LS Systems & Ors v Scott & Anor

This is an application by the claimants, presently LS Systems Ltd and Lovania Nurseries Ltd, and by a prospective third claimant Lovania Nurseries, a partnership, for various forms of relief, but primarily summary judgment.

The application is brought against the first defendant Mr David Scott, who was formerly the financial controller of the two claimant companies and later the managing director of the first claimant.

In brief summary, the claimants’ contention is that Mr Scott, during the period of his employment, misappropriated the funds of the claimants and made secret profits, and the claimants seek to make him accountable for that.

It is important at the outset, having regard to what Mr Scott said to me in his address, to note the chronology of the matter. The proceedings were commenced by the issue of a claim form on 14 July 2014, which was served on 17 July 2014. Also on 17 July 2014, an order was made by consent by Mr Justice Peter Smith, which was a freezing order and an order requiring the provision of information.

Subsequent to that order, the claimants were given permission to amend their particulars of claim, to increase the ceiling on the freezing order and to seek further disclosure of information by an order made by Mr Justice Birss on 28 July 2014.

The present application was launched by an application notice dated 22 October 2014, which was served together with the supporting evidence on Mr Scott on 5 November 2014. At that time, Mr Scott was represented by a firm of solicitors called Atticus Law.

In correspondence between the claimants’ solicitors and Mr Scott’s solicitors, a timetable for the application was agreed on 18 November 2014 providing for Mr Scott to serve his evidence in response to the application by 16 January 2015. In the event, no evidence was served by or on behalf of Mr Scott by the time agreed, or indeed at all prior to today’s hearing.

Last week, as I understand it, Mr Scott’s solicitors came off the record and since the end of last week or the beginning of this week, Mr Scott has been acting in person.

I mention that chronology for two reasons. First, when Mr Scott addressed me in response to the application, he referred to the fact that his solicitors had recently come off the record and to the fact that, as a result, he had had difficulty in preparing for today’s hearing. He further told me that it was only relatively recently that he became aware of today’s hearing at all and that he had not been aware of the passing of the date for the service of evidence in response to the application. He therefore sought an adjournment of the matter in order that he should have the chance to obtain alternative representation and in particular to sort out funding for that to happen.

Clearly, the Court has every sympathy with people who are not professionally legally represented and are forced to act in person. Nevertheless, the fact remains that in the present case Mr Scott did serve a Defence to the Amended Particulars of Claim, which was professionally drafted, on 26 September 2014. Accordingly, he has had the opportunity to set out his defence to the bulk of the claimant’s allegations at a time when he was professionally represented. Furthermore, the chronology that I have set out indicates that Mr Scott had plenty of time, at a time when he was professionally represented, to prepare and serve evidence in answer to the application if he was advised to do so. In those circumstances, I am not satisfied that an adjournment of this hearing would be justified.

I will come to the second reason for mentioning the chronology later in this judgment.

I turn therefore to set out the background to the matter in a little more detail. As is common ground, Mr Scott was employed by the claimant companies in 2007 as a financial controller. It is also common ground that in August 2012 he became managing director of the first claimant company. There is a dispute as to the precise circumstances in which Mr Scott became managing director, but that is immaterial for present purposes.

The present claims have their origins in financial irregularities that the claimants say that they discovered when Mr Scott was suspended in the summer of 2014. Those alleged financial irregularities were investigated by a firm of forensic accountants called Wilson Henry. They found evidence of large sums of money which had been transferred from the claimants’ bank accounts to an account maintained by Mr Scott. Mr Scott had maintained an account at the Lord Street, Southport branch of NatWest, with an account code ending in the digits 626, into which his salary was paid. That account, which was known to the claimants, has been referred to in the proceedings as the “Known Account”. As a result of the investigations conducted by Wilson Henry, an additional account at the same branch with an account number ending in the digits 841 was discovered. This has been referred to as the “Unknown Account”. Later in time, a yet further account with an account number ending in the digits 285, referred to as the “Third Account”, has also been discovered.

The claims made by the claimants fall into three groups. The first group, which is numerically the bulk of the claims, concerns bank transfers made to accounts maintained by Mr Scott at NatWest, and in particular the Unknown Account and the Third Account.

