Scope of the attribution doctrine, illegality defence and extra-territorial effect of s.213 Insolvency Act 1986
On 22 April 2015, the Supreme Court provided its judgment in Jetivia SA v Bilta (UK) Limited, but with conspicuously differing views and perspectives from their Lordships as to the scope and application of the attribution doctrine, and the “illegality defence” (ex turpi cause non oritur actio). While some of the attribution principles have been partially clarified, their Lordships’ comments on the illegality defence were largely obiter, as the Jetivia case was not the appropriate forum to address this issue, and there was a need to consider this matter at the next available opportunity to further clarify and establish clear guidelines on the scope and applicability of this defence, taking account of the unsatisfactory nature of the House of Lords decision in Stone & Rolls Limited v Moore Stephens  1 AC 1391.
In November 2009, Bilta (UK) )”Bilta”) was wound up compulsorily based on a winding up petition presented by HMRC, as a creditor. Subsequently, Bilta’s liquidators issued proceedings against its two former directors (“directors”), and against Jetivia SA (a Swiss company) and Jetivia’s chief executive (“appellants”). The allegations were that the directors and appellants were parties to an “unlawful means conspiracy” to injure Bilta by a fraudulent scheme by the directors breaching their fiduciary duties in their capacity as Bilta’s directors, and Jetivia and its chief executive in dishonestly assisting them in this process.
The nature of the conspiracy was that Bilta’s directors caused Bilta to enter into transactions relating to the European Emissions Trading Scheme Allowances with various parties including Jetivia, and that these transactions amounted to a “carousel fraud” (VAT fraud).
Bilta’s liquidators claimed (i) damages in tort from Bilta’s directors, Jetivia and its chief executive; (ii) compensation based on constructive trust from Jetivia and its chief executive; and (iii) a contribution from each of the four defendants under s.213 Insolvency Act 1986 (fraudulent trading) (“IA 1986”).
The appellants applied to strike out Bilta’s claim on the basis of the defence of illegality and that s.213 IA 1986 did not have extra territorial effect. The appellants claimed that Bilta’s claim against its directors could not be upheld because of the criminal nature of Bilta’s conduct while under the directors’ control. They contended that, in effect, Bilta served as a vehicle for defrauding HMRC and the illegality defence prevented Bilta from suing the directors to recover the company’s loss for the benefit of Bilta’s creditors.
The case before the Supreme Court addressed three principal issues on appeal:
- 1. The circumstances in which the knowledge of directors and other persons is attributed to a legal person such as a company (“Attribution”).
- 2. The purpose of the illegality defence and its application to Bilta’s claims (“Illegality Defence”); and
- 3. The extra territorial effect of s.213 IA 1986 (“Extra Territorial Effect”).
The Supreme Court held that the illegality defence could not bar Bilta’s claims against the appellants. This was because the conduct of the directors could not be attributed to Bilta in respect of a claim against directors for breach of their duties. Further, s.213 IA 1986 had extra territorial effect and could be invoked against the appellants.
The Supreme Court’s starting point on Attribution was that that a company had a separate legal personality distinct from its shareholders: Salomon v Salomon & Co Ltd  AC 22 and Prest v Petrodel Resources Limited  2 AC 415. A company has a real legal existence regardless of whether it was controlled by one or more persons. However, as a company was not a natural person, it could not operate in vacuum: it must act through its directors and agents who control how the company will function in its day to day existence: Aberdeen Railway Co v Blaikie Brothers (1854) 1 Macq 461. They are also accountable to their company and owe fiduciary duties to the company through common law, equity and their general duties under the Companies Act 2006. The independent existence of the company signifies that the company can incur liabilities; it can enter into contracts; it can sue and be sued, whether in contract, tort or otherwise. Generally, directors can be described as the “directing mind and will” of the company, in that their acts and state of mind may be attributed to the company through application of the agency principles at common law. However, this attribution rule was not of general application but was subject to limitations, and consideration must be given to the very specific and particular context or situation in which the acts and state of mind of the directors could be attributed to the company. In this regard, the court will consider the nature of the agency relationship between the company and its directors, and the nature of the principal’s or the other party’s claim.
