Supreme Court confirms key elements of claim in knowing receipt in failed claim against bank

The Supreme Court has unanimously upheld the decisions of the Court of Appeal and High Court, dismissing a claim brought in knowing receipt against a bank and providing helpful clarification in respect of a number of key elements of the cause of action: Byers & Ors v Saudi National Bank [2023] UKSC 51.

In the present case, the claimants’ shares were transferred by a trustee to the bank in breach of trust, in circumstances where the bank was aware of the breach of trust at the time and has not subsequently transferred, destroyed or dissipated the property. However (as held by the Court of Appeal and was common ground between the parties), the fact of the transfer from the trustee to the bank had the effect under the applicable foreign law of Saudi Arabia of giving the bank clear title to the shares, free from the claimants’ beneficial interest in the property.

Finding in favour of the bank on the appeal, the Supreme Court confirmed the following key principles in respect of claims in knowing receipt:

  1. A claim in knowing receipt cannot be made if a claimant’s equitable interest in the property in question has been extinguished by the time of the defendant’s knowing receipt of the property. This result is not altered by the defendant’s knowledge that the transfer was in breach of trust.
  2. In terms of timing, a claim in knowing receipt will be “killed off” at the same time as any proprietary claim in the property transferred, ie when the recipient receives the property, if that is sufficient to defeat a proprietary claim.
  3. If the original knowing recipient subsequently transfers the property to a third party, in circumstances where the proprietary equitable interest has been extinguished, the second transfer will not give rise to liability in knowing receipt, either on the part of the original or secondary recipient, even where they have notice of the breach of trust (obiter).
  4. The “knowledge” requirement of the cause of action cannot be satisfied by mere “notice” and will not be satisfied simply because it would be unconscionable for the recipient to retain the benefit of the property received. However, the Supreme Court declined to reach a conclusion as to whether constructive knowledge will be sufficient and suggested that the question of knowledge will require a distinct separate test, which was not formulated on this appeal.

The Supreme Court’s judgment will be welcomed for its clarification of the requirements of knowing receipt, which is a common cause of action included in claims against financial institutions. However, a number of important elements are left unresolved by the present judgment and will require subsequent court guidance, including the precise test for “knowledge” in knowing receipt claims, and whether a claim in knowing receipt should be categorised formally as ancillary to a proprietary claim.

We consider the decision in further detail below.

Background

The background to this decision is more fully set out in our blog post on the High Court decision, here.

In summary, Saad Investments Company Limited (SICL) was a Cayman Island registered company and the beneficiary of certain Cayman Island trusts. Trust property included shares in five Saudi Arabian companies (the Shares).

In breach of trust, the trustee of the Cayman Island trusts (Mr Al-Sanea) transferred the Shares to a bank based in Saudi Arabia (the Bank). The purpose of the transfer was to discharge part of a debt owed by Mr Al-Sanea, in his personal capacity, to the Bank.

The relevant law governing the transfer of Shares to the Bank was Saudi Arabian law, which does not recognise the distinction between: (i) legal title to property (being, in this case, the title held in the Shares by Mr Al-Sanea as trustee); and (ii) equitable interest in property (being, in this case, the interest in trust property held by SICL as beneficiary of the trust). As a result, the effect of the transfer under Saudi Arabian law was to extinguish SICL’s equitable interest in the Shares. The Bank therefore became the sole owner of the Shares following the transfer.

In July 2009, SICL went into liquidation. The liquidators of SICL, the claimants, subsequently brought a claim for knowing receipt against the Bank, on the basis that the Bank knew (or ought to have made / was reckless in failing to make inquiries which would have revealed) that the trustee held the Shares on trust for SICL and that the transfer was in breach of trust.

A key question in this dispute was whether the claimants needed to have a continuing proprietary interest in the Shares to succeed in their knowing receipt claim.

High Court decision

The High Court’s reasoning is discussed in our previous blog post.

The High Court found in favour of the Bank and dismissed the claim. It held that a claim in knowing receipt where dishonest assistance is not alleged will fail if, at the moment of receipt, the beneficiary’s equitable proprietary interest is destroyed or overridden so that the recipient holds the property as beneficial owner of it. In the absence of a formal allegation of dishonesty against the Bank, and given the claimants’ failure to prove that SICL’s beneficial interest continued under local law, the claim failed.

SICL appealed to the Court of Appeal.

Court of Appeal decision

The Court of Appeal’s reasoning is discussed in our previous blog post.

The Court of Appeal upheld the High Court’s decision and found in favour of the Bank. It held that a continuing proprietary interest in the relevant property is required for a knowing receipt claim to be possible. A defendant cannot be liable for knowing receipt if it took the property free of any interest of the claimant. Absent a continuing proprietary interest in the Shares at the time of the registration, the claim in knowing receipt failed.

SICL appealed to the Supreme Court.

Supreme Court decision

The Supreme Court unanimously dismissed SICL’s appeal. It held that a claim for knowing receipt cannot be made if a claimant’s equitable interest in the property in question has been extinguished by the time of the defendant’s knowing receipt of the property.

The leading judgment was delivered by Lord Hodge (with whom Lord Leggatt and Lord Stephens agreed), with Lord Briggs and Lord Burrows delivering concurring judgments. While the full panel agreed that the case law contained pointers in favour of the conclusion in this case, it did not provide a definitive answer, which was therefore decided as a matter of equitable principle (which was reached by slightly different reasoning in the different judgments).

Nature of an equitable interest in property

The Supreme Court summarised several well-established legal principles regarding the nature of an equitable interest in property, including the following:

  • An equitable interest is good against all the world, except a bona fide purchaser for value (in contrast to a legal interest, which is good against all the world without exception).
  • Accordingly, the transfer of trust property by a trustee (even if in breach of trust) to a bona fide purchaser for value, will extinguish any proprietary equitable interest.
  • Even, if the bona fide purchaser later becomes aware that the property was transferred in breach of trust, this does not resuscitate the claimant’s proprietary equitable interest.
  • A proprietary equitable interest, having been extinguished, is also not revived when the original purchaser transfers the property to a further transferee, who, at the time of the transfer, is aware that there has been a breach of trust.

As such, a claim in knowing receipt cannot succeed in these circumstances.

Close link between claims in knowing receipt and proprietary claims

The Supreme Court emphasised that knowing receipt claims are closely linked to a proprietary claim which attaches to the trust property. In particular:

  • Knowing receipt claims come into play where the transferee is not a bona fide purchaser for value without notice, and a proprietary claim would fail because the recipient no longer has the property (eg because they have transferred/dissipated/destroyed the property after learning of the breach of trust).
  • It would be logically inconsistent for the law to allow the personal claim in knowing receipt to survive where the proprietary claim has been defeated by the lack of a continuing proprietary equitable interest. This means the claims will be “killed off” at the same time, ie when the recipient receives the property if that is sufficient to defeat a proprietary claim.
  • In terms of timing, if the proprietary equitable interest is extinguished at the time when the recipient receives the property (and so a proprietary claim would be defeated).

The panel did not reach agreement on the precise categorisation of claims in knowing receipt and proprietary claims. Lord Briggs analysed a claim in knowing receipt as ancillary to a proprietary claim (which Lord Hodge preferred) while Lord Burrows categorised a claim in knowing receipt as an “equitable proprietary wrong”. This difference did not alter their shared conclusion that a claim in knowing receipt is precluded where the claimant’s proprietary equitable interest has been extinguished or overridden by the time when the recipient receives the property.

The Supreme Court agreed that its conclusions could not be displaced by comparing the claim in knowing receipt to a claim for dishonest assistance (ie a claim against a non-trustee who induces or assists the breach of trust by a trustee). Liability for dishonest assistance is an ancillary liability – ancillary to the breach of trust by the trustee. It renders the assister liable as an accessory to the same extent as the trustee. There is no requirement that the assister has even received trust property. A claim in knowing receipt is significantly different, being closely linked to a proprietary claim for the return of the trust property.

Knowledge” necessary to trigger liability for knowing receipt

The Supreme Court highlighted a number of areas of possible uncertainty concerning knowing receipt, including the precise boundaries and content of the requirement to show what is now called “knowledge” necessary to trigger the recipient’s personal liability to account or pay equitable compensation under the doctrine of knowing receipt.

The Supreme Court noted that it is now common ground that mere “notice” is not sufficient, but in the absence of full submissions on the point, declined to reach a conclusion as to whether the requirement for knowledge may be satisfied by constructive knowledge.

However, although the regulation of unconscionable conduct may be the underlying purpose of many equitable principles, the court was clear that the knowledge requirement will not be satisfied simply because it would be unconscionable for the recipient to retain the benefit of the property received (disagreeing with Nourse LJ in BCCI v Akindele [2000] EWCA Civ 502). The judgment suggests that the question of knowledge will require a distinct separate test, but did not need to consider the formulation of that test further on this appeal.

Applying this reasoning to the facts of the case

The operation of Saudi Arabian law, had the effect that SICL’s proprietary equitable interest in the Shares was extinguished by Mr Al-Sanea’s transfer to the Bank and the registration of those Shares in the Bank’s name.

This result was not altered by Mr Al-Sanea’s breach of trust and any knowledge which the Bank had that the transfer was in breach of trust.

Accordingly, the Supreme Court dismissed the appeal.

Chris Bushell
Chris Bushell
Partner
+44 20 7466 2187
Ajay Malhotra
Ajay Malhotra
Partner
+44 20 7466 7605
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
John Mathew
John Mathew
Senior Associate
+44 20 7466 2913

 

High Court finds defendant bank did not dishonestly assist company restructure to put assets beyond reach of creditors

The High Court has rejected an allegation of dishonest assistance against a bank, in circumstances where the claimants argued that the restructuring of the bank’s customer was a scheme to defraud its creditors and avoid the customer paying its liabilities. The court held that the customer’s directors had not breached their duties to the company, and so no question of accessory liability in dishonest assistance on the part of the bank arose. However, the court also found that the bank had not acted dishonestly in any event: Henderson & Jones Ltd v Ross & Ors [2023] EWHC 1276 (Ch).

This judgment will be of interest to those in the banking sector, as claims for dishonest assistance are a fairly common cause of action against financial institutions, albeit this was a novel scenario. By way of reminder, such claims involve an allegation that the defendant dishonestly assisted a fiduciary (such as a director) to commit a breach of fiduciary duty (such as the general duties of directors under the Companies Act 2006). For financial institutions, it is important to note that such liability, if established, may result in vicarious liability for the employer in respect of the acts of individual employees.

In this case, the claimant argued that a senior employee in the bank’s restructuring unit had turned a “blind eye” to the detrimental impact of the restructure on the company and its underlying purpose to defraud creditors. In support of this allegation, it was suggested that, because the bank was sufficiently secured in terms of its exposure, it was only interested in refinancing its loan to the business.

Having considered the evidence, and noting there were a number of problems with the bank’s purported motive, the court confirmed it would have rejected the dishonest assistance claim against the bank (even if it had found the directors acted in breach of fiduciary duty), as it could not be said that the bank failed to act as a reasonably honest person by not asking further questions. Indeed, the evidence indicated that the bank “took a significant interest in its customer” over an extended period to ensure the business was turned around and, where an issue was identified, the bank took specific legal advice and proposed actions consistent with maintaining the company’s business.

The decision highlights the importance of the enquiries made by the bank and the fact that these were contemporaneously documented. The judgment also provides a good summary of the principles underpinning dishonest assistance claims.

At a consequentials hearing (Henderson & Jones Ltd v Ross & Ors [2023] EWHC 1585 (Ch)), the court refused the claimant’s application for permission to appeal and awarded the defendants their costs on the indemnity basis.

The Court of Appeal has also refused the claimants’ request for permission to appeal the High Court’s decision.

Background

The claimant in this case was a litigation investment company and assignee of the claim. It commenced proceedings concerning the restructure of a group of companies (the Group) of which The Hospital Medical Group Limited (THMG) was formerly the main trading company. The defendants to the claim were directors of THMG, a former director and consultant to THMG, Barclays Bank (the Bank, as a secured lender to THMG) and THMG’s solicitors.

The claimant argued that the restructuring was intended to put THMG’s assets beyond the reach of its creditors, including in respect of potential liabilities arising from: (1) the Poly Implant Prothèse (PIP) breast implant scandal; and (2) sums due to HMRC in respect of VAT liabilities. It was alleged that the restructuring was unlawful in a number of respects, notably that the directors of THMG breached their fiduciary duties to the company and that the Bank dishonestly assisted such breaches.

The court set out the factual background in great detail in the judgment. In very brief summary, in 2011, THMG’s file was passed to its Bank’s Business Support Unit (BBS) in light of a number of developments with the company, including a forecast debt service covenant breach (and a required loan note restructure to avoid breach). The restructure of the Group completed in November 2012. In January 2013, the Bank’s BBS function ceased its involvement with THMG in light of the company’s strong upward trajectory. However, by 2015, the THMG board resolved that the company was unable to pay its debts and in February 2016, THMG entered creditors’ voluntary liquidation. Although THMG had been in negotiations with the PIP claimants’ solicitors in July 2015, these broke down and THMG’s parent company was no longer willing to offer support. The claimant argued that these were the natural and probable consequences of the 2012 restructure, designed to make THMG reliant on parent company support. In May 2016, default judgment on liability was entered against THMG in the PIP litigation.

The claimant commenced proceedings seeking common law damages and/or equitable compensation. The defendants denied liability, arguing that the restructure was not unlawful but was reasonably and honestly undertaken for value, for good commercial reason and in THMG’s interests. As such, no liability could attach to the directors for breach of duty, and as such the Bank and the other defendants could not be liable as accessories in dishonest assistance and were not dishonest in any event.

Decision

In a lengthy judgment, the High Court found that the directors had not breached their fiduciary duties to THMG. In light of this, the court held that no question of accessory liability in dishonest assistance arose on the part of the Bank. Nevertheless, given the severity of the accusations, the court went on to consider the allegations of dishonesty, holding that the Bank had not been dishonest in any event. We focus below on the dishonest assistance claim against the Bank.

As to the dishonesty element of the claims, the court noted that it is required first to ascertain the actual (subjective) state of the person’s knowledge or belief as to the facts. Once that has been established, the court then determines (objectively) whether the conduct of the person was (dis)honest by applying the standards of ordinary decent people. The court noted that it is not necessary for a defendant to appreciate their dishonesty by those standards, citing the case of Ivey v Genting Casinos (UK) Ltd (trading as Crockfords Club) [2018] AC 391.

The court confirmed that the knowledge of a fact can be imputed to a person if that person has turned a “blind eye” to it or has deliberately abstained from enquiry to avoid certain knowledge of what the person suspects to be the case. For blind eye knowledge to be imputed, it must first be shown (subjectively) that the person suspected that certain specific facts may exist and, second, that the person then made a conscious decision to refrain from taking any steps to verify the existence of those facts. The court noted that a person’s suspicions, falling short of actual or blind-eye knowledge are still relevant at the first stage of the dishonesty test (per Group Seven Ltd and Anor v Notable Services LLP and Anor [2019] EWCA 614).

As a preliminary matter in respect of the claims of dishonest assistance against the Bank, the court accepted that the absence of a discernible motive does not preclude a finding of dishonesty, referring to the case of Webb v Solicitors’ Regulation Authority [2013] EWHC 2078. However, the authorities recognised that motive and overall probability form an important part of the assessment of the evidence in a fraud case and that it is inherently improbable, absent some financial or other incentive, that professionals would act dishonestly.

In this case BS, the relevant senior employee (ie. the individual whose knowledge or suspicion of wrongdoing the claimant argued founded the Bank’s liability), was descried by the court as an “impressive witness”. The court found him to be an “honest banker (and witness)” with experience spanning decades and commented that although his “innate honesty might not preclude a lapse, this seems inherently improbable”. While the documentary record was acknowledged by the court to be incomplete (particularly with respect to THMG’s documents and those of its former auditors), the court relied heavily on BS’s meeting notes/emails and specific legal advice taken by the bank in reaching the conclusions outlined below.

