Appointing fund directors from a Regulated Firm or unregulated individuals?
There are fundamental differences between appointing directors to the board of a fund who are regulated and subject to oversight and the alternative of appointing an individual or company that is not. It is an important question to ask when selecting a director for a fund and protecting the interests of investors.
In a world with ever increasing regulation and investor due diligence, it is important that fund managers can provide comfort to investors and reduce the risk associated when appointing directors to the board who are not only suitably qualified and experienced, but also subject to regulatory oversight themselves on a wide range of risks.
For Cayman funds, there are no residency requirements for directors of investment funds. However, in most cases professional independent directors are appointed because of the expertise that they possess combined with the fact that they are themselves an employee of a regulated firm.
What does a regulated director firm encompass?
For Cayman director firms who are licensed Company managers, they are subject to oversight by the Cayman Islands Monetary Authority (CIMA), the financial regulator for the Cayman Islands. This entails periodic inspections on compliance as well as prudential inspections with enforcement powers and sever penalties for breaches. These range from non-discretionary fines of $5,000 (or potentially $20,000) for a minor breach to $1 million for a very serious breach. CIMA would be able to impose cumulative fines of up to $20,000 for a single minor breach. For example, see recent fines:
Section 34 of the Monetary Authority Act enables CIMA to issue or amend Rules, Statements of Guidance and Statements of Principle. In addition, Section 48 provides for the issuance of a Regulatory Handbook to contain the policies and procedures of CIMA in carrying out its regulatory and co-operative functions. Such functions include:
1. Corporate Governance
2. Business Contingency Planning
3. Financial audits – fee engagement to engage an auditor
4. Internal audits
5. Market Conduct
6. Cybersecurity and data security controls – independent cybersecurity audit conducted by a professional firm.
7. Internal Controls, record keeping.
8. Professional Indemnity Insurance
9. succession planning
10. Outsourcing
11. Marketing Policies
12. Recruitment of Employee policies
13. AML/CFT policies and procedures
14. Appointment of AMLCO, MLRO and DMLRO
15. Regulatory Fees payable to CIMA for each client that a Company Manager provides services to.
16. Regulatory Fees payable annually to CIMA
17. Prudential Reporting
Director Registration & Licensing
This is a mandatory requirement, and a fee is payable annually but this is not the same as a director being subject to regulatory oversight.
Conflicts of Interest
It is necessary that directors can demonstrate that they are acting independently in their decision-making process. This is difficult to demonstrate if also affiliated with the fund manager, law firms or the fund administrator. Directors should be truly independent.
A director must not put himself in a position where there is an actual or potential conflict between his personal interest and his duty to the company.
A director owes fiduciary obligations towards the company he acts for requiring the
observance of general standards of loyalty, good faith and the avoidance of a conflict of
duty and self-interest (Cayman Islands News Bureau Limited v. Cohen and Cohen Associates Limited [1988-89] CILR 195, Grand Court). A fiduciary will not be allowed to benefit from a gain or advantage obtained by virtue of having acted in a manner in conflict with or not in accordance with his fiduciary duties (Corporacion Nacional Del Cobre de Chile v. Interglobal Incorporated and Avendano Sabugao [2002] CILR, 298, Cayman Islands Grand Court).
A conflict of interest will arise where the director seeks to exploit the assets or opportunities of the company for his own benefit. The effect of this at common law is that a director may not enter into a valid contract (other than a service contract) with the company, directly or indirectly, unless the company gives its approval in general meeting, or the Articles permit such transaction.
A Director’s Duties
It has long been established that a director owes both common law and fiduciary duties to the company for whom he acts. In essence, this means that directors, operating and making decisions as a board, are required to:
act in good faith in the best interests of the company;
use powers conferred on them for their proper purpose; and
exercise whatever skill they possess and reasonable care when acting in the company's interests.
Where a director breaches any of his common law or fiduciary duties, the company can take action to recover its property or to obtain payment of damages from the director as
compensation for any loss incurred. The company is also entitled to recover any personal profit a director may have made by exploiting his position.
