British Virgin Islands: Claims By Insolvent Companies Against Fraudulent Directors

On 22nd April 2015, the Supreme Court of the United Kingdom gave judgment in Jetivia SA v Bilta UK Limited (in liquidation) [2015] UKSC 23. The court's decision deals with the defence of illegality and the attribution of a delinquent director's fraud to the company in the context of an action by the company's liquidators against the director and alleged co-conspirators. Although the decision on the illegality issue was ultimately unanimous, there were some marked differences of approach in the judgments, and this area of the law remains complex, with some unanswered questions. The decision also addresses the extra-territorial effect of section 213 of the Insolvency Act 1986 (the "UK Insolvency Act"). Both aspects of the decision have implications for insolvencies conducted in the British Virgin Islands (the "BVI").

Background

Bilta (UK) Limited ("Bilta") was an English company which was ordered to be wound up upon the petition of Her Majesty's Revenue and Customs ("HMRC"). Bilta's liquidators commenced proceedings against Bilta's two former directors Mr Chopra and Mr Nazir, a Swiss company called Jetivia SA ("Jetivia") and Jetivia's chief executive Mr Brunschweiler. The liquidators alleged that those four defendants were parties to an unlawful means conspiracy, which involved Mr Chopra and Mr Nazir breaching their fiduciary duties to Bilta with the dishonest assistance of Jetivia and Mr Brunschweiler. The conspiracy involved the use of a carousel fraud, whereby Bilta purchased carbon credits from sources outside the UK and resold them, mostly at a loss, to UK companies registered for VAT. The proceeds of the scheme were sent out of the UK to Jetivia and various other offshore companies and Bilta was left without the funds needed to pay the output tax it owed to HMRC. Bilta was effectively insolvent at all material times. The defendants caused loss to Bilta by depriving it of the monies it needed to discharge its liability to HMRC. The liquidators claimed damages in tort, equitable compensation based on constructive trust and a contribution to the estate under section 213 of the UK Insolvency Act for knowing participation in Bilta's fraudulent trading.

Jetivia and Mr Brunschweiler applied to strike out the claims against them. As to the claims for damages and for equitable compensation, they argued that they were bound to defeat those claims on the basis of an illegality defence because those claims were barred by reason of the nature of Bilta's criminal conduct. As to the claim for a contribution to the estate, they argued that section 213 does not have extra-territorial effect.

Jetivia and Mr Brunschweiler were unsuccessful on each argument at first instance before the High Court, on appeal before the Court of Appeal and on further appeal before the Supreme Court. The Supreme Court held unanimously that the illegality defence was not available and that section 213 does have extra-territorial effect. However, different members of the court reached their conclusions as to the illegality defence by different paths. Lord Neuberger (with whom Lords Carnwarth and Clarke, and also – save in one minor respect – Lord Mance, all agreed) held that the illegality defence failed because the wrongful activity of Bilta's directors and shareholder could not be attributed to Bilta in those proceedings, attribution always being context-specific. In the particular context of the case it would absurd to attribute the directors' knowledge and activity to Bilta so as to prevent the company from pursuing those responsible for the fraud. Lords Toulson and Hodge also considered that there should be no attribution in the context, but preferred to base their decision on policy grounds, whereas Lord Sumption held that there should be no attribution, but took a different approach to his consideration of the attribution issue.

Attribution and illegality

The illegality defence was summarised by Lord Mansfield CJ in Holman and Johnson (1775) 1 Cowp 341 at 343 in the following terms (cited by Lord Sumption at [55] and [60]):

Where a defendant raises a defence of illegality against a claimant company, it will often be necessary for the defendant to establish that the acts and the state of mind (such as dishonesty or fraudulent intent) of one or more individuals should be attributed to the company. Notwithstanding certain nuances between the approaches taken in the various judgments, all members of the court agreed that in the present case Mr Chopra's and Mr Nazir's acts and state of mind could not be attributed to Bilta in an action by Bilta (through its liquidators) against them. Lord Neuberger considered that the conclusions of Lord Sumption and of Lords Toulson and Hodge on this point were not materially different and could be reduced to the following proposition (at [7]) with which he agreed:

Without the attribution of Mr Chopra's and Mr Nazir's acts and state of mind to Bilta, the illegality defence could not be made out.

