ON APPEAL FROM THE HIGH COURT OF JUSTICE
The Hon Mr Justice Lewison
Claim No HC07C03030
Strand, London, WC2A 2LL
B e f o r e :
LORD JUSTICE RICHARDS
LORD JUSTICE HUGHES
| Sinclair Investments (UK) Ltd
|- and -
|Versailles Trade Finance Limited (in administrative receivership)
Versailles Group Plc (in administrative receivership)
National Westminster Bank Plc
Anthony V Lomas
Royal bank of Scotland Plc
Respondents and Cross-appellants
WordWave International Limited
A Merrill Communications Company
190 Fleet Street, London EC4A 2AG
Tel No: 020 7404 1400, Fax No: 020 7831 8838
Official Shorthand Writers to the Court)
Matthew Collings QC (instructed by Denton Wilde Sapte LLP) for the Respondents
Hearing dates : 14th, 15th and 16th February 2011
Crown Copyright ©
The Master of the Rolls:
The facts in outline
"VTFL's turnover was inflated in the following manner: (i) the accounts showed money paid to and received from other companies controlled and managed by Mr Cushnie and Mr Clough (the so-called cross-firing companies) as if they were genuine trading payments and receipts, which they were not; and (ii) the nominal ledger contained entries which purported to be sales, purchases and trading receipts and payments which were not justified by any actual trading. The main cross-firing companies were [effectively controlled by Mr Cushnie]. In broad terms, it worked as follows. VTFL had a Customer Service Division, which was a genuine trade generating funds. VTFL was financed by bank loans. It also received finance . from March 1996, from TPL; [which was] financed by the traders. The money so received by VTFL was then revolved around the cross-firing companies. [B]etween June 1993 and October 1999 hundreds of millions of pounds were transferred both ways between VTFL and various cross-firing companies. VTFL's receipts were disguised in its cash books to make them appear as genuine sales to genuine customers, so falsely inflating its turnover."
For many years the fraud was well concealed. Banks, investors, VTFL's auditors and the financial press were all taken in.
The claims in these proceedings
i) Mr Cushnie owed TPL fiduciary duties, including a duty not to make secret or unauthorised profits and not to apply traders' funds in breach of the terms of the agreements with the traders.
ii) Mr Cushnie breached those duties by misusing, or permitting the misuse of, the monies entrusted to TPL ("the TPL Trust monies") in the cross-firing fraud.
iii) This misuse of the TPL Trust monies was calculated to, and did, increase the share price of VGP above its true value, which was at all times nil.
iv) Mr Cushnie realised the value of this increase on 9 November 1999 by selling the Shares for £28.69m.
v) The £28.69m was an unauthorised gain made by Mr Cushnie in the course of his fiduciary relationship with TPL, a gain he was only able to make through the misuse of the TPL Trust monies.
vi) Accordingly, the moment it was made, the £28.69m was held by Mr Cushnie on constructive trust for the benefit of TPL.
vii) TPL is therefore entitled in equity to claim the traceable proceeds of the gain, and this entitlement is a proprietary right, good against anyone except a purchaser for value without notice.
viii) As VTFL was a defaulting fiduciary for TPL, neither it nor its holding company VGP can have a competing proprietary claim. Nor can the banks, who are merely creditors of VTFL.
The applicable legal principles
The duties of trustees and others in fiduciary positions
Personal claims against fiduciaries
"that a trustee in breach of trust must restore or pay to the trust estate either the assets which have been lost to the estate by reason of the breach or compensation for such loss. Courts of Equity did not award damages but, acting in personam, ordered the defaulting trustee to restore the trust estate. If specific restitution of the trust property is not possible, then the liability of the trustee is to pay sufficient compensation to the trust estate to put it back to what it would have been had the breach not been committed."
"A beneficiary's claim against a trustee for breach of trust is a personal claim. It does not entitle him to priority over the trustee's general creditors unless he can trace the trust property into its product and establish a proprietary interest in the proceeds."
"Stated comprehensively in terms of the liability to account, the principle of equity is that a person who is under a fiduciary obligation must account to the person to whom the obligation is owed for any benefit or gain (i) which has been obtained or received in circumstances where a conflict or significant possibility of conflict existed between his fiduciary duty and his personal interest in the pursuit or possible receipt of such a benefit or gain or (ii) which was obtained or received by use or by reason of his fiduciary position or of opportunity or knowledge resulting from it. Any such benefit or gain is held by the fiduciary as constructive trustee ".
Claims based on constructive trust
"A constructive trust arises by operation of law whenever the circumstances are such that it would be unconscionable for the owner of property to assert his own beneficial interest in the property and deny the beneficial interest of another. In th[is] class of case, the constructive trustee really is a trustee. In these cases the plaintiff does not impugn the transaction by which the defendant obtained control of the property. He alleges that the circumstances in which the defendant obtained control make it unconscionable for him thereafter to assert a beneficial interest in the property.
