In a landmark judgment handed down this morning, the Supreme Court unanimously refused to accept that defendants to fraud-type claims by a company can rely on their own wrongdoing to escape liability for the fraud. The same rule extends to claims against third parties the wrongdoing of the complicit company directors.
In the first reported case on a second issue, they ruled a liquidator can bring a claim for fraudulent trading against any defendants wherever in the world they are. The Court’s reach on fraudulent trading claims is not limited to defendants in the UK.
This case arose out of alleged MTIC fraud on carbon credit sales – which the liquidators said caused approximately £38m of losses to the company and its main creditor HMRC.
On the first issue, the third party defendants tried to argue the claimant company should be fixed with the acts or knowledge of the fraudulent directors. This meant that to bring the claim against the complicit third parties for the fraudulent scheme, the company would have to rely on ‘its own’ wrongdoing. It’s been a public policy rule for some centuries that the courts won’t allow a company to benefit from its own wrong (in Latin – ex turpi causa non oritur actio.). Six of the seven top judges on the panel held that where a company suffers loss because of a fraudulent scheme by its directors and their accomplices, the acts or knowledge of the directors would not be attributed to the company victim. No question of illegality or wrong by the claimant company would arise and the Court did not need to consider the illegality rule any further. Conversely – if the company was on the receiving end of a claim by an innocent third party for the same fraudulent scheme – it would be fixed with the knowledge or acts of the directors – and would be liable to compensate losses caused by the illegal scheme. Whether a director’s acts or knowledge is attributed to a company is therefore fact sensitive and depends on the circumstances of the case.
The final judge thought that a company would always be fixed with the knowledge and acts of its directors – but the court should then review whether the case came within an exception so a director could not avoid liability. In this case, the exception would be where the director’s acts or knowledge were a breach of his duty to the company.
The Court stressed the much-criticised decision in Stone & Rolls Limited v. Moore Stephens “should be put on one side and marked ‘not to be looked at again’”. In that case, the liquidator of a company with only one director/shareholder tried to sue the company’s auditors for negligently failing to uncover the director/shareholder’s fraudulent scheme. The claim failed – the court holding the company in this case was fixed with the director/shareholder’s fraudulent acts and knowledge and could not rely on its own wrong to found the claim against the third party auditors. The Supreme Court has made it clear the relevance of this decision is confined to the highly fact sensitive issues in that case. Clarity is always welcome – this aspect of today’s decision may cause ripples as defendants to these types of claims have long relied on the decision to avoid liability.