The offshore director: Risks, responsibilities, liability

Part 2:

The Offshore Director: Risks, responsibilities, liability. Part II

This is the first part of a speech given by former Cayman Islands Monetary Authority Chairman Timothy Ridley at the International Funds Conference held earlier this year.


We live in interesting and concerning times for offshore directors (independent, non executive or otherwise), who may be forgiven for thinking that they are about to join the elevated ranks of those left standing who must routinely expect to be sued if things go wrong. The auditors (and to a lesser extent, legal counsel) have long since become accustomed to being treated as a deep pocket and to live with litigation as a cost of doing business (for which their insurers and their clients ultimately pay). But, despite blustering and manoeuvring by law enforcement, regulators, liquidators, litigation and insolvency lawyers and the media over the years, the offshore director has remained relatively unscathed. Even where things went badly awry, the director seemed to suffer no more than the odd reprimand from Head Office, shrugged this off and continued as before (reputations appear to be unaffected locally, on the basis of “there but for the grace of God go I”). I have for some years questioned whether this could continue. The warning signs have been there and the wake up calls are now sounding more loudly to those that have ears to hear. 


I am sure that most of you will be aware that a number of directors and auditors (and law firms) based in the Cayman Islands have been and are being sued in the US courts and that some locally based directors have been the subject of subpoenas issued by foreign regulatory authorities. The various recent meltdowns, particularly in the hedge fund space, will certainly prove fruitful fishing grounds for lawyers and insolvency experts over the next few years. Bernie (“trust me I am your friend”) Madoff’s activities should certainly make the directors and auditors (not to mention the promoters, investment advisors and administrators) of some fund of funds and feeder funds feel very nervous. 

It will also not have escaped your notice that the US has brought tax conspiracy charges against a senior Zurich based officer of a major Swiss bank, that the Australian authorities are seeking extradition of an accountant in Jersey (Channel Islands) and will possibly seek the extradition of a fellow accountant in Monaco in connection with high profile tax evasion investigations involving Paul Hogan of Crocodile Dundee fame. 

There is a school of thought in the US (likely to grow under the Obama presidency) that offshore service providers that supply directors and other services to structures that enable US taxpayers to evade taxes should be sanctioned and put out of business by their home regulators, e.g. by the revocation of their licences on the grounds they are carrying on business contrary to the public interest or in a manner that is not fit and proper. 

All this is evidence that the former practice of foreign regulators and law enforcement of not going after the offshore professionals (provided they delivered the information to sink the client) is fast disappearing. The only surprise to me is that it has taken so long for the onshore agencies, regulators and law enforcement to work out that the best way to deter offshore professionals from actively assisting in illegal activities is to pursue them as conspirators (or to refuse them visas or entry to the USA). Dropping a subpoena on someone in Miami airport to give evidence or produce documents is one thing (it may prove a minor inconvenience to the vacation); charging that person with criminal conspiracy is a much more serious matter. So the prudent professional would be well advised to carry in his or her wallet the 24 hour cell phone number of a retained criminal and immigration law firm in the US. It may be the best investment you ever make.

It is ironic that, as offshore centres rush to expand their cross border assistance and exchange of information arrangements, the frustration and level of complaint from major onshore jurisdictions continue to rise. A current example is the proposed Stop Tax Haven Abuse legislation in the USA. As presently worded, it makes no difference whether a jurisdiction has a tax information exchange or similar agreement with the US. So even if it is a goose willing to lay golden eggs, it is still a pariah as far as the US Congress is concerned. Another example is the opprobrium coming out of EU members with respect to financial services centres that have voluntarily implemented the European Savings Directive.


The traditional business model in most offshore centres is for service providers such as trust companies, company managers and the like to supply the services of directors to their clients. And to charge a fee for so doing. The individual employee who serves as a director will be paid a salary (and bonus perhaps) by the service provider for whom he or she works. The directors’ fees will typically not go to the director but to the service provider. Sometimes, he or she may be a shareholder of the service provider, but more often than not, there will be no equity interest. Under current Cayman case law (the 1999 Court of Appeal Paget Brown v. Omni Securities decision following the 1991 Privy Council Kuwait Asia Bank v. National Mutual Life decision), the service provider is typically not liable for the acts or defaults of the employee as a director of a client company. Good for the service company and its owners; not so good for the client or even the employee. Little wonder that the offshore director is looked upon with derision as a man of straw by outsiders (and maybe by insiders too). As an employee, he is unlikely to have significant assets so there is no point in suing him for breach of duty, negligence etc. And the service company that put him forward and collected the fees cannot be successfully sued under the Paget Brown principle. In the context of the offshore financial business, this has many scratching their heads. I suspect we will see litigation in the future that will challenge the Paget Brown decision.

Serious questions may arise as to whether the employee is entitled to an implied indemnity from his service provider employer if he is sued or incurs personal liability in his capacity as a director, where he has accepted the directorship in the course of his employment. The prudent employee will therefore ask for a copper bottomed written indemnity in his contract of employment. Whether his employer has sufficient assets or insurance should the worst happen, is a matter the employee should ponder and investigate, preferably before accepting the position.

There are also questions of conflicts of interest that may seem academic at the outset, yet which are anything but when things go wrong. A good example is where a law firm acts as legal counsel to a fund and the service company owned by that same law firm provides the directors of the fund. These directors then approve the various agreements and transactions on behalf of the fund. The directors can scarcely be considered truly independent (if that is one of the reasons for their appointment). And taking waivers from all and sundry at the outset when all appears rosy, is a fig leaf and no proper solution. If the deal falls apart and/or questions are raised about the legal advice or the transactions, it will quickly become apparent why the model is flawed. The law firm may well head for the hills, ironically now pleading conflicts of interest and suggesting new legal counsel be retained by all parties and possibly that new directors be appointed. The directors under fire will also likely have to retain their own legal counsel. Pontius Pilate could hardly have done better.

Local auditing firms that owned service companies and provided directorships and other services to audit clients were forced to give up this lucrative income by their head offices in the USA and Europe in compliance with professional standards and/or regulatory requirements. Lawyers should do likewise and stick to being lawyers and not play both ends against the middle by taking on the administration and directorships through their wholly owned service companies. Arguing this is what the clients want and the market demands misses the point. Lawyers should educate their clients and explain why it is in the clients’ best interests to avoid the conflicts of interest from day one. And they will get better legal advice, service and loyalty from their lawyers as well.

Read more about current models and also the importance of understanding the transaction next month.