Worldwide: Financial Institution Liable When Put On Inquiry Of A Misappropriation Of Funds

Last Updated: 9 February 2018
Article by James Cooper

On 1 February 2018 the Court of Appeal handed down judgment in the case of Singularis v Daiwa [2018] EWCA Civ 84, dismissing all of the stockbroker's appeals and upholding the decision of the High Court, which found that Daiwa was negligent in paying out monies from its client account on the instructions of one director and the only shareholder of the client, where the circumstances indicated that those client instructions may not have been bona fide.

This case serves as a warning to all institutions handling client monies and marks the first time that the "Quincecare duty" (established more than 25 years ago in the case of Barclays Bank Plc v Quincecare [1992] 4 All ER 363) has been applied. It also looks at issues of attribution and Daiwa's (unsuccessful) defence of illegality applying the test in Patel v Mirza [2016] UKSC 42.

Facts

Singularis (the "Company") was wholly owned by a high net worth individual, Mr Al Sanea, to manage his personal assets. Mr Al Sanea was a director of the Company, together with his wife, his daughter, and four other individuals of standing within the business community. Mr Al Sanea also, and separately, owned a substantial business group based in Saudi Arabia known as the Saad group.

Daiwa, the London-based subsidiary of a Japanese investment bank and brokerage firm, was at the time primarily an equity and bond brokerage business. Daiwa entered into a stock lending agreement in April 2007 with the Company, pursuant to which the Company made equity investments generally using debt financing. Daiwa held the Company's funds in its client account for this purpose. The shares the Company purchased stood as security for the loans and Daiwa was entitled to make margin calls on the company in certain circumstances.

During the emergence of the financial crisis, the Company's liquidity remained at sufficient levels to meet any margin calls from Daiwa. However, in the first half of 2009, the Company sold a number of significant shareholdings. Later, it was reported that the Al Gosaibi group (of which Mr Al Sanea's wife was part) had defaulted on a $1bn debt, that the Saudi Arabian money authority had frozen the assets of Mr Al Sanea and his family, and that the Saad group had written to 40 lender banks seeking to restructure its loans. Daiwa's executives raised concerns as to the Company's continued solvency and questioned whether, and how, they might seek to exit the relationship. Caution was advised regarding the sums held on account.

Throughout June and July 2009, Daiwa received several requests from Mr Al Sanea to pay monies out of the Company's client account to Saad group companies, totalling $204m, which were largely authorised without further enquiry.

On 24 July 2009, the Cayman Courts issued a worldwide freezing order over the assets of the Saad group. The Company ultimately went into liquidation and the liquidators brought a claim against Daiwa for repayment of the $204m claiming:

  1. Mr Al Sanea had acted in breach of his fiduciary duty to the Company by instructing Daiwa to make these payments and that Daiwa's staff had dishonestly assisted Mr Al Sanea to defraud the Company; and
  2. Daiwa was liable to the Company in negligence having breached the Quincecare duty.

Daiwa was found to not have dishonestly assisted Mr Al Sanea's breach of fiduciary duty. Whilst several defences were raised in relation to the second claim, the key points at first instance and on appeal were whether the Quincecare duty applied where only the creditors of the Company, to whom the duty is not directly owed, stand to benefit from it in practice. Further, whether Mr Al Sanea's fraudulent conduct/knowledge should be attributed to the Company so as to bar its claim against Daiwa on grounds of illegality.

The Quincecare Duty

This duty is derived from the judgment of Barclays Bank Plc v Quincecare [1992] 4 All ER 363: "...a banker must refrain from executing an order if and for as long as the banker is "put on inquiry" in the sense that he has reasonable grounds (although not necessarily proof) for believing that the order is an attempt to misappropriate the funds of the company..."

At first instance the Judge considered the scope of Daiwa's duty and held that Daiwa did owe a duty of care to the Company in respect of the money in its client account and that Daiwa was in breach of the Quincecare duty of care. The Judge referred to "obvious, even glaring, signs that Mr Al Sanea was perpetrating a fraud on the company" which should have put Daiwa on inquiry that the funds were being misappropriated. On appeal, the parties agreed that the Quincecare duty was owed only to the Company and not directly to its creditors (notwithstanding that the Company was on the verge of insolvency) but Daiwa maintained that since the claim was brought exclusively for the benefit of creditors to whom the duty was not owed, no claim lay against Daiwa.

