1. On establishment

"The directors should have made enquiry to ensure that they properly understood the nature and scope which each of the professional service providers were proposing to do, or perhaps more importantly, proposing not to do, and that it would result in a proper division of responsibility….A desktop review of contract documents is inherently unlikely to be sufficient for this purpose…"

Appointing reputable lawyers to put in place the various service provider contracts is helpful, but no panacea. "It is [the directors] duty to stand back, review the various contracts and satisfy themselves that each one is appropriate and consistent with industry standards…"

When it came to the Auditor, the court concluded that the directors could not have applied their attention to the terms of appointment. The unfortunate giveaway were board minutes reciting that PWC had been appointed when in fact Ernst and Young were in the hotseat!

Regarding the offering document, the court said that it should be subject to a verification exercise to establish that it is accurate and complete. In this regard it is suggested that the directors will need to make an enquiry of the lawyers co-ordinating the verification process and the drafting of the offering document; so both lawyers and managers should expect more probing questions…

2. In the Ordinary Course of Business

The approach of the directors in question to the ongoing supervision of the activities of the fund through quarterly board meetings attracted significant criticism. The failures here included not reviewing recent monthly management accounts, never seeking reports on operation of the fund and never inviting representatives of the service providers (save for the portfolio manager) to attend meetings.

To the extent reports were received from the Administrator, they were not properly reviewed by the directors. If they had been, the directors would have noted persistent breaches of investment restrictions (notwithstanding regular board minutes "noting" that the investment manager was acting within the guidelines and restrictions set by the board). The court said that if they asked the Administrator or the compliance person in the investment manager to report on whether the fund was being managed in accordance with the restrictions, they "would have been entitled to rely on them to perform the work honestly and competently". Their problem was not making any attempt.

Their willingness to approve the fund's financial statements was also a breach of their duties. Accounts had been approved with little evidence of discussion amongst the directors and no attempt to discuss them with the Administrator or Auditor. Additionally, their ability to rely on the expertise and professional standing of the Administrator and Auditor was fatally undercut by the directors' failure to examine and understand the terms on which those service providers served the fund.

3. The onset of the financial crisis and liquidation

The collapse of Lehman (to whom the fund had no exposure) triggered significant redemption requests, but no particular desire by the directors to exercise their supervisory functions. A review of the Administrator's quarterly reports for Q3 and Q4 2008 would have shown (amongst other things) that:

• the main derivatives counterparty to the fund was a related company of which one of the fund directors was also a director (in fact he actually thought the counterparty was dormant);
• the Administrator was reliant on this counterparty for valuations;
• the reported exposure to this counterparty was 107% of NAV (thus in breach of investment restrictions); and
• a number of profitable transactions had been closed out between Q3 and Q4 for zero value.

Aside from all this going unnoticed at the meetings of the directors in late 2008 and 2009, the directors also signed minutes to two meetings in 2008 which the judge found had never occurred.

As well as highlighting the need for directors to properly perform their functions in terms of high level supervision of a fund, an important "take away" point from the case is that while any exclusions from liability from which directors benefit in the articles might protect directors who do their incompetent best, they will not protect them if those directors do nothing at all.

Be warned!