Bermuda: Investment Fund Administrators: Liability For "Gross Negligence"

Last Updated: 16 October 2019
Article by Mark Chudleigh and Laura Williamson

Decisions involving liability claims against fund administrators are relatively rare in the English courts, as they are in the courts of offshore financial centres with legal systems based on English common law. But if any environment is likely to produce a claim and a judgment it is the one that arose in the aftermath of the vast Ponzi scheme operated by Bernard Madoff, which first came to light some 11 years ago.

A Cayman Islands case involving a huge damages claim against a fund administrator, Primeo Fund v Bank of Bermuda and HSBC Securities, is now on its way to the Privy Council with an appeal likely to be heard in 2020. Much of the interest in the case relates to the findings of the Cayman Islands Court of Appeal on the rule against the recovery of "reflective loss", which ultimately resulted in the failure of the claims (for some US$2 billion of damages), as the loss incurred by Primeo Fund (the Fund) was reflective of loss suffered by companies in which the Fund was a shareholder.

However, the decision is also of interest to fund administrators and other service providers who have service agreements containing exclusion clauses in respect of liability caused other than by wilful default or gross negligence. These clauses are particularly common in offshore service contacts, engagement agreements and trust deeds and provide valuable protection to offshore professionals and trustees and their indemnity insurers.

Background

  • Bank of Bermuda (Cayman) Limited (BOB) was the administrator and HSBC Securities Services (Luxembourg) SA (HSBC) was the custodian in respect of the Fund, which made investments in a managed account with Bernard L Madoff Investment Securities LLC (BLMIS).
  • The brokerage agreements between the Fund and BLMIS gave BLMIS complete discretion to buy and sell investments, without reference to the Fund.
  • The administration agreement required BOB to calculate the net asset value (NAV) of the Fund on each valuation day, subject to a standard exclusion of liability clause in the absence of "gross negligence or wilful default".
  • BLMIS' management of the investment, and the secrecy employed by Madoff in respect of his business dealings, meant that the only documentary evidence of trades available to BOB took the form of individual trade confirmations and month-end statements from BLMIS itself.

The administrator's shortcomings

At trial, the judge found that BOB had been guilty of gross negligence in its performance of the NAV calculations. In particular, whilst BOB could not be faulted when it came to confirming the pricing of assets, it had failed adequately to verify the existence of those assets in circumstances where its only information had come from BLMIS itself.

As noted by the Court of Appeal, "in financial terms, the books and records maintained by [BOB] and the accounts it generated as at each valuation day were almost entirely dependent upon information received from BLMIS. These accounts were reconciled with the month end statements received from BLMIS as part of the process of determining the total NAV."

Whilst at first this constituted mere negligence (when BOB could rely on the unqualified reports of the Fund's auditors, EY), it transformed to gross negligence when Bank of Bermuda became aware that the auditors were not prepared to accept information coming from BLMIS, yet BOB continued to rely on such information. The trial judge considered that BOB's continued willingness to rely on single source information from BLMIS represented a "serious disregard of the risks".

Both the Fund and BOB appealed the trial judge's findings on negligence: the Fund, on the basis that BOB had been guilty of gross negligence from an earlier point in time; and BOB, on the basis that it had never been negligent and certainly had not been grossly negligent, even after the concerns raised by the auditors.

What constitutes gross negligence?

In the Court of Appeal, BOB argued that it had not disregarded the risks, but had in fact had due regard to them, weighing them up before ultimately deciding that the risks were acceptable. The Court of Appeal found, however, that gross negligence did not depend on BOB having disregarded the risks: "It is the failure to take the steps which a reasonably competent administrator would take which constitutes negligence (or gross negligence), not necessarily the failure to think about it".

Analysing the difference between negligence and gross negligence, the Court of Appeal found that gross negligence meant "simply 'very great', 'extreme' or 'flagrant' negligence" and that the difference was one of degree. It upheld the trial judge's findings that BOB had been grossly negligent in relying on single source information from BLMIS after it became aware of the auditor's concerns.

BOB was therefore denied the protection of the exclusion clause under the administration agreement. The only thing standing between it and liability for the loss suffered by the Fund was the application of the rule against reflective loss.

Whilst determining whether particular conduct by a service provider amounts to gross negligence will always turn on the particular facts, and the court's assessment of the evidence, the Cayman Court of Appeal's decision demonstrates that broad liability exclusions can be overcome and that in appropriate cases, courts will make a finding of gross negligence. In this case, were it not for the finding on reflective loss (which is subject to appeal), the fund administrator could have found itself on the wrong end of a substantial judgment.

Read more items in Offshore Professional Risks Brief – October 2019

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. Kennedys operates in Bermuda in association with Kennedys Chudleigh Ltd.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions