A new case addressing the issue of the standard of care to be exercised by independent directors of a publicly traded investment fund is sending shock waves through common law jurisdictions. In a strongly worded judgment on Aug. 26 in Weavering Macro Fixed Income Fund Ltd. (in Liquidation) v. Peterson, Justice Jones of the Grand Court of the Cayman Islands, Financial Services Division, concluded that the ostensibly “independent” and unpaid directors of an investment fund were guilty of wilful neglect because they were entirely derelict in meeting their supervisory duties to the corporation.
Jones found that because the directors failed to perform their duties, which he said was a conscious decision on their part, they should be denied the benefits of a limitation of liability clause included in the company’s articles of incorporation. Judgment was delivered against the directors in the amount of US$111 million.
This judgment is important for two reasons. First, it provides a comprehensive and detailed exposition on the duties and obligations of independent directors. Second, and importantly, it holds that the failure of directors to perform these functions can be more than mere negligence, but can (and did in this case) amount to wilful neglect or default so that the directors are not protected under the terms of exculpatory provisions contained in the company’s articles or bylaws.
The effect of such a finding could be far-reaching. It could result in the director being precluded from relying upon an indemnity clause or even D&O insurance, depending upon the terms of the clause or the policy.
In early 2009, the directors and professional service providers of the Weavering Macro Fixed Income Fund Ltd. discovered that most of the assets reflected on the fund’s balance sheet were fictitious, and the fund was put into liquidation.
The fund had been created in 2003, and was listed on the Irish Stock Exchange. Its investment manager, WCUK, was indirectly owned and controlled by the fraudster, Magnus Peterson, who was also the fund’s promoter. The fund had a conventional third-party professional fund administrator and custodian, and had appointed Ernst & Young as auditors. Both the investment manager and the administrator were supposed to be subject to supervision by the fund’s directors, and the directors were responsible for approving its financial statements. However, the fund’s directors were not truly independent; they were Peterson’s younger brother and his elderly stepfather. As the trial evidence revealed, the directors were in actual fact nothing more than Peterson’s puppets, who blindly signed off on whatever documentation was put under their noses, without exercising any independent thought, inquiry, or judgment.
In his decision, Jones provides an extensive and detailed enumeration of the duties and responsibilities of investment fund directors in general, as well as a scathing rebuke in respect of the failings of the directors in this case. Most of this list of directors’ duties should apply with equal force to any corporate directors, not just those of publicly traded investment funds. Independent, non-executive directors of both private and public companies would be well-advised to keep these directions in mind before they agree to assume a board position, as well as after they have taken on the role, to ensure that they are up to the task.
As this case clearly demonstrates, when one accepts a directorship, one cannot be a passive onlooker. Acting in the best interests of the company means actually taking an active role in the governance and operations of the company, and failure to do so can have devastating consequences.
Directors’ duties and obligations
Weavering is peppered with directions about the nature and extent of directors’ duties, obligations, and responsibilities. Here, I have gathered all those findings into one comprehensive list:
1. Directors must exercise reasonable care, skill, and diligence, which comprise both an objective and a subjective element. They must exercise the care, skill, and diligence that would be exercised by a reasonably diligent person having the general knowledge, skill, and experience to be expected of a person assuming the directorship in question. They should act in a professional and businesslike manner. Whether the position is paid or unpaid is irrelevant to the scope of the duty.
2. Directors must exercise their powers independently, without subordinating their judgment or powers to the will of others, except to the extent that the powers may be properly delegated. Jones explained the duty as follows:
“For example, when asked to sign the financial statements and accompanying management representation letter addressed to the auditors, the directors must exercise an independent judgment by conducting a review in an inquisitorial manner and making appropriate enquiries of those involved, in particular the administrator and the auditor. They are not entitled to assume the posture of automatons, as these Directors did, by signing whatever documents are put in front of them by the investment manager without making enquiry or applying their minds to the matter in issue, on the assumption that the other service providers have all performed their respective roles (actual or perceived) and therefore to no need to be supervised in any way whatsoever.”
3. Directors have a continuing duty to acquire and maintain a sufficient knowledge and understanding of the company’s business to enable them to properly discharge their duties. In Weavering, that duty included:
• Being able to read a balance sheet, and having a basic understanding of the audit process;
• understanding the financial condition of the company, including reviewing the financial results of the fund’s trading activities at the quarterly board meetings;
• ensuring that the trading strategy described in the offering memorandum was being properly executed by the investment manager, and if this was not within the director’s personal ability, then ensuring that someone with the requisite knowledge was performing a proper analysis;
• satisfying themselves on an ongoing basis that the professional service providers were performing their functions in accordance with the terms of their contracts; and
• ensuring that there were no gaps in the managerial and administrative functions that had been delegated to others.
4. Subject to the provisions of the corporate articles, directors may delegate some functions to those below them in the management chain (including professional third-party service providers), and they may trust the competence and integrity of the delegates to a reasonable extent, but that delegation does not absolve the directors from their duty to adequately supervise the discharge of the delegated functions.
