The Court of Appeal has struck out Quincecare duty and dishonest assistance claims brought by the liquidators of a company running a Ponzi scheme against a correspondent bank that operated various accounts for the company. In doing so, the Court of Appeal confirmed that the scope of the Quincecare duty, which may arise in the context of a financial institution processing client payments, is limited to protecting customers of the financial institution, and does not extend to protect the customer’s creditors: Stanford International Bank Ltd v HSBC Bank plc  EWCA Civ 535.
In relation to the Quincecare duty claim, the Court of Appeal found that the company had no claim in damages because it suffered no loss. The way the Ponzi scheme operated, payments made by the bank to genuine investors reduced the company’s assets, but equally discharged the company’s liabilities to those investors by the same amount. The net asset position therefore remained the same in the period between: (a) when the liquidators said the bank should have recognised the “red flags” and stopped processing its customer’s payments, thereby exposing the fraud; and (b) the date upon which the accounts were eventually frozen by the bank.
In reaching this conclusion, the Court of Appeal overturned the decision of the High Court, which had refused to strike out the claim (see our banking litigation blog post). The High Court relied on the company’s state of insolvency as a key factor, finding that if the bank had performed its Quincecare duty, then more cash would have been available to pay other creditors once the company’s insolvency process began (at a later date). However, in the Court of Appeal’s view, the problem with this argument was that it proceeded on the basis that the bank owed a direct duty to the company’s creditors, which it did not. It said the High Court erred in its reasoning by confusing the company’s position before and after the inception of an insolvency process. Before an insolvency process commences (and the statutory insolvency regime is invoked), the fact that a company has slightly lower liabilities is a corresponding benefit to its net asset position, even if the company is in a heavily insolvent position. Having more cash available upon the eventual inception of its insolvency for the liquidators to pursue claims and for distribution to creditors, is a benefit to creditors, but not to the company while it is still trading.
The Court of Appeal upheld the High Court’s decision to strike out the dishonest assistance claim, emphasising that dishonesty and blind-eye knowledge allegations against corporations (large or small) must still be evidenced by the dishonesty of one or more natural persons. Blind-eye knowledge cannot be constituted by a decision not to enquire into an untargeted or speculative suspicion rather than a targeted and specific one; and the liquidators could not hide behind the fact that the defendant bank was a large corporation.
This decision is a reassuring one for financial institutions faced with Quincecare and dishonest assistance claims from liquidators in relation to the processing of payment mandates in connection with customer accounts. The decision limits the scope of the Quincecare duty that is owed by a bank in such circumstances to its customer; it will not extend to the customer’s creditors. It also suggests that claimants may face difficulties in pursuing similar Quincecare claims against banks that have been inadvertently involved in processing the payments of a Ponzi scheme.
The underlying claim was brought by the liquidators of the claimant (SIB). SIB was an Antiguan bank, alleged by the liquidators to have been operating a Ponzi scheme fraud since its inception.
The defendant bank (Bank) operated various accounts as a correspondent bank for SIB from 2003 onwards. The liquidators claimed that the Bank breached its so-called Quincecare duty of care to take sufficient care that monies paid out from the accounts under its control were being properly paid out. The liquidators argued that the Quincecare duty required the Bank to have reached the conclusion by 1 August 2008 (at the latest) that there was something very wrong and to have frozen payments out of the accounts. Instead, the accounts continued to operate until circa February 2009. The claim was to recover the sums paid out by the Bank during that period, amounting to approximately £118 million (although it is worth noting that the balance in the accounts on 1 August 2008 was £80 million, with the difference between this figure and the amount paid out during the relevant period likely due to new depositors paying into the account).
The payments made by the Bank during this period were made (directly or indirectly) to individual investors holding certificates of deposit who had claims on SIB for the return of their capital and interest, save for one payment to the English Cricket Board (ECB) (which is not considered further in this blog post).
The Bank applied to strike out the claim, or obtain reverse summary judgment under CPR Part 24, on the ground that SIB had suffered no loss. For the purpose of the application, the Bank accepted that there was a sufficiently arguable case of breach of the Quincecare duty. The Bank argued that a Quincecare duty claim is a common law claim for damages for breach of a tortious duty (or an implied contractual duty), and so the remedy is damages to compensate for loss suffered. It said that SIB had no claim for damages, because on a net asset basis it was no worse off as a result of the Bank’s actions: the payment of £118 million reduced SIB’s assets by £118 million, but it equally discharged SIB’s liabilities by the same amount. This was because monies paid out by the Bank went (ultimately) to deposit-holders in satisfaction of their contractual rights against SIB.
