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|Judgments - Moore Stephens (a firm) (Respondents) v Stone Rolls Limited (in liquidation (Appellants)
HOUSE OF LORDS
 UKHL 39
on appeal from: EWCA Civ 644
OF THE LORDS OF APPEAL
FOR JUDGMENT IN THE CAUSE
Moore Stephens (a firm) (Respondents) v Stone Rolls Limited (in liquidation (Appellants)
Lord Phillips of Worth Matravers
Lord Scott of Foscote
Lord Walker of Gestingthorpe
Lord Brown of Eaton-under-Heywood
Michael Brindle QC
Mark Simpson QC
(Instructed by Norton Rose LLP)
Jonathan Sumption QC
Tom Adam QC
(Instructed by Barlow Lyde & Gilbert LLP)
10-12 FEBRUARY 2009
THURSDAY 30 JULY 2009
HOUSE OF LORDS
OPINIONS OF THE LORDS OF APPEAL FOR JUDGMENT
IN THE CAUSE
Moore Stephens (a firm) (Respondents) v Stone Rolls Limited (in liquidation) (Appellants)
 UKHL 39
LORD PHILLIPS OF WORTH MATRAVERS
1. Mr Stojevic is a fraudster. He used the appellant company, (S&R) as a vehicle for defrauding banks. The fraud was discovered and both S&R and Mr Stojevic were successfully sued for deceit by the principal victim, Komercni Bank SA (the Bank). The respondent, Moore Stephens, were S&Rs auditors. Moore Stephens accept that they owed S&R a duty to exercise reasonable skill and care in carrying out their duties as auditors. For purposes of the present argument they also accept that they were in breach of that duty and that, but for their breach, the fraud that Mr Stojevic was perpetrating through S&R would have ended earlier. In this action S&R seek to recover losses caused to them in consequence of the extension of the period of their fraudulent activity that they submit was caused by Moore Stephens breach of duty. Moore Stephens contend that this claim cannot succeed because it is founded on S&Rs fraud and is met by the defence commonly described by the Latin maxim ex turpi causa non oritur actio (ex turpi causa). Whether ex turpi causa provides a defence to the claim advanced by S&R is the preliminary issue raised by this appeal.
2. Although he was a shadow director acting under power of attorney and the shares in S&R are held in the name of a family trust it has been common ground that Mr Stojevic was the sole directing mind and will and the beneficial owner of S&R.
3. I have had the benefit of reading in draft the opinion of each of your Lordships. Each has summarised the nature of the fraud perpetrated by Mr Stojevic through S&R. It involved S&R obtaining payments under letters of credit by presenting to banks false documents in relation to fictitious commodity trading. My noble and learned friend Lord Mance has explained in a little more detail how the fraud worked. When the fraud was ultimately discovered, the monies fraudulently obtained by S&R had all been paid away to other participants in the fraud. The damages awarded to the Bank against S&R and Mr Stojevic exceed $94 million. Neither defendant could satisfy the judgment. The liquidators have started the present action in the name of S&R in an attempt to recover damages for the benefit of S&Rs creditors, who are the banks defrauded by S&R. The claim for breach of Moore Stephens duty of care is brought in both contract and tort.
4. Mr Stojevic had planned to use S&R to perpetrate this fraud before Moore Stephens were engaged, indeed the engagement of Moore Stephens was part of his plot. S&R, which was not at the material time carrying on any significant business, had an auditor who was a sole practitioner based in Rotherhithe. Mr Stojevic decided to replace him with Moore Stephens as part of a strategy to make S&R appear respectable in the eyes of European Banks. In persuading Moore Stephens to become S&Rs auditors, Mr Stojevic gave a fictitious account of the business that S&R had been doing and of the business whose accounts Moore Stephens would be auditing.
