The illegality defence is based on legal policy designed to prevent a person who has been involved in some form of illegal conduct from enforcing their normal legal rights and from profiting from their own wrongs. The Chancellor of the High Court considered the operation of this defence in the context of breach of duty in respect of a VAT fraud claim brought by an insolvent company and its liquidators against the company’s directors and the other parties involved in the fraud3.

Bilta, a company incorporated in England and registered for the purposes of VAT, traded in the purchase and sale of carbon credits in 2009. Bilta owed £38 million in unpaid VAT to HMRC and the company was wound up. The liquidators and Bilta commenced proceedings to recover the £38 million from Bilta’s two directors (one of whom was also the sole shareholder) and from other companies involved in the fraudulent trades. These were companies that had sold the carbon credits to Bilta and also the companies that had bought them. The design and effect of the fraudulent scheme was to render Bilta insolvent and unable to discharge its VAT liability.

The liquidators and Bilta claimed that the defendants conspired to injure and defraud Bilta and carried on Bilta’s business with the intention to defraud Bilta’s creditors, and other fraudulent purposes.

The defendants relied on the illegality defence, on the basis that the frauds of Bilta’s directors were to be attributed to the company, and that following Moore Stephens (a firm) v Stone & Rolls Limited4, Bilta could not rely on those frauds to found its claim.

The House of Lords’ ruling in Stone & Rolls was considered in detail. By way of reminder, Stone & Rolls committed credit fraud. The company was owned and controlled by one director (a “one man company”). The liquidator of the company claimed against the company’s accountants for failing to detect the fraud. The accountants successfully defended the claim on the basis that the company could not rely on its own illegal acts to found its claim against them.

The High Court in Bilta distinguished Stone & Rolls on the basis that (a) Bilta was the victim of the fraud and not the villain, as the conspiracy denuded Bilta of its assets; and (b) it was the directors who owed the relevant duty to Bilta (whereas in Stone & Rolls the duty was that of the accountants).

In circumstances where a company is, or is likely to become, insolvent, the directors are required to consider and act in the interests of the present and future creditors of the company. In Stone & Rolls the accountant’s duty was owed only to the company and its members.

Bilta was not a party to, or beneficiary of, the conspiracy. The illegality defence was therefore not available to the directors and so it could also not be available to the other defendants, who were one step removed from the directors and who fraudulently conspired with them to breach their duties. The defendants were liable for conspiracy and fraudulent trading.