|Judgments - Moore Stephens (a firm) (Respondents) v Stone Rolls Limited (in liquidation (Appellants)
HOUSE OF LORDS
 UKHL 39
on appeal from:  EWCA Civ 644
OF THE LORDS OF APPEAL
FOR JUDGMENT IN THE CAUSE
Moore Stephens (a firm) (Respondents) v Stone Rolls Limited (in liquidation (Appellants)
Lord Phillips of Worth Matravers
Lord Scott of Foscote
Lord Walker of Gestingthorpe
Lord Brown of Eaton-under-Heywood
Michael Brindle QC
Mark Simpson QC
(Instructed by Norton Rose LLP)
Jonathan Sumption QC
Tom Adam QC
(Instructed by Barlow Lyde & Gilbert LLP)
10-12 FEBRUARY 2009
THURSDAY 30 JULY 2009
HOUSE OF LORDS
OPINIONS OF THE LORDS OF APPEAL FOR JUDGMENT
IN THE CAUSE
Moore Stephens (a firm) (Respondents) v Stone Rolls Limited (in liquidation) (Appellants)
 UKHL 39
LORD PHILLIPS OF WORTH MATRAVERS
"119. Does common sense matter? Yes. It is contrary to all common sense to uphold a claim that would confer direct or indirect benefits on the corporate vehicle, which was used to commit the fraud and was not the victim of it, and the fraudulent driver of the fraudulent vehicle".
The second reason why common sense led me, initially, to consider that S&R's claim should not succeed was that Moore Stephens were also the victims of S&R's fraud. They were induced to agree to act as S&R's auditors by a fictitious and fraudulent account of S&R's business, given to them on behalf of the company by Mr Stojevic, and they were deceived in carrying out their audits by accounts fraudulently prepared on behalf of the company, albeit that it is for present purposes to be assumed that they were negligent in not detecting the fraud. It does not seem just that, in these circumstances, S&R should be able to bring a claim in respect of the very conduct that S&R had set about inducing. The final reason of common sense that predisposed me against this claim was one which would not, unlike the other two, occur to the man in the street but might occur to a student with knowledge of the principles of the law of negligence. Looking at the realities, this claim is brought for the benefit of banks defrauded by S&R on the ground that Moore Stephens should have prevented S&R from perpetrating the frauds. Why, if this is a legitimate objective, should the banks not have a direct cause of action in negligence against Moore Stephens? One answer, I would suggest, is that a duty of care in negligence will only arise where this is fair, just and reasonable. It would not be considered fair, just and reasonable for auditors of a company to owe a duty of care to an indeterminate class of potential victims in respect of unlimited losses that they might sustain as a result of the fraud of the company. If it would not be fair, just and reasonable for the banks to have a direct claim, then it would not seem fair just and reasonable that they should achieve the same result through a claim brought by the company's liquidators for their benefit. In a lecture to the Chancery Bar Association entitled "Common Sense and Causing Loss" given on 15 June 1999 Lord Hoffmann commented adversely on the practice of those judges who justify their decisions by reference to "common sense". He suggested that this was far too often an unsatisfactory alternative to the identification of the relevant principles. The differences of opinion between the members of the committee underline the need to identify the relevant principles that apply in this case. It also underlines the difficulty of that task. The first step is to identify the issues raised by the parties.
The issues raised by the parties
" to allow recovery in these cases would be to allow recovery for what is illegal. It would put the courts in the position of saying that the same conduct is both legal, in the sense of being capable of rectification by the court, and illegal. It would, in short, introduce an inconsistency in the law. It is particularly important in this context that we bear in mind that the law must aspire to be a unified institution, the parts of which - contract, tort, the criminal law - must be in essential harmony. For the courts to punish conduct with the one hand while rewarding it with the other, would be to 'create an intolerable fissure in the law's conceptually seamless web': Weinrib - "Illegality as a Tort Defence" (1976) 26 U.T.L.J. 28 at p. 42. We thus see that the concern, put at its most fundamental, is with the integrity of the legal system".
"There is not to be imputed to a company a fraud which is being practised against it even if it is being practised by someone whose acts and state of mind in the ordinary way are attributed to the company."
Mr Sumption submits that this principle does not prevent attribution to S&R of Mr Stojevic's fraud which was directed not against S&R but against the banks.
The decisions of the Courts below
A Summary of my conclusions
1) Under the principle of ex turpi causa the court will not assist a claimant to recover compensation for the consequences of his own illegal conduct.
2) This appeal raises the question of whether, and if so how, that principle applies to a claim by a company against those whose breach of duty has caused or permitted the company to commit fraud that has resulted in detriment to the company.
3) The answer to this question is not to be found by the application of Hampshire Land or any similar principle of attribution. The essential issue is whether, in applying ex turpi causa in such circumstances, one should look behind the company at those whose interests the relevant duty is intended to protect.
4) While in principle it would be attractive to adopt such a course, there are difficulties in the way of doing so to which no clear resolution has been demonstrated.
5) On the extreme facts of this case it is not necessary to attempt to resolve those difficulties. Those for whose benefit the claim is brought fall outside the scope of any duty owed by Moore Stephens. The sole person for whose benefit such duty was owed, being Mr Stojevic who owned and ran the company, was responsible for the fraud.
6) In these circumstances ex turpi causa provides a defence to the claim.
The duties of auditors
Ex turpi causa
" it is now clearly established that at law (as opposed to in equity), property in goods or land can pass under, or pursuant to, such a contract. If so, the rights of the owner of the legal title thereby acquired will be enforced, provided that the plaintiff can establish such title without pleading or leading evidence of the illegality. . . .
A party to an illegality can recover by virtue of a legal or equitable property interest if, but only if, he can establish his title without relying on his own illegality.
. . .
In a case where the plaintiff is not seeking to enforce an unlawful contract but founds his case on collateral rights acquired under the contract (such as a right of property) the court is neither bound nor entitled to reject the claim unless the illegality of necessity forms part of the plaintiff's case."
"I do not believe that there is any general principle that the claimant must either plead, give evidence of or rely on his own illegality for the principle to apply. Such a technical approach is entirely absent from Lord Mansfield's exposition of the principle"
I agree with that observation.
"The maxim ex turpi causa expresses not so much a principle as a policy. Furthermore, that policy is not based upon a single justification but on a group of reasons, which vary in different situations".
The underlying policy
"The objection, that a contract is immoral or illegal as between plaintiff and defendant, sounds at all times very ill in the mouth of the defendant. It is not for his sake, however, that the objection is ever allowed; but it is founded in general principles of policy, which the defendant has the advantage of, contrary to the real justice as between him and the plaintiff, by accident, if I may so say. The principle of public policy is this; ex dolo malo non oritur actio. No court will lend its aid to a man who founds his cause of action upon an immoral or an illegal act. If, from the plaintiff's own stating or otherwise, the cause of action appears to arise ex turpi causâ, or the transgression of a positive law of this country, there the court says he has no right to be assisted. It is upon that ground the court goes; not for the sake of the defendant, but because they will not lend their aid to such a plaintiff. So if the plaintiff and defendant were to change sides, and the defendant was to bring his action against the plaintiff, the latter would then have the advantage of it; for where both are equally in fault, potior est conditio defendentis.
The policy can be subdivided into two principles in relation to contractual obligations:
(i) The court will not enforce a contract which is expressly or impliedly forbidden by statute or that is entered into with the intention of committing an illegal act.
(ii) The court will not assist a claimant to recover a benefit from his own wrongdoing. This extends to claims for compensation or an indemnity in respect of the adverse consequences of the wrongdoing - see Beresford v Royal Insurance Co Ltd  AC 586.
It is the second principle that is in play on this appeal.
