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Directors, stay involved or pay the consequences

A recent change in Bermuda's company law aimed at enhancing the Island's attractiveness as an international financial centre has also brought into sharp focus the standards of governance advisable in the investment funds industry.

The Companies Amendment Act (No 2) 2011 (the “Amending Act”) allows Bermuda exempted companies to appoint a sole director who may be a corporate director. Prior to the Amending Act, Bermuda law required that all Bermuda investment funds (the “Funds”) appoint and have at all times at least two directors, both of which were required to be individuals.

While this move makes Bermuda more attractive to international companies seeking to set up on the Island, the investment fund industry should be careful to evaluate whether having one director is appropriate and in the best interests of the Fund.

Funds in Bermuda are pooled investment vehicles structured as either mutual fund companies, unit trusts or partnership funds. The Fund's directors are responsible for managing the affairs of the Fund through its relationships with a series of service providers performing investment management, administration and accounting functions.

In the wake of the Madoff case and the financial crisis of 2008, corporate governance in the investment funds industry has come under the microscope. Fund governance relies, in large part, on each Fund's director(s) to guard against the conflicts of interest inherent in the Fund's interactions with its service providers, and a director's duty to exercise independent judgment.

Directors owe a variety of duties to the Fund. When a Fund is insolvent, the directors' duties include having regard to the interests of the general body of shareholders. Under common law, directors are subject to the duty of skill and care and a number of statutory duties, including:

· the duty to act in good faith in what the director considers is in the best interests of the Fund and not for any collateral purpose

· the duty to exercise power for a proper purpose, advancing the interests of the Fund itself as a separate entity, distinct from its shareholders

· the duty to avoid conflicts of interest with the Fund and not put himself or herself in a position in which his or her duties to the Fund and his or her personal interests may conflict (unless the conflict is disclosed), and

· the duty not to make secret profits.

Directors owe a fiduciary duty to the Fund to act bona fide (in good faith) in the best interests of the Fund as a whole. This does not mean that the courts will consider whether any given transaction is in the best interests of the company from a commercial perspective. Instead, the courts examine the bona fides of the directors and will only, as a general rule, impugn a director's conduct when he has acted improperly or for an improper purpose. Cases involving breaches of fiduciary duty often feature circumstances where the directors allowed their personal interests to conflict with the interests of the company which they serve.

The common law rule of duty of skill and care has three aspects:

· a degree of skill the standard required from the director is that of a person of his particular knowledge and experience

· attention to business a director should attend to the affairs of the company diligently, and

· reliance on others a director is not liable for the acts of co-directors or company officers solely by virtue of being a director; rather, a director may rely in good faith on executives who have been appointed specifically for the purpose of attending to the detail of management. However, directors cannot absolve themselves entirely of their responsibilities by delegation to others.

A recent decision in The Cayman Islands has highlighted the standards of governance appropriate to investment funds. In the Cayman Islands Grand Court judgement of Weavering Macro Fixed Income Limited (In Liquidation) (“Weavering”) v Peterson and Ekstrom, delivered on 25 August 2011, two directors of Weavering were found guilty of wilful neglect of their duties and held personally liable for losses of US$111 million.

The key point to draw from the court's decision is for directors to understand that they can no longer fulfill their role in a relatively passive manner. Rather, they must take an active approach, ensuring not only that they make enquiries of, and consider the input of the various service providers, but also that any steps that are taken are fully recorded.

Given the recent amendment to company law in Bermuda allowing for the possibility of an investment funds company having just one director and the greater attention being paid to standards of governance by both investors and the courts the advisability of having just one director is an important issue for investment funds companies to consider.

Attorney Andrea Moniz-DeSouza is an Associate in the Funds & Investment Services Team within the Corporate & Commercial department at Appleby (Bermuda) Limited. A copy of Ms Moniz-DeSouza's column can be obtained on the Appleby website at www.applebyglobal.com. This column should not be used as a substitute for professional legal advice. Before proceeding with any matters discussed here, persons are advised to consult with a lawyer.

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Published April 09, 2012 at 2:00 am (Updated April 09, 2012 at 9:14 am)

Directors, stay involved or pay the consequences

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