Primeo v HSBC: Cayman Islands Court of Appeal dismisses Madoff Feeder Fund's Appeal

The Cayman Islands Court of Appeal ("CICA") has dismissed the appeal brought by Primeo Fund (in Official Liquidation) ("Primeo") against Bank of Bermuda (Cayman) Limited ("BoBC") and HSBC Securities Services (Luxembourg) S.A ("HSSL") in their respective and former capacities as administrator and custodian of Primeo (together, the "Respondents").

Primeo appealed the first instance judgment of Mr Justice Jones QC (handed down in August 2017) (the "First Instance Judgment") which ultimately dismissed Primeo's claims valued in excess of US$2 billion in damages against the Respondents for their alleged failings as professional service providers to Primeo, which had unknowingly invested in Bernard Madoff's Ponzi scheme (the "Appeal"), but also made a number of significant adverse findings as against the Respondents. Justice Jones held at first instance that the Respondents had owed and breached various ongoing duties to Primeo as its administrator and/or custodian in particular by:

  • adopting grossly negligent NAV calculation procedures;
  • failing to consider or make any recommendations to Primeo in relation to safeguards which were readily available and if implemented, would have been effective to safeguard Primeo's assets;
  • failing to ensure that Bernard L Madoff Investment Securities LLC ("BLMIS") was and/or remained suitable to act as sub-custodian; and
  • failing to verify and establish whether the assets purportedly held by BLMIS actually existed.

The Respondents sought to uphold the First Instance Judgment on additional grounds, whilst also filing an extensive cross-appeal seeking to overturn those adverse findings that the Respondents owed duties to Primeo and had breached them (the "Cross-Appeal"). The hearing of the Appeal and Cross Appeal lasted two weeks and concluded on 7 December 2018. Please see our previous advisory relating to the Primeo v HSBC first instance and appeal proceedings, here. 

The CICA delivered its 184 page judgment on 13 June 2019 in which it upheld the central finding by Justice Jones at first instance that Primeo is barred from recovering any loss. This was because the CICA determined that all such losses were to be treated as suffered in its capacity as a shareholder in two other Madoff feeder funds (Herald Fund SPC (in Official Liquidation) ("Herald")* and Alpha Prime Fund Ltd ("Alpha"), as those funds themselves were the proper plaintiffs in respect of such losses (based upon the doctrine of reflective loss). This was the case notwithstanding that Primeo had claimed for losses incurred during an initial period when it had funds directly invested with BLMIS (that is, prior to its investments being transferred to Herald and/or Alpha). Although Primeo had originally invested its funds directly with BLMIS, the CICA held that it did not matter that Primeo's claims were fully accrued before it transferred its investments because the proper time to consider whether the claims were reflective was when the claims were issued rather than when they accrued (noting that at the time Primeo's claims were issued in 2013, Primeo was then a shareholder in Herald and Alpha). In doing so, the CICA has clarified the broad scope of the rule against reflective loss under Cayman Islands law which not only safeguards against the risk of double recovery (that is, recovery sought by both a company and its shareholder or creditor from the same defendant in respect of the exact same loss) but also prevents such a shareholder or creditor from "scooping the pool" by bringing its own competing claim against a defendant, where the company's claim has a real prospect of success.

The CICA rejected the Cross-Appeal because they determined that the Respondents did not take any steps to verify that Madoff actually held the assets it claimed to hold nor did they recommend any safeguards to Primeo. The CICA judgment will likely be of interest to the fund industry in the Cayman Islands as the appeal also addresses a number of important legal principles and overturns certain of Justice Jones' findings with respect to causation, contributory negligence and limitation. In contrast to the First Instance Judgment, the CICA found that: 

  • parts of Primeo’s claim were not time-barred since BLMIS concealed certain facts from Primeo up until February 2007 (meaning that its liquidators were unaware of the fraud until Madoff’s arrest in December 2008);
  • if Primeo’s claim against BoBC had succeeded, any damages awarded should only be reduced by 50% (as opposed to the 75% reduction awarded at first instance) since they were equally at fault;
  • Jones J's decision that Primeo was unable to establish that the Respondents were the dominant cause of Primeo’s losses should be overturned as well (because the CICA was of the view that the auditors would not have produced clean audits of BLMIS if it had not received the custody confirmations from HSSL); and
  • whilst Jones J was correct to determine that HSSL was strictly liable for the breach of duty by BLMIS, the CICA went further and determined that Primeo suffered loss on each occasion that money intended for investment was misapplied by BLMIS (that is, there were regular ongoing breaches)
It is understood that the liquidators of Primeo are considering appealing the judgment of the CICA to the ultimate appellate court of the Cayman Islands, the Judicial Committee of the Privy Council in London.

(*Walkers act for the Principal Liquidators and Additional Liquidator of Herald.)