Qualifications to the second principle
The Consequences of Moore Stephens' primary case
The opinions of the Committee
Attribution and Hampshire Land
"The company's primary rules of attribution together with the general principles of agency, vicarious liability and so forth are usually sufficient to enable one to determine its rights and obligations. In exceptional cases, however, they will not provide an answer. This will be the case when a rule of law, either expressly or by implication, excludes attribution on the basis of the general principles of agency or vicarious liability. For example, a rule may be stated in language primarily applicable to a natural person and require some act or state of mind on the part of that person 'himself', as opposed to his servants or agents. This is generally true of rules of the criminal law, which ordinarily impose liability only for the actus reus and mens rea of the defendant himself. How is such a rule to be applied to a company?
One possibility is that the court may come to the conclusion that the rule was not intended to apply to companies at all; for example, a law which created an offence for which the only penalty was community service. Another possibility is that the court might interpret the law as meaning that it could apply to a company only on the basis of its primary rules of attribution, i.e. if the act giving rise to liability was specifically authorised by a resolution of the board or an unanimous agreement of the shareholders. But there will be many cases in which neither of these solutions is satisfactory; in which the court considers that the law was intended to apply to companies and that, although it excluded ordinary vicarious liability, insistence on the primary rules of attribution would in practice defeat that intention. In such a case, the court must fashion a special rule of attribution for the particular substantive rule. This is always a matter of interpretation: given that it was intended to apply to a company, how was it intended to apply? Whose act (or knowledge, or state of mind) was for this purpose intended to count as the act etc of the company? One finds the answer to this question by applying the usual canons of interpretation, taking into account the language of the rule (if it is a statute) and its content and policy."
"But their Lordships would wish to guard themselves against being understood to mean that whenever a servant of a company has authority to do an act on its behalf, knowledge of that act will for all purposes be attributed to the company. It is a question of construction in each case as to whether the particular rule requires that the knowledge that an act has been done, or the state of mind with which it was done, should be attributed to the company."
" Where the directing mind conceives and designs a plan and then executes it whereby the corporation is intentionally defrauded, and when this is the substantial part of the regular activities of the directing mind in his office, then it is unrealistic in the extreme to consider that the manager is the directing mind of the company Where the criminal act is totally in fraud of the corporate employer and where the act is intended to and does result in benefit exclusively to the employee-manager, the employee-directing mind, from the outset of the design and execution of the criminal plan, ceases to be a directing mind of the corporation and consequently his acts could not be attributed to the company under the identification doctrine".
This statement was made in relation to criminal charges brought against the company. It describes a principle of attribution that I would accept as applicable under English common law.
Attribution in this case
"At common law there was no difficulty in finding liability in a corporation in the law of torts, even though the state of mind of the corporation was established by imputing to that corporation the intentions and the conduct of its servants and agents. Thus, in the law of torts, the courts from the earliest times found vicarious liability in the corporation on the principles of agency."
In this case, however, it is necessary to distinguish between vicarious and primary liability for the purpose of considering the application of ex turpi causa. There is no way of doing this other than by applying the same approach as applies in other circumstances where this exercise is necessary. Indeed Bowstead & Reynolds at 8-188 identifies "the supposed fraud exception to the rules as to imputation of the agent's knowledge to the principal" as one of the situations where it may be necessary to consider whether conduct ranks as the act of the corporation itself. The words of Lord Reid in Tesco Supermarkets Ltd v Nattrass  AC 153 at 170 are directly in point:
"A living person has a mind which can have knowledge or intention or be negligent and he has hands to carry out his intentions. A corporation has none of these: it must act through living persons, though not always one or the same person. Then the person who acts is not speaking or acting for the company. He is acting as the company and his mind which directs his acts is the mind of the company. There is no question of the company being vicariously liable. He is not acting as a servant, representative, agent or delegate. He is an embodiment of the company or, one could say, he hears and speaks through the persona of the company, within his appropriate sphere, and his mind is the mind of the company. If it is a guilty mind then that is the guilt of the company. It must be a question of law whether, once the facts have been ascertained, a person in doing particular things is to be regarded as the company or merely as the company's servant or agent. In that case any liability of the company can only be a statutory or vicarious liability."
"Set out in these bald terms, the defendant's conduct was dishonest. By the same token, and for good measure, B.L.T. also acted dishonestly. The defendant was the company, and his state of mind is to be imputed to the company."
"The bank operated its business dishonestly and corruptly. On the assumed facts, this was not a case where one or two individuals, however senior, were behaving dishonestly. Matters had gone beyond this. They had reached the point where the bank itself could properly be identified with the dishonesty. This was a dishonest business, a corrupt business."
"It is not just the case that he was managing director and majority shareholder of the company; he was [the company]. He treated the company as his own and nothing of consequence happened without his say so."
The very thing
"Here, the alleged turpitudinous act is the very thing that the defendant had a duty to try to prevent, imposed by a law of negligence which itself appeals to public conscience or at least public notions of reasonableness"
Claim by the company against the directing will and mind
The significance of the fact that S&R was a "one man company"
"These considerations amply justify the conclusion that auditors of a public company's accounts owe no duty of care to members of the public at large who rely upon the accounts in deciding to buy shares in the company. If a duty of care were owed so widely, it is difficult to see any reason why it should not equally extend to all who rely on the accounts in relation to other dealings with a company as lenders or merchants extending credit to the company. A claim that such a duty was owed by auditors to a bank lending to a company was emphatically and convincingly rejected by Millett J. in Al Saudi Banque v. Clarke Pixley "
"No doubt these provisions establish a relationship between the auditors and the shareholders of a company on which the shareholder is entitled to rely for the protection of his interest. But the crucial question concerns the extent of the shareholder's interest which the auditor has a duty to protect. The shareholders of a company have a collective interest in the company's proper management and in so far as a negligent failure of the auditor to report accurately on the state of the company's finances deprives the shareholders of the opportunity to exercise their powers in general meeting to call the directors to book and to ensure that errors in management are corrected, the shareholders ought to be entitled to a remedy. But in practice no problem arises in this regard since the interest of the shareholders in the proper management of the company's affairs is indistinguishable from the interest of the company itself and any loss suffered by the shareholders, e.g. by the negligent failure of the auditor to discover and expose a misappropriation of funds by a director of the company, will be recouped by a claim against the auditors in the name of the company, not by individual shareholders.
I find it difficult to visualise a situation arising in the real world in which the individual shareholder could claim to have sustained a loss in respect of his existing shareholding referable to the negligence of the auditor which could not be recouped by the company."
"It is the auditors' function to ensure, so far as possible, that the financial information as to the company's affairs prepared by the directors accurately reflects the company's position in order, first, to protect the company itself from the consequences of undetected errors or, possibly, wrongdoing (by, for instance, declaring dividends out of capital) and, secondly, to provide shareholders with reliable intelligence for the purpose of enabling them to scrutinise the conduct of the company's affairs and to exercise their collective powers to regard or control or remove those to whom that conduct has been confided .
Thus the history of the legislation is one of an increasing availability of information regarding the financial affairs of the company to those having an interest in its progress and stability. It cannot fairly be said that the purpose of making such information available is solely to assist those interested in attending general meetings of the company to an informed supervision and appraisal of the stewardship of the company's directors, for the requirement to supply audited accounts to, for instance, preference shareholders having no right to vote at general meetings and to debenture holders cannot easily be attributed to any such purpose. Nevertheless, I do not, for my part, discern in the legislation any departure from what appears to me to be the original, central and primary purpose of these provisions, that is to say, the informed exercise by those interested in the property of the company, whether as proprietors of shares in the company or as the holders of rights secured by a debenture trust deed, of such powers as are vested in them by virtue of their respective proprietary interests."