5. My initial reaction to S&Rs claim was that, as a matter of common sense, it could not succeed. There were three reasons for this reaction. The first was that S&R are seeking to put themselves forward as the victims of fraud when they were, in fact, the perpetrators of the fraud. The true victims of the fraud were the banks. True it is that S&R are now subject to a paper liability to the Komercni Bank of over $94m, but common sense would suggest that this is not really a loss that they have suffered. They started with nothing and their alleged losses are sums that they acquired by fraud and then paid away as part of the same fraudulent transaction. If a person starts with nothing and never legitimately acquires anything he cannot realistically be said to have suffered any loss. This was the reasoning of Mummery LJ who, in a short judgment in the Court of Appeal, agreed with Rimer LJ that the claim of S&R should be struck out. Keene LJ agreed with both judgments. Mummery LJ concluded his judgment:
119. Does common sense matter? Yes. It is contrary to all common sense to uphold a claim that would confer direct or indirect benefits on the corporate vehicle, which was used to commit the fraud and was not the victim of it, and the fraudulent driver of the fraudulent vehicle".
The second reason why common sense led me, initially, to consider that S&Rs claim should not succeed was that Moore Stephens were also the victims of S&Rs fraud. They were induced to agree to act as S&Rs auditors by a fictitious and fraudulent account of S&Rs business, given to them on behalf of the company by Mr Stojevic, and they were deceived in carrying out their audits by accounts fraudulently prepared on behalf of the company, albeit that it is for present purposes to be assumed that they were negligent in not detecting the fraud. It does not seem just that, in these circumstances, S&R should be able to bring a claim in respect of the very conduct that S&R had set about inducing. The final reason of common sense that predisposed me against this claim was one which would not, unlike the other two, occur to the man in the street but might occur to a student with knowledge of the principles of the law of negligence. Looking at the realities, this claim is brought for the benefit of banks defrauded by S&R on the ground that Moore Stephens should have prevented S&R from perpetrating the frauds. Why, if this is a legitimate objective, should the banks not have a direct cause of action in negligence against Moore Stephens? One answer, I would suggest, is that a duty of care in negligence will only arise where this is fair, just and reasonable. It would not be considered fair, just and reasonable for auditors of a company to owe a duty of care to an indeterminate class of potential victims in respect of unlimited losses that they might sustain as a result of the fraud of the company. If it would not be fair, just and reasonable for the banks to have a direct claim, then it would not seem fair just and reasonable that they should achieve the same result through a claim brought by the companys liquidators for their benefit. In a lecture to the Chancery Bar Association entitled Common Sense and Causing Loss given on 15 June 1999 Lord Hoffmann commented adversely on the practice of those judges who justify their decisions by reference to common sense". He suggested that this was far too often an unsatisfactory alternative to the identification of the relevant principles. The differences of opinion between the members of the committee underline the need to identify the relevant principles that apply in this case. It also underlines the difficulty of that task. The first step is to identify the issues raised by the parties.
The issues raised by the parties
6. This appeal arises out of a strike-out application in which only one of a number of possible defences to the claim is advanced. Mr Sumption QC for Moore Stephens has admitted that his clients owed S&R a duty to exercise reasonable care in relation to the auditing of S&Rs accounts and, for the purpose of these proceedings, that they were in breach of that duty. He submits, however, that S&R are precluded from claiming a remedy for that breach of duty by a defence of public policy, namely ex turpi causa. He submits that the nature and extent of this defence has been definitively determined by the decision of this House in Tinsley v Milligan  1 AC 340. It involves the application of what he has described as a reliance test. A claimant cannot succeed if, in order to make good his claim, he has to aver and rely upon his own illegal conduct. This principle, so he submits, is not based as it was once thought to be upon a disinclination by the courts to award a remedy in circumstances where this would be an affront to the public conscience". It is simply a principle that the court will not allow its process to be used to further an object which is, on its face, illegal. The principle applies automatically and inflexibly. The effect of illegality is not substantive but procedural - Tinsley v Milligan at p. 374. To apply the test you have to do no more than consider the essential averments of the particulars of claim. Mr Sumption submits that in Tinsley v Milligan this House reduced ex turpi causa to the narrowest possible test for the public policy defence short of actually discarding it".
