|Judgments - Moore Stephens (a firm) (Respondents) v Stone Rolls Limited (in liquidation (Appellants)
186. My Lords, after trying to analyse the intricacies of a complex and difficult case it is often helpful to stand back, as we say, and try to identify the essentials. Had Mr Stojevic acted alone in his fraud (for instance, had S & R been a completely fictitious company, never properly incorporated) it is perfectly clear that he would have had no cause of action against Moore Stephens because of (among other reasons) the ex turpi causa rule. That would have been the case even if the action had been taken by his trustee in bankruptcy acting solely for the benefit of the defrauded bank and other innocent creditors. That was the clear view of Langley J (in his conclusions at para 65(2)) and it has not been challenged. The ex turpi causa rule is distinct from the general principle that a claimant should not obtain a personal profit from his own wrong, although the two often overlap.
187. The same results would follow if Mr Stojevic had an individual partner in crime (as Mr Alon may have been, although his participation has not formed part of the argument). Two highwaymen may be partners in crime but neither can sue the other for an account: Everet v Williams (1725), a case which was once thought to be apocryphal, but is verified by a note in (1893) 9 LQR 197 (see also Sir George Jessel MR in Sykes v Beadon (1877) 11 Ch D 170, 195-196). The bill in equity for a partnership account would also have been dismissed out of hand if it had been brought, not by Everet himself but by the administrator of his insolvent estate, after Everet had been hanged at Tyburn, even though the administrator might have been suing exclusively for the benefit of those whom the pair had robbed.
188. Why then does it make a difference that S & R, Mr Stojevics partner in crime, was not an individual but a corporation? For present purposes there is an obvious parallel between an action by a company in insolvent liquidation, and an action by the trustee in bankruptcy of an individual, or the administrator of the estate of an individual who has died insolvent. In each case the action is being brought by or under the control of a fiduciary for the benefit of innocent creditors. But in each case the fiduciary can have no better cause of action than the insolvent company or individual, since the ex turpi causa rule is unforgiving and uncompromising". I can see no reason why the corporate status of S & R should alter the analysis. Once it is accepted (first) that a company can have a guilty mind (Tesco Supermarkets Ltd v Natrass; Royal Brunei Airlines v Tan) and (second) that S & R was directly (and not merely vicariously) liable for the frauds, then it seems to me to be in just the same position as one of the highwaymen.
189. My noble and learned friend Lord Scott of Foscote considers that the position is different because S & R was itself a victim. It had been turned, in his view, into a corporate automaton. That view contradicts not only the Court of Appeal but also the judge. Langley J observed (para 65(6)):
The primary victims of the fraud were KB and the other losers. The fraud undoubtedly exposed S & R to liabilities to KB and the other losers, which it could not meet once, as was intended, the moneys fraudulently obtained were paid away as they were to those responsible for the fraud. On the other hand S & R lost nothing to which it was ever entitled. S & R was in a real sense the perpetrator of the fraud on KB and the banks and the liability to which it was thereby exposed was not just the product of that fraud but the essence of it. In the particular circumstances of this case in my judgment it would be artificial not to fix S & R with the knowledge and wrongdoing of Mr Stojevic and also artificial to describe S & R even as a secondary victim of the fraud.
That puts the point very clearly. Lord Scotts view seems to me to treat the most obvious and extreme situation of a company which has a guilty mind (a one-man company engaged in wholly fraudulent activities) as amounting to a situation in which the company has no mind at all. That view, with great respect, seems to me to be inconsistent with Royal Brunei Airlines v Tan (which is generally regarded as a decision of high authority) and to put the clock back to Abrath v North Eastern Railway Co.
