Poaching Fabergé Eggs
The Grand Court of the Cayman Islands weighs in on directors' fiduciary duties
The recent decision of the Grand Court of the Cayman Islands (the "Court") in Renova v Gilbertson1 is a cautionary tale for directors of closely held companies of the potential consequences of allowing their personal interests to trump their duties of good faith. It also contains some useful guidance for trustees of family trusts who may be looking to act prudently, so as to protect their beneficiaries.
The dispute arose out of a Cayman Islands based private equity fund, known as the Pallinghurst Structure. The fund, established in early 2006, was to be a joint venture between (on the one hand) the Russian-based Renova Group headed by Mr Viktor Vekselberg and (on the other) Mr Brian Gilbertson, a South African businessman with extensive experience in the mining and resources sector. Mr Gilbertson and his team were to provide the management expertise for the fund. Renova was to be the cornerstone investor. Renova and Mr Gilbertson's team would share the profits, with each of Mr Gilbertson and Renova having a right of veto with respect to the fund entering into new investment projects. The essential terms of the deal were set out in the so-called "Letter Agreement".
The Pallinghurst Structure involved a series of Cayman Islands exempted limited partnerships ("ELPs"). The ultimate general partner was a company of which Mr Gilbertson and an employee of Renova were the directors.
Very early in the process, Mr Gilbertson identified the purchase of the Fabergé brand as a potential investment for the fund. Fabergé of course has a long history of producing high-end jewellery, including the iconic Russian imperial eggs. Mr Gilbertson believed the brand had not been optimally managed by its then owner, Unilever, and considered that it had great potential. Although the Fabergé investment did not fit clearly within the Pallinghurst Structure's core business of mining and resources, Mr Gilbertson thought Mr Vekselberg (who is a keen collector of Fabergé eggs) would be interested. He was correct.
Renova authorised initial bids for the Fabergé rights up to a maximum of $30 million – but would not agree to go beyond that without a detailed business plan. By the beginning of December 2006, Unilever was demanding $40 million for the Fabergé rights. Mr Vekselberg agreed with Mr Gilbertson that he could bid up to $40 million, but on the basis that the purchase price would be paid, not by Renova, but by Mr Vekselberg personally (out of one of his private companies). By 20 – 21 December 2006, it was clear to all the parties that what Mr Vekselberg specifically required in exchange for the funding was that his private company would own the title to the Fabergé brand, on the basis that all the economic and management rights would go to the fund.
While Mr Gilbertson and his team were not particularly happy with these arrangements, they did not veto the investment. Rather, they caused the fund to proceed with signing up the Unilever deal. On 21 December 2006, Mr Gilbertson emailed Mr Vekselberg saying he would trigger the transaction, and that he would advise Mr Vekselberg "as soon as [he was] officially the global 'Mr Fabergé'". A sale and purchase agreement for the Fabergé Rights was signed between Unilever and a company called Project Egg Limited ("PEL"), a wholly owned subsidiary of the Master Fund. On 23 December 2006, Mr Gilbertson emailed Mr Vekselberg saying, "I congratulate you on this entrenchment of your interest in this revered brand name".
The transaction was due to complete on 3 January 2007. Over the holiday period, between late December 2006 and early January 2007, Renova and Mr Gilbertson's team worked to agree the exact terms on which the investment would be structured between the Fund and Mr Vekselberg's private company. Those negotiations were not straightforward, but were progressing.
At the same time, however, Mr Gilbertson appeared to have other plans. As early as August 2006, he had said in an email to his son and business associate: "Buy the Egg, and I'll pull the plug on 'em". By late December 2006, that is what he started actively planning to do. On 23 December 2006, he emailed two of his business contacts and potential investors saying he had agreed to go along with Mr Vekselberg's requirements, but that he had told Renova that "unless [he had] binding assurances, well in advance, they will pay on time, I will finance the $38 million from other sources". That was not true – he had made no such disclosures to the Renova team.
Mr Gilbertson's assertion was that he awoke on New Year's Day 2007 with a realisation that an agreement was not going to be reached with Renova. He triggered his plan to acquire the Fabergé rights himself, with the assistance of his consortium of investors rather than through the Pallinghurst Structure and with Renova and Mr Vekselberg. In one of a number of emails to his consortium members, he wrote: "Deal now being pushed by the Russians will serious sub-optimise for us. I think [the three of us] should do it … then negotiate with the Russians from a position of strength". That was what then happened.
During the opening days of 2007 Mr Gilbertson's team continued to negotiate (or to purport to negotiate) with Renova. However, on 2 January Mr Gilbertson telephoned the trustee of his family trust, Fairbairn, to let them know he had "bought [himself] a Christmas present", in the form of the Fabergé rights, and that he "need[ed] some money to pay for it". With no genuine due diligence, Fairbairn authorised the investment, through a shelf-company incorporated in the BVI called Autumn Holdings.
On 3 January, the deal with the brand's owner closed, funded by Mr Gilbertson (via Autumn), and his consortium. They loaned PEL $40 million at commercial interest rates. They also received shares in PEL amounting to over 99% of its equity, diluting the Fund's investment in PEL to less than 1% - although that was gratuitous, and was not a condition of the funding by Autumn or the other syndicate members. The fund was, in effect, cut out of the deal, and the Fabergé rights were now owned almost entirely by Mr Gilbertson and his consortium.
