On 22 April 2015, the Supreme Court handed down its decision in Jetivia SA v Bilta (UK) Limited, unanimously holding that where a company has been the victim of wrong-doing by its directors, that wrong-doing should not be attributed to the company so as to afford the directors an illegality defence.
The result is clear and not a surprising one. The judgments are less clear however. The Court highlighted the difficulties in developing illegality principles of general application for future cases, but then decided now was not the time to try.
The case also looked again – in less than glowing terms – at the House of Lords’ decision inStone & Rolls Limited v Moore Stephens, the case in which auditors successfully struck out the claim against them on illegality grounds. That decision may in time prove to be something of a high water mark.
Bilta (UK) Limited (“Bilta”) was an English company, which was compulsorily wound up in November 2009, with an outstanding VAT liability payable to HMRC of some £38million. Bilta’s sole shareholder was Mr Chopra who, together with Mr Nazir, also acted as Bilta’s board of directors. It was alleged that Mr Chopra and Mr Nazir caused Bilta to engage in fraudulent trading in carbon credits with various third parties, including Jetivia SA (“Jetivia”), a Swiss company.
The transactions in question constituted what is commonly known as “carousel fraud”, a type of VAT fraud. In short, Bilta purchased carbon credits from Jetivia, free of VAT (as purchased from outside the UK), before selling them back-to-back to UK companies registered for VAT(but often at a slightly lower price, so that the UK company could make a profit when selling them again). The proceeds of sale (including VAT) received by Bilta were subsequently paid away to other parties, including Jetivia, leaving Bilta insolvent and unable to meet its VATliability.
Proceedings were brought by Bilta (through its liquidators) against the directors, alleging conspiracy to defraud Bilta and breach of fiduciary duties. It was alleged that Jetivia and its chief executive officer (Mr Brunschweiler) dishonestly assisted them to do so. Claims were also brought against all defendants for fraudulent trading under section 213 of the Insolvency Act 1986.
The defendants applied to strike out Bilta’s claims on the grounds that:
- Bilta could not maintain its claim in light of the principle of ex turpi causa (the principle that a claimant cannot found a cause of action on his own illegal act); and
- Section 213 of the Insolvency Act 1986 does not have extra-territorial effect.
The defendants’ application was dismissed both at first instance and by the Court of Appeal. The Supreme Court unanimously agreed that the appeal should be dismissed on both counts.
“Ex Turpi Causa”
A panel of seven Judges heard the appeal. Lord Neuberger (with Lord Clarke and Lord Carnwath agreeing) summarised the decision of the Judges as “[w]here a company has been the victim of wrong-doing by its directors, or of which its directors had notice, then the wrong-doing, or knowledge, of the directors cannot be attributed to the company as a defence to a claim brought against the directors by the company’s liquidator, in the name of the company…”
Whilst the Judges were agreed that the appeals should be dismissed, their reasoning differed. Lords Neuberger, Clarke, Carnwath and Mance all felt that this was an inappropriate case in which to set out a general approach to the illegality defence – although Lord Neuberger made it clear that this issue needed to be addressed by the Supreme Court as soon as possible. This particular case turned on questions of attribution of knowledge and, as a result, insufficient argument had been heard by the Court to address illegality definitively. Lords Toulson and Hodge (in a joint judgment) viewed the case as one of public policy, and the statutory duties of directors. They analysed the public interest which underpins the duty that directors of an insolvent company owe to protect the interests of the company’s creditors, and found that the law should not place obstacles in the way of enforcing those duties to protect the creditors’ interests. The fact that the directors in this case were in sole control of Bilta and in a position to act (in breach of fiduciary duty) for their own benefit at the expense of creditors, made it important for the protection of interests of creditors that liquidators should be able to bring these proceedings. Lord Sumption disagreed that a public policy based argument was appropriate. Instead, he viewed the illegality defence as a “rule of law”, not subject to judicial discretion, or policy. He therefore embarked on an analysis of the development of the law of attribution of knowledge, and the exceptions to it, concluding that a claim by a company against its directors was the paradigm case for the application of the “breach of duty exception” (sometimes referred to as the “fraud exception”, or the Hampshire Land principle).
