Stone & Rolls Ltd v Moore Stephens (a firm)

The first-named Defendants, Moore Stephens, were, for the years 1996, 1997 and 1998, the auditors of the Claimant company (“S&R”). S&R alleges that in each year the audits were conducted negligently. The claim is for USD 173.6 million. There is an allegation of “shutting eyes” fraud in relation to the 1998 audit but that, like negligence, is strenuously denied and is of no relevance to the present issues. The damage claimed arises from a letter of credit fraud committed against banks. The fraud consisted of the presentation by S&R of false documents to the Banks, the receipt of funds by S&R and the payment away of those funds to other parties to the fraud. The documents were shams purporting to reflect a commercial transaction which had not occurred. The claim asserts that Moore Stephens should, by one route or another, have “blown the whistle” bringing the fraud to an end. S&R was owned, controlled and managed by a Mr Stojevic. He was the person who committed the fraud and, with S&R, was found liable for it in relation to the major losing Bank by Toulson J in 2002 in a decision entitled Komercni Banka AS v. Stone and Rolls Ltd and Another [2002] EWHC 2263(Comm). “Another” was Mr Stojevic.

To my mind, the major question which arises on the present applications by Moore Stephens to strike out the claim and/or for summary judgment, is one to which there is no easy answer and on which there are lines of authority which it is not easy to reconcile. The issue has been very well argued. In short summary the question is whether and if so when can a claim by a company against its auditors infringe the maxim, still familiarly expressed in Latin, that ex turpi causa non oritur actio. The uncertainties, including the uncertain rationale of the maxim, have been adverted to by the Supreme Court of Canada in Hall v Hebert 101 D.L.R (4^th) 129 and by the Law Commission in Consultation Paper No 160 (May 2001) on the Illegality Defence in Tort.

If it is accepted, as I think it must be, that an individual cannot claim losses suffered as a result of his own criminal conduct the question which arises is when, if at all, does a similar principle apply to a claim by a corporation and does it make any difference that the defendant is an auditor whose duty of care to the company audited, if performed, would have led to the disclosure and end of the criminal conduct and the losses.

It is the submission of Mr Howard, QC, for Moore Stephens, that Mr Stojevic was the “one man” and the “controlling mind and will” of S&R which was a “one man band”; that S&R was itself guilty of fraud; and that S&R is therefore seeking to rely upon and recover a loss caused by its own fraud. At the forefront of this submission is the feature of the fraud, which on the evidence has been established, that S&R was never in any real sense deprived of its own money but was simply a conduit for the passage of fraudulently obtained funds. The funds were only obtained by fraud and, so Mr Howard submits, it is the consequent liability to repay the defrauded banks which is, or which on analysis is, the loss claimed. That, he submits, is the perhaps unusual feature of this claim which results in it falling foul of the maxim as stated by the House of Lords in Tinsley v Milligan [1994] 1 AC 340.

Mr Simpson, for S&R, submits that the claim by the company is for the losses occasioned by S&R paying away the monies and that the duty of care owed by Moore Stephens to S&R included a duty to detect the fraud and to blow the whistle. At the forefront of his submissions was the decision of the Court of Appeal in Reeves v Commissioner of Police for the Metropolis [1999] QB 169 that the rule has no application in circumstances where the alleged “turpitudinous act” is “the very thing” the defendant had a duty to prevent. In second place he relied upon the authorities which address the question in what circumstances is the knowledge and conduct of an individual to be attributed to the company and, he submits, that in the case of Mr Stojevic his dishonesty is not to be attributed to S&R which is not therefore seeking to rely upon its own dishonest actions in bringing this claim.

Neither counsel submitted that this was a case in which further evidence or information was likely to or might affect the outcome although Mr Simpson understandably stressed the final nature of the relief sought and Mr Howard, also rightly, stressed that the applications necessarily proceed on the assumption, despite their denial, that the matters alleged in the claim would be established at a trial.

The claim includes a claim for compound interest as special damage in an amount of some USD 81 million. Moore Stephens submit that this claim is in any event unsustainable and should be struck out/dismissed accordingly.

In context it is accepted that the two rules of the CPR on which Moore Stephens rely come to the same thing. CPR 3.4(2)(a) enables the court to strike out a statement of case which “discloses no reasonable grounds for bringing…the claim”. CPR 24.2(a)(i) enables the court to give summary judgment against a claimant on the whole of a claim or on a particular issue if “it considers that that claimant has no real prospect of succeeding on the claim or issue” and there is no other compelling reason for a trial. Mr Simpson has not sought to put forward any case for any “other compelling reason”.

The claimant (KB) was a Czech Bank. It was the major victim of the fraud. The letters of credit were issued by the Bank at the request of an Austrian company called BCL. The Letters of Credit related to purported sales of agricultural products by S&R to BCL. S&R was the beneficiary. The claims related to 30 letters of credit which were honoured upon presentation by S&R of the relevant documents but for which KB received no payment from BCL. They were issued between July 1998 and July 1999. The first letters of credit were issued at the end of December 1997 but they were paid on maturity. KB’s case was that the documents presented to it were false in particular by representing that the issuing warehouse as S&R’s agent was holding the invoiced goods in favour of KB when in fact there were no goods at all. KB alleged that Mr Stojevic was responsible for procuring the fraudulent presentation of documents to it and that he and S&R were jointly liable to KB in deceit. The defendants denied dishonesty.

Toulson J found that the documents presented to KB by S&R were false to the knowledge of both S&R and Mr Stojevic; that their presentation had caused KB to pay S&R or its assignee (where discounted by S&R) the face value of the letters of credit; and so had caused the loss to KB arising from those payments. Toulson J also held that while KB had itself been negligent that was no answer for a fraudster. He gave judgment for KB against both defendants for USD 94.5 million. That was the figure paid out by KB under the 30 unreimbursed letters of credit. The evidence before Toulson J showed that of the total amount received by S&R from the fraud of approximately USD 90 million, some 80 million was paid to BCL or companies connected with BCL. The evidence before this court shows that the inwards receipt of monies was promptly followed by the outward payments.