7. Mr Sumption submits that the best explanation of the reason for the ex turpi causa defence is that suggested by McLachlin J in Hall v Hebert (1993) 101 DLR (4th) 129, at p.165:
to allow recovery in these cases would be to allow recovery for what is illegal. It would put the courts in the position of saying that the same conduct is both legal, in the sense of being capable of rectification by the court, and illegal. It would, in short, introduce an inconsistency in the law. It is particularly important in this context that we bear in mind that the law must aspire to be a unified institution, the parts of which - contract, tort, the criminal law - must be in essential harmony. For the courts to punish conduct with the one hand while rewarding it with the other, would be to create an intolerable fissure in the laws conceptually seamless web': Weinrib - Illegality as a Tort Defence (1976) 26 U.T.L.J.28 at p. 42. We thus see that the concern, put at its most fundamental, is with the integrity of the legal system".
8. Mr Sumption has accepted that the reliance test is subject to one important qualification. The unlawful conduct relied on must be that of the claimant himself, not conduct for which he is vicariously liable or which is otherwise attributed to him under principles of the law of agency.
9. The first answer to Mr Sumptions case advanced on behalf of S&R by Mr Brindle QC founds on that qualification. He submits that S&Rs liability to the banks for Mr Stojevics fraud is vicarious. The second answer is that, whether the first answer is right or wrong, for the purposes of the application of ex turpi causa, Mr Stojevics fraud cannot be attributed to S&R. In support of this submission Mr Brindle relies (i) on a principle of the law of agency known as the Hampshire Land principle after the decision in In re Hampshire Land Company  2 Ch 743, and (ii) on the principles governing the attribution of actions and states of mind to companies identified in the speech of Lord Hoffmann in Meridian Global Funds Management Asia Ltd v Securities Commission  2 AC 500.
10. Both Mr Brindles first and second answers proceed on the premise that Mr Sumptions reliance test is correctly formulated. They accept that the reliance test applies to the facts of this case and that, in applying it, a company has to be treated in the same way as a natural person. He has, however, an alternative and more fundamental answer to Mr Sumption. He submits that ex turpi causa does not provide a defence where the claimants illegal conduct was the very thing that the defendant was under a duty to prevent. Here again he founds his argument on jurisprudence that relates to natural persons.
11. Finally, and very much as a fall-back position, Mr Brindle submits that ex turpi causa applies only where this is fair, just and reasonable and that it is not fair, just and reasonable that the defence should apply in the circumstances that have given rise to this appeal.
12. The debate between the parties has largely centred on the nature and effect of the Hampshire Land principle. Mr Sumption summarised this principle as follows in oral argument:
There is not to be imputed to a company a fraud which is being practised against it even if it is being practised by someone whose acts and state of mind in the ordinary way are attributed to the company.
Mr Sumption submits that this principle does not prevent attribution to S&R of Mr Stojevics fraud which was directed not against S&R but against the banks.
13. Mr Brindle does not accept that the Hampshire Land principle is as narrow as this. He submits that it also applies in respect of fraud on the part of an agent of the company that is directed against a third party in as much as the fraud is likely ultimately to come home to roost with consequent detriment to the company. Thus the company is a secondary victim of the fraud. That is precisely what has happened in this case, for S&R has been held liable for Mr Stojevics fraud.
14. Mr Sumption has a fall back position that meets this argument. It turns on the fact that Mr Stojevic was, in effect, the sole shareholder in S&R and also solely responsible for S&Rs activities. Mr Sumption submits that where there is no human embodiment of the company other than the fraudster, attribution of the fraud to the company is inevitable.
