Case Alert [2016] UKSC 42

The Supreme Court, by a majority of 6-3, has now firmly overruled the rule based approach often used when considering the illegality defence (also known as "ex turpi causa, non oritur actio") and has adopted a more flexible, policy-based approach instead. This is in line with the recommendations by the Law Commission and with the approach adopted in other commonwealth jurisdictions, such as New Zealand, Australia and Canada.

The decision is welcome to the extent that it has clarified the test to be used, hopefully removing some of the confusion which has existed under the previous case law in this area. However, the new test is broadly framed and it remains to be seen how it will be applied to different fact patterns and whether new areas of contention might in fact arise. As a result, and while the Patel decision is of real interest, the law in this area still cannot be regarded as settled. Indeed, it could be some years before we have a good sense of how the new test might apply to any particular case, and the decision is bound to be an engine of uncertainty and dispute in the meantime.

A key issue for accountancy and other professional services firms and their insurers will be whether and how the case will affect the application of the Stone & Rolls v Moore Stephens (2009) decision, where it was held that where a "one-man company" had intentionally committed fraud, the ex turpi causa doctrine prevented it from claiming against its auditors for failing to detect that fraud. That was a case in which the defendant auditors relied on the now rejected rule-based "reliance" approach in Tinsley v Milligan (1994) (see further below) but which involved very different facts and a number of different considerations from Patel. For example, as a case involving two individuals, Patel does not grapple with the difficult questions of the attribution to a corporate entity of the knowledge and dishonesty of its officers which were so central to much of the reasoning in Stone & Rolls and are so frequently in issue in cases involving corporate claimants. What can be said, however, is that while the full implications remain to be worked out by the courts, Stone & Rolls is already regarded as operating within narrow confines, and it seems unlikely that the Patel decision will cause its boundaries to be expanded so as to afford defendants an illegality defence based on Stone & Rolls in a substantially broader range of circumstances.

Context

The courts have had to grapple frequently over the years with the application of the illegality doctrine when dealing with cases where the relationship between the parties is tainted by illegality. The practical question for the courts has always been whether, in the circumstances, to allow the claimant the remedy sought, or refuse it on the basis that the illegality taints the claim to such an extent that relief ought to be denied.

Various overlapping/contrasting approaches have emerged over the years to help determine this question, which have given rise to legal complexity and confusion over which approach is to be followed. The different legal approaches include:

  • the "reliance" test, which bars the claim if it must rely on the facts disclosing the illegality (Tinsley v Milligan)
  • the "sufficiently close connection" test, which bars claims with a sufficiently close connection with the illegality
  • whether the illegality is merely "collateral" to the claim (if it is then the defence fails)
  • the "inextricable link" test, barring the claim if an inextricable link exists between the relief claimed and the illegal conduct
  • the "causative" test, whereby the defence only succeeds if the illegality has a causative relationship to the loss claimed
  • the of disallowing claims where that would be seen to condone illegal conduct.

The doctrine has come under criticism from many corners, including the Law Commission who, whilst acknowledging that the decisions in this area generally achieved a fair result, found that this was as a result of judges creating exceptions to the rules by straining their application. It regarded the illegality defence as presenting serious problems in terms of complexity, uncertainty, arbitrariness and lack of transparency. Further, in the recent case of Jetivia v Bilta (2015), Lord Neuberger pleaded for urgent clarification by the Supreme Court of the correct approach to be followed.

Patel v Mirza

A rule based approach (including the reliance test advocated in Tinsley v Milligan) has now been expressly rejected and the Supreme Court has stipulated that a flexible policy-based approach is to be preferred when considering the merits of the defence, with reference to an important trio of principles, namely:

  • a purposive approach
  • a general public policy criterion
  • a proportionate response

The facts of this case are as follows. The claimant, Mr Patel, and the defendant, Mr Mirza, entered into a conspiracy to commit the offence of insider dealing. Mr Patel transferred sums totalling £620,000 to Mr Mirza for the purpose of betting on the price of RBS shares using advance insider information which Mr Mirza expected to obtain from RBS contacts regarding an anticipated government announcement. Mr Mirza's expectation of an announcement proved to be mistaken and so the intended betting did not take place. However, despite promises to do so, Mr Mirza failed to repay the money given to him by Mr Patel. Mr Patel then brought a claim for the recovery of the sums on various bases, including contract and unjust enrichment. In order to establish his claim to the return of his money, it was necessary for Mr Patel to explain the nature of the agreement and Mr Mirza sought to rely on the defence of illegality, by invoking the so-called "reliance principle" (Tinsley v Milligan) i.e. that the claim could not be brought because it involved reliance on the claimant's own illegality.

Lord Toulson, giving the leading judgment, held that "a person who satisfies the ordinary requirements of a claim in unjust enrichment will not prima facie be debarred from recovering money paid or property transferred by reason of the fact that the consideration which has failed was an unlawful consideration". That said, Lord Toulson accepted that there may be reasons why courts might refuse assistance to a claimant, but stated that "such cases are likely to be rare." Since Mr Patel satisfied the ordinary requirements of a claim for unjust enrichment, Lord Toulson held that he should not be barred from enforcing his claim by reason only of the fact that the money which he sought to recover was paid for an unlawful purpose.

When discussing the illegality defence, Lord Toulson highlighted that the two policy reasons for the illegality defence were: (i) that a person should not be allowed to profit from his own wrongdoing; and (ii) the law should be coherent and not self-defeating, "condoning illegality by giving with the left hand what it takes with the right hand."

The new correct approach for a court, when considering the application of the common law doctrine of illegality, is to have regard to the policy factors involved and to the nature and circumstances of the illegal conduct in determining whether the public interest in preserving the integrity of the justice system should result in denial of the relief claimed.

In order to assess whether the public interest would be harmed in that way, he held it necessary to consider three key factors:

  1. the underlying purpose of the prohibition which has been transgressed and whether that purpose will be enhanced by denial of the claim;
  2. any other relevant public policy on which the denial of the claim may have an impact; and
  3. whether denial of the claim would be a proportionate response to the illegality, bearing in mind that punishment is a matter for the criminal courts.

In reaching these conclusions, Lord Toulson rejected the strongly expressed dissenting view (as expressed by Lords Mance, Sumption and Clarke) that this "open and unsettled range of factors" (per Lord Mance) approach would lead to uncertainty. He replied that the principal criticism of the law was its uncertainty and that he is not aware that this has been a source of problems in jurisdictions where a flexible approach is adopted. In any event, he noted that there are areas in which certainty is important, but the same considerations do not apply in the same way to those contemplating unlawful activity.