As stated above, Lords Neuberger, Carnwath and Clarke [at 9] and Mance [at 44] all agreed that attribution of knowledge to a company is always dependent on the context, including both the factual background and also the nature of the proceedings themselves. Lords Toulson and Hodge [at 203] were of the same view. Lord Sumption took a different approach, holding that it was first necessary to apply the basic rules of attribution (the so-called "primary rules of attribution" identified by Lord Hoffmann in Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500 at 506, the rules of agency and any special requirements arising from a particular rule of law) and then to assess whether the "breach of duty exception" might apply. That exception is derived from the decision in Re Hampshire Land [1986] 2 Ch 743: "if [the agent] had been guilty of fraud, the personal knowledge of [the agent] of the fraud that he had committed on the company would not have been the knowledge of the [principal] of the facts constituting that fraud; because common sense at once leads one to the conclusion that it would be impossible to infer that the duty either of giving or receiving notice will be fulfilled where the common agent is himself guilty of fraud" (Vaughan Williams J). In Lord Sumption's view, it was only the breach of duty exception that was context-specific because only that stage involved policy considerations [at 86].

Although Lords Toulson and Hodge agreed that the directors' wrongdoing should not be attributed to Bilta in the context, their primary basis for rejecting the illegality defence was founded on policy. In their view, the illegality defence is a not a rule of law but, rather, a rule of public policy. Lords Toulson and Hodge held that it would be contrary to the statutory policy which underlies the directors' duties provisions in Part 10, Chapter 2 of the Companies Act 2006 – including the policy that the directors must have regard to the interests of the creditors of an insolvent or prospectively insolvent company – to allow the illegality defence to be raised in Bilta (at [130]):

The majority (Lords Neuberger, Carnwath, Clarke and Mance) preferred to leave this point open, but it was expressly rejected by Lord Sumption. In his view (at [62]), the illegality defence:

Underlying the difference on the role of policy was a difference of opinion as to the proper approach to the illegality defence, and all members of the court, with the exception of Lord Sumption, called for this issue and the authorities bearing on it (such as Tinsley v Milligan [1994] 1 AC 340) to be revisited in an appropriate future case (see Lord Neuberger at [15], Lord Mance at [34] and Lords Toulson and Hodge at [174]).

Likewise, there was not complete agreement on what was decided by the much-maligned decision in Stone & Rolls Ltd v Moore Stephens [2009] UKHL 39. However, all agreed that the illegality defence would not be available in a claim by the company against a third party for losses arising from a fraud, even if the company's directing mind and will was guilty of the fraud, where there were innocent shareholders (or directors), seemingly on the basis that it would not be appropriate to attribute the directing mind and will's knowledge/dishonesty to the company where there were such innocent persons (Lord Neuberger [26], Lord Sumption [80]). Where there are no innocent shareholders or directors, attribution (and therefore the defence) may apply, at least where the company was in sound financial health at the relevant time, but it was left open whether the position would be different where the company was in or near insolvency (Lord Neuberger [27-28]). Subject to the above, a clear majority of the court indicated that Stone & Rolls should be considered to be confined to its own facts and "not looked at again".

One interesting by-product of the decision in Jetivia is the re-emergence of the concept of a "directing mind and will". That term had previously drawn some criticism and in Moulin Global Eyecare Trading Ltd v Commission of Inland Revenue [2014] HKCFA 22 Lord Walker expressed the hope that the phrase might disappear altogether. However, as a number of members of the court in Jetivia used the phrase (Lords Neuberger [26], Mance [40], Sumption [67-68] and Toulson and Hodge [180]), it would appear that this concept will continue to be of some relevance. The notion that a person who is "actually although not constitutionally" the "directing mind and will" of a company may have their knowledge and acts attributed to the company is of particular relevance to BVI companies. Many BVI companies have shareholders and directors who are mere nominees, and the constitutional organs may not possess the knowledge of the person or persons who really control the company. Attribution of the knowledge of such persons to the company may be important whenever it is necessary to fix the company with some knowledge or wrongdoing.

