The decision of Mrs Justice Rose in Singularis Holdings Ltd v Daiwa Capital Markets Europe Ltd  EWHC 257 determined that a financial institution, Daiwa, owed a duty to its customer, Singularis, not to pay out $204m from its account where evidence of fraud was obvious. The illegality defence was relied on unsuccessfully by Daiwa. In finding against Daiwa, the judgment provided the clearest judicial application of the “range of factors” test in Patel v Mirza to date.
In 2007, Singularis, a company set up to manage the personal assets of its sole shareholder, Mr Al Sanea, invested very heavily in shares in a number of major banks. During the first half of 2009, concerns were raised about the solvency of Singularis and in May 2009, Mr Al Sanea's personal accounts were frozen by the Saudi Central Bank and his consolidated group of companies, the Saad Group, was downgraded to "junk" by Moody's. Despite Daiwa's knowledge of these solvency concerns, in June 2009, Daiwa followed instructions by Mr Al Sanea, the only director that took an active part in the management and operation of Singularis, to make a number of payments amounting to $204m out of funds it held on behalf of Singularis. The payments were to entities related to Mr Al Sanea and were fraudulent. The monies were lost and the liquidators of Singularis sought repayment by Daiwa.
Breach of Quincecare Duty
Singularis alleged that Daiwa breached the Quincecare duty of care owed to Singularis (so called after the decision in Barclays Bank Plc v Quincecare) by negligently failing to realise that Mr Al Sanea was committing a fraud on Singularis and misappropriating its monies.
Mrs Justice Rose held: "The Quincecare duty…require[s] a bank to do something more than accept at face value whatever strange documents and implausible explanations are proffered by the officers of a company facing serious financial difficulties".
Daiwa was held to have breached that duty as "any reasonable banker would have realised that there were many obvious, even glaring, signs that Mr Al Sanea was perpetrating a fraud on the company when he instructed the money to be paid to other parts of his business operations".
The illegality defence
Daiwa sought to rely on the illegality defence, arguing that Singularis was effectively a “one man company” and Mr Al Sanea’s fraud should be attributed to Singularis. In other words, Mr Al Sanea's illegal conduct should be treated as the illegal conduct of Singularis so as to defeat Singularis' claim against Daiwa.
Mrs Justice Rose concluded the dishonest conduct of Mr Al Sanea should not be attributed to Singularis so as to provide Daiwa with a defence of illegality. The House of Lord’s decision in Stone and Rolls under which auditors successfully relied on the illegality defence was strictly limited to its unusual facts, namely where the claimant was a “one man” company set up, and run, to perpetrate the fraud, with no “innocent” shareholders or directors to whom the auditors could have reported. Here, Singularis was not a "one man company" (there were innocent directors) and it was not set up to perpetrate fraud.
Mrs Justice Rose went on to consider the test under Patel v Mirza “in case I am wrong in coming to that conclusion”.
By way of reminder, in Patel v Mirza in the Supreme Court introduced the “range of factors” test in a binding judgment, replacing previous case law on the application of the illegality defence. Lord Toulson held in the leading judgment: “The essential rationale of the illegality doctrine is that it would be contrary to the public interest to enforce a claim if to do so would be harmful to the integrity of the legal system [and in assessing that] it is necessary a) to consider the underlying purpose of the prohibition which has been transgressed and whether that purpose will be enhanced by denial of the claim, b) to consider any other relevant public policy on which the denial of the claim may have an impact and c) to consider whether denial of the claim would be a proportionate response to the illegality, bearing in mind that punishment is a matter for the criminal courts”.
In relation to factor a), Mrs Justice Rose held the illegality in question exposed the bank to being the victim of a deceit and the company to having its funds misappropriated. Although one could say that the purpose of protecting the bank would be enhanced by denial of the claim, that purpose was achieved here by ensuring that the bank could only be liable if it had breached the “Quincecare duty”. It was possible to strike the right balance between the competing interests of the customer and the bank by determining liability and whether the bank owed a duty of care under the test in Quincecare. It would not enhance the integrity of the law to undermine that balance by denying the claim on grounds of illegality.
In relation to factor b), Mrs Justice Rose noted the public policy interest in preventing regulated entities (i.e. Daiwa) escaping the consequences of failing to identify and prevent financial crime through being allowed to rely on the illegality defence.
Finally, under factor c), Mrs Justice Rose held denial of the claim would be an unfair and disproportionate response to the wrongdoing on the part of the Singularis, particularly when liability could be adjusted by making a deduction to reflect any contributory negligence on its part.
It is interesting to have a decision which demonstrates a clear and readily comprehensible application of the range of factors test (Patel v Mirza) to the illegality defence. There is a concern amongst legal practitioners that the test will lead to uncertainty in whether the defence might apply in future cases given the very wide judicial discretion it allows. We may yet see future cases in which the test is applied in surprising ways, encouraging defendants to “have a go” and rely on the defence. However, this decision appears to be sensible, leading to what on the face of it is an understandable, and therefore predictable, result.
For auditors which face claims from liquidators of companies which perpetrated a fraud, the position is currently as follows. The House of Lords decision in Stone Rolls, in which the auditors successfully relied on the illegality defence, is limited to its unusual facts, namely a one man company with no "innocent" directors/shareholders, set up to perpetrate a fraud. It remains to be seen whether the courts, applying the range of factors test, will extend the illegality defence for auditors to different facts.