Supreme Court ruling on fraudulent trading liability

In May, the UK Supreme Court handed down judgment in the case of Bilta (UK) Ltd (in liquidation) and others v Tradition Financial Services Ltd. The case related to issues arising from a 2009 Missing Trader Intra-Community Fraud (“MTIC Fraud”), also known as carousel fraud, that resulted in losses of tens of millions to HMRC.

What is MTIC Fraud?
MTIC Fraud exploits the fact that goods traded between EU countries are VAT-free. This allows goods to be imported from a seller in another EU state without paying VAT on the purchase. When the importer sells the goods domestically, VAT is paid to the seller in accordance with the typical rate for domestic sales. The importer owes the VAT it received to the revenue authority, but instead of paying, disappears and goes ‘missing’ before it is paid.

The carousel is created by networks of connected companies repeating sale and purchase transactions, with the final company then exporting the goods and reclaiming the VAT, which was paid when they purchased the goods, but which is then retained by the criminal organisation behind the connected companies. The connections are concealed to make detection of the fraud more difficult. In this way, revenue authorities can be targeted through (i) tax not being paid; and (ii) tax being reclaimed by businesses who have purchased goods that include VAT.

MTIC Fraud has been a long-standing blight to domestic revenue authorities across Europe, estimated to cost governments, and taxpayers, billions every year. The goods involved in such schemes are ideally (for fraudsters): high-value and easily transportable. Such items can include precious metals, mobile phones or, as in this case, carbon credits, which are of course electronic so require no transportation at all but can still be traded across borders.

Background
The claimants in this case were five companies (Nathanael Eurl Ltd (“Nathanael”), Inline Trading Ltd (“Inline”), Bilta (UK) Ltd (“Bilta”), Weston Trading UK Ltd (“Weston”) and Vehement Solutions Ltd (“Vehement”), all of which were in liquidation, represented by their respective Joint Liquidators.

The claimant companies engaged in carbon credit trading under the EU Emissions Trading Scheme (also known as EU Allowances). A carbon credit is issued by a governmental organisation to companies which fixes the amount of carbon dioxide they may release into the atmosphere. Companies with a surplus of carbon credits can sell to those who are deficient (i.e., companies that release more carbon dioxide into the atmosphere than their carbon credits allow).

The domestic spot-trading of carbon credits under the EU Allowances attracted VAT, and became a new product with which fraudsters could commit MTIC Fraud.

The claimant companies were used as part of a chain of vehicles to carry out an MTIC Fraud from May to July 2009 involving the buying and selling of carbon credits. Tradition Financial Services Ltd (“TFS”) was a broker involved in spot-trading of carbon credits. TFS is alleged by the claimants to have knowingly participated in the fraudulent scheme by brokering trades in furtherance of the commission of the MTIC Fraud.

The claimants issued claims against TFS on 8 November 2017 alleging that: (i) TFS had dishonestly assisted the fraudulent directors of the various companies in breach of their fiduciary duties, and (ii) that TFS were liable to make a contribution to the companies’ assets under section 213 Insolvency Act 1986 (“s.213 IA 1986”) because they knowingly participated in facilitating the fraud.

In the High Court, Marcus Smith J held that the dishonest assistance claims were time-barred, but that TFS were liable to make such a contribution to the assets of the companies because they were a knowing participant. The Court of Appeal agreed. TFS appealed the decision on the latter, and the claimants cross-appealed the decision that the claims in dishonest assistance were time-barred.

The claimants and TFS reached a partial settlement agreement which left the two substantive issues before the Supreme Court to be decided on the basis of assumed facts.

The Issues
The Supreme Court considered the following points:

1. Whether the scope of s.213 IA 1986 is limited to those in control or management of the fraudulent business; and

2. The effect of section 32 Limitation Act 1980 (“s.32 LA 1980”) during a period when the claimant companies were dissolved, and whether during that period they could, with reasonable diligence, have discovered the fraud, concealment, or mistake, in accordance with the terms of the statutory provision.

Section 213 IA 1986
Pursuant to s.213 IA 1986, liquidators may apply to the Court (in the course of the winding up of a company) for a declaration of liability against any persons knowingly party to the carrying on of any business of the company intended to defraud creditors, or for any other fraudulent purpose.

As a third-party service provider, TFS submitted that it was not within scope of s.213 IA 1986 because it only applied to those exercising management or control over the company in question.

The Supreme Court applied the well-established approach to the interpretation of a statutory provision, namely that the derivation of meaning of a provision comes from both the wording Parliament has used (so as not the frustrate the ordinary reading of it), and the wider statutory and historical context in which the legislation was drafted, having regard to the underlying redress intended for particular mischiefs.

Reciting the words of Templeman J in Re Gerald Cooper Chemicals Ltd [1978] Ch 262, 268 – “a man who warms himself with the fire of fraud cannot complain if he is singed” – the Supreme Court found that the wording in s.213 IA 1986 is certainly broad enough on its ordinary reading to encompass both the “insiders” of a company as well as any person who has engaged with the company in knowledge of, in furtherance of, or as a contributor in some way to, the fraudulent activity in some way.

