UK: Illegality, Insolvency And Fraudulent Directors: Clarity At Last?

The Supreme Court recently handed down its judgment in Jetivia SA and another v Bilta (UK) Ltd (in liquidation) and others [2015] UKSC 23. The Court was unanimous in dismissing the appellants' case that the claimants' claims against them should be struck out on the grounds of illegality and on the basis that section 213 of the Insolvency Act 1986 does not have extra-territorial effect.

Background Bilta was wound-up following its involvement in a VAT carousel fraud which left Bilta with a liability of £38 million to HMRC. Consequently, Bilta's liquidators brought proceedings against its two directors (one of whom was its sole shareholder) and against Jetivia and Jetivia's chief executive. The claims were that the four defendants were parties to an unlawful means conspiracy, which involved the directors of Bilta breaching their fiduciary duties to the company as directors, and against Jetivia and its chief executive for dishonestly assisting them in doing so. Claims were brought for damages against the defendants, and for contributions under section 213 of the Insolvency Act 1986. The appellants sought to strike out Bilta's claim on the basis that:

a. The principle of ex turpi causa or illegality applied - i.e. the principle that a party cannot bring a claim that relies on its own illegal act; and

b. In so far as the claims for contribution were based on section 213 of the Insolvency Act 1986, that section could not be invoked for it does not have extra-territorial effect.

Decision The Supreme Court was unanimous in dismissing the appeal on both points. The Court held that the directors' conduct could not be attributed to Bilta in this case where there was a claim against the directors for a breach of their duties. To do so would deprive the duties owed by a director of all meaning. The Court also found that section 213 did have extra-territorial effect.

Illegality and attribution The illegality defence was based on the notion that the claims were barred as a result of the criminal nature of Bilta's conduct while under the directors' control. In other words, it was necessary to establish that the directors' acts were 'attributed' to those of the company itself, which, if so, would mean that Bilta would effectively be relying on its own illegal acts to bring the claim.

It was argued that because Bilta's function was to serve as a vehicle for defrauding HMRC, the doctrine of illegality prevented Bilta from suing the directors as a means of recovering the company's loss for the benefit of its creditors. This prompted the court to examine the circumstances in which a director's knowledge should be attributed to the company.

In this regard, the starting position is that a company, by nature of its legal personality, can only act through its directors. Accordingly, in most cases, the directors' states of mind can be attributed to the company on normal agency principles. However, whether the state of mind can be attributed to the company in any particular case depends upon the context in which the question arises. The court determined that in circumstances such as the present case, i.e. claims against the directors arising from the use of the company for the purposes of committing a fraud, it would be inappropriate to attribute to the company the fraud committed by its directors, even though the acts and minds of the directors could in other contexts be attributed to the company. Here, the company had been a victim that suffered loss, so attribution would be inappropriate and would indeed allow the real perpetrators to defeat the claim.

There were differences in the reasoning applied by the judges, but Lord Neuberger summarised the decision in his judgment:

"Where a company has been the victim of wrong-doing by its directors, or of which its directors had notice, then the wrong-doing, or knowledge, of the directors cannot be attributed to the company as a defence to a claim brought against the directors by the company's liquidator, in the name of the company...".

As the court did not find that this was a case where the acts of the directors could be attributed to the company, the purpose and scope of the defence of illegality was not explored more generally and the court concluded that the principle of illegality should be considered further in a more suitable case.

Section 213 of the Insolvency Act Section 213 allows a liquidator to apply to court to seek a contribution from 'any persons' who knowingly engaged in action with intent to defraud creditors. The appellants in this case argued that the reference to 'any persons' only extended to persons in the United Kingdom, so a contribution could not be sought from Jetivia, which was registered in Switzerland, or from its chief executive, Mr Brunschweiler, who was domiciled in France.

Lord Sumption described this argument as "misconceived", on the basis that the English court has worldwide jurisdiction when winding up an English company. The court ruled that insolvency law has long contained provisions granting powers to office holders to recover from those contributing to a company's insolvency.

In an ever globalised world, it would be difficult to utilise these powers if they did not extend beyond the United Kingdom. Referring to a number of similar discretionary powers contained in the Insolvency Act which also include reference to 'any persons', for example sections 214, 238 and 239, it was noted that none of those provisions contained any express limits on their territorial reach. Lord Sumption referred to the decision in In re Paramount Airways Ltd [1993] Ch 223 which held that section 238 applied without any territorial limitation and considered that that decision was equally applicable to section 213.

Reed Smith comment: what this means for officeholders Albeit that the outcome of the Supreme Court's decision appears unsurprising, achieving a common sense and just result, it is a welcome development following the House of Lords judgment in Stone & Rolls v Moore Stephens [2009] 1 AC 1391, a case in which an auditor successfully struck out a claim for negligence brought by the liquidators of a fraudulent 'one man company', on the grounds of illegality. Lord Neuberger's view was that Stone & Rolls provides little in the way of reliable principle and should be confined to its facts, and so should be "put on one side and marked 'not to be looked at again'".

The decision also confirms the approach in Paramount of giving a literal meaning to 'any persons' in section 213, 214, 238 and 239 of the Insolvency Act so as to give meaningful effect to the provision and will be of comfort to liquidators seeking a recovery from outside the United Kingdom.

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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