The Court of Appeal has unanimously upheld an order refusing to strike out a claim by a “one-man” company in liquidation, which had been the vehicle for a VAT fraud, against its former directors and overseas suppliers alleged to have been involved in the fraud. The court held that the claim was not precluded by the public policy principle that a party cannot bring a claim which relies on its own illegal act (known as the “ex turpi causa” principle): Jetivia SA & anor v Bilta (UK) Limited (in liquidation) & ors [2013] EWCA Civ 968.

As the claimant company was the victim of the alleged fraud, the law would not attribute to the company the fraud of its directors and prevent it from proceeding with its claim. The fact that it was a one-person company did not matter: the “sole actor exception” was not an answer to a claim by a company against its fraudulent directors.

The court distinguished the House of Lords’ landmark decision in Stone Rolls Ltd v Moore Stephens [2009] 1 AC 1391 (see post), in which the majority dismissed on ex turpi causa grounds a claim brought by a company’s liquidators against its former auditors for failing to detect the fraud of its only director. In the Court of Appeal’s view there was a significant difference between, on the one hand, the liability of auditors who were not party to the fraud but were negligent in not alerting the company to the fraud and, on the other, a conspiracy against the company by its directors and others to deprive it of its assets. Stone & Rolls was “readily distinguishable” on that basis.

This limited application of the House of Lords ruling in Stone & Rolls will be welcomed by office-holders and creditors as it permits a company in liquidation to seek to recover money from fraudulent directors (and their associates) even where all directors were involved in the fraud. Tom Henderson comments further on the decision below.

Background

Bilta (UK) Limited and its liquidators brought proceedings to recover £38 million in unpaid VAT from two former directors, Bilta’s sole shareholder and various third parties including the appellants, Jetivia SA and its sole director, Mr Brunschweiler.

Bilta traded in the purchase and sale of carbon credits on the Danish Emissions Trading Registry. It bought carbon credits from traders carrying on business outside the UK, including Jetivia, a company incorporated in Switzerland, which was zero-rated for purposes of VAT. The carbon credits were then sold on back-to-back to VAT registered UK persons. These were taxable supplies at the standard rate in the UK and, as a result, Bilta owed HMRC £38 million in VAT on the transactions. However Bilta was unable to pay the VAT as it made no profit on the transactions. It never received or retained the proceeds of sale of the carbon credits. Instead, on the instructions of Bilta’s directors the price payable on the sale of carbon credits in the UK was paid directly to the Bilta’s third party suppliers, including Jetivia. Bilta was wound up and liquidators were appointed.

Bilta brought claims for conspiracy and dishonest assistance, alleging that the defendants had conspired to injure and defraud Bilta by depriving it of money to which it was contractually entitled and thereby preventing it from being able to meet its VAT liabilities. The liquidators brought separate claims for fraudulent trading under section 213 of the Insolvency Act 1986.

Two defendants, Jetivia and Mr Brunschweiller, sought summary judgment on the basis that the ex turpi causa principle precluded Bilta’s claims. They argued that as Bilta was a one-person company, following Stone & Rolls, the fraud could be attributed to Bilta and therefore Bilta was not able to rely on that fraud to found its claim. They also submitted that the liquidators’ section 213 claim had to fail because that section only applied to persons within the jurisdiction and had no extraterritorial effect.

The Chancellor of the High Court dismissed the application and allowed the claims to proceed. Jetivia and Mr Brunschweiler appealed to the Court of Appeal, relying on two key arguments (both of which were relied upon by the auditors in Stone & Rolls):

  1. Unless Bilta could properly be regarded as the victim of the fraud, the fraud should be properly attributable to it. The true victim on the facts was HMRC who suffered loss from a fraud in which Bilta was a key participant. As such Bilta was a villain, not a victim, and could not rely on its own fraud to found a cause of action against its co-conspirators.
  2. Alternatively, the “sole actor exception” applied. As Bilta was a one-person company, there were no innocent participators in the company who could be said to be prejudiced by its inability to recover compensation for the consequences of the directors’ fraud.

They also appealed on the territorial scope of section 213.

Decision

The Court of Appeal dismissed the appeal and allowed the claim to proceed. Lord Justice Patten gave the leading decision, with which the Master of the Rolls and Lord Justice Rimer agreed. The Court of Appeal broadly agreed with the Chancellor’s reasoning in finding that neither the principle of ex turpi causa nor the decision in Stone & Rolls precluded Bilta’s claim.

In relation to the first argument, the court applied the fundamental rule accepted in Belmont Finance Corpn Ltd v Williams Furniture Ltd [1979] Ch 250 (and also in Stone & Rolls) that the law would not attribute the fraud or other unlawful conduct of the director to the company when it is itself the intended victim of that conduct. As Patten LJ pointed out “the fact that the fraudulent director is the directing mind and will of the company has never been regarded as an answer to a claim by the company against the directors for a breach of duty committed against the company”.

On the facts as pleaded, Bilta was the “intended and only victim” and could rely on the Belmont principle to bring the claim. The court noted the appellants’ argument that the Belmont principle did not apply because this was in reality a conspiracy to defraud HMRC but said that was a point to be decided at trial. For the purposes of an application for summary judgment, the claim had to be considered as pleaded.

On the second argument, Patten LJ said that the “sole actor exception” was not “an established feature of English law for all purposes”. In the context of a claim by a company against its fraudulent directors, “the rule [had] no place in English law and would directly contradict the protection given to creditors under s. 172 and 239 of the Companies Act 2006″. He distinguished Stone & Rolls on the basis that there was a significant difference between the liability of an auditor for failing to notify the company about what was taking place and a conspiracy against the company by its directors and others to deprive it of its assets. Stone & Rolls was “readily distinguishable” and ” should be confined … to the claim and the facts in that case”.

The Court of Appeal also upheld the Chancellor’s finding that section 213 had extraterritorial effect. In Re Paramount Airways Ltd [1993] Ch 223 the Court of Appeal held that section 238 of the Insolvency Act 1986 (transactions at an undervalue) applied to “any person”, whether within the jurisdiction or not. There was no reason to distinguish between section 213 and section 238 in terms of whether Parliament intended them to have extra-territorial effect.

Comment

This decision is of interest for its consideration of the ex turpi causa principle in the context of an insolvent company’s claims against directors and others that have committed a fraud against it. It is helpful in confirming that the principle will not prevent a company bringing such claims where the company was a victim of the fraud, regardless of whether it is a one-person company or whether all directors were involved in the fraud.

When considering this decision it also important to bear in mind the crucial role played by office-holders in this jurisdiction in attempting to recover money from former directors on behalf of a company’s creditors. The UK’s approach to direct creditor redress against those responsible for fraud is much more limited than in other jurisdictions. In the United States, for instance, creditors themselves have the right to take recovery action against directors who have committed misconduct. By contrast, in the UK creditors of insolvent companies are heavily reliant on the ability of insolvency practitioners to pursue civil remedies against former directors (either in their own name or in the name of an insolvent company) to seek appropriate redress.

This issue has recently been highlighted by the Department for Business, Innovation & Skills (“BIS”) in a new discussion paper, Transparency & Trust: A Discussion Paper. BIS identified a “need to find ways to increase trust in our regime by ensuring that if directors (and those advising them) act fraudulently or recklessly they personally run the risk of being required to compensate those suffering loss as a result; and to ensure that directors are aware of this”. The Court of Appeal’s limited application of the ex turpi causa defence in the present case increases the prospect of culpable directors being pursued and will be welcomed in this context.