Primeo v HSBC: Uncharted territory

This case concerns the efforts of the liquidators of a Madoff feeder fund to recover losses suffered as a result of fraud from service providers to the fund, in this case the administrator and the custodian. As explained below, the recent judgment handed down by Justice Andrew Jones QC in the Grand Court of the Cayman Islands addresses a number of novel legal issues and takes the law into unchartered territory.


As is well-documented, Bernard Madoff, the former NASDAQ Chairman, perpetrated the world’s largest known Ponzi scheme and was eventually sentenced to 150 years in prison for securities fraud. Prior to his arrest in December 2008, Madoff purportedly managed money and traded on behalf of clients across the globe. Primeo Fund (in official liquidation) was one such client.

Primeo was incorporated in the Cayman Islands in 1993 and, until 2007, invested directly in Bernard L Madoff Investment Securities LLC (BLMIS). Thereafter, Primeo continued to invest in BLMIS indirectly, primarily through another Cayman-domiciled investment fund, Herald Fund SPC (in official liquidation). As explained below, that change in investment structure became the focal point in the judge’s mind at first instance.

Members of the HSBC Group, Bank of Bermuda (Cayman) Limited (BoB Cayman) and HSBC Securities Services (Luxembourg) SA (HSSL) (together, the HSBC defendants), acted as administrator and custodian to Primeo. Having been placed in liquidation, Primeo initiated proceedings against the HSBC defendants in February 2013. Broadly, Primeo alleged that the HSBC defendants had been grossly negligent in performing their respective functions as administrator and custodian and, by their breaches of duty, had caused Primeo’s underlying investors to suffer very substantial losses.

The trial commenced in early November 2016 and concluded in late February 2017. During the course of the trial, the Grand Court heard evidence from 10 factual witnesses, including former Primeo directors and senior HSBC executives, and 17 expert witnesses ranging from investment management consultants to a former director of the FBI.

Last month, Justice Jones held that the HSBC defendants breached various ongoing duties in their capacities as administrator and custodian to Primeo. However, despite those findings, the HSBC defendants escaped liability at first instance as a result of a number of novel legal findings. Those findings have been appealed and will now be determined by the Cayman Islands Court of Appeal.

Other Madoff feeder funds have also brought claims against HSBC entities and are likely to be encouraged by this decision. Without a technical legal argument specific to the way in which Primeo’s investments were restructured in 2007, which does not apply to other funds, the HSBC Defendants would have been found liable for Primeo’s losses.

Serious breaches

The judge was satisfied that the HSBC defendants owed and breached their duties to Primeo in various ways from 2002 to 2008. In particular, he concluded that:

  • the custodian was in breach of its ‘on-going suitability’ and ‘most effective safeguards’ duties by not recommending safeguards to protect Primeo’s assets;
  • the custodian was also in breach of contract when it failed in August 2002, June 2003, March 2004, March/April 2005 and February 2007 to give any consideration or make any recommendations to Primeo about effective safeguards which were readily available;
  • the administrator did not exercise reasonable care and skill in calculating the net asset value after April 2005. It was grossly negligent to continue to produce valuations based on single-source information received from Madoff at the end of each of the following months;
  • the unqualified audit opinion for Primeo was based, to a material extent, upon the custody confirmation issued to the auditors by HSSL, acting as Primeo’s custodian. The judge found that HSSL had no proper basis for confirming the existence of the assets, in circumstances where the assets were supposedly held by BLMIS and HSSL had taken no steps to verify that they existed; and
  • faced with various concerns and the other background information, a reasonably competent custodian should have given notice for resignation and explained its reasons for doing so. Although there was no legal duty to do so, it would have been commercially unrealistic for the custodian to resign without providing an explanation.

The judge found that Madoff would have refused to implement any measures suggested by the HSBC defendants, due to the risk of the fraud being uncovered. Accordingly, the judge held that, when faced with a refusal from Madoff in these circumstances, any competent custodian would have either resigned or sought to re-negotiate terms with Primeo to limit its functions and liability.

By 2005, it was held to be grossly negligent for the HSBC defendants to continue to produce a NAV based on single-source information, i.e. information received only from Madoff acting in three capacities as sub-custodian, broker and investment manager.

The judge also held that, by virtue of entering into a sub-custody agreement with BLMIS in 2002, HSSL became strictly liable to Primeo for BLMIS’ defaults as sub-custodian. This is important because it means that in relation to that cause of action Primeo does not have the burden of showing that HSSL caused Primeo’s loss.

The judge labelled the evidence of a number of former and current senior HSBC executives as “contrived” and “not credible.” The judge found that they had held “wholly untenable” views, and ignored the serious consequences of their actions. Certain HSBC executives were found to have been “indifferent to obvious risk,” having acted with such serious disregard of the risks as to be guilty of gross negligence.

The effect of the 2007 switch

Nevertheless, despite the damaging findings referred to above, in determining the ultimate issue of liability, the judge focused on Primeo’s 2007 restructuring from direct to indirect investment in BLMIS. This restructuring is the sole reason that the HSBC defendants escaped any liability at first instance.