The Court of Appeal held that the scope of the Quincecare duty was to protect a bank's customer from losing funds held in its account where the circumstances put the bank on inquiry. The question of solvency was relevant to whether Daiwa was in breach of its Quincecare duty but not to the scope of that duty. The fact that only the creditors stood to benefit was irrelevant. The Court of Appeal declined to accept the parallels made by Daiwa with respect to auditors whom the courts have held do not owe a duty to protect future creditors against the possibility of trading with an insolvent company. Quoting the Judge: "The duty is only relevant in a situation where the instructions to pay out the money are given by the person who has been entrusted by the company as a signatory on the bank account. If there were no properly authorised instruction to transfer the money, the company would not need to rely on the Quincecare duty. The existence of the duty is therefore predicated on the assumption that the person whose fraud is suspected is a trusted employee or officer. So the duty when it arises is a duty to save the company from the fraudulent conduct of that trusted person. This is a very different duty from the duty on auditors to report to shareholders about the affairs of the company."

Illegality

The Latin maxim ex turpi causa non oritur actio is a legal doctrine which prevents a claimant from pursuing a claim if the claim arises from or is founded upon the illegality of the claimant. It is often referred to as the illegality defence.

In order for the defence to succeed in this case, the fraudulent activities of Mr Al Sanea would need to be attributed to the Company, on the basis that the Company was claiming against Daiwa.

Daiwa asserted that the Judge at first instance should have determined that the Company was a "one-man company" since its other directors appeared to have little involvement in, or influence over, the affairs of the Company. Essentially, Daiwa was arguing that where a fraudster effectively owns and manages the company, a third party should not be held liable. The Liquidators' response to this was that a "one-man company" was not one where the other directors are "merely supine"; those directors needed to be complicit in the fraud. The Company had not been created to perpetrate a fraud (as was the case in Stone & Rolls Ltd (in liquidation) v Moore Stephens (a firm) [2009] UKHL 39).

The Court of Appeal agreed with the Liquidators, applying Jetivia SA and another v Bilta (UK) Limited (in liquidation) [2015] UKSC 23, in which it was held that a "one-man company" was one without any innocent directors or shareholders. The Court of Appeal queried how useful the concept of a "one-man company" was in this context, given that attribution is highly fact-sensitive and dependent on context.

In circumstances where the Court of Appeal had concluded that Mr Al Sanea's fraudulent knowledge and conduct should not be attributed to Singularis so as to bar the Liquidators' claim on the grounds of illegality, it was not necessary to go on to apply the test in Patel v Mirza [2016] UKSC 42. However, the Court of Appeal commented that had it been necessary to decide the issue, it would have reached the same conclusion as the Judge at first instance (i.e. that the Liquidators' claim would not be barred by an illegality defence – applying the 3-fold test in Patel v Mirza: (i) it would not be contrary to the public interest to allow the claim; (ii) denying the claim would have a material negative impact on the growing reliance on banks to help reduce financial crime; and (iii) it would be a disproportionate response to any wrongdoing on the Company's part, particularly where this could be more accurately reflected by reducing damages for contributory negligence). The Court of Appeal further commented that where the test to be applied involves the balancing of multiple policy considerations and a determination of what would be proportionate, an appellate court should not interfere merely because it would have come to a different view.

Comment

The case follows in the same path as Jetivia v Bilta in finding that the fraudulent knowledge/conduct of one director should not be attributed to the company. The company (or in this case its liquidators) was therefore permitted to pursue third parties, the stockbroker in this case being unable to rely on the illegality defence in circumstances where it had been put on inquiry such that it owed the client a duty to refrain from complying with payment instructions which it believed might constitute an attempt to misappropriate company funds.

This case is significant as it is the first time that a court has found against a financial institution in respect of the Quincecare duty. In effect, Daiwa was held liable for failing to prevent the fraud. This is a step further than the requirements of the FCA that a firm "must establish, implement and maintain adequate policies and procedures sufficient ... for countering the risk that the firm might be used to further financial crime" (SYSC 6.1.1R).

The Singularis v Daiwa case is unlikely, however, to open the floodgates to similar claims. It is rare that the circumstances would put a bank on inquiry, but where a client is known to be in serious financial difficulty, financial institutions will want to consider carefully any unusual payment instructions received from a single director (even if accustomed to dealing with that individual) and ensure that those on the front line of their operations are alert to the need for caution.

A final point of note is that the Court held that the exclusion clause in Daiwa's standard terms of business for liability other than that caused by its gross negligence, wilful default or fraud failed to protect it because, on the facts, the standard terms had not been sent to the Company; demonstrating the importance of ensuring terms of business are sent to clients at all times.

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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