FFSB Ltd (Formerly known as Fortis Fund Services (Bahamas) Ltd) v Seward & Kissel LLP
| Jurisdiction | UK Non-devolved |
| Judge | Lord Hoffmann |
| Judgment Date | 13 March 2007 |
| Neutral Citation | [2007] UKPC 16 |
| Court | Privy Council |
| Docket Number | Appeal No 71 of 2005 |
| Date | 13 March 2007 |
[2007] UKPC 16
Present at the hearing:-
Lord Hoffmann
Lord Hope of Craighead
Lord Walker of Gestingthorpe
Baroness Hale of Richmond
Sir Christopher Rose
Privy Council
[Delivered by Lord Hoffmann]
In the early 1990s, cash-starved local authorities in the United States tried to find innovative ways of raising money. One of these was to assign at a discount their rights to arrears of property taxes, secured by liens over the properties. These Tax Sales Certificates ("TSCs") were attractive to purchasers who were willing and able to use energetic methods of collection. In some cases they could obtain good returns by making loans at high rates of interest to debt-laden home owners who wanted to avoid foreclosure and in others they could make capital gains by foreclosure and resale. But such investments, although potentially profitable, were not particularly liquid. The collection of debts from defaulted debtors or the foreclosure and sale of their properties needs time.
Among the participants in this market was the Breen Capital Group ("Breen") of New Jersey, which acquired a substantial portfolio of such liens, mainly over houses in New Jersey and Florida. In 1993 Breen and a Mr William Rafter, an investment fund manager of Philadelphia, set up a scheme to make investment in TSCs available to a wider public through a mutual fund. In order to attract European investors, the fund was established off-shore, at first in the Cayman Islands and afterwards in The Bahamas. The Bahamian fund took the form of a company named Oracle Fund Limited ("the Fund"), incorporated under the International Business Companies Act 1989 on 3 May 1995 and licensed under the Mutual Funds Act 1995.
Investors were invited by an "Offering Memorandum" to subscribe for "A" or "B" Investor Shares, the former being redeemable after three months and the latter after two years. Over the next four years, very substantial sums were subscribed for these shares. The Fund advanced the money it had raised to Breen companies (described in the Memorandum as "Special Purpose Corporations") against promissory notes paying an attractive rate of interest. There was in this arrangement an inherent mismatch between the liquidity promised to shareholders, having a right of redemption on relatively short notice, and the illiquidity of the company's investments, which were realisable only to the extent that the Breen companies were able to raise cash from their TSCs. This mismatch plagued the Fund throughout its life and eventually led to its collapse. As Mr Rafter ruefully commented in 1998 [IIIb/741] "I have learned that liquidity and investment are mutually exclusive states of being".
The first serious indication of trouble came towards the end of 1996 from Coopers & Lybrand, the Fund's Bahamian auditors, when they signed off the accounts for the period from the commencement of operations in The Bahamas until 31 December 1995. Although Mr Johnson, the local partner, dated his formal letter of Comments and Suggestions 7 January 1997, he appears in accordance with normal practice to have discussed its terms in advance with Mr Rafter. Mr Johnson's main point was that the Fund was fully invested in Breen promissory notes which were not due for redemption until late in 1997. It was therefore entirely illiquid and in the absence of a credit facility would be unable to meet demands for redemption of shares which exceeded the new money being invested. The auditors suggested that a portion of the Fund be kept in liquid assets such as Treasury bills. Mr Johnson also pointed out that the promissory notes did not give the Fund any security over the TSCs held by Breen or prevent Breen from borrowing money from other sources on security which conferred priority over the Fund. He raised a number of other points which it is not presently necessary to mention.
Mr Rafter tried to deal with the question of liquidity by setting up a company in the Cayman Islands named Guarnerius Investment Ltd to provide what he called a "liquidity facility", to which the Fund would lend money for investment in easily realisable securities. For one reason or another, this did not prove satisfactory and he incorporated an Isle of Man company named Arquebus Ltd for the same purpose. Both of these companies were funded by loans made by the Fund.