It is not disputed that BLMIS misappropriated and misused Primeo’s money and perpetrated fraud on a massive scale. The judge accepted that HSSL was strictly liable for the willful defaults of BLMIS as sub-custodian. However, the judge held that Primeo suffered no relevant loss as a result of BLMIS’ defaults. He decided that, notwithstanding that Primeo did not receive any cash as part of the 2007 transaction and rather received potentially worthless shares in Herald (which had invested all its assets with BLMIS), Primeo realized the full value of its assets through the switch into Herald. For that reason, the judge found that there was no relevant loss for which HSSL was strictly liable.

Similarly, the judge held that Primeo’s claim for the loss of its investment is barred by the rule against reflective loss. The rule against reflective loss operates where a company suffers loss by requiring any claim for the loss to be brought by the company, and not by shareholders in the company. The shareholders’ loss is said to be reflective of the company’s loss, with a view to preventing multiplicity of proceedings, potential multiple recovery and possible prejudice to the company as a result.

However, the rule operates where the shareholder is a shareholder in the company at the time the loss is suffered. The rule has never been applied to prevent someone who suffered loss before they became a shareholder from pursuing a claim simply because they subsequently became a shareholder in a company which suffered a similar loss under an entirely different set of contractual arrangements and did not even exist at the time the shareholder accrued certain claims. The judge’s finding in this regard is unprecedented in the common law world and, if upheld on appeal, would substantially enlarge the rule against reflective loss.

The judge also found that, for the rule against reflective loss to apply, it was only necessary for HSBC to show that Herald had a claim that had a real prospect of success, namely a claim that would survive an immediate strike out application but was thought to have less than a 50 percent chance of success (and which was therefore likely to fail). Again, it is difficult to understand why the fact that Herald may have a poor claim against HSBC should operate to deprive Primeo of the good claims that it had prior to investing in Herald.

In the absence of these inter-related legal findings in relation to events in 2007 (i.e. long after the HSBC defendants first breached their respective duties), Primeo’s claim against the HSBC defendants would have been successful. Accordingly, these issues will be key issues for the Court of Appeal to consider.


The judge held that the causes of action which accrued against the HSBC defendants from February 2007 are not statute barred. This would allow Primeo to recover for those claims but not for claims which accrued earlier.

However, he rejected arguments made by Primeo that the HSBC defendants deliberately concealed their wrongdoing so as to extend the limitation period. For the purposes of the law, deliberate concealment does not require intentional concealment of the breach of duty, rather it is sufficient if a defendant knowingly commits a breach of duty in circumstances where that breach is unlikely to be discovered for some time. Primeo argued that this was the case here, because the HSBC Defendants had known since 2002 that they were unable to verify the existence of the underlying assets and were therefore unable to comply with their obligations to safe keep the assets and to determine the value of them.

Although the judge found that the HSBC defendants had breached their obligations, he said that they did not knowingly breach their obligations but were instead reckless (i.e. not caring) as to whether they had complied with them. The judge did not accept that recklessness is sufficient. As a result, despite his other findings, for example, that senior HSBC executives “did not apply their minds to and failed to consider whether any safeguards, or any more effective safeguards, could or should be implemented,” the judge said that causes of action which had accrued before February 2007 were time-barred.

Again, these issues will be important issues for the Court of Appeal and may affect the amount of damages that Primeo can recover.


Although causation is not relevant to Primeo’s strict liability claim, it is relevant to the claims for breaches of the administration and custodian duties. The law requires that the breach is one of the elements that caused the loss, but not that it is the sole or most effective cause of the loss. Nevertheless, the judge held that Primeo had not established that the HSBC defendants’ serious breaches of contract caused Primeo’s losses.

Primeo called three former directors of Primeo, two of whom reside in Austria. Primeo also served a number of hearsay notices in relation to transcripts of evidence given by former Primeo directors in Austria and Primeo’s liquidators obtained thousands of contemporaneous documents from multiple sources, including former directors. However, on the facts of the case, the Judge found that there was “no evidence from any of those who would actually have made the decision” to withdraw Primeo’s investment.

As many readers will be aware, liquidators are in a uniquely challenging position in relation to evidence gathering. They often have no power to compel individuals to give evidence and have no entitlement to documents falling outside the realm of their statutory powers (in Cayman, sections 103 and 138 of the Companies Law). Even where there is a clear entitlement, third parties will often fight to restrict access to documents. By way of example, the HSBC defendants, as key service providers to Primeo, resisted the Primeo liquidators’ early attempts to gather information and documentation.

This may be a dangerous precedent which, if not over-turned, may make it almost impossible for liquidators to prove the causation element of breach of duty claims. In this litigation, due to the Judge’s findings on strict liability, it may not be necessary to succeed on causation on appeal. However, often causation will be an essential element of any claim and this part of the Judge’s decision is particularly problematic for liquidators.


As the title of this article suggests, the first instance judgment takes this case into uncharted legal territory. The issues relating to whether the 2007 transaction cured all Primeo’s loss, reflective loss and limitation are all very important and novel legal issues which will now have to be determined by the Court of Appeal, and in due course possibly by the Privy Council in London. They could set legal precedents with far reaching implications across the common law world.