The decisions of the Courts below
15. Both Langley J at first instance and the Court of Appeal accepted that the relevant issues were those that I have just described. Langley J rejected the first two answers advanced by Mr Brindle to ex turpi causa. He held that S&R were primarily, and not just vicariously, responsible for the fraudulent conduct and that the Hampshire Land principle did not apply. Mr Stojevics fraud was properly attributed to S&R. He accepted, however, Mr Brindles third answer. He held that ex turpi causa could not prevent a claim founded on fraud that would not have occurred had Moore Stephens properly complied with their very duty as auditors of the company.
16. Rimer LJ, in giving the leading judgment in the Court of Appeal, agreed that Hampshire Land did not apply, but for a different reason. He held that the critical question was whether it was right to treat S&R as the villain or the victim. In the former case the fraud would be attributed to S&R; in the latter case it would not. He held that S&R was the villain and not the victim, Hampshire Land did not apply and ex turpi causa was a defence to S&Rs claim. Thus he accepted Mr Sumptions definition of Hampshire Land and rejected Mr Brindles wider definition.
17. Rimer LJ rejected Mr Brindles argument based on the principle that he described as the very thing". He accepted Mr Sumptions submission that this was a principle that related to causation and that it did not displace the operation of the defence of ex turpi causa.
A Summary of my conclusions
18. In order to assist in following this lengthy opinion I propose at this stage to summarise my conclusions:
1) Under the principle of ex turpi causa the court will not assist a claimant to recover compensation for the consequences of his own illegal conduct.
2) This appeal raises the question of whether, and if so how, that principle applies to a claim by a company against those whose breach of duty has caused or permitted the company to commit fraud that has resulted in detriment to the company.
3) The answer to this question is not to be found by the application of Hampshire Land or any similar principle of attribution. The essential issue is whether, in applying ex turpi causa in such circumstances, one should look behind the company at those whose interests the relevant duty is intended to protect.
4) While in principle it would be attractive to adopt such a course, there are difficulties in the way of doing so to which no clear resolution has been demonstrated.
5) On the extreme facts of this case it is not necessary to attempt to resolve those difficulties. Those for whose benefit the claim is brought fall outside the scope of any duty owed by Moore Stephens. The sole person for whose benefit such duty was owed, being Mr Stojevic who owned and ran the company, was responsible for the fraud.
6) In these circumstances ex turpi causa provides a defence to the claim.
The duties of auditors
19. I agree with my noble and learned friend Lord Mance that the starting point for considering the issues raised by this appeal is the duties undertaken by Moore Stephens as auditors. I am grateful for his detailed and helpful analysis. I would summarise the position as follows. The leading authority is Caparo Industries Plc v Dickman  2 AC 603. The duties of an auditor are founded in contract and the extent of the duties undertaken by contract must be interpreted in the light of the relevant statutory provisions and the relevant Auditing Standards. The duties are duties of reasonable care in carrying out the audit of the companys accounts. They are owed to the company in the interests of its shareholders. No duty is owed directly to the individual shareholders. This is because the shareholders interests are protected by the duty owed to the company. No duty is owed to creditors - Al Saudi Banque v Clarke Pixley  Ch 313. The Auditing Standards require auditors who have reason to suspect that the directors of a company are behaving fraudulently to draw this to the attention of the proper authority. The scope of the duty of care owed by auditors is a matter to which I shall return later in this opinion. For present purposes it suffices to note that the duty is unquestionably imposed in the interests of, at least, the shareholders of the company.
