Law report

Negligence—Auditor—Ex turpi causa non oritur actio

House of Lords, Lord Phillips, Lord Scott, Lord Walker, Lord Brown & Lord Mance, 30 July 2009

A company whose sole director, shareholder and controlling mind is that of a fraudulent individual, who has used the company as a vehicle for committing frauds on banks, will be barred by the principle of ex turpi causa non oritur actio from bringing a claim against the company’s auditors for negligence in failing to stop the fraud.

Michael Brindle QC, Mark Simpson QC and David Murray (instructed by Norton Rose LLP) for the company.

Jonathan Sumption QC and Tom Adam QC (instructed by Barlow Lyde & Gilbert LLP) for the auditors.

S was the sole directing mind and will as well as the beneficial owner of the claimant company. He used the company as a vehicle for defrauding banks. Both S and the company were successfully sued for deceit by the bank which was the principal victim of the fraud. Neither S nor the company could satisfy the judgment.

The liquidator of the company brought proceedings in the company’s name against the defendant auditors, seeking to recover losses caused in consequence of the extension of the period of its fraudulent activity that, it was submitted, was caused by the auditors’ breach of duty. The auditors applied to strike out the claim. They argued that the action was founded on the company’s own fraud and was therefore met by the defence ex turpi causa non oritur actio. The judge ruled in favour of the liquidator. The Court of Appeal allowed the auditors’ appeal and the company appealed to the House of Lords.

Lord Phillips:

His lordship summarised his decision:

(i) Under the principle of ex turpi causa the court would not assist a claimant to recover compensation for the consequences of his own illegal conduct;

(ii) the instant case raised the question of whether, and if so how, that principle applied to a claim by a company against those whose breach of duty had caused or permitted the company to commit fraud that had resulted in detriment to the company;

(iii) the essential issue was whether, in applying ex turpi causa in such circumstances, one should look behind the company at those whose interests the relevant duty was intended to protect;

(iv) while in principle it would be attractive to adopt such a course, there were difficulties in the way of doing so to which no clear resolution had been demonstrated;

(v) on the extreme facts of the instant case it was not necessary to attempt to resolve those difficulties. Those for whose benefit the claim was brought fell outside the scope of any duty owed by the auditors. The sole person for whose benefit such duty was owed, being S who owned and ran the company, was responsible for the fraud;

and (vi) in those circumstances ex turpi causa provided a defence to the claim.
 

His lordship would therefore dismiss the appeal.

Lord Walker:

Had S acted alone in his fraud, he would have had no cause of action against the auditors because of the ex turpi causa rule. The ex turpi causa rule was distinct from the general principle that a claimant should not obtain a personal profit from his own wrong, although the two often overlapped.
The same results would have followed if S had had an individual partner in crime. Two highwaymen could be partners in crime but neither could sue the other for an account: Everet v Williams (1725). The bill in equity for a partnership account would also have been dismissed out of hand if it had been brought, not by Everet himself but by the administrator of his insolvent estate, even though the administrator might have been suing exclusively for the benefit of those whom the pair had robbed.
It should not make a difference that the company, S’s partner in crime, was not an individual but a corporation. Once it was accepted that a company could have a guilty mind (Royal Brunei Airlines Sdn Bhd v Tan [1995] 3 All ER 97) and (second) that the company was directly (and not merely vicariously) liable for the frauds, then it was in just the same position as one of the highwaymen.
Someone who had been robbed by the highwaymen would have had a direct civil claim against both as joint tortfeasors, just as in the instant case the bank had a claim against S and the company. But the bank had no possibility of a direct claim against the auditors. What if there were innocent minority shareholders who had no say in the management of the company? What if majority shareholders, even, had been “hijacked” by a fraudulent but dominant managing director? Those were difficult questions but cases of that sort would plainly not be suitable for a strike-out. In a case of that sort the court would have to enquire closely into the facts in order to see whether it would be contrary to justice and common sense to treat the company as complicit. But in the instant case it was the claimant’s own case that the position was clear. The instant case was a rare and extreme case, so extreme that it was appropriate for summary disposal.

His lordship would also dismiss the appeal.

Lord Brown delivered a concurring judgment and Lord Mance and Lord Scott dissented.