In this case, Bilta was being used by its directors as a vehicle to commit a fraud on a third party causing losses to the company in breach of the directors’ fiduciary duties to the company. Under these particular circumstances, it was not appropriate to attribute to the company the fraud to which the alleged breach of duty related, even if this was being practiced by a person whose acts and state of mind would be attributed to the company in other contexts. The Supreme Court identified three situations in a civil law context concerning attribution of knowledge to a company:
- In relation to a claim by a defrauded third party against the company. Here under the agency rules, the company should be treated as a perpetrator of the fraud. The acts and state of mind of the director are attributed to the company. The company is treated as an absent human owner of a business who leaves it to his managers to operate the business.
- In respect of a claim between the company against its directors for breach of a duty (whether fiduciary or otherwise), the delinquent directors should not be able to rely on their own breach of duty nor should their actions or state of mind be attributed to the company. It would also defeat the policy of the Companies Act provisions, which provisions were intended to protect the company including the interests of the company’s creditors on where the company is insolvent or near insolvency – the “statutory policy” argument put forward by Lords Toulson and Hodge.
Where a company claims against a third party, whether or not there is attribution of the director’s act or state of mind will depend upon the nature of the claim that is in issue.
- The application of the Attribution principles in the context of a company/director relationship makes it clear that there is no place to hide for a director who breaches his duties. The director cannot attribute his acts and state of mind as those of the company.
The Supreme Court did not consider the Jetivia case as an appropriate forum to address fully the illegality defence and stated the urgency in reviewing this defence in any forthcoming case on this issue. Many of their Lordships comments were therefore obiter with differing perspectives of their Lordships as to the proper application of this defence. According to Lords Toulson and Hodge, the defence of illegality was a rule of public policy dependent upon the nature of the particular claim brought by the claimant and the relationship between the parties. Owing to the fiduciary duties of directors towards an insolvent company, directors must have proper regard to creditors’ interests: a position addressed under s.172 CA 2006 and at common law and equity: Kinsella v Russell Kinsela Pty Ltd (in liquidation) (1986) 4 NSWR 722; and West Mercia Safetywear v Dodd  BCLC 250. The significant feature of the illegality defence was based on public policy grounds, and directors could not escape liability for breach of their fiduciary duty on the ground that they were in control of the company. Another different perspective put forward by Lord Sumption was that the defence of illegality was a rule of law independent of any judicial value judgment about the balance of equities in each case. However, Lord Sumption did not agree with Lords Toulson and Hodge on the “statutory policy” argument defeating the claim of Illegality Defence.
Section 213 IA 1986 and its Extra Territorial Effect
The Supreme Court unanimously held that that s.213 IA 1986 (fraudulent trading) had extra territorial effect. Section 213 applies where any person who has knowingly become a party to the carrying of that company’s business for a fraudulent purpose. The section applied to companies registered in Great Britain; however the effect of a winding up order was worldwide. It would seriously affect the efficient winding up of a British company if the jurisdiction of the court responsible for the winding up of an insolvent company did not extent to people and corporate bodies resident overseas who had been involved in the carrying on of the company’s business.
- The doctrine of attribution is applied generally in a variety of situations and contexts under general agency principles. However, when attributing liability, consideration should be given to the particular factual context and circumstances in which the doctrine is being used. In the company context, a company has independent legal existence separate from its shareholders. However, the company cannot act or function alone: it acts through the directors and agents who control the company’s operations. The issue is: where directors are in breach of their duties, can they attribute that breach and state of mind (if appropriate) to the company? In this regard, the attribution doctrine becomes more significant in the particular context of the company/director relationship. Where the company has been the victim of wrong-doing by its directors or of which directors had notice, the wrong-doing or knowledge of the directors cannot be attributed to the company as a defence to a claim brought against the directors by the company’s liquidator, in the name of the company and/or on the company’s behalf. This principle will apply even where the directors were the only directors and shareholders of the company, and even though the wrong-doing or knowledge of the directors may be attributed to the company in many other ways.
- The Supreme Court could not reach any unanimous opinion as to the proper approach which should be adopted to the Illegality Defence. Their Lordships held differing views and approaches to the defence, but agreed to defer further discussion when the appropriate case arises in the future. Lord Sumption was of the view that the law on the defence of illegality was established in Tinsley v Milligan  1 AC 340 and developed in Les Laboratoires Servier v Apotex Inc  UKSC 55 and their consistency with the decision in Hounga v Allen  UKSC 47. Lords Toulson and Hodge adopted the Court of Appeal’s approach in Tinsley with Hounga as supporting the Court of Appeal’s approach to the defence of illegality.