"The essence of the claim made by the first Plaintiffs, Berg, against Dearden Farrow is that Mr Surrey ought not to have accepted the statements made, and the assurances given, to him by Mr Golechha. It is no part of the Plaintiffs' case that Mr Golechha, nor any director or shareholder of Berg, was in any way misled by anything which Dearden Farrow said or did; nor is it alleged that Mr Golechha, or any member of the company, in any way relied upon anything Dearden Farrow said or did. It further is not alleged that Mr Golechha was not fully aware of all relevant facts and considerations. Under these circumstances, it will be appreciated that there are serious further difficulties in the way of formulating and substantiating the claim of Berg against the Defendants. The existence of a contractual duty to exercise proper skill and care in and about the audit owed by the Defendants to Berg is not in dispute. But whether, assuming that there has been some breach, there is on any view a right to recover anything more that nominal damages is very definitely in dispute. The Defendants submit that the first Plaintiffs' claim is misconceived and cannot succeed even if some breach of contract is established."
"It also follows that the purpose of the statutory audit is to provide a mechanism to enable those having a proprietary interest in the company or being concerned with its management or control to have access to accurate financial information about the company. Provided that those persons have that information, the statutory purpose is exhausted. What those persons do with the information is a matter for them and falls outside the scope of the statutory purpose. In the present case the first Plaintiffs have based their case not upon any lack of information on the part of Mr Golechha but rather upon the opportunity that the possession of the auditor's certificate is said to have given for the company to continue to carry on business and to borrow money from third parties. Such matters do not fall within the scope of the duty of the statutory auditor."
"Where an agent is party or privy to the commission of a fraud upon or misfeasance against his principal, his knowledge of such fraud or misfeasance, and of the facts and circumstances connected therewith, is not imputed to the principal."
He commented, at p 54:
"In the present case it has not been proved that there was any fraud by Mr Golechha in relation to the 1981 audit, still less that at that time Mr Golechha was practising any fraud upon his principal, Berg. There was no entity which it can be said he misled or in relation to which it can be said that he was acting fraudulently in relation to the audit in October 1982. However one identifies the company, whether it is the head management, or the company in general meeting, it was not misled and no fraud was practised upon it. This is a simple and unsurprising consequence of the fact that every physical manifestation of the company Berg was Mr Golechha himself. Any company must in the last resort, if it is to allege that it was fraudulently misled, be able to point to some natural person who was misled by the fraud. That the Plaintiffs cannot do."
"It is never sufficient to ask simply whether A owes B a duty of care. It is always necessary to determine the scope of the duty by reference to the kind of damage from which A must take care to save B harmless. 'The question is always whether the defendant was under a duty to avoid or prevent that damage, but the actual nature of the damage suffered is relevant to the existence and extent of any duty to avoid or prevent it:' see Sutherland Shire Council v. Heyman, 60 A.L.R. 1, 48, per Brennan J. Assuming for the purpose of the argument that the relationship between the auditor of a company and individual shareholders is of sufficient proximity to give rise to a duty of care, I do not understand how the scope of that duty can possibly extend beyond the protection of any individual shareholder from losses in the value of the shares which he holds."
Lord Oliver made a similar comment at p. 651:
"It has to be borne in mind that the duty of care is inseparable from the damage which the plaintiff claims to have suffered from its breach. It is not a duty to take care in the abstract but a duty to avoid causing to the particular plaintiff damage of the particular kind which he has in fact sustained."
"A duty of care such as the valuer owes does not however exist in the abstract. A plaintiff who sues for breach of a duty imposed by the law (whether in contract or tort or under statute) must do more than prove that the defendant has failed to comply. He must show that the duty was owed to him and that it was a duty in respect of the kind of loss which he has suffered. Both of these requirements are illustrated by Caparo Industries plc. v. Dickman  2 AC 605. The auditors' failure to use reasonable care in auditing the company's statutory accounts was a breach of their duty of care. But they were not liable to an outside take-over bidder because the duty was not owed to him. Nor were they liable to shareholders who had bought more shares in reliance on the accounts because, although they were owed a duty of care, it was in their capacity as members of the company and not in the capacity (which they shared with everyone else) of potential buyers of its shares. Accordingly, the duty which they were owed was not in respect of loss which they might suffer by buying its shares."
LORD SCOTT OF FOSCOTE
The ex turpi causa rule
"No court will lend its aid to a man who founds his cause of action upon an immoral or an illegal act. If, from the plaintiff's own stating or otherwise, the cause of action appears to arise ex turpi causa . there the court says he has no right to be assisted."
The ex turpi causa rule was the subject of careful consideration in Tinsley v Milligan  1 AC 340 where this House unanimously rejected the proposition that the application of the rule depended "on such an imponderable factor as the extent to which the public conscience would be affronted by recognising rights created by illegal transactions" (per Lord Browne-Wilkinson at 369). It is necessary, therefore, to put firmly to one side any question of whether, or to what extent, public conscience would be affronted by the spectacle of Moore Stephens being held liable to pay negligence damages to S&R, thus enabling the liquidators to pay dividends to the defrauded creditors of S&R, and to concentrate on whether S&R is founding its action on its "own dishonest acts" (para.3(1) of the Defence).
S&R's contractual cause of action
"It has no mind of its own any more than it has a body of its own; its active and directing will must consequently be sought in the person of somebody who for some purposes may be called an agent, but who is really the directing mind and will of the corporation, the very ego and centre of the personality of the corporation."
Lord Haldane's remarks were examined by Lord Hoffmann in giving the judgment of the Board in Meridian Global Funds Management Asia Ltd v Securities Commission  2 AC 500, on an appeal from the Court of Appeal of New Zealand. Lord Hoffmann, at 506, noted that any proposition about a company's directing mind and will necessarily involved a reference to a set of rules of attribution. The company's primary rules would, he said, generally be found in the company's constitution, typically its articles of association, but would include also rules implied by company law, such as, for example, the rule that the unanimous decision of all the shareholders in a solvent company to do something that the company had power to do under its memorandum of association would be the decision of the company. He went on to say this :
"These primary rules of attribution are obviously not enough to enable a company to go out into the world and do business. Not every act on behalf of the company could be expected to be the subject of a resolution of the board or a unanimous decision of the shareholders. The company therefore builds upon the primary rules of attribution by using general rules of attribution which are equally available to natural persons, namely, the principles of agency. It will appoint servants and agents whose acts, by a combination of the general principles of agency and the company's primary rules of attribution, count as the acts of the company."
" contrary to justice and common sense to treat the knowledge of such persons as that of their company, as if one were to assume that they would make a clean breast of their delinquency" (p.19)
"The defendant accepted that he knowingly assisted in that breach of trust. In other words, he caused or permitted his company to apply the money in a way he knew was not authorised by the trust of which the company was trustee. Set out in these bald terms, the defendant's conduct was dishonest. By the same token, and for good measure, BLT also acted dishonestly. The defendant was the company, and his state of mind is to be imputed to the company."
The liability of Moore Stephens
The procedural reason
"S&R was controlled by Mr Stojevic and owned by Law Investments Limited , an Isle of Man company which was in turn owned by Mr Stojevic's family trust "
None of this justifies the assumption that Mr Stojevic was absolutely beneficially entitled to the S&R shares.
"SR's ultimate ownership is obscure, but Mr Stojevic was in command of its dealings with BCL and the bank"
He returned to the point in paragraph 25:
"The shares in SR are held by an Isle of Man company called Law Investments Ltd, whose shareholders are nominee companies operating under an Isle of Man trust known as the Lucia trust. Mr Stojevic acknowledged that he was one of the beneficiaries of the trust. Objection was taken to his being asked to identify the other beneficiaries or the extent of his own beneficial interest, and the matter was not ultimatedly pressed by Mr Doctor QC on behalf of [KB]"
None of this justifies the assumption that Mr Stojevic was the absolute beneficial owner of the shares in S&R.