To Whom Duty is Owed
Generally, directors' duties are owed to the company as a whole and not to individual
members. It follows that the general rule is that the enforcement of a director’s duties is for the company alone and this rule is subject to only limited exceptions, for instance, where derivative claims can be bought by a minority shareholder.
In this context, the company is defined usually by reference to the shareholders as a whole, as opposed to any particular shareholder. As a general principle, the directors need to balance the short-term interests of the present members against the long-term interests of future members.
It should be noted that where there are different groups of shareholders with different
interests, the directors must act fairly as between these different groups. There is an
element of objectivity in this test (Mutual Life & Insurance Co. of New York v. Rank
Organisation Ltd [1985] BCLC 11 followed by Re BSB Holdings Ltd (No 2) [1996] 1 BCLC 155, both English 1st Instance decisions).
Importantly, whilst the interests of the shareholders as a whole are paramount in
circumstances where a company is a going concern, it is now well settled that where a
company becomes insolvent or is nearly so, then the interests of the company include the interests of the creditors and in such cases, the interests of the creditors may be paramount.
Duty to Act in Good Faith
An individual director must act in good faith in his dealings with or on behalf of the company and exercise the powers conferred on him and fulfil the duties of his office honestly.
Duty to Exercise Powers for a Proper Purpose
A company's memorandum of association and articles of association, relevant
shareholders' resolutions and Board minutes will determine the powers conferred upon
directors and the context in which they can be reasonably exercised. Any director who
exercises these powers over the company's assets other than for the purposes intended or for the benefit of the company as a whole will be liable for a breach of duty.
Duty Not to Fetter his Own Discretion
By extension, a director must not in general ‘fetter his discretion' to act in the best interests of the company. This means that a director must not enter into an agreement with a third party as to how he will exercise his discretion. To do so would prevent the director from exercising an independent judgment at the appropriate time. Accordingly, a director who is appointed by a shareholder cannot agree with that shareholder, for example, to vote at board meetings in any particular way (even if voting in that way would not otherwise be a breach of his duties to the company). This situation is distinguishable from one where the directors enter into an agreement on behalf of the company under which they bind themselves to vote in such a way as to ensure that the company performs its obligations under that agreement (Fulham Football Club Limited and Others v Cabra Estates plc [1994] 1 BCLC 363 (English Court of Appeal)).
Secret profits
A director's fiduciary position precludes him from taking a personal profit from any
opportunities that result from his position as a director even if he is acting honestly and for the good of the company. Any profit arising in such circumstances must be repaid to the company unless it has been previously disclosed and authorised. This applies whether the profit arises from a contract with the company or a third party.
Duty of Skill and Care
The directors' fiduciary duties impose on them a largely negative obligation to do nothing which conflicts with the company's interests. At the same time, when they are acting in the company's interests they are expected to exercise whatever skill they possess and reasonable care.
Case law has long established that a director must attend diligently to the affairs of the
company and that in performing his duties he must display the 'reasonable care … an
ordinary man might be expected to take in the same circumstances on his own behalf' (Re Brazilian Rubber Plantations and Estates Ltd [1911] 1 Ch 425 (English 1st Instance decision)).
The leading case on the nature and extent of the duty of skill and care is the English Court of Appeal decision in Re City Equitable Fire Insurance Co Ltd [1925] Ch 407, (“City Equitable”), as approved in the Cayman Islands Court of Appeal decision in Paget Brown and Company Limited v. Omni Securities Limited [1999] CILR 184, and more recently In the Matter of Bristol Fund Limited [2008] CILR 317 (Cayman Islands Grand Court). This case established three basic principles as follows:
A director is not an expert and need only display skills he actually possesses. He is not expected to exercise a level of skill he does not have.
A director need not devote his continuous attention to the business.
A director is entitled, in the absence of suspicious circumstances, to rely on the experience and expertise of his co-directors and other officers of the company.