- Their Lordships also addressed the role of statutory policy with reference to the Illegality Defence, with Lords Toulson and Hodge dismissing the appellants’ appeal based on statutory policy in that it would be contrary to statutory policy and duties contained under s.172(3) CA 2006 if directors against whom a claim was brought under that provision, could rely on the Illegality Defence. The codification of general duties of directors derived from common law and equity and the statutory general duties of directors merely restated these rules. It would, therefore, be contrary to statutory policy to apply the Illegality Defence in this context.
- The Supreme Court was also divided in the proper analysis to be attributed to Stone & Rolls Limited v Moore Stephens  1 AC 1391. In Stone & Rolls, the majority of the Law Lords reached different conclusions as to how the Illegality Defence should be applied, including the difficulty of identifying the ratio of the case. However, there was agreement that Stone & Rolls was particular to its facts and should be confined to such particular facts and not looked at again. See too and Safeway Stores Ltd v Twigger  EWCA Civ 1472.
- While the Supreme Court has to some extent clarified some of the law relating to the doctrine of Attribution and the contexts of its application where a company is involved, it has not clarified the scope and application of the Illegality Defence and its application in Stone & Rolls. The diverse views of their Lordships as to the proper approach will need much further analysis in a future case addressing this issue. Stone & Rolls will most probably be left to gather dust as confined to its particular facts with no pertinent ratio that serves any useful purpose. The attribution rules in the context of a company will bite most in the company/director relationship, where directors are in breach of their fiduciary duties, and they cannot exonerate themselves by attributing liability to the company, because the acts and state of mind are clearly not those of the company. Directors’ duties should not, therefore, be taken lightly and a heavy burden is imposed on directors to act in the best interests of the company and its various stakeholders. Directors can no longer shield behind the company for their wrongful acts.
- There are two provisions which directors may take into account in connection with breaches of their duty. Section 239 CA 2006 applies to ratification by a company of conduct by a director amounting to negligence, default, breach of duty or breach of trust in relation to the company. Although shareholders may ratify conduct of directors (“conduct” being defined as an act or omission), they will not, however, be able to ratify fraudulent or illegal conduct on the part of directors: s.236(7) CA 2006.
Further, directors may wish to consider s.1157 CA 2006. Where directors or other officers are found to be in breach of their duties, apart from seeking relief from liability from the shareholders, they may be able to apply to the court to seek relief from the impact of Part 10 CA 2006. Section 1157 CA 2006 is concerned with the power of the courts to grant relief in certain circumstances. It states that if in proceedings for negligence, default, breach of duty or breach of trust against:
(a) an officer of a company, or
(b) a person employed by a company as auditor (whether he is or is not an officer of the company),
it appears to the court hearing the case, that the officer or person is or may be liable but that he acted honestly and reasonably, and that having regard to all the circumstances of the case (including those connected with his appointment) he ought fairly to be excused, the court may relieve him, either wholly or in part, from his liability on such terms as it thinks fit: CA 2006, s.1157(1).
The effect of s.1157 is to provide relief to a director or officer from past acts or future acts. It provides a wide discretion to the court to provide partial, full or such relief as the court thinks fit. The starting point is that there has been negligence, default, breach of duty or breach of trust on the part of the director or officer in connection with the company’s affairs. The director must show as an absolute precondition that he acted honestly and reasonably: Bairstow v Queens Moat Houses plc  2 BCLC 531, where on the facts the directors had acted dishonestly in falsifying the company’s accounts, it was not open to the court to find aspects of honesty. Further, as Lord Nicholls stated in Royal Brunei Airlines Sdn Bhd v Tan  3 All ER 97 at 106:
‘The standard of what constitutes honest conduct is not subjective. Honesty is not an optional scale, with higher or lower values according to the moral standards of each individual. If a person knowingly appropriates another’s property, he will not escape a finding of dishonesty simply because he sees nothing wrong in such behaviour.’
Although the question as to whether a director has acted honestly is tested subjectively; the question whether he has acted reasonably is an objective one: Coleman Taymar Ltd v. Oakes  2 BCLC 749. See too Re Loquitur Ltd  2 BCLC 442.
The court will have regard to all the circumstances of the case in assessing whether the director “ought fairly to be excused” from liability. In Ultraframe (UK) Ltd v Fielding  EWHC 1638, Lewison J stated that “the expression “the case” does not mean “the litigation”; but primarily means the circumstances in which the breach took place… [and] include a review of the director’s stewardship of the company; but they do not involve a more wide-ranging inquiry into the director’s character and behaviour”.
Saleem Sheikh is author of Company Law Handbook 2015 (Bloomsbury Professional, 2014)