Mr Gilbertson did indeed then seek to negotiate from this "position of strength" in 2007. Those negotiations did not succeed – and in 2008 he and Autumn were sued by Renova, by way of a derivative action, the first reported case of the Court, where a derivative action has been permitted to proceed2.
Mr Gilbertson's breaches of fiduciary duties
The Court reiterated the well-established principle that whether or not someone is a fiduciary, depends on whether he is acting for or on behalf of another "in a particular matter in circumstances which give rise to a relationship of trust and confidence".
Mr Gilbertson argued that it was possible for the shareholders to modify a director's fiduciary duties to the company, such that he would be entitled to act in his own interests rather than the interests of the company. More controversially, he contended that the Letter Agreement amounted to such an agreement, and its terms were such as to entitle him to act in his own best interests - in effect, by exercising his right of veto under the Letter Agreement, leaving him free to acquire the Fabergé rights for himself.
Foster J did not accept that, holding that it would be contrary to the overall intent of the parties, as reflected in the Letter Agreement, for a director to seek to veto or withdraw consent to an investment project, so as to enable him to pursue that investment project for himself. After a careful analysis of the background and the Letter Agreement, Foster J held that:
"…once a proposed Investment Project had been brought by Mr. Gilbertson for consideration by the Investment Committee and proceeding with it had not been consented to by [the Renova appointed director], Mr. Gilbertson as a director of the Company, was subject to the fundamental principles of loyalty and good faith in relation to that Investment Project, including not making a profit for himself out of his position, not placing himself in a position where his interest may conflict with that of the Company and not acting for his own benefit or exploiting the opportunity for himself, at least without the informed consent of the Company."
In essence, Mr Gilbertson allowed himself to be placed in a position of trust and confidence when it came to the Fabergé rights – and as a result the Company and the Pallinghurst Structure were entitled to expect his "single minded loyalty". In order to modify that position, he needed the "fully informed and express consent" of the company, which he had not obtained. The Court also found that the Letter Agreement did not attenuate Mr Gilbertson's duties in the way he alleged – to the contrary, it tended to further support the conclusion that he was in a position of trust and control with respect to the Fund's investment opportunities, through his role under that agreement as the day-to-day manager of the Fund's affairs, including its proposed investment in Fabergé.
This ruling is a useful reminder of the strict nature of a fiduciary's duty of loyalty. While directors' fiduciary duties might be capable of a degree of modification in certain circumstances, to be effective such modifications must be made clearly, expressly and openly. A fiduciary who acts clandestinely to secure a profit for himself cannot expect any sympathy from the Courts.
Autumn as a knowing recipient
As the company used by the trustee of Mr Gilbertson's family trust to fund his share of the acquisition, Autumn was sued on the basis that it received proceeds of Mr Gilbertson's breach of duty, in circumstances where it knew or ought to have known about the breach. It was ordered to account to the fund for the fruits of that breach, including both the PEL shares it received as well as the interest it made on the loan to PEL.
Autumn contended it was unaware that Mr Gilbertson was breaching his fiduciary duties. Mr Gilbertson was not a director of Autumn, which was ostensibly controlled by Fairbairn, the Jersey based corporate trustee of Mr Gilbertson's family trust. However, that fact alone did not prove sufficient to insulate Autumn from liability.
As Foster J observed, there were two different ways in which Autumn could be said to have the requisite knowledge: (a) by imputation to it of Mr Gilbertson's actual knowledge, or (b) through what representatives of Fairbairn knew or should have known. In addressing these questions, the Court closely examined the practical realities of Autumn and Fairbairn's relationship with Mr Gilbertson (including transcripts of discussions which took place between Mr Gilbertson and representatives of Fairbairn in the lead-up to his breach). It was clear Fairbairn did little or no real due diligence in connection with the investment, and was simply acting in accordance with Mr Gilbertson's directions. As Foster J observed, the responsible officer at Fairbairn was "very ready to comply with Mr Gilbertson's requirements and to place great reliance upon him in doing so. There was no question of Mr Gilbertson overriding him; there was little or nothing to override."
Even to the extent it could be said to be the guiding mind of Autumn, it was also clear that Fairbairn (and therefore Autumn) knew or ought to have known that what Mr Gilbertson was doing amounted to a breach. For example, the responsible officer at Fairbairn enquired what Mr Vekselberg's thoughts would be if Mr Gilbertson went ahead and acquired Fabergé without using Pallinghurst. Mr Gilbertson replied "He'll be extremely pissed off I would think".
The judgment reinforces how important it can be for trustees of this nature to be truly independent and to exercise a proper level of due diligence. Trustees should bear in mind that, in circumstances such as this, the Court will invariably focus on substance over form2.
1 Maples and Calder's Cayman Islands litigation team acted for the successful Renova Group parties.
2The general rule is that a company is the only proper plaintiff in any action where the company itself is entitled to relief. However, where a member of a company wishes to sue on behalf of a company for a wrong committed against the company (such as a breach of directors' duties), and where (for example) the alleged wrongdoer controls the company or is in a position to prevent it from taking action on its own behalf, the Cayman Islands Court rules provide a procedure whereby the court determines, as a preliminary issue, whether the shareholder is entitled to continue with an action on a derivative basis.