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Wednesday, 17th April 2024
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Legal issues could lead to liability over a fund Back  
The rise in litigation against financial services companies has led many firms to examine their requirements protect themselves from the most common types of claims, say Rosaleen Byrne and Grahame Walsh.
The last couple of years have seen a significant increase in the number of legal actions taken in the US and UK against financial services company and their directors, particularly in the funds area, over issues such as negligent investment, fraud, and misrepresentation.

This experience is likely to be mirrored in Ireland and we have already witnessed an increase in similar cases here. This has included legal actions arising out of the miscalculation and mis-statement of the net asset value (NAV) and the knock-on loss or gain that arises; cases arising from subscription or redemption requests being incorrectly carried out; cases against investment managers and advisors for unwise investment decisions; cases relating to underperformance of a fund, and cases arising from allegations of fraud.

So who is at risk from such actions? The unfortunate answer is any party who has been involved with the fund or investment product, whether as fund manager or service provider to the fund.

Investors, who are the most likely plaintiffs (alleging that they have lost money arising from, for example, the characteristics of a fund being misrepresented), will seek to join as many parties as possible at an early stage.

The most obvious defendant will be the party who has had day-to-day control of the investment - the fund manager. Given any reasonable opportunity, others such as the prime broker and fund administrator will also be joined to what will be complex multi-party and multi-jurisdictional litigation.
It’s obviously not possible to create a completely ‘litigation proof’ a business. Nor is it possible to identify all the possible scenarios that might trigger a claim. However, if one bears in mind the basic legal principles behind the most common claims (as outlined below), it should be easier to avoid disputes.

Breach of contract
You have signed an agreement (for example, an administrators’ agreement or an investment management agreement) that clearly sets out your obligations - the things you have agreed to do. If you don’t do those things, and if someone suffers a loss as a result, you are likely to be sued for breach of contract.

But it’s not that simple: sometimes contractual terms are unclear, sometimes they give a mandate (for example, a mandate to an investment manager about investment objectives), but allow a broad range of discretion in terms of how the mandate should be achieved. It may be that through your words, conduct or correspondence you vary a contract and create additional obligations or even create a new contract. Terms can also be implied into contracts - such as a requirement to use reasonable skill and care when providing a service.

The main points in relation to contracts are:
• Be clear about what you have agreed to do

• Make sure you do what you have agreed to do and try not to introduce uncertainty by changing an agreement without recording those changes

• Make sure your employees and any outsourcing partners are clear about your organisation’s contractual obligations.

Negligence arises if you owe a duty of care to someone, regardless of whether you have a contractual arrangement, and you do not properly discharge that duty. Even if you do have a contractual agreement, your duty of care may require you to act in a certain way which may not be spelled out in the contract.

The general rule is that you owe a duty of care to any person who you can reasonably foresee will be affected by your acts or omissions. For example, investment managers, custodians and administrators owe a duty of care to the fund (with which they have a contract anyway), but they also owe a duty of care to investors.

You can be liable for damages if you do not discharge your duty of care properly. The test that is applied to determine this is the ‘reasonable person test’.

If you are sued for negligence, a court will look at what a reasonable investment manager, a reasonable custodian or a reasonable administrator would have done in the circumstances. While the courts will, of course, take industry practice into account, the test is not ‘what would most administrators (for example) have done?’ but rather ‘what would a reasonable administrator have done?’

Certain persons in positions of trust (typically trustees and directors) have additional and more onerous duties and are expected to discharge their duty of care to a higher standard.
One particular type of negligence is negligent misrepresentation. Claims for negligent misrepresentation are very common in financial services cases. You can be liable for negligent misrepresentation if you have a special skill or expertise and you give incorrect or misleading information to persons who you know will rely on that information. Obviously a claim will only arise where persons have relied on information to their detriment resulting in some loss to them.

When people suffer a loss they will look to see who they can blame, who they can recover money from. However, for someone to succeed in a claim they have to show:
1. They have suffered loss
2. They will have to quantify that loss
3. They have to show that the acts or omissions complained of have caused that loss.

This issue of causation is very important in the funds area where so many parties play a role in the promotion, management and administration of a fund and thereby contribute to its success or downfall as the case may be. Even when a link is established between certain acts or omissions and a loss, it can be difficult to quantify the appropriate level of damage that has flowed from those acts or omissions.

Because of the number of parties involved and because a fund’s performance can be affected by so many factors, it can be difficult to establish a link between losses of the fund and the conduct of specific parties. It is partly for this reason that when there is a claim in relation to a fund, the claim tends to be made against a number of parties.

In general, if litigation is commenced in Ireland in relation to issues arising in connection with funds, the litigation will almost certainly be complex, multi-party and even multi-jurisdictional. In such a scenario, the process of mediation might prove a more attractive option to resolve any dispute promptly and cost effectively.

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