Stone & Rolls Ltd v Moore Stephens [2009] UKHL 39

Stone & Rolls Ltd, controlled solely by fraudster Mr Stojevic, sued its auditors Moore Stephens for negligently failing to detect fraud perpetrated through the company against banks. The House of Lords held that the ex turpi causa defence barred the claim as the company was a one-man company where the sole directing mind and beneficial owner was complicit in the fraud.

Facts

Stone & Rolls Ltd (S&R) was a company under the complete control and effective ownership of Mr Stojevic. Mr Stojevic used S&R as a vehicle for fraud, obtaining funds from banks (principally Komercni Banka) through false documents relating to fictitious commodity trades. The funds were then paid away to third parties under Mr Stojevic’s control. When the fraud was discovered, Komercni Banka obtained judgment against S&R for over US$94 million. S&R went into liquidation and, through its liquidators, brought proceedings against its former auditors, Moore Stephens, alleging negligence in failing to detect the fraud.

Issues

Primary Issue

Whether the defence of ex turpi causa non oritur actio (no action arises from a disgraceful cause) barred S&R’s claim against its auditors for negligently failing to detect fraud perpetrated by the company’s sole directing mind and beneficial owner.

Secondary Issues

Whether the Hampshire Land principle prevented attribution of Mr Stojevic’s fraud to S&R for purposes of the ex turpi causa defence. Whether the ‘very thing’ principle (that a defendant cannot rely on the occurrence of what it was duty-bound to prevent) displaced the ex turpi causa defence.

Judgment

The House of Lords, by a majority of 3-2, dismissed the appeal and held that the ex turpi causa defence barred S&R’s claim.

Majority Reasoning

Lord Phillips, Lord Walker and Lord Brown held that where a company is a ‘one-man company’ with the sole directing mind and beneficial owner being complicit in the fraud, the ex turpi causa defence applies. Lord Walker stated:

“In the case of a one-man company (in the sense indicated above) which has deliberately engaged in serious fraud, I would follow Royal Brunei (and the strong line of United States and Canadian authority) in imputing awareness of the fraud to the company, applying what is referred to in the United States as the ‘sole actor’ exception to the ‘adverse interest’ principle.”

Lord Brown observed:

“It is on this basis and this basis alone—the one-man company or sole actor basis—that I would uphold the Court of Appeal’s judgment that S&R is in no different or better position than Mr Stojevic himself to resist the ex turpi causa defence.”

Minority Reasoning

Lord Scott and Lord Mance dissented. Lord Mance emphasised the separate legal identity of a company and its shareholders, and the duties owed by auditors:

“The world has sufficient experience of Ponzi schemes operated by individuals owning ‘one man’ companies for it to be questionable policy to relieve from all responsibility auditors negligently failing in their duty to check and report on such companies’ activities.”

Lord Scott considered that attributing Mr Stojevic’s dishonesty to S&R for the purpose of defeating the company’s claim against its officers would constitute bad jurisprudence:

“The wielding of a rule of public policy in circumstances where public policy is not engaged constitutes, in my respectful opinion, bad jurisprudence.”

Implications

This decision has significant implications for auditors’ liability and corporate governance. It establishes that the ex turpi causa defence can bar claims by companies against auditors where the company is effectively a one-man company controlled entirely by the fraudster. However, the decision was expressly limited to the extreme facts of the case and left open the position where there are innocent shareholders. The case also highlights the tension between the doctrine of separate corporate personality and the attribution of wrongdoing by controlling individuals to the company itself.

The decision has been criticised for potentially weakening auditors’ accountability in precisely those situations where fraud detection is most important. Lord Mance warned in dissent that the majority’s approach would diminish auditors’ exposure in relation to companies most vulnerable to management fraud.

Verdict: Appeal dismissed. The ex turpi causa defence barred Stone & Rolls Ltd’s claim against Moore Stephens. The majority held that where a company is a one-man company with the sole directing mind and beneficial owner being complicit in fraud, the fraud is attributed to the company and the ex turpi causa principle prevents the company from recovering damages from its auditors for negligently failing to detect that fraud.

Source: Stone & Rolls Ltd v Moore Stephens [2009] UKHL 39