Fund Directors: Practical Things To Consider When Service Providers Seek Indemnities Or To Limit Liability
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By Alric Lindsay
Directors of Cayman-based funds will be familiar with provisions of agreements with fund administrators, auditors and other service providers where these third parties seek indemnities or to limit or exclude liability. Sometimes, these provisions are left unchallenged because fund directors are told they are “industry standard.” In other cases, they are not addressed because the fund’s lawyer was not instructed to advise specifically on these points. Notwithstanding the foregoing, directors of Cayman-based funds should closely inspect indemnity, limitation of liability and exclusion of liability provisions because it is in the best interests of the relevant fund to do so. Otherwise, the relevant fund may have fewer options available when breaches occur and losses are suffered by the fund.
Common indemnity provisions
One example of an indemnity in a fund administrator’s service agreement is where a fund indemnifies the administrator out of its assets and holds it harmless from and against all liabilities, damages, costs, claims, and expenses incurred by the administrator, save where such liabilities, damages, costs, claims, and expenses arise from the administrator’s wilful neglect or default.
If a fund director discusses this wording with Cayman legal counsel, he or she may learn that wilful neglect or default are high standards to prove. In the circumstances, the fund director may ask the fund’s lawyer to seek an amendment to the wording to state that the fund will not indemnify in instances of negligence, which is easier to establish than wilful neglect or default.
Limitation of liability
A common feature of some third-party service agreements is that the third party limits liability to the service provider’s annual fee.
The obvious issue here is that where a service provider’s annual fee is low, say $30,000, this may be far less than the actual losses incurred by the fund due to a breach by the service provider. In such cases, the fund director should discuss the wording with the fund’s Cayman legal counsel and negotiate a limitation of liability provision that reflects a higher annual fee multiple, say, five to seven times the annual fee.
The fund’s best interests are the key
Notwithstanding the importance of fund directors doing the above, some may hesitate because they do not want to upset their relationship with the fund manager or fund administrator. In both cases, the hesitation is because the third-party service providers may be sources of income for the fund directors arising from referrals for directorship appointments from time to time. In addition, there may be a reluctance to suggest changes because a subsidiary of the third-party service provider employs the fund director. Notwithstanding these scenarios, the fund director should remember that his or her duty is to the fund (akin to all investors taken as a whole) and not a third-party service provider. A fund director who appreciates this will be able to make relevant suggestions accordingly and without fear of repercussions.
Note to readers:
The author, Alric Lindsay, is a non-executive director of Cayman-based investment funds with over 25 years of experience in the financial services industry. He can be contacted at [email protected].
Nothing herein is to be deemed Cayman legal advice and fund directors must consider the specific circumstances of each Cayman fund and each agreement governed by Cayman Islands law, guided by a qualified Cayman legal advisor.