On motive, the court held that there were a number of problems with the alleged motive. The claimant had argued that, although the Bank had realised the dishonest design intended for THMG as part of the restructure, BS’s only concern was to complete the refinancing as soon as possible as the Bank was amply secured for its own exposure to THMG’s business. However, the court found, contrary to the claimant’s allegations, that the Bank “took a significant interest in its customer”, over an extended period of some 14 months to ensure that the business was turned around and its strategic review, including the restructure, was successfully implemented to place the Group on a sound financial footing.

In furtherance of this, BS had taken a close interest in matters which might have impacted THMG’s brand, including in respect of PIP, and BS had concluded that this had, in fact, had a positive impact given how THMG had been able to position its approach to the PIP issue in the market. Moreover, where issues were identified, BS had taken specific legal advice, considered its impact on the Bank’s facilities and proposed actions consistent with the maintenance of THMG’s business standing.

The court accepted BS’s evidence that he would have looked at matters holistically at the Group level rather than in respect of the individual companies within the Group. This approach, the court considered, was an entirely reasonable approach from the Bank’s perspective.

The court also held that the reason BS had asked questions about a particular point was not because he was suspicious but because he was confused about what he understood to be new transaction steps and wanted to understand them. Indeed, the court also noted that the report from the Bank’s lawyers in respect of the matter did not indicate any suspicion. The court also considered that it was significant that BS’s email exchanges went to seven different persons. The court therefore considered that the Bank had not turned a blind eye or failed to act as a reasonably honest person by not asking further questions; on the contrary, BS had expressly broached the subject.

In light of the court’s analysis and of what the court described as a “very thin motive suggested for a banker of more than 30 years’ standing at the time to act dishonestly”, the court held that it would have rejected the dishonest assistance claim against the Bank.

Damien Byrne Hill
Damien Byrne Hill
Partner
+44 20 7466 2114
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Sarah McCadden
Sarah McCadden
Professional Support Lawyer
+44 20 7466 2193

Supreme Court decision gives further clarity on claims by distressed companies against directors

We recently published a blog post on the Supreme Court’s judgment in Stanford International Bank Ltd (In Liquidation) v HSBC Bank plc [2022] UKSC 34, in which the Supreme Court upheld the Court of Appeal’s decision to strike out a claim brought by the liquidators of a Ponzi scheme against its correspondent bank, alleging that the bank breached its so-called Quincecare duty to take sufficient care that monies paid out from the accounts under its control were being paid out properly.

The judgment also provides further clarity on the circumstances in which a distressed or insolvent company may seek to make claims against its directors, which colleagues in our RTI team have considered in further detail.

The key aspects affecting directors’ liabilities presented in the Supreme Court ruling are that:

  1. At least where unlawful preference rules are not engaged, loss to the company is a necessary element of the company’s claims against its directors for misappropriation of the company’s assets; and
  2. Building on the principles considered in BTI 2014 LLC v Sequana SA & Ors [2022] UKSC 25, a company’s losses for these purposes are not one and the same as those suffered by its creditors.

This means that, where other remedies are not available to recover sums paid out to third parties in breach of duty, insolvency practitioners and creditors alike should not assume that recourse will lie against defaulting directors to increase the amounts distributable upon liquidation.

This is the first reported judgment to consider the landmark BTI v Sequana decision which clarified the duties owed by directors of distressed and insolvent companies and was the subject of a recent briefing paper produced by our restructuring team.

For a more detailed analysis of this decision relating to claims against directors of distressed companies, please see our Restructuring, Turnaround and Insolvency Legal Briefing.

Andrew Cooke
Andrew Cooke
Partner
+44 20 7466 7566
Richard Mendoza
Richard Mendoza
Senior Associate
+44 20 7466 2024

Supreme Court strikes out Quincecare claim where no loss suffered by insolvent Ponzi scheme

The Supreme Court has upheld the Court of Appeal’s decision to strike out a claim brought by the liquidators of a Ponzi scheme against its correspondent bank, alleging that the bank breached its so-called Quincecare duty to take sufficient care that monies paid out from the accounts under its control were being paid out properly: Stanford International Bank Ltd (In Liquidation) v HSBC Bank PLC [2022] UKSC 34.

This is the second case considering the Quincecare duty to reach the Supreme Court, the first being Singularis Holdings v Daiwa Capital Markets [2019] UKSC 50 (see our blog post). While the present Supreme Court judgment did not consider the scope of the Quincecare duty expressly, it highlights that the court will consider the question of whether any pecuniary loss has been suffered in such cases with a critical eye. It also demonstrates that the court is prepared to deal with Quincecare claims on a summary basis where appropriate, in contrast with some recent unsuccessful applications (see our blog posts here and here). Finally, the judgment places heavy emphasis on retaining the narrow boundaries of the Quincecare duty, so that it does not unduly interfere with commercial certainty and the ability of a bank to act upon the payment instructions given to it by its customer promptly and without fear.

The appeal concerned £116m paid to genuine investors (directly or indirectly) from the bank’s account, in the period between when the claimants said the bank should have recognised the “red flags” and stopped processing its customer’s payments (thereby exposing the fraud), and the date upon which the accounts were eventually frozen by the bank. The precise scope and content of the Quincecare duty was not critical for the present appeal. Assuming (for the purpose of the strike out application) that the bank owed and breached the duty, the appeal considered whether that breach gave rise to any recoverable loss suffered by the claimant. The claimant argued that it had lost the chance of discharging the debts owed to investors who were wise or lucky enough to redeem their investment early, for a few pence in the pound, rather than those investors being paid out in full.

By a majority of 4:1 (Lord Sales dissenting), the Supreme Court held that the claimant had no claim in damages because it suffered no loss. The Supreme Court considered the nature of the chance that the claimant had lost. In the counterfactual scenario where the bank had complied with its Quincecare duty and disobeyed the claimant’s instructions, the claimant would have had an extra £116m to its credit. However, even if this meant that all the customers received the same dividend (i.e. there was no longer any distinction between those investors who redeemed their investment early and those who did not), no additional customer indebtedness would be paid off.

The dissenting judgment of Lord Sales provided some interesting (obiter) commentary on the Quincecare duty, suggesting that (in principle) the formulation of the duty covers payments made to creditors where a company is in a situation of “hopeless insolvency”, just as much as any other kind of misappropriation. However, this is likely to have limited impact since banks are not expected to police the solvency of their customers, and the test of “hopeless insolvency” is such a stringent one that examples in practice will be rare.

We consider the decision in further detail below.

Background

The underlying claim was brought by the liquidators of the claimant (SIB). SIB was a company incorporated in Antigua and Barbuda, which operated a Ponzi scheme fraud until its collapse in 2009.

The defendant bank (Bank) provided correspondent banking services for SIB from 2003 onwards. Those accounts were frozen on 17 February 2009, following news that the beneficial owner and controller of SIB (Mr Robert Allen Stanford) had been charged by the US Securities and Exchange Commission.

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. The claim was to recover the sums paid out by the Bank during the period from 1 August 2008 and 17 February 2009. The claim concerned £116m paid to customers (directly or indirectly) from the Bank’s accounts. There was no consequential loss claimed by SIB.

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 £116 million reduced SIB’s assets by £116 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, 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.

By way of background and context, in separate but related proceedings brought by the liquidators in Antigua and pursued on appeal to the Privy Council, it was held that there was no possibility of recovering the money from the customers who had been wise or lucky enough to redeem their investment and be paid out in full: see In re Stanford International Bank Ltd [2019] UKPC 45; [2020] 1 BCLC 446.

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. It found that, absent the Bank’s breach of its Quincecare duty, the funds sitting in SIB’s accounts as at 1 August 2008 (£80 million) 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 £116 million reduced SIB’s assets by £116 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’s reasoning is discussed in our previous banking litigation blog post.