The Court reasoned that, elsewhere in the IA 1986, where Parliament had intended to limit the scope of liability or other provisions to certain connected individuals, it had done so expressly, citing narrower provisions of the IA 1986 such as s.212 and 216.

The extent of a third party’s involvement in the fraudulent business will be a question of fact and degree on a case-by-case basis. The Court was minded to note that to incur liability, such a person must not merely be involved with a “one-off fraudulent transaction, unless the fraud is sufficient evidence on its own of the carrying on of a fraudulent business”, but must have had an active involvement in the carrying on of the fraud. Failure to advise will not meet the test.

Section 32 LA 1980
Pursuant to s.32 LA 1980, the running of time for the purpose of the limitation period in cases of fraud is postponed until such a time that a claimant discovers the fraud, or could with reasonable diligence have discovered it. The burden of proof is on the claimant to establish their entitlement to rely on the provision.

The claimants had brought claims against TFS that TFS had dishonestly assisted the directors of the claimant companies in breaches of duty from May to July 2009. The claim against TFS was issued on 8 November 2017, well after the primary limitation period of six-years had passed (which was at the end of July 2015). The High Court judge concluded that all claims were time-barred.

Nathanael and Inline were granted permission to appeal, though both were dismissed by the Court of Appeal. They appealed again to the Supreme Court, relying on s.32 LA 1980 and asserting that they could not have with reasonable diligence discovered the fraud before 8 November 2011 on the basis that the companies were dissolved and had no directors or officers in post during that time.

Nathanael’s and Inline’s directors abandoned the respective companies post-July 2009, as is usual in MTIC fraud. Subsequently, Nathanael was struck off and dissolved on 1 February 2011 and Inline was struck off and dissolved on 7 December 2010. Later, Nathanael and Inline were restored to the register on 19 March 2012 and 8 June 2015, respectively.

S.1032 Companies Act 2006 (“CA 2006”) – Effect of court order for restoration to the register
In accordance with s.1032 CA 2006, when companies are restored to the register, they are deemed to have continued in existence as if they had never been struck off and dissolved.

Nathanael and Inline argued that there was an inherent interrelationship between s.32 LA 1980 and s.1032 CA 2006, and invited the Court to conclude that neither company would have had any directors or officers during its period of dissolution, and therefore it would not have been possible to discover the wrongdoing. Both the Court of Appeal and the Supreme Court concluded that the wording of s.1032 CA 2006 does not deem that the company would not have had any directors or officers who would have been able to discover the fraud. Were every restored company to be deemed to have had no directors or officers whilst dissolved this would allow all dissolved companies to be able to rely on s.32 LA 1980, which could be unreasonably exploited, and which was not the purpose of s32, namely to postpone the running of time in favour of prima facie deserving claimants.

It was common ground that the companies had not discovered the fraud and that the burden of proof was on the party seeking to rely on s32. Therefore, the test was whether the companies could prove that they could not with reasonable diligence have discovered the fraud before 8 November 2011. The Supreme Court found that the starting point was that the court was applying s32 to the counterfactual (being that the company was deemed to have continued in existence) and not the historical fact (that it was dissolved without any officers or directors). Therefore the question of whether a restored company seeking to rely on s32 would have had directors or officers of some kind must seek to show what the position would have been on the balance of probabilities and by reference to evidence. In the event, Nathanael and Inline had adduced no such evidence, and thus their argument failed because neither company had discharged their burden of proof. The claims in dishonest assistance were, therefore, found to be time-barred.

The settlement agreed between the parties was on terms that the amount payable in respect of the claim under s.213 was the same as for dishonest assistance, so the finding that the companies had valid claims under s.213 meant that the outcome of the limitation point had no commercial consequence in this case. However, the Supreme Court dealt with it as it had been argued, the reasoning of the court below was different, and there was no other authority directly on the point, and because it was of general public importance.

Conclusion
It is now beyond question (if it ever was not) that company insiders and third parties alike can be held liable for fraudulent trading under s.213 IA 1986, provided they are involved in fraudulent activity of a company’s business to a sufficient fact and degree. This had previously been the position adopted by the Courts, and this decision just serves to confirm the previous decisions.

In respect of the limitation point, the decision makes clear that the fact a company was dissolved does not automatically mean that there were no officers or directors able to discover a fraud. A restored company needs to consider, and evidence, what the position would have been on the counterfactual, that the company is deemed to have continued in existence. 

A claimant must seek to evidence that there would have only been fraudulent directors or officers during the dissolution period or that the fraud could not reasonably otherwise have been discovered to be able to discharge the burden of proof and stop the limitation clock. 

It is somewhat unsatisfactory that the decision did not set out what evidence would be required to satisfy the requirement in a case of this nature. Given the risk of the limitation clock ticking while a company is dissolved, liquidators should ensure that they do not delay in issuing proceedings when appropriate once appointed, and carefully consider how they might meet the evidential burden, as failing to do so could jeopardise the creditors’ position.