British Virgin Islands

Offshore Directors – A Matter of Trust and Confidence

By Tim Haynes, Counsel, Walkers, Hong Kong (01/03/2013)

In the past four years in Asia there has been a surge in restructuring, insolvency and litigation work which has involved and required key determinations to be made by the courts of offshore jurisdictions.

With international financial centres such as the Cayman Islands and British Virgin Islands so embedded in Asian corporate structures, the decisions of their respective courts on issues including minority shareholder remedies, creditor rights, redemption rights, interlocutory relief, investor appraisal rights, insolvent trading, provisional liquidation and liquidation, and directors duties are all very closely watched by the Asian market.

The first point of note when the question of directors’ duties arises in an offshore context is that there are significant differences between the BVI and the Cayman Islands in the extent to which local statutes codify the relevant equitable and common law principles.

In the BVI, the Business Companies Act prescribes the core duties so that, as regards equitable duties, a director of a BVI company, in exercising his powers or performing is duties, is obliged by statute to act honestly and in good faith and in what he believes to be the best interests of the company[1].

He is also required by statute to exercise his powers for a proper purpose and “shall not act, or agree to the company acting, in a manner that contravenes this Act or the memorandum or articles of the company”[2]. The memorandum and articles might offer a degree of flexibility so that, for example, where so permitted by the M&A, a director of a BVI company carrying out a joint venture between shareholders may act in what he believes to be the best interests of the shareholder or shareholders who appointed him, even if that is not in the best interests of the company as a whole[3].

The common law standard of care is enshrined in the legislation in the BVI so that a director must exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances taking into account (without limitation) the nature of the company, the nature of the decision and the position of the director and the nature of the responsibilities undertaken by him[4].

There are other prescriptive parts of the legislation which, for example, specify the circumstances in which a director of a BVI company may rely upon information and advice provided by third parties but the duties set out in the Act are not exhaustive and are usually complimented by other general equitable or common law principles[5].  Based on the general position at common law, for example, it is possible for a breach of director’s duty to be ratified by the shareholders after full and frank disclosure if this does not go beyond the general powers of the company[6].      

The Companies Law in the Cayman Islands, by way of contrast, contains no attempt to codify core director’s duties. Whilst there are statutes that potentially may impact a director in the performance and discharge of his duties (the Companies Law, but also the Penal Code, Proceeds of Crime Law and, in the case of a regulated fund, the Mutual Funds Law), the essential principles remain common law and equitable principles outside of the legislation.  That said, the five main aspects of common law fiduciary duty in the Cayman Islands are unsurprising and familiar to all common law jurisdictions, namely: (1) to act in good faith and in the best interests of the company; (2) to exercise powers in the company’s interest and only for the purposes for which they are given; (3) not to put a director in a position where there is an actual or potential conflict between the director’s duties to the company and the director’s own personal interests; (4) not to misuse company property; and (5) not to improperly fetter the exercise of the director’s discretion. 

Predictably, there is also a common law duty for a director to exercise whatever skill he in fact possesses with reasonable skill and care.  In the context of the management of offshore funds, this area of the law publically came to the attention of the global investment community in 2011 with the decision of the Cayman Islands Grand Court in Weavering v Peterson[7] and it is the continuing implications of this decision, together with the recent (November 2012) decision from the same Court in Renova Resources v Gilbertson[8], that the remainder of this article will explore.

Weavering remains important for its application in an insolvency context of the well-established general common law principles (referred to above) to the management of an offshore fund. The Court’s judgment in August 2011 against the independent non-executive directors of the Weavering fund for US$111 million plus costs, notwithstanding the presence of an indemnity absolving directors from liability for anything other than “wilful neglect or default”, unsurprisingly caught the immediate attention of the offshore world. The fund in question had been indirectly owned and promoted by its “principal investment adviser” and ultimately failed, the Court concluded, by reason of very substantial losses caused by the independent directors’ failures to take any active part in management of the business and failures to detect that the promoter was dishonestly misrepresenting the fund’s investments when the fund was in fact suffering very substantial losses.

