Vol 6 (2009) - Issue 5

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House of Lords Rules on Auditors’ Liability in Fraud Case

In a decision handed down just before the end of term, auditors have won an important House of Lords ruling in Moore Stephens v Stone Rolls Limited [2009] UKHL 39 limiting their liability in cases where a ‘one-man’ company is used as a vehicle for fraud. The law lords dismissed by a majority of three to two a negligence claim brought against an audit firm for failing to detect a massive fraud at Stone & Rolls Limited, a trading company that fell in the late 1990s – holding that the liquidators could not bring a claim for damages when the company itself was responsible for the fraud.

Background

The liquidator acting on behalf of Stone & Rolls Limited (the ‘Company’) brought proceedings in the Commercial Court in December 2006 against Moore Stephens (the ‘Auditors’) claiming that they had been negligent in conducting the Company’s audits in the years 1996, 1997 and 1998.

In particular, the Company alleged that the Auditors had breached their duty to act with reasonable skill and care in failing to detect and report to regulators a fraudulent scheme which was being perpetuated by Mr Zvonko Stojevic using the Company as his vehicle. Had the auditors fulfilled their duty, it was said, the fraud would have been revealed and stopped. The fraud involved the Company obtaining payments under letters of credit by presenting to banks false documents in relation to fictitious commodity trading. The monies fraudulently obtained were subsequently taken out of the Company and passed to other participants in the scheme.

When one of the banks upon whom the fraud had been perpetrated sued the Company and Mr Stojevic in deceit, that bank was awarded substantial damages. However, the bank was unable to recover anything from Mr Stojevic and the Company was insolvent. As a result the Company went into liquidation and the liquidator brought the present claim against the auditors in an attempt to recover damages of almost USD 174 million.

The Auditors sought summary judgment on, alternatively a strike out of, the Company’s claim on the basis that, even if they had been negligent (which they accepted for the purpose of the application) they had a complete defence based upon the public policy principle that a party in bringing a claim was not allowed to rely upon its own illegal behaviour (ex turpi causa non oritur actio ('ex turpi')).

The decisions of the courts below

The parties’ legal arguments

In support of the application, the defendant Auditors relied upon the fact that Mr Stojevic was the sole 'controlling mind and will' of the Company, which was said to be a 'one-man band'. Thus, Mr Stojevic’s fraud was the Company’s fraud and the Company could not rely upon that fraud when bringing its claim against the Auditors. The Company was, the argument ran, barred from its claim by the operation of the ex turpi maxim.

In response, the Company sought to rely upon the principle in Re Hampshire Land Co [1896] 2 Ch 743, that where an officer or employee of a company commits a fraud upon the company itself then the knowledge of his own fraud is not the knowledge of the company. In Belmont Finance v Williams Furniture [1979] 1 Ch 250, the principle was put in terms that knowledge should not be attributed to the company where the company was the 'victim' of the improper conduct of its officers. The Company further argued that, in any case, the ex turpi maxim did not provide a defence as the fraud was the 'very thing' that the Auditors owed a duty to prevent.