High Court refuses to strike out Quincecare duty claim against a PSP where its customer was hijacked by fraudsters

The High Court’s judgment in Gareth Hamblin and Marilyn Hamblin v World First Limited and Moorwand NL Limited [2020] EWHC 2383 (Comm) is the first decision to follow the Supreme Court’s ruling in Singularis Holdings Ltd v Daiwa Capital Markets [2019] UKSC 50, considering the so-called Quincecare duty of care (see our banking litigation blog post).

As a reminder, the Quincecare duty arises where a bank or deposit holding financial institution must refrain from processing a payment mandate made by an authorised signatory of its customer for as long as the bank is “put on enquiry” i.e. it has reasonable grounds for believing that the instruction is an attempt to misappropriate funds from the customer. This is an objective test to be judged by the standard of an ordinary prudent banker.

The present decision considered a novel factual scenario not previously analysed by the court in the context of the Quincecare duty, namely whether such a claim can be brought against a financial institution (here, a payment services provider) where the customer was an insolvent shell company, without any directors, which had been hijacked by fraudulent individuals and used for the purpose of a fraud. Even in these extreme circumstances, the court found that a Quincecare claim was realistically arguable. Following Singularis, the court emphasised that the Quincecare duty is owed to the company not to those in control of it, and as such it was possible for the shell company itself to be a “victim” of the fraud.

The court refused to attribute the knowledge of the fraudsters to the shell company, arguably taking a conservative approach to the test for attribution in Singularis. In that case, the Supreme Court confirmed that there is no principle of law that the fraudulent conduct of a director is to be attributed to the company if it is a one-man company. The court applied this principle here, even though on the facts the company was not even a “one-man company” because it had no directors at all, it was in the control of those who were at best de facto directors, all of whom had been intimately involved in the prosecution of the fraudulent scheme. As per Singularis, the court said that the question of attribution in such circumstances is always to be found in consideration of the context and the purpose for which the attribution is relevant.

The decision highlights the creep in the scope of the Quincecare duty first established in Barclays Bank plc v Quincecare Ltd [1992] 4 All ER 343. Quincecare itself considered the duty in the context of a current account, but it has since been extended to depository accounts (JP Morgan Chase Bank, N.A. v The Federal Republic of Nigeria [2019] EWCA Civ 1641, see our banking litigation blog post), investment banks (Singularis) and it is now being considered in the context of a payment service provider in the present case. It is presenting an increasing risk for financial institutions that process client payments, as the spate of recent judgments indicates (see also our recent banking litigation blog post on Stanford International Bank Ltd v HSBC Bank plc [2020] EWHC 2232 (Ch)).

Further, it will be interesting to see the court’s decision on the merits of the claimants’ alternative breach of mandate claim against the bank (for purporting to act on the instructions of an individual whose identity had been stolen by the fraudsters, where in fact there were no registered directors of the company). The court held that the claimants had an arguable case to narrow the established principle that a customer is estopped from claiming damages resulting from its own instruction where the bank has acted in good faith and in the ordinary course of business (see Bank of England v Vagliano Brothers [1891] AC 107). In the court’s view, this principle may need to be refined in the context of a corporate entity controlled by fraudsters, particularly in light of the distinction between where the customer is an individual vs a company, as highlighted in Singularis.

Background

The claim arose out of a sophisticated investment fraud using the second defendant, Moorwand NL Limited (Moorwand NL) as the corporate vehicle by which the fraud was carried into effect by individuals unknown. Those individuals set up an account in the name of Moorwand NL on the application of a Mr Carter, whose identity had been stolen by the fraudsters. At no material time was Mr Carter a director of Moorwand NL, nor did Moorwand NL have any registered directors. Moorwand NL’s account was set up and maintained by the first defendant (against which no allegations of fraud were made), a payment service provider known as World First Limited (WF).

The claimants were persuaded by the fraudsters to open an investment account and transferred £140,000 to Moorwand NL’s account with WF. Subsequently, WF paid out the £140,000 credited to Moorwand NL’s account on instructions apparently received on behalf of Moorwand NL. The sums paid out were misappropriated and the individuals behind the investment fraud were never found.

The claimants commenced proceedings against both WF and Moorwand NL (now in insolvent liquidation) to recover the £140,000 they lost. The claim against WF was brought on the grounds that Moorwand NL was a trustee of the claimants’ funds and that the claimants (as beneficiaries of the trust) had standing to bring representative proceedings (i.e. claims belonging to Moorwand NL) directly against WF.

WF applied for strike out or reverse summary judgment on the grounds that the claims were bound to fail as a matter of law. This blog post focuses on the following issues in the application:

  1. Breach of the Quincecare duty i.e. that WF owed Moorwand NL a duty of care to use reasonable care and skill to not execute a payment instruction in circumstances where a reasonable service provider would be placed on notice that the payments had not been duly authorised.
  2. Breach of mandate because: (i) no authority to pay out from Moorwand NL’s account could have been obtained since Moorwand NL had no directors at any material time and/or (ii) payment out of the account was not authorised by Mr Carter since his identity was stolen and he was not asked nor gave authority for payment out of the account.
  3. The claimants’ right to bring representative proceedings.

For the purpose of the application, WF did not dispute that there was a proper factual basis for alleging that a reasonable service provider ought to have been on notice that the payments out were not duly authorised.

Decision

The High Court (Pelling J) ruled that the claimants had a realistically arguable case against WF for breach of the Quincecare duty and/or breach of mandate, and realistically arguable standing to bring the claim.

Breach of the Quincecare duty

WF submitted that no claim for breach of the Quincecare duty could succeed because:

  1. No loss could be caused by a breach of the Quincecare duty that was within the knowledge of those in control of the customer.
  2. As a matter of policy, the only claim available to a person in the position of the claimants was a claim for dishonest assistance (which was not available on the facts of this case).

Taking each of these arguments in turn, WF argued that the Quincecare duty requires the bank’s customer to have been the victim of the fraud, but here the customer (Moorwand NL) was controlled by fraudsters. Accordingly, any claim for breach of duty brought by Moorwand NL would be bound to be met with an assertion that no loss could be caused by a breach within the knowledge of those in control of Moorwand NL. Any such claim brought by Moorwand NL against WF would give rise to a complete circuity of action, since WF would then be entitled to sue Moorwand NL for fraudulent misrepresentation.

The court highlighted the emphasis given by Lady Hale in Singularis to the fact that the Quincecare duty is owed to the company not to those in control of it. This is because the purpose of the duty is to protect the legally distinct company against the misappropriation of the company’s assets. Taking Moorwand NL as a distinct legal entity, the court held that it was realistically arguable on the facts as they were assumed that Moorwand NL was itself a victim of the fraud.

On the question of whether to attribute the knowledge of the fraudsters to Moorwand NL, the court again cited Singularis, which confirmed that where a company (e.g. Moorwand NL, represented by the claimants) is suing a third party (e.g. WF) for breach of duty, there is no principle of law that the fraudulent conduct of a director is to be attributed to the company if it is a one-man company. In the court’s view, it was at least realistically arguable that this principle would apply here, even though on the facts Moorwand NL was not even a “one-man company” (because it had no directors at all, it was in the control of those who were at best de facto directors, all of whom had been intimately involved in the prosecution of the fraudulent scheme). As per Singularis, the court said that the question of attribution in such circumstances is always to be found in consideration of the context and the purpose for which the attribution is relevant. The court echoed the reasoning in Singularis that to attribute the knowledge of the fraudsters to Moorwand NL so as to defeat the claim would be to denude the Quincecare duty of much of its practical utility.

The court also disagreed with WF’s policy argument, that allowing the claimants to pursue a claim for breach of the Quincecare duty, would be contrary to the deliberate public policy of limiting the claims available to a person in the position of the claimants to a claim for dishonest assistance.

For the above reasons, the court ruled that the claimants had a realistically arguable case for breach of the Quincecare duty by WF.

Breach of mandate

The claim under this head was that WF breached its mandate with Moorwand NL because it purported to act on the instruction of Mr Carter, where Mr Carter could not and did not give any instructions  (because his identity had been stolen by the fraudsters and in fact there were no registered directors).

WF relied on the principle set out in Vagliano Brothers, which held that if a bank acts upon a representation by a customer in good faith and in the ordinary course of business, the customer is estopped from suing the bank for any loss which occurred based on the representation, where that loss would not have occurred if the representation had been true. Accordingly, because the fraudsters (presumably on behalf of Moorwand NL) had impersonated Mr Carter, WF argued that this principle estopped the claimants from bringing the breach of mandate claim.

The claimants argued that the time may have come to review, refine or confine this proposition of law, so as not to apply to a situation where the “customer” was a corporate entity controlled by fraudsters. They said a distinction needed to be drawn between when an individual/partnership of individuals was the customer (as was the case in Vagliano Brothers) and when a company was the customer. In particular, the claimants relied on the following passage from Singularis (emphasis added):

“In Luscombe v Roberts (1962) 106 SJ 373, a solicitor’s claim against his negligent accountants failed because he knew that what he was doing – transferring money from his clients’ account into his firm’s account and using it for his own purposes – was wrong. But companies are different from individuals. They have their own legal existence and personality separate from that of any of the individuals who own or run them. The shareholders own the company. They do not own its assets, and a sole shareholder can steal from his own company.”

The court recognised that Singularis dealt with different facts and a different cause of action, but said that the principle of law was generally stated and well established. On the present application (and in a case where the defence had not been filed nor meaningful disclosure taken place), the court found that the distinction between an individual and a company observed in Singularis was maintainable. Further, the court was not prepared to conclude that Vagliano Brothers provided a certain answer to the claimants’ claim that WF was in breach of mandate, in circumstances where Moorwand NL had no directors and had come under the control of fraudsters who were at best de facto directors of the company.

The court suggested that this would amount to a “modest but incremental” development of the law, but that any development to that effect should be on the basis of facts properly established at trial and not assumed facts as was the case at the interim stage.

Representative proceedings

The final issue considered was whether the claimants had standing to bring the claim at all, which the court found was realistically arguable.