190. Some of the reasoning in Lord Scotts opinion proceeds on the basis that Moore Stephens, as auditors, were officers of S & R. There is long-standing authority that an auditor is an officer for the purpose of a misfeasance summons under what is now section 212 of the Insolvency Act 1986: Re London and General Bank  2 Ch 166, a decision of the Court of Appeal which was followed by another constitution of that Court (though with Lord Herschell expressly withholding his opinion) in Re Kingston Mill Cotton Company  1 Ch 6. In the leading case of Re City Equitable Fire Insurance Co. Ltd  Ch 407 counsel for the auditors reserved this point (see at p 422) but the case did not reach this House. The law may now be taken as settled that for the purposes of a misfeasance summons under section 212a procedural provisionan auditor is an officer of a company. But he is in a quite different position from a director or manager, as Bingham LJ pointed out in Caparo  QB 653, 681, cited by Lord Bridge of Harwich in this House  2 AC 605, 625-626:
In carrying out his investigation and in forming his opinion the auditor necessarily works very closely with the directors and officers of the company. He receives his remuneration from the company. He naturally, and rightly, regards the company as his client. But he is employed by the company to exercise his professional skill and judgment for the purpose of giving the shareholders an independent report on the reliability of the companys accounts and thus on their investment. No doubt he is acting antagonistically to the directors in the sense that he is appointed by the shareholders to be a check upon them': In Re Kingston Cotton Mill Co  1 Ch 6, 11, per Vaughan Williams J".
His part is, and must be, independent (section 27(1) of the Companies Act 1989 provides that a person is ineligible for appointment as company auditor of a company if he is an officer or employee of the company). In short, even if an auditor is for some purposes an officer of the company for which he acts, he is in a totally different position from that of the directors and managers who are running its business. In my respectful opinion it does not assist the task of analysis to equate them.
191. Someone who had been robbed by the highwaymen would have had a direct civil claim against both as joint tortfeasors, just as in this case KB had a claim (which it pursued to judgment) against S & R and Mr Stojevic. But KB had no possibility of a direct claim against Moore Stephens. That is clear from the judgment of Millett J in Al Saudi Banque v Clarke Pixley  Ch 313 (decided after the decision of the Court of Appeal but before the decision of this House in Caparo Industries plc v Dickman) and by the decision of this House in the latter case, approving the decision in Al Saudi Banque. Much of the opinion of my noble and learned friend Lord Mance seems to me, with great respect, to be seeking to attenuate by indirect means the Houses decision in Caparo, although we are not invited to depart from it.
192. Lord Mance is rightly concerned at the difficulty of pinning down the concept of a one-man company. What if there are innocent minority shareholders who have no say in the management of the company? What if majority shareholders, even, have been hijacked by a fraudulent but dominant managing director? These are difficult questions but what can be said with confidence is that cases of that sort would plainly not be suitable for a strike-out (compare the unreported case of Marlwood Commercial Inc v Kozeny  EWHC 872 (Comm) mentioned in paras 48-51 of the judgment of Langley J). In a case of that sort the court would have to enquire closely into the facts in order to see (as Saville LJ put it in Group Josi) whether it would be contrary to justice and common sense to treat the company as complicit. But here it was the claimants own case that the position was clear. As Rimer LJ said (to repeat para 9 of his judgment),
It is the essence of the companys claim that Mr Stojevic was its controlling mind and will. Nobody else was in a like position. In a real sense the company was his company. It was, for practical purposes, a one-man company'. It is a further part of the claim that the company was throughout used by Mr Stojevic as a vehicle for fraud, by extracting money from KB so that it could then be paid away to the fraudsters.
Some observations in Lord Scotts opinion appear to overlook this point.
193. I add a final comment on the very thing argument. It is nonsensical, the argument goes, to assert that there is a duty (for an auditor to detect fraud, or for the police to protect a man in custody from self-harm) but at the same time to empty that duty of content, either on grounds of causation or by applying the ex turpi causa rule. I see the force of that argument, but the analysis seems to me to rely on a good deal of hindsight. When the police hold a man in custody they owe him a variety of duties, including the duty to keep him safe from harm (whether from the police themselves, or from other detained persons, or from self-harm). The duty to take precautions against suicide is part of this duty. If a man in a good state of mental health deliberately kills himself while in police custody, his estate may be unable to recover damages, but that does not to my mind drain the police duty of care of all content. In Reeves only Buxton LJ seems to have been troubled by this point. Similarly with auditors. The detection of fraud is only a small part of the total statutory and common law duties owed by auditors, and the discovery that an apparently respectable and prosperous company is carrying on activities that are wholly fraudulent must be a very rare occurrence. This case is, as Mr Sumption emphasised in his written and oral submissions, a rare and extreme case, so extreme that it is in my opinion appropriate for summary disposal.
