Australia: Knowingly assisting fraud: Victorian Court of Appeal provides guidance

Harstedt Pty Ltd v Tomanek [2018] VSCA 84

Often, when fraud occurs, the victim is left with very few (if any) options for recovery against the fraudster. Typically, this is either because the fraudster has no remaining assets against which a judgment can be enforced, or in extreme circumstances, the fraudster has 'skipped town' and cannot be located.

The victim's only options are therefore third parties who may have been involved in the commission of the fraudulent conduct.

Recently, the Victorian Court of Appeal handed down a decision casting light on the issue of when a third party can be held responsible for its involvement in fraudulent activity.

Background

The case involved Harstedt Pty Ltd (Harstedt) seeking to invest in a scheme whereby investors were promised handsome profits, to be generated by the investment of capital by a humanitarian organisation. Harstedt deposited $250,000 into a bank account in the name of Apollo Development Enterprises Pty Ltd (Apollo). Several months later, a director of Apollo and another investor arranged for the funds in the account, including the sum deposited by Harstedt, to be transferred to an account in Spain that was not in the name of Apollo. From there, the funds vanished without a trace.

Harstedt commenced proceedings against Apollo and others associated with Apollo, including Apollo's company secretary, Mr Tomanek. Harstedt argued that Apollo had committed a fraudulent breach of trust by transferring the funds overseas into an account not in the name of Apollo, without the consent of investors. Harstedt also argued that Mr Tomanek, as company secretary, was also liable as a 'knowing assistant' in the fraud.¹

The trial judge decided in favour of Harstedt against Apollo, deciding that Apollo's conduct in transferring the funds amounted to a fraudulent and dishonest breach of trust. Mr Lopez, who was a director of Apollo was also found to be liable as 'knowing assistant' in the fraud.

Relevantly, however, the trial judge dismissed Harstedt's claim against Mr Tomanek.

In the proceedings before the Victorian Court of Appeal, Harstedt appealed the decision to dismiss the claim against Mr Tomanek.

Whilst ultimately deciding in favour of Mr Tomanek, their Honours² helpfully identified the different types of claims that can be made against third parties who are involved in breaches of fiduciary duties.

Their Honours then dealt with what is required to prove 'assistance' of a breach of trust or fiduciary duty, including a discussion of what is necessary to establish 'knowledge' of fraudulent activity.

Claims against third parties

Importantly, Harstedt did not allege that Mr Tomanek had received, dealt with, or otherwise benefitted in any way from the misappropriation of the funds held by Apollo.³ Rather, Harstedt sought to allege that Mr Tomanek was liable on the basis that he, like Mr Lopez, was a 'knowing assistant' in the fraud perpetrated by Apollo. Their Honours noted that the state of the law on accessorial liability in this context has been riddled with uncertainty and disunity.

In addition to the 'knowing receipt' form of liability, where a party has actually received or benefitted from misappropriated funds from a breach of fiduciary duty or fraudulent activity, their Honours discussed the various other forms of liability which may attach to third parties, summarised briefly below:

• 'Knowing assistance' in the breach – where a person knowingly assists with a dishonest and fraudulent scheme. This was the claim brought against Mr Tomanek and is discussed further below
• 'Knowing inducement' or immediate procurement of the breach – where a third party procures or in some way induces fraudulent conduct or a breach of fiduciary duty they may be liable as an accessory. This type of liability is distinct from someone who actually participates or assists in the fraud
• Corporate alter ego – where a company is the 'corporate creature or vehicle' of the wrongdoer. In such cases, the company is fully liable for the profits made as a result of the fraudulent activity or the breach of the fiduciary duty, and
• Trustee de son tort – essentially, this is where a party is not a trustee but presumes to act as a trustee and then commits a breach of trust or fraudulently profits from their position. In such circumstances, the trustee is to be held liable as a 'trustee de son tort', translated as, 'of his own wrong'.

Although it may seem that the above categories draw extremely fine and possibly arbitrary distinctions in relation to fraudulent and dishonest conduct by either corporate entities or individuals, the decision in Harstedt serves as a timely reminder that it is imperative for pleadings and causes of action to be appropriately framed to ensure the best possible prospects of recovery for litigants.

'Knowing assistance' by a third party

In Harstedt, their Honours took the opportunity to canvass the elements required to establish that a person has 'knowingly assisted' fraudulent conduct or a breach of a fiduciary duty. It was alleged by Harstedt that, although Mr Tomanek did not directly benefit from the fraudulent scheme devised by Apollo, he should nonetheless be held liable on the basis that he assisted in the scheme. Under Australian law, the necessary elements of establishing liability of a third party for 'knowing assistance' are generally understood as follows:

• the existence of a fiduciary duty (as trustee or otherwise)
• a dishonest and fraudulent breach on the part of the fiduciary
• assistance by the third party in that breach, and
• knowledge on the part of the third party of the circumstances constituting that breach.

