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10-09-2015

The incidence of investment fraud in the UK is staggering. Between October 2013 and September 2014, losses reported to Action Fraud (a national service operated by the City of London Police and the National Fraud Intelligence Bureau) totalled £1.73 billion. The total including unreported losses will have been much greater.

The challenge faced by the authorities is therefore huge and the courts play an important role in developing a legal armoury for victims seeking the return of their monies. The Privy Council decision in Federal Republic of Brazil v Durant International Corporation establishes a helpful new weapon for victims.

The term “investment fraud” encompasses a broad range of criminality from pyramid schemes, boiler-room frauds, tangible assets trading frauds (e.g. wine, art, diamonds), so-called land banking and apparently sophisticated bank guarantee and other financial instrument frauds.

Whilst the subject matter and operation will vary, one common feature is that (for monetary investments) a victim’s initial deposit will rarely stay segregated in the bank account into which it was first paid. Monies will be transferred between accounts, converted into different assets, divided up and dissipated, in the process obscuring the identities of those responsible and impeding the victim’s ability to recover.

Tracing is the law’s solution to this problem (and also to losses by reason of mistake or other misappropriation). Tracing is a process by which a victim identifies his asset (often monies) in the hands of a third party, that asset having been transferred, converted or substituted one or more times. Importantly, tracing does not in itself give rise to a cause of action against the holding third party; instead, it establishes an evidential right to claim.

The doctrine of tracing has developed over time. Under the common law, victims are able to claim transmitted monies into whosever hands they pass, but “clean substitutions” are required. In other words, tracing would not be effective if the monies had been mixed with other funds. Equity provides an alternative approach, dealing with the common situation in which monies have been mixed in one bank account or where an asset has been included within a wider pool of pre-existing assets.

Refinements have continued to the point where, last year, the Court of Appeal held in Relfo Ltd (in liq) v Varsani [2014] EWCA Civ 360, that it was not even necessary to establish a complete chain of transactions following the initial deposit. The court was prepared to draw the necessary inferences if any evidential gaps in the chain were present.

The Relfo case also touched upon the idea of “backward” tracing. Backward tracing is necessary when credits into and debits out of a bank account do not follow each other in strict chronological order. In an age where money laundering has become a sophisticated process, fraudsters are alive to the ability of victims to trace their monies. To defeat such claims, interconnected debits and credits have been used, through mixed accounts. However, Relfo did not itself provide conclusive authority for the ability to trace backward.

On 3 August 2015, Lords Neuberger, Mance, Carnwath, Toulson and Hodge of the Privy Council delivered their judgment in Federal Republic of Brazil and another v Durant International Corporation and another [2015] UKPC 35 (an appeal from the Court of Appeal of Jersey). The facts of the case were as follows.

In 1998 the mayor of the Municipality of Sao Paolo received a series of bribes in relation to an infrastructure project. Of these bribes, US$ 10,500,055.35 was transferred into an account held in New York under the control of the mayor’s son. From that account, payments totalling US$13,120,000 were made into an account held by Durant International Corporation in Jersey. A final series of transfers took place totalling US$13,500,000 from the Durant account into an account held by co-appellant Kildare Finance Limited, also in Jersey.

Regardless of the mixing of funds, the municipality brought proceedings in Jersey tracing the original US$10,500,055.35 which had been paid by the mayor’s son to Durant and then on to Kildare. Having failed in their opposition of the claim and their appeal to the Court of Appeal in Jersey, Durant and Kildare appealed to the Privy Council in London, relying in part on the inability of victims to trace backward under English law.

The appeal hinged on the fact that the last three payments into the New York account (which together comprised the claimed US$10,500,055.35) had been made after the payments into the Durant account. The corollary of this, it was submitted, was that at least part of the US$10,500,055.35 had never actually been remitted to Durant. At best, the municipality’s claim was limited to US$7.7million.

The Privy Council reviewed the authorities on the point, starting with the case of James Roscoe (Bolton) Ltd v Winder [1915] 1 Ch 62. This and a string of subsequent cases had established a line of authority providing that when tracing monies through a chain of transactions, if at any stage the traceable proceeds dipped below the value of the original investment, then a victim’s claim was limited to that lower sum.

In a bold move, the Board observed that: “The development of increasingly sophisticated and elaborate methods of money laundering, often involving a web of credits and debits between intermediaries, makes it particularly important that a court should not allow a camouflage of interconnected transactions to obscure its vision of their true overall purpose and effect. If the court is satisfied that the various steps are part of a coordinated scheme, it should not matter that, either as a deliberate part of the choreography or possibly because of the incidents of the banking system, a debit appears in the bank account of an intermediary before a reciprocal credit entry.

Accordingly, where there was a “a coordination between the depletion of the trust fund and the acquisition of the asset which is the subject of the tracing claim” the Board concluded that backward tracing could be used to pursue the full value of an asset.

This is a valuable decision (albeit not binding on the English courts) delivered by leading justices of the UK Supreme Court upon largely English authorities. It is true that the decision leaves certain important questions unanswered, such as the treatment of multiple victims, the position of third parties acquiring assets for value and without knowledge, and the interplay with insolvency law and priority over unsecured creditors. But it helpfully clarifies that when combating ever more sophisticated fraudulent schemes, assets can be traced backwards where the relevant transactions were within a connected arrangement.

Christopher Burt (cburt@moonbeever.com)

This is intended for general information only and should not be considered as giving advice in relation to any individual case nor be taken as applying to any particular case. No liability is accepted for any such use of the information contained here.

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