194. For these reasons I would dismiss this appeal.
LORD BROWN OF EATON-UNDER-HEYWOOD
195. Suppose as a solicitor practising on my own account I engage an accountant to complete my annual tax return. I have earned fees of £200,000 but, with a view to defrauding the Revenue, I tell him that my fees were only £100,000 and provide him with my fee book for only six months of the year. He neglects to query this despite being provided with documents showing travelling expenses incurred over the full twelve month period. The Revenue are not so stupid and eventually my fraud is uncovered, I am charged the shortfall and heavily fined into the bargain. Can I sue my accountant in negligence or for breach of his contractual duty of care towards me? Plainly not. There could hardly be a more obvious application of the ex turpi causa principle to bar my claim. Luscombe v Roberts (1962) 106 SJ 373 illustrates the point. Suppose then I am bankrupted. Can my trustee in bankruptcy bring the claim for the benefit of my creditors? Equally plainly not. He enjoys no better claim than I had.
196. Suppose then essentially the same scenarios but this time I have incorporated my practice and carry it on as a one-man company. Would that bring about a different result? Would the accountant in those circumstances become liable for whatever losses the fraud ultimately occasioned the company? It would be odd were it so and in my opinion it is not so and could not be so ever since the rejection, over a century ago, of Lord Bramwells view expressed in Abrath v North Eastern Railway Co. (1886) 11 App. Cas. 247, 251 that a company, as a fictitious person, is incapable of malice or of motive". Once it is recognised that a company can itself be fraudulent there could be no clearer instance of it than that suggested above, unless perhaps it is this very case.
197. The facts of this case are fully set out in the opinions of others of your Lordships and need not be repeated. Here, as my noble and learned friend Lord Walker of Gestingthorpe makes plain, not merely was Mr Stojevic the directing mind and will of the corporation, the very ego and centre of the personality of the corporation (Viscount Haldane LC in Lennards Carrying Co Ltd v Asiatic Petroleum Co Ltd  AC 705, 713), but Stone & Rolls Ltd (S & R) was, even on the most exacting definition of the term, a one-man company. As Mr Sumption QC put it, uncontentiously, at the beginning of his printed case:
[Mr Stojevic] was as completely identified with the company as it is possible for a human agent to be. He had sole control over the companys every act. He was the companys sole beneficial owner. There were no independent or innocent directors whom Mr Stojevic had to deceive to make the fraud happen. There were no innocent shareholders relying upon the auditors to monitor the management. There were no employees.
198. How in these circumstances there is any room for the application of the Hampshire Land principlesee In re Hampshire Land Company  2 Ch 743I cannot for the life of me see. That principle, otherwise described as the adverse interest rule, operates as an exception to the ordinary rule of attribution, itself a general principle of agency, that ordinarily one imputes to the company (the principal) the knowledge of a director (the agent) on the basis that the agent may be presumed to have discharged his duty to disclose all material facts to his principal. The Hampshire Land exception recognises that in reality agents will not disclose to their principals the fact that they are committing fraud, least of all when they are defrauding the principals themselves, and that it would be contrary to common sense and justice for the law to presume otherwise. Indeed, the Hampshire Land principle may well go wider than this and extend also to breaches of duty by the agent short of fraudconsider, for example, Vaughan Williams Js judgment in Hampshire Land itself and Rix Js judgment in Arab Bank plc v Zurich Insurance Co.  1 Lloyds Rep 262and to agents frauds even if committed against others than their principals, and perhaps irrespective of whether the principal is to be regarded as a secondary victimsee again Rix Js judgment in Arab Bank. For the purposes of the present appeal, however, it is quite unnecessary to explore, let alone decide, any of this.
199. In the present case Mr Stojevic and S & R were in effect one and the same person. It is absurd to describe Mr Stojevic as the agent and S & R as the principal for all the world as if, but for the Hampshire Land principle, the law would presume that Mr Stojevic had been disclosing to S & R his fraudulent conduct towards the Czech Bank. As Lord Reid said in Tesco Supermarkets Ltd v Nattrass  AC 153, 170:
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 guilt is the guilt of the company.
200. For this reason I find the concept of the sole actor exception to the adverse interest exception (the Hampshire Land principle) a somewhat puzzling one. Why is it necessary to except from an exception a category of case which cannot logically fall into the exception in the first place? Assuming, however, that there is scope for such an exception to the Hampshire Land principle, then the need for it seems to me compelling and as good a statement of it as any is to be found in The Mediators Inc v Manney 105 F 3d 822 (1997) already fully set out at para 163 of Lord Walkers opinion.
201. It is on this basis and this basis alonethe one-man company or sole actor basisthat I would uphold the Court of Appeals judgment that S & R is in no different or better position than Mr Stojevic himself to resist the ex turpi causa defence (and the liquidator of S & R in no better position than either of them).
202. Lord Mance, as I understand his opinion, would find liability here in respect of all such losses as were occasioned by the fraud from the time when the auditors should have uncovered it. But what is this if not liability in an indeterminate amount for an indeterminate time to an indeterminate class of claimantswhoever came to be defrauded by the company in the trading period after the fraud should have been ended to whatever was the extent of their loss. (The quoted phrase comes, of course, from Cardozo CJs judgment in Ultramares Corporation v Touche (1931) 174 N.E. 441, adopted by Millett J in Al Saudi Banque v Clarke Pixley  Ch 313, a judgment approved by the House in Caparo Industries plc v Dickman [1990 ] 2 AC 605.) The company, through its liquidator, would be suing to recover on behalf of all those whom it had defrauded. That, indeed, is precisely the nature of this claim. Such an approach seems to me to run diametrically counter to the principles established in Caparo. I also find it difficult to reconcile with Hobhouse Js decision in Berg, Sons & Co Ltd v Mervyn Hampton Adams  Lloyds Rep PN 41, an authority which Lord Mance prays in aid. Applying Caparo and rejecting a liquidators claim against the companys former auditors, Hobhouse J said that the company had based their case not upon any lack of information on the part of Mr Golechha [the companys directing mind] but rather upon the opportunity that the possession of the auditors certificate is said to have given for the company to continue to carry on business and borrow money from third parties. Such matters do not fall within the scope of the duty of the statutory auditor". Here too, by the assumed negligence on the part of the auditors, the company was able to continue to carry on business, in this case stealing rather than borrowing money from third parties.
203. I recognise, of course, that confining the ex turpi causa defence, as I would, to one man company frauds means that, where any innocent shareholders are involved, a claim against the auditors may well lie (through the company) at their suit. This, however, would not be an open-ended claim, wholly indeterminate as to its potential scope and extent at the time of the audit, such as that presently brought. Quite how it would fall to be confined is no doubt open to argument. But on one view it might be limited to the innocent shareholders own loss suffered through the continuing fraud from the time when, following a diligent audit, it should have been uncovered and brought to an end. A claim of that nature would seem to me to accord altogether more readily with the policies and principles generally understood to apply in this context.
204. With regard to the very thing argument, I agree entirely with what Lord Walker says and wish to add nothing on the point.
205. For these reasons, which really do no more than echo those of Lord Walker, I too would dismiss this appeal.
206. The world has sufficient experience of Ponzi schemes operated by individuals owning one man companies for it to be questionable policy to relieve from all responsibility auditors negligently failing in their duty to check and report on such companies activities. The speeches of my noble and learned friends in the majority have that effect. In my opinion, English law does not require it. I consider that the key to a proper resolution of this appeal is to bear firmly in mind: (a) the separate legal identities of a company and its shareholders; (b) the common law and contractual duties which it is common ground that auditors owe and which included in this case an express undertaking to comply with Auditing Standard SAS 110 on fraud and error of the Auditing Practices Board; (c) the rights that a company has as a result as against those who, whether as officer or auditor, commit wrongs against it; (d) the distinction between on the one hand a companys claim for its own net losses, for which it is entirely consistent with Caparo Industries plc v. Dickman  2 AC 605 that it should be able to sue auditors whose negligence led to such losses, and on the other hand its creditors losses, for which under Caparo its creditors cannot sue negligent auditors; (e) the basic company law principle that the interests and powers of shareholders yield to those of creditors in a company which is actually or potentially insolvent. I differ from the majority speeches in this case because they fail in my respectful opinion to take these points duly into account.