The second class of case is different. It arises when the defendant is implicated in a fraud. Equity has always given relief against fraud by making any person sufficiently implicated in the fraud accountable in equity. In such a case he is traditionally though I think unfortunately described as a constructive trustee and said to be 'liable to account as constructive trustee'. Such a person is not in fact a trustee at all, even though he may be liable to account as if he were. He never assumes the position of a trustee, and if he receives the trust property at all it is adversely to the plaintiff by an unlawful transaction which is impugned by the plaintiff. In such a case the expressions 'constructive trust' and 'constructive trustee' are misleading, for there is no trust and usually no possibility of a proprietary remedy; they are 'nothing more than a formula for equitable relief': Selangor United Rubber Estates Ltd v Cradock (No 3)  1 WLR 1555 at 1582 per Ungoed-Thomas J."
"Equitable compensation for breach of trust is designed to achieve exactly what the word compensation suggests: to make good a loss in fact suffered by the beneficiaries and which, using hindsight and common sense, can be seen to have been caused by the breach."
However, although it is subject to limiting principles, equitable compensation is a more flexible concept than common law damages. Kirby J in the High Court of Australia put it this way in Maguire v Makaronis (1997) 188 CLR 449, 496:
"[Equitable] remedies will be fashioned according to the exigencies of the particular case so as to do what is 'practically just' as between the parties. The fiduciary must not be 'robbed'; nor must the beneficiary be unjustly enriched."
First main issue: TPL's proprietary claim to the sale proceeds of the Shares
The proprietary claim to the proceeds of sale of the Shares: the arguments
The proprietary claim to the proceeds of sale of the Shares: the cases up to 1993
"[Pearson] cannot in the fiduciary position he occupied, retain for himself any benefit or advantage that he obtained under such circumstances. He must be deemed to have obtained it under circumstances which made him liable, at the option of the cestuis que trust, to account either for the value at the time of the present he was receiving, or to account for the thing itself and its proceeds if it had increased in value."
James LJ (in a judgment which I suspect betrays the court's view of the underlying merits of the case) and Baggallay JA agreed see at LR 5 Ch D 336, 342.
"The ground of this suit is concealed fraud. If a man receives money by way of a bribe for misconduct against a company or cestui que trust, or any person or body towards whom he stands in a fiduciary position, he is liable to have that money taken from him by his principal or cestui que trust. But it must be borne in mind that that liability is a debt only differing from ordinary debts in the fact that it is merely equitable, and in dealing with equitable debts of such a nature Courts of Equity have always followed by analogy the provisions of the Statute of Limitations ."
"Then comes the question, as between [employer] and [employee], whether [the employee] can keep the money he has received without accounting for it? Obviously not. I apprehend that he is liable to account for it the moment that he gets it. It is an obligation to pay and account to [the employer] . But the relation between them is that of debtor and creditor; it is not that of trustee and cestui que trust. We are asked to hold that it iswhich would involve consequences which, I confess, startle me. One consequence, of course, would be that, if [the employee] were to become bankrupt, this property acquired by him with the [bribe] would be withdrawn from the mass of his creditors and be handed over bodily to [the employer]. Can that be right? Another consequence would be that [the employer] could compel [the employee] to account to them, not only for the money with interest, but for all the profits which he might have made by embarking in trade with it. Can that be right? It appears to me that those consequences shew that there is some flaw in the argument."
The last three sentences indicate that Lindley LJ thought that equitable compensation would not have extended to enabling the employer to claim the full value of the profits made on the business or asset purchased by the employee with the bribe, which, as Mr Miles said, rather undermines Mr Collings's suggestion that equitable accounting would enable a fiduciary to be held accountable for any profit he made on an asset which he acquired with a bribe.
"When a bribe is offered and accepted in money or in kind, the money or property constituting the bribe belongs in law to the recipient. Money paid to the false fiduciary belongs to him. The legal estate in freehold property conveyed to the false fiduciary by way of bribe vests in him. Equity, however, which acts in personam, insists that it is unconscionable for a fiduciary to obtain and retain a benefit in breach of duty. The provider of a bribe cannot recover it because he committed a criminal offence when he paid the bribe. The false fiduciary who received the bribe in breach of duty must pay and account for the bribe to the person to whom that duty was owed. In the present case, as soon as the first respondent received a bribe in breach of the duties he owed to the Government of Hong Kong, he became a debtor in equity to the Crown for the amount of that bribe. So much is admitted. But if the bribe consists of property which increases in value or if a cash bribe is invested advantageously, the false fiduciary will receive a benefit from his breach of duty unless he is accountable not only for the original amount or value of the bribe but also for the increased value of the property representing the bribe."
The proprietary claim to the proceeds of sale of the Shares: principle and precedent
"Keech v Sandford might arguably be brought within [Millett LJ's] class 1 [in Paragon  1 All ER 400, 409], but, if so, only because of the special nature of the property involved. As was explained in Biss v Biss  2 Ch 40, 56 , the renewal is treated as 'an accretion to or graft upon the original term arising out of the goodwill or quasi-tenant right annexed thereto'. It provides no analogy for a similar link between the voting rights and the new shares in the present case."
Conclusion on the proprietary claim to the proceeds of sale of the Shares
"The fiduciary duty relied on in the present case is a duty owed by Mr Cushnie to TPL. The unauthorised profit is a profit realised by Mr Cushnie on the sale of shares in VGP. Mr Cushnie acquired those shares before TPL was even incorporated. But at any rate his initial acquisition of the shares could not, in my judgment, have amounted to an acquisition of property that belonged in any sense to TPL. Before his sale of those shares he did not owe trustee-like duties in relation to that specific property. It follows, in my judgment, that the claim by TPL to the profit realised by Mr Cushnie on a sale of those shares is a claim based on the transaction which gave rise to those profits, and the circumstances in which it was made. It is, therefore, a case which falls into [Millett LJ's] second class; and gives rise to a personal remedy only. Since the claim gives rise to a personal remedy only, it is not open to TPL to trace those profits into the proceeds of sale of the Kensington property and to assert a proprietary claim to those proceeds. The settlement of personal claims between VTFL and Mr Cushnie cannot be undone by TPL in reliance on a personal claim. That settlement could only be undone by a trustee in bankruptcy or liquidator."
Second main issue: Following any proprietary claim to the Share sale proceeds
The concept of notice
"The doctrine of notice lies at the heart of equity. Given that there are two innocent parties, each enjoying rights, the earlier right prevails against the later right if the acquirer of the later right knows of the earlier right (actual notice) or would have discovered it had he taken proper steps (constructive notice). In particular, if the party asserting that he takes free of the earlier rights of another knows of certain facts which put him on inquiry as to the possible existence of the rights of that other and he fails to make such inquiry or take such other steps as are reasonable to verify whether such earlier right does or does not exist, he will have constructive notice of the earlier right and take subject to it."
"[The plaintiff] attempted to establish constructive notice on the part of each of the defendants by a meticulous and detailed examination of every document, letter, record or minute to see whether it threw any light on the true ownership of the [relevant] shares which a careful reader with instant recall of the whole of the contents of his files ought to have detected. That is not the proper approach. Account officers are not detectives. Unless and until they are alerted to the possibility of wrongdoing, they proceed, and are entitled to proceed, on the assumption that they are dealing with honest men. In order to establish constructive notice it is necessary to prove that the facts known to the defendant made it imperative for him to seek an explanation, because in the absence of an explanation it was obvious that the transaction was probably improper."
Notice: is it right to impute the legal consequences of known facts?
"In my view, knowledge of a claim being made against the solicitor's client by the other party is not sufficient to amount to notice of a trust or notice of misapplication of the moneys. In the present case, which involves unsolved questions of fact, and difficult questions of German and English law, I have no doubt that knowledge of the plaintiffs' claim is not notice of the trusts alleged by the plaintiffs."
Sachs LJ took the same view, and at  2 Ch 276, 290 described "the duty to inquire" as "vary[ing] according to the facts", and that, in that case, when it came to the law, the defendants "were under no duty in such a complex matter either to make enquiries or to attempt to assess the result."
Notice: the approach to be adopted in this case
"It cannot, I think, be questioned that under ordinary circumstances a person, be he banker or other, who takes money from his debtor in discharge of a debt is not bound to inquire into the manner in which the person so paying the debt acquired the money with which he pays it. However that money may have been acquired by the person making the payment, the person taking that payment is entitled to retain it in discharge of the debt which is due to him."
Notice so far as the banks are concerned
Can VTFL claim to be a bona fide purchaser without notice?
Third main issue: TPL's proprietary claim to the monies held by VTFL
Is the proprietary claim defeated by the inextricable mixing of monies?
"It is a well-established doctrine in this court, that if a trustee or agent mixes and confuses the property which he holds in a fiduciary character with his own property, so as that they cannot be separated with perfect accuracy, he is liable for the whole."
Ungoed-Thomas J considered and applied this principle in Re Tilley's Will Trusts  Ch 1179, saying this:
"The words in that passage 'so as that they cannot be separated with perfect accuracy' are an essential part of the Vice-Chancellor's proposition, and indeed of the principle of Lupton v. White. If a trustee mixes trust assets with his own, the onus is on the trustee to distinguish the separate assets, and to the extent that he fails to do so they belong to the trust."
"If a man mixes trust funds with his own, the whole will be treated as trust property, except so far as he may be able to distinguish what is his own."
The finding that the banks were first on notice in July 2001
"He knew that the banks had mortgage debentures over the book debts; and he accounted to the banks for his recoveries. Whether those recoveries might be impressed with a trust in favour of TPL did not enter his mind. Had he thought that the debts did not belong to VTFL or that they were not covered by the banks' charges, he would not have accounted to them in the way that he did. He appreciated that there were mixed monies, but that was as far as it went."
The repayments of corporation tax
The extent of TPL's claim
Lord Justice Richards:
Lord Justice Hughes: