Primeo v HSBC: Cayman Court dismisses US$2bn claim by Madoff feeder fund

Primeo Fund (In Official Liquidation) v (1) Bank of Bermuda (Cayman) Limited (2) HSBC Securities Services (Luxembourg) SA (FSD 30/2013)

In a recent judgment of the Cayman Islands Grand Court, Mr Justice Andrew Jones QC has dismissed a US$2bn professional negligence claim against HSBC arising out of the Madoff investment fraud.

The claim was brought by the liquidators of Primeo Fund, a Cayman fund that invested, both directly and indirectly, in Bernard L Madoff Investment Securities LLC (BLMIS), the vehicle through which Bernie Madoff perpetrated his vast Ponzi scheme. The Defendants were two HSBC Group companies, which acted as the fund’s administrator and custodian respectively.

As against the First Defendant, Primeo alleged breach of various express and implied duties, but the thrust of its case was that in view of the heightened operational risk posed by BLMIS’ triple role as broker, investment adviser and de facto custodian to the fund, the administrator should have attempted to take a series of further steps to verify the existence of the fund’s assets. As against the Second Defendant, Primeo alleged that BLMIS had been appointed sub-custodian in respect of the fund’s assets and the Second Defendant had breached safekeeping duties as well as duties of due diligence and supervision of BLMIS, and in any event was to be held strictly liable for BLMIS’ defaults in its capacity as sub-custodian.

Primeo claimed damages principally on the footing that if the Defendants had properly discharged their duties, Primeo would have withdrawn its money from BLMIS prior to the fraud being uncovered and reinvested profitably elsewhere.

A four-month trial of the claim took place in the Cayman Islands between November 2016 and February 2017. Along with ten factual witnesses, 17 expert witnesses gave evidence on issues including the standards and practices of global custodians and hedge fund administrators, US securities law and practice, the Luxembourg law of custody and financial regulation, and hedge fund investment management.

In his Judgment, delivered on 23 August 2017, Mr Justice Jones found that the Defendants had breached their duties to Primeo in certain respects, but he nonetheless dismissed the claims in their entirety. He held that Primeo was unable to prove causation and he rejected the claim that the Second Defendant was strictly liable for Primeo’s losses. Moreover, the Judge held that the majority of the claims were time-barred and all the claims fell foul of the rule against reflective loss.

On causation, the Judge found that Primeo had failed to prove that but for the Defendants’ breaches, it would have terminated its relationship with BLMIS. Primeo’s directors knew and accepted the risks associated with the investment. They were “firmly committed to Madoff” and would have “worked hard” to avoiding withdrawing from BLMIS.

On limitation, the Judge rejected Primeo’s arguments on deliberate breach and concealment and held that all causes of action that accrued prior to 20 February 2007 were statute-barred.

The reflective loss issue arose because from May 2007 Primeo ceased to invest directly with BLMIS and instead invested indirectly via shareholdings in two other Madoff feeder funds, Herald and Alpha, for which the Defendants also provided fund services. Both Herald and Alpha have sued the Defendants in Luxembourg and Alpha has also asserted claims in Bermuda and in the US Bankruptcy Court. Having heard Luxembourg law evidence as to the merits of Herald’s claims, the Judge was satisfied that both funds had a real prospect of success in claims against the Defendants which would make good Primeo’s loss, with the result that Primeo’s claims were for reflective loss and could not be maintained.

Had Primeo been able to make out its claim for damages, the Judge would also have reduced any damages award against the First Defendant by 75% to reflect Primeo’s contributory negligence, since “Primeo was, to a very substantial degree, the author of its own misfortune”.

The Judgment (which is subject to an appeal) is notable for its discussion of the function and duties of independent administrators and custodians to offshore hedge funds, on which there is little previous authority. It is also one of the few final judgments to be given on claims against professional service providers arising out of the Madoff fraud. Numerous other claims still await determination in multiple jurisdictions, some nine years after BLMIS collapsed.

Richard Gillis QC represented the successful Defendants, leading William Willson, Toby Brown and Simon Gilson (instructed by Campbells).

The Judgment is available here.