Weavering Litigation - Cayman Hedge Fund Directors' Duties And Indemnity/Exculpation Clauses Back In The Spotlight

On 12 February 2015, the Cayman Islands Court of Appeal issued its much anticipated decision in Weavering Macro Fixed Income Fund Limited (In liquidation) (the "Fund") vs Stefan Peterson and Hans Ekstrom (the "Directors"). The appellate Court's decision - which held that the Directors had not acted with wilful neglect or default - now stands as the leading Cayman Islands authority on the high-level supervisory duties of Cayman investment fund directors, and on the meaning and effect of 'wilful neglect or default' in the context of exculpation and indemnity provisions.

1. Summary

   The Fund collapsed in 2009 following the discovery that the majority of its recorded assets (being US$625m of interest rate swap positions held with a single connected counterparty, Weavering Capital Fund Limited) were in fact fictitious. Following the Fund entering into official liquidation in 2009, liquidators brought proceedings in the Grand Court of the Cayman Islands alleging that the Directors had acted in 'wiful neglect or default' of their high-level duty as independent non-executive directors to supervise the Fund's affairs. The liquidators argued that had the Directors not so acted, the fictitious nature of the Fund's assets would have been identified sooner and the Fund would not have made redemptions on the basis of grossly inflated NAVs; those redemptions caused the Fund to make at least US$111m in over payments.

   The Court of Appeal overturned the decision of the Grand Court, by holding that the evidence at trial did not satisfy either of the two limbs of the legal test for "wilful default or neglect". The Directors could therefore rely on an exculpation provision contained in the Fund's Articles of Association and thereby defeated the liquidators' claim.

   The decision is now being appealed to the Privy Council.

2. Background

   The Fund's Structure

   The Fund's structure was not unusual. The Fund was incorporated as a Cayman Islands exempted company to carry on business as an open-ended investment fund, with shares admitted to listing on the Irish Stock Exchange. Mr Stefan Peterson and Mr Ekstrom were the Fund's sole directors. PNC Global Investment Servicing (Europe) Limited was the Fund's appointed Administrator and PNC International Bank Limited was its custodian. The Fund's appointed auditors were Ernst & Young. The Fund also appointed an Investment Manager: Weavering Capital Management Ltd (the "Investment Manager"). One notable and unusual feature, however, was that the Investment Manager's director and chief executive officer, Mr Magnus Peterson, had close familial relations with the Fund's Directors: he was the elder brother of one (Mr Stefan Peterson) and the step-son of the other (Mr Ekstrom).

   The Fund's Articles of Association provided that:

   subject to the usual provisos, the business of the Fund should be managed by the Directors who might exercise all powers of the Fund; the Directors had the power to appoint any person to act as Manager of the Fund's affairs, and the Directors had the ability to "entrust to and confer upon the Manager any of the functions, duties, powers and discretions exercisable by them as Directors upon such terms and conditions ... and with such powers of delegation and such restrictions as they think fit". Article 182 contained the provisions on indemnity and exculpation which proved pivotal in the case: "Every Director, agent or officer of the [Fund] shall be indemnified out of the assets of the [Fund] against any liability incurred by him as a result of any act or failure to act in carrying out his functions other than such liability (if any) that he may incur by his own willful neglect or default. No such Director, agent or officer shall be liable to the [Fund] for any loss or damage in carrying out his functions unless that liability arises through the willful neglect or default of such Director, agent or officer." (emphasis added).

   The Fund's Investments

   The Offering Memorandum reflected the Irish Stock Exchange Listing Rule requirement that no more than 20% of the value of the Gross Assets of the Fund was to be lent to or invested in the securities of any one issuer or is exposed to the creditworthiness or solvency of any one counterparty. Despite this, during the period 2005 to 2008, the Fund purportedly entered into 30 Interest Rate Swap contracts (or "IRS contracts") with Weavering Capital Fund Limited, a related party incorporated in BVI with no external administrator, and in which Mr Magnus Peterson held a majority interest. These IRS contracts were not traded on public exchange but were "over the counter" transactions. The reported combined value of the IRS contracts rose from US$2.6 million in February 2005 to US$637.1 million in February 2009.

   The Judge held that it should have been apparent from the Quarterly Reports provided to the Directors by the Administrator that the 20% investment restriction was being ignored, and noted, in reference to...