5. No universal rule can be formulated in respect of the duty in No. 4. The extent of the duty will depend on the particular circumstances of the case, including the director’s role in the management of the company.
6. Directors must conduct board meetings in a businesslike manner, including the preparation of minutes that fairly and accurately record the matters considered and decisions taken. Elaborating on this point in respect of the case before him, Jones concluded:
“. . . I do not accept that any real business was ever done at these meetings. . . . I was left with the impression of an elderly gentleman sitting at home chatting with his two stepsons in a congratulatory way about [Peterson]’s apparently successful investment fund business. If they had ever attempted to perform their duties as directors, one would expect to see occasional e-mails identifying matters for discussion or reflecting decisions made. In fact, there is no documentary evidence reflecting that these Directors ever sought to discuss or enquire about any subject at all throughout the period of almost six years that they held office. [fn excluded] In my judgment, the minutes of these meetings are nothing more than a self-serving “note” prepared by [Peterson] for the file. . . . The way in which the meetings were conducted and documented suggests that the Directors met his needs and never attempted or intended to conduct any real business.”
Wilful neglect or default
Failure of the directors to meet any of these duties, obligations, and responsibilities could result in a finding of negligence in the ordinary course. Here, however, the directors failed to meet any of their obligations, and were nothing more than mere “automatons,” signing papers presented to them for signature by the fraudster, without question. This, Jones found, was wilful.
Wilful neglect involves conscious conduct. The party must be found to have known he or she was committing a breach of duty, or she or he was acting with reckless disregard to whether or not the act or omission is a breach. Jones found that the Weavering directors knew they had a duty to supervise, but did nothing. This, he concluded, must be intentional neglect.
“If the evidence establishes that directors have completely and utterly ignored their legal duty and made no serious attempt to perform their duty, in spite of being conscious of a duty to supervise . . . then their default must be regarded as wilful,” wrote Jones. “The purpose and intended effect of Article 182 is to protect directors who do their incompetent best. Those who attempt to perform their duty, but fail as a result of their carelessness, no matter how gross, are relieved from liability. Those who have an appreciation of their duty, but make no attempt, or at least no serious attempt, to perform the duty, are not relieved from liability.”
Whether this analysis of wilful neglect will find traction in Canadian courts remains to be seen. However, this case does signal a strong warning to directors who fancy themselves as “figurehead” directors, or who otherwise fail to give due attention to the responsibilities that they have assumed. Dereliction of these duties may well result in findings of wilful neglect, and leave directors exposed to personal liability when they thought that they were otherwise protected by a corporate indemnity or exculpatory clause.
Jones found that because the directors failed to perform their duties, which he said was a conscious decision on their part, they should be denied the benefits of a limitation of liability clause included in the company’s articles of incorporation. Judgment was delivered against the directors in the amount of US$111 million.
This judgment is important for two reasons. First, it provides a comprehensive and detailed exposition on the duties and obligations of independent directors. Second, and importantly, it holds that the failure of directors to perform these functions can be more than mere negligence, but can (and did in this case) amount to wilful neglect or default so that the directors are not protected under the terms of exculpatory provisions contained in the company’s articles or bylaws.
The effect of such a finding could be far-reaching. It could result in the director being precluded from relying upon an indemnity clause or even D&O insurance, depending upon the terms of the clause or the policy.
In early 2009, the directors and professional service providers of the Weavering Macro Fixed Income Fund Ltd. discovered that most of the assets reflected on the fund’s balance sheet were fictitious, and the fund was put into liquidation.
The fund had been created in 2003, and was listed on the Irish Stock Exchange. Its investment manager, WCUK, was indirectly owned and controlled by the fraudster, Magnus Peterson, who was also the fund’s promoter. The fund had a conventional third-party professional fund administrator and custodian, and had appointed Ernst & Young as auditors. Both the investment manager and the administrator were supposed to be subject to supervision by the fund’s directors, and the directors were responsible for approving its financial statements. However, the fund’s directors were not truly independent; they were Peterson’s younger brother and his elderly stepfather. As the trial evidence revealed, the directors were in actual fact nothing more than Peterson’s puppets, who blindly signed off on whatever documentation was put under their noses, without exercising any independent thought, inquiry, or judgment.
In his decision, Jones provides an extensive and detailed enumeration of the duties and responsibilities of investment fund directors in general, as well as a scathing rebuke in respect of the failings of the directors in this case. Most of this list of directors’ duties should apply with equal force to any corporate directors, not just those of publicly traded investment funds. Independent, non-executive directors of both private and public companies would be well-advised to keep these directions in mind before they agree to assume a board position, as well as after they have taken on the role, to ensure that they are up to the task.
As this case clearly demonstrates, when one accepts a directorship, one cannot be a passive onlooker. Acting in the best interests of the company means actually taking an active role in the governance and operations of the company, and failure to do so can have devastating consequences.
