Update: company

Several outrageous frauds made legal headlines last year, calling into question the extent of the civil liability of both the fraudsters and the 'gatekeepers' '“ non-executive directors, auditors and solicitors '“ whose job, it might be thought, is to help detect fraud and prevent further losses. Causation is a recurrent issue.

A fraudster is bound, generally speaking, to pay compensation for the damage directly flowing from his fraud. In Komercni Banka AS v Stone and Rolls Ltd and another [2002] EWHC 2263 (Comm), the claimant bank succeeded in an action for deceit brought against both its customer, Stone and Rolls Limited, and its customer's 'directing mind and will', one Zvonko Stojevic. The measure of damages in such an action is tortious, the general idea being to put the claimant in the position he would have been in if no false representation had been made. Thus, the starting point for the assessment of the bank's loss in the case was the amount it paid out under letters of credit issued in reliance on false and fraudulently presented documents, to wit nearly US$95m. Furthermore, in deceit, the tortfeasor is liable for all the direct consequences of his fraudulent statement, whether foreseeable or not. The defence of contributory negligence is not available to a fraudster. There is on the other hand a duty to mitigate. Komercni Banka also had to give credit for certain benefits it received from the transactions in question, albeit that these amounted to a mere US$250,000. That left both Stone and Rolls Limited (hereafter 'in liq.') and Mr Stojevic liable to pay just over US$94m.

Common law and equitable claims

What is fraud anyway, in the civil sense, but a label applied to assorted claims that might be brought at common law or in equity? Or at common law and in equity, as in National Grid Electricity Transmission Plc v McKenzie Harbour Management Resources Ltd & Anor [2009] EWHC 1817 (Ch). The 'other' in the case name was Andrew McKenzie, a project engineer in the employ of National Grid who routinely took bungs from contractors, assisted them to overcharge his employer and generally helped himself and others, including his then girlfriend, to an array of secret profits (National Grid only learned of McKenzie's activities when his affair went sour and his girlfriend turned whistleblower). The employer sued for breach of contract, deceit and conspiracy as well as for breach of fiduciary duty. At trial it elected not to claim bribes on a pound-for-pound basis (£161,403, to be precise) since, being in a position to prove actual losses suffered by reason of the overcharging, it could substantiate a claim in excess of £400,000. It also succeeded in claiming (if not recovering) consequential losses to the extent of a healthy proportion (£575,000) of the costs of investigating the fraud. Where loss could not be shown, National Grid reverted to claims in equity. In relation to one scheme which diverted to McKenzie and others a profit which otherwise would have been earned by a third party, it argued that he was liable to account in full for the secret profit (i.e. both his take and that of the other 'joint venturers'). In relation to another 'joint venture', McKenzie was held to be in breach of fiduciary duty and liable to account to the extent of his presumptive share of the estimated profit: another £185,000. Norris J cautioned against combining common law and equitable claims in respect of the same facts unless, as on these facts, one would expect a significantly different outcome. One senses that it was all fairly academic in terms of effecting recovery.

Failing to act

Now what about those professionals or quasi-professionals who might have, or be a conduit to, deeper pockets?

In Lexi Holdings Plc v Luqman & Ors [2007] EWHC 2652 (Ch) the issue was not so much the misappropriation by managing director Shaid Luqman of nearly £50m of Lexi's cash under the noses of auditors, solicitors and bankers, as it was the related failure of two non-executive directors, Shaid's sisters, to discharge their duties to the company. Taking his cue from now boilerplate language in a company's statutory accounts, Briggs J determined that what was at issue in the case was the directors' responsibility 'for safeguarding the assets of the company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities'. Among other things, Shaid's sisters knew but failed to disclose that their brother had previous convictions for dishonesty. They were held to have breached both their fiduciary and common law duties by virtue of inactivity.

The next question was whether the sisters' inactivity caused the losses that were suffered by Lexi. Causation, said Briggs J, citing an old Maxwell case (Ian, not Robert: Bishopsgate Investment Management Ltd v Maxwell (No 2) [1994] 1 All ER 261) is no less a part of a claim based upon breach of fiduciary duty by inactivity as it is a part of a claim based upon breach of a common law duty of care.

Briggs J's causation analysis was long and tortuous and resulted in a finding in the sisters' favour (at [2008] EWHC 1639 (Ch)). It was also, according to the Court of Appeal (at [2009] EWCA Civ 117), flawed. In particular, Briggs J had concentrated on what in all probability would have happened had the sisters done what they should have done. But if a person '“ director or auditor '“ should have done something, then he is liable for the consequences of not doing it (per Sir Andrew Morritt C). Causation was established and each of Shaid's sisters was ordered to pay in the neighbourhood of £40m.

Hidden gems

Stone and Rolls Ltd (in liq) v Moore Stephens [2009] UKHL 39 was the grand finale to a case in which, if the liquidators had had their way, allegations of auditorial misconduct would have become the central issue. It was not to be. In surely one of the most extraordinary cases of the year, one of the last cases to be heard by the House of Lords, by a split decision (three to two) and on a strike-out application to boot, the auditors prevailed. Jonathan Sumption QC successfully argued that as the negligence action against his clients was founded on the company's own fraud, it was countered by the ex turpi causa non oritur actio defence: no one can found a cause of action on his own criminal conduct. There was literally no case to answer.

In the view of Lord Walker and Lord Brown, where the directing mind and will of a company is also its owner, his fraudulent conduct is to be treated as that of the company. Thus, Stone and Rolls Limited was in no different position than Zvonko Stojevic himself would have been to resist the ex turpi causa defence and the liquidators were in no better position either. The analysis would have been different if there had been innocent shareholders in the fraudulent/defrauded company, making Stone and Rolls Ltd (in liq) an even more exceptional case. There was a nice moment during three days of intense legal argument when counsel were invited by the lords to explain why Brink's Mat Ltd v Noye [1991] 1 Bank LR 68 was being debated when it had not been cited below. This was a case that arose out of the theft in 1983 of thousands of gold bars and other valuable metals and stones, many of which have never been recovered. Michael Brindle QC, for the liquidators, and Jonathan Sumption QC glanced at each other. 'There are many hidden gems in the law,' quipped the latter.

Stone and Rolls Limited had argued at all stages that the ex turpi causa maxim should provide no defence where the detection of dishonesty in the company's affairs was 'the very thing' that the auditors were retained and paid to do. But Rimer LJ agreed with Mr Sumption, as in the final analysis did Lords Walker and Brown, that this was an argument which could only go to causation. As such it could not trump ex turpi causa.

Where does the line fall?

It is fairly predictable in a case such as Lexi Holdings that at some point the wrongdoer will instruct the company's solicitors to deal with client monies otherwise than in the company's interests. While there may in general be no duty on solicitors to inquire behind the instructions received from, say, a client's managing director, it must at some point become untenable (as well as unprofessional) to rely on the authority of even an MD. But when? How suspicious must a situation be before solicitors who fail to make additional inquiry will be deprived of an ability to rely on apparent authority? Might a failure to inquire due to carelessness '“ as opposed to actual or Nelsonian (blind-eye) knowledge '“ suffice? The cases fail to identify precisely where the line falls, or at any rate failed to do so sufficiently clearly for Briggs J to grant summary judgment in the administrators' favour on the facts of Lexi Holdings v Pannone and Partners [2009] EWHC 2590 (Ch).

In disqualification proceedings, nice legal issues of causation are liable to be eschewed: Re Barings No 5 [1999] 1 BCLC 433. With effect from 25 February 2009, Shaid Luqman was disqualified for 15 years '“ the second occasion in fact on which he had received the maximum period of disqualification permitted under the Company Directors Disqualification Act 1986. The court, accepting that he had already effectively been disabled from acting as a director for a period of four years by virtue of an erroneous bankruptcy order, disqualified Zvonko Stojevic for 11 years.

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