"In a real sense the company was [Mr Stojevic's] company. It was, for practical purposes, a 'one man company'."
And Mummery LJ, at paragraph 114, referred to S&R as "the one-man company owned and controlled by Mr Stojevic".
The substantive reason
LORD WALKER OF GESTINGTHORPE
The illegality defence
"No court will lend its aid to a man who founds his cause of action upon an immoral or an illegal act. If, from the plaintiff's own stating or otherwise, the cause of action appears to arise ex turpi causa, or the transgression of a positive law of this country, there the court says he has no right to be assisted. It is upon that ground the court goes; not for the sake of the defendant, but because they will not lend their aid to such a plaintiff."
The same principle has been described by McLachlin J in the Supreme Court of Canada, writing for the majority, as based on the need to preserve the integrity of the legal system: Hall v Hebert (1993) 101 DLR (4th) 129, 1993 CanLII 141,160, 165.
Primary or vicarious liability?
"I must start by considering the nature of the personality which by a fiction the law attributes to a corporation. A living person has a mind which can have knowledge or intention or be negligent and he has hands to carry out his intentions. A corporation has none of these: it must act through living persons, though not always one or the same person. Then the person who acts is not speaking or acting for the company. He is acting as the company and his mind which directs his acts is the mind of the company. There is no question of the company being vicariously liable. He is not acting as a servant, representative, agent or delegate. He is an embodiment of the company or, one could say, he hears and speaks through the persona of the company, within his appropriate sphere, and his mind is the mind of the company. If it is a guilty mind then that guilt is the guilt of the company."
"It was this coincidence which left Viscount Haldane LC's speech open to the interpretation that he was expounding a general metaphysic of companies."
In short not every company has a single directing mind and will, but some companies do.
"It is the essence of [S & R's] claim that Mr Stojevic was its controlling mind and will. Nobody else was in a like position. In a real sense the company was his company. It was, for practical purposes, a 'one man company'. It is a further part of the claim that the company was throughout used by Mr Stojevic as a vehicle for fraud, by extracting money from KB so that it could then be paid away to the fraudsters."
The Hampshire Land principle
"My Lords, there can obviously be no acquiescence without knowledge of the fact as to which acquiescence is said to have taken place. The person who is sought to be estopped is here a company, an abstract conception, not a being who has eyes and ears. The knowledge of the company can only be the knowledge of persons who are entitled to represent the company. It may be assumed that the knowledge of directors is in ordinary circumstances the knowledge of the company. The knowledge of a mere official like the secretary would only be the knowledge of the company if the thing of which knowledge is predicated was a thing within the ordinary domain of the secretary's duties. But what if the knowledge of the director is the knowledge of a director who is himself particeps criminis, that is, if the knowledge of an infringement of the right of the company is only brought home to the man who himself was the artificer of such infringement? Common sense suggests the answer, but authority is not wanting."
He then referred to Hampshire Land. Similarly Viscount Sumner said of the Lowes (at p19):
"Their silence was accordingly a notable breach of duty. It has long been recognised that it would be contrary to justice and common sense to treat the knowledge of such persons as that of their company, as if one were to assume that they would make a clean breast of their delinquency. Hence, for the purpose of estopping the company, some knowledge other than theirs has to be brought home to other directors, who can be presumed not to be concerned to suppress it. This was laid down, following earlier cases, in Re Hampshire Land Co, and was even then treated as incontestable."
"It may emerge at a trial that the facts are not as alleged in the statement of claim, but if the allegations in the statement of claim are made good, the directors of the plaintiff company must then have known that the transaction was an illegal transaction.
But in my view such knowledge should not be imputed to the company, for the essence of the arrangement was to deprive the company improperly of a large part of its assets. As I have said, the company was a victim of the conspiracy. I think it would be irrational to treat the directors, who were allegedly parties to the conspiracy, notionally as having transmitted this knowledge to the company; and indeed it is a well-recognised exception from the general rule that a principal is affected by notice received by his agent that, if the agent is acting in fraud of his principal and the matter of which he has notice is relevant to the fraud, that knowledge is not to be imputed to the principal.
So in my opinion the plaintiff company should not be regarded as a party to the conspiracy, on the ground of lack of the necessary guilty knowledge."
It should be noted that Belmont was not, on any view, a one-man company; and it was, as Buckley LJ observed, the victim of a conspiracy.
Sole actors and secondary victims
The modern cases
"Whether a man in total control of a limited liability company (by reason of his shareholding and directorship) is capable of stealing the property of the company; and whether two men in total control of a limited liability company (by reason of their shareholdings and directorships) are (while acting in concert) capable of jointly stealing the property of the company."
Two men, who were between them in total control of a company, had plundered its assets in extravagant living and it was insolvent to the extent of about £2.5m. The case was largely concerned with the application to that situation of the language of section 2(1)(a) and (b) of the Theft Act 1968. For my part I do not think that the decision assists either side. It is really concerned with the correct construction of a criminal statute and its application to a situation which Parliament may not have contemplated when the Theft Act 1968 was being enacted.
"Here the corporate entity named Scadlynn was, however odd the notion may seem at first sight, the victim of wrongful arrangements to deprive it improperly of a large part of its assets: see Belmont Finance Corporation Ltd v Williams Furniture Ltd  Ch 250, at pp 261-262. If the facts were such that the bank should have recognised the possibility of such an impropriety, and if the scope of the bank's duty of care was wide enough to impose an obligation to take steps to forestall it, I see no reason why the cause of action should not be enforced by Scadlynn for the ultimate benefit of the creditors who would look to those assets for satisfaction of their debts."
Similarly Nicholls LJ said (at 73):
"On the facts alleged in the proposed amendments, Scadlynn was at all material times being used by Chappell and Palmer and others for a fraudulent purpose, viz, to realise the proceeds of sale of the robbery. But the plaintiff was not implicated in any such fraudulent purpose. On the contrary, along with the owners of the gold, the plaintiff was the intended victim of the scheme. Likewise, Scadlynn itself was an intended victim, in that Scadlynn was being used as a vehicle for committing a fraud on its creditors and a fraud on those beneficially interested in property held by Scadlynn. In those circumstances the fraudulent purposes of those controlling Scadlynn are not to be imputed to the company itself: see Belmont Finance Corpn Ltd v Williams Furniture Ltd  Ch 250, per Buckley LJ at pp 261-262."
"In the present case it has not been proved that there was any fraud by Mr Golechha in relation to the 1981 audit, still less that at that time Mr Golechha was practising any fraud on his principal, Berg. There was no entity which it can be said he misled or in relation to which it can be said that he was acting fraudulently in relation to the audit in October 1982. However one identifies the company, whether it is the head management, or the company in general meeting, it was not misled and no fraud was practised upon it. This is a simple and unsurprising consequence of the fact that every physical manifestation of the company Berg was Mr Golechha himself. Any company must in the last resort, if it is to allege that it was fraudulently misled, be able to point to some natural person who was misled by the fraud. That the plaintiffs cannot do."
Hobhouse J distinguished Belmont because there was no conspiracy to defraud Berg. He referred to Attorney General's Reference (No 2 of 1982) as "nearer to the point" but only, as I understand it, because in that case also there was no individual victim. But again the case was distinguishable because it involved fraud, and there was no fraud against Berg.
"In the present case the reinsurers rely upon cases where knowledge has been attributed, while the reinsured rely upon cases dealing with what has been called 'the fraud exception' or the rule in Re Hampshire Land Co  2 Ch 743, i.e. cases where knowledge of the fraudsters of a fraud on a corporation has been unsuccessfully sought to be attributed to the corporation.
Mr Bartlett [for the reinsurers] accepted that there were circumstances in which the 'fraud exception' meant that knowledge was not attributed. In his submission, the essence of the relevant principle is that the court will not infer that a company has knowledge of a fact known to an agent or director of the company where, because of the agent's or director's fraud or other breach of duty to the company, it would be contrary to justice and common sense to draw such inference.
