London Market - December 2009

Professional negligence, knowledge of agent

Stone & Rolls Ltd v Moore Stephens (30 July 2009), Stone and Rolls (S&R) had been used as a vehicle for defrauding banks by its sole director, Zvonko Stojevic.  On discovery of the fraud, Komercni Bank SA, a main victim to his fraud, sued S&R and Mr Stojevic for deceit.  This amounted to US$100 million; S&R could not pay and went into liquidation.

The liquidators brought a professional negligence claim on behalf of S&R against Moore Stephens, the auditors of S&R.  It was alleged that auditors should have detected Mr Stojevic’s deceit.  The auditors applied to strike-out the claim on the basis of ex turpi causa non oritur actio, that an action may not be founded on illegality.

The application failed at fist instance, was reversed by the Court of Appeal and went to the House of Lords, where the auditors accepted they had breached their duty of care, which in turn enabled the fraudulent activity to continue.  S&R’s liquidators contended that S&R were merely vicariously liable for that fraudulent conduct and therefore the auditors could not plead ex turpi causa to defeat its claim, as in order to do this, S&R would need to be primarily liable.

Held
Lord Walker referred to the principle that knowledge of an agent would not be imputed to its principal where that knowledge related to the agents own breach of duty to the principal (re Hampshire Land Co [1892]).  This “adverse interest exception” was deemed to be a general principle of agency which could apply to any issue as to a company’s notice, knowledge or complicity, whether arising as a matter of claim or defence.  This principle was pleaded to insulate the company, for the purposes of the ex turpi causa rule, from Mr Stojevic’s fraudulent conduct.  However there was no doubt Mr Stojevic was the quintessence of the company.

The House of Lords therefore held by a majority, Lord Scott and Lord Mance dissentin, that the appeal should be dismissed. 

S&R was a one-man vehicle used by an individual, Mr Stojevic, to defraud. S&R was therefore primarily liable for Mr Stojevic’s frauds. Accordingly, the auditors could rely on ex turpi causa. If the auditors were held liable, this would basically amount to allowing S&R to benefit from its own illegal activity as “a company, exclusively controlled by a single director so as to be primarily liable for frauds committed against third parties, could not bring a claim for damages against its auditors …since any such claim would be based on the company’s own illegal conduct and was accordingly debarred by the defence of ex turpi causa non oritur actio.”

Lord Waker stated that:

1. The illegality defence, that no one could found a cause of action on his own criminal conduct, was a fundamental principle of public policy (Holman v Johnson [1775]).
2. The test for its application is whether the claimant had to rely on or plead his own illegality (Tinsley v Milligan [1994]).
3. If Mr Stojevic had carried out his frauds on his own, rather than through the company, neither he nor his trustee in bankruptcy would have had a claim against the auditors, since the illegality defence would have been unanswerable.