The Court of Appeal overturned the decision of the High Court on the Quincecare duty, finding that SIB 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 1 August 2008 and 17 February 2009.

The Court of Appeal said that the High Court erred in its reasoning by proceeding on the basis that the bank owed a direct duty to the company’s creditors, which it did not. The High Court had confused 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.

SIB appealed to the Supreme Court in respect of the Quincecare duty claim only.

Supreme Court decision

By a majority of 4:1, the Supreme Court dismissed SIB’s appeal and upheld the Court of Appeal’s decision to strike out the Quincecare claim, thus dismissing the claim in full.

The appeal proceeded on the basis of two critical assumptions: (1) that there had been a breach by the Bank of the Quincecare duty; and (2) that the Quincecare duty may be breached where there is nothing wrong with the transaction itself but where the bank is put on notice of some background fraudulent activity being carried on by the person purporting to authorise the payment from the customer’s account.

During the course of the appeal, SIB accepted that the net asset point which formed the basis of the Court of Appeal’s decision was a good one. SIB recognised that the £116m payments out relieved it of £116m debt that it owed under contracts with its customers, and so there was no depletion of the company’s net assets in the amount paid away. Accordingly, SIB put its allegations on an alternative basis, arguing that the damage it suffered was the loss of a chance, as per Chaplin v Hicks [1911] 2 KB 786 and Allied Maples Group Ltd v Simmons & Simmons [1995] EWCA Civ 17. The Supreme Court’s analysis of the loss of a chance case is considered in further detail below.

Loss of a chance case

SIB said that at the time the disputed payments were made, SIB was hopelessly insolvent and it has since gone into liquidation. It argued that if the Bank had not made the payments, those debts would still have been owed to the customers who withdrew their funds in full and escaped without loss (the “early investors”). Those early investors would then have to prove their debts in the liquidation and would be likely to receive a dividend of only a few pence in the pound. SIB’s loss was, therefore, the loss of the chance of discharging those debts owed to the early investors for a few pence in the pound.

In the leading judgment given by Lady Rose (with whom Lord Hodge and Lord Kitchin agreed), the Supreme Court considered the nature of the chance that SIB had lost. In the counterfactual scenario where the Bank had complied with its Quincecare duty and disobeyed Mr Stanford’s instruction to pay out SIB’s money, SIB would have had an extra £116m to its credit. However, even if this meant that all the customers received the same dividend (i.e. there was no longer any distinction between early and late investors), no additional customer indebtedness would be paid off.

SIB argued that the chance lost was a chance for SIB to act more fairly as between customers, by making sure that the early investors did not benefit at the expense of the late investors. However, Lady Rose concluded that SIB had not suffered the loss of a chance that had any pecuniary value to it and so there was nothing recoverable on its pleaded case.

The concurring judgment of Lord Leggatt reached the same conclusion: that the amount that SIB “lost” by paying the early investors in full was offset by the equal amount that SIB “gained” by paying the late investors less than they would otherwise have received. In Lord Leggatt’s judgment, SIB’s argument was flawed because it disregarded the net loss rule (as per British Westinghouse Electric & Manufacturing Co Ltd v Underground Electric Railways Co of London Ltd [1912] AC 673).

The “breach date rule”

As part of Lord Leggatt’s discussion of how the court should address the value of the chance that was lost when the Bank made the payments, he gave some commentary on the “breach date rule”.

In summary, the Bank argued that, as a matter of law, loss caused by breach of a duty owed under a contract or in tort is generally to be assessed as at the date of breach. However, SIB submitted that the court could take account of a contingent event at the date of breach of contract, which has since arisen, i.e. the court could have regard to the fact that the chance of a liquidation as at 1 August has turned into an actual liquidation. SIB said that, when assessing the chance that it lost when the payments were made, the value should be calculated by taking the likelihood of the liquidation happening as 100%.

In the view of Lord Leggatt, this was “unnecessarily complicated and involves a misunderstanding of the relevant legal principles”. He said that there is no such rule of law that loss caused by a breach of duty is generally assessed as at the date of the breach (as per Bunge SA v Nidera BV (formerly Nidera Handelscompagnie BV) [2015] UKSC 43).

Limits of the Quincecare duty

While the scope of the Quincecare duty was not an issue in this appeal, the dissenting judgment of Lord Sales gave some interesting (obiter) commentary on the coherence of the law and the limits of the duty.

He emphasised that the Quincecare duty should be kept within narrow bounds, so that it does not unduly interfere with the conduct of commerce. In ordinary circumstances, a bank should be able to act upon the payment instructions given to it by its customer promptly and without fear. The Quincecare duty qualifies that position, balancing commercial certainty for the bank against the need for some reassurance that the payment instruction was legitimate. The impact of the Quincecare duty should be kept within bounds by a strict approach governing when it applies, and by careful analysis of the scope of the duty.

In the view of Lord Sales, the formulation of the Quincecare duty covers the situation where the order is an attempt to misappropriate the funds of a company by using them to make full payments which ought not to be made to creditors in a situation of “hopeless insolvency”, just as much as any other kind of misappropriation. He said that the company suffers a loss in both situations because its own funds are misappropriated. However, since the test of hopeless insolvency is such a stringent one, it will only be in a rare case that a bank will be found to have knowledge of this or to be on notice of it to the requisite standard. Banks are not expected to police the solvency of their customers as an ordinary incident of the service they provide.

Director’s duties owed to a company on the verge of insolvency

Lord Leggatt and Lord Sales considered, in some detail, the nature of the fiduciary duty owed by a director to a company on the verge of going into insolvent liquidation. Their observations will be of interest to insolvency practitioners, in particular the analysis of the recent decision of the Supreme Court in BTI 2014 LLC v Sequana SA [2022] UKSC 25 (see this briefing prepared by our Restructuring, Turnaround and Insolvency team).

Chris Bushell
Chris Bushell
Partner
+44 20 7466 2187
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948

Court of Appeal clarifies requirements of claims in knowing receipt in failed claim against bank

The Court of Appeal has dismissed a knowing receipt claim against a bank for receipt of shares, which were transferred to the bank in breach of trust, on the basis that the claimant did not have a continuing proprietary interest in the relevant shares: Byers & Ors v The Saudi National Bank [2022] EWCA Civ 43.

The decision provides helpful clarification as to the elements required to make good a claim in knowing receipt. It confirms that liability for knowing receipt arises from the recipient’s knowledge of the fact that it has received trust property which has been transferred in breach of trust. This includes where a recipient has received the property without knowing that it was transferred in breach of trust and only later discovers the fact. Once the recipient acquires such knowledge, it makes it unconscionable for the recipient to retain the property and imposes a duty on the recipient to treat the property as if they are a trustee of it and to restore it to the trust. This contrasts with liability for dishonest assistance, where liability is fault-based and arises from the recipient’s dishonesty in assisting a trustee to commit a breach of trust (or assisting a fiduciary to commit a breach of fiduciary duty).

A key battleground in the present case, was whether a continuing proprietary interest in the relevant property is required for a claim in knowing receipt claim. In the view of the Court of Appeal, a defendant cannot be liable for knowing receipt if it takes the property free of any interest of the claimant. In this case, given the claimant had failed to prove at trial that its beneficial interest in the shares continued under local law following transfer to the bank, the claim in knowing receipt failed.

We consider the decision in more detail below.

Background

The background to this decision is more fully set out in our blog post on the High Court decision, here.

In summary, Saad Investments Company Limited (SICL) was a Cayman Island registered company and the beneficiary of certain Cayman Island trusts. Trust property included shares in five Saudi Arabian companies (the Shares). In July 2009, SICL went into liquidation.

In breach of trust, the trustee of the Cayman Island trusts transferred the Shares to a bank based in Saudi Arabia (the Bank). The purpose of the transfer was to discharge part of a debt owed by the trustee to the Bank.

The liquidators of SICL, the claimants, subsequently brought a claim for knowing receipt against the Bank, on the basis that the Bank knew (or ought to have made / was reckless in failing to make inquiries which would have revealed) that the trustee held the Shares on trust for SICL and that the transfer was in breach of trust.

