Can the illegality defence bar a claim against a dishonest director?
06 July 2015
In Jetivia SA & anr v Bilta (UK) Ltd (in liquidation) & ors  UKSC 23, 22 April 2015, the Supreme Court ruled on the law of corporate attribution and the "illegality defence", which holds that a party cannot pursue a legal remedy that arises in connection with its own illegal act. The Supreme Court unanimously found that the illegality defence could not bar Bilta's claim against the directors and the appellants because the directors' acts, being committed in breach of their duties to Bilta, could not be attributed to Bilta in the context of a claim by Bilta for a breach of their duties. The court resisted making findings on the wider principle of illegality other than to the extent necessary for this decision, leaving the law in this area in an uncertain state.
The liquidators of Bilta (UK) Ltd (Bilta) sued its two former directors, its CEO, and Jetivia SA in relation to a carousel fraud that caused losses to Bilta (a GBP 38 million liability to HMRC). Bilta alleged that this scheme involved a breach by the two directors of their fiduciary duties, dishonestly assisted by its CEO and Jetivia SA (together, the appellants).
The appellants applied to strike out the claims, relying on the illegality defence in arguing that the directors' fraudulent acts should be attributed to the company, thus making the fraudulent transaction the company's own illegal act. As such, the appellants argued, the company should be prevented under ex turpi causa from pursuing a legal remedy from the appellants because such remedy arose in connection with the company's own illegal act. This application failed at first instance and the Court of Appeal rejected the appellants' appeal, which then came before the Supreme Court.
The Supreme Court unanimously found that the illegality defence could not bar Bilta's claim against the directors and the appellants because the directors' acts – being committed in breach of their duties to Bilta – could not be attributed to Bilta in the context of a claim by Bilta for a breach of their duties. The Justices took different approaches to their analysis but reached the same outcome nonetheless.
Attribution: the nature and context of the claim is key
The Justices were in agreement that the appellants should not be able to attribute the directors' dishonest breaches of duty to Bilta so as to bar Bilta's claim against the appellants for their own dishonest assistance in the directors' breaches. All shared the view that the nature of the claim is central to the attribution outcome, and reinforced the distinction (established in Bilta in the Court of Appeal and in Moulin Global Eyecare Trading Ltd (in liquidation) v Commission of Inland Revenue  HK CFA 22 in the Hong Kong Court of Final Appeal) between so-called "redress" and "liability" cases (though without always expressing the distinction in these terms). In cases that involve a company bringing proceedings against its fraudulent directors (and accomplices, as in the case of the appellants here) – the "redress" scenario – the directors' dishonest acts and/or state of mind will not be attributed to the company, as to do so would be contrary (in one way or another) to common sense and justice.
In contrast, in "liability" cases in which a company faces a claim from a third party in relation to a wrong committed against that third party arising out of the company's directors' breach of duty, the rules of agency will generally apply so as to attribute the act and state of mind of the director/employee to the company. The third party is the innocent victim and its interests take priority over the loss the company suffers at the hands of its own directors.
It is not entirely clear how other factual scenarios would fit into this analysis. Lords Toulson and Hodge suggest that in claims by a company against a third party attribution will depend on the nature of the claim, but where the third party participated in the breach of duty by the company's directors (eg a claim for conspiracy or dishonest assistance) there is no good policy reason why the knowledge of the dishonest director should be attributed to the company. In some ways the company can still be seen as the victim here and the same arguments would seem to apply for avoiding a perverse outcome whereby a fraudulent party (be that the dishonest director or third party accomplice) can defeat a claim by the company by attributing their acts to the company itself and seeking to rely on an illegality defence on this basis.
Although one can detect some divergence between the Justices as to which analytical tools they find most useful to approach this point, in the end all were more or less in agreement that the focus must be on the nature and factual context of the claim at hand, when asking "whose act (or knowledge or state of mind) was for this purpose intended to count as the act etc of the company" (per Lord Hoffmann in Meridian Global Funds Management Asia Ltd v Securities Commission  2 AC 500).
