Worldwide: Controlling Minds: Whose Knowledge Counts?

Federal Republic Of Brazil And Another v Durant International Corporation And Another [2012] JRC 211

1. In Federal Republic of Brazil and Another v Durant International Corporation and Another [2012] JRC 211 the Plaintiffs sought recovery of monies (in the principal sum of US$ 10.5 million) from the Defendant companies on the basis that, inter alia, they had been received with knowledge of their tainted origin.

2. A question of crucial importance for the Royal Court - Commissioner Page QC - was therefore, whose knowledge could be attributed to the acts of the Defendant Companies.

THE FACTS

3. In order to facilitate the movement and concealment of the diverted monies, Paulo and Flavio Maluf created an offshore asset holding structure which was administered in Jersey. At its apex sat Sun Diamond Limited ("SDL"), of which the Court found that at the times of the material transfers, Paulo Maluf was the sole shareholder. In turn SDL was Trustee of the Sun Diamond Trust ("SDT"), a Jersey trust of which Paulo Maluf was the principal beneficiary. SDT held all the shares in a BVI company, Durant International Corporation ("Durant"), which itself held all the shares in a further BVI company, Kildare Finance Limited ("Kildare"). Kildare held units in six unit trusts created for the purposes of acquiring shares in the family business Eucatex SA with the diverted monies.

4. At all material times Flavio Maluf was the director of Durant and gave all instructions for money movements. The other director of Durant and sole director of Kildare was a Swiss based intermediary who it was asserted acted on the instructions of the Malufs. Notably, Paulo Maluf was never a director of either of the BVI companies.

5. The Plaintiffs maintained that the knowledge of Flavio Maluf and more importantly that of Paulo Maluf, notwithstanding his lack of formal appointment, could be attributed to Durant and Kildare on the following bases:

a. Paulo Maluf was the ultimate beneficial owner of Durant and Kildare in his capacity as principal beneficiary of SDT;

b. Paulo Maluf was the settlor of SDT and intimately involved in setting up the corporate structure;

c. At all material times Paulo Maluf held the bearer shares of SDL;

d. Flavio Maluf provided instructions for money movements over the companies in his capacity as director of Durant and Kildare.

THE LAW

6. The issue of attribution of knowledge, in respect of the acts of a corporate entity, is one which is not always easy to resolve (as demonstrated by El Ajou v Dollar Land Holdings Plc [1994] 1 BCLC and Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500). The starting point will usually be to look at who the directors of the company are. However, difficulties as to the attribution of knowledge tend to arise where the act or omission complained of has been committed by an officer or employee of a company, without the knowledge or involvement of the board of directors.

7. The Royal Court cited the classic test of Lord Haldane L.C. in Lennard's Carrying Co. Ltd. V Asiastic Petroleum Co. Ltd [1915] AC 705, namely that the court should look to who is the "directing mind and will" of the company in question, noting as Lord Hoffmann did that "different persons may for different purposes satisfy the requirements of being the company's mind and will." (Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500, at 474)

8. However, the Court recognised that, in and of itself, Lord Haldane's test was not to be treated as a panacea. Indeed the Court found that in a time where a growing trend exists to the effect that the legislature increasingly provides for the imposition of liability on corporate entities, it is more important than ever to look at "whose act (or knowledge, or state of mind) was for this purpose intended to count as the act...of the company". (Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500, per Hoffman L.J. at 508)

9. However, in Brazil the Royal Court found that where the acts or omissions in question are those of someone who is "intimately associated with the ultimate ownership and control of the company as Paulo and Flavio Maluf", the Court found that there "could be no room for doubt" as to whose knowledge should be attributed to Durant and Kildare. Accordingly, the Court found that "it is plain from the evidence that that concept [controlling mind and will] could not be personified more strikingly that it was by Paulo Maluf and Flavio Maluf."

COMMENT

10. The flexibility afforded by the test adopted by the Royal Court in Brazil allows for reflection upon the policy considerations aimed at eliminating financial crime within offshore centres such as Jersey, prior to the Court reaching a conclusion as to whose knowledge should be attributed to a company.

11. The judgment in Brazil serves to highlight the Royal Court's established practice of looking beyond the articles of association and rules of company law to ascertain who truly exerts control over corporate structures. Further it has the potential to prevent wrongdoers who are "intimately associated with the ultimate ownership and control of the company" from exploiting such entities as a means of distancing themselves from illegal transactions, thereby allowing companies used for the purposes of financial crime to escape liability for claims in knowing receipt.

12. The concept of a controlling mind and will is already embodied in Jersey's AML/CFT legislation under Article 2 of the Money Laundering (Jersey) Order 2008 - Beneficial ownership and control. This identifies that a beneficial owner or controller of a company is deemed to be such where that person is "an individual who ultimately controls or otherwise exercises control over the management of that other person [in Brazil, the Defendant companies] (whether the individual does so alone or with any other person or persons)". It appears that the legislature had exactly in mind the circumstances which arose in Brazil when drafting the law.

13. The Handbook which accompanies the AML/CFT framework also refers extensively to the concept of controllers but, to date, there has not been a Jersey case which has fully considered the issue and given such clear guidance to the regulated community.

14. We would also draw a distinction between controllers and shadow directors. Shadow directors tend to operate in the open even if they are not directors of record. In order to distance themselves from the proceeds of crime, controllers such as Paulo Maluf do not do so and therefore are often, but not always, harder to detect.

15. Now more than ever, it is important for those involved in the administration of corporate entities to identify the ultimate beneficial owners of the structures they administer and those persons who may exert sufficient control over those entities such that their acts could be deemed to be those of the entity.

16. In summary, financial institutions have a legal obligation to look beyond the directors of record and to identify the substance of the control arrangements behind structures and Brazil sets out the legal test to be applied. We would recommend that institutions revisit not only their policies and procedures manuals but also consider the true nature of the relationships with those who provide instructions.

17. The decision of the Royal Court has recently been appealed by the Defendants, however, that appeal was dismissed in its entirety. The Court of Appeal [2012]JCA071 held that the evidence before the Royal Court was more than sufficient to enable it to reach a finding that, on the balance of probabilities Paulo Maluf was connected with the ownership and control of the Companies such that the knowledge of the Malufs was properly attributed to them.

18. Baker & Partners acted for the Plaintiffs: the Federal Republic of Brazil and the Municipality of São Paulo.

www.bakerandpartners.com

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.

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