November 8, 2019

Ending the “blunt force” of the illegality defence in Stone & Rolls

Singularis (In Official Liquidation) -v- Daiwa Capital Markets Europe Ltd [2019] UKSC 50

The Supreme Court has handed down its much awaited decision…

Overview

The decision in this appeal by Daiwa focuses on whether the actions of a dominant personality owner-director should be attributed to the company; and, if so, whether a claim by the company against its bank should fail by reason of illegality, among others.

The Supreme Court justices have held unanimously that the fraud by the owner-director (Mr Al Sanea) was not attributable to the company, and therefore the illegality defence does not apply (although the defence would have failed in any event due to other reasons).

This decision confirms a trend seen in several cases since Moore Stephens (a firm) -v- Stone & Rolls Limited (in liquidation) [2009] UKHL 39 that rejects the 'one man band' illegality defence.  In doing so it permits a more nuanced deduction for contributory negligence, rather than the 'all or nothing' "blunt instrument of the illegality defence".

Background facts

Singularis is a company registered in the Cayman Islands and set up to manage the personal assets of Mr Al Sanea.  He was the sole shareholder, a director and also Singularis' chairman, president and treasurer.  The company's six other directors were reputable but had no influence on its running.  

The appellant, Daiwa, is the London subsidiary of a Japanese investment bank and brokerage firm.

In 2009 Mr Al Sanea instructed Daiwa to make eight payments, totalling approximately US$204,500,000, out of Singularis' account.  Daiwa duly made those payments, which were fairly obvious misappropriations of Singularis' funds and relied on documentation provided by Mr Al Sanea which he knew to be false.

Having been put into voluntary liquidation, the liquidators brought a claim against Daiwa in 2014 for the full amount of the payments, based on (i) its alleged dishonest assistance in Mr Al Sanea's breach of fiduciary duty and (ii) breach of Daiwa's Quincecare duty of care to the company, by reason of Daiwa's having given effect to payment instructions which it ought in the circumstances to have questioned.

Judgment

The illegality defence is founded on the basis that a valid claim does not arise in connection with a claimant's own illegal act.

The Supreme Court unanimously upheld the First Instance Judge's rejection of Daiwa's illegality argument on the basis that Singularis' fraud could not be attributed to the company, rejecting Daiwa’s argument that Singularis was a “one-man company” as Singularis had other directors, even if they were largely inactive, and that, in any event, Stone & Rolls was not to be taken as establishing a rule that the illegality defence was available where there were no innocent directors or shareholders. In any case, the test for a successful defence in Patel -v- Miraz [2016] UKSC 42 was not met.  That test dictates that the Court should make a flexible assessment of whether the public interest would be harmed by upholding the enforcement of an illegal contract, rather than applying the rigid 'reliance' test (Tinsley -v- Milligan [1994] 1 AC 340), whereby a party to an illegal contract cannot enforce a claim against the opposition if he has to rely on his own illegal conduct as an element of his claim.

However, the defence would have failed irrespective of a finding of attribution due to the context in which the defence was raised, namely, the Quincecare duty: this duty would be undermined if the bank were able to deny the claim due to illegality by Mr Al Sanea when it is that very illegality which causes the duty to arise.  There are also good public policy reasons for preventing financial institutions from escaping their liability in these circumstances and, it would be unfair and disproportionate to allow the defence to succeed; contribution was more appropriate.

As Mr Al Sanea was the "directing mind" and sole shareholder of Singularis, Daiwa should have been cautious about instructions given by him, and so should have suspended the payments pending the completion of reasonable enquiries.  In failing to do so, Daiwa breached its Quincecare duty of care to Singularis, which was a victim of that negligence as opposed to the author of its own misfortune.

Comment

The consistent rejection of the Stone & Rolls illegality defence in this decision continues the trend seen in Bilta (UK) Ltd -v- Nazir (No 2) [2015] UKSC 23, which stands as authority that where a company has been the victim of wrongdoing by its directors, the wrongdoing of the directors cannot be attributed to the company as a defence to a claim brought by the directors.

In Stone & Rolls the beneficial owner and sole director was the "directing mind and will" of the company.  Therefore knowledge of his fraudulent activities was attributed to the company, and the company could not complain that the auditors failed to detect it.  That decision was criticised in Bilta and it was suggested it should be confined to its facts. The Bilta decision highlighted that the key to establishing attribution to the company was the content and purpose for which the attribution was relevant.  The Supreme Court in Singularis confirms this context approach to attribution.  Here the relevant context was the Quincecare duty: to attribute Mr Al Sanea’s fraud to the company would “denude the duty of any value in cases where it is most needed”.

The Supreme Court's latest decision in Singularis confirms that Stone & Rolls is ultimately a case which has no majority decision; it stands as authority for the point which it decided, but nothing more and may now "finally be laid to rest".

That may overstate the impact more generally but it is clear that for an illegality defence to stand a chance both the specific fact pattern and the policy considerations will need to point in the right direction.  Daiwa did not achieve that in Singularis, and few will.