There has been recent high-level review of the application of the doctrine of ex turpi causa to claims involving fraudulent directors, in the context of insolvency litigation. The doctrine defined at its simplest is that no action can be founded on illegal or immoral conduct – a legal form of fair play. In October 2014 the Supreme Court heard the appeal in Jetivia SA v Bilta (UK) Limited (Bilta). Judgment is imminent, and will hopefully clarify the scope of the ex turpi causa defence, including to the implications for negligent professionals caught up in the fraud of others.
This doctrine has been revisited in Bilta. Bilta (a limited company) was involved, at the instigation of its directors, in a fraudulent scheme that resulted in its liquidation and the non-payment of £38 million VAT. The liquidators of Bilta pursued a claim by the company against its directors and various third parties apparently involved in the fraud (including Jetivia), alleging conspiracy and dishonest assistance.
Jetivia applied for summary dismissal of the claim, invoking an ex turpi causa defence. It alleged that Bilta had been engaged in the fraud (because the directors’ wrongdoing was to be attributed to Bilta itself), so could not pursue a claim based on its own illegal acts. The application relied heavily on the 2009 case of Stone & Rolls Limited v Moore Stephens (Stone & Rolls). There, the claim was again by the liquidators of an insolvent company where the (sole) director had acted fraudulently, but it was against the auditors alleging they acted negligently in failing to identify the fraud.
In Stone & Rolls, the House of Lords held that the sole director and the company had to be seen as one because the director’s fraud could be attributed to the company. Ex turpi causa meant the company could not rely on its own fraud to pursue a claim in negligence: good news for the auditors. However in Bilta, the Court of Appeal distinguished Stone & Rolls, with Patten LJ stating that the decision “should be confined … to the claim and the facts in that case.” Even though there were no innocent directors at Bilta, the court was not prepared to attribute the directors’ wrongdoing to the company. This meant the company was “the victim” for the purpose of the claim, and neither Jetivia nor the directors of Bilta could rely on an ex turpi causa defence.
The status quo
The dividing line between Stone & Rolls and Bilta is less than clear. The best we can say at the moment is that where a professional has negligently advised a fraudulent “one man” company, the professional can credibly seek to rely on an ex turpi causa defence. However, where a third party (which could include professionals) has actively participated in the fraud, it is unlikely to be able to do the same.
This idea that dishonest conduct is more reprehensible than negligent conduct is not new. However, such a distinction can raise practical difficulties, including the question of where negligent behaviour ends and dishonest behaviour begins.
The upcoming Supreme Court judgment in Bilta will be of interest not only to insolvency practitioners, but also to professional indemnity insurers. This is because the professionals involved on the fringes of a fraud may present more attractive defendants than delinquent (and probably impecunious) directors. In Stone & Rolls, the company’s liquidators pursued the allegedly negligent auditors, rather than the allegedly dishonest director.
We think it unlikely that the Supreme Court will overturn the Court of Appeal’s decision in Bilta, given the public policy considerations at stake. Ultimately, it is Her Majesty’s Revenue and Customs who will benefit as a creditor if Bilta’s claim is successful. It would be a surprising result if the interests of co-conspirators in a fraud were preferred over the public purse.
The real risk to professional indemnity insurers is that the scope of Stone & Rolls will be further restricted. This would increase the vulnerability of professionals to negligence claims by companies in liquidation, even where all directors have been involved in a fraud. Whatever the outcome, with a seven judge panel, it looks set to prove a landmark decision.