Degree of Skill
The level of skill required by a director based on the City Equitable case is subjective and
implies that he would not be expected, merely by virtue of his office, to possess any
particular skills. His performance is judged by the way he applies any skills which he actually has.
The most concerning limitation of this subjective test is that it exonerates the incompetent but honest director from his actions on the basis that he can do no better.
In reality, such person is unlikely to remain a director of the company for long.
The English Courts have increasingly applied an “objective’ test in respect of the standard of skill and care expected of a director and the Cayman Islands Courts are likely to follow this approach. In that respect, the standard of skill and care expected of directors has been held to be that of:-
“A reasonably diligent person having both – (a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and (b) the general knowledge, skill and experience that that director has”.
Further, where there is a service contract between the director and the company, where the director is under a contractual obligation to fulfil specific tasks within the company based upon his expertise, knowledge and experience, the director would be required to display an objective level of skill implied in such contract.
Attention to the Business
It was held in City Equitable that:-
“a director is not bound to give continuous attention to the affairs of the company. His duties are of an intermittent nature”.
This dictum is clearly more appropriate to the circumstances of a director who does not
have a service contract with the company and refers specifically to attendance at board
meetings. A director's service contract normally requires that he devotes his full attention to the business of the company.
Reliance on Others
Generally, a director is entitled to rely on his fellow directors and officers of the company.
Thus in Dovey v Cory [1901] AC 477 (House of Lords), it was held that a director was entitled to rely on a subordinate 'put in a position of trust for Similarly, in City Equitable it was held that:-
“In respect of duties…that may properly be left to some other official, a director is, in the absence of grounds for suspicion, justified in trusting that official to perform such duties honestly”.
Thus, in this case, the directors were entitled to sign cheques which appeared to be properly authorised although subsequently put to an unauthorised use.
Directors may also rely on the opinions of outside experts, and in fact may be negligent if they do not obtain an outside opinion in appropriate circumstances (Re Duomatic [1969] 2 Ch 365 (English 1st Instance decision)). In Coulthard v Neville Russell, [1998] 1 BCLC 143, (English Court of Appeal) it was held that auditors had failed to exercise their duty of care, not only to the company but also to its directors, to advise them that payments and other financial arrangements amounted to unlawful financial assistance for the purchase of own shares.
It is important to note that directors cannot absolve themselves entirely of responsibility by delegation to others. For example, in Selangor United Rubber Estates Ltd v Cradock [1967] 2 All ER 1255 (English 1st Instance decision) the directors were held liable where they should have been aware of a wrong even though they were in fact ignorant of it. Ignorance is therefore not necessarily a defence, and directors were expected to exercise their judgment and to delegate and supervise activities in such a manner as to uncover any unauthorised or unapproved actions. Furthermore, in Re Barings plc; Secretary of State for Trade and Industry v Baker (1998) BCC 583 at 586, when making a disqualification order the judge held that whilst directors may be entitled to delegate functions, the high level of responsibility associated with their office requires them to supervise the delegated functions, even where they trust the competence and integrity of those below them. Consistent with this, in Re Barings Plc (No 5) [2000] BCLC 523, the English Court of Appeal held that:-
“… the exercise of the power of delegation does not dissolve a director from the duty to supervise the discharge of the delegated functions”.
Directors’ Duties In an Insolvency Context
When a company encounters financial difficulties and is insolvent or is of uncertain
solvency, under Cayman Islands Law, the directors must, in addition, consider the creditors’ interests as well as part of their duty to act in the interests of the company itself. This is demonstrated by the Cayman Islands decision in Hutchinson Limited, Crain Creek LimitedMountain Dew Limited and Forum Limited –v- Cititrust (Cayman) Limited and Ten Others [1998] CILR 43 at page 61, where it was found that:-
“It is settled law in the Cayman Islands and England that when a company is insolvent or doubtfully solvent it is incumbent upon its Directors to keep its assets inviolate for its creditors. If directors fail to perform this duty they will be in breach of their fiduciary duties “.
