Can Directors Avoid Liability by Relying on Attribution of Their Own Wrongdoing?

A common response by defendants to a claim by a company in liquidation arising from the fraud of directors is that the company cannot bring the action, because the company itself is responsible for the fraud.

This issue has been particularly live since the controversial decision by the House of Lords in Stone & Rolls Ltd v Moore Stephens [2009] 1 AC 1391, which gave the auditors of a “one man” company (ie. sole shareholder and director) a free pass from potential liability, on the basis that the fraud of the sole director/shareholder was to be attributed to the company, with the effect that the company could not rely on its own illegal acts to claim against its former auditors.

Since the decision in Stone & Rolls, defendants have opportunistically sought to expand the circumstances in which the conduct of fraudulent directors will be attributed to the company.  For example, an illegality defence is now part of the standard catalogue of defences pursued by auditors, even of listed companies.

Post Jetivia, it is clear that such defences will not succeed. Rather than expanding on the circumstances in which the conduct of wrongdoers will be attributed to the company to defeat the company’s claim, Jetivia makes clear that Stone & Rolls is, at most, to be confined to its own facts.

In Jetivia, an illegality defence was pursued by the fraudulent directors themselves, to attempt to defeat the company’s claims. The directors argued that because their knowledge and conduct would ordinarily be attributed to the company, Bilta was itself a wrongdoer in the fraud and therefore could not bring a claim based on its own fraud.

The Supreme Court rejected this argument, and held that a company that has been defrauded by its directors is not prevented from claiming compensation against those involved in the fraud on the basis that the directors’ wrongful conduct is attributable to it. To have found otherwise would have led to the absurd result that a company could not take action against former directors to obtain compensation for the consequences of the directors’ fraud.

The Court held that attribution of knowledge is context specific and depends on the circumstances of the case, including the question of who is seeking redress from whom. In other words, where the company is a defendant to a claim, knowledge and actions of its directors may be attributed to it to establish the company’s liability, but that when the company itself seeks to recover any damage from its directors in relation to the same wrong, there is no such attribution.

The following conclusions arise from Jetivia:

• as an authority, the analysis in Stone & Rolls should be “put on one side and marked ‘not to be looked at again’”. At best, the case should be confined to its own narrow facts (per Lord Neuberger at [30], also at [24], Lords Toulson and Hodge at [152-154], Lord Sumption at [81]);
• whether Stone & Rolls would be followed in the future in a case involving a “one man” company is open for argument, and would likely turn upon questions of the scope of the auditors’ duty of care rather than illegality and attribution; and
• the broader question of when a claim is barred by illegal conduct of the plaintiff is similarly open for argument in future cases (see Lord Neuberger at [15-16], Lord Mance at [34] and Lords Toulson and Hodge at [174]).