High Court decision

The High Court’s reasoning is discussed in our previous blog post.

In summary, the High Court found in favour of the Bank and dismissed the claim. It held that a claim in knowing receipt where dishonest assistance is not alleged will fail if, at the moment of receipt, the beneficiary’s equitable proprietary interest is destroyed or overridden so that the recipient holds the property as beneficial owner of it. In the absence of a formal allegation of dishonesty against the Bank, and given the claimants’ failure to prove that SICL’s beneficial interest continued under local law despite receipt of the Shares by the Bank, the claim failed.

The claimants appealed to the Court of Appeal. The claimants argued that they did not need to have a continuing proprietary interest in the Shares to succeed in their knowing receipt claim.

Court of Appeal decision

The Court of Appeal found in favour of the Bank and dismissed the appeal by the claimants. In summary, it held that a continuing proprietary interest in the relevant property is required for a knowing receipt claim to be possible. A defendant cannot be liable for knowing receipt if he took the property free of any interest of the claimant. Absent a continuing proprietary interest in the Shares at the time of the registration, the claim in knowing receipt failed.

We consider below some of the key issues considered by the Court of Appeal in relation to the knowing receipt claim.

Accessory liability and the distinction between knowing receipt and dishonest assistance

The Court of Appeal highlighted that the starting point for establishing accessory liability for breach of trust is the well-known statement of principle in Barnes v Addy (1874) LR 9 Ch App 244:

  • Strangers are not to be made constructive trustees merely because they act as the agents of trustees in transactions within their legal powers, unless those agents receive and become chargeable with some part of the trust property, or unless they assist with knowledge in a dishonest and fraudulent design on the part of the trustees.

The Court of Appeal then went on to note the distinction between knowing receipt and dishonest assistance:

  • Liability for dishonest assistance arises where a person dishonestly procures or assists in a breach of trust or fiduciary duty. While the standard by which the law determines whether a mental state is objective, negligence does not suffice. For a defendant to be liable for dishonest assistance, his mental state has to have been such as by ordinary standards would be characterised as dishonest (as per Barlow Clowes International Ltd v Eurotrust International Ltd [2005] UKPC 37 and Ivey v Genting Casinos (UK) Ltd [2017] UKSC 67). However, there is no requirement that the defendant should have received property to which the trust or fiduciary obligation has ever attached.
  • To establish a claim for knowing receipt, a claimant must show: first, a disposal of his assets in breach of fiduciary duty; secondly, the beneficial receipt by the defendant of assets which are traceable as representing the assets of the plaintiffs; and thirdly, knowledge on the part of the defendant that the assets he received are traceable to a breach of fiduciary duty (as per El Ajou v Dollar Land Holdings plc [1994] 2 All ER 685).
  • The recipient’s state of knowledge must be such as to make it unconscionable for him to retain the benefit of the receipt. While a knowing recipient will often be found to have acted dishonestly, it has never been a prerequisite of the liability that he should (as per Bank of Credit and Commerce International (Overseas) Ltd v Akindele [2001] Ch 437).
  • A recipient need not necessarily have had any knowledge or even notice of any breach of duty at the point of receipt to be liable for knowing receipt. A person who has received trust property transferred to him in breach of trust can incur liability either if he received it with notice that it was trust property and that the transfer to him was a breach of trust or if he received it without such notice but subsequently discovered the facts. What matters is that the recipient’s state of knowledge should have become such as to make it unconscionable for him to retain the benefit of the receipt (as per Agip (Africa) Ltd v Jackson [1990] 1 Ch 265).

Mental element for establishing knowing receipt

The Court of Appeal noted that, as per Akindele, the mental element to establish liability for knowing receipt arises from the recipient’s knowledge of the fact that it has received trust property which has been transferred in breach of trust. This makes it unconscionable for the recipient to retain the property. Knowing receipt is not concerned with unconscionability of receipt, but with unconscionability of retention.

In the Court of Appeal’s view, liability for knowing receipt may arise where there has been no unconscionable conduct by the recipient. Indeed, a recipient could receive the property without knowing that it has been transferred in breach of trust and only later be informed of the fact. If the property is still in the recipient’s possession when they become aware of its provenance, the duty to deal with it as a constructive trustee immediately arises. Failure to do so will give rise to liability for knowing receipt, even where – up until the moment of knowledge – the recipient has done nothing unconscionable.

The requirement for a continuing proprietary interest

The Court of Appeal said that a continuing proprietary interest in the relevant property is required for a knowing receipt claim to be possible. A defendant cannot be liable for knowing receipt if he took the property free of any interest of the claimant. Absent a continuing proprietary interest in the Shares at the time of the registration, the claim in knowing receipt failed.

The Court of Appeal agreed with the High Court that such a conclusion was borne out by a consistent line of case law in which it has either been decided that a claim in knowing receipt cannot succeed unless the claimant has a continuing proprietary interest following the impugned transfer or that has been assumed to be correct. As per Lightning Electrical Contractors Ltd (2009) 1 TLI 35 the court could not grant relief against a transferee if under the lex situs the claimant’s equity was extinguished by the transfer. Also, as per Akers v Samba Financial Group [2017] UKSC 6, where under the lex situs of the relevant trust property the effect of a transfer of the property by the trustee to a third party is to override any equitable interest which would otherwise subsist, that effect should be recognised as giving the transferee a defence to any claim by the beneficiary. Also, as per Courtwood Holdings SA v Woodley Properties Ltd [2018] EWHC 2163, the foundation of a knowing receipt claim is that the assets do not belong in equity to the recipient and that what gives the equity to the claimants is the fact that the transaction which is impugned is not one which transfers a good title to the recipient.

The Court of Appeal also underlined that as per Macmillan Inc v Bishopsgate Investment Trust plc (No 3) [1995] 1 WLR 978, a bona fide purchaser without notice can defeat a continuing proprietary interest claim as it will have taken free of the claimant’s interest.

Accordingly, for the reasons above, the Court of Appeal found in favour of the Bank and dismissed the appeal by the claimants.

Permission to Appeal

The Court of Appeal refused the claimants’ application for permission to appeal to the Supreme Court.

Chris Bushell
Chris Bushell
Partner
+44 20 7466 2187
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Nihar Lovell
Nihar Lovell
Professional Support Lawyer
+44 20 7466 2529
Eleanor Dole Sheaf
Eleanor Dole Sheaf
Associate
+44 20 7466 7612

Court of Appeal considers tests for “blind-eye” knowledge and vicarious liability in the context of a dishonest assistance claim

The Court of Appeal has ordered the re-trial of a dishonest assistance claim by insolvent companies and their respective liquidators against a bank and its indirect subsidiary on the basis that the High Court failed to consider key evidence in reaching its findings, which were thrown into further doubt by the 19 months delay in the handing down of the lower court’s judgment: Natwest Markets plc & Anor v Bilta (UK) Ltd & Ors [2021] EWCA Civ 680.

The Court of Appeal underlined that:

  • when considering whether there has been dishonesty in the test for blind-eye knowledge, it was not enough that a defendant merely suspects something to be the case, or that he negligently refrains from making further inquiries.
  • the tests for vicarious and dual liability are a highly fact sensitive exercise – such liability was usually imposed for policy reasons and was not concerned with fault or contractual liability.

This decision is noteworthy for financial institutions faced with claims alleging blind-eye knowledge on the part of a bank’s employees and/or vicarious liability in relation to a fraud because it highlights:

  • the difficulties for claimants in establishing that there has been dishonesty where a defendant merely suspects something to be the case or if the defendant negligently refrains from making further queries.
  • the risks for financial institutions, particularly a parent bank and any of its subsidiaries, faced with claims of vicarious liability; any contractual arrangements in place around the group to attribute the risk of vicarious liability are unlikely to assist.

We consider the Court of Appeal’s decision in more detail below.