Ex turpi causa
20. Ex turpi causa is a principle that prevents a claimant from using the court to obtain benefits from his own illegal conduct. In the years immediately before the decision in Tinsley v Milligan the courts had developed a flexible approach to the defence of illegality, applying the test of whether, having regard to the illegality involved in the case, it would shock the public conscience to afford the claimant the relief sought. This test has been said to have originated from the judgment of Hutchison J in Thackwell v Barclays Bank plc  1 All ER 676 although reference to shocking the public conscience can be traced back at least to the judgment of Salmon LJ in Gray v Barr  2 QB 554 at p. 581. Tinsley v Milligan involved a dispute between two single women as to title to a house. The house had been purchased with their joint funds, but put into the sole name of the appellant. The reason for this was to facilitate fraudulent claims by the respondent on the Department of Social Services. The respondent claimed that, as the property had been bought with joint funds it was held on a resulting trust under which she had an equitable interest. The appellant contended that the respondent was precluded from asserting her claim because of the illegal purpose of the arrangement. The Court of Appeal, by a majority, had found in favour of the respondent, applying a test of whether, having regard to the illegality, it would be an affront to the public conscience to grant the relief sought. This House was in agreement that this was not the correct test. There was not, however, unanimity as to the correct approach to illegality. Lord Keith of Kinkel and Lord Goff of Chieveley would have allowed the appeal on the basis that the respondent was not entitled to equitable relief because the effect of the illegality was that she did not come to the court with clean hands". The reasoning of the majority appears from the following passages of the speech of Lord Browne-Wilkinson at pp. 369, 375 and 377:
it is now clearly established that at law (as opposed to in equity), property in goods or land can pass under, or pursuant to, such a contract. If so, the rights of the owner of the legal title thereby acquired will be enforced, provided that the plaintiff can establish such title without pleading or leading evidence of the illegality. . . .
A party to an illegality can recover by virtue of a legal or equitable property interest if, but only if, he can establish his title without relying on his own illegality.
. . .
In a case where the plaintiff is not seeking to enforce an unlawful contract but founds his case on collateral rights acquired under the contract (such as a right of property) the court is neither bound nor entitled to reject the claim unless the illegality of necessity forms part of the plaintiffs case.
21. The House in Tinsley v Milligan did not lay down a universal test of ex turpi causa. It was dealing with the effect of illegality on title to property. It established the general principle that, once title has passed, it cannot be attacked on the basis that it passed pursuant to an illegal transaction. If the title can be asserted without reliance on the illegality, the defendant cannot rely on the illegality to defeat the title. This principle had been applied in the case of personalty in Bowmakers Ltd v Barnet Instruments Ltd  KB 65. The House held that it also applied in the case of both legal and equitable title to realty. The House did not hold that illegality will never bar a claim if the claim can be advanced without reliance on it. On the contrary, the House made it plain that where the claim is to enforce a contract the claim will be defeated if the defendant shows that the contract was for an illegal purpose, even though the claimant does not assert the illegal purpose in making the claim - see Alexander v Rayson  1 KB 169, approved by Lord Browne-Wilkinson at p. 370.
22. Hewison v Meridian Shipping Services Pte Ltd  EWCA Civ 1821;  PIQR P252 illustrates another situation in which ex turpi causa defeated a claim albeit that the illegality was not asserted by the claimant.
23. In Cross v Kirkby (CA 18.2.2000) Beldam LJ remarked:
I do not believe that there is any general principle that the claimant must either plead, give evidence of or rely on his own illegality for the principle to apply. Such a technical approach is entirely absent from Lord Mansfields exposition of the principle
I agree with that observation.
24. In Tinsley v Milligan the ex turpi causa defence failed because the respondent did not need to plead the illegal agreement in order to establish her equitable title. Mr Sumption relies on the decision as establishing a general principle that is the converse of that applied by the majority of the House. This is that if the claimant has to rely on his own illegality to establish his claim the courts will never entertain the claim (the reliance test). I have already noted that Mr Sumption advanced one qualification to this rule - it only applies where the illegality is personal to the claimant, not vicarious. In the course of argument when dealing with United Project Consultants Pte Ltd. v Leong Kwok Onn  SGCA 38;  4 SLR 214 he accepted another qualification. The illegality must involve turpitude. The defence may not apply where the claimants illegality consists of an offence of strict liability of which he is unaware. Those, as I shall shortly show, are valid qualifications to the defence of ex turpi causa in the context in which it is raised on this appeal. They are not, however, of general application to the defence of ex turpi causa.