Mr Rafter's main difficulty with the auditors was to persuade Mr Johnson that the advances to Breen were fully recoverable and that no provision needed to be made. He tried to obtain valuations of the Breen portfolio which would satisfy Mr Johnson that the indebtedness to the Fund was fully covered by realisable assets. He even arranged a transaction by which Arquebus (with money borrowed from the Fund) paid for a purchase of some of Breen's foreclosed properties in order to provide evidence of their value in the open market. But all to no avail. Coopers & Lybrand refused to give an unqualified report on the accounts for the years ending 31 December 1996 and 1997. In consequence, the Fund's operations were suspended and on 12 July 2000 it went into voluntary liquidation. An order for compulsory winding up was made on 11 September 2000. The investment in Guarnerius appears to have been redeemed without loss in 1998 but there was a deficiency of about $200m on realisation of the investments in Breen and Arquebus.
The joint liquidators of the Fund then considered who could be held responsible for the loss. Mr Rafter had arranged for the Fund to be administered in The Bahamas by MeesPierson Fund Service Ltd, afterwards Fortis Fund Services (Bahamas) Ltd, a subsidiary of the well known Fortis international banking and insurance group based in the Netherlands and Belgium. After a change of ownership, their subsidary is now called FFSB Ltd ("FFSB"). Employees of FFSB were appointed directors of the Fund and FFSB entered into an Administration Agreement which set out its duties ("the general administration of [the Fund's] business and affairs") and contained an exemption clause by which FFSB was to be liable only for losses attributable to "wilful misfeasance, bad faith or gross negligence". Mr Rafter himself (acting through a company in Philadelphia) acted as the Fund's investment adviser in return for a fee calculated as a percentage of the assets. He also received a commission or "sponsor payment" from Breen calculated on the sums advanced by the Fund. Seward & Kissel LLP ("S & K") of New York, who have been described as "the top hedge fund lawyers", acted as legal advisers to the Fund and were so described on all the Offer Memoranda. They drafted the Memoranda, the promissory notes issued by Breen and some of the documentation relating to the formation of Guarnerius, Arquebus and the funding of the purchase of the Breen properties. The advice which they provided to the Fund appears to have been almost entirely through the medium of Mr Rafter, who passed it on to the directors in Nassau. Direct communications with the Fund were largely confined to submitting their bills for payment. This no doubt reflected a realistic appreciation of the Fund's decision-making processes.
On 10 April 2001 the Fund (in liquidation) issued a writ against FFSB and four individuals alleged to have been members of the board. One of them, Mr Barry Herman, was originally an employee of FFSB but left them in July 1996. He nevertheless remained a director until the end of 1998. The others were FFSB employees. The Statement of Claim alleged against FFSB that it had acted in breach of the Administration Agreement and its statutory duties under the Mutual Funds Act 1995. FFSB was also alleged to have owed the Fund a common law duty of care and to have been in breach by allowing the funds to be invested in Breen, Guarnerius and Arquebus. The directors were also alleged to have been in breach of their duties of care to the Fund in causing or permitting the investments to be made.
Fortis and Mr Herman filed separate defences in which they denied liability. Mr Herman's defence denied that he had been negligent, saying that he had followed the recommendations of Mr Rafter which were "known to the auditors and lawyers of the Fund", with whom Mr Rafter had regular meetings and whose advice he had reported to FFSB. In paragraph 24 he said that reports were made to the Fund by Mr Rafter and S & K, "the Fund's legal advisers" and that the directors were entitled to rely on them.
On 21 May 2002 FFSB issued a third party notice, accompanied by a statement of claim, against Mr Herman. It claimed that if (which was denied) FFSB was liable to the Fund, it was entitled to a contribution or indemnity from Mr Herman as a joint tortfeasor under the Tortfeasors Act 1995.
On 14 June 2002 FFSB applied ex parte to Small J for leave to issue another third party notice, this time against S & K, for service out of the jurisdiction at their offices in New York. The application was supported by a short affidavit by Claire Hepburn, a partner in FFSB's solicitors in Nassau. She said that if FFSB was liable to the Fund for breaches of duties owed (inter alia) in tort, then both Mr Herman and S & K were liable in respect of the same damage and were liable to contribute to any damages for which FFSB was liable. The main allegation against S & K was that at all material times it was "the Fund's attorneys" and that "by reason of its knowledge and of the relationship between it and the Fund" it owed it a duty to advise as to the propriety of its investment policy. Small J granted leave and the third party notice was served.
S & K then applied to discharge the order giving leave to serve them. Mr Rigney, who had been...
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