The second group of claims concerns Mr Scott’s use of the claimants’ funds to settle invoices from suppliers for goods and services delivered to Mr Scott in connection with work on a property of his called “Four Winds”.

The third group of claims relates to alleged misuse of an ebay account maintained by the first claimant. It is said that proceeds from that account were diverted to an account held by the second defendant Mr Richard Adderley, and subsequently paid out from that account to Mr Scott in cash.

The basis for the claimants’ claims is that Mr Scott owed each of the claimants fiduciary duties throughout the period of his employment and office. Those duties required him to account for his use of their funds. For the most part, the duties are admitted and the claimants say that, even where there is an issue, the evidence that the duty was owed is overwhelming. Accordingly, the claimants say that the onus lies upon Mr Scott to account for, establish the propriety of and justify his dealings with the claimants’ monies. They bring this application on the basis that Mr Scott has no realistic prospect of justifying his dealings.

That being the basis of the claim, the starting point is to consider the basis for the claim that Mr Scott owed fiduciary duties to the claimants at the material times. Two sources of those fiduciary duties are relied upon.

The first and the most straightforward is Mr Scott’s statutory fiduciary duties as director of the first claimant from August 2012. That duty is not in dispute, being admitted in the Defence. Although that duty does not strictly apply to the second claimant, still less to the prospective third claimant, counsel for the claimants submitted, and I agree, that the fiduciary duty owed by Mr Scott to the first claimant will have extended to not misappropriating the funds of the first claimant’s sister company and related partnership.

The second source of fiduciary duty relied upon is the duty which the claimants contend that Mr Scott owed them as a senior employee charged with responsibility as financial controller. The claimants accept that the mere fact that Mr Scott was an employee of the claimants is not without more sufficient to result in him owing them a fiduciary duty generally speaking. They contend, however, that as financial controller of the business, Mr Scott plainly owed fiduciary duties in respect of the claimants’ funds which were under his control.

So far as that is concerned, the Defence not merely admits that Mr Scott was the claimants’ financial controller throughout the relevant period, but also that he had authority to approve or not approve the making of payments. It is denied in the Defence that he had control of the on-line banking system and Sage accounting software used by the claimants’ companies. That denial is, in my judgment, obviously incredible. There is a great deal of contemporaneous documentation before the Court, including a large number of emails from Mr Scott to other employees of the claimants (and in particular a number of individuals in the accounts department such as Carole Hulmston, Hayley Forrester and Dawn Bond), in which it can be seen that Mr Scott is fully in control of the on-line banking system and the Sage accounting system and giving instructions to his subordinates as to what to do.

In any event, it seems to me that the matters admitted in the Defence are in themselves sufficient to show that Mr Scott owed the claimants a fiduciary duty in respect of the claimants’ financial affairs and in particular the claimants’ monies with which he was dealing.

Given that I am satisfied that Mr Scott did indeed owe the claimants fiduciary duties, it follows that he bears the onus of establishing that his dealings with the claimants’ monies are proper and justified: see, for example, Psycare Ltd v Mundy [2013] EWHC 4573 (Ch) at [30] - [31].

In the present case, it is submitted on behalf of the claimants that there is simply no prospect of Mr Scott being able to discharge that burden. On the contrary, it is submitted on behalf of the claimants that there is before the Court overwhelming evidence of systematic misuse of the claimants’ funds. I accept that submission. It is not necessary for present purposes to go through all the wealth of detail which is contained in the claimants’ evidence, and in particular in exhibit LKW3 to the witness statement of Leanne Wheeler made in support of the present application, which organises in relation to each claim copies of the relevant contemporaneous documents.

So far as the first category of claims is concerned, it is admitted by Mr Scott in his Defence that he has received in the accounts referred to as the Unknown Account and the Third Account a considerable number of payments in the form of bank transfers from the claimants’ accounts. It is significant that in many cases the true beneficiary of the payments was disguised in the relevant payment instructions.