Directors’ duties and obligations
Weavering is peppered with directions about the nature and extent of directors’ duties, obligations, and responsibilities. Here, I have gathered all those findings into one comprehensive list:
1. Directors must exercise reasonable care, skill, and diligence, which comprise both an objective and a subjective element. They must exercise the care, skill, and diligence that would be exercised by a reasonably diligent person having the general knowledge, skill, and experience to be expected of a person assuming the directorship in question. They should act in a professional and businesslike manner. Whether the position is paid or unpaid is irrelevant to the scope of the duty.
2. Directors must exercise their powers independently, without subordinating their judgment or powers to the will of others, except to the extent that the powers may be properly delegated. Jones explained the duty as follows:
“For example, when asked to sign the financial statements and accompanying management representation letter addressed to the auditors, the directors must exercise an independent judgment by conducting a review in an inquisitorial manner and making appropriate enquiries of those involved, in particular the administrator and the auditor. They are not entitled to assume the posture of automatons, as these Directors did, by signing whatever documents are put in front of them by the investment manager without making enquiry or applying their minds to the matter in issue, on the assumption that the other service providers have all performed their respective roles (actual or perceived) and therefore to no need to be supervised in any way whatsoever.”
3. Directors have a continuing duty to acquire and maintain a sufficient knowledge and understanding of the company’s business to enable them to properly discharge their duties. In Weavering, that duty included:
• Being able to read a balance sheet, and having a basic understanding of the audit process;
• understanding the financial condition of the company, including reviewing the financial results of the fund’s trading activities at the quarterly board meetings;
• ensuring that the trading strategy described in the offering memorandum was being properly executed by the investment manager, and if this was not within the director’s personal ability, then ensuring that someone with the requisite knowledge was performing a proper analysis;
• satisfying themselves on an ongoing basis that the professional service providers were performing their functions in accordance with the terms of their contracts; and
• ensuring that there were no gaps in the managerial and administrative functions that had been delegated to others.
4. Subject to the provisions of the corporate articles, directors may delegate some functions to those below them in the management chain (including professional third-party service providers), and they may trust the competence and integrity of the delegates to a reasonable extent, but that delegation does not absolve the directors from their duty to adequately supervise the discharge of the delegated functions.
5. No universal rule can be formulated in respect of the duty in No. 4. The extent of the duty will depend on the particular circumstances of the case, including the director’s role in the management of the company.
6. Directors must conduct board meetings in a businesslike manner, including the preparation of minutes that fairly and accurately record the matters considered and decisions taken. Elaborating on this point in respect of the case before him, Jones concluded:
“. . . I do not accept that any real business was ever done at these meetings. . . . I was left with the impression of an elderly gentleman sitting at home chatting with his two stepsons in a congratulatory way about [Peterson]’s apparently successful investment fund business. If they had ever attempted to perform their duties as directors, one would expect to see occasional e-mails identifying matters for discussion or reflecting decisions made. In fact, there is no documentary evidence reflecting that these Directors ever sought to discuss or enquire about any subject at all throughout the period of almost six years that they held office. [fn excluded] In my judgment, the minutes of these meetings are nothing more than a self-serving “note” prepared by [Peterson] for the file. . . . The way in which the meetings were conducted and documented suggests that the Directors met his needs and never attempted or intended to conduct any real business.”
Wilful neglect or default
Failure of the directors to meet any of these duties, obligations, and responsibilities could result in a finding of negligence in the ordinary course. Here, however, the directors failed to meet any of their obligations, and were nothing more than mere “automatons,” signing papers presented to them for signature by the fraudster, without question. This, Jones found, was wilful.
Wilful neglect involves conscious conduct. The party must be found to have known he or she was committing a breach of duty, or she or he was acting with reckless disregard to whether or not the act or omission is a breach. Jones found that the Weavering directors knew they had a duty to supervise, but did nothing. This, he concluded, must be intentional neglect.
“If the evidence establishes that directors have completely and utterly ignored their legal duty and made no serious attempt to perform their duty, in spite of being conscious of a duty to supervise . . . then their default must be regarded as wilful,” wrote Jones. “The purpose and intended effect of Article 182 is to protect directors who do their incompetent best. Those who attempt to perform their duty, but fail as a result of their carelessness, no matter how gross, are relieved from liability. Those who have an appreciation of their duty, but make no attempt, or at least no serious attempt, to perform the duty, are not relieved from liability.”
Whether this analysis of wilful neglect will find traction in Canadian courts remains to be seen. However, this case does signal a strong warning to directors who fancy themselves as “figurehead” directors, or who otherwise fail to give due attention to the responsibilities that they have assumed. Dereliction of these duties may well result in findings of wilful neglect, and leave directors exposed to personal liability when they thought that they were otherwise protected by a corporate indemnity or exculpatory clause.
