This guide provides an overview of the duties and liabilities of directors of hedge funds and private equity funds. It is not to be taken as specific legal advice applicable to particular issues or circumstances.
As a leading provider of independent directors to Cayman companies including investment funds and other investment entities, we have witnessed a complete shift in the appreciation for the risk and role that the board of directors have in the fundamental operations and prosperity of a company and investment fund. Traditionally, it was the case that clients forming a Cayman company would do so and seek to do this with the sole focus on cost and the appointment of directors was an inconvenience best avoided by appointing someone within the investment management firm to act. These days have largely disappeared.
Nowadays, investors expect to see experienced independent directors on the board who are there to represent their interests rather than possible conflicts with the investment manager. We have also witnessed a huge increase in local regulation and new laws which have placed significant burdens, liability and risk on those charged with overseeing the activities of the company, the board of directors. It is no longer feasible for managers to ignore the local requirements and concentrate solely on the performance of the fund to the detriment of best practice governance.
Appointing independent and professional directors should be seen as bolstering the offering of a fund, demonstrating good governance, making the investor due diligence hurdle easier to navigate and see the board as a significant benefit to the ongoing operations of the fund. Moreover, when issues do arise such as litigation or restructuring, having an experienced board that is responsive and commercial is in the interests of all parties.
The duties and liabilities of the directors of a company under Cayman Islands law arise from:
the common law: the duties have developed over many years by way of analogy with other legal relationships, particularly the relationship between principal and agent and between trustee and beneficiary;
statute: principally the Companies Law (the Companies Law), but also the Penal Code (the Penal Code), the Proceeds of Crime Law (the Proceeds of Crime Law) and, where appropriate, the Mutual Funds Law (the Mutual Funds Law); and
the memorandum and articles of association of the company: its constitution, within the limits of which the directors are obliged to operate. Common law duties and liabilities of directors Under the common law, directors owe fiduciary duties and certain duties of skill and care. Fiduciary duties An individual director must act in good faith in his dealings with or on behalf of the company and exercise the powers and fulfil the duties of his office honestly. His fiduciary duty has five aspects:
a duty to act in good faith in what the director considers are the best interests of the company;
a duty to exercise powers in the company's interests and only for the purpose or purposes for which they are given;
a duty not to put himself in a position where there is an actual or potential conflict between his duty to the company and his personal interests;
a duty not to misuse company property; and
a duty not to improperly fetter the exercise of the director's future discretion. Duties of skill and care A director's fiduciary duty imposes on him a largely negative obligation to do nothing which conflicts with the company's interest. However, when a director is acting in the company's interest he is expected to exercise whatever skill he possesses with reasonable care. This duty has two aspects:
a duty to acquire and maintain a sufficient knowledge and understanding of the company's business to enable the director to properly discharge his duties; and
a duty to attend diligently to the affairs of the company. However, a director is entitled to rely upon his fellow directors and the other officers of the company and can delegate power to others where it is reasonable to do so. If a director breaches his fiduciary duties or duties of skill and care, he may be personally liable to the company for damages. Offences for which a director may be liable under the common law include negligent misstatement and deceit.
Negligent misstatement
Where a director has been negligent in making a statement he may be liable under a claim for damages brought by a plaintiff who has suffered loss through acting in reliance on that statement. In connection with mutual funds, each director should read the offering document as it progresses to final proof. Each director should consider every material statement of fact or of opinion contained therein and satisfy himself prior to publication of the document that:
• he is not aware of anything which would cause him to doubt the accuracy of any statement in the document; and
• each statement has been the subject of sufficient verification by appropriate and competent people to afford him reasonable grounds to believe that it is true and not misleading.
Deceit
If the directors have been fraudulent in misrepresenting facts by making a statement either with knowledge of its falsity or being reckless as to whether it is true or false they could be liable for damages to a shareholder or purchaser thereby deceived. The measure of damages in an action for deceit is the actual damage suffered by the plaintiff, including consequential loss and it is not limited to damages which were reasonably foreseeable as a result of the misstatement.
Statutory duties and liabilities of directors
The general principles governing a director's conduct set out above are augmented by a range of specific duties imposed by statute.
The Companies Law
The Companies Law places certain duties upon the directors of Cayman Islands companies, some of which are sanctioned by criminal penalties. Many of these duties are specifically imposed upon the directors.
In addition, in a number of instances the Companies Law provides that where a company is in breach of a particular statutory obligation, any 'officer' of the company (which includes a director) who is 'in default' shall be liable to a penalty as well as the company. The Companies Law states that for this purpose the expression 'officer who is in default' means any officer of the company who knowingly and wilfully authorises or permits the default, refusal or contravention mentioned in the enactment. Among the most important statutory
provisions that are sanctioned in this way are the following.
No distribution or dividend may be paid to members out of the share premium account unless immediately following the date on which the distribution or dividend is proposed to be paid the company shall be able to pay its debts as they fall due in the ordinary course of business.
CIMA Statement of Guidance
In January 2014, the Cayman Islands Monetary Authority (CIMA) published a statement of guidance (the SOG) for regulated mutual fund governing bodies (bodies responsible for overseeing the activities of funds) and operators (members who together comprise the governing bodies of funds) to ensure that the management and direction of funds is conducted in the fit and proper manner expected by CIMA – the SOG sets out the minimum requirements
The SOG sets out key principles which should be interpreted and applied in the context of each regulated fund, taking into account factors such as the fund's structure, complexity and size. The SOG sets out that:
• a fund's governing body is required to effectively supervise and oversee a fund's activities (as highlighted in the much publicised Weavering judgment3 as being absent in the case of the Weavering fund). This requirement underpins the other principles which the SOG establishes and includes a requirement that the governing body of a fund should meet at least twice per year;
• a fund's operators must ensure internal documents are maintained which fully record the proceedings of meetings of the fund's governing body;
• communication between the operators of a fund and its governing bodies should include appropriate reporting on compliance and transparency with investors where disclosure is appropriate; and
• a fund's risks should be appropriately managed and mitigated (and discussed at meetings of the funds governing body).
CIMA has released a Statement of Guidance which establishes key principles of good governance which must be observed by each Cayman Islands regulated mutual fund. Such principles require, inter alia, the board of directors to properly oversee the activities of the fund's service-providers, suitably identify, disclose and manage all conflicts of interest and meet at least twice a year or otherwise more frequently as determined by the size, nature and complexity of the fund.
Protections against directors' liability
Indemnity
A company may include a provision in its articles of association or may enter into a separate contractual arrangement with a director indemnifying a director in certain circumstances, provided however that such constitutional or contractual indemnification cannot override a director's common law or statutory duties and liabilities.
Insurance
The company may also purchase and maintain insurance for directors and certain other persons against liability incurred as a result of any negligence, default, breach of duty or breach of trust in relation to the company.
CV5 Capital - Fund Governance Services
We are routinely act on the board of alternative investment fund board as independent directors. Our professionals provide comfort to investors, regulators and other service providers that there is expert independent oversight of fund operations, risk and compliance. With seek to add real value form our expertise to bolster the corporate governance framework and build long term relationships with fund managers and the industry. We work with asset managers around the globe and accept just a select number of positions to ensure that we can adequately discharge our duties. For further information on our independent director services, please feel free to contact us: info@cv5capital.com
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