For the purposes of this case at least, I am prepared to proceed on the basis of this proposition."
"There remains the question, . . . whether the Hampshire Land doctrine is confined to cases of fraud where the principal is himself the victim of the fraud, or whether, as Mr Justice Vaughan Williams put it in Hampshire Land itself, the doctrine extends to other breaches of duty where common sense would destroy the inference of transfer of knowledge. In the typical case in which the doctrine has been applied, Houghton, Belmont, PCW and Group Josi Re, fraud has been found or assumed. In the present case, fraud is also assumed, but the primary victim of the fraud has been the lending institution which has relied on the valuation. I would accept, however, the plaintiffs' submission that JDW was also a victim, even if only a secondary victim, of the assumed fraud. One consequence of that assumed fraud has been JDW's liability to the plaintiffs, albeit in negligence. Moreover, even if it could be said that JDW, unlike the plaintiffs, was not the victim of Mr Browne's fraud, Mr Browne has, on the assumed facts, been guilty of dishonesty, and one can hardly visualise a graver dereliction of his duty to his company. Although the cases often involve fraud, Hampshire Land itself did not necessarily do so, and I note that in Group Josi Re, Lord Justice Saville was prepared to accept as a working definition of the scope of the principle the cases of 'the agent's or director's fraud or other breach of duty to the company' (at p 367). In my judgment, Mr Browne's fault comes within the concept of an agent's fraud on his principal, but, even if it does not, his fault is such a breach of duty to JDW as in justice and common sense must entail that it is impossible to infer that his knowledge of his own dishonesty was transferred to JDW."
"In my judgment, the tribunal correctly concluded that there should be attribution in the present case, since the company could not sensibly be regarded as a victim of the fraud. They were right to hold that the fraud was 'neutral' from the company's point of view. The circumstances in which the exception to the general rule of attribution will apply are where the person whose acts it is sought to impute to the company knows or believes that his acts are detrimental to the interests of the company in a material respect. This explains, for example, the reference by Viscount Sumner in J C Houghton and Co v Nothard, Lowe and Wills Ltd  AC 1 at p19 to making 'a clean breast of their delinquency'. It follows that, in judging whether a company is to be regarded as the victim of the acts of a person, one should consider the effect of the acts themselves, and not what the position would be if those acts eventually prove to be ineffective."
I have to say that I find it difficult to understand, as a matter of fact, why the fraud was "neutral" from the point of view of McNicholas. But the important point is Dyson J's view that in principle "in judging whether a company is to be regarded as the victim of the acts of a person, one should consider the effect of the acts themselves, and not what the position would be if those acts eventually prove to be ineffective."
"As in McNicholas, the acts of Mr Samant were not in fact targeted at BoI. He was acting for, and in what he apparently believed to be the interests of, BoI in seeking to gross up the balance sheet for the purposes of the year end accounts. The potential liability of BoI under s213 is irrelevant in deciding whether BoI was a victim of Mr Samant and whether his knowledge should be attributed to it for the purposes of s 213."
"In our judgment, the facts and the contractual context make Arab Bank a different case. It did not lay down a general principle of attribution of knowledge which governs this case of statutory liability to make compensation to victims of fraudulent trading. Arab Bank is not, as Mr Moss contended, authority for the proposition that knowledge of fraud can only be attributed to a company if the individual with the relevant knowledge was a director or directing mind of the company, or where it can be inferred from all the circumstances that the individual transferred his knowledge to the company or to its directing mind and will; nor is it authority for the proposition that there can be no attribution of knowledge where the company is a 'secondary victim' of the individual's wrongdoing or breach of duty."
Discussion of the 'sole actor' exception
"Set out in these bald terms, [Mr Tan's] conduct was dishonest. By the same token, and for good measure, BLT also acted dishonestly. [Mr Tan] was the company, and his state of mind is to be imputed to the company."
Belmont was referred to in the Judicial Committee's judgment, but only on the issue of the degree of improbity required for accessory liability.
"It has become the fashion to call companies of this class 'one man companies.' That is a taking nickname, but it does not help one much in the way of argument. If it is intended to convey the meaning that a company which is under absolute control of one person is not a company legally incorporated, although the requirements of the Act of 1862 may have been complied with, it is inaccurate and misleading: if it merely means that there is a predominant partner possessing an overwhelming influence and entitled practically to the whole of the profits, there is nothing in that that I can see is contrary to the true intention of the Act of 1862, or against public policy, or detrimental to the interests of creditors."
"Second, the adverse interest exception does not apply to cases in which the principal is a corporation and the agent is its sole shareholder. As noted, the adverse interest exception is to a presumption that an agent has discharged the duty of disclosing material facts to the principal. Under New York law, where the agent is defrauding the principal, such disclosure cannot be presumed because it would defeator have defeatedthe fraud. However, where the principal and agent are one and the same, the adverse interest exception is itself subject to an exception styled the 'sole actor' rule. This rule imputes the agent's knowledge to the principal notwithstanding the agent's self-dealing because the party that should have been informed was the agent itself albeit in its capacity as principal. Where, as here, a sole shareholder is alleged to have stripped the corporation of assets, the adverse interest exception to the presumption of knowledge cannot apply."
"The second part of the imputation testwhether fraudulent conduct was perpetrated for the benefit of the debtor corporationis often analysed under the 'adverse interest exception.' Under this exception, fraudulent conduct will not be imputed if the officer's interests were adverse to the corporation and 'not for the benefit of the corporation.'
The Committee argues that the Shapiro family's fraud was adverse to the interests of the Debtors, and indeed, caused damage to them through 'deepening insolvency.' Thus, the Committee maintains that the Shapiros did not act for the benefit of the Debtors and their fraudulent conduct cannot be imputed to those corporations. However, even assuming that the Shapiros' interests were adverse to the Debtors' interests, the Committee cannot prevail because the 'adverse interest exception' is itself subject to an exceptionthe 'sole actor' exception. The general principle of the 'sole actor' exception provides that, if an agent is the sole representative of a principal, then that agent's fraudulent conduct is imputable to the principal regardless of whether the agent's conduct was adverse to the principal's interests. The rationale for this rule is that the sole agent has no one to whom he can impart his knowledge, or from whom he can conceal it, and that the corporation must bear the responsibility for allowing an agent to act without accountability."
"The corporation could not be said to have been defrauded in any relevant sense when the only thing of which it was deprived was part or indeed all of the product of the crime with which it was charged. It was no defence that some of the illegal compensation was diverted to the individuals."
"the firm did not owe a duty of care to the company, which was a fraudster in the total grip of another fraudster."
On the assumption that the auditors did owe a duty of care to S & R, it was a duty owed to that company as a whole, not to individual shareholders, or potential shareholders, or current or prospective creditors, as this House decided in Caparo Industries plc v Dickman  2 AC 605. If the only human embodiment of the company already knew all about its fraudulent activities, there was realistically no protection that its auditors could give it. In Caparo this House approved the decision of Millett J in Al Saudi Banque v Clarke Pixley  Ch 313, the facts of which were comparable to those of the present case.
Discussion of secondary victims
"In these circumstances I am of the opinion that this is not a case in which the Hampshire Land principle has any application. The essence of the case is that it is one in which the sole directing mind and will of the company procured it to enter into fraudulent transactions with banks. It was the company that dealt with the banks and, so it seems to me, clear that, as between the company and the banks, the principles of attribution require the dishonesty of the company's sole human agent to be imputed to the company. Mr Sumption's submissions satisfied me that this is a case in which such an imputation should be made and that the company should therefore itself be liable for the frauds. Whilst, as I have said, Mr Brindle did not accept that this is the correct analysis, he did not argue against it and he was prepared to accept it for the purposes of the present debate. It is not therefore a case in which the company was the target, or the victim, of its agent's dishonesty. It was itself the fraudster, and it was not the target of the fraud, and in my view it can make no difference that its frauds were likely, when and if found out, to result in the incurring of liabilities by the company itself."