For the purpose of the application, the court found that Moorwand NL was a trustee. In such circumstances, Hayim v Citibank NA [1987] AC 730 (PC) enabled the claimants to bring representative proceedings as a beneficiary where Moorwand NL had committed a breach of trust or “in other exceptional circumstances”. The court found that this requirement was satisfied (at least to the level of realistic argument) where Moorwand NL as the trustee was in insolvent liquidation and there was no dispute that it had been hijacked by fraudulent individuals and used as the means by which a fraud was carried into effect.

The court therefore dismissed the application for strike out or summary judgment.

Chris Bushell

Chris Bushell
Partner
+44 20 7466 2187

Ceri Morgan

Ceri Morgan
Professional Support Consultant
+44 20 7466 2948

Mannat Sabhikhi

Mannat Sabhikhi
Associate
+44 20 7466 2859

High Court considers Quincecare and dishonest assistance claims against bank in context of Ponzi scheme

The trend of claims against financial institutions alleging breach of the so-called Quincecare duty continues to grow, with the most recent judgment from the High Court refusing to strike out such a claim on the ground that the claimant had suffered no loss because it was an insolvent Ponzi scheme. A parallel claim against the bank for dishonest assistance has, however, been struck out: Stanford International Bank Ltd v HSBC Bank plc [2020] EWHC 2232 (Ch).

In this case, the court considered claims brought by the liquidators of Stanford International Bank Limited (SIB), the infamous Ponzi scheme masterminded by Robert Allen Stanford, the former billionaire who was well known for sponsoring a multi-million pound series of cricket matches with the England and Wales Cricket Board (ECB), before the fraud was exposed and Mr Stanford was convicted in the United States.

The liquidators of SIB have brought proceedings against a correspondent bank (the Bank) that operated various accounts for SIB (which paid out/received deposits to/from investors), arguing that the Quincecare duty required the Bank to have recognised the red flags by 1 August 2008 (at the latest) and to have “sent the balloon up”, freezing the payments to investors out of the accounts and thereby exposing the fraud. The liquidators claim the monies paid out in the period from 1 August 2008 until the accounts were actually frozen in February 2009.

The present judgment relates to a novel application made by the Bank to strike out or seek reverse summary judgment in respect of the Quincecare claim on the basis that SIB has no claim in damages as it suffered no loss. The Bank argued that SIB suffered no loss because its net asset position remained the same during the relevant period: the payments out to investors reduced SIB’s assets, but equally discharged SIB’s liabilities to investors by the same amount.

While the court accepted that the net asset position of a solvent company may remain the same in these circumstances, it found that the position may very well be different for an insolvent individual or company (such as SIB); and said that the counterfactual scenario must be interrogated for the purpose of assessing damages. Here, the court held that if the Bank had frozen the accounts on 1 August 2008, SIB would have had £80 million of assets in its accounts with the Bank. It would have had a very large number of creditors, but it would have had that money in its accounts and available for the liquidators to pursue claims. The court found that SIB did not need to give credit for the fact that it had been saved £80 million of liabilities, because SIB was still just as insolvent, but with a slightly different mix of creditors.

There are a number of Quincecare duty claims progressing through the courts, but still only one finally determined case in which the duty has been found to be owed and breached (see our blog post: Supreme Court upholds first successful claim for breach of the so-called “Quincecare” duty of care). The decision in SIB v HSBC therefore provides a helpful addition to this body of case law, as financial institutions continue to grapple with the emerging litigation risks associated with processing client payments.

The court granted a separate application made by the Bank to strike out the liquidators’ claim for dishonest assistance in relation to breaches of fiduciary duty owed to SIB by Mr Stanford. It held that the allegation of dishonesty was not sufficiently pleaded in the statements of case, clarifying a number of issues in relation to aggregation of knowledge, corporate recklessness and blind-eye knowledge, which are discussed in further detail below.

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 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 ECB (which is not considered further in this blog post).

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.

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.

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.

Decision

The court described the Bank’s argument on loss in respect of the Quincecare allegation as “simple and beguiling attractive”, but ultimately refused to strike out or grant summary judgment. The court did strike out the allegation of dishonest assistance.

Quincecare duty

The court acknowledged that it is trite law that (with some exceptions) a party suing for damages arising from an alleged wrongdoing must give credit against the loss claimed for any benefits obtained as a result of the same wrongdoing.

In the case of a solvent company, the court said that paying £100 of its money and discharging £100 of its liabilities, on the one hand reduces its assets but on the other hand is offset by a corresponding benefit to the company by reducing the creditors that have to be paid. Accordingly the net asset position of the solvent company is the same.

However, the claimant’s case was that SIB was always heavily insolvent (somewhere in the region of £4 to 5 billion) and the court accepted that the position may very well be different for an insolvent individual or company.  Taking the example above, the court said that if the company is insolvent, then paying £100 on the one hand reduces its assets, but that is not offset by a corresponding benefit to the company and a reduction in its liabilities, as it still does not have enough to pay them all, and it still has no net assets at all.