Whichever way the case was analysed, the same result was achieved: the directors could not rely on the illegality defence. As Lord Mance put in “°ne way or another, it is certainly unjust and absurd to suggest that the answer to a claim for breach of a director’s (or any employee’s) duty could lie in attributing to the company the very misconduct by which the director or employee had damaged it.”
Stone & Rolls
A discussion by the Supreme Court of issues of illegality and attribution of knowledge inevitably entailed revisiting the decision in Stone & Rolls. That was a case in which an auditor successfully struck out a claim by the liquidators of a fraudulent “one man company” on the grounds of illegality.
A common theme in each judgment was to repeat the difficulty in deriving principles of law which have general application from that decision – largely due to the (unhelpful) fact that there are significant differences between the reasoning of the majority in Stone & Rolls. As Lord Neuberger commented, the difficulty in analysing those judgments was highlighted by the different interpretation of that authority by Lord Sumption on the one hand, and Lords Toulson and Hodge on the other, in their judgments in this case.
Lord Sumption did, however, seek to derive three principles, the following two of which seemed to find favour with Lord Neuberger:
- it was critical that Stone & Rolls was a “one-man company” – the defence of illegality is not available where there are innocent shareholders (or, it appears, directors); and
- as between a “one-man” company and a third party, the latter could raise the illegality defence on account of the agent’s dishonesty, at any rate where it was not itself involved in the dishonesty.
As to the second point, Lord Mance suggested that it should, however, remain an open question whether that proposition would apply to preclude a claim against auditors where, at the relevant audit date, the company concerned was in or near insolvency. This was point which he had made in his dissenting judgement in Stone & Rolls. Whilst Lord Neuberger felt that such a scenario would be covered by the second proposition above, he agreed that this should remain an open question.
Despite seeking to draw these principles from Stone & Rolls, Lord Sumption stated that “[t]he scope of an auditor’s duty and its relationship to the illegality defence may one day need to be revisited by this court…”, and Lord Neuberger concluded that, subject to deriving the points above, “… the time has come in my view for us to hold that the decision in Stone & Rolls should… be “put on one side and marked ‘not to be looked at again.”
In any event, however, the judges agreed that the real issue in the present case was a different one.
Application of S.213 Insolvency Act 1986
All of the judges dealt with this point relatively shortly. When winding up an English company, the English court claims worldwide jurisdiction over its assets and their proper distribution. Section 213 provides a remedy against any person who has knowingly become a party to the carrying on of that company’s business with a fraudulent purpose.
It would seriously handicap the efficient winding up of a UK company in an increasingly globalised economy if that jurisdiction did not extend to persons resident overseas. The Supreme Court approved the approach of the Court of Appeal in Paramount Airways Limitedon this point.
Common sense would appear to dictate that directors should not be able to attribute their own dishonesty / misconduct to the company in order to circumvent entirely their own liability for breach of fiduciary duties. In that sense, the result is unsurprising. But it should provide certainty to liquidators when considering actions against fraudulent directors, and conspiring parties, who may be based overseas. This is an argument which has been run before in, for instance, the Madoff litigation.
Beyond that, however, the judgments in Bilta only help to highlight the increasing difficulty in distilling points of principle in relation to “ex turpi causa”. The Supreme Court appeared keen to side-line the application of Stone & Rolls. Lords Neuberger, Toulson and Hodge all referred to the observations of the Law Commission in its report on “The Illegality Defence” that “[i]t is difficult to anticipate what precedent, if any, Stone & Rolls will set regarding the illegality defence” as, in their view, “there was no majority reasoning”.
As Lords Toulson and Hodge stated: “Stone & Rolls should be regarded as a case which has no majority ratio decidendi. It stands as authority for the point which it decided, namely that on the facts of that case no claim lay against the auditors, but nothing more”.
Critical as the Law Lords were of Stone & Rolls, this case unfortunately sets out no clearer general principles on the illegality defence.
On the same day as this decision, the Court of Appeal handed down another judgment on ex turpi causa (McCracken v Smith and others  EWCA Civ 380), albeit on very different issues – this time relating to a road traffic accident and the issues of what amounted to illegality, and competing causes of loss. The recent run of cases on the scope and application of the illegality defence highlights that this remains a developing area of law.
Clarity in this area, it seems, will need to await another day.