By Ronan Guilfoyle (pictured) and Casey McDonald, independent directors, Calderwood, a Cayman Islands Fund Governance Firm – It is not uncommon these days for an investment fund to find itself in the situation where it may be able to recover certain assets through the process of litigation. Perhaps an investment has soured but left the fund with claims against certain associated parties, or alternatively, the fund could find itself in the scenario where it has claims against its service providers, possibly due to fraud or some other unfortunate circumstances, which have made the fund no longer viable.
The duties of a director are detailed and widespread and beyond the scope of this article. It is fair to say, however, that investors are always looking for transparency and independence from the directors of their funds, and this is even more so during a potentially ‘distressed’ wind down.
When faced with the prospect of initiating litigation, we would expect an independent director to be in close contact with the fund’s legal counsel. It will be important for the director(s) to have a good understanding of any potential claims the fund may have and their likelihood of success, not only in order to make an informed decision on whether to proceed with litigation, but also to facilitate communication with investors and to ensure that the litigation is being funded in the most appropriate manner.
A director’s primary duty is to the fund he’s appointed over, and while the views of the stakeholders should certainly be considered, he or she must do what’s in the best interests of that fund, rather than any set of investors. It is not uncommon for a group of investors to quickly take diverging views on whether to fund litigation with the hopes of greater future returns, or whether to get whatever cash they can out of the fund now and simply move on.
Regardless of which route is chosen, we consider it to be imperative for a director to ensure there are regular and clear communications with investors, that set out the planned course of action and reasons behind any important decisions. Litigation can potentially take years to run its course, and in Cayman, has the potential for adverse costs. As such, it is inherently difficult for a director to be able to make even a ball park estimate of how much, if any, cash will become available for distributions to investors. Several factors will need to be considered, which are always fact-sensitive.
In the decision of internal versus external funding there are a number of areas of focus for a director such as the merits of the claim as well as the possibility of requiring further expert advice. The availability of all information to the board as well as the level of funding required are also important parts of the equation. With respect to external funding, the above all apply but there are also further issues to be aware of, such as securing the best terms possible in any tender process, as well as the actual experience of the funder itself. In particular, whether their involvement have any impact on the level of control given to the directors and who will have responsibility for adverse costs in such a situation.
At the end of the day, the more risk an external funder takes on, the more favourable the terms you would expect a funder to demand, however tangible benefits often include a greater level of experience and the ability to distribute funds to investors earlier than would otherwise be possible.
A director will need to weigh up all of these points when determining whether to fund litigation internally or externally, and whether it is in the best interests of the fund.
However, the more time spent considering these issues should enable a director to not only make an informed decision when it comes to funding, but also put the director in a better position to communicate the pros and cons of the various courses of action and obtain investor buy-in, which should ultimately lead to a smoother process, whichever route is chosen.