The court only needed to go so far in this case as to determine that the illegality defence could not be used to bar Bilta's claims against the appellants. As to the application of the illegality defence more widely, the Justices resisted tackling the issue head-on, taking the view that this was not the case in which to do so since wider arguments about the application of the doctrine had not been pleaded. Bilta, then, does not add anything decisive to this already-confused area of law and highlights the range of possible interpretations of the existing, extensive case law.
Lord Sumption devoted much space in his judgment to an analysis of the illegality case law and its developments over time, expressing his view that the law in this area had by the end of the 20th century "become encrusted with an incoherent mass of inconsistent authority" featuring "a mass of sub-rules, each appropriate to its own context." In a bid to overcome this situation, the courts started to move towards suggesting that the process of applying the illegality principle might be better considered discretionary in nature. However, the House of Lords in Tinsley v Milligan  1 AC 340 shifted back from this path and re-asserted that the illegality defence is a rule of law rather than a matter of discretion and pragmatism, a view that was reaffirmed by the Supreme Court in Les Laboratoires Servier v Apotex Inc  UKSC 55 which determined (in Lord Sumption's words) that "the illegality defence is based on a rule of law on which the court is required to act…It is not a discretionary power on which the court is merely entitled to act, not is it dependent upon a judicial value judgment about the balance of equities in each case." Here the Justices part company: Lords Toulson and Hodge (the former who dissented in Les Laboratories) clearly favour the more pragmatic approach and took from the Supreme Court's decision in Hounga v Allen  UKSC 47 a return to a broader view of context and competing public policy aims which seemed to conflict with Tinsley v Milligan.
In this context, Lords Toulson and Hodge held that they would also decide the case on a statutory public policy basis; ie on the grounds that to allow attribution (and thus the illegality defence) in this instance would run counter to the directors' duties under the Companies Act 2006 (CA06) and indeed "make a nonsense" (per Lord Neuberger) of the duty imposed on directors by s172(3) CA06 to have regard to the interests of creditors of an insolvent/prospectively insolvent company, and indeed deprive the statutory duties that the directors owed Bilta of all content.
It is not entirely clear from the judgments where this analysis fits into the overall attribution/illegality landscape. While Lord Neuberger read Lords Toulson and Hodge as suggesting that they would resolve the attribution question itself by applying broad policy statements, it seems that in fact all of the Justices were broadly in agreement as to the basic structure of the law on attribution. Instead, Lords Toulson and Hodge's emphasis on statutory policy is better seen as a separate ground on which they conclude that this case should be resolved as part of their analysis of how the illegality defence should work (ie as a question of factual context and competing public policy objectives; in this case, the competition being between the CA06 public policy and the public policy rooted in the illegality doctrine). The other Justices either did not agree with Lords Toulson and Hodge (in the case of Lord Sumption) or did not take their analysis down this route, leaving it aside as part of the question of how the illegality defence works (which they decided not to engage with more generally in this case).
We are left, then, with a situation in which the Supreme Court has given recent judgments that can be interpreted as taking different approaches to the application of the illegality defence and whose effect remains in dispute even between the Justices. Unfortunately, the judgment in Bilta has not provided any clarity on the Supreme Court's view on which approach ought to be taken in this area, which was acknowledged by Lord Neuberger, who noted that this issue needs to be dealt with as soon as the appropriate case comes before the court.
While on the one hand the decision on attribution in this case adds further certainty to this field by reinforcing other recent approaches in the case law, the picture on illegality is less comforting. The apparent conflict between a number of recent decisions of the same court on illegality leaves the law in this area distinctly uncertain and – as the Supreme Court emphasised – in real need of urgent resolution. Whether the law should be anticipated to move in a principles-based direction or towards a more discretionary, context-specific approach remains entirely unclear. It remains to be seen whether the Law Commission, which had previously explored putting this area on a statutory footing, might pick up the mantle again or whether, as the Supreme Court suggests, we will have to wait patiently for the right case to come before the Supreme Court and for the court to take the opportunity to articulate its decisive view on this area.