Wong Partnership
annabelle.yip@wongpartnership.com
Joy Tan, Partner, WongPartnership
joy.tan@wongpartnership.com