It was common ground between the parties that at the time of the transfer of the funds, Apollo, as trustee of an express trust, owed Harstedt a fiduciary duty in respect of the $250,000 deposited into Apollo's bank account. Further, Mr Tomanek conceded that Apollo's conduct was dishonest and fraudulent, amounting to a breach of the fiduciary duty owed to Harstedt.

However, the key questions before the court was whether Mr Tomanek had the requisite knowledge of the fraudulent conduct and whether he had 'assisted' Apollo in perpetrating the fraud against Harstedt.

Knowledge

In finding that it was 'more probable than not'⁴ that Mr Tomanek had knowledge of Apollo's fraudulent scheme, their Honours provided useful guidance on the requirement of knowledge when establishing liability on the part of third parties involved in fraud and breaches of fiduciary duties. Referring to the decision in Baden⁵, their Honours held that knowledge can be established within one of the following categories:

1. actual knowledge
2. wilfully shutting one's eyes to the obvious
3. wilfully and recklessly failing to make such inquiries as an honest and reasonable person would make
4. knowledge of circumstances which would indicate the facts to an honest and reasonable person, or
5. knowledge of circumstances which would put an honest and reasonable person on inquiry.

Their Honours affirmed the position that since the High Court's decision in Farah⁶, knowledge falling within any of the first four of the above categories, but crucially not the fifth, represents the law in Australia.

However, the finding that Mr Tomanek had knowledge of Apollo's conduct was not sufficient to entitle Harstedt to relief from Mr Tomanek. Harstedt was additionally required to prove that Mr Tomanek also had in fact 'assisted' Apollo.

Assistance

Their Honours noted that case law on the issue of what constitutes 'assistance' in respect of third party liability currently offers very little guidance and that 'in practical terms, the ways in which a third party may provide assistance are myriad.'⁷

Harstedt argued that evidence of Mr Tomanek's assistance could be found, among other things, in the fact he was company secretary of Apollo, signatory to its bank accounts and was promoter of the fraudulent scheme in question.

Mr Tomanek in response argued that Harstedt had failed to adduce any evidence that pointed to any active involvement in Apollo's fraudulent conduct. In fact, Harstedt was forced to concede that it could not point to any individual act by Mr Tomanek that facilitated the transfer of the investors' funds.

In this regard, it was accepted that Mr Tomanek had not authorised the debiting of Apollo's bank account when the funds were transferred overseas.

Their Honours concluded their remarks by noting that simply because a company officer is considered part of the 'inner sanctum' of a company, this does not mean that the officer assists or participates in any dishonest and fraudulent activities of the company.

Assistance by acquiescence?

Crucially, Harstedt advanced its claim against Mr Tomanek only on the basis of direct and active involvement in the fraudulent conduct of Apollo, which it was unable to sustain.

It did not contend that Mr Tomanek acquiesced in Apollo's dishonest and fraudulent design such that his acquiescence caused the loss arising from Apollo's fraudulent conduct and breach of fiduciary duty. Their Honours therefore did not need to determine whether mere acquiescence could amount to 'knowing assistance' by a third party.

Their Honours did, however, note that the authorities on this point 'appear to be in disharmony'.⁸

The answer to this question may have significant implications in future cases as it will be necessary to determine to what extent a person can simply 'turn a blind eye' to fraudulent conduct and not be held responsible.

In any case, this decision serves as an important reminder to litigants that careful pleading is required when framing an action for breach of fiduciary duty or the existence of fraudulent conduct on the basis of 'knowing assistance'.

Footnotes

¹ In Barnes v Addy (1874) 9 Ch App 244, the seminal decision dealing with breaches of trusts and fiduciary duties, it was held that a third party could breach a trust either by 'knowing receipt' or 'knowing assistance'.
² Santamaria, McLeish and Niall JJA.
³ This form of 'knowing receipt' liability is often called the 'first limb' of Barnes v Addy, see above footnote 1.
⁴ [2018] VSCA 84, 103.
⁵ Baden v Société Générale pour Favoriser le Dévelopment du Commerce et de l'Industrie en France SA [1992] 4 All ER 16. ⁶ Farah Constructions Pty Ltd v Say-Dee Pty Ltd (2007) 230 CLR 89.
⁷ [2018] VSCA 84, 116.
⁸ [2018] VSCA 84, 84.

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