The judgment (no doubt because it was not necessary) contains no analysis of whether the liability of S&R was founded on vicarious liability for the fraud of Mr Stojevic, attribution of knowledge, or otherwise.

Following, and as a result of, the judgment of Toulson J, S&R went into provisional liquidation on 15 November 2002. The present claim is brought by the liquidators. Should the claim succeed there is no doubt that KB (or its assigns, if any) will be the main beneficiary as the major creditor of S&R. It is not in dispute that as a matter of law KB would itself have no direct claim against Moore Stephens because Moore Stephens did not owe a duty of care to the creditors of S&R including KB. It is in dispute whether that legal analysis has any relevance to the present issue. Mr Howard submits that the liquidation of S&R cannot “improve” the claim in the sense that if S&R is caught by the ex turpi maxim then the liquidator can be in no better position. Mr Simpson, on the other hand, places some emphasis on the fact that if this claim succeeds it will enure to the benefit of the “defrauded creditors” because he acknowledges that if and to the extent that Mr Stojevic himself were to benefit from a successful claim that would fall foul of the maxim, whether that benefit came by way of payment of sums due to him from S&R or as a shareholder or otherwise. The present claim is undoubtedly a claim by the company for what is said to be its own loss and not by “an innocent third party” save as the indirect beneficiary of the claim should it succeed: compare Gardner v Moore [1984] 1 AC 548 at 560.

The Particulars of Claim is a daunting document of 399 paragraphs, 3 schedules and 4 Annexes. But because what is being claimed, and on what basis, is a matter of some importance and debate there is no choice but to offer an analysis of it. Thankfully and helpfully some of the early paragraphs contain a summary of the claim and I will quote from them:

“SUMMARY

1.

This summary is included for the convenience of the Court. It does not form part of the Claimant’s case, which is set out more fully below.

THE CLAIMANT

2.

The Claimant (“S&R”) is a company incorporated under the laws of England and Wales. At all material times:

(1)

…

(2)

the manager of S&R was a Croatian national, Zvonko Stojevic, who:

(a)

was a shadow director of S&R; and

(b)

held a power of attorney on behalf of S&R

THE DEFENDANTS

3.

…

4.

Moore Stephens were extensively involved in the affairs of S&R and other entities controlled by Mr Stojevic in the period leading up to S&R’s liquidation in 2002. In particular, Moore Stephens acted as auditors to S&R between 1997 and 2001, signing unqualified audit reports for the financial periods ending 31 December 1996 to 1999.

THE LIQUIDATION OF S&R

9.

S&R went into provisional liquidation on 15^th November 2002 as a result of the judgment of Mr Justice Toulson…

10.

The judge awarded Komercni Banka $94,470,382.28 damages for deceit against both defendants. He found that Mr Stojevic, who was the controlling mind of S&R, had dishonestly colluded with an Austrian company, BCL Trading GmbH (“BCL”), to create artificial commodity sales to enable S&R to obtain funds under letters of credit issued by Komercni Banka, with such funds then being recycled to BCL.

11.

On 15^th January 2003 the provisional liquidators of S&R, Ian Williams and Laurence Pagden of Benedict Mackenzie LLP, were appointed liquidators of S&R by the Secretary of State.

S&R’S CASE IN OUTLINE

12.

In this action S&R alleges that:

(1)

Moore Stephens were negligent in their conduct of the audits for 1996 to 1998;

(2)

Mr Chasty and Mr Anstis were dishonest in certain aspects of their conduct of the audit for 1998;

(3)

As a result of the above, Moore Stephens failed to detect and/or (through Mr Chasty and Mr Anstis for the 1998 audit) turned a blind eye to:

(a)

Mr Stojevic’s dishonesty; and

(b)

a pattern of fraud involving numerous fraudulent and/or irregular payments out by S&R to entities controlled by Stojevic and his associates;

(4)

any reasonably competent auditor who had detected such matters, and/or not turned a blind eye to them, would have resigned and/or reported them to the relevant authorities. S&R’s primary case is that this would have occurred by the end of October 1997 at the latest;

(5)

thereafter Mr Stojevic would have been unable to procure that fraudulent and/or irregular payments were made out of S&R.

13.

The losses to S&R resulting from the continuance of the fraudulent and/or irregular payments out are set out in Schedule 1.”

Schedule 1 sets out (before various credits) the loss claimed by reference to sums said to have been “dissipated fraudulently and/or not in usual course of business” and lists payments made to BCL, related entities, and various other entities.

Under the heading “History” the claim includes:

“14.

At all material times until its provisional liquidation in November 2002, S&R was controlled by Mr Stojevic and owned by Law Investments Limited (“Law Investments”), an Isle of Man company which was in turn owned by Mr Stojevic’s family trust. Mr Stojevic is, and was, a highly intelligent and secretive Croatian businessman who controlled numerous companies in various jurisdictions and used trustees and nominee directors in order to conceal his association with them.

16.

Mr Stojevic’s intention throughout was to use S&R as a vehicle of fraud, i.e. it was intended to be, and became, a vehicle through which funds were extracted from banks which believed that they were financing bona fide commodity trades and then paid away to third parties who were under the influence or control of Mr Stojevic. The fraudulent transactions which he planned and executed through S&R became both larger and more obviously fraudulent as he realised that Moore Stephens had failed to detect his earlier frauds and would probably not detect his frauds in the future.”

Under the heading “The S&R Audit Retainer” S&R alleges (and the allegation must be taken to be accurate for the purposes of these applications) amongst other matters that:

“EXPRESS TERMS

48.

The express terms of Moore Stephens’ retainer were set out in a letter of engagement from Moore Stephens to the directors of S&R, dated 19^th December 1996. This was signed by Mr Stojevic on behalf of S&R, to confirm agreement with its terms, on 14^th January 1997.

49.

