Months of waiting are over as today the Supreme Court handed down its decision in the Bilta case. Seven Justices (including Lord Mance a minority Judge in the Stone & Rolls case) considered this vitally important case in the fraud arena, albeit of wider application. The Supreme Court has not however decided to deal fully with the question of illegality, saying that this case was not going to be determinative of the questions and thus those questions would wait for another day.
Per Lord Neuberger “In common with all members of the court, I consider that this appeal should be dismissed because the Court of Appeal was right to hold that (i) illegality cannot be raised by Jetivia or Mr Brunschweiler as a defence against Bilta’s claim because the wrongful activity of Bilta’s directors and shareholder cannot be attributed to Bilta in these proceedings, and (ii) section 213 of the Insolvency Act 1986 has extra-territorial effect.”
Lord Neuberger confirmed that “a claim against directors under section 172(3) cannot be defeated by the directors invoking the defence of ex turpi causa.”
The principle of ex turpi causa was originally defined by Lord Mansfield CJ in Holman v Johnson (1775) : “no Court will lend its aid to a man who founds his cause of action upon an immoral or illegal act”.
Bilta (UK) Limited (“Bilta”) went into liquidation on 29 September 2009 on an HMRC petition. It had only ever had two directors - Messrs. Nazir and Chopra, though Mr Chopra was the sole shareholder. For a period of 3-4 months to July 2009, the company was engaged in a substantial 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%). Similar to the traditional MTIC fraud where mobile phones or cpus were supposedly traded back to back, carbon credits had the advantage of requiring no physical transportation or storage.
As with the phones, Bilta bought ex UK from suppliers including Jetvia (VAT free trade within the EU) then sold to UK traders at a price lower than that they paid, and then the UK traders paid Jetvia rather than Bilta anyway.
This left Bilta with VAT liabilities of £38,733,444 which it had no means of paying. When the very significant scam was discovered and the company wound up, the liquidators sued various parties they alleged had been involved in a conspiracy to defraud Bilta, including Jetivia. The causes of action pleaded were conspiracy and dishonest assistance by the company, and by the liquidators for fraudulent trading under s.213 of the Insolvency Act 1986.
At trial the Defendants relied on the House of Lords decision in 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 prevented by the principle of “ex turpi causa” (see above) 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 Defendants appealed and the Court of Appeal unanimously upheld the trial Judge.
Lord Justice Patten said the key question for the Court of Appeal to determine 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 serves sets out how to determine the circumstances in which the knowledge of a company’s officers and/or employees will be attributed to the company. The Judge said that whilst ordinarily knowledge held by a company’s officers would usually be attributed to the company, it would not be the case if the acts of the officers are directed against/are harmful to the company.
Patten LJ also said that one had to consider whether the company is the primary or secondary victim of the damage.
In a typical MTIC and as here, the target is HMRC not the company per se. Therefore HMRC can of course act against the company. Once the company has suffered the penalties and charges owed, caused by the directors’ fraud, it is a victim and can sue the officers who could not then plead ex turpi causa.
Thus in Bilta of course the company was the victim of its officers, and the damage was the deficit, the liabilities it could not pay to HMRC.
Patten LJ did however say that the ex turpi causa defence 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.
In other words had a sole director and shareholder been responsible such that there was no bit of the company which was an innocent victim, then the knowledge of the dishonest officer would be attributed to the company, so that an innocent third party such as the auditor in Stone & Rolls, or a solicitor say, would be have a defence to a claim by the company.
Bilta was a two-man company but they were both culpable so the court could have said the case was on all fours with Stone & Rolls, but it did not. The claim was against the fraudulent directors themselves (and/or those dishonestly assisting them). Patten LJ agreed with the trial Judge that a breach of a duty owed to the company by directors extends to shareholders and creditors, whereas the auditors only owed a duty to the company itself. In Bilta the directors’ duties included a duty to consider the interests of creditors under s.172 of the Companies Act 2006, and this would be so even where a ‘one-man' company sued its sole director and owner for a breach of duty against the company. Of course, there was also running a fraudulent trading claim under s.213 of the Insolvency Act 1986. The Defendant Appellants also argued that, in so far as the claims were based on section 213, it could not be invoked against the appellants as it did not have extra-territorial effect.
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”.
The case was appealed to the Supreme Court, the Court of Appeal not having gone into huge detail about the circumstances where the ex turpi causa defence might apply or be defeated. However, the Supreme Court has decided this is not the case in which to expand the discussion. It did say that Stone & Rolls was limited to its facts. Lord Neuberger said that “Those propositions concern the circumstances in which an illegality defence can be run against a company when its directing mind and will have fraudulently caused loss to a third party and it is relying on the fraud in a claim against a third party. The second proposition, with which I agree, is that the defence is not available where there are innocent shareholders (or, it appears, directors). The third proposition, with which I also agree, is that the defence is available, albeit only on some occasions (not in this case, but in Stone & Rolls itself) where there are no innocent shareholders or directors.”
Interestingly Lord Neuberger didn’t rule out Lord Mance’s attempt to row back Stone & Rolls “Lord Mance suggests that it should be an open question whether the third proposition would apply to preclude a claim against auditors where, at the relevant audit date, the company concerned was in or near insolvency. While it appears that the third proposition, as extracted from three judgments in Stone & Rolls, would so apply, I have come to the conclusion that, on this appeal at least, we should not purport definitively to confirm that it has that effect. I am of the view that we ought not shut the point out“.
This would be interesting in cases where the company is simply a vehicle for fraud, and often therefore insolvent from inception; in those circumstances not only the officers but perhaps third parties innocent or not might be caught. Stone Rolls makes perfect sense in its own context of course but it is wise not to widen it beyond that. I particularly liked Lord Neuberger’s suggestion that, following Lord Denning, Stone Rolls should be put to one side and marked “not to be looked at again”.
I am becoming a Lord Mance Fan Club.
Frances Coulson (email@example.com)
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