The High Court has endorsed the use of an interpleader application pursuant to CPR Part 86 by a financial services firm seeking guidance from the court to determine the appropriate recipient of funds which are subject to potentially competing claims: Global Currency Exchange Network Ltd v Osage 1 Ltd  EWHC 1375 (Comm).
Part 86 allows (among other things) a stakeholder to apply to the court for a direction as to where it should pay a debt or money when competing claims are made (or expected to be made) by two or more persons in respect of that debt or money. In the present case, the claimant financial services firm had suspicions that one of its customers was engaged in alleged fraudulent activity using its accounts with the firm (including operating a suspected Ponzi scheme). After freezing its customer’s accounts, the firm made an application under Part 86 seeking guidance from the court as to where it should pay the frozen funds.
The judgment will provide financial institutions with some comfort that the court will assist them to determine the appropriate recipient of funds where the firm expects competing claims, including where the firm has reasonable grounds to suspect criminal conduct (even if there is ultimately no finding of fraud or other criminal conduct).
This was a particularly interesting decision in circumstances where:
- At the time of the hearing, there was no indication of any potential competing claims being brought by the alleged victims. The court considered that such claims were still “expected”, because the firm had coherent reasons for its concerns regarding alleged fraudulent activity, and as such there were reasonable grounds to believe that – once appraised of the facts – the alleged victims would make claims in respect of the funds.
- Another key battleground was the nature of the competing claims which could be brought. This was an unusual case in the sense that, because competing claims over the funds had not yet been made, the financial services firm was in the position of having to suggest the potential legal basis on which those claims might, in due course, rely.
- It provides a procedural alternative to a claim for declaratory relief. Both Part 86 and a claim for declaratory relief (under Parts 7 or 8) are procedural mechanisms which may be pursued by parties seeking clarity from the court as to the legal/factual position. One of the key differences between these procedural tools is the potential costs consequences for the applicant. Part 86 expressly provides that the court may make any costs order it thinks “just”, departing from the general rule on costs (i.e. that the loser will pay the winner’s costs, subject to the court’s discretion). With no particular weight given to whether the applicant is successful, this suggests an increased flexibility on costs under Part 86 in comparison to a claim for declaratory relief (where the general rule will apply). This follows, given that the claimant under Part 86 is a stakeholder who will (almost always) be a neutral party seeking protection from liability, rather than looking to make a financial gain. Part 86 also provides that the court may summarily assess the stakeholder’s costs, if the respondent fails to appear at the hearing.
The impact of this decision is not limited to situations where a financial services provider has reasonable grounds for suspecting fraud. It may also assist financial institutions in other circumstances, for example where the authority of an institution or client is uncertain or vulnerable to future challenge. In this scenario, a bank or other financial services provider which wishes to pay money to its customer could potentially use Part 86 to limit the possibility of a claim that it has paid funds to the “wrong party” (i.e. a party which was not authorised to represent the customer). Such application could, in certain circumstances, be made by consent with the claimant as a neutral party requesting the court’s assistance and the “defendant” setting out coherently why it is entitled to the funds.
The defendant (“Osage”) was a company formed in 2014 for the purpose of raising capital through the sale of non-voting shares, in order to acquire and develop the rights to drill for oil in Oklahoma. It received foreign exchange and payment services from the claimant (“GCEN”), which was an FCA-registered payment institution. Prospective shareholder investors paid funds directly into Osage’s accounts at GCEN.
In September 2015, GCEN froze all of Osage’s account facilities because of concerns they were obtained by means of fraudulent misrepresentation. The funds remained frozen for over three years, during which period there was no indication of any potential investor claim.
Part 86 Application
In March 2018, GCEN issued a Part 8 claim in the form of an interpleader application pursuant to Part 86, which allows (among other things) a stakeholder to apply to the court for a direction as to whom it should pay a debt or money where competing claims are made or expected to be made against the stakeholder in respect of that debt or money by two or more persons.
GCEN accepted that the funds did not belong to it and confirmed it would pay the funds to whichever party or parties the court may direct. It anticipated competing claims because:
- Osage claimed the funds and previously threatened an injunction and proceedings to recover them; and
- If investors were made aware of the details of Osage’s investment scheme, GCEN expected that they too would make claims against it for the return of the funds.
GCEN sought directions for the service of its application and evidence on various investors to allow them the opportunity to make legal claims to the funds. Osage complained that GCEN was unilaterally withholding payment of monies GCEN held on Osage’s behalf and seeking, via its Part 86 application, an indemnity to which it was not entitled.
The court held that the case fell within Part 86 and gave directions for the investors to be notified of the proceedings.
Applicability of Part 86
The court looked first at the wording of Part 86, which applies where a person is under a liability in respect of debt, and competing claims are made (or expected to be made) against that person in respect of that debt by two or more persons.
The court then approached the question of whether Part 86 was applicable by considering whether: (1) there was any legal basis for prospective investors claims; and (2) whether competing claims were expected.
Legal basis for prospective investor claims
The court found that investors might bring claims against the funds on two bases (rejecting numerous other legal bases asserted by GCEN), each of which is considered in further detail below.
- Investors’ right to rescind and claim the funds
On the evidence before the court, it found that investors may have a claim in fraudulent misrepresentation, and concluded that this meant the subscription agreements between the investors and Osage were voidable rather than void, following the general rule summarised in In the Matter of Crown Holdings (London) Limited (in Liquidation)  EWHC 1876 (Ch).
The court rejected GCEN’s attempt to rely on an exception to this principle where the contract itself is the instrument of fraud (i.e. the purported transaction is in effect unreal, a pure instrument of fraud): see Halley v Law Society  EWCA Civ 97. Under this exception, there would be no need for the investors to rescind their investment contracts because they would still own the funds in equity. The court found the evidence did not go that far, meaning that the investors did not have a proprietary claim based on fraudulent misrepresentation unless and until they rescinded their contracts with Osage.
However, the court held that because investors had the right to rescind their subscription agreements with Osage (which would give rise to proprietary claims against the funds), this meant that Osage would then hold the funds on constructive trust for the investors. In the court’s view, a claim which could be brought provided the claimant took a prior legal step (here rescission) was still a competing claim, which was sufficient to satisfy the requirement of Part 86 for expected competing claims (subject to such claims actually being ‘expected’ – see below).
- Quistclose trust
It was common ground that pending GCEN’s completion of money laundering checks, it received and held payments made by investors on a Quistclose trust, to hold the funds on behalf of the investor. Thereafter GCEN was to pay those funds to Osage to enable the investor to become a non-voting shareholder in Osage.
The court held that GCEN was unable to fulfil the purpose of the Quistclose trust by making payment to Osage. This would put GCEN at risk of committing a criminal offence contrary to section 327 or 328 of the Proceeds of Crime Act 2002, because it suspected that the funds represented a benefit obtained by Osage from criminal conduct (such as a fraud by false representation contrary to section 2 of the Fraud Act 2006). As a result, the court found that GCEN held the funds on resulting trust for the investors, which would provide the investors with a legal basis for a claim against the funds.
In considering this legal basis, the court made a number of interesting observations, in particular:
- The court rejected an alternative argument put forward by GCEN as to why it was unable to fulfil the Quistclose trust. This was on the basis that paying the funds to Osage would breach GCEN’s Quincecare duty of care, which provides that “a banker must refrain from executing an order if and for as long as the banker is ‘put on inquiry’ in the sense that he has reasonable grounds (although not necessarily proof) for believing that the order is an attempt to misappropriate the funds of the company”. Although the Quincecare duty derives from a case of the same name, the only case in which the duty has been found to be owed and breached is in Singularis Holdings (in liquidation) v Daiwa Capital Markets Europe  EWCA Civ 84 (see our banking litigation blog post).
- The court did not consider Quincecare and Singularis to provide an apt analogy for the present case. It noted that those cases related to a duty to decline to make payments to a third party where any reasonable financial institution would believe the customer was being defrauded. In the present case Osage, not the investors, was GCEN’s customer, and the payment Osage sought was from GCEN to Osage rather than to a third party.
- Another reason given by GCEN for its inability to fulfil the Quistclose trust was the fact that this could give rise to other civil liability claims by investors against GCEN. In this context, the court commented that it seemed possible that a party which holds funds after receiving notice of grounds for rescission (such as fraudulent misrepresentation) could be bound by the equity which the victim has pending rescission. This would make the party holding funds liable to the holder of the right to rescind if it paid the money away notwithstanding the notice it had been given (even though the equity does not give the victim a proprietary interest in the funds).
- As an overarching point, the court expressed surprise at the proposition (by Osage) that a person holding funds which it has reason to believe may have been obtained by fraudulent misrepresentation, could escape civil liability by paying them over to the suspected fraudster before the victim of the fraud learned the facts and rescinded the transaction.
- Other legal bases
As noted above, the court rejected the other legal bases suggested by GCEN for prospective investors claims. In particular, it is noteworthy that GCEN’s argument that it was the investors’ agent and owed fiduciary duties to them directly (on the basis of receiving investor funds) did not succeed.
Whether competing claims were expected
The court noted that CPR 86.1(1)(b) uses the phrase “claims are made or expected to be made” and not, for example, “claims are made or threatened”. As a matter of ordinary language, the court noted that it is possible for a claim to be “expected” even if it has not yet been asserted.
The court considered that there were reasonable grounds to believe that once appraised of the facts, investors would make claims in respect of the funds, and held that the case therefore fell within Part 86. The court noted that GCEN would be entitled to seek the court’s assistance in any event, for example by suing for a declaration (which would be the only option if none of the investors were to come forward and assert a claim).
Accordingly, the court held that the case fell within Part 86 and gave directions for the investors to be notified of the proceedings.