Background

In 2008, the first defendant bank, then known as the Royal Bank of Scotland (RBS), entered into a joint venture with an energy infrastructure company, which operated through a limited liability partnership (RBS Sempra). In 2009, pursuant to that joint venture, the second defendant (RBS SEEL), a subsidiary of RBS Sempra, traded carbon credits through its trading desk. The relevant arrangements were governed by a Commodities Trading Activities Master Agreement (the Agreement) to which RBS, RBS Sempra and a group of companies (including RBS SEEL) were parties. The trading desk was manned by two traders employed by RBS SEEL, but seconded to RBS under the terms of the Agreement.

In 2009 the claimant companies were used by their directors as vehicles for a fraud involving spot trades in certain carbon credits known as EU Allowances (EUA), through an intermediary known as CarbonDesk Limited (CarbonDesk). There was no direct contact between the claimant companies and the defendants. Each claimant company was left without assets, defaulted on its obligations to account to HMRC for VAT, and went into insolvent liquidation.

Subsequently, the claimant companies and their respective liquidators brought a claim against RBS and RBS SEEL alleging dishonest assistance and knowing participation in fraudulent trading claiming that:

  • from 15 June 2009 and at all material times thereafter the traders should have been aware that the nature and pattern of RBS’s EUA trading with CarbonDesk was suspicious and such as to call for an inquiry “as to whether the trade was legitimate or whether there was a substantial chance that it was part of a VAT fraud“.
  • In failing to raise the trading as a matter of concern and failing to seek a satisfactory explanation from CarbonDesk, the traders were wilfully shutting their eyes to the obvious which was “that there was no legitimate explanation for the trades and/or that they were connected with VAT fraud”.

RBS and RBS SEEL denied the claims stating that:

  • neither of the traders fully understood the nature or extent of the risk of VAT fraud in the EUA market.
  • the increase in volumes of EUAs had caused the traders no concerns except as regards CarbonDesk’s business model, which had been raised and satisfactorily explained.
  • one of the traders spoke to the RBS SEEL compliance officer about the carbon credit trading at the end of June 2009.

High Court decision

The High Court held that RBS and RBS SEEL were both vicariously liable for dishonest assistance and knowingly being a party to fraudulent trading, by reason of the trading conducted by the traders employed by RBS SEEL. In reaching its conclusion, the High Court:

  • noted that the traders caused RBS to enter into trades with CarbonDesk. These trades formed part of a chain of transactions linking the actions of the traders with the misappropriation or misapplication of the VAT monies by the directors of the claimant companies. The traders therefore provided the necessary “assistance” to the defaulting fiduciaries. The High Court acknowledged that the traders were separated from the frauds at the claimant companies by at least one buffer company (CarbonDesk – against which fraud was not alleged) and that the traders were therefore not as closely connected to the operation of a fraudulent scheme as might be the situation in other cases. However, the High Court said those were factors which went to the question of dishonesty, rather than assistance.
  • determined that the traders were not fundamentally dishonest men. At the start of the trading with CarbonDesk, the traders were motivated by making good money and proving themselves to their employers. However, by mid-2009 the traders were making significant sums of money from increased and sustained trading with CarbonDesk with no information as to where CarbonDesk was obtaining its large volume of EUAs – the traders decided not to report their suspicions or ask questions in case doing so would lead them to ceasing such profitable trading – this was dishonest behaviour.
  • although the traders were recognisable as employees of RBS SEEL by whom they were legally employed, paid and supervised, they had the power and authority to commit RBS to trading contracts as agents for RBS; at all times they had to operate within the guidelines and restrictions imposed by RBS and were subject to directions that might be given by RBS and the trading activity they were conducting was that of RBS, so they were operating in the RBS and RBS SEEL spheres of operations. The High Court therefore considered it appropriate to regard the traders as employees of RBS as well as RBS SEEL and found that both RBS and RBS SEEL were vicariously liable for the acts of the traders, commenting that this was a “paradigm case for the imposition of dual vicarious liability”.

RBS and RBS SEEL appealed against the High Court’s findings on dishonest assistance, knowingly being a party to fraudulent trading, and vicarious liability. The claimants cross-appealed that the High Court ought to have found that the dishonest assistance occurred over a longer period.

Court of Appeal decision

The Court of Appeal allowed the appeal by RBS and RBS SEEL on the dishonest assistance and knowingly being a party to fraudulent trading issues. The Court of Appeal commented that it was not satisfied that the High Court’s finding and conclusions were right in light of: (i) the failure of the High Court to consider key documents or evidence in making its finding of dishonesty – they could have made a difference to the outcome and could not therefore be treated as immaterial; and (ii) the 19 months delay in handing down the judgment. A re-trial was ordered. In light of the above, the Court of Appeal said it was unnecessary to address the claimant’s cross-appeal.

However, the Court of Appeal dismissed RBS SEEL’s appeal on the vicarious liability issue.

We consider below some of the key issues which are likely to be of broader interest to financial institutions.

Blind-eye knowledge

The Court of Appeal said it was not necessary to address the claimants’ cross appeal (insofar as it was based on the submission that the test for dishonest assistance was satisfied earlier than the High Court had found) as the re-trial meant that all issues of fact, including the critical question of whether and if so when, the traders satisfied the test for blind-eye knowledge in Manifest Shipping v Polaris [2001] UKHL 1 would be a matter for the new trial judge to determine.

However the Court of Appeal noted that it was not persuaded by the claimants’ alternative argument that all the claimants needed to do in order to prove dishonesty for the purposes of establishing that the traders dishonestly assisted in the perpetration of a VAT fraud by CarbonDesk’s clients was to establish that one of the traders in question had “questions and concerns” about the trading with CarbonDesk which he knew or believed he ought to have brought to the attention of RBS SEEL’s compliance officer.

The Court of Appeal highlighted the following key principles relating to the tests for dishonest assistance and blind-eye knowledge:

  • Dishonest assistance. Per Ivey v Genting Casinos (UK) Limited [2017] UKSC 67, where dishonesty is alleged, the fact-finding tribunal must ascertain: (i) the defendant’s actual state of knowledge or belief as to the facts; and (ii) whether, in the light of that state of mind, their conduct was honest or dishonest, applying the objective standards of ordinary decent people.
  • Blind-eye knowledge. Per Group Seven Ltd and another v Nasir and others [2020] EWCA Civ 614), when applying the Ivey v Genting test in the context of a claim for dishonest assistance in a breach of trust, at stage 1 of the Ivey test “knowledge” includes blind-eye knowledge, but in principle “belief” may include suspicion which in and of itself falls short of blind-eye knowledge. However, it is not enough that the defendant merely suspects something to be the case, or that he negligently refrains from making further inquiries. The state of a person’s mind is a question of fact, and suspicions of all types and degrees of probability may form part of it, and thus form part of the overall picture to which the objective standard of dishonesty is to be applied.

The Court of Appeal then commented that when the matter was re-tried that it would be a matter for the judge to determine whether the traders’ trading with CarbonDesk had been dishonest, in the light of all relevant circumstances, including the unprecedently high volumes of transactions and the traders’ states of mind, specifically their knowledge (actual or imputed), beliefs, and conduct (including, but not limited to their dealings with the RBS SEEL compliance officer).

Vicarious and Dual Liability

RBS SEEL submitted that the High Court’s conclusion that this was a paradigm case for imposing dual liability was wrong, because despite nominally remaining its employees, all responsibility for the traders had been transferred to RBS, which should be solely responsible for their tortious acts. RBS SEEL contended that the High Court’s finding in relation to supervision stemmed from its mistaken and erroneous construction of certain sections of the Agreement.

The Court of Appeal stated that the High Court’s decision on this issue could not be impugned. The High Court was entitled to decide that the traders were so much a part of the work, business and organisation of both RBS and RBS SEEL that it was just to make both employers liable, and commented that the circumstances in which such a complete shift from the actual employer to the organisation to which the employee is loaned will arise must be very rare.

Vicarious and dual liability principles

The Court of Appeal noted that the principles which underpin the imposition of vicarious liability for tort had been considered by the Supreme Court in Various Claimants v Catholic Child Welfare Society [2013] AC 1 (also known as the Christian Brothers case) and more recently in Barclays Bank plc v Various Claimants [2020] UKSC 13. The Court of Appeal then highlighted the following key principles:

  • Two stage test for vicarious liability. The test requires a synthesis of two stages: (i) to consider the relationship of D1 and D2 to see whether it is one that is capable of giving rise to vicarious liability; (ii) an examination of the connection that links the relationship between D1 and D2 and the act or omission of D1. In the vast majority of cases the relationship which gives rise to vicarious liability is that of employer and employee under a contract of employment; the employer will be vicariously liable when the employee commits a tort in the course of his employment. There were a number of policy reasons that usually made it fair, just and reasonable to impose vicarious liability when certain criteria are satisfied.
  • Transfer of vicarious liability. A heavy burden of proof lay on an employer to shift responsibility for the negligence of its employees; liability is incurred without fault because the employer is treated by the law as picking up the burden of an organisational or business relationship which he has undertaken for his own benefit (such as the utilisation of secondees from a parent or subsidiary company as part of its usual business activities).
  • Allocation of the risk of vicarious liability in a contract. The question of vicarious liability was not to be determined by the terms of any agreement between the two employers under which they may have declared whose “servant” the employee was to be at any particular time. Although contractual provisions might apportion liability between them, the question of vicarious liability turns on all the circumstances of the case (as per Mersey Docks & Harbour Board v Coggins & Griffiths (Liverpool) Ltd [1946] UKHL 1). Such liability was imposed as a matter of public policy and was not concerned with fault or with contractual liability. It was not possible to avoid the imposition of vicarious liability by a contractual arrangement with the body to which an employee is loaned; to determine liability it is necessary to take all the actual circumstances into account and consider what happened on the ground.
  • Dual vicarious liability. It was possible to have dual vicarious liability where an employee was loaned to or hired by another organisation. Where two defendants are potentially vicariously liable for the act of a tortfeasor it is necessary to give independent consideration to the relationship of the tortfeasor with each defendant in order to decide whether that defendant is vicariously liable. If the employee is so much a part of the work, business or organisation of both employers it may be just to make both employers liable for his negligence. One is therefore looking for practical and structural considerations (as per Christian Brothers and Viasystems (Tyneside) v Thermal Transfer (Northern) Ltd [2005] EWCA Civ 1151).
  • Fact sensitive exercise. The imposition of vicarious liability is a highly fact sensitive exercise. It is all the more so in the circumstances in which an employee has been loaned or hired out or seconded to another organisation (as per Group Seven).

Accordingly, for the reasons given above, the Court of Appeal dismissed RBS SEEL’s appeal on the vicarious liability issue.

John Corrie
John Corrie
Partner
+44 20 7466 2763
Mark Tanner
Mark Tanner
Senior Associate
+44 20 7466 2412
Nihar Lovell
Nihar Lovell
Professional Support Lawyer
+44 20 7374 8000

Court of Appeal confirms that the Quincecare duty does not extend to protect creditors

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 [2021] 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.

Background

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 [2018] 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:

  1. 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[2020] EWCA Civ 699); and
  2. 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 [1995] 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 [2019] 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 [2003] 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 [1952] KB 232 and Greenridge Luton One Ltd v. Kempton Investments Ltd [2016] 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.

Chris Bushell
Chris Bushell
Partner
+44 20 7466 2187
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Andrew Cooke
Andrew Cooke
Senior Associate
+44 20 7466 7566
Nihar Lovell
Nihar Lovell
Professional Support Lawyer
+44 20 7374 8000

High Court considers distinction between liability for dishonest assistance and knowing receipt in failed claim against bank

The High Court has dismissed a claim brought by the liquidators of an investment company against a bank for knowing receipt, in circumstances where the investment company’s shares were transferred by a trustee (in breach of trust) to the bank, and used by the bank to discharge part of a debt owed by the trustee to the bank: Byers & Ors v Samba Financial Group [2021] EWHC 60 (Ch).

One of the key issues before the court was whether the claimants’ claim in knowing receipt must fail, where the beneficiary’s interest in the shares was extinguished by the transfer (as per local Saudi Arabian law, which was applicable to the property). Such a question does not arise in relation to English property under the general law of England and Wales, but may arise (as in this case) where under the foreign law applicable to the property, the transferee’s title may trump the interest of the beneficial owner and knowledge of that interest is irrelevant.

In summary, the court found that a claim in knowing receipt where dishonest assistance is not alleged, will fail if, at the moment of receipt, the beneficiary’s equitable proprietary interest is destroyed or overridden so that the recipient holds the property as beneficial owner of it. In the absence of a formal allegation of dishonesty against the bank, and given the claimants’ failure to prove that the investment company’s beneficial interest continued under local law despite receipt of the shares by the bank, the claim failed.

The judgment is noteworthy for its analysis of the distinction between liability for dishonest assistance and knowing receipt, both of which are common types of claim made against financial institutions. Historically, there has been some blurring of the line between the two causes of action, further complicated by references to “dishonest receipt” in certain judgments. The decision provides the following helpful clarification:

  1. Dishonest assistance is truly fault-based. It arises from the dishonesty of the defendant in assisting a trustee to commit a breach of trust (or assisting a fiduciary to commit a breach of fiduciary duty). From the perspective of financial institutions, it is important to note that such liability, if established, may result in vicarious liability for the employer of the individual defendant. For example, in Bilta (UK) Ltd (in Liquidation) v Natwest Markets plc & Anor [2020] EWHC 546 (Ch), the parent bank and its indirect subsidiary were found vicariously liable for the dishonest assistance of carbon credit traders employed by the subsidiary).
  2. Knowing receipt unconnected with dishonesty is different, at least at the moment of receipt. The recipient is not liable in such a claim for wrongly agreeing to receive the property. The knowing recipient’s liability depends on their knowledge that the property they receive is trust property and is to be dealt in that way. The principal duty of a knowing recipient is to deal with the property once received as if they are a trustee of it and to restore it to the trust; it would be unconscionable for them to do otherwise.

The decision is considered in more detail below.

Background

Saad Investments Company Limited (SICL) was a Cayman Island registered company and the beneficiary of certain Cayman Island trusts. Trust property included shares in five Saudi Arabian companies (the Shares). In July 2009 SICL went into liquidation.

In September 2009, Mr Al Sanea (the trustee) in breach of trust transferred the Shares to a bank, based in Saudi Arabia (the Bank). The purpose of the transfer was to discharge part of a debt which Mr Al Sanea owed to the Bank. Mr Al Sanea’s account was then credited by the Bank with the market value of the Shares on the day of the transfer; in the region of 801 Saudi Riyals (USD $318 million).

The liquidators of SICL, the claimants, subsequently brought a claim for knowing receipt against the Bank seeking compensation for the value of the Shares transferred to it. The claimants’ case was that the Bank received trust property with knowledge of a breach of trust. Alternatively, the Bank ought to have made (or was reckless in failing to make) inquiries, which would have revealed that the Shares were held by Mr Al Sanea on trust for SICL and that the transfer was in breach of trust.

One of the key issues before the court (which is the focus of this blog post) was whether – if SICL’s interest in the Shares was extinguished by the transfer (as per Saudi Arabian law) – the claimants’ claim in knowing receipt must fail (as per English/Cayman Islands law). This involved the important question of whether a transferee, who upon receipt obtains title to the property free from a beneficiary’s equitable proprietary interest, can nonetheless be personally liable in equity for knowing receipt because they received the property with sufficient knowledge that the transfer was a breach of trust.

Such a question does not arise in relation to English property under the general law of England and Wales, but may arise (as in this case) where under the foreign law applicable to the property, the transferee’s title may trump the interest of the beneficial owner and knowledge of that interest is irrelevant.

Decision

The High Court found in favour of the Bank and dismissed the claim. In summary, the court held that a claim in knowing receipt where dishonest assistance is not alleged will fail if, at the moment of receipt, the beneficiary’s equitable proprietary interest is destroyed or overridden so that the recipient holds the property as beneficial owner of it.

