Investment fund administrators: liability for “gross negligence”

Primeo Fund (In Official Liquidation) v Bank of Bermuda (Cayman) Limited and HSBC Securities Services (Luxembourg) SA [13.06.19]

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.


  • 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