In a case such as this, where the claimant is insolvent, the court said that the counterfactual scenario must be interrogated for the purpose of assessing damages. The relevant counterfactual scenario in this case was described by the court as follows:

  • As at 1 August 2008, SIB had the sum of £80 million in its accounts with the Bank.
  • If the Bank had frozen the accounts on that date, the Ponzi scheme would have been uncovered and SIB would have collapsed into insolvent liquidation on or around that date.
  • In that scenario, SIB would have had £80 million of assets available to it. It would have had a very large number of creditors, but it would have that money in its accounts with the Bank.
  • Had SIB had the £80 million, it would have had that money available for the liquidators to pursue such claims as they thought they could usefully pursue and for distribution to its creditors.

As a result of what actually happened, SIB did not have the £80 million. Assuming (for the purpose of the application) that the Bank breached its Quincecare duty, the court said that effect of the breach was to deprive SIB of the opportunity to use the £80 million as described above. The court held that this was a real loss and it was contrary to “instinctive and common sense reaction to the facts” to describe SIB as currently being in exactly the same financial position as it would have been on 1 August 2008.

The claimant’s argument on the “no net assets” point (with which the court agreed), was put concisely as follows:

“…once your liabilities vastly exceed your assets, it really is a matter of indifference to you whether you have £5bn of liabilities or £6bn of liabilities. If your assets are only in the hundreds of millions, on any view you are hopelessly and irredeemably insolvent. You therefore have no net assets on any view, but a net liability, and if that net liability is only £5bn instead of £6bn (or £5.118bn), that does not make any difference to you – you still have no net assets.”

In the court’s view, SIB did not need to give credit for the fact that it had been saved £80 million of liabilities, because it did not make SIB any better off, it was still just as insolvent as it was, but with a slightly different mix of creditors.

The Bank argued that the position of SIB as the company (as opposed to the creditors) was no worse off by having £80 million of its assets wrongfully extracted from its bank accounts, given that there would be nothing left over for the company or its shareholders on any view. In this context, the Bank pointed out that the Quincecare duty is only owed to the company and not to its creditors. However, the court rejected this argument, because under the counterfactual scenario, SIB would have had £80 million in the bank, rather than nothing.

Accordingly, the court dismissed the application for reverse summary judgment or strike out of the Quincecare loss claim (for the balance over and above the ECB payment). The court was not asked decide the point on a final basis in favour of the claimant, and so it will technically be open to the Bank to continue to run these arguments at trial.

Dishonest assistance

In respect of the dishonest assistance claim, the only point argued before the court was whether there was a sufficient plea of dishonesty against the Bank to survive the strike out application. The court held that there was not, and the key themes of its analysis are considered further below.

Aggregation of knowledge

Counsel for the claimant acknowledged that he was unwilling to plead dishonesty against any particular individual at the Bank, because he did not have the material to do so at that stage of the proceedings. The claimant therefore pleaded a case of dishonesty against the Bank collectively, on the basis that if disclosure revealed a case that could be properly pleaded against individuals at the Bank, the claimant would seek to amend to do so.

The court noted that it is a thoroughly well-established principle of English law that one cannot aggregate two innocent minds to make a dishonest whole: see Armstrong v Strain [1952] KB 232. As such, the court held that no case could be made against the Bank that relied on aggregating knowledge held by different people at the Bank if none of those individuals was alleged to be dishonest.

Corporate recklessness

In the alternative, the claimant argued that the Bank acted with “corporate recklessness. The court considered the question of whether corporate recklessness is sufficient to amount to dishonesty in the context of a dishonest assistance claim.

The claimant submitted that recklessness could amount to dishonesty, as per the statement by Lord Herschell in Derry v Peek (1889) 14 App Cas 337. In this case Lord Herschell explained the meaning of “fraud” in the context of a claim for deceit, saying said that fraud is proved where it is shown that a false representation has been made: (1) knowingly; or (2) without belief in its truth; or (3) recklessly, careless whether it be true or false.

The claimant built on the analysis in Derry v Peek to allege a case of corporate recklessness against the Bank for not knowing or caring whether SIB was being run properly not, or was a fraud on its investors, saying this was sufficient to amount to dishonesty in a dishonest assistance claim.

The court disagreed. It held that the words of Lord Herschell cannot be transposed into a generalised allegation that if one does not know or care about something one is dishonest in relation to it. Lord Herschell was dealing specifically with a claim in deceit (a tort that depends on fraudulent misrepresentation) and the court in this case said the claimant’s argument was an attempt to stretch his words beyond their proper application. One could not simply say that companies that act recklessly in the sense of not knowing and not caring are therefore dishonest.

The court considered the sharp distinction between honesty and dishonesty discussed in Agip (Africa) Ltd) v Jackson [1990] Ch 265 at 293E. The court said that this was relevant when considering why the Bank did not ask questions that would have revealed the nature of SIB’s business as a fraud. If questions were not asked because the Bank/its employees did not suspect wrongdoing, then they were not dishonest, even if they ignored the Bank’s own policies, and it did not assist to say that they had developed an ingrained culture of failing to obtain knowledge.

Blind-eye knowledge

The claimant also alleged that the Bank turned a blind eye as to whether SIB was being run dishonestly.

On the question of what will amount to blind-eye knowledge, the court considered the speech of Lord Scott in Twinsectra v Yardley [2002] UKHL 12, which was also referred to by the Court of Appeal in Group Seven Ltd v Nasir [2019] EWCA Civ 614. In summary, this confirms that blind-eye knowledge requires targeted suspicion and a deliberate decision not to look.

Absent an allegation of targeted suspicion and of a deliberate decision not to look (which did not appear in the claimant’s statements of case), the court found that the allegations made against the Bank could not be characterised as allegations of dishonesty.

Strike out

Accordingly, the court struck out the dishonest assistance claim. It noted that, by striking out  the claim rather than granting summary judgment, the claimant would preserve the opportunity to seek to re-plead a case of dishonesty following disclosure, if it could properly do so.

Chris Bushell

Chris Bushell
Partner
+44 20 7466 2187

Ceri Morgan

Ceri Morgan
Professional Support Consultant
+44 20 7466 2948

Supreme Court upholds first successful claim for breach of the so-called “Quincecare” duty of care

The Supreme Court has upheld the first successful claim for breach of the so-called Quincecare duty of care: Singularis Holdings Ltd (In Official Liquidation) (A Company Incorporated in the Cayman Islands) v Daiwa Capital Markets Europe Ltd [2019] UKSC 50.

The Supreme Court’s judgment in this case follows hot on the heels of the Court of Appeal’s refusal to strike out a Quincecare duty claim in JPMorgan Chase Bank, N.A. v The Federal Republic of Nigeria [2019] EWCA Civ 1641 (see our banking litigation blog post). The judicial attention that this cause of action is currently receiving highlights the litigation risks of inadequate safeguards/processes governing payment processing at financial institutions, and the recent decision is therefore likely to be of significant interest to the sector.

A brief recap on the Quincecare duty. The duty arises in the context of a deposit holding financial institution processing a payment mandate in relation to a customer’s account, where that mandate was made by an authorised signatory of its customer, but where the instructions turn out to have been made fraudulently and to the detriment of the customer. It is the duty imposed on the bank to refrain from executing the order if (and for as long as) it is “put on inquiry” that the order is an attempt to misappropriate its customer’s funds. This is an objective test, judged by the standard of an ordinary prudent banker.

In the present case, breach of the Quincecare duty was established at first instance and not appealed. The issue for the Supreme Court was whether the fraudulent state of mind of the authorised signatory could be attributed to the company which had been defrauded and, if so, whether the claim for breach of the Quincecare duty could be defeated by the defence of illegality (and certain other grounds of defence). The Supreme Court found against the bank in respect of both points.

In reaching this conclusion, the Supreme Court clarified a number of important implications, including:

  1. Test for attribution: Declaring that the often criticised decision in Stone & Rolls Ltd v Moore Stephens [2009] UKHL 39 can “finally be laid to rest”, the Supreme Court restated and clarified the test for attribution. It confirmed that whether knowledge of a fraudulent director can be attributed to the company is always to be found in consideration of the context and the purpose for which the attribution is relevant. The Supreme Court expressly stated that there is no principle of law that, in any proceedings where the company is suing a third party for breach of a duty owed to it by that third party, the fraudulent conduct of a director is to be attributed to the company if it is a one-man company.
  2. Illegality defence in response to a Quincecare claim: In the present case the Supreme Court found that the bank did not meet the test for a successful illegality defence laid down in Patel v Mirza [2016] UKSC 42. While this will be fact specific in any given case, the reasoning given by the court highlights the challenges which financial institutions may face to make good such a defence. In particular, as a matter of public policy, the Supreme Court said that denial of the claim would have a material impact upon the growing reliance on banks and other financial institutions to play an important part in reducing and uncovering financial crime and money laundering. If a regulated entity could escape from the consequences of failing to identify and prevent financial crime by casting on the customer the illegal conduct of its employees that policy would be undermined.

In combination with the JPMorgan v Nigeria decision, this judgment suggests that it may be prudent for financial institutions to review safeguards governing payment processing, to review protocols in place for what steps must be taken in the event that a red flag is raised, and also to consider reviewing the standard form wording of client account agreements seeking to exclude the Quincecare duty.

We consider the decision in more detail below.

Background

For further detail on the background to the claim, please see our blog post on the Court of Appeal’s decision.

In summary, Singularis Holdings Limited (“Singularis”) held sums on deposit with Daiwa Capital Markets Europe Limited (the “Bank”). In 2009, the Bank was instructed by an authorised signatory on the account (Mr Al Sanea) to make payments out of Singularis’s account. Mr Al Sanea was the sole shareholder, a director and also chairman, president and treasurer of Singularis. There were six other directors, who were reputable people, but did not exercise any influence over the management of Singularis. Very extensive powers were delegated to Mr Al Sanea to take decisions on behalf of Singularis, including signing powers over the company’s bank accounts.

The Bank approved and completed the transfers notwithstanding “many obvious, even glaring, signs that Mr Al Sanea was perpetrating a fraud on the company” and that Mr Al Sanea “was clearly using the funds for his own purposes and not for the purpose of benefiting Singularis”. It was common ground at trial that Mr Al Sanea was acting fraudulently when he instigated the transfers.

In 2014, Singularis (acting by its joint official liquidators) issued a claim against the Bank for US$204m, the total of the sums transferred in 2009. There were two bases for the claim: (1) dishonest assistance in Mr Al Sanea’s breach of fiduciary duty in misapplying Singularis’ funds; and (2) breach of the Quincecare duty of care owed by the Bank to Singularis by giving effect to the payment instructions.

High Court decision

The High Court held that the claim of dishonest assistance failed, but that the Bank did act in breach of its Quincecare duty by making the payments in question without proper inquiry, finding that any reasonable banker would have noticed the signs that Mr Al Sanea was perpetrating a fraud on Singularis and that there was a failure at every level within the Bank: Singularis Holdings Ltd v Daiwa Capital Markets Europe Ltd [2017] EWHC 257 (Ch).

The Bank advanced an illegality defence relying on the legal doctrine of ex turpi causa, which prevents a claimant from pursuing a civil claim if the claim arises in connection with some illegal act on the part of the claimant. In this instance, the claim against the Bank for breach of duty was brought by Singularis, but the illegal acts were carried out by Mr Al Sanea. The focus of the argument before the High Court on the illegality defence was therefore whether Mr Al Sanea’s dishonest conduct should be attributed to Singularis. However, this (and the Bank’s other defences) was rejected. The court reduced the damages payable by 25% to account for Singularis’s contributory negligence.

The Bank appealed. The grounds of appeal did not include an appeal against the finding of the Quincecare duty of care, or breach of that duty. The grounds related to the illegality defence and other defences, or alternatively (if remaining unsuccessful on those defences), the amount by which Singularis’s damages should be reduced for contributory negligence.

Court of Appeal decision

The Court of Appeal unanimously dismissed the appeal: Singularis Holdings Ltd v Daiwa Capital Markets Europe Ltd [2018] EWCA Civ 84 (see our banking litigation blog post for more detail).

It upheld the High Court’s finding that Mr Al Sanea’s fraudulent state of mind could not be attributed to Singularis. However, the Court of Appeal held that, even if the Bank had been successful on attribution, the claim for breach of the Quincecare duty would still have been successful and not defeated by any of the Bank’s defences, and that the finding of 25% contributory negligence was a reasonable one.

The Bank appealed to the Supreme Court.

Supreme Court decision

Two broad issues arose for the Supreme Court to consider:

  1. When can the actions of a dominant personality, such as Mr Al Sanea, who owns and controls a company, even though there are other directors, be attributed to the company?
  2. If such actions are attributed to the company, is the claim defeated (i) by illegality; (ii) by lack of causation; or (iii) by an equal and countervailing claim in deceit?

We consider the Supreme Court’s response to these issues below (in reverse order).

The Bank’s defences

The Supreme Court rejected all three of the Bank’s defences, based on illegality, causation and a countervailing claim in deceit.

Defence of illegality

Both the High Court and Court of Appeal rejected the illegality defence raised by the Bank on two grounds: (1) that Mr Al Sanea’s fraud could not be attributed to Singularis (in other words, his fraud could not be held to be the company’s fraud) – considered below; and (2) in any event, the Bank did not meet the test for a successful illegality defence laid down in Patel v Mirza.

An illegality defence will operate in an appropriate case to prevent a claimant from pursuing a civil claim if the claim arises in connection with some illegal act on the part of the claimant. In this case, the illegality relied on was Mr Al Sanea’s provision of documents which he knew to be false and his breach of his fiduciary duty towards Singularis. The Bank argued that these illegal acts by Mr Al Sanea (attributed to Singularis) defeated the breach of Quincecare duty claim.

Looking at the test for a successful illegality defence, the Supreme Court noted that Patel v Mirza rejected a test which depended on whether or not the claimant had to plead the illegal agreement in order to succeed. Instead the Supreme Court in that case adopted an approach based on whether enforcing the claim would be harmful to the integrity of the legal system and therefore contrary to the public interest. It set out a three-fold test to assess whether the public interest would be harmed in that way:

“…it is necessary (a) to consider the underlying purpose of the prohibition which has been transgressed and whether that purpose will be enhanced by denial of the claim, (b) to consider any other relevant public policy on which the denial of the claim may have an impact and (c) to consider whether denial of the claim would be a proportionate response to the illegality, bearing in mind that punishment is a matter for the criminal courts.”

The Supreme Court considered each element of the test, agreeing with the conclusions of the first instance judge and finding against the Bank in respect of each element.

(a) Purpose of the prohibition:

Prohibition against breach of fiduciary duty by Mr Al Sanea: The Supreme Court held this prohibition was to protect Singularis from becoming the victim of the wrongful exercise of power by officers of Singularis. That purpose would not be enhanced by preventing Singularis from getting back the money which had been wrongfully removed from its account.

Prohibition against false statements made by Mr Al Sanea: The Supreme Court held this prohibition was both to protect the Bank from being deceived and Singularis from having its funds misappropriated. That purpose would be achieved by ensuring that the Bank was only liable to repay the money if the Quincecare duty was breached: that duty struck a careful balance between the interests of the customer and the interests of the Bank.

Accordingly, the first limb of the Patel v Mirza test was not satisfied by the Bank, because denial of the Quincecare duty claim would not enhance the purpose of the relevant prohibitions (i.e. the prohibitions against breach of fiduciary duty or making false statements).