Three cases relied on by S & R
The 'very thing' issue
"[W]hatever views one may have about suicide in general, a 100 per cent apportionment of liability to Mr Lynch gives no weight at all to the policy of the law in imposing a duty of care upon the police. It is another different way of saying that the police should not have owed Mr Lynch a duty of care."
In Reeves illegality was run as a defence in the Court of Appeal, but not in this House. On the other hand volenti non fit injuria was run in this House, and was rejected. Mr Brindle submits (on the strength of Smith v Baker & Sons  AC 325, 360) that that is not a principle of causation. The volenti principle is far from precise and it may sometimes operate not as a principle of causation, but to negative any duty (or any breach). But in this context it operates as an element in causation. As Lord Hoffmann said in Reeves  1 AC 360, 367:
"In the present case, volenti non fit injuria can only mean that Mr Lynch voluntarily caused his own death to the exclusion of any causal effect on the part of what was done by the police. So I think it all comes to the same thing: was the breach of duty by the police a cause of the death?"
"The respondent, however, alleged that the commission by the appellant of a statutory offence constituted an illegal act that disentitled the latter from pursuing its claim in tort. This argument placed the proverbial cart before the horse. On a proper appreciation of the facts, the appellant's running afoul of the Act could be attributed solely to the fact that the respondent had failed in his duty to warn. To allow the respondent to rely upon a consequence that was directly caused by his own failings and to absolve him from liability, would be to reward the wrongdoer and punish the innocent party."
In my opinion that shows confusion of thought, since if the trader had been convicted of the more serious offence under section 96 of the Singapore Income Tax Act it would have been guilty of deliberate and dishonest tax evasion and could not have been described as an innocent party.
The effect of liquidation
The opinions of the minority
"The primary victims of the fraud were KB and the other losers. The fraud undoubtedly exposed S & R to liabilities to KB and the other losers, which it could not meet once, as was intended, the moneys fraudulently obtained were paid away as they were to those responsible for the fraud. On the other hand S & R lost nothing to which it was ever entitled. S & R was in a real sense the perpetrator of the fraud on KB and the banks and the liability to which it was thereby exposed was not just the product of that fraud but the essence of it. In the particular circumstances of this case in my judgment it would be artificial not to fix S & R with the knowledge and wrongdoing of Mr Stojevic and also artificial to describe S & R even as a secondary victim of the fraud."
That puts the point very clearly. Lord Scott's view seems to me to treat the most obvious and extreme situation of a company which has a guilty mind (a one-man company engaged in wholly fraudulent activities) as amounting to a situation in which the company has no mind at all. That view, with great respect, seems to me to be inconsistent with Royal Brunei Airlines v Tan (which is generally regarded as a decision of high authority) and to put the clock back to Abrath v North Eastern Railway Co.
"In carrying out his investigation and in forming his opinion the auditor necessarily works very closely with the directors and officers of the company. He receives his remuneration from the company. He naturally, and rightly, regards the company as his client. But he is employed by the company to exercise his professional skill and judgment for the purpose of giving the shareholders an independent report on the reliability of the company's accounts and thus on their investment. 'No doubt he is acting antagonistically to the directors in the sense that he is appointed by the shareholders to be a check upon them': In Re Kingston Cotton Mill Co  1 Ch 6, 11, per Vaughan Williams J".
His part is, and must be, independent (section 27(1) of the Companies Act 1989 provides that a person is ineligible for appointment as company auditor of a company if he is an officer or employee of the company). In short, even if an auditor is for some purposes an officer of the company for which he acts, he is in a totally different position from that of the directors and managers who are running its business. In my respectful opinion it does not assist the task of analysis to equate them.
"It is the essence of the company's claim that Mr Stojevic was its controlling mind and will. Nobody else was in a like position. In a real sense the company was his company. It was, for practical purposes, a 'one-man company'. It is a further part of the claim that the company was throughout used by Mr Stojevic as a vehicle for fraud, by extracting money from KB so that it could then be paid away to the fraudsters."
Some observations in Lord Scott's opinion appear to overlook this point.
LORD BROWN OF EATON-UNDER-HEYWOOD
"[Mr Stojevic] was as completely identified with the company as it is possible for a human agent to be. He had sole control over the company's every act. He was the company's sole beneficial owner. There were no independent or innocent directors whom Mr Stojevic had to deceive to make the fraud happen. There were no innocent shareholders relying upon the auditors to monitor the management. There were no employees."
"He is not acting as a servant, representative, agent or delegate. He is an embodiment of the company or, one could say, he hears and speaks through the persona of the company, within his appropriate sphere, and his mind is the mind of the company. If it is a guilty mind then that guilt is the guilt of the company."
The audit role
"235(1) A company's auditors shall make a report to the company's members on all annual accounts of the company of which copies are to be laid before the company in general meeting during their tenure of office.
(2) The auditors' report shall state whether in the auditors' opinion the annual accounts have been properly prepared in accordance with this Act, and in particular whether a true and fair view is given .
(3) The auditors shall consider whether the information given in the directors' report for the financial year .. is consistent with those accounts; and if they are of opinion that it is not they shall state that fact in their report." (Emphasis added).
"The members, or shareholders, of the company are its
'No doubt he is acting antagonistically to the
The auditor's report must be read before the company in
" .. in practice no problem arises in this regard since the interest of the shareholders in the proper management of the company's affairs is indistinguishable from the
Consistently with this, Lord Oliver of Aylmerton at p.630F-G described the auditor's function as being
"to protect the company itself from the consequences of undetected errors or, possibly, wrongdoing (by, for instance, declaring dividends out of capital) and, secondly, to provide shareholders with reliable intelligence for the purpose of enabling them to scrutinise the conduct of the company's affairs and to exercise their collective powers to reward or control or remove those to whom that conduct has been confided."
At p.653H, he quoted with approval the statement by O'Connor LJ in the Court of Appeal (at p.714) to the effect that loss by "fraudulent abstraction of assets by directors or servants ..is recoverable by the company".
" the history of the legislation is one of an increasing
Further, s.394 provides that:
"394(1) Where an auditor ceases for any reason to hold office, he shall deposit at the company's registered office a statement of any circumstances connected with his ceasing to hold office which he considers should be brought to the attention of the members or creditors of the company or, if he considers that there are no such circumstances, a statement that there are none." (Emphasis added)
S.394(3) provides that the company must either send a copy of any statement identifying any such circumstances to every member, debenture-holder and person entitled to notice of general meetings or apply to the court.
"(11) The responsibility for safeguarding the assets of the company and for the prevention and detection of fraud, error and non-compliance with law or regulations rests with yourselves. However, we shall endeavour to plan our audit so that we have a reasonable expectation of detecting material misstatements in the financial statements or accounting records (including those resulting from fraud, error or non-compliance with law or regulations) but our examination should not be relied upon to disclose all such material misstatements or frauds, errors or instances of non-compliance as may exist .."
"should (a) consider whether the matter may be one that ought to be reported to a proper authority in the public interest; and where this is the case (b) except in the circumstances covered in SAS 110.12, discuss the matter with the board of directors, including any audit committee".
SAS 110.12 (para. 52) provides that
"When a suspected or actual instance of fraud casts doubt on the integrity of the directors auditors should make a report direct to a proper authority in the public interest without delay and without informing the directors in advance."
The text at paragraph 56 explains that matters to be taken into account when considering whether disclosure is justified in the public interest may include "the extent to which the suspected or actual fraud is likely to affect members of the public". Plainly, one situation in which members of the public would be affected is where the fraud conceals or risks bringing about the company's insolvency. The viability of a company as a going concern is always a matter of audit importance.