It is sufficient for the purposes of this judgment to refer to the first example to which I was taken by counsel for the claimants in the course of his submissions. This relates to a transfer that was made on 27 November 2009. In an email from Mr Scott to Carole Hulmston sent on 30 November 2009, Mr Scott wrote as follows:

“When doing the bank rec for Lovania I have made payment to Brinkmans for £11,605.45 on Friday 27^th November. I have all the documentation. Please post to fixed assets plant and machinery and I will sort the further journals out once the funding is authorised by Lombard. No need to print anything off further. Keith had whined about documents in the office being on general view. Oops!!!!”

It can be seen from the statements for the account I have referred to as the Unknown Account for the relevant period that a CHAPS transfer was indeed received from the second claimants’ bank account on 27 November 2009 in the sum of £11,605.45. Moreover, it bears the reference “Re Brinkmans”.

In his Defence, Mr Scott admits receipt of the money in question. He denies that the payment was disguised. That denial is quite simply untenable. There is absolutely no reason for either the CHAPS transfer or the email he sent to Ms Hulmston to refer to Brinkmans at all if in fact the true beneficiary was Mr Scott. Furthermore, the email he sent to Ms Hulmston shows that he was not merely misleading Ms Hulmston as to the beneficiary of the payment, he was also instructing her to make a false entry in the second claimants’ accounting records. I will come to what I regard as the real defence advanced by Mr Scott in relation to this claim in a moment. Suffice it to say for present purposes that there are numerous other examples of this kind amongst the first group of claims.

The principal defence advanced by Mr Scott in relation to thirty-one of these bank transfers totalling some £568,000 was that he was entitled to these monies by way of commission. What is said in paragraph 23 of the Defence is that the payments in question were authorised and approved by Mr Keith Ball, who is one of the two owners of the claimant companies together with his wife. It is said that in April 2009 a company called Whiterigg Alpines Ltd, a supplier of alpine plants in the UK, entered into administration. Mr Scott investigated the possibility of the business of Whiterigg Alpines being acquired, but it turned out to be too expensive. Instead, it is said that Mr Scott conceived the idea of recruiting the former staff of Whiterigg Alpines and developing part of the first claimant’s businesses in the field of alpines. Accordingly, it is then said that Mr Ball and Mr Scott put that plan into action, and that as a result the first claimant’s business grew substantially. It is then pleaded as follows:

“It was agreed as between Keith Ball and the first defendant that the first defendant would be entitled, in addition to his salary, a sum equivalent to 5% of the turnover in the first claimant’s alpine business as a consequence of and reflecting the works undertaken by the first defendant.”

It is then repeatedly pleaded in the Defence that payments of this kind were made in satisfaction of that entitlement to commission.

The claimants contend, and I agree, that this defence is manifestly preposterous and a fabrication. There are a whole series of reasons for that conclusion.

First, if the bank transfers in question were commission due to Mr Scott and Mr Scott was acting honestly as the claimants’ financial controller, there would be no reason for the beneficiaries of the payments to be disguised. The beneficiary would have been openly declared to be Mr Scott. Similarly, there would be no reason for the apparent purpose of the payments to be disguised, as in the Brinkmans example to which I have just referred, where the overt purpose (at least according to the falsified accounting records) was a purchase of plant and machinery. The purpose of the payment would have been openly declared as being that of paying Mr Scott’s commission. I should make it clear in this respect that, out of the thirty-one payments which Mr Scott claims were due to him as commission, twenty-nine were concealed in one way or another.

The second reason is that there is no reference to the alleged agreement or commission anywhere in the contemporaneous documentary evidence. It is also noticeable in that regard that the alleged agreement in the Defence is wholly unparticularised.

Thirdly, the agreement to pay commission was first mentioned in the Defence. It was not mentioned in the inter partes correspondence between July and September 2014, nor was it mentioned in either of the two affidavits that Mr Scott swore on 28 July and 12 August 2014. Indeed, in the first affidavit Mr Scott said that he could not remember receiving fifteen of the thirty-one payments which he now says that he received by way of his entitlement to commission. If the story were true, it beggars belief that Mr Scott would not have remembered it at the time that he made his first affidavit.