(b) Relevant public policy:

The Supreme Court said that denial of the claim would have a material impact upon the growing reliance on banks and other financial institutions to play an important part in reducing and uncovering financial crime and money laundering. If a regulated entity could escape from the consequences of failing to identify and prevent financial crime by casting on the customer the illegal conduct of its employees that policy would be undermined.

(c) Proportionality:

In the opinion of the Supreme Court, denial of the claim would be an unfair and disproportionate response to any wrongdoing on the part of Singularis. The possibility of making a deduction for contributory negligence on the customer’s part enables the court to make a more appropriate adjustment than the rather blunt instrument of the illegality defence.

Accordingly, the Supreme Court held that – even if the acts of Mr Al Sanea could be attributed to Singularis – the claim for breach of the Quincecare duty could not be defeated by the defence of illegality.

Defence of causation

The Bank argued that, if the fraud was attributed to the company, the company’s loss was caused by its own fault and not the Bank’s. The Supreme Court recognised that there is a there is a difference between protecting people against harm caused by third parties and protecting them against self-inflicted harm. However, the present case was one of the rare cases in which the Bank had a duty to protect against self-inflicted harm. That is the purpose of the Quincecare duty: to protect a bank’s customers from harm caused by those for whom the customer is, one way or another, responsible.

Countervailing claim in deceit

The Bank argued that, because it would have an equal and countervailing claim in deceit against the company, the company’s claim in negligence should fail for circularity. The Supreme Court dismissed this argument in brief terms, citing the Court of Appeal’s reasoning that, since the fraud was a precondition for the claim for breach of the Quincecare duty, it would be a surprising result if the Bank could escape liability by placing reliance on the existence of that same fraud.

Attribution of knowledge and conduct

The Bank argued that, as Singularis was effectively a one-man company and Mr Al Sanea was its controlling mind and will, his fraud should be attributed to Singularis.

In seeking to establish attribution in this case, the Bank relied on the decision in Stone & Rolls, in which the House of Lords held that the knowledge of the fraudulent activities of the beneficial owner and “directing mind and will” of a company was attributable to that company. In Stone & Rolls, this meant that the defrauded company (which was by that stage in liquidation) could not bring a claim against its auditors for failing to detect the fraud. The decision has been much criticised, in particular because it deprived the company’s creditors of a remedy.

The Supreme Court noted that Stone & Rolls was a case between a company and a third party, but a similar argument was subsequently considered in the context of a case brought by a company against its directors and others who were alleged to have dishonestly assisted the directors in a conspiracy to defraud the company: Bilta (UK) Ltd v Nazir (No 2) [2015] UKSC 23. The Supreme Court in Bilta confirmed that the key to any question of attribution was always to be found in considerations of the context and the purpose for which the attribution was relevant.

However, the Supreme Court in the present case recognised that because of certain comments made by the majority in Bilta, the case has been treated as if it established a rule of law that the dishonesty of the controlling mind in a “one man company” could be attributed to the company whatever the context and purpose of the attribution in question.

Taking all of the above into consideration, the Supreme Court made two important findings:

  1. It confirmed that whether knowledge of a fraudulent director can be attributed to the company is always to be found in consideration of the context and the purpose for which the attribution is relevant (emphasis added). The Supreme Court expressly stated that there is no principle of law that in any proceedings where the company is suing a third party for breach of a duty owed to it by that third party, the fraudulent conduct of a director is to be attributed to the company if it is a one-man company. Accordingly, Stone & Rolls can “finally be laid to rest”.
  2. In any event, the Supreme Court held that Singularis was not a one-man company in the sense used in Stone & Rolls and Bilta because:
    • Singularis had a board of reputable people and a substantial business.
    • There was no evidence to show that the other directors were involved in or aware of Mr Al Sanea’s actions.
    • There was no reason why the other directors should have been complicit in this misappropriation of the money.

Having confirmed the test for attribution at point (1) above, the Supreme Court proceeded to consider the context and purpose for which the attribution was relevant in the present case.

It said the context was the breach by Bank of its Quincecare duty of care towards Singularis. The purpose of that duty was to protect Singularis against the misappropriation of its funds by a trusted agent of the company who was authorised to withdraw its money from the account. In these circumstances, the Supreme Court held that the fraud of Mr Al Sanea could not be attributed to Singularis, commenting:

To attribute the fraud of that person to the company would be, as the judge put it, to “denude the duty of any value in cases where it is most needed” (para 184). If the appellant’s argument were to be accepted in a case such as this, there would in reality be no Quincecare duty of care or its breach would cease to have consequences. This would be a retrograde step.”

Having found that the Bank’s defences failed, and that the fraudulent state of mind of Mr Al Sanea could not be attributed to Singularis in any event, the Supreme Court dismissed the Bank’s appeal.

Chris Bushell

Chris Bushell
Partner
+44 20 7466 2187

Maura McIntosh

Maura McIntosh
Professional Support Consultant
+44 20 7466 2608

Ceri Morgan

Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948

COURT OF APPEAL JUDGMENT ON SCOPE AND EXCLUSION OF ‘QUINCECARE’ DUTY OF CARE

The Court of Appeal has recently handed down an important judgment considering the so-called Quincecare duty of care: JPMorgan Chase Bank, N.A. v The Federal Republic of Nigeria [2019] EWCA Civ 1641.

