Weavering Case Overview

An August 26, 2011 judgment of the Grand Court of the Cayman Islands, Financial Services Division, held two independent directors personally liable for “wilful neglect or default” in exercising their supervisory responsibilities as directors of the Weavering Macro Fixed Income Fund Limited (the “Fund”). The two independent directors were ordered to pay US $111 million plus costs.

The judgment is notable because it gives guidance for directors of Cayman Islands companies in discharging their “duty to exercise independent judgment, to exercise reasonable care, skill and diligence and to act in the interests of the [Fund].”  The guidance is likely to impact the manner in which offshore directors supervise functions that are delegated to professional service providers, including investment managers and administrators.  The court indicated that the exercise of the power of delegation “does not absolve [independent directors] from the duty to supervise the delegated functions.”  “They are not entitled to assume the posture of automatons . . . without making enquiry . . . on the assumption that the other service providers have all performed their respective roles . . . .”

The following points made by the court in the opinion provide useful guidance for independent directors as well as the professional service providers in coordinating with and responding to the supervision of independent directors.

Supervision During Fund Establishment Phase

• Directors should satisfy themselves that the overall structure of a fund is consistent with Cayman Island industry standards and that the terms in the service providers’ contracts are reasonable.
• Directors should understand the nature and scope of work of each of the professional service providers and determine that the division or responsibilities between the service providers is appropriate.
• Directors should satisfy themselves that the hedge fund offering documents comply with the requirements of Cayman Islands law (in particular section 4(6) of the Mutual Funds Law). The court suggests that this may be done by making inquiry of the lawyers who have coordinated the work of developing the offering documents.

Supervision During Ongoing Operations

• Directors should convene board meetings to discuss matters of substance and not simply to rubber stamp routine matters raised by the investment manager. Generally, an agenda should be prepared in advance of the meeting and the substance of discussions should be maintained in the minutes at least to the extent that it is necessary to understand the basis upon which any decisions were made and any resolutions passed.
• Directors should review a fund’s balance sheet and other financial reports so that they can understand the fund’s general financial/NAV position and satisfy themselves that a fund is trading in accordance with any investment restrictions.
• If directors accept a responsibility for a fund’s financial statements, they must exercise independent judgment in satisfying themselves that the financial statement do present fairly the fund’s financial condition.
• Directors must be cognizant of issues that are likely to arise from side letters and determine whether there could be an adverse impact on a fund before approving or signing the letters.

Conclusion

We have talked previously about some of the offshore hedge fund structural considerations and we have discussed the issues involved with establishing a Cayman hedge fund, but we have not specifically written a post about the obligations of directors of offshore hedge funds.  Independent directors of offshore funds will need to be more cognizant about their duties going forward and the position needs to be taken seriously.  As with other high profile hedge funds that have failed, certain service providers and directors are being taken to task for not properly doing what they were supposed to do.  As more lawsuits go through the courts we are likely to see more lawsuits similar to this lawsuit.

The case can be found here: Weavering Judgement – Grand Court of the Cayman Islands

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Cole-Frieman & Mallon LLP provides legal services to domestic and offshore hedge funds.  Bart Mallon can be reached directly at 415-868-5345.  Karl Cole-Frieman can be reached at 415-352-2300.