Fourthly, the alleged agreement defies commercial and indeed common sense. At the time, Mr Scott was a salaried employee earning between £40,000 and £45,000 per annum. In those circumstances, it is simply incredible that Mr Ball would have agreed to pay him a sum equivalent to 5% of turnover (and note, turnover not profit) for the supposed work that he had done in this regard. This becomes particularly incredible when one considers the sheer scale of the alleged commission payments that Mr Scott claims that he received, which are bigger by an order of magnitude than the size of his salary.

Fifthly, two of the payments that Mr Scott seeks to justify in this way pre-date the administration of Whiterigg Alpines Ltd by a period of over seven months. Clearly, those cannot possibly be justified by an agreement allegedly made after that administration.

Sixthly, the amounts and timing of the payments are extremely erratic. This is plainly inconsistent with the payments being in respect of an entitlement to receive a fixed percentage of a particular regular revenue stream. This is all the more so when one takes into account Mr Scott’s contention that the result of his idea was that the first claimant’s business grew rapidly. In fact, when one looks at the payments they do not show a steady increase as would reflect that, but on the contrary go up and down in an apparent random manner.

Seventhly, the claimants have produced evidence that for at least one of the relevant tax years, the payments were not declared by Mr Scott to HMRC or taxed.

Finally, they do not appear as payments of commission to Mr Scott in the claimants’ accounts for which Mr Scott was responsible.

For all of those reasons, I am satisfied that this defence is completely fictitious and that Mr Scott has no realistic prospect of succeeding in it at trial.

For good measure, however, it is worth saying that Mr Scott has yet further problems with the credibility of his defence not only of these claims but more generally. The first problem arises out of the fact that there are a number of instances in evidence where it is clear that financial records have been falsified and the only possible explanation is that it is Mr Scott who has falsified them in support of his activities in misappropriating the claimants’ funds. It is unnecessary for the purposes of this judgment for me to go through all the examples, but one of them relates to what is in financial terms a fairly small claim made against Mr Scott concerning tyres purchased for his Range Rover on 8 April 2014.

The claimants’ case is that Mr Scott paid for the tyres in question using his company credit card. Despite that, he subsequently filed an expense claim in respect of this expenditure on the basis that he had paid for the tyres himself. In support of his expense claim, he produced a receipt from the vendor of the tyres, Tarleton Tyre Services. On its face, the receipt is dated 18 April 2014, which the claimants contend was to put anyone who might be looking off the scent from realising that in fact the transaction was the one of 8 April 2014 for which the company card had been used.

Leaving aside the documentary evidence, the claimants rely upon a witness statement from Michael Pinkard, the proprietor of Tarleton Tyre Services and as it happens an ex-policeman, who gives compelling evidence as to why the receipt in question was not written by him on 18 April 2014, nor related to any transaction on that date, namely that he (Mr Pinkard) was away in the Isle of Man on that date and his business was closed.

As I say, that is merely one example. A yet further problem for Mr Scott is that, as a number of the examples to which I have already referred demonstrate, the claimants’ evidence shows strong reasons for considering that Mr Scott has behaved dishonestly. I should emphasise that it is not a necessary ingredient in the claimants’ claim that Mr Scott has behaved dishonestly, still less that he should have defrauded the claimants in the technical sense. Nevertheless, the evidence of dishonesty is supportive of the claimants’ contention that Mr Scott has no real prospect of successfully defending the claim.

In this regard, a final matter to mention, albeit I give this in itself little weight, is that it is the claimants’ contention that it was only when investigating the financial irregularities that came to light last summer that the claimants discovered that Mr Scott had previously been convicted upon his own confession of the common law offence of cheating the Revenue on 14 August 2006 and that on 22 September 2006 he was sentenced to six months imprisonment for that offence. I should say in that regard that Mr Scott told me this afternoon that that was a matter that he had disclosed to Mr Ball at his employment interview. As I say, that in itself is not a matter that I place any great weight upon.

It remains for me to consider the second and third categories of the claimants’ claim.