The Court’s approach is demonstrated by the Cayman Islands case of Prospect Properties Limited (In Liquidation) v. McNeill and J.M. Bodden II [1990-91] CILR 171, which approved the New South Wales Court of Appeal decision in Kinsela v. Russell Kinsela Pty Ltd (1986) 4 ACLC 215 at 223, where it was held:-
“In a solvent company the proprietary interests of the shareholders entitle them as a general body to be regarded as the company when questions of the duty of directors arise … But where a company is insolvent the interests of the creditors intrude. They become prospectively entitled, through the mechanism of liquidation, to displace the power of the shareholders and directors to deal with the company’s assets. It is in a practical sense their assets and not the shareholder’s assets that, through the medium of the company, are under the management of the directors pending either liquidation, return to solvency, or the imposition of some alternative administration”.
Accordingly, depending upon the circumstances, the creditors interests may be paramount over the shareholders’ interests. In this respect, the directors must have regard for all the general creditors and not one creditor or a section of creditors (In Re Pantone 485 Ltd [2002] 1 BCLC 266 (English 1st Instance decision). Upon insolvency or uncertain solvency the Directors must therefore have regard to what is in the best interests of the general body of creditors. In this context, there are no prescribed statutory duties; duties are determined by reference to the common law.
Statutory Duties
The Companies Act (as Revised) contains a number of provisions relating to directors’ duties.
For example, liability may arise where:-
the books of account, minutes of meetings, or the statutory registers of members, mortgages and charges or directors have not been properly maintained;
a director authorises or permits any distribution or dividend in breach of the Companies Act;
a director knowingly or willfully authorises or permits any payment out of capital by a company for a redemption or purchase of its own shares when the company is insolvent;
there has been a failure to provide certain information to specified persons as required by the Companies Act;
a director makes or authorises a false annual return to the Registrar; and
an exempted company has carried on business within the Cayman Islands.
Directors of any Exempted Segregated Portfolio Company (“SPC”) have additional duties
and liabilities, including:-
the duty to establish and maintain the segregation of a portfolio’s assets from other segregated portfolios and the general assets of the SPC; and
the duty to ensure that the SPC states the capacity in which it is contracting in relevant transactional documentation
Breach of Duty by Directors
A director who fails in his duties to the company may have unlimited liability for a loss
suffered by the company, even if he himself has not made any personal gain. Similarly,
directors may be directly accountable to third parties for any loss or damage suffered by
them as a result of their actions, omissions or in respect of information supplied by them.
Where a director breaches his fiduciary duty or his duty of skill and care to the company, he will be liable to civil action instigated by the party, most often the company, to whom the duty is owed for any loss suffered or undisclosed profit made or advantage taken. The company may consider it appropriate that the director's breach of duty be ratified after the event, permissible in certain circumstances, or may take legal action to obtain:
an injunction to restrain the director and prevent him from carrying out or continuing with the action constituting the breach of duty in the future;
damages by way of compensation where the director’s action is considered negligent;
restoration of the company's property, provided it does not prejudice an innocent third party, where the director's fiduciary duty has been broken and assets have been misappropriated;
an account of profits made by the director;
rescission of a contract in which the director has an undisclosed interest; or
dismissal of the director
It should also be noted that, pursuant to the Companies Act (as Revised), liquidators have a wide range of powers to take action against directors who have acted in breach of their duties.
Bell Rock Independent Director Services
Our directors act for leading asset managers and emerging managers to bolster fund governance throughout the life cycle of a fund. As a fully regulated and licensed firm. Investors expect to have directors who are independent and not affiliated with other service providers such as the law firm, fund administrator or fund manager. Each of our directors has over 25 years of senior level expertise having worked for well-known names in the industry and hold qualifications in law, fund management, investment banking, securities and investments, fund administration and compliance. We act on a select number of boards for offshore hedge funds, venture capital, private equity, real estate, crypto and blockchain funds, investment committees, governance committee’s and regulated investment management entities also. All directors are also CIMA registered. For further information on appointing us as an independent director to your fund, please feel free to contact us: info@bellrockgroup.com
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