The Court of Appeal recently handed down its much-anticipated judgment in (1) Jetivia S.A. (2) URS Brunschweiler v Bilta (UK) Limited (in liquidation) (2013). In doing so, it revisited the decision of the House of Lords in the auditors’ liability case of Stone & Rolls Ltd (In Liquidation) v Moore Stephens (a firm) (2009), where it was held by a majority that a claim by a “one-man” company defrauded by its director, against auditors who were said to have failed, negligently, to alert the company to the fraud, was barred by the principle of ex turpi causa as that director was the company’s sole mind, will and beneficial owner and his dishonesty was therefore to be attributed to the company.
The Court in Bilta, a case involving the different situation of a claim by a company against parties said to have dishonestly assisted the company’s directors in defrauding the company, circumscribed the ambit of this “sole actor” exception and decided that it did not apply in this case. A question remains, however, as to the implications of this for third party professionals such as solicitors or accountants who might be sued by an insolvent company on the basis that those professionals have failed to spot or alert the company to a fraud perpetrated by its directors.
Bilta (UK) Limited (“Bilta”) had been in liquidation since 29 September 2009. At all material times prior to the liquidation, the company had only two directors - Messrs. Nazir and Chopra - and a sole shareholder, Mr Chopra. Between April and July 2009, the company was engaged in an elaborate VAT fraud, based on the purchase and resale of European Emissions Trading Scheme Allowances (EUAs). EUAs were, at this time, treated as taxable supplies under the VAT Act 1994 and were therefore liable for VAT at the standard rate (15%).
Bilta would buy the EUAs from a number of traders based outside the UK, including Jetivia, whose sole director was one Mr Brunschweiler. Bilta paid no VAT when it acquired the EUAs from Jetivia but then sold these EUAs on to a number of UK based traders who were registered for VAT. The sales of these EUAs were taxable supplies and Bilta thereby incurred substantial liabilities in respect of VAT. However, as part of the fraudulent scheme, when the EUAs were sold to the UK based traders they were sold at a price below the price paid to Jetivia plus the VAT due. Further, the payments made by the UK based traders were either made directly to Jetivia or to various offshore bank accounts.
Accordingly, Bilta did not receive the proceeds of the sales of the EUAs, which left it unable to meet its VAT liabilities, in the sum of GBP 38,733,444. In the meantime, both Jetivia and the UK based traders were able to make significant profits at the expense of Bilta.
When the scheme unravelled, liquidators were appointed and the company was wound up. Subsequently, the liquidators issued proceedings against a number of parties it alleged to have been involved in a conspiracy to defraud Bilta, including Jetivia and Mr Brunschweiler (who subsequently became the Appellants). The proceedings involved both a claim by the liquidators on behalf of Bilta against the Appellants and others for conspiracy and dishonest assistance, and parallel claims by the liquidators for fraudulent trading under s.213 of the Insolvency Act 1986.
As noted above, Jetivia and Mr Brunschweiler were said by the liquidators to have dishonestly assisted the directors in the conspiracy to defraud the company. At first instance, and on appeal, the Appellants sought to have this claim struck out, relying on the principle of ex turpi causa non oritur actio, on the basis that the company itself was part of a conspiracy to defraud HMRC. The principle of ex turpi causa was originally defined by Lord Mansfield CJ in Holman v Johnson (1775) as the rule that “no Court will lend its aid to a man who founds his cause of action upon an immoral or illegal act”.
The Court of Appeal dismissed the Appellants’ appeal unanimously, upholding the first instance decision that the claim should not be struck out. Lord Justice Patten provided the reasoned decision and explained that the key question for the Court to determine on appeal was whether the knowledge and behaviour of the directors who both took part in the conspiracy could be attributed to the company. In addressing this question, Patten LJ considered: (1) the principle in In re Hampshire Land Co (1896); and (2) the “sole actor” principle as set down by the House of Lords in Stone & Rolls.
The principle in Hampshire Land
The principle in Hampshire Land serves as the basis for determining the circumstances in which the knowledge of a company’s officers and/or employees will be attributed to a company. Patten LJ explained that, whilst knowledge held by a company’s officers would usually be attributed to the company, this would not be the case if the acts of the officers are directed against and are harmful to the company. In other words, the attribution to the company of the knowledge held by its officers cannot take place if the company is the victim of the officers’ actions.
Patten LJ went on to explain that, in determining whether the acts of the officers are directed at - and are therefore harmful to - the company, it is important to consider whether the company is the primary or secondary victim of the damage in question. In assessing this, Patten LJ accepted that:
“in judging whether a company is to be regarded as the victim of the acts of a person, one should consider the effect of the acts themselves, and not what the position would be if those acts eventually prove to be ineffective”.
So, in a classic VAT fraud by a director, the primary victim would be the Revenue and not the company because the company only suffers any adverse consequences if/when the fraud is discovered. Accordingly, the company would initially be considered to be the villain, not the victim, and knowledge of the fraud would be attributed to the company, thereby allowing the Revenue to take action against the company.
However, subsequently, the company, having paid any fines and discharged any liabilities due to the Revenue, would be free to take action against the director responsible. At this point the company would have suffered (secondary) damage (in the form of the fines and other liabilities) and would notionally be the victim. Hence, the rule in Hampshire Land would apply and the director would not be able to rely on a defence of ex turpi causa, by asserting that the company had knowledge of the fraud.