The letter of engagement provided, in part, as follows:

…(2) We have a statutory responsibility to report to members whether in our opinion the financial statements give a true and fair view and whether they have been properly prepared in accordance with the Companies Act 1985. In arriving at our opinion, we are required to consider the following matters, and to report on any in respect of which we are not satisfied:

(a)

whether proper accounting records have been kept by the company…

(b)

whether the company’s balance sheet and profit and loss account are in agreement with the accounting records and returns;

(c)

whether we have obtained all the information and explanations which we consider necessary for the purpose of our audit; and

(d)

whether the information in the directors’ report is consistent with that in the financial statements…

(4)

We have a professional responsibility to report if the financial statements do not comply in any material respect with applicable accounting standards, unless in our opinion the non-compliance is justified in the circumstances. In determining whether or not the departure is justified we consider:

(a)

whether the departure is required in order for the financial statements to give a true and fair view; and

(b)

whether adequate disclosure has been made concerning the departure…

Scope of audit

(7)

Our audit will be conducted in accordance with the Auditing Standards issued by the Auditing Practices Board, and will include such tests of transactions and of the existence, ownership and valuation of assets and liabilities as we consider necessary…

(11)

The responsibility for safeguarding the assets of the company and for the prevention and detection of fraud, error and non-compliance with law or regulations rests with yourselves. However, we shall endeavour to plan our audit so that we have a reasonable expectation of detecting material misstatements in the financial statements or accounting records (including those resulting from fraud, error or non-compliance with law or regulations), but our examination should not be relied upon to disclose all such material misstatements or frauds, errors or instances of non-compliance as may exist…

IMPLIED TERM

The Accounting Standard, SAS 110, is pleaded and relied upon insofar as it provides guidance on an auditor’s responsibility to consider fraud and error and requires auditors to:

“plan and perform their audit procedures and evaluate and report the results thereof, recognising that fraud or error may materially affect the financial statements.”

SAS 110 also provides, in circumstances where an auditor becomes aware of or suspects fraud and concludes that the matter ought to be reported to “an appropriate authority in the public interest”, for auditors to report it if the company does not. That provision reflects the decision of the Court of Appeal in Sasea Finance Ltd v KPMG [2000] 1 All ER 676. In that case, Kennedy LJ, at page 682, asked rhetorically “why that should be” adding that “the obvious and commonsense answer” was “that by so doing the company may be spared” the loss likely to result from the fraud. The decision itself is authority for the proposition that the duty to report to a third party applies, perhaps applies particularly, where the fraud is the fraud of the directing mind and will of the audited company.

Paragraphs 112 and 113 of the Particulars of Claim, under the heading “a dominant proprietor” allege that Moore Stephens was aware that Mr Stojevic was “in complete control of every aspect of S&R’s business” and that “S&R had no employees and neither the nominee director…nor the part-time bookkeeper…played any role in the running of the business.”

Allegations of negligence are made in respect of each audit year. The detail does not matter. Mr Simpson drew the court’s attention (paragraph 241) to one allegation, in respect of a particular transaction examined by Moore Stephens, which he said (rightly) was typical, arising in relation to the 1997 accounts. It is there alleged that “any reasonably competent auditor … would have realised this was a letter of credit fraud”, and (paragraph 255) would have “blown the whistle” in one or more of the respects pleaded in paragraph 157. The loss claimed and the claim for compound interest are pleaded in paragraphs 396-8 as follows:

“LOSS

396.

As a result of the matters set out above, S&R has suffered loss and damage, as set out in Schedules 1 and 2 below. The sums set out in Schedule 1 all constitute irregular and/or fraudulent payments out to third parties for no value and/or not made in the ordinary course of business and were the continuation of a type of irregular and/or fraudulent transaction which Moore Stephens negligently failed to discover during the course of their audits. Against those sums S&R gives credit for the sums set out in Schedule 2 on the basis that those sums were paid back to S&R by the recipients of the sums set out at Schedule 1.

397.

The total sum, net of interest, claimed by S&R is thus $141,721,864.85 less $47,007,249.11 = $94,714,615.74.

INTEREST

398.

At all material times Moore Stephens was aware of the extent of S&R’s indebtedness, whether to banks or to other parties, and of the fact that (1) trading and other receipts would be used to reduce this indebtedness and/or that (2) payments out to third parties would increase that indebtedness. On this basis S&R claims compound interest as special damages at the US Prime Rate plus 1% totalling $78,890,064.12. Particulars of the calculation of this sum are contained in Schedule 3.”

(1) It is, I think, clear that it is part of S&R’s case that Mr Stojevic was the controlling mind and will of S&R: see paragraphs 15 and 19. There was no-one else. In a real sense he was the company.

The maxim is of very long standing. In Holman v Johnson (1775) 1 Cowp 341 at 343, Lord Mansfield CJ expressed it to be that:

“No court will lend its aid to a man who founds his cause of action on an immoral or an illegal act. If, from the plaintiff’s own stating or otherwise, the cause of action appears to arise ex turpi causa…there the court says that he has no right to be assisted. It is on this ground the court goes; not for the sake of the defendant, but because they will not lend their aid to such a plaintiff.”

In Tinsley v Milligan [1994] 1 AC 340 the plaintiff and the defendant had purchased a property from joint funds on the understanding that they were joint beneficial owners but vested it in the sole name of the plaintiff to assist the defendant, with the connivance of the plaintiff, in continuing to make false benefit claims. The monies obtained contributed in only a small way to the acquisition of the equity in the property in which the parties lived. The defendant had an attack of conscience and confessed to the fraud. The parties quarrelled and the plaintiff moved out. The plaintiff then sought to claim possession of the property asserting that she was sole owner of it. The defendant counterclaimed for a declaration that the property was held by the plaintiff in trust for the parties in equal shares.

The judge and the Court of Appeal (by a majority) dismissed the claim and allowed the counterclaim. The majority in the Court of Appeal founded their decision on the ground that in the circumstances the public conscience would not be affronted if the defendant were to succeed. The majority decision of the House of Lords is well summarised in the headnote:

“Held, dismissing the appeal (Lord Keith of Kinkel and Lord Goff of Chieveley dissenting), that a claimant to an interest in property, whether based on a legal or equitable title, was entitled to recover if he was not forced to plead or rely on an illegality, even although it transpired that the title on which he relied was acquired in the course of carrying through an illegal transaction; that, in the circumstances, by showing that she had contributed to the purchase price of the property and that there was a common understanding between the parties that they owned the property equally the defendant had established a resulting trust; that there was no necessity to prove the reason for the conveyance into the sole name of the plaintiff, which was irrelevant to the defendant’s claim, and that since there was no evidence to rebut the presumption of a resulting trust the defendant was entitled to succeed on her counterclaim.”