"the court must fashion a special rule of attribution for the particular substantive rule. This is always a matter of interpretation: given that it was intended to apply to a company, how was it intended to apply? Whose act (or knowledge, or state of mind) was for this purpose intended to count as the act etc. of the company? One finds the answer to this question by applying the usual canons of interpretation, taking into account the language of the rule (if it is a statute) and its content and policy." (p.507D-F)
Mr Stojevic's position as the company's directing mind
Ex turpi causa as between S & R and Mr Stojevic
The Hampshire Land principle
" . the fraudulent actions of Barry and Vithoulkas [the principals] were for their own financial gain. The corporation was merely a tool or vehicle which they implemented as an instrument of their fraud and to give the scheme a veneer of respectability. There was no benefit to the company from their actions. Rather, they stripped from the company all of its assets, both in terms of cash and consigned vehicles, and then absconded with them, leaving the corporation an empty shell with nothing but liabilities. In my view, it cannot be said that Barry and Vithoulkas have in these circumstances acted as the ego of the company itself and for the benefit of the company so as to bring the identification principles into play."
On appeal, the Court of Appeal dealt summarily with a submission that it could not be said that the actions constituted a fraud on the company, when, it was submitted, the corporation was set up for the very purpose of effecting their fraudulent scheme. The court said:
"There was no admissible evidence before the trial judge which would allow her to conclude that the corporation was set up with a view to perpetrating the frauds. Further, we do not read these comments of the trial judge as meaning anything other than Vithoulkas and Barry perpetrated a fraud on the corporation as a means of achieving personal gain. It does not detract from the main thrust of the judge's finding that Barry and Vithoulkas were acting for their own benefit only."
I agree with the last two sentences, and add that it cannot sensibly make any difference whether or not the corporation there or S & R here was originally incorporated with a view to perpetrating the relevant fraud. Whatever the motives with which it was incorporated, it was not a sham. Once incorporated as a separate legal entity, it was entitled to be respected as such - even (indeed especially) by those who created and became its directing minds, wills and beneficial owners - and was not to be treated as their puppet.
Directing minds and will who are also sole shareholders
"The scope of the common law duty requiring directors to consider the interests of creditors is more controversial. Cases support a variety of propositions, but the better accepted view is that a duty is owed by directors to the company (and not to the creditors themselves: Kuwait Asia Bank EC v National Mutual Life Nominees Ltd.  1 AC 187 at 217 PC; Yukong Line Ltd. v. Rendsburg Investments Corp (No 2)  1 WLR 294 [Toulson J]), and this duty requires directors of insolvent or borderline insolvent companies to have regard to the interests of the company's creditors (West Mercia Safetywear Ltd. v Dodd  BCLC 250 CA)."
The auditors' liability where the company's directing mind is fraudulent
"acknowledge that there may be occasions when it is necessary for an auditor to report directly to a third party without the knowledge or consent of the management. Such would be the case if the auditor suspects that management may be involved in, or is condoning, fraud or other irregularities and such would be occasions when the duty to report overrides the duty of confidentiality".
The Court of Appeal cannot have thought such a duty in shareholders' interests would only exist if senior management below the level of the company's directing mind or board were complicit in the fraud.
Overseas authority on attribution
The auditor's position where some of the shareholders have engaged in fraud
"The corporation is not the mere aggregate of shareholders. If the corporation were suing for the purpose of paying over again to the shareholders what the shareholders had already received the Court would not allow it. But that is not the case here, the company is insolvent, and there is no objection to allowing it to get back its funds for the purpose of paying debts. The case of the liquidator is stronger, for in some respects he, as a quasi trustee for creditors as well as shareholders, stands in a different position from the company. But I rely on this, that the money was not paid to the corporation, but was paid improperly to individuals, and the corporation can sue the directors to get it back that it may be applied in payment of the debts of the corporation."
As Giles J observed in Segenhoe v Atkins, Cotton LJ's "reference to 'the shareholders' was probably to the particular shareholders who had received the dividends, rather than to the shareholders as a fluctuating body", and later case-law has tended to explain Cotton LJ's dictum as a reference to the court's power to give directions in a liquidation as to the proceedings which a liquidator may pursue. However, the dictum is on any view irrelevant in the present case where the company is irredeemably insolvent. If a case ever arose of a solvent company, the English courts would have the opportunity, as Giles J did, of reconsidering the dictum, and of either taking the same view as Giles J or fashioning the dictum into a rule preventing any possible double recovery (perhaps building on the VGM principle: see below).
The auditor's position where all the shareholders have engaged in fraud
"the purpose of the statutory audit is to provide a mechanism to enable those having a proprietary interest in the company or being concerned with its management or control to have access to accurate financial information about the company. Provided that those persons have that information, the statutory purpose is exhausted. What those persons do with that information is a matter for them and falls outside the scope of the statutory purpose. In the present case the first plaintiffs [the company] have based their case not upon any lack of information on the part of Mr Golechha but rather upon the opportunity that the possession of the auditor's certificate is said to have given for the company to continue to carry on business and to borrow money from third parties. Such matters do not fall within the scope of the duty of the statutory auditor."
"However one identifies the company, whether it is the head management, or the company in general meeting, it was not misled and no fraud was practised upon it. This is a simple and unsurprising consequence of the fact that every physical manifestation of the company Berg was Mr Golechha himself. Any company must in the last resort, if it is to allege that it was fraudulently misled, be able to point to some natural person who was misled by the fraud. That the Plaintiffs cannot do."
In the result, the company was entitled only to nominal damages for the technical breach of contract involved in the failure to qualify the audit report. Hobhouse J's words must be taken in context. The company was solvent at the relevant dates. There was no-one but Mr Golechha to think or act for or be interested in it.
The significance of insolvency at the audit date
"The West Mercia case was a clear case of a director abusing his position for his own advantage but the same principle applies wherever it can be shown that those in charge of the affairs of a company or in control of it are acting contrary to the principles governing insolvency. It is only in this sense that it can be said that once a company is insolvent the interests of the company become those of its creditors. The duty of the company and its directors is then to preserve the assets of the company. The present case does not involve any such situation at any material time. The company may have been trading imprudently; but there is no evidence that in 1982 it was trading in fraud of its creditors. There is no allegation that Dearden Farrow were a party to any breach by Mr Golechha of any of his fiduciary duties."
This passage shows that the earlier passage in Hobhouse J's judgment (at p.54) quoted in para 260 above must be read in context. It does not mean that a company's only claim against its officers (including in this term its auditor) lies in deceit. It does not mean that a company is always to be equated with its directing mind. It does not address the context of insolvency.
