FRANCE: Strict Liability for Depositaries: Paris Appeals Court upholds AMF decisions

Friday April 17 2009

A key issue falling out of the Madoff Affair is the question of whether the Depositary has strict liability for safekeeping of the assets of the scheme where sub-custody is delegated. The Paris Appeals court has now held that strict liability does apply. Whilst not currently dealt with by UCITS IV proposals, this is an important issue and we will surely see some movement in coming months. It is a key issue from an investor protection perspective. It is also a key issue because Depositaries in UK, Dublin and Luxembourg generally dispute the existence of strict liability and any move to impose strict liability may therefore lead to an increasing of custody fees or to some of those players (those without their own global sub-custody network) exiting the market. In a decision last week, the Paris Appeals Court upheld the AMF `s administrative directions against RBC Dexia and SociEtE GEnErale requiring them to return the securities they had placed in safekeeping with Lehman Brothers International (Europe) to three French hedge funds for which they were custodians. The AMF has now said that “it will continue its determined efforts to ensure uniform enforcement of the obligation throughout the European Union, because this is vitally important in winning back retail investors ` confidence in the mechanisms of the Single Market.” The Irish Approach A contrasting vies can be seen in the following document from 2004 from the Irish Regulator which states that, although it would ultimately be up to the European Court of Justice to decide on the matter. ” It is the view of the Financial Regulator, which is supported by its own legal advice, that a trustee `s liability in relation to its sub-custodians is not strict liability. Such legal advice would suggest that once a trustee has demonstrably exercised the level of care and diligence in the appointment and subsequent supervision / monitoring of its agents, in the context of the market in which the sub-custodian is operating, it is unlikely to be found liable by the Courts for losses arising in respect of the actions or inaction of such agents.” Click here for details – http://www.financialregulator.ie/industry-sectors/funds/Documents/Trust%20Deeds%20Custodian%20Agreements.pdf UCITS provisions Note that the point in issue is how to interpret and apply the provisions of Article 9 of the UCITS Directive which reads as follows: Article 9 A depositary shall, in accordance with the national law of the State in which the management company `s registered office is situated, be liable to the management company and the unit-holders for any loss suffered by them as a result of its unjustifiable failure to perform its obligations or its improper performance of them. Liability to unit-holders may be invoked either directly or indirectly through the management company, depending on the legal nature of the relationship between the depositary, the management company and the unit-holders. It is worth noting that this language of unjustifiable failure and improper performance differs from the more usual Common Law language used of duty of care, reasonableness and negligence