The majority decision was therefore firmly founded on a property right and the ability to claim it without being “forced to plead or rely on illegality.” The House was unanimous in rejecting the “public conscience test” applied by the Court of Appeal.

Lord Goff was in the minority as to the result. But it was he who gave the leading speech on the relevant test quoting the passage from Lord Mansfield’s judgment in Holman v Johnson which I have quoted. At page 355B Lord Goff said:

“It is important to observe that, as Lord Mansfield made clear, the principle is not a principle of justice; it is a principle of policy, whose application is indiscriminate and so can lead to unfair consequences as between the parties to litigation. Moreover the principle allows no room for the exercise of any discretion by the court in favour of one party or the other.”

There is something unattractive about a rule or principle the operation of which can lead to injustice or unfairness, and Mr Simpson submits (not without some support in authority) that, by one route or another, courts have managed to avoid such an outcome (as the majority of the House did in the case itself). Lord Goff would have decided the case differently on the basis that all that was required to invoke the rule was that the alleged misconduct had “an immediate and necessary relation to the equity sued for” (at 362B). For the majority, the material question was whether the claimant has to plead or rely on his own illegal conduct in order to found the claim: Lord Browne-Wilkinson at 376E.

A large number of further authorities have been cited to me. Those which turned on or addressed the ex turpi maxim are relatively few and far between; and of those that did in very few did the maxim operate to defeat the claim and in even fewer was the claim brought by an incorporated body.

Mr Howard placed considerable reliance on the decision of the Court of Appeal in Clunis v Camden and Islington Health Authority [1998] QB 978. The decision was delivered on 2 December 1997, some 3 weeks after the decision of the Court of Appeal in Reeves. The two cases were proceeding substantially in tandem and the outcome of Reeves was unknown at the time Clunis was argued.

In Clunis the plaintiff killed a Mr Zito by stabbing him. He pleaded guilty to manslaughter by reason of diminished responsibility and was ordered to be detained in a secure hospital. He had previously been detained in hospital under the Mental Health Act and been released subject to after-care by the defendant health authority. To quote the headnote:

“He brought an action against the defendant claiming that he had suffered injury, loss and damage and that the defendant was in breach of a common law duty to treat him with reasonable professional care and skill, that on the known information the responsible medical officer should have realised that he was in urgent need of treatment and was dangerous, and that, had he been given treatment, he would not have committed manslaughter and would not have been subject to the prolonged detention which he faced. The judge refused to strike out the action, holding that the plaintiff was not precluded from recovering damages consequent on his own criminal act.

On appeal by the defendant:-

Held, allowing the appeal, (1) that the rule of public policy that a plaintiff should not be able to rely on his own criminal or immoral act was not confined to particular causes of action; and that public policy only required a court to deny its aid to a plaintiff seeking to enforce a cause of action if he was implicated in the illegality and sought to rely on the illegal act in putting forward his case, and the operation of the policy was restricted to those who were presumed to have known that what they had been doing was unlawful; that acceptance of a plea of diminished responsibility did not remove the plaintiff’s responsibility for his criminal act; and that, accordingly, since his claim arose out of his commission of a criminal offence, and since he had to be taken to have known what he was doing and, despite the reduction of his culpability by reason of his mental disorder, that it was wrong, the court was precluded from entertaining his claim.”

It was part of the submissions of counsel for the plaintiff that the deterioration of the plaintiff’s mental health and his subsequent violence were exactly the sort of occurrence which it was the defendant’s duty to prevent and that the cause of action did not arise directly from the act of manslaughter but from the failure of medical care for which the defendant (by a Dr Sergeant) was responsible. Counsel also submitted that the ex turpi maxim did not apply at all to causes of action founded in tort.

Beldam LJ, giving the judgment of the court (Potter LJ and Bracewell J) said, at page 987A:

“We do not consider that the public policy that the court will not lend its aid to a litigant who relies on his own criminal or immoral act is confined to particular causes of action. Although Mr. Irwin asserted that in the present case the plaintiff’s cause of action did not depend upon proof that he had been guilty of manslaughter, the claim against the defendant is founded on the assertion that the manslaughter of Mr. Zito was the kind of act which Dr. Sergeant ought reasonably to have foreseen and that breaches of duty by the defendant caused the plaintiff to kill Mr. Zito. Further the foundation of the injury, loss and damage alleged is that, having been convicted of manslaughter, the plaintiff will in consequence be detained under the Mental Health Act 1983 for longer that he otherwise would have been. In our view the plaintiff’s claim does arise out of and depend upon proof of his commission of a criminal offence. But whether a claim brought is founded in contract or in tort, public policy only requires the court to deny its assistance to a plaintiff seeking to enforce a cause of action if he was implicated in the illegality and in putting forward his case he seeks to rely upon the illegal acts.”

The judgment continues that in view of the conviction the court is precluded from entertaining the claim unless it could be said that the plaintiff did not know the nature and quality of his act or that what he was doing was wrong.

As Mr Howard submitted, the court decided that the rule applied if the plaintiff sought to rely upon his illegal acts in putting forward his case and, it seems, if that was so, that was that.

In Cross v Kirkby (unreported) on 18 February 2000 the Court of Appeal (Beldam, Otton and Judge L.JJ) gave judgment in a case in which the claimant was trespassing on the defendant’s land seeking to disrupt a hunt and had violently attacked the defendant with a baseball bat. The defendant had wrestled the bat from him and hit the claimant with a single blow to the head from which the claimant had suffered serious injury. The defendant defended the claim on two grounds; self defence and the ex turpi maxim. The judge decided in favour of the claimant but awarded him only 40% of the agreed damages on the basis that he was 60% responsible for the injuries he had suffered. The Court of Appeal allowed the defendant’s appeal.