The Quincecare duty arises in the context of a deposit holding financial institution receiving and processing a payment mandate in relation to a customer’s account, where that mandate was made by an authorised signatory of its customer, but where the instructions turn out to have been made fraudulently and to the detriment of the customer. It is the duty imposed on the bank to refrain from executing the order if (and for as long as) it is “put on inquiry” in the sense that it has reasonable grounds (although not necessarily proof) for believing that the order is an attempt to misappropriate the funds of its customer. This is an objective test, judged by the standard of an ordinary prudent banker.

In the present case, the Court of Appeal refused an application made by the defendant bank for reverse summary judgment/strike out on the basis that there was no Quincecare duty of care applicable on the facts because such a duty was inconsistent with, or was excluded by, the express terms governing the claimant’s depository account with the bank. In doing so, the Court of Appeal upheld the decision of the High Court (given by the now Lord Burrows, who recently received a leapfrog promotion to the Supreme Court): The Federal Republic of Nigeria v JPMorgan Chase Bank, N.A. [2019] EWHC 347 (Comm).

There are three significant points arising from the Court of Appeal’s judgment:

  1. Scope of the Quincecare duty of care:

The Court of Appeal has arguably expanded the scope of the Quincecare duty of care. The judgment states that, in most cases, the Quincecare duty will require “something more” from the bank than simply pausing and refusing to pay out on the mandate when put on enquiry that the order is an attempt to misappropriate funds. It commented that the question of what a bank should do will vary according to the particular facts of the case. In the present case, the Court of Appeal said that the trial judge will be in a better position to determine what the bank should have done if it had decided not to execute the instructions it was given to transfer funds.

The effect is that the Quincecare duty comprises both:

    • A negative duty to refrain from making payment; and
    • A positive duty on the bank to proactively do “something more“.

In the Court of Appeal’s view, these negative and positive duties carry equal weight, and neither is separate or subsidiary or additional to the other. In the High Court, the judge inclined to the view that the positive duty was a duty of enquiry. However, the Court of Appeal’s formulation of the positive duty is not limited to one of enquiry or investigation and for that reason it has arguably expanded the scope of the Quincecare duty.

Further, the Court of Appeal consciously avoided identifying factors which might be relevant to assessing what the “something more” is or might consist of, thus offering banks little practical guidance; it will depend on the facts of the case in question.

  1. Exclusion of the Quincecare duty is possible

The Court of Appeal endorsed the High Court’s view that it is possible for a bank and its client to agree to exclude the Quincecare duty (subject to any statutory restrictions, such as the clause being reasonable under the Unfair Contract Terms Act 1977). However, both the High Court and Court of Appeal emphasised that such an exclusion would have to be sufficiently clear (which was not the position on the facts of the present case). While an exclusion in such clear terms is therefore possible, it may be commercially unpalatable.

  1. Whether the Quincecare duty was inconsistent with express terms of the depository agreement

The Quincecare duty either arises by operation of an implied term of the contract governing the customer’s account, or under the tort of negligence. In the present case, the bank argued that there were certain express terms of the contract which meant that the Quincecare duty could not arise by operation of an implied term (because an implied term cannot be inconsistent with an express term), nor could it arise in tort (because the tortious duty is shaped, and can be excluded by, contractual terms). The bank argued that the express terms directly conflicted with what the Quincecare duty would seek to impose, and therefore the duty did not arise.

However, both the High Court and the Court of Appeal read references in express terms to there being no duty to “enquire” or “investigate” as meaning that there was no duty of care to enquire or investigate prior to the point at which the bank had the relevant reasonable grounds for belief. It therefore held such clauses were consistent with the Quincecare duty, even if it imposes an additional positive duty to enquire/investigate along with the negative duty not to pay.

There have been a number of recent cases shining a spotlight on the Quincecare duty of care. We previously considered the Court of Appeal’s decision in Singularis Holdings Ltd v Daiwa Capital Markets Europe Ltd [2018] EWCA Civ 84, in which the court rejected a bank’s attempt to defeat a Quincecare duty claim with a defence of illegality (see our banking litigation blog post). Earlier this year, the Supreme Court heard the bank’s appeal in that case and judgment is currently awaited.

The Singularis case remains the first and only case in which a bank has been found liable for breach of its Quincecare duty of care. However, the number of cases in which the duty is being argued highlights this as a risk area for financial institutions handling client payments. In particular given the potential expansion of what is encompassed within the Quincecare duty, it may be prudent for financial instructions to review safeguards governing payment processing, and also review the protocol in place for what steps must be taken in the event that a red flag is raised, not limited to refraining from making the payment, but extending to positive steps of investigation and the record-keeping of those steps. Financial institutions may also wish to consider reviewing the standard form wording of client account agreements.

Background

In 2011, the Federal Republic of Nigeria (the “FRN”) opened a depository account in its name with JPMorgan Chase Bank, N.A. (the “Bank”). The account was opened following a long-running dispute about the rights to exploit an offshore Nigerian oilfield, in which there were competing ownership claims from a company called Malabu Oil and Gas Nