Judgments - Moore Stephens (a firm) (Respondents) v Stone Rolls Limited (in liquidation (Appellants)

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25.  Although Tinsley v Milligan does not establish a general rule that if a claimant founds his claim on his own illegal conduct, the defence of ex turpi causa will apply, earlier cases support this principle: Marles v Philip Trant & Sons Ltd [1954] 1 QB 29; Archbolds (Freightage) Ltd v S. Spanglett Ltd [1961] 1 QB 374. I do not believe, however, that it is right to proceed on the basis that the reliance test can automatically be applied as a rule of thumb. It is necessary to give consideration to the policy underlying ex turpi causa in order to decide whether this defence is bound to defeat S&R’s claim. As Lord Hoffmann recently remarked in Gray v Thames Trains Ltd [2009] UKHL 33; [2009] 3 WLR 167 at para 30:

“The maxim ex turpi causa expresses not so much a principle as a policy. Furthermore, that policy is not based upon a single justification but on a group of reasons, which vary in different situations”.

The underlying policy

26.  The policy underlying ex turpi causa was explained by Lord Mansfield in 1775 in Holman v Johnson 1 Cowp. 341, 343; 98 ER 1120, 1121:

“The objection, that a contract is immoral or illegal as between plaintiff and defendant, sounds at all times very ill in the mouth of the defendant. It is not for his sake, however, that the objection is ever allowed; but it is founded in general principles of policy, which the defendant has the advantage of, contrary to the real justice as between him and the plaintiff, by accident, if I may so say. The principle of public policy is this; ex dolo malo non oritur actio. No court will lend its aid to a man who founds his cause of action upon an immoral or an illegal act. If, from the plaintiff’s own stating or otherwise, the cause of action appears to arise ex turpi causâ, or the transgression of a positive law of this country, there the court says he has no right to be assisted. It is upon that ground the court goes; not for the sake of the defendant, but because they will not lend their aid to such a plaintiff. So if the plaintiff and defendant were to change sides, and the defendant was to bring his action against the plaintiff, the latter would then have the advantage of it; for where both are equally in fault, potior est conditio defendentis.

The policy can be subdivided into two principles in relation to contractual obligations:

(i)  The court will not enforce a contract which is expressly or impliedly forbidden by statute or that is entered into with the intention of committing an illegal act.

(ii)   The court will not assist a claimant to recover a benefit from his own wrongdoing. This extends to claims for compensation or an indemnity in respect of the adverse consequences of the wrongdoing - see Beresford v Royal Insurance Co Ltd [1938] AC 586.

It is the second principle that is in play on this appeal.

Qualifications to the second principle

27.  The two qualifications recognised by Mr Sumption apply in respect of the second, but not the first principle. Thus they apply to the type of claim with which your Lordships are concerned. S&R are not seeking to enforce an illegal agreement. They are seeking compensation for the adverse consequences of having engaged in unlawful conduct. A number of authorities to which we have been referred support Mr Sumption’s acceptance that in these circumstances the defence of ex turpi causa will only apply where the claimant was personally at fault and thus where his responsibility for wrongdoing was primary rather than vicarious: Burrows v Rhodes and Jameson [1899] 1 QB 816; Hardy v Motor Insurers’ Bureau [1964] 2 QB 745 at p.760; Lancashire County Council v Municipal Mutual Insurance Ltd [1997] QB 897 at p. 908; United Project Consultants Pte Ltd v Leong Kwok Onn [2005] 4 SLR 214. Furthermore, there has never been any suggestion that it is contrary to public policy for a company to insure against liabilities that it may vicariously incur as a consequence of the wrongdoings of its agents. Arab Bank plc v Zurich Insurance Co [1999] 1 Lloyd’s Rep 262 was such a case.

28.  Thus Mr Sumption is correct to accept that, in the context of a claim for compensation for the adverse consequences of wrong-doing, ex turpi causa applies where the wrongdoing is personal, or primary, but not where it is vicarious.

The Consequences of Moore Stephens’ primary case

29.  The consequences of Moore Stephens’ primary case are best considered in a case where the facts are not as extreme as those with which your Lordships are concerned. Assume that a company carries on legitimate business, owns legitimate assets and has shareholders who are not complicit in the conduct of the man who runs the company, “the directing mind and will” of the company. Assume that the directing mind and will, in breach of his duties to the company, involves the company in fraudulent trading and that this causes the company to sustain losses. On Moore Stephens’ primary case, as Mr Sumption accepted, a claim for damages for misfeasance against the directing mind and will would be defeated by the defence of ex turpi causa on the ground that the directing mind and will’s turpitude was attributed to the company.

30.  Assume that the auditors of the company had negligently failed to identify the fact that the directing mind and will was acting fraudulently, with the consequence that his fraud was permitted to continue. The company’s claim against the auditors for the benefit of its shareholders, whose interests the auditors should have protected, would be barred by the very wrongdoing that the auditors’ negligence had permitted to occur.

31.  Mr Brindle would avoid these consequences in one of two ways. First he says that the fraud of the directing mind and will does not fall to be treated as the fraud of the company for the purposes of ex turpi causa. This is because where the company becomes a victim of the fraud, although the fraud is directed at a third party, the Hampshire Land principle prevents the fraud from being attributed to the company. Alternatively he argues that where the fraud is “the very thing” that the defendant was under a duty to prevent, ex turpi causa does not apply at all.

The opinions of the Committee

32.  My noble and learned friends Lord Walker of Gestingthorpe and Lord Brown of Eaton-under Heywood have not adopted the reasoning of Rimer LJ in finding in favour of Moore Stephens. They have based their decisions on Mr Sumption’s fall back position. Each has held that Hampshire Land does not apply, that Mr Stojevic’s fraudulent conduct is to be treated as the conduct of S&R and that ex turpi causa defeats S&R’s claim. In doing so, however, their Lordships have restricted their reasoning to the situation where the directing mind and will of the company is also its owner. This leaves open the question of whether ex turpi causa will bar a claim by a company with independent shareholders where those shareholders have been unaware that the directing mind and will of the company has been involving the company in fraud.

33.   My noble and learned friend Lord Scott of Foscote considers that Mr Stojevic’s fraud would not be attributed to S&R so as to bar a claim by S&R against Mr Stojevic. This is because his fraud constituted a breach of the duty that he owed to S&R as an officer of the company. Lord Scott applies the same reasoning to the claim that is brought against Moore Stephens. They too, as auditors, owed duties as officers of S&R and the claim brought by S&R is for breach of those duties. In these circumstances, Mr Stojevic’s fraud should not be attributed to S&R. This result is not reached by the application of Hampshire Land on the facts of this case. Rather, so it seems to me, Lord Scott accepts the force of “the very thing” argument, at least where the very thing relates to a duty imposed on the defendant as an officer of the claimant company.

34.  Lord Mance starts by considering what the position would have been as between S&R and Mr Stojevic if the latter had not been the sole shareholder in S&R. He concludes that if S&R had sued Mr Stojevic ex turpi causa would not have applied as there would be no question of Mr Stojevic benefiting from his own wrong and it would be nonsensical to attribute his wrong to the company in such circumstances. He also considers that Hampshire Land would apply in that situation, because S&R had to be considered as a separate legal entity from Mr Stojevic and Mr Stojevic’s conduct could properly be characterised as a fraud on S&R.

35.  Lord Mance next turns to consider whether the position is affected by the fact that Mr Stojevic was sole shareholder in S&R. He concludes that had S&R been solvent there might have been difficulty in establishing any claim against Mr Stojevic. As, however, it was insolvent, Mr Stojevic was in breach of duty in failing to have regard to the interests of the creditors. S&R would have been able to sue him for breach of this duty and ex turpi causa could not be relied upon as a defence.

36.  Lord Mance then considers whether S&R could have claimed against Moore Stephens if S&R had had independent shareholders rather than Mr Stojevic. Applying similar reasoning Lord Mance concludes that ex turpi causa could not defeat a claim against Moore Stephens for failing to detect the very fraud that was asserted by way of that defence.

37.  Does it make a difference that Mr Stojevic was the sole shareholder in the company? Had S&R been solvent Moore Stephens would not have committed any actionable breach of duty in failing to draw the attention of the owner of the company to his own fraud. Lord Mance concludes that the critical factor is that S&R was insolvent. Just as Mr Stojevic was in breach of his duty to have regard to the interests of the creditors, so the auditors’ duty to the company extended beyond the interests of the shareholders to the interests of the creditors. Ex turpi causa affords no defence to breach of this duty.

38.  Having summarised the conclusions reached by your Lordships I turn to consider the topic that has formed the central bone of contention between the parties, namely the application of the Hampshire Land principle.

Attribution and Hampshire Land

Attribution

39.  The principles governing the attribution of conduct and states of mind to companies have been helpfully analysed by Lord Hoffmann in Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500, an appeal to the Privy Council from New Zealand. The appellant company, Meridian, was an investment management company. Its chief investment manager and senior portfolio manager had acquired shares for the company without the knowledge of the managing director or the board of the company. The company was under a statutory obligation to give notice of this acquisition, but failed to do so. It appears to have been common ground that the company was only in breach of this obligation if it had knowledge of the acquisition in question. The issue was whether the company had the requisite knowledge.

40.  At p. 506 Lord Hoffmann first dealt with what he described as the “primary rules of attribution” of acts of a company, namely those set out in the articles of association of the company or implied by company law. He then referred to the application to a company of the “general rules of attribution” that apply equally in the case of natural persons, such as principles of agency, estoppel, ostensible authority in contract or vicarious liability in tort.

41.  At p. 507 Lord Hoffmann commented:

“The company’s primary rules of attribution together with the general principles of agency, vicarious liability and so forth are usually sufficient to enable one to determine its rights and obligations. In exceptional cases, however, they will not provide an answer. This will be the case when a rule of law, either expressly or by implication, excludes attribution on the basis of the general principles of agency or vicarious liability. For example, a rule may be stated in language primarily applicable to a natural person and require some act or state of mind on the part of that person ‘himself', as opposed to his servants or agents. This is generally true of rules of the criminal law, which ordinarily impose liability only for the actus reus and mens rea of the defendant himself. How is such a rule to be applied to a company?

One possibility is that the court may come to the conclusion that the rule was not intended to apply to companies at all; for example, a law which created an offence for which the only penalty was community service. Another possibility is that the court might interpret the law as meaning that it could apply to a company only on the basis of its primary rules of attribution, i.e. if the act giving rise to liability was specifically authorised by a resolution of the board or an unanimous agreement of the shareholders. But there will be many cases in which neither of these solutions is satisfactory; in which the court considers that the law was intended to apply to companies and that, although it excluded ordinary vicarious liability, insistence on the primary rules of attribution would in practice defeat that intention. In such a case, the court must fashion a special rule of attribution for the particular substantive rule. This is always a matter of interpretation: given that it was intended to apply to a company, how was it intended to apply? Whose act (or knowledge, or state of mind) was for this purpose intended to count as the act etc of the company? One finds the answer to this question by applying the usual canons of interpretation, taking into account the language of the rule (if it is a statute) and its content and policy.”

42.  While initially Lord Hoffmann had spoken of attribution of acts here he spoke of attribution of an act or knowledge or a state of mind. Normally the attribution of an act will carry with it the attribution of knowledge of the act, but this is not necessarily the case as Lord Hoffmann made plain at p. 511:

“But their Lordships would wish to guard themselves against being understood to mean that whenever a servant of a company has authority to do an act on its behalf, knowledge of that act will for all purposes be attributed to the company. It is a question of construction in each case as to whether the particular rule requires that the knowledge that an act has been done, or the state of mind with which it was done, should be attributed to the company.”

Hampshire Land

43.  Lord Walker has summarised the relevant authorities where the Hampshire Land principle has been applied. The important point to note is that Hampshire Land is an exception to the normal rules for the attribution of an agent’s knowledge to his principal. It is not a rule about the attribution of conduct. Hampshire Land applies where an agent has knowledge which his principal does not in fact share but which under normal principles of attribution would be deemed to be the knowledge of the principal. The effect of Hampshire Land is that knowledge of the agent will not be attributed to the principal when the knowledge relates to the agent’s own breach of duty to his principal. The rationale for Hampshire Land has been said to be that it is contrary to common sense and justice to attribute to a principal knowledge of something that his agent would be anxious to conceal from him.

44.  The cases demonstrate some confusion as to the precise nature and scope of the Hampshire Land principle and doubt has even been expressed as to whether it exists - see Bowstead & Reynolds on Agency 18th ed (2006, at 8-188 and 8-213 and Watts, “Imputed Knowledge in Agency Law - Excising the Fraud Exception” (2001) 117 LQR 300 at pp. 319-320. There is a tendency to confuse the Hampshire Land principle with a similar principle developed by the courts of the United States, referred to as “the adverse interest exception to imputation".

45.  The nature of what I shall call “the adverse interest rule” varies from state to state. It is an exception to the imputation principle under which both the knowledge and the conduct of an employee or agent are attributed to his principal where that person is acting in the course of his employment or within his apparent authority. Under the adverse interest rule the knowledge and conduct of an agent will not be attributed to the principal where the agent’s actions are adverse to the interests of his principal. In some States the agent’s conduct must be targeted against the principal if the rule is to apply. In others, the rule applies more widely, in circumstances where the agent’s conduct is done for his personal benefit and is adverse to the interests of his principal, but is not aimed against his principal. A helpful overview of United States law on this topic has been provided by Amelia T Rudolph and Elizabeth V Tanis in a paper entitled “Invoking In Pari Delicto to Bar Accountant Liability Actions Brought by Trustees and Receivers” (2008) ALI-ABA Study Materials.

46.  The adverse interest rule would, so it seems to me, operate at least in some circumstances as a normal rule of attribution under established principles of the English law of agency, rather than as an exception to the norm. Under it an English court would not attribute to a company the act of its managing director in dishonestly transferring the company’s funds into his own account.

47.  The operation of a similar principle in the context of the criminal liability of a company for the acts of its directing will and mind is to be found in the decision of the Canadian Supreme Court in Canadian Dredge & Dock Co Ltd v The Queen (1985) 19 DLR (4th) 314. In the course of giving the judgment of the court Estey J put the position as follows at p. 351:

“ Where the directing mind conceives and designs a plan and then executes it whereby the corporation is intentionally defrauded, and when this is the substantial part of the regular activities of the directing mind in his office, then it is unrealistic in the extreme to consider that the manager is the directing mind of the company…Where the criminal act is totally in fraud of the corporate employer and where the act is intended to and does result in benefit exclusively to the employee-manager, the employee-directing mind, from the outset of the design and execution of the criminal plan, ceases to be a directing mind of the corporation and consequently his acts could not be attributed to the company under the identification doctrine".

This statement was made in relation to criminal charges brought against the company. It describes a principle of attribution that I would accept as applicable under English common law.

48.  I believe that Mr Sumption’s definition of the Hampshire Land principle that I have quoted in paragraph 12 above more accurately describes the adverse interest rule. Confusion between the two principles has tended to obfuscate what, at the end of the day, is a question of attribution that is not difficult to answer on the facts of this case.

Attribution in this case

49.  Mr Brindle submits that this case involves two questions of attribution. The first is whether S&R’s liability to the banks was primary or vicarious. The second is whether, for the purpose of ex turpi causa, Mr Stojevic’s fraudulent conduct falls to be attributed to S&R. These are two different ways of posing the same question. The purpose for which the question of attribution has to be answered is in order to decide whether the defence of ex turpi causa applies. If Mr Sumption’s reliance test is applied, the question that has to be answered is whether S&R is relying upon its own fraud, rather than fraud for which it is only vicariously liable, in order to found its claim. If the underlying principle of public policy is applied, the question that has to be answered is whether S&R is seeking to obtain compensation for the consequences of its own fraud rather than for the consequences of fraud for which it is only vicariously liable. To answer the question it is necessary to decide whether the fraud of Mr Stojevic falls to be treated as the fraud of S&R itself.

50.  As between a company that has committed fraud and the victim of the fraud, the question of whether the company’s liability is primary or vicarious seldom, if ever, arises. As Estey J remarked in Canadian Dredge & Dock Co Ltd v The Queen, at pp 324-325:

“At common law there was no difficulty in finding liability in a corporation in the law of torts, even though the state of mind of the corporation was established by imputing to that corporation the intentions and the conduct of its servants and agents. Thus, in the law of torts, the courts from the earliest times found vicarious liability in the corporation on the principles of agency.”

In this case, however, it is necessary to distinguish between vicarious and primary liability for the purpose of considering the application of ex turpi causa. There is no way of doing this other than by applying the same approach as applies in other circumstances where this exercise is necessary. Indeed Bowstead & Reynolds at 8-188 identifies “the supposed fraud exception to the rules as to imputation of the agent’s knowledge to the principal” as one of the situations where it may be necessary to consider whether conduct ranks as the act of the corporation itself. The words of Lord Reid in Tesco Supermarkets Ltd v Nattrass [1972] AC 153 at 170 are directly in point:

“A living person has a mind which can have knowledge or intention or be negligent and he has hands to carry out his intentions. A corporation has none of these: it must act through living persons, though not always one or the same person. Then the person who acts is not speaking or acting for the company. He is acting as the company and his mind which directs his acts is the mind of the company. There is no question of the company being vicariously liable. He is not acting as a servant, representative, agent or delegate. He is an embodiment of the company or, one could say, he hears and speaks through the persona of the company, within his appropriate sphere, and his mind is the mind of the company. If it is a guilty mind then that is the guilt of the company. It must be a question of law whether, once the facts have been ascertained, a person in doing particular things is to be regarded as the company or merely as the company’s servant or agent. In that case any liability of the company can only be a statutory or vicarious liability.”

51.  Where those managing the company are using it as a vehicle for fraud, or where there is only one person who is managing all aspects of the company’s activities, there is no difficulty in identifying the fraud as the fraud of the company. Thus in Royal Brunei Airlines Sdn Bhd v Tan [1995] 2 AC 378, a case concerning a company, BLT, that was owned and managed by one man, Lord Nicholls of Birkenhead, when giving the advice of the Privy Council, observed at p. 393:

“Set out in these bald terms, the defendant’s conduct was dishonest. By the same token, and for good measure, B.L.T. also acted dishonestly. The defendant was the company, and his state of mind is to be imputed to the company.”

52.  Lord Nicholls returned to this theme in Mahmud v BCCI [1998] AC 20 at p. 34 where he said this about BCCI:

“The bank operated its business dishonestly and corruptly. On the assumed facts, this was not a case where one or two individuals, however senior, were behaving dishonestly. Matters had gone beyond this. They had reached the point where the bank itself could properly be identified with the dishonesty. This was a dishonest business, a corrupt business.”

53.  A similar issue of attribution arose in KR v Royal & Sun Alliance plc [2006] EWCA Civ 1454; [2007] 1 All ER (Comm) 161 in relation to a clause in a policy of liability insurance. The clause excluded the insurers’ liability in respect of: “Injury damage or financial loss which results from any deliberate act or omission of the insured…” The insured was a company that operated children’s homes. The issue was whether the clause exempted the insurers from liability in respect of the company’s liability for physical abuse perpetrated by the managing director and major shareholder in the company. The Court of Appeal held at paragraph 65 that the intention of the clause was to exclude liability for damage or injury caused by the deliberate acts of the person who was to be regarded as, in effect, the company, as opposed to the acts of those who were mere employees. As such it excluded liability in respect of the acts of the managing director:

“It is not just the case that he was managing director and majority shareholder of the company; he was [the company]. He treated the company as his own and nothing of consequence happened without his say so.”

 
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