Primeo Fund v HSBC: Cayman Islands Court Of Appeal Dismisses Primeo's Appeal

In a judgment delivered on 13 June 2019, the Cayman Islands Court of Appeal ("CICA") dismissed the appeal by Primeo Fund (in Official Liquidation) ("Primeo"), a Madoff feeder fund, against the 2017 judgment of the Grand Court which had dismissed Primeo's claims valued in excess of US $2 billion against its administrator and custodian, Bank of Bermuda (Cayman) Ltd ("BBCL") and HSBC Securities Services (Luxembourg) S.A. ("HSSL").1 The CICA's judgment, which runs to 184 pages, addresses numerous issues that will be of interest to funds industry participants.

In dismissing Primeo's appeal, the CICA (Beatson, Birt and Field JJA) upheld the central finding by the first instance judge (Jones J) that Primeo is barred from recovering any loss it suffered in its capacity as a shareholder in two other Madoff feeder funds which are, as a matter of law, the proper plaintiffs in respect of any such loss. Any loss suffered by Primeo was therefore "reflective" (i.e. inseparable from the general loss suffered by the company) and therefore barred by the rule against the recovery of reflective loss. Significantly, the CICA confirmed the broad ambit of the rule against reflective loss, which not only guards against the risk of double recovery (i.e. recovery by a company and its shareholder or creditor from the same defendant in respect of the same loss) but also prevents such a shareholder or creditor "scooping the pool" by bringing its own competing claim against a defendant, where the company's claim has a real prospect of success.

BACKGROUND

Primeo, a Cayman Islands investment fund, was established and managed by Bank Austria. From 1993 until December 2008, Primeo invested with Bernard L Madoff Investment Securities LLC ("BLMIS"), the company through which Bernard Madoff perpetrated his infamous Ponzi scheme. In 2003, Primeo began investing some of its funds with BLMIS "indirectly", via shareholdings in two other Madoff feeder funds: Alpha Prime Fund Ltd ("Alpha") and Herald Fund SPC ("Herald"). Following an in specie transfer on 1 May 2007 (the "Herald Transfer"), all of Primeo's investments with BLMIS were "indirect", through Primeo's shareholdings in Herald and Alpha.

Primeo appointed BBCL and HSSL as its administrator and custodian respectively (together, the "Respondents") at a time when both entities were part of the Bank of Bermuda group of companies, the entirety of which was subsequently acquired by HSBC in 2004.

Upon Madoff's arrest in 2008, Primeo entered liquidation but it was not until 2013 that the joint official liquidators of Primeo sued the Respondents for the alleged losses suffered by Primeo as a result of the Madoff fraud.

As against the custodian, Primeo alleged that HSSL breached its contractual duties concerning the appointment and supervision of BLMIS as its sub-custodian, and that HSSL was in any event strictly liable for the wilful default of BLMIS. As against the administrator, Primeo alleged that BBCL breached its obligations to maintain Primeo's books and records and determine its net asset value ("NAV") per share. Primeo alleged that, had the Respondents complied with their obligations, Primeo would have withdrawn its investments with BLMIS prior to the fraud being uncovered and reinvested the proceeds elsewhere, generating a significant profit.

FIRST INSTANCE DECISION

During a twelve-week trial in 2016/17, Mr Justice Jones QC heard evidence from more than 25 factual and expert witnesses including three of Primeo's former directors and a number of experts in the fields of custody and fund administration. In its judgment delivered in August 2017, the Grand Court dismissed Primeo's claims in their entirety, on the following grounds:

Reflective Loss: The rule against reflective loss operated to bar the recovery of any of Primeo's alleged loss, because Primeo was seeking to recover losses suffered by way of a...