NEGLIGENCE—AUDITOR— EX TURPI CAUSA NON ORITUR ACTIO

Queen’s Bench Division (Commercial Court)
Langley J
27 July 2007

It should not be impermissible to allow a claimant company to pursue an action against negligent auditors, by use of the unforgiving application of the ex turpi causa non oritur actio rule. The objective of the maxim can properly be fulfilled by precluding any recovery which would enure to the benefit of the individual perpetrator or perpetrators of the impugned conduct, rather than to innocent creditors of the company.

Mark Simpson and David Murray (instructed by Norton Rose) for the claimant.
Mark Howard QC and Tom Adam (instructed by Barlow Lyde and Gilbert) for the defendant.

The defendants were the auditors of the claimant company in 1996, 1997 and 1998. The claimant alleged that in each year the audits were conducted negligently and, in respect of the 1998 audit, with “shutting eyes” fraud. The allegations concerned a letter of credit fraud committed against banks. The fraud consisted of the presentation by the claimant of false documents to the banks, the receipt of funds by the claimant and the payment away of those funds to other parties in the fraud. The documents were shams purporting to reflect a commercial transaction which had not occurred. The claimant issued proceedings alleging that the defendants should—by one route or another—have “blown the whistle”, bringing the fraud to an end. The owner and controller of the claimant, S, was the person who committed the fraud. Along with the claimant, he was found liable for it in relation to the major losing bank in 2002. The defendants applied, to strike out the claim. The principle issue arising on the application was whether, and if so, when, a claim by a company against its auditors would infringe the maxim ex turpi causa non oritur actio.

MR JUSTICE LANGLEY:

His lordship considered, Clunis v Camden and Islington Health Authority  [1997] EWCA Civ 2918, [1998] 3 All ER 180; Reeves v Commissioner of Police of the Metropolis [1997] EWCA Civ 2686, [1998] 2 All ER 381; and Tinsley v Milligan [1993] UKHL 3, [1993] 3 All ER 65. The conclusion he drew from those authorities was that the ex turpi maxim required a “reliance test” to be satisfied. The claim had to be “founded on” or “arise from” an illegal act of the claimant, or the facts which gave rise to the claim had to be “inextricably linked with” the illegality. The contrast was with a claim to which the illegality was only “collateral” or “insignificant” or “incidental”. It was also acceptable that only part of a claim or a loss was defeated by the maxim.
There could be no doubt that if the present claim were to be pursued by S himself, it would be defeated by the ex turpi maxim. There was no reason why the same result should not follow if the relevant personal claim were to be pursued by S’s trustee in bankruptcy. The trustee should in principle be in no better position than the bankrupt.

There was also no compelling reason why a corporation should not be subject to the same considerations in circumstances in which the relevant wrongdoing was to be attributed to the corporation following the normal principles of law applicable to attribution.

In this case, the law of attribution would attribute to the claimant the knowledge and the wrongdoing of S, save for the question whether the claimant was the victim of the wrongdoing or the perpetrator of it.
The answer to that question was not so straightforward. The primary victims of the fraud were the paying bank and the other losers. The fraud undoubtedly exposed the claimant to liabilities to the bank and the other losers, which it could not meet once, as was intended, the monies fraudulently obtained were paid away as they were to those responsible for the fraud. However, the claimant lost nothing to which it was ever entitled. The claimant was in a real sense the perpetrator of the fraud on the bank, 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 it would be artificial not to fix the claimant with the knowledge and wrongdoing of S and also artificial to describe the claimant even as a secondary victim of the fraud.

The defendant argued with reference to Reeves  that creditors of the claimant should not obtain via a company which had committed a fraud against them compensation from the auditors to the company which they could not in law obtain direct. They also rightly said that the duty of an auditor could not be expressed in terms of a duty to prevent a fraud being committed against or by the company audited.

Trying to stand back, and at the risk of fudging the strictures to be found in Tinsley, his lordship did not think the “conscience of the ordinary citizen” would find anything so repugnant in the claimant pursuing this claim which would justify ruling it impermissible by use of the unforgiving and uncompromising operation of the ex turpi maxim. His lordship derived some comfort from the accepted application to the claim of the law of contributory negligence. The objective of the maxim could properly be fulfilled by precluding any recovery which would enure to the benefit of the individual perpetrator or perpetrators of the impugned conduct, in this case S. Nor was there any principled basis on which defrauded creditors of a company should be in a worse position than those whose debts arose in the ordinary course of business.