The second category, as I said earlier, relates to claims that Mr Scott used the claimants’ funds to pay suppliers for work done on his own property. So far as that is concerned, the claimants’ evidence is that this was done under the cover of an accounting code 226 for supposed work described as irrigation at Chorley. Mr Scott in his Defence admits that the monies in question were paid to him. Moreover, there is broad agreement as to the amounts involved; a total of £147,000 was paid, of which it appears some £47,000 was repaid by Mr Scott and therefore the net amount paid is approximately £100,000. So far as this is concerned, Mr Scott denies any involvement in the 226 code. Importantly, however, he contends that it was agreed between him and Mr Ball (see paragraph 39 of the Defence):

“…that the accounts would be settled either directly by means of making payment in satisfaction of the accounts. Indeed, the first defendant has paid c.£47,000. Or, and in due course, by means of set-off as against monies owed by the first claimant to the first defendant in relation to the Alpine deal as referred above.”

It can be seen from that, therefore, that again Mr Scott relies upon the Alpine commission story as an important plank of his defence with regard to this claim.

It follows from what I have already said that I consider that Mr Scott has no real prospect of succeeding in that defence in relation to this claim any more than in relation to the first class of claims.

Finally, there is the matter of the ebay account. So far as that is concerned, the outline facts are not in substantial dispute. Mr Adderely operated an ebay account on behalf of the first claimant in relation to which he also maintained a PayPal account. A quantity of Hunter Wellington boots were bought and sold on enay and the proceeds were paid into Mr Adderely’s PayPal account. The sum of some £26,000 was then paid out in cash to Mr Scott. So far as this claim is concerned, Mr Scott’s defence in essence is that, although it was handled in an irregular manner, the payment of this sum was authorised by Mr Ball and that what happened to the money was that it was distributed by way of bonuses to members of the claimants’ staff in a manner that avoided paying tax on those bonuses.

So far as this story is concerned, however, there are two striking features of the evidence. The first is that this is another case where there is strong evidence of financial documents having been altered by Mr Scott. In the present case, two bank account statements containing details of payments were altered so as apparently to show £20,000 worth of extra payments. During the course of a disciplinary hearing held with regard to Mr Adderley, Mr Scott admitted that it was he who had falsified the bank statements and that he had done so in order to cover his tracks.

The second matter which is quite striking is that, notwithstanding the frank admission made by Mr Scott during the course of the disciplinary hearing which was recorded on tape and a transcript of which is in evidence, in his Defence he denies doing any such thing. In the light of his frank admission at the disciplinary hearing, again that denial is quite simply incredible. Moreover, there is no alternative explanation as to how or by whom the bank statements in question were falsified.

Accordingly, the position so far as this claim is concerned is that it seems to me to be quite clear that Mr Scott has no real prospect of justifying the use of the money. Even if it is the case, as he says, that the money was in turn distributed to other members or at least some of the money was distributed to other members of the staff by way of off-the-record bonus payments, that does not amount to justification of use of the funds such as to defeat a claim for breach of fiduciary duty.

For completeness I should say that, in relation to the first class of payments, other than the quite weak defence which is the primary defence, there are one or two other minor disputes arising out of Mr Scott’s Defence, but I should make it clear that I do not regard any of the other matters raised as having any greater prospect of success than the principal defences to which I have referred.

Accordingly, I am satisfied that, on the basis of the evidence before me, the claimants are entitled to summary judgment in respect of all three classes of claims. Before moving on, I should also mention that, in the course of his address to me this afternoon, Mr Scott raised a number of other matters which had not been mentioned by him in either of his affidavits or in his Defence. The gravamen of his allegations was that everything that he had done had been done with the full knowledge and authority of Mr Ball. Moreover, he alleged that documentary evidence which would support his account which was contained in a blue file that had been in his office at the claimants’ premises had gone missing. So far as those matters are concerned, it seems to me that they are not entitled to any weight given that Mr Scott has had the opportunity to advance matters that he relied on by way of defence in a professionally crafted Defence and has failed to file evidence in answer to the present application. In any event, however, it seems to me that, even if those matters had been pleaded by way of Defence or put into proper evidence in support of the application, the answer would be the same, namely that they do not establish a realistic defence to the claimants’ claim.

It remains for me to deal with two matters. The first concerns the position of the prospective third claimant.

As I have indicated, the prospective third claimant Lovania Nurseries, is a partnership. It is owned by Mr Ball and his wife. The explanation for the application to join Lavonia Nurseries as third claimant is that the claimants have discovered that a small number of the claims advanced in the existing Particulars of Claim have been made on the basis that the payments were made by the second claimant when in fact, on further investigation, it turns out the payments were made by the prospective third claimant. In the circumstances, I am satisfied that it is entirely appropriate to give the claimants permission to amend so as to join Lovania Nurseries as third claimant and to correct the errors in the identity of the relevant claimant that made the payments in question.

The final matter concerns the relief to which the claimants contend that they are entitled, if they are successful on this application. So far as that is concerned, the claimants seek proprietary remedies in respect of three properties the legal title to which is owned by Mr Scott.

The claimants rely upon the principle that, where a fiduciary obtains a benefit in breach of his fiduciary duty and the benefit is an asset belonging beneficially to the principal, for example as here where the fiduciary has gained the benefit by misappropriating or misapplying the principal’s property, this gives rise to a constructive trust over the benefit in favour of the principal. Furthermore, the claimants rely upon the principle that, even if the property constitutes funds which are mixed by the defendant with his own funds, insofar as the traceable proceeds of the misappropriated funds still exist the claimants have a proprietary claim over those proceeds and anyone who derives title from him other than a bona fide purchase of a value without notice.

In the present case, the claimants contend that Mr Scott has used the claimants’ money to purchase and improve three properties. The first is the Four Winds property to which I have already referred. That was purchased by Mr Scott on 23 November 2012 for a price of £380,000. The second property is 208 Ainsworth Hall Road, Bolton, which Mr Scott purchased on 18 November 2009 for a price of £305,000, and the third is 1 Cooperative Buildings, Cope Road, Rossendale, which he purchased on 10 October 2008 for a price of £200,000. Each of these properties was purchased with the aid of a mortgage and the properties remain mortgaged. The outstanding sums due in respect of the three properties are approximately £266,000, £248,000 and £151,000 respectively. Accordingly, the beneficial interest which the claimants seek to establish in those properties is subject to those mortgages.

The claimants contend, and I accept, that the evidence shows that the balances of the respective purchase prices were funded by Mr Scott using the claimants’ money. In particular, by way of example, in the case of Four Winds the documentary evidence shows that on 12 February 2012 Mr Scott received somewhat over £119,000 of money from the second claimant into what I have described as the Known Account. Prior to that, the account contained just £239. Later the same day, he transferred £109,000 in tranches of £59,000 and £50,000 from the Known Account into the Third Account. The Third Account had previously had a balance of £10,032. On 19 October 2012, Mr Scott transferred a little under £113,000 from the Third Account to a firm of solicitors called Ellis & Thomas for the purchase of the Four Winds property. Thus it can be seen that almost all of the balance of the purchase price derived from the money that Mr Scott had received from the second claimant.

Furthermore, Mr Scott has admitted in his affidavits and Defence using other receipts from the claimants to improve the Four Winds property. There are also admissions of receipts of money to purchase or improve the other two properties, and again it can be seen from the financial documentation that Mr Scott received funds from which the balances of the purchase prices were paid.

I should say that in the case of the Four Winds property there is a sum of approximately £4,000 which may have come from elsewhere at the time of the purchase. It seems to me, however, that in the circumstances of the present case that can be disregarded for three reasons. In the first place, it is a relatively small percentage of the balance of the purchase price. Secondly, as I have said, the property has subsequently been substantially improved as a result of expenditure made on it by Mr Scott using funds derived from the claimants. Thirdly, in the case of the other two properties it can be seen that the monies that Mr Scott received actually exceeded the amounts required by way of balancing payments for the purchase of the properties.

In all of those circumstances, I am satisfied that the claimants’ proprietary claim to the three properties is established. Accordingly, I will give summary judgment for the claimants and I will give permission to amend the particulars of claim as sought.