08/09 Ex turpi causa revisited...again


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Readers may recall that in July of last year we reported on the Court of Appeal's decision of Stone & Rolls Limited (In Liquidation) v Moore Stephens (a firm) [2008] EWCA Civ 644 which held that the ex turpi causa maxim (which prevents claimants from claiming losses suffered as a result of their own criminal conduct) operated to defeat a liquidator's claim for audit negligence where the claimed losses arose from the wrongful act of the insolvent company in question.  Stone & Rolls Limited ("S&R") appealed this decision and, on 30 July 2009, the House of Lords released a judgment in which it dismissed the appeal.

Background

In 2002, S&R, along with its owner/manager Mr Stojevic, was found liable in Komercni Banka AS v Stone & Rolls Limited and Another [2002] EWHC 2263 (Comm) for credit fraud. The fraud consisted of the presentation by S&R of false documents to a number of banks, the receipt of funds by S&R and the payment away of those funds to other parties to the fraud. Subsequently, S&R went into provisional liquidation.

In December 2006, the liquidators of S&R commenced a claim for damages against the auditors of S&R, Moore Stephens ("the auditors"). The crux of the liquidator's case was that the auditors had a duty to detect the fraud and to "blow the whistle" which, had they done so, would have put an end to the criminal conduct and prevented the consequent losses.  The auditors applied to strike out the claim in February 2007 on the basis that S&R was in effect seeking to recover a loss caused by its own fraud and therefore could not succeed under the ex turpi causa maxim.  The court at first instance denied the auditor's application on the basis that the conscience of the ordinary citizen would not find the pursuit of the claim by S&R so repugnant that it ought to be prevented by the operation of the ex turpi causa maxim.

Court of Appeal

The Court of Appeal found that Mr Stojevic, the sole directing mind and will of S&R, had procured it to enter into fraudulent transactions and that the principles of attribution required the dishonesty of S&R's sole human agent to be imputed to S&R.  The Court reasoned that S&R was not the victim of the fraud, but the villain, and it made no difference that its frauds were likely to result in S&R itself incurring losses.   Accordingly, S&R was barred by the ex turpi causa maxim from seeking compensation for the losses that its own frauds had brought upon itself.

The Court of Appeal also considered whether the ex turpi causa maxim could provide a defence for the auditors in light of the fact that the detection of dishonesty in the operation of S&R's affairs was "the very thing" that the auditors had been retained to do.  The Court found that there was no support for the proposition that the ex turpi causa maxim would be overridden in such circumstances so as to enable S&R to bring a claim that relied on its own illegality.

The House of Lords hearing

The House of Lords considered three main issues which were raised as potentially preventing the ex turpi causa maxim operating to defeat the claim against the auditors:

1 Whether S&R was primarily (or directly) liable for the fraud committed by Mr Stojevic or was merely vicariously liable.  It was common ground that primary or direct liability of S&R would be necessary and that vicarious liability would not be enough.
2 If S&R was primarily liable for the fraud, to what extent did the Hampshire Land principle apply so as to prevent the ex turpi causa maxim from operating.  S&R submitted that as S&R was itself a victim of the fraud perpetrated by Mr Stojevic, under the Hampshire Land principle, the dishonesty of Mr Stojevic could not be attributed to S&R.  The Hampshire Land principle recognises that in reality agents will not disclose to their principals the fact that they are committing fraud particularly when agents are defrauding the principals themselves.
3 The extent to which the fact that the fraud on the part of S&R was "the very thing" that the auditors were under a duty to detect meant that the auditors could not excuse themselves from liability by saying that the loss was caused by the fraud of S&R.
 

The House of Lords' analysis

The majority of the House of Lords found that S&R was primarily and directly liable for the fraud.  There was no doubt that Mr Stojevic was the embodiment of S&R for all purposes and that S&R was essentially a "one-man company" having in reality only one single dominant director and shareholder.  In the case of a one-man company which has deliberately engaged in serious fraud, awareness of the fraud is to be imputed to the company and the fraudulent conduct is to be treated as the conduct of the company.

The majority of the House of Lords found that the Hampshire Land principle has no application to the facts of this case.  The House of Lords did this on the basis of different reasoning to that of the Court of Appeal.  The House of Lords found that in the case of a one-man company, there is simply no room for the application of the Hampshire Land principle.  With a one-man company, there are no innocent participators (whether directors or shareholders) connected with the company who can be regarded as an innocent party deceived and prejudiced by the fraud.  The House of Lords' decision on this point is limited to one-man companies.

The Court of Appeal in its decision had rejected this analysis of the Hampshire Land principle and had instead considered the critical question to be whether S&R should be regarded by the Court as the villain or victim of the story.  If S&R was to be regarded as the victim of Mr Stojevic's dishonesty, the Hampshire Land principle would operate so that Mr Stojevic's dishonesty would not be attributed to S&R.  The Court of Appeal found that S&R was not the target or the victim of Mr Stojevic's dishonesty, it was itself the fraudster and therefore the Hampshire Land principle did not apply.

The House of Lords found in relation to "the very thing" principle that this principle (which is essentially a principle of causation) cannot "trump" the maxim ex turpi causa where the maxim otherwise applies.

None of the issues raised therefore prevented the ex turpi causa maxim operating as a defence to S&R's claims against the auditors.

Practical implications

The House of Lords' decision on the Hampshire Land principle is expressly limited to one-man companies.  That is, a company where the person or persons with ownership and control of the company are entirely complicit in the fraud, so that there is no single individual connected with the company who can be regarded as an innocent party deceived and prejudiced by the fraud.

It therefore leaves unanswered the question as to whether the ex turpi causa maxim would operate to bar a claim by a company with one or more innocent participants (whether shareholders or directors) where those innocent participants had been unaware that the directing mind and will of the company had been involving the company in fraud.  It remains to be seen whether the Court of Appeals analysis will be deemed appropriate to deal with such a situation - whether the company should be regarded by the Court as the villain or victim of the story.