In his decision, Mr Justice Jones QC observed that whilst in open ended funds the investment management, administration and accounting are invariably delegated to contracted professional service providers, this does not absolve the directors (including independent non-executive directors) from their duty actively to supervise the delegated functions. In this instance, the non-executive directors, the subject of the liquidators’ claims of breach of fiduciary duty, had effectively done nothing more than sign documents that the promoter had put before them.  

The Judge took the opportunity of carefully reviewing and analysing the various stages in the typical lifecycle of a fund and concluded that directors’ minimum participation must include satisfying themselves on a continuing basis that: (1) The investment manager’s strategy is accurately described in the offering document; (2) The investment manager is complying with any investment restrictions; (3) There is an appropriate division of function and responsibility between the investment manager and the administrator, failing which the directors would have an increased responsibility to supervise; and (4) the various service providers are performing their functions in accordance with their contracts and that no functions that ought to be performed are not being performed.  

All Directors are expected to be able to read a balance sheet and have an understanding of the financial position of the business and the audit process. The judgment helpfully sets out an overview of what directors of Cayman Islands funds are expected to do in order to ensure compliance with the relevant statutes but the key general conclusion from Weavering remains that directors, at all times, must exercise an independent judgment on matters relating to any business which falls within their scope of supervision.  It is not possible for that duty to be delegated away.    

In the more recent decision in Renova Resources, the Grand Court looked at a scenario where a director of a Cayman company (Mr Gilbertson) was alleged to have allowed his personal interests in the business, specifically the acquisition of the rights to the Faberge Egg brand, to override his duties to act in good faith and in the best interests of the company. In early 2006, Mr Gilbertson established a Cayman Islands fund with his joint venture partner (the Russian based enterprise, Renova Resources) and, early in the process, identified the acquisition of the famous Faberge brand as a potentially lucrative investment. He was enthusiastically engaged in the bidding process to acquire the brand and a sale and purchase agreement was concluded in late December 2006 between Unilever (the then existing owner) and a company called Project Egg Limited (PEL), a wholly owned subsidiary of the fund. However, Mr Gilbertson, without the knowledge of the joint venture partner, then proceeded to pursue and conclude a further deal with the brand’s owner that ultimately had the effect of benefiting himself through another entity and massively diluting the fund’s investment, all but cutting the fund out of the deal. 

In a robust and lengthy judgment, the Grand Court accepted that Mr Gilbertson had been acting in “circumstances which give rise to a relationship of trust and confidence” in connection with the dealings of the company and rejected his arguments that it is possible for shareholders, by their actions, to modify a director’s fiduciary duties to the point where it would be permissible for a director to act in his own interests against the interests of the company. In a strong re-iteration of some of the core principles, the Court held that Mr Gilbertson had allowed himself to be placed into a position of trust and confidence regarding the Faberge rights and as a director of the company was “…subject to the fundamental principles of loyalty and good faith in relation to [the project], including not making a profit for himself out of his position, not placing himself in a position where his interest may conflict with that of the Company and not acting for his own benefit or exploiting the opportunity for himself, at least not without the informed consent of the Company.” 

There is a further dimension to the case of interest to those involved in trusts in that Mr Gilbertson had used his family trust to fund a share of the acquisition. The trust was sued on the basis that it had knowingly received the proceeds of Mr Gilbertson’s breach of duty (the shares in PEL and Faberge), in circumstances where the trustees knew, or ought to have known, about the breaches. The Court decided that the trustees had done little or no due diligence in connection with the investment and were acting on Mr Gilbertson’s instructions without properly considering the interests of the beneficiaries. As well as underscoring the importance of company directors maintaining a clear and obvious separation between their own personal interests from those of the company, and making the requisite disclosures where necessary, the decision in Renova Resources emphasises the importance of independent oversight by professional trustees.    

[1] Section 120(1) of the BVI Business Companies Act 2004

[2] Section 121

[3] Section 120 (4)

[4] Section 122

[5] For example, a liability to account for secret or unauthorized profits 

[6] Eg, Bamford v Bamford [1970] Ch 212 

[7] Mr Justice Jones QC in Weavering Macro Fixed Income Fund Limited (in liquidation) v Stefan Peterson and Hans Ekstrom                

[8] Mr Justice Foster in Renova Resources Private Equity Limited v Brian Patrick Gilbertson