In addition to its Quincecare claim, the liquidators brought a claim against the Bank for dishonest assistance in relation to breaches of fiduciary duty owed to SIB by Mr Stanford, the ultimate beneficial owner of SIB who has now been convicted in the United States. The Bank applied to strike out the dishonest assistance claim on the basis that the allegation of dishonesty was not sufficiently pleaded in the statements of case.
High Court decision
The High Court’s reasoning is discussed in our previous banking litigation blog post.
In summary, the High Court dismissed the Bank’s application for reverse summary judgment or strike out of the Quincecare loss claim (for the balance over and above the ECB payment). It found that, absent the Bank’s breach of its Quincecare duty, the £80 million in SIB’s accounts as at 1 August 2008 would have been available to pay creditors when insolvency supervened. It agreed with the claimants that, because of SIB’s state of insolvency, SIB had “no net assets”. Accordingly, although the payment of £118 million reduced SIB’s assets by £118 million, the payment did not discharge SIB’s liabilities, because SIB was insolvent and had no assets on any view, but a net liability.
The High Court did strike out the allegation of dishonest assistance, finding that the plea of dishonesty against the Bank was insufficient.
The Bank appealed against the High Court’s refusal to strike out the Quincecare loss claim or to grant reverse summary judgment, whereas SIB appealed against the High Court’s strike out of the allegation of dishonest assistance.
Court of Appeal decision
The Court of Appeal found in favour of the Bank on both issues.
Issue 1: Quincecare loss claim
As briefly mentioned above, the claimants argued (and the first instance judge found) that SIB’s state of insolvency was a key factor, because if the Bank had performed its Quincecare duty, then SIB would have had (at least) £80 million more in cash, and therefore more cash would have been available to pay other creditors once SIB’s insolvency process began.
In the Court of Appeal’s view, the problem with this argument was that it proceeded on the basis that the Bank owed a direct duty to SIB’s creditors. It noted that while SIB’s directors owed a duty to its creditors as soon as SIB became insolvent (which it had long before 1 August 2008) (as per Liquidator of West Mercia Safetywear Ltd v Dodd (1988) 4 BCC 30), in contrast, the Bank did not.
The Court of Appeal said that the Bank’s duty was to SIB alone, as explained in the Court of Appeal’s decision in Singularis Holdings Ltd (In Liquidation) v Daiwa Capital Markets Europe Ltd  EWCA Civ 84. Giving the leading judgment in the present case, Sir Geoffrey Vos referred to his own judgment in Singularis, which recorded the parties’ agreement that the Quincecare duty was owed to Singularis (the customer) and not directly to its creditors, even though the company was on the verge of insolvency. He also cited a further paragraph from his judgment in Singularis, which again confirmed that the duty is owed only to the bank’s customer: “…the scope of the Quincecare duty is narrow and well defined. It is to protect a banker’s customer from losing funds held in a bank account with that banker, whilst the circumstances put the banker on inquiry” (emphasis added).
The Court of Appeal also underlined that SIB itself did not lose anything as a result of the payments to discharge creditors: its net asset position at the end of the period was the same as at the beginning.
It said that the High Court had made an error in its reasoning by confusing the company’s position before and after the inception of an insolvency process. In the Court of Appeal’s view, the true distinction is between a company that is trading and a company in respect of which a winding up process has commenced, not between a solvent trading company and an insolvent trading company. For example, if a company is trading (even insolvently) then £100 paid to a creditor reduces its assets, but is offset by a corresponding benefit to the company in reducing its liabilities. The fact that a company has slightly lower liabilities is a corresponding benefit to its net asset position, even if the company is in a heavily insolvent position. Having more cash available upon the eventual inception of its insolvency for the liquidators to pursue claims and for distribution to creditors, is a benefit to creditors, but not to the company while it is trading.
Accordingly, the Court of Appeal allowed the Bank’s appeal on the Quincecare loss claim.
Issue 2: Dishonest assistance claim
SIB argued that the dishonest assistance claim should not have been struck out on the basis that:
- A mere failure to identify at the outset the directors, officers or employees who had the relevant state of knowledge does not mean that such an allegation is liable to be struck out if such particulars are given as soon as feasible (as per Sofer v Swissindependent Trustees SA EWCA Civ 699); and
- The test of dishonesty or recklessness for large corporations like the Bank is or should be different to that applicable to individuals.
In relation to (i), the Court of Appeal said that Sofer was a very different case to the present one. SIB suggested that it should be allowed to proceed even if it could never identify any employee or agent of the Bank who was either dishonest or who had blind-eye knowledge of the fraud. The Court of Appeal held that this was not a tenable approach.
In support of its argument on (ii), SIB submitted that the Bank’s senior management dishonestly allowed the Bank to be run in such a way that nobody ever got to the point of realising that SIB was a massive Ponzi scheme. The thrust of its point was that, although human beings must have known that the extensive failures pleaded were recklessly dishonest, SIB may never be able to identify those particular human beings. SIB said that it did not need to so, on the grounds that the only relevant question was whether the Bank’s conduct was objectively dishonest (as per Royal Brunei Airlines Sdn Bhd v Tan  2 AC 378). Accordingly, the Court of Appeal proceeded to consider the test for dishonesty and its application.
The test for dishonesty
The Court of Appeal said that it was settled law that the touchstone of accessory liability for breach of trust or fiduciary duty is dishonesty as explained in Royal Brunei Airlines. It noted that the basic law of dishonesty was recently restated in this context in Group Seven Ltd v Nasir  EWCA CIV 614 and was not in dispute. The Court of Appeal then highlighted the following key principles that are relevant to the test for dishonesty:
- Actual state of knowledge or belief. The defendant’s actual state of knowledge or belief as to the facts will form a crucial part of the first stage test.
- Objective assessment of conduct. Once the relevant facts have been ascertained including the defendant’s state of knowledge or belief as to the facts, the standard of appraisal which must then be applied to those facts is a purely objective one: namely whether the defendant’s conduct was honest or dishonest according to the standards of ordinary decent people.
- Blind-eye knowledge. As per Manifest Shipping & Co Ltd v. Uni-Polaris Insurance Co Ltd  1 AC 469, the imputation of blind-eye knowledge requires two conditions to be satisfied: (i) the existence of a suspicion that certain facts may exist; and (ii) a conscious decision to refrain from taking any step to confirm their existence. The suspicion in question must be firmly grounded and targeted on specific facts and, the deliberate decision not to ask questions must be a decision to avoid obtaining confirmation of facts in whose existence the individual has good reason to believe. Blind-eye knowledge cannot be constituted by a decision not to enquire into an untargeted or speculative suspicion (although suspicions falling short of blind-eye knowledge may form part of the overall picture to which the objective standard of dishonesty is applied).
- Aggregation of knowledge. As per Armstrong v. Strain  KB 232 and Greenridge Luton One Ltd v. Kempton Investments Ltd  EWHC 91 (Ch), it is not possible to aggregate two innocent minds to make a dishonest whole.
Application of the test for dishonesty
The Court of Appeal said that High Court was right to strike out the dishonest assistance claim, finding that SIB’s submissions on this issue were flawed for three principal reasons:
- SIB was unable to allege that any specific employee was either dishonest or suspected the Ponzi fraud and made a conscious decision to refrain from asking questions.
- This was a case falling squarely within the strictures of Manifest Shipping and what is required to prove blind-eye knowledge. In the view of the Court of Appeal, if a plea of dishonesty were to be permitted in these circumstances, it would allow blind-eye knowledge to be constituted by a decision not to enquire into an untargeted or speculative suspicion rather than a targeted and specific one.
- SIB could not hide behind the fact that the Bank was a large corporation. The Court of Appeal maintained that dishonesty and blind-eye knowledge allegations against corporations (large or small) must still be evidenced by the dishonesty of one or more natural persons. The Court of Appeal emphasised that the subjective dishonesty stage of the test must be satisfied (either by the dishonesty of a person within the corporation or the blind-eye knowledge of such a person) in order to proceed to the objective dishonesty stage of the test. It was not possible to avoid the subjective dishonesty stage and move straight to objective dishonesty, as SIB had sought to do.
Accordingly, the Court of Appeal dismissed SIB’s appeal on the dishonest assistance claim. As a result, the only surviving claim is SIB’s claim for breach of the Quincecare duty in relation to the payment made by the Bank to the ECB.