The reluctance to allow fraudsters to profit at the expense of creditors underlying the judgments of all members of the Supreme Court in Jetivia would doubtless be shared by the BVI court, which could be expected to take an equally dim view of any attempt to raise the illegality defence in such a context. The approach to attribution in Jetivia is therefore likely to be followed in the BVI.

One question that has yet to be fully answered is this: when will a company be fixed with the knowledge or wrongdoing of an agent when the company is bringing a claim against a third party that is not party to the fraud? Where the situation is reversed and the third party is bringing the claim against the company ("situation 1"), attribution will generally occur, if attribution is needed at all: see Lords Toulson and Hodge [201, 205] and Lord Sumption [88]. Whereas where ("situation 2") the company is suing the wrongdoing director or agent (or a third party who has knowingly assisted), Jetivia shows that attribution will generally not occur (certainly where the company is in liquidation and the claim is being brought by the company's liquidators): Lord Neuberger [7], Lord Mance [38] and [44], Lord Sumption [89] and Lords Toulson and Hodge [201-202, 206, 207].

But a claim by the company against a third party who is not party to the fraud ("situation 3") is a different matter, and it will be necessary to consider the nature of the particular claim and its factual context. Only Lords Sumption, Toulson and Hodge expressly considered this situation (though Lord Neuberger addressed the narrower question of the availability of the illegality defence at [26]). At first sight the Hampshire Land (breach of duty) exception would seem likely to negate attribution (the wrongdoing agent hardly being likely to notify the company of the wrongdoing), but a blanket rule to that effect would seem inconsistent with situation 1. Some judges (including Lord Walker in Moulin Global, who resiled from the wider view previously expressed in Stone & Rolls) consider that the breach of duty exception should only be applicable where the company's claim is against the wrongdoer. Indeed, in Jetivia Lord Sumption appeared to take the view that the knowledge of the wrongdoing "directing mind" (and presumably also director or agent) should generally be attributed to the company [91], but his approach to attribution was not adopted by the majority. Lords Toulson and Hodge [191, 207] considered that attribution would always depend on the context, approving the statement in Bowstead & Reynolds on Agency (2014): "Before imputation occurs there needs to be some purpose for deeming the principal to know what the agent knows". As situation 3 could encompass a myriad of different types of claims and circumstances it is likely that each case will turn on its own facts. The presence of innocent shareholders (and possibly directors) may well be a factor negating attribution (Lord Neuberger [26] and Lords Toulson and Hodge [160-161]), and the same may apply if there are innocent creditors, at least where the company was in or near insolvency (Lord Neuberger at [28], and cf Berg v Mervyn Hampton Adams [2002] Lloyd Rep PN 41). Whether the company is an intended victim of the wrongdoer is also relevant: where it is, it has been said that it would be "irrational" to treat the director/agent as notionally having transmitted the knowledge to the company (Belmont Finance Corporation v Williams Furniture [1979] Ch 250; cf Bank of India v Morris [2005] BCC 739).

In the Canadian case of Livent Inc v Deloitte & Touche [2014] ONSC 2176, the court also found that attribution depended on context [253] and declined to attribute the fraud of the directing mind and will to the company because there were innocent shareholders and directors of the claimant company [270]. The court also declined to attribute the fraud of the former management for the purposes of the defence of contributory negligence (and it had not been argued that the innocent directors had been negligent), and so no reduction was made to the damages awarded against the auditor. This approach is consistent with the majority in Jetivia and supports the view that, at least as long as there are innocent shareholders and directors, liquidators of companies should be able to pursue third parties who, in breach of duty, failed to warn the company of a fraud being perpetrated by the directors or agents of the company.

Extra-territorial application of section 213

Section 213 of the UK Insolvency Act provides that:

Jetivia and Mr Brunschweiler argued that section 213 does not have extra-territorial effect. They did not dispute that the English courts had personal jurisdiction over them. Instead, their contention was that section 213 did not confer on the English courts subject matter jurisdiction with respect to conduct engaged in by non-residents outside the United Kingdom.

All members of the court rejected this argument peremptorily. Lord Sumption (at [108]-[109]) and Lords Toulson and Hodge (at [213]) emphasised that, when the English courts wind up an English company, they claim worldwide jurisdiction over the company's assets and over the process of their distribution. In that context, and in an increasingly globalised economy with ease of international travel and communication, a provision such as section 213 would be rendered ineffectual if its operation were confined to acts undertaken in the United Kingdom. Lord Neuberger (at [10]) and Lord Mance (at [53]) agreed.

Their Lordships also referred (with approval) to Court of Appeal authority in which it was held that other similar provisions of the UK Insolvency Act have extra-territorial effect. In In re Paramount Airways Ltd [1993] Ch 223, the Court of Appeal ascribed extra-territorial effect to section 238, which empowers the court to set aside undervalue transactions. In Re Seagull Manufacturing Co Ltd [1993] Ch 345, the Court of Appeal ascribed extra-territorial effect to section 133, which empowers the court to summon officers of the company for public examination. The powers under each of sections 213, 238 and 133 are discretionary, so the court can refuse to make an order in circumstances where there defendant has an insufficient connection with England to warrant the court exercising the jurisdiction vested in it (Lord Sumption at [109]-[110]; Lords Toulson and Hodge at [214]-[215]).

Bilta's liquidators contended that worldwide jurisdiction was also conferred on the English courts by article 3(1) of Council Regulation 1346/2000 on insolvency proceedings, as interpreted by the Court of Justice of the European Union in Schmid v Hertel (Case C-238/12) [2014] 1 WLR 633 but the Court did not consider it necessary to decide the point in view of the fact that the position was clear under domestic law.

Many of the provisions of the Insolvency Act 2003 (the "BVI Insolvency Act") in force in the BVI were modelled on, or are similar to, those that appear in the UK Insolvency Act. These include section 255 (Fraudulent trading), section 246 (Undervalue transactions) (read together with section 249 (Orders in respect of voidable transactions)) and section 284 (Application for examination before Court). Those provisions are closely analogous to sections 213, 238 and 133 of the UK Insolvency Act, which as noted above have been held to apply extra-territorially. Numerous other examples can be found, particularly elsewhere within Part IX (Malpractice), Part VIII (Voidable Transactions) and Division 3 of Part XI (Investigation of Insolvent Company's Affairs), where the abovementioned provisions of the BVI Insolvency Act are located.

The Privy Council held in Stichting Shell Pensioenfonds v Krys [2015] 2 WLR 289 that the worldwide jurisdiction claimed by an English court in the winding up of an English company is also claimed by the BVI court in the winding up of a BVI Company (at [34], [38]). It follows that the considerations which led the Supreme Court in Jetivia SA v Bilta UK Limited (in liquidation) to ascribe extra-territorial effect to section 213 of the UK Insolvency Act would support the view that the equivalent fraudulent trading provision in section 255 of the BVI Insolvency Act (as well as the other provisions mentioned above) should also be given extra-territorial effect.

In proceedings of that type, it would be commonplace in BVI for the defendant to be resident outside the jurisdiction. The court would retain a discretion to refuse permission to serve outside the jurisdiction, for instance on forum non conveniens grounds, and the absence of a sufficient jurisdictional connection might also lead the court to refuse relief following a substantive hearing. However, the analysis in Jetivia SA v Bilta UK Limited (in liquidation) suggests that a court would be slow to refuse permission or relief in the face of compelling evidence that a foreign defendant has engaged in fraudulent conduct causing loss to the estate.

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