Fraudulent Company’s $170 Million Claim Against Auditors Struck Out

In a lengthy judgment given yesterday, the House of Lords, by a 3 to 2 majority, upheld the Court of Appeal's decision to strike out a $170m claim. The claim had been brought by a company’s liquidator against the company’s auditors. It was alleged that the auditors had failed to spot that the company was being used as a vehicle of fraud and therefore failed in their duty of care to the company.

The Lords held that the claim against the auditors would not succeed. Although the claim was brought by the liquidator, it was in fact the company’s claim. The claim failed because in bringing it the company would be relying on its own illegal conduct. It is a well-established legal principle that the courts will not assist a claimant in bringing a claim based on its own illegal act. Although the principle is well established, its application to companies rather than individuals has always proved difficult and was the subject of lengthy discussion and fierce disagreement by their lordships.

In reaching the decision the House of Lords considered the following issues:

• Whether the fraudulent behaviour of the company’s director could be attributed to the company i.e. whether the company was in fact the victim of the fraud or the villain?
• If the fraud could be attributed to the company, did it prevent the company from claiming against the auditors?
• Did it make a difference that one of the very things that the auditors were engaged to do was to detect fraud?

Although the precise reasoning varied, the following conclusions can be drawn from the majority judgments:

• The fraudulent director was the sole “controlling mind and will” of the company. Accordingly, the company was attributed with knowledge of the fraud. However, it appears that it was an important factor that there was no one else involved in the management or ownership of the company other than the fraudulent director himself.
• Accordingly, to bring its claim against the auditors, the company would need to rely on its own illegal act – which it was not entitled to do.
• It did not matter that one of the very things the auditors were engaged to do was to detect fraud.

Comment

This judgment should reassure auditors and their insurers that companies that are exclusively controlled and owned by fraudsters cannot bring claims against their auditors for failing to detect their deception. This will even be the case where the company has become insolvent and the claim is brought by a liquidator for the benefit of the company’s creditors.

Further reading: Moore Stephens (a firm) v Stone & Rolls Limited (in liquidation) [2009] UKHL 39