207. Within the majority speeches, although their reasoning differs, there can be found (i) an inversion of the decision in Caparo - whereby the denial to creditors in that case of recovery against auditors because the company would have its own claim is deployed to deny the companys claim against auditors because this would indirectly benefit the companys creditors; (ii) a suggestion never pleaded or raised by the auditors that the auditors contractual engagements might be unenforceable ab initio; (iii) a suggestion that the company did not suffer any loss at all - a surprising proposition, when its assets were over years steadily abstracted from it leaving it with a large deficit out of which it was unable to meet its liabilities to the banks; (iv) a suggestion that a company might be unable to recover against auditors, if some or apparently even one of its shareholders were complicit in fraud committed by the companys directing mind and will causing the company to suffer loss - a suggestion which if good would have provided auditors with immunity in a large number of auditors negligence claims. I will explain my disagreement with each of points (i) to (iv) in the course of this speech. However, it is points (d), (e) and (i) together which ultimately divide the House and are, or ought to be, central to this appeal. I address them in paras. 265 to 273 and 275 to 277 below.
208. The appeal - against an order of the Court of Appeal expressed to be for summary judgment on, or to strike out, the whole of a companys claim against its auditor - raises for the first time in this jurisdiction the issue whether the maxim ex turpi causa non oritur actio can apply to a claim in contract and/or tort by a company against its auditors for professional negligence. Moreover, the issue is raised in an acute form by the auditors primary submission, that there are only three pre-conditions to the application of the maxim: (a) fraud should have been committed by a person counting as the companys directing mind and will; (b) it should have been committed by the company, not against it; and (c) the company should also have to rely on the fraud in order to plead its case against the auditor. Only in the alternative does the auditor submit that, if those conditions do not alone engage the maxim, then the fact that the fraud was committed by the sole beneficial owner of the company delivers the coup de grace. In response, the company submits, inter alia, that the auditors submissions undermine the purpose of an audit, and that, at least in circumstances where the company was insolvent at the relevant audit date, the companys interests can no longer be equated with those of its shareholders and the company can recover for loss it sustained by a scheme of fraud, which would have been detected and stopped by a careful audit.
209. The essential facts to be assumed for the purposes of this appeal can be shortly stated. The appellant company, Stone & Rolls Ltd. (S & R - incorporated in England and Wales and in liquidation since November 2002), was at all material times under the complete control and effective ownership of a Mr Stojevic. (Mr Stojevic was not formally a director - the only such director was a resident of Sark - and the beneficial ownership which Mr Stojevic is admitted in the agreed statement of facts to have had of S & Rs shares was indirect and covert, through an Isle of Man company the shares of which were held by a trust.) The respondent acted as S & Rs auditors for periods ending 31st December in the years 1996 to 1999, in each case under a separate contractual engagement. Mr Stojevic was throughout those years using S & R as a vehicle for fraud. The fraud involved the extraction from various banks, principally it appears Komercni Banka A.S (the former State Bank of Czechoslovakia), of increasingly large amounts under letters of credit providing for deferred payment at maturity dates as long as 180 or even 360 days. The banks believed they were financing bona fide commodity trades, but the documents presented were false and did not relate to actual goods. S & R obtained funds without waiting for the expiry of the deferred periods by assigning or forfeiting the letters of credit. The funds were then paid away to third parties under the influence or control of Mr Stojevic, and used, in part only, to reimburse the banks in respect of previous maturing letters of credit (and so secure the issue of further larger letters of credit). The sums outstanding under these circular transactions grew steadily until eventually reimbursement of the banks ceased, and the banks were left with unsecured and very substantial losses. In proceedings before Toulson J in 2002, Komercni Banka A.S. exposed the fraud and obtained judgment in deceit against S & R for US$94,470,382.28:  EWHC 2263 (Comm);  1 Lloyds Rep 383. S & R, having been stripped of its assets by Mr Stojevic and his associates, has nothing with which to meet this or any other liability or indebtedness, and is in liquidation.