Applying these principles to this case, Patten LJ held that Bilta was unquestionably the victim: it had suffered the primary damage and the principle in Hampshire Land would therefore apply.
Stone & Rolls: the “sole actor” exception
Patten LJ explained that, notwithstanding the principle in Hampshire Land, a defence based on ex turpi causa would still be available to the Appellants, provided they could show that the claim against them fell into the “sole actor” exception that had been established by the House of Lords’ decision in Stone & Rolls.
Broadly speaking, the “sole actor” exception applies when, on the facts of the case, the officer responsible for the fraudulent acts is the company’s sole director and only shareholder, such that there was no human embodiment of the company who was not aware of the fraudulent acts. In these circumstances, regardless of whether the company was ostensibly the “victim” or “villain”, the knowledge of the dishonest officer would be attributed to the company, with the result that an ex turpi causa defence would be available to a third party defendant to a claim by the company.
While there was no exact factual match between Bilta and Stone & Rolls (which was a “one-man” company; in Bilta there were two directors, one of whom was the only shareholder, and both of whom were involved in the conspiracy), an opportunity presented itself to the Court of Appeal to extend the operation of the “sole actor” exception. For example, the decision in Stone & Rolls had left open the question of whether the exception applied to such factual scenarios (rather than a simple “oneman” company) and/or to a claim by a company against its directors.
An extension of the exception was arguably open to the Court on the basis that there was still, in Bilta, no human embodiment of the company who was unaware of the conspiracy.
However, the Court decided that the “sole actor” exception did not apply to a case like Bilta, where the claim was against the fraudulent directors themselves (and/or those dishonestly assisting them). Amongst other things, Patten LJ agreed with the court below that the reasoning in Stone & Rolls is not applicable to a case in which the claim is based on breach of a duty which (unlike the duty owed by the auditors in Stone & Rolls, which the majority of the House of Lords accepted was a duty owed to the company alone) extends beyond the interests of the fraudsters as shareholders, to creditors. Stone & Rolls did not, therefore, apply in Bilta, where (as Patten LJ noted) the directors’ duties had always included a duty to consider the interests of creditors under s.172 of the Companies Act 2006 (and it should be noted that there were also parallel proceedings under s.213 of the Insolvency Act 1986). Patten LJ said that this would be the position even in a case where a true “one-man” company sued its sole director and owner for a breach of duty against the company. Indeed, Patten LJ held that the circumstances in which the “sole actor” exception should apply are extremely limited, saying that the decision in Stone & Rolls “should be confined in my view to the claim and facts in that case” and that “in the context of a claim by the company against its fraudulent directors, the rule has no place in English law”.
Patten LJ in part seems to justify his decision to limit the application of the “sole actor” exception in this way on the basis that a wider application would have the potential to undermine other protections afforded to creditors under various statutory provisions, including sections 172 and 239 of the Companies Act 2006 which apply “regardless of whether the company is…a one-man company or one in which there are innocent directors and shareholders”.
The decision in Bilta serves to illustrate the uncertainty that had existed, following Stone & Rolls, as to the potential availability of the “sole actor” exception. The Court of Appeal’s judgment goes some way in clarifying the position, in that it held that the “sole actor” exception was of limited application, and in particular does not apply to claims by a company against its fraudulent director(s). Patten LJ does not, however, provide a great deal of explanation for circumscribing the extent of the “sole actor” exception in this way. This was also a Court of Appeal rather than a Supreme Court decision and it remains to be seen whether the legal position will be tested further.
Interestingly, in Bilta, as is commonly the case in a claim brought by an insolvent company, the main beneficiary of a successful claim would be the Revenue and, ultimately, the taxpayer. As such, in some ways, the decision facing the Court of Appeal was a simple one. Either the Court allowed a claim to progress that could result in substantial recovery for the taxpayer or it allowed alleged fraudsters (the Appellants) to defeat the claim and avoid liability. It is easy to identify the public policy in play, although it would be interesting to see how the Court might respond in circumstances where the claim, if successful, would not ultimately benefit the taxpayer but some other third party, such as a litigation funder.
Further, and significantly for solicitors and other professionals, the Court of Appeal’s judgment does not really explore in detail the limits of the “sole actor” rule in quite different situations to those involving a claim by a company against its fraudulent directors - for example, in claims against a negligent third party, such as where solicitors or accountants engaged by a client company negligently fail to uncover a dishonest scheme that is being conducted by the officers and shareholders of the client. For example, the Court of Appeal has not taken the opportunity to clarify or expand, in relation to such cases, the category of companies in relation to which it can be said that there was no innocent human embodiment of the company so as to attract the “sole actor” exception. As such, the issues may well be revisited in due course. In the circumstances, despite Patten LJ’s rather stark statement that the principle in Stone & Rolls “should be confined in my view to the claim and facts in that case”, it is hoped that Bilta will itself be considered to be authority for a relatively narrow proposition, which is applicable to claims involving directors’ duties, and that Stone & Rolls will continue, in appropriate circumstances, to assist third party professionals who are sued by a company in relation to an alleged failure to uncover fraud committed by a “sole actor”. The availability of the ex turpi causa defence should, therefore, continue to depend to a large degree on the facts, including in particular who is being sued.