The Supreme Court has held that, where a company had been the victim of wrong-doing by its directors, the directors’ wrong-doing could not be attributed to the company to prevent it (or its liquidators) from bringing claims against the directors.
The Supreme Court dismissed an application by a Swiss company and its chief executive to strike out claims brought by the liquidators of an English company, rejecting the illegality defence raised by the defendants, that as the company, through the conduct of the directors, had been party to the wrong-doing, it was precluded from pursuing the claims.
Bilta (UK) Ltd participated in buying and selling carbon credits. This involved buying carbon credits from entities outside the UK (which were zero rated for VAT purposes) and later reselling them (usually at a loss) to UK companies registered for VAT. The proceeds were remitted to offshore companies, including a Swiss company, Jetivia. The scheme rendered Bilta insolvent and unable to meet its liabilities to HM Revenue and Customs. The company was wound up on an application by HMRC and liquidators appointed.
The liquidators alleged that the directors had participated in VAT fraud. They brought claims against the directors (one of whom was also the sole shareholder) for breach of fiduciary duty and conspiracy to injure the company and against Jetivia and its chief executive, alleging conspiracy and knowingly assisting the directors in their breaches of fiduciary duty. The liquidators also brought claims against all defendants under section 213 of the Insolvency Act 1986 (fraudulent trading).
Jetivia and the chief executive applied to strike out the claims against them based on the illegality defence (the ‘ex turpi causa’ principle that a claimant cannot found his cause of action on an immoral or illegal act). They argued that Bilta was, through its directors and shareholder, party to the illegality which precluded the company (through the liquidators) from pursuing the claims.
As against the section 213 claims, the appellants said that section 213 did not have extra-territorial effect.
The strike out application was unsuccessful at first instance and before the Court of Appeal. Jetivia and the chief executive appealed to the Supreme Court and the application was heard by a panel of seven judges.
Supreme Court’s decision
The Supreme Court were unanimous in finding that the illegality defence could not be relied upon to defeat the claims, although there were some differences in the ways in which the judges reached that conclusion.
On the question of attribution of knowledge, Lord Neuberger summarised the views of the majority as being that where a company had been the victim of wrong-doing by its directors (or where the directors had notice of the wrong-doing), then the wrong-doing, or knowledge, of the directors could not be attributed to the company as a defence to a claim brought against the directors by the company's liquidators. This was the case even where, as in this case, the directors were the only directors and shareholders of the company. As Lord Mance noted, it would be “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 has damaged it” .
The judgments highlight, however, differences between the members of the Supreme Court on a number of issues, including the proper approach to the illegality defence. The judges said that there is a need for the issue to be considered by the Supreme Court but that this was not the case in which it should be decided as there had been no real argument on the topic (the issue in the case being attribution).
There were also differences in the interpretation of the House of Lords’ decision in Stone & Rolls Ltd v Moore Stephens (2009) and the Court of Appeal’s decision in Safeway v Twigger (2010).
In Stone & Rolls the House of Lords held that a claim brought by a company’s liquidator against the company’s auditors could not succeed because in bringing the claim the company would be relying on its own illegal conduct. The Supreme Court said that Stone & Rolls was authority for the principles that:
Once it has been shown that the directing mind and will of a company has caused it to defraud a third party and the company is relying on the fraud to bring a claim, the illegality defence was not available where there were innocent shareholders or directors; and
The defence could sometimes be available where there were no innocent shareholders or directors.
Subject to these limited principles, however, the Supreme Court’s judgments suggest that Stone & Rollsshould be “put on one side and marked ‘not to be looked at again'".
In Safeway v Twigger the Court of Appeal held that a company on which the Office of Fair Trading had imposed a penalty for breaches of competition law was precluded by the illegality defence from suing its former directors, officers or employees for damages equivalent to that penalty or the costs of the OFT investigation. While stating that they were expressing no view as to the merits of the decision inSafeway, Lord Toulson and Lord Hodge (with whom Lord Mance agreed) nevertheless made clear that they disagreed with the reasoning that the illegality defence applied to Safeway’s claim because the company’s liability under the Competition Act was “personal” to the company.
Section 213 defence
The defendants argued that the words “any persons” in section 213 could only mean persons in the United Kingdom and could have no application to Jetivia, which was domiciled in Switzerland, or to its chief executive, who was domiciled in France. Finding in favour of the liquidators, the Supreme Court rejected the defendants’ argument and held that section 213 does have extra-territorial effect. The Court approved the reasoning of the Court of Appeal in In re Paramount Airways Ltd (1993) where section 238 of the Insolvency Act, which deals in similar terms to section 213 with preferences and transactions at an undervalue, was held to apply without territorial limitations.
While the Supreme Court’s decision will be welcomed by liquidators seeking to bring claims against fraudulent directors, the judgment will be of concern to directors and officers and their insurers. It seems likely that it will in future be more difficult for directors to raise an illegality defence when faced with claims brought by the company (or liquidators on the company’s behalf).