Overseas authority on attribution
i. Canadian Dredge & Dock Co. Ltd. v The Queen (1985) 19 DLR (4th) 314, 1985 CanLII 32 was decided by the Canadian Supreme Court, after reference to English case-law including Tesco Supermarkets Ltd. v Nattrass. It concerned a criminal prosecution. Not surprisingly in this context, the Supreme Court took a limited view of the circumstances in which the company could disclaim the acts and state of mind of its directing mind. Estey J described these as being "when the directing mind ceases completely to act, in fact or in substance, in the interests of the corporation", or "where all of the activities of the directing mind are directed against the interests of the corporation with a view to damaging that corporation, whether or not the result is beneficial economically to the directing mind". Only then, might there "be said to be fraud on the corporation" or an act "totally in fraud of the corporate employer" (p.351). Two comments may be made. First, the language of fraud on a company was being used in the unfamiliar context of a charge against the company. In such a context, as I have said, the hurdle for disclaimer of responsibility was, not surprisingly, set high. Second, the phraseology developed in the judgment and used in subsequent Canadian cases (and some other common law cases: see e.g. In re The Mediators, Inc., paras. 6-7, discussed in paragraph 239 above, and Duke Group Ltd. v Pilmer 73 SASR 180 (1999),  SASC 97, para.632. indicates a test which is both more rigid and more extreme than that which English law would adopt, particularly since the Privy Council's decision in Meridian.
ii. Despite the first point, the reasoning in Canadian Dredge has been transposed in Canada to the context of an auditor's negligence claim in a first instance decision. Hart Building Supplies Ltd. v. Deloitte & Touche  BCSC 55 was a case where Mr Larson, a director and the directing mind and a 15% shareholder, had falsified Hart's inventory records and inflated its profits by false invoices "to try to help Hart's business", and so misled the auditors. The company's claim was brought at the instance of its innocent 85% shareholder against the auditors for negligence. The judge in applying "the law as set out in Canadian Dredge" took principles which may be appropriate when determining a company's liability to the third party and applied them, without question, to the different situation of a company seeking redress from a third party on the face of it in breach of duty to the company. For reasons I have given, this does not represent English law, and it has also been subjected to trenchant Canadian critique: Emaciating the statutory audit - a comment on Hart Building Supplies Ltd. v. Deloitte & Touche by Ass. Prof. Darcy MacPherson, University of Manitoba: (2005) 41 Can Bus LJ 471.
iii. Australian authority has adopted a more sceptical attitude to the scope and appropriateness of application of Canadian Dredge in the audit context: Edwards Karwacki Smith & Co. Pty. Ltd. v Jacka Nominees Pty. Ltd. (1994) 15 ACSR 502, where the Supreme Court of West Australia, after reviewing inter alia Canadian Dredge, refused summary disposal of a claim against auditors for negligently failing to discover that the directing mind of a "one-man company" had been fraudulently concealing the true state of the business and so fraudulently inducing investors in it.
iv. American authority is copious and less easy to digest (as well appears from the May 2008 continuing legal education study paper of the American Law Institute and Bar Association which the House was shown). Various broad approaches emerge. One takes the general law's theory of attribution or "imputation" and subjects it to an "adverse interest" exception (itself stated in differing terms, some resembling the Canadian Dredge test, others considerably more nuanced), which is then in turn subject to a "sole actor" exception. Another suggests that, in the context of a professional duty to check upon and report fraud such as the audit duty, either the general theory of imputation or the ex turpi causa doctrine (known in the United States as the in pari delicto defense) itself requires modification.
v. The early case of Cenco Inc. v. Seidman & Seidman 686 F2d 449 (1982) (USCA, 7th Circ.) concerned a claim by a still solvent company to recover damages from auditors who had failed to discover a fraud at top management and board level, consisting of inflating the value of inventory, and so of stock which was used to buy up other companies. Speaking for the court and applying the common law of Illinois, Judge Posner upheld the trial judge's directions to a jury which had led the jury to dismiss Cenco's claim. He differentiated fraud by top management involving theft from the company from the actual fraud which involved "turning the company into an engine of theft against outsiders". The case is therefore distinguishable from the present, which I would, for reasons indicated in paras 230 to 234, place in the former category for the purposes of the company's claim against Mr Stojevic or its auditors. Judge Posner went on to say that, even in deciding how to treat the latter category, the Illinois courts would be guided by "the underlying objectives of tort liability". Holding that these justified the judge's directions, he adopted a two-pronged "cost-benefit" analysis. To allow recovery would, first, benefit stockholders without differentiating between innocent and guilty stockholders and, second, shift the loss to all stockholders (who the court said were "slipshod in their oversight [of their chosen board] and so share responsibility for the fraud"), thus, in the court's view, reducing the incentive for stockholders to hire and monitor honest stockholders (pp.455-456).
vi. In Schacht v. Brown 711 F2d 1343 (1983) (also USCA, 7th Circ.), top management had fraudulently continued an insurance company in business past its point of insolvency and systematically looted it of its most profitable and least risky business and income, aggravating its insolvency. Cenco was distinguished on various grounds: first, as decided under Illinois law, whereas the issue in Schacht arose under federal law and the court could say that "we therefore write on a clean slate and may bring to bear federal policies in deciding the estoppel question"; second, on the ground that the fraud in Schacht, including the "Pyrrhic 'benefit'" of its artificially prolonged life, was not sufficient to engage the Cenco analysis of a company operating as the engine of fraud on others; and, third, on the ground that the two-pronged analysis adopted in Cenco led in Schacht to a different answer, because in Schacht the company was insolvent, there was no indication that the fraudulent top management would benefit from any recovery and "no evidence here of the existence of large corporate shareholders capable of conducting an independent audit, as in Cenco, and whose lack of investigatory zeal would be rewarded by a decision favourable to the [liquidator]" (p.1349).
vii. Similar thinking appears in (a) In re Jack Greenberg Inc. (Larry Waslow, Trustee v. Grant Thornton LLP) (U.S. Bankruptcy Court, E.D. Penn., Phil. Div.) 240 BR 486 (1999), where the court emphasised that "while the imputation doctrine may be applied in auditor liability cases, the doctrine was not crafted with that purpose in mind" and should be allowed "to be invoked only where the objectives of tort liability dictate" (p.508); (b) NCP Litigation Trust v. KPMG LLP 901 A.2d 871 (N.J. 2006), where the Supreme Court of New Jersey differentiated between shareholders engaged in a fraud involving inflation of profits and other innocent shareholders, holding that imputation could only be asserted to preclude recovery by the former, disagreed with the suggestion in Cenco that "imputation must be applied to shareholder suits to deter future such wrongdoing", noted differences between Illinois and New Jersey law, and, referring to Schacht, also concluded that the management's fraud "inflating a corporation's revenues and enabling a corporation to continue in business 'past the point of insolvency' cannot be considered a benefit to the corporation", but that, even if it could, "any benefit would not be a complete bar to liability, but only a factor in apportioning damages" (p.888); and (c) In re Sunpoint Securities, Inc. (U.S. Bankruptcy Court, E.D. Texas, Tyler Div.) (377 BR 513 (2007).
viii. One, though by no means the only, strand of the reasoning in Schacht and Jack Greenberg, involves a possible distinction between situations of solvency and insolvency. This is controversial in American law, particularly in the light of s.541 of the Federal Bankruptcy Code (according to which the bankruptcy estate "is comprised of .. all legal or equitable interests of the debtor in property as of the commencement of the case"), and there is authority rejecting such a distinction in cases covered by s.541: Official Committee of Unsecured Creditors v. R.F. Lafferty & Co., Inc. 267 F.3d 340 (3rd Cir. 2001). Earlier authorities had rejected the defence of in pari delicto as an answer to claims by receivers against negligent auditors: Federal Deposit Insurance Corpn v. O'Melveny & Myers 61 F3d 17, 19, (1995) and Scholes v. Lehmann 56 F3d 750, 754, (1995). The court in Lafferty distinguished these authorities on the ground that receivers are not within s.541 (Lafferty, p.358). However, in a still more recent decision, Knauer v. Jonathon Roberts Financial Group, Inc. 348 F3d 230, (2003) the Court of Appeals for the Seventh Circuit has taken the view that receivers do stand in the shoes of the company in relation to entities deriving no benefit from the fraud, as opposed to direct beneficiaries of the fraud.
ix. The "cost-benefit" analysis and other techniques deployed in American case-law do not find any easy match in English law. Case-law in some states permitting direct claims against auditors by injured third parties (including creditors) also complicates any appreciation of the practical significance of American authority: see e.g. Bily v. Arthur Young & Co. 3 Cal 4th 370 (1992). However, the general message in the recent case-law that I have examined is one of increasing reluctance to hold that top management fraud provides a defence to a negligent auditor, and this at least corresponds with my conclusions as to the right approach in principle in English law.