We consider below some of key issues considered by the court in relation to the knowing receipt claim.

The claimants’ arguments

The key arguments articulated by the claimants were as follows:

  • There should in principle be a personal remedy and it was irrelevant whether under Saudi Arabian law the transfer of the Shares to the Bank extinguished SICL’s proprietary interest in them, as the Bank received the Shares for its own purposes with sufficient knowledge that they had been transferred in breach of trust.
  • Under Saudi Arabian law the effect of the registration of the Bank as the owner of the Shares did not deprive SICL of the ability to assert its equitable interest against the Bank.
  • That liability in knowing receipt arises from the wrongful receipt of property by the transferee, i.e. it is a fault-based liability. The transferee knows (sufficiently) that the property belongs to another and that it has been wrongly transferred to them. The transferee therefore is not entitled, as against the beneficiary to receive and retain the property for itself.

No allegation of dishonesty

The court said that although the claimants at times came close to alleging the Bank was an accessory to the theft of the Shares, they did not allege dishonesty as would be required to establish liability as a constructive trustee for dishonest assistance in a breach of trust. Also, the court noted that an allegation that a person has failed recklessly to make the enquiries that an honest person would have made is not an allegation of dishonesty. The fact that there was no allegation of dishonesty underpinned the rest of the court’s analysis of the claim.

Distinction between liability for dishonest assistance and knowing receipt

The court commented that the claimants’ arguments failed to draw a sufficiently clear distinction between liability for dishonest assistance and knowing receipt.

The court underlined that a defendant can be liable for both dishonest assistance and knowing receipt, but as a matter of law the distinction is clear. In the court’s view, dishonest assistance is truly fault-based – the equity arises from the dishonesty of the defendant in assisting a trustee to commit a breach of trust.

Knowing receipt unconnected with dishonesty is different, at least at the moment of receipt. The recipient is not liable in such a claim for wrongly agreeing to receive the property. The knowing recipient’s liability depends on their knowledge that the property they receive is trust property and is to be dealt in that way. The principal duty of a knowing recipient is to deal with the property once received as if they were a trustee of it and to restore it to the trust; it would be unconscionable for the recipient to do otherwise.

Approach to knowing receipt claim where there is no dishonesty

The court explained that a knowing receipt claim that does not allege dishonesty requires the claimant to have a continuing proprietary basis for it (as per Macmillan Inc v Bishopsgate Investment Trust plc (No.3) [1995] 1 WLR 978).

A claimant must be able to assert that the defendant received the property and was obliged to deal with it as if they were a trustee of it. If the recipient was from the outset entitled to deal with the property as their own, the claim cannot succeed. In the present case, the claimants needed to prove that SICL’s proprietary interest in the Shares was not extinguished at the moment of receipt by the Bank; but the claimants failed to do so. The knowing receipt claim therefore failed.

Permission to Appeal

The court granted the claimants permission to appeal to the Court of Appeal on the knowing receipt issue.

Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Nihar Lovell
Nihar Lovell
Professional Support Lawyer
+44 20 7466 2529
Eleanor Dole Sheaf
Eleanor Dole Sheaf
Associate
+44 20 7466 7612

High Court confirms potential liability of creditors for breaches of duty by administrators

The decision in Davey v Money & Anor [2018] EWHC 766 (Ch) serves as a useful reminder for secured creditors (such as banks) of the potentially broad-ranging scope of liabilities that they may be exposed to in the course of dealings with administrators. In addition to the usual sorts of claims for ‘accessory liability’ that might be raised in that context, in this case the court concluded that, in the same way as a mortgagee can be responsible for the actions of a receiver, it was possible for a secured creditor to be liable for breaches of duty by an administrator on the basis that it directed or interfered in the conduct of an administration.

In particular, it shows that secured creditors may be liable in circumstances beyond those which might give rise to liability for dishonest assistance, procuring a breach of duty or an unlawful means conspiracy. Secured creditors should therefore be mindful of seeking to control the conduct of an administration. As a practical measure, it may also be sensible to ensure that proper records of dealings are kept and that relevant communications are set out in writing.

Background

The claimant was the sole director and shareholder of Angel House Developments Ltd (“Angel“), a property development company in liquidation. The claimant was also the guarantor of Angel’s indebtedness to Dunbar Assets plc (“Dunbar“), which appointed Mr James Money and Mr Jim Stewart-Koster as administrators (the “Administrators“).

The claimant brought a claim under paragraph 75 of Schedule B1 to the Insolvency Act 1986, which empowers the courts to inquire into potential misfeasance by an administrator at the request of a creditor or contributory.

The claimant alleged that:

  • the Administrators conducted a “light-touch” administration in which they failed to exercise independent judgment and instead had excessive regard to the interests and wishes of Dunbar;
  • the Administrators failed to take steps to involve the claimant in the administration which, the claimant alleged, would have led to the rescue and survival of Angel;
  • the Administrators sold Angel’s main asset, a commercial property, at a significant undervalue in reliance on unsuitable agents (Alliance Property Asset Management Limited, “APAM“) who had conducted a flawed marketing campaign and whom Dunbar had in effect selected;
  • Dunbar directed or interfered in the conduct of the administration so as to make the Administrators its agents, and that it was therefore liable for their breaches of duty;
  • Dunbar procured the breaches of duty by the Administrators; and
  • Dunbar conspired with APAM to cause Angel and/or the claimant loss by unlawful means, namely by deliberately causing the Administrators to carry out a limited sale process for Angel so as to realise insufficient monies to enable the secured indebtedness to Dunbar to be repaid, leaving Angel liable for the balance and the claimant liable on the personal guarantee.

Decision

The court dismissed all of the claimant’s allegations. However, on the question of whether it was possible as a matter of law for a secured creditor to direct or interfere in the conduct of the administration so as to make an administrator its agent, the court concluded that it was difficult to see any convincing policy reason why there should be any difference between the position that applies if the sale of the property were to be conducted by a receiver (where the authorities hold that it could make such a disposal) or an administrator.

That being the case, the court went on to consider what level of involvement would be required in order to justify a finding that an agency relationship had been created between an administrator and a secured creditor or otherwise to justify the imposition of liability on a secured creditor. The court adopted the formulation from the receivership authorities, that the mortgagee might be liable if it “directed or interfered” in the conduct of the receivership. It found that, to establish such a liability, it would be necessary to show something going beyond the legitimate involvement that a secured creditor could expect to have in the administration process by reason of his legal status and rights. That was because the formulation of the “directed or interfered” standard indicated that the administrator should either have been compliant with directions given by the secured creditor, or have been unable to prevent some interference with his intended conduct of the administration:

So, for example, I do not think that an agency relationship would be established merely because the secured creditor gave its consent to a sale of charged property which had been organised by the administrator. Nor would that be the case simply because an administrator had consulted the secured creditor and taken account of its wishes, even on a regular basis. Nor would such a relationship be established merely because the secured creditor took a commercial decision in the exercise of its own rights which necessarily constrained the administrator’s freedom of action. But if, in contrast, the secured creditor gave directions which the administrator unquestioningly followed, or if (to adapt the example in Morgan v Lloyds Bank plc) the secured creditor misled the administrators or exerted sufficient pressure on them so as to defeat their free will, then I see no reason why the courts should not be able to hold the secured creditor liable if the property in question was sold negligently for a price that diminished or eliminated the value of the company’s equity of redemption.

The court then considered whether Dunbar had procured breaches of statutory duty by the Administrators and whether Dunbar had conspired with APAM to injure Angel or the claimant by unlawful means. The court dismissed both of these allegations on the facts. It also emphasised that a claim for accessory liability against Dunbar in respect of breaches of fiduciary duty on the part of an administrator would lie in a claim for dishonest assistance.

Comment

Although the claimant’s allegations failed on the facts, the court’s judgment highlights the range of liabilities which secured creditors may be exposed to if they ‘overstep the mark’ in the course of an administration.

Natasha Johnson
Natasha Johnson
Partner
+44 20 7466 2981
Alex Lerner
Alex Lerner
Associate
+44 20 7466 2206