Bilta (UK) Ltd in liquidation) & others v Muhammad Nazir & others [30.07.12]

High Court refuses to accept that a claim by an insolvent one-man company against its director for breach of his duties would be barred by ex turpi causa.

Bilta had two directors, one of whom owned all the company’s issued shares, effectively making it a "one-man company". The directors used Bilta to perpetrate a huge VAT fraud which left the company owing £38 million to HMRC. As a result, it was placed into insolvent liquidation.

Bilta's liquidator brought proceedings against a Swiss company and its director who allegedly participated in the fraudulent conspiracy; by dishonestly assisting breaches of duty by Bilta’s directors and knowing receipt of funds.

The defendants applied for summary judgment on the grounds that the claims were barred by the public policy maxim "ex turpi causa non oritur actio", i.e. a claimant cannot succeed if, in order to make good his claim, he has to rely on his own illegal conduct. They argued that Bilta’s claims could not succeed without it relying on its own illegal conduct in the VAT fraud.

The knowing assistance claims against the defendants were based on the liability of Bilta’s own directors to the company. It was common ground, therefore, that the real issue for the court was whether Bilta’s directors could rely on ex turpi causa to defeat claims against them by Bilta for breach of their duties.

The defendants relied on the House of Lords’ decision in Stone & Rolls Ltd (in liquidation) v Moore Stephens (a firm) [2009] 1 AC 1391, which we reviewed in 2009. Stone also concerned a one-man company which had been used by its director and sole shareholder, Mr Stojevic, as a vehicle for fraud. The company’s liquidator brought a negligence claim against its auditors, alleging that their audits should have detected the fraud and prevented further liabilities.

The auditors raised a defence of ex turpi causa, which was accepted by the majority in the House of Lords. Lord Phillips focused on the scope of the defendant’s duty of care: an auditor’s duty is to the company and its shareholders as a class but, as Mr Stojevic was the sole shareholder, this meant that the sole person to whom the defendant owed a duty was the person responsible for the fraud. The other members of the majority focused on the fact that Stone was a one-man company: in their view, it was not possible to identify the company as an innocent "secondary victim" of the frauds.

The defendants in Bilta argued that the reasoning in Stone applied to their case: there was no innocent "secondary victim" to whom the directors’ duties were owed, so the directors would be entitled to rely on ex turpi causa.

Decision

The High Court dismissed the defendants’ application and allowed the claims to proceed to trial. It held that Stone did not apply to the facts of this case because Bilta traded whilst insolvent, meaning its directors owed duties not only to the company and its shareholders, but also to its creditors, whose conduct was blameless. The Judge said:

"…Stone is not applicable to cases in which the claim is based on a breach of duty the scope of which encompasses persons or interests other than the fraudsters in corporate form … I do not suggest that creditors of a company not in liquidation have any proprietary interest in the assets of the company, but their interests as creditors are within the scope of the duties of directors at least where the company is or may become insolvent…"

Comment

The key distinction for the court in this case appears to have been that the directors (on whose liability the claims against the defendants were based) owed duties to the creditors of the company because it was trading whilst insolvent. There were, therefore, innocent victims of the fraud – or, put another way, innocent beneficiaries of the directors’ duties - who did not have to rely on their own illegal conduct.

By contrast, in Stone, the majority in the House of Lords did not accept that the auditors owed any duties to creditors. The only persons to whom they owed a duty of care – the company and the shareholders as a class – were indistinguishable from Mr Stojevic, who perpetrated the fraud.

It is too early to say whether this decision represents a significant increase in the potential liabilities of directors and their insurers in the context of the one-man company. There is an appeal pending, to be heard in spring 2013, and it is also possible that a different outcome may be achieved at trial after a full hearing. In any event, directors, their insurers and their advisors should keep a close eye on the progress of this case.