Beldam LJ would have allowed the appeal on the ground of self-defence but also on the ground that the claimant’s injury arose from his own criminal and unlawful acts. At page 6 of the transcript, Beldam LJ, also quoting Lord Mansfield, described the relevant question to be:

“whether, in this case, the plaintiff’s demand is founded upon the ground of any immoral act or conduct…”(my emphasis)

At page 8 of the transcript he also said:

“I do not believe that there is any general principle that the claimant must either plead, give evidence of or rely on his own illegality for the principle to apply. Such a technical approach is entirely absent form Lord Mansfield’s exposition of the principle. I would, however, accept that for the principle to operate the claim made by the claimant must arise out of criminal or illegal conduct on his part. In this context “arise out of” clearly denotes a causal connection with the conduct, a view which is implicit in such different cases as Lane v Holloway and the recent case to which we were referred in this court, Standard and Chartered Bank v Pakistan National Shipping Corporation & Ors, Court of Appeal transcript, Friday 3 December, 1999. In my view the principle applies when the claimant’s claim is so closely connected or inextricably bound up with his own criminal or illegal conduct that the court could not permit him to recover without appearing to condone that conduct.”

Although Beldam LJ had expressly referred to the rejection of the “public conscience” test in Tinsley v Milligan this last statement seems to have echoes of it.

Otton LJ agreed with Beldam LJ. Judge LJ, at page 11 of the transcript said:

“In summary, therefore, if ex turpi causa is to apply in tort something more than wrongdoing, whether general or even on the occasion directly in question, is needed. Perhaps the most useful starting point for discovering this additional ingredient is found in the observations of Bingham LJ (as he then was) in Saunders v Edwards [1987] 2 All ER 651, [1987] 1 WLR 1116. Although the case was concerned with an illegality arising from a misrepresentation the discussion is of general application:

Where issues of illegality are raised, the courts have to steer a middle course between two unacceptable positions. On the one hand it is unacceptable that any court of law should aid or lend its authority to a party seeking to pursue or enforce an object or agreement which the law prohibits. On the other hand it is unacceptable that the court should, on the first indication of unlawfulness affecting any aspect of a transaction, draw up its skirts and refuse all assistance to the claimant, no matter how serious his loss, nor how disproportionate his loss to the unlawfulness of his conduct. On the whole the courts have tended to adopt a pragmatic approach to this problems, seeking, where possible, to see that genuine wrongs are righted, so long as the court does not thereby promote or countenance a nefarious object or bargain which it is bound to condemn. Where the claimant’s action in truth arises directly ex turpi causa he is likely to fail. Where the claimant has suffered a genuine wrong to which the allegedly unlawful conduct is incidental, he is likely to succeed.

…

In my judgment, where the claimant is behaving unlawfully, or criminally, on the occasion when his cause of action in tort arises, his claim is not liable to be defeated ex turpi causa unless it is also established that the facts which give rise to it are inextricably linked with his criminal conduct. I have deliberately expressed myself in language which goes well beyond questions of causation in the general sense.”

In Hewison v Meridian Shipping [2002] EWCA Civ 1821, the claimant suffered serious personal injury whilst working as a crane operator on board a vessel. He brought an action for damages against the owners of the vessel, the charterers and his employers. Liability was admitted and judgment for damages to be assessed entered against the three defendants. The damages claimed included loss of wages until age 62. The claimant was 35 when the accident occurred. The defendants contended that it was against public policy to award damages for loss of earnings because continued employment as a crane operator would have required the claimant to continue to deceive his employers by fraudulently representing that he did not suffer from epilepsy. The judge rejected the claim for loss of earnings for that reason; the Court of Appeal (Tuckey and Clarke L-JJ, Ward LJ dissenting) dismissed the claimant’s appeal. To quote the headnote:

“the authorities supported the proposition that where a claimant has to rely upon his own unlawful act in order to establish part or the whole of his claim, the claim will fail, in whole or in part. In order for the claimant to continue to work in his employment, he would have to deceive his employers by falsely representing that he did not suffer from epilepsy, and would thus have committed a criminal offence: that of obtaining a pecuniary advantage by deception. This deception would be neither collateral nor insignificant, not least because of the risks to others caused by the claimant continuing to work whilst suffering from such a condition. The claimant’s deliberate deception struck at the root of the contract under which he earned remuneration. It was inappropriate for the courts to approach the case by considering the question of whether or not the public conscience would be affronted.”

In the course of his judgment Clarke LJ referred to Clunis and said, at paragraphs 27 and 28:

“The correct principle seems to me to be substantially the same as that identified by Beldam L.J. as being applicable to cases in which the maxim ex turpi causa non oritur actio applies. It is common ground that that maxim does not itself apply here because it is correctly agreed that there is no principle of public policy which prevents the appellant from pursuing his cause of action for damages for negligence or breach of duty against the respondents. The question is not whether he can recover at all but whether he is debarred from recovering part of his alleged loss.

However, as I see it, the principle is closely related. It is common ground that there are cases in which public policy will prevent a claimant from recovering the whole of the damages which, but for the rule of public policy, he would otherwise have recovered. The principle can perhaps be stated as a variation of the maxim so that it reads ex turpi causa non oritur damnum, where the damnum is the loss which would have been recovered but for the relevant illegal or immoral act. A classic example is the principle that a person who makes his living from burglary cannot have damages assessed on the basis of what he would have earned from burglary but for the defendant’s negligence.”

Tuckey LJ, at paragraph 51, said:

“Illegality may affect a tort claim in many ways ranging from an essential part of the story giving rise to liability to some remote aspect of quantum. For this reason I favour a broad test of the kind proposed by Clarke L.J. namely: is the claim or the relevant part of it based substantially (and not therefore collaterally or insignificantly) on an unlawful act? Such a broad test has the merit of simplicity. It does not involve the judge having to make very specific and difficult value judgments about precisely how serious the misconduct is or whether it would result in imprisonment or whether the claimant’s loss is disproportionate to his misconduct.”

