One-Man Company Engaging In Fraud Cannot Sue Its Own Auditors.

Moore Stephens (a firm) v Stone & Rolls Ltd (in liquidation) [2009] UKHL 39

The House of Lords, in its final week of sitting before the Supreme Court starts work in October, handed down a welcome judgment for auditors by dismissing an appeal brought by the liquidators of a company (Stone & Rolls Ltd) against the company's former auditors (Moore Stephens) for contractual and tortious negligence. Their Lordships ruled (by a 3-2 majority) that the courts will not assist a one-man company to recover losses which have been brought about by its own fraud.

The sole director and shareholder of Stone & Rolls Ltd [double dagger]'S&R'), a Mr Zvonko Stojevic, had used his company to defraud banks of tens of millions of dollars, following which a European bank sued and was awarded substantial damages. Unable to pay, the company was placed into liquidation. In bringing the claim on behalf of its creditors (for losses of $174 million), the liquidators argued that Mr Stojevic's actions were distinct from those of the company, that S&R was itself a victim of the fraud, and that it should not be prevented from bringing a claim for breach of duty (in contract and tort) against the auditors, who had failed to spot the fraud.

The majority in the House of Lords noted that while fraud may be an example of the 'very thing' auditors are engaged to detect, this does not supersede the principle that a company cannot bring a claim that relies on its own illegal conduct (applying the principle of ex turpi causa non oritur actio -- often summarised as 'no court will lend its aid to a man whose cause of action is founded upon an illegal or immoral act'). Following Caparo Industries plc v Dickman [1990] 2 AC 603, it was clear that auditors owed a duty to a company's shareholders and not to its creditors (or liquidators). In this case, as the auditors' duty was owed to Mr Stojevic, and therefore the only person to whom the duty was owed was party to the illegal conduct, the company was not entitled to rely on the fraud to claim a breach of duty. Accordingly, ex turpi causa was a complete defence for the auditors and the liquidators' claim was struck out.

Dissenting, Lord Scott and Lord Mance found that ex turpi causa should not be a defence, and that the liquidators should be able to claim from the auditors for their breach of duty. Lord Scott concluded that, though the case was "very difficult, Mr Stojevic's dishonest actions should not be attributed to S&R for the purposes of S&R's claim against the auditors: in essence, the principle of ex turpi causa was designed to prevent wrongdoers from benefiting from their actions, and in this case since the company was insolvent it was the creditors who would be the beneficiaries of the claim (and not the shareholders, such as Mr Stojevic). The creditors had done no wrong and did not deserve to be barred. Lord Mance agreed, stating that 'the world has sufficient experience of Ponzi schemes operated by individuals owning 'one-man' companies for it to be questionable policy to relieve from all responsibility auditors negligently failing in their duty to check and report on such companies' activities'

The judgment is significant for its consideration of the Caparo v Dickman principles, and in particular the way in which the House examined the circumstances in which fraud by a company's principals is attributable to the company, particularly in the case of sole shareholder/directors. In this case, the House noted that the fraud benefited the company in the first instance and that as Mr Stojevic was the sole directing mind and will of the company, Stojevic's fraud was attributable to the company as its own. Though the majority found that the creditors could not recover, they were careful to limit the ex turpi causa defence to one-man company frauds.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Mr Jeremy Mash

Olswang

90 High Holborn

London

WC1V 6XX

UNITED KINGDOM

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