The conclusion I draw from these authorities is that the ex turpi maxim requires a “reliance test” to be satisfied. The claim must be “founded on” or “arise from” an illegal act of the claimant (Lord Mansfield) or the illegal act must necessarily be pleaded or relied upon to sustain the claim (Tinsley v Milligan) or to put forward the case (Clunis) or the facts which give rise to the claim are “inextricably linked with” the illegality (Cross v Kirby per Judge LJ). The contrast is with a claim to which the illegality is only “collateral” or “insignificant” (Hewison) or “incidental” (Bingham LJ). It is also acceptable that only part of a claim or a loss is defeated by the maxim (Hewison).

None of the authorities to which I have so far referred concerned claims by companies.

In Standard Chartered Bank v Pakistan National Shipping Co [2000] 1 Lloyd’s Rep 218, the bank claimed against the defendants damages for deceit, misrepresentation and conspiracy for presenting falsely dated documents (bills of lading) to the bank as confirming bank of a letter of credit. The defendants raised the defence of ex turpi essentially alleging that the bank had through its employees connived at the late presentation of documents in order to claim over against the bank which had issued the letter of credit.

The Court of Appeal (Evans, Aldous and Ward L.JJ) held that the bank had made false statements to the issuing bank to the knowledge of the employee who authorised the statements to be made and that the bank would have been exposed to liabilities in deceit to the issuing bank if the latter had acted upon the statements to its loss (which in fact it did not). The Court held that the ex turpi plea failed. It did so on the basis of a comparison of the bank’s conduct with the conduct of the defendants and that “the conduct of SCB was not as egregious, though potentially unlawful, and its share of responsibility for its own loss was not so weighty that the Court should refuse to entertain the claim.” That, though described as a “pragmatic” test, seems to me to be a thinly disguised public conscience test. But it was also the submission of leading counsel for SCB that the bank’s cause of action was complete when it paid on the letter of credit in reliance on the false bill of lading and so the later presentation to the issuing bank was of no relevance to the loss. Evans LJ rejected that distinction (paragraph 50) on the basis that the decision to claim an indemnity from the issuing bank was an integral part of the decision to pay on the letter of credit. Aldous LJ, however, decided that the reliance test was not satisfied because SCB could plead and prove its case without relying on its attempt to get an indemnity from the issuing bank. Ward LJ agreed with Aldous LJ.

The decision is not an easy one. But the case could not have taken the course it did if the ex turpi maxim was not applicable at all to corporations and attribution of knowledge seems to have been thought to have been the applicable principle in that context.

The question of application of the rule to a corporation also arose on the facts addressed in an unreported decision of Jonathan Hirst QC, sitting as a deputy judge of the High Court, in Marlwood Commercial Inc v Kozeny [2006] EWHC 872 (Comm). The case concerned claims by companies which were investment vehicles arising out of the losses they suffered as a result of supposed investments in Azerbaijan. The claims were brought in deceit against those individuals said to be responsible for the fraud. The defence included allegations that the claimants had themselves, through a director, Mr Lewis, been engaged in a scheme to corrupt Azeri officials and the causes of action were directly connected to the illegal conduct of the claimants. The Judge found that three individuals, including Mr Lewis, were party to the corruption. At paragraph 135 the Judge said two key issues arose:

“(1)

Is the knowledge of Mr Lewis … to be attributed to the Claimants?

(2)

If so, does the illegality, of which the Claimants would then be treated as having been aware, mean that their claims in these proceedings are so tainted or…so inextricably linked with the corruption that the court should decline to entertain them?”

The Judge held that the answer to the first question could only properly be given after a trial.

It appears from paragraphs 173 to 178 of the judgment, that in the case of a company (“effectively his company”) the Judge would have decided that the knowledge of Mr Lewis was plainly to be attributed to it and so the claim of that company (which had been discontinued) would have failed but so, too, in the case of any other claimant company to which Mr Lewis’ knowledge of the corruption was after a trial to be attributed:

“I consider that the court should decline to entertain the deceit claim on the grounds that the alleged deceit is so closely involved with the illegal venture: ex turpi causa non oritur actio. The same applies to the conspiracy and breach of fiduciary duty claims.”

Thus the Judge seems to have thought that the case of a “one man band” was clear but also any other case in which knowledge of an unlawful act was to be attributed to the company, assuming always that what I have called the “reliance test” is satisfied.

In Sasea Finance, however, a massive fraud was committed by an individual who was the directing mind and will of the group of companies which were the vehicles for his fraud. The claim by a member company of the group against its auditors for failing to blow the whistle was the subject of a striking out application which failed. But the application was not made on the basis of the ex turpi maxim which, if the present applications by Moore Stephens are correct, is perhaps surprising. It was, I think, considerations of this sort which led to the emphasis in Mr Howard’s submissions on the feature of the fraud in this case that S&R had no assets save those which were fraudulently obtained. That, he submitted, made the fraud the fraud of the company not a fraud committed against the company.

In the circumstances of this case I think it plain that the knowledge of Mr Stojevic would be attributed to S&R at least for many of the purposes in which the law may require that issue to be addressed such as to make S&R liable to third parties for the conduct of Mr Stojevic, carried out in the name of S&R, for example by way of a claim for “knowing receipt” of monies obtained by fraud: see, El Ajou v Dollar Land Holdings plc [1994] 2 All ER 685. The test for attribution of knowledge applied was “the directing mind and will” test stated by Viscount Haldane, LC, in the leading authority of Lennards Carrying Co. Ltd v Asiatic Petroleum Co Ltd [1915] AC 705 at 713. In El Ajou that test was applied on the basis that “the directing mind and will could be found in different persons in respect of different activities” and “it was therefore necessary to identify the person who had management and control in relation to the act or omission in point.” In the case itself the knowledge of the chairman of the defendant company who took no active part in its management but who made all the arrangements for the receipt of the fraudulently acquired monies was attributed to the company in the context of a claim by the loser for knowing receipt.

In the course of his judgment, at page 706, Hoffman LJ, referring to the fraudulent transaction as “the Yulara transaction”, the chairman as Mr Ferdman and the company as DLH, said:

“The authorities show clearly that different persons may for different purposes satisfy the requirements of being the company’s directing mind and will. Therefore the question in my judgment is whether in relation to the Yulara transaction, Mr Ferdman as an individual exercised powers on behalf of the company which so identified him. It seems to me that Mr Ferdman was clearly regarded as being in a different position from the other directors. They were associates of his who came and went. SAFI charged for their services at a substantially lower rate. It was Mr Ferdman who claimed in the published accounts of DLH to be its ultimate beneficial owner. In my view, however, the most significant fact is that Mr Ferdman signed the agreement with Yulara on behalf of DLH. There was no board resolution authorising him to do so. Of course we know that in fact he signed at the request of Mr Stern, whom he knew to be clothed with authority from the Americans. But so far as the constitution of DLH was concerned, he committed the company to the transaction as an autonomous act which the company adopted by performing the agreement. I would therefore hold, respectfully differing from the judge, that this was sufficient to justify Mr Ferdman being treated, in relation to the Yulara transaction, as the company’s directing mind and will. Nor do I think it matters that by the time DLH acquired Yulara’s interest in the Nine Elms project on 16 March 1988, Mr Ferdman had ceased to be a director. Once his knowledge is treated as being the knowledge of the company in relation to a given transaction, I think that the company continues to be affected with that knowledge for any subsequent stages of the same transaction. So, for example, if (contrary to the judge’s finding) the £1,030,000 sent by Yulara on 29 May 1986 had been received beneficially by DLH as a loan, but Mr Ferdman had resigned or died a week earlier, I do not think that DLH could have said that it received the money without imputed knowledge of the fraud.”

Seen in this light, as it seems to me, El Ajou does not develop the directing mind and will test to an extent which might be thought to make it incompatible with the ex turpi rule. At one stage Mr Howard was minded to submit that so long as a company was vicariously liable for a fraud of an employee a claim to recovery of its loss would be defeated by the ex turpi rule. That, I think, goes much too far. On the other hand, Mr Simpson’s submission that different principles apply to attribution for the purposes of knowing receipt or illegality than for the ex turpi rule seems to me also to derive no support from the authorities.

The judgment of Hoffman LJ also, I think, addresses a further point which was raised in the course of submissions. If a company is to have attributed to it the knowledge of an individual in respect of a given transaction, and attribution at some other time is not material, it cannot matter that the circumstances of the company subsequently change, for example because it goes into liquidation.

The principle is not in doubt. Where an officer or employee of a company is committing a fraud upon the company itself then the knowledge of his own fraud is not the knowledge of the company. In Re Hampshire Land Company [1896] 2 Ch 743, Vaughan Williams J, at pages 749-50 expressed the principle to be applicable to cases of breach of duty as well as fraud. That was approved by the Privy Council in J.C. Houghton & Co v Nothard Lowe and Wills [1928] AC 1 at pages 15 and 19. Rix J, in Arab Bank v Zurich Insurance [1999] 1 Lloyd’s Rep 262 at pages 282-3 said of the conduct of the managing director that even if it did not come within the concept of an agent’s fraud on his principal his fault was such a breach of duty to the company “as in justice and commonsense must entail that it is impossible to infer that his knowledge of his own dishonesty was transferred” to the company.

In Belmont Finance v Williams Furniture [1979] 1 Ch 250 the principle was expressed in terms that knowledge should not be attributed to the company where the company was the “victim” of the improper conduct of its officers: see per Buckley LJ at page 261 H. The same principle applies in criminal law: Attorney-General’s Reference (No 2 of 1982) [1984] QB 624. The fact, if it be so, that the knowledge in question is the knowledge of the person or persons who are the directing mind and will of the company does not qualify or affect the application of the principle. In the Arab Bank Case, Rix J accepted a submission by the plaintiff banks, which, on the assumed facts, had lent large sums on the basis of fraudulent valuations made by the managing director of agents, that there could be primary and secondary victims of such a fraud. The claim was brought by the banks against the insurers of the agents. The banks were the primary victims but, at page 282, Rix J opined that the agents themselves were also “a victim, even if only a secondary victim, of the assumed fraud” because “one consequence of that assumed fraud has been (the agents’) liability to the (banks)…” Mr Howard submits in this case that it is unrealistic to describe S&R as any sort of “victim”. All S&R ever had it obtained by fraud.

The plaintiff was the administratrix of the estate of a prisoner (Mr Lynch) held in a police cell who hanged himself. The judge found that the police officers in whose custody the deceased was were in breach of a duty of care to take reasonable steps to prevent his suicide because they knew he was a suicide risk, but that since the deceased was of sound mind his deliberate act of suicide entitled the defendant Commissioner of Police to rely on defences of novus actus interveniens, volenti non fit injuria, contributory negligence and ex turpi causa. The headnote records, I think accurately, the decision of the Court of Appeal (Lord Bingham, C.J, Morritt and Buxton L.JJ) as follows:

“Held, (1) that where the deceased, whether of sound or unsound mind, had committed suicide when the defendant was found in breach of a duty of care to guard against his doing so, it would not represent covert connivance at or countenancing of suicide or constitute an affront to the ordinary citizen’s conscience to permit his estate to recover against the defendant; and that, accordingly, the defendant could not rely on a defence based on public policy or the maxim ex turpi causa…

(2)

Allowing the appeal (Morritt L.J dissenting), that, since the duty of care found owing to the deceased existed irrespective of his being of sound or unsound mind, and since his suicide was the very act against which the defendant had been required to guard, that act did not constitute a new or intervening act such as would break the chain of causation, nor was the defendant’s breach a failure to which he had knowingly and willingly consented; and that, accordingly, the defences of novus actus interveniens and volenti non fit injuria were inapt and could not be invoked to bar the plaintiff’s claim…

(3)

That (per Lord Bingham of Cornhill C.J), although the Act of 1945 was applicable, it was inappropriate in the circumstances to reduce the plaintiff’s award to reflect responsibility by the deceased for his loss; and that (per Buxton L.J.) since the deceased’s act was that which the defendant had been under a duty to take steps to prevent, the statutory defence was inapposite; and that, accordingly, the plaintiff’s claim succeeded in full…”

With reference to ex turpi, Buxton LJ at pages 184-6, following the lead of Kerr LJ in Euro-Diam v Bathurst [1990] 1 QB, 1 at 35, and of the Court of Appeal in Kirkham v Chief Constable of the Greater Manchester Police [1990] 2QB 283, asked the question whether or not to afford relief in such a case would “affront the public conscience” or “the conscience of the ordinary citizen”. He held not, because “here the alleged turpitudinous act is the very thing that the defendant had a duty to prevent, imposed by a law of negligence which itself appeals to public conscience or at least to public notions of reasonableness.” Buxton LJ continued at 185 E to G:

“Second, the present case does not fit at all well into the explanation of the defence given by Kerr L.J. in the Euro-Diam case [1990] 1 Q.B. 1: the defence applies where it would affront public conscience to grant relief “because the court would thereby appear to assist or encourage the plaintiff in his illegal conduct or to encourage others in similar acts.”

I accept that this does not purport to be a complete statement of the nature and terms of the defence. I also accept that the actual application of Kerr L.J.’s exposition of ex turpi causa in the Euro-Diam case itself has been disapproved: see Tinsley v. Milligan [1994] 1 A.C. 340, 363. Nevertheless, the exposition in my view remains a valuable guide to the basis of the defence, and was accepted as such by Lloyd L.J in the Kirkham case [1990] 2 Q.B. 283. To grant relief in our case does not assist or encourage either Mr Lynch or others in his situation to continue in their disapproved conduct; and even less is that the effect of the grant of relief to Mr Lynch’s representatives. Nor even are others in Mr Lynch’s position encouraged to act on their representatives’ behalf: all that the latter recover is their actual loss, and no element of profit or windfall benefit.”

Morritt LJ, dissenting, at page 190 B to C, said

“It is true that the failure to take reasonable care provides the opportunity for the suicide but the occurrence of that event depends wholly on the will and intention of the prisoner. In my view the voluntary, deliberate and informed act of a plaintiff (or one whom the plaintiff represented) intended to exploit the situation created by the defendant albeit in breach of duty precludes a causative link between the breach of duty and the consequences of the plaintiff’s action. If the law is otherwise then those who fail to take reasonable care will become insurers for the deliberate actions of those to whom they owe their duty of care. In my view this would extend the law of negligence far beyond its proper scope.”

But, at 195E, Morritt LJ did not think the act of suicide one to be branded as contrary to public policy or offensive to public conscience such that the claim was barred by the ex turpi rule. Lord Bingham, CJ, at 197E to H, also considered that “the conscience of the ordinary citizen” would not be affronted by an award of damages in such a case.

In the House of Lords reliance by the Commissioner on the ex turpi maxim was abandoned. The House (Lord Hobhouse dissenting) held that even a deliberate and informed act intended to exploit a situation created by a defendant did not negative causation where the defendant was in breach of a specific duty imposed by law to guard against that very act. Lord Hope, at page 379H, remarked that it was “unusual” for a person to be under a duty of care to prevent another person doing something to his loss, injury or damage deliberately, and, at page 381B, echoing Buxton LJ, enunciated the “very thing” test: “the deceased did to himself the very thing that the commissioner was under a duty to take reasonable care to prevent while he remained in his custody.” The House also held, reversing the Court of Appeal, that Mr Lynch’s act was “fault” for the purposes of the Law Reform (Contributory Negligence) Act 1945 and apportioned responsibility equally between his estate and the Commissioner. In this case Mr Simpson accepts that the court could reduce the claim for contributory “fault” on the part of S&R. Mr Howard commented (rightly) that the court could not do so for any contributory negligence on the part of KB or the other creditors who would be the beneficiaries of any recovery.

Mr Howard made a number of submissions about the application of Reeves. In substance, I think, those submissions came to a submission that Reeves was a decision of limited application to the very unusual circumstance in which a specific or express duty to prevent the very thing giving rise to the claim was owed by the defendant to the claimant. He also submitted that otherwise there was an inconsistency between the decisions in Reeves and in Clunis. The two cases do not lie easily together. If a choice has to be made between them, I prefer the reasoning in Reeves. But in Clunis the foundation of the loss claimed was the direct consequence of the killing of Mr Zito and the loss, if recovered, would have compensated the killer; nor do I think it would have been right to describe Dr Sergeant’s duty in terms of a duty to prevent the killing either specifically or by way of a specific application of the proper discharge of her duty of care.

(1) There can, I think, be no doubt that if the present claim were to be pursued by Mr Stojevic himself, it would be defeated by the ex turpi maxim. Mr Simpson recognises that any recovery enuring to the benefit of Mr Stojevic would fall foul of the maxim. However the claim is expressed (payment in or payment out) it would, I think, satisfy what I have called the reliance test.

It is therefore my overall conclusion that Moore Stephens’ applications to strike out or dismiss the entire claim fail.

It is trite (if occasionally criticized) law that claims to statutory interest do not permit awards of compound interest: President of India v La Pintada Co [1985] 1 AC 104.

In my judgment the claim for compound interest is hopeless. It is postulated on S&R making legitimate use by way of paying off loans or other debts or making deposits of the monies fraudulently obtained. Far from there being any evidence that the monies would have been so used, the evidence is overwhelming that the whole rationale of the fraudulent scheme was to pay away what came in so that it was not held by S&R. Moreover, I think Mr Howard is plainly right that a claim for compound interest at least requires it to be alleged and proved that Moore Stephens had knowledge from which it should have had in contemplation such a loss if Moore Stephens broke their duty of care as auditors in the manner alleged: see paragraph 21(7)

In my judgment, therefore, Moore Stephens are entitled to have paragraph 398 of the Particulars of Claim and Schedule 3 struck out.

I will hear the parties on the terms of the Order to be made, and any ancillary matters arising from this judgment, which cannot be agreed, when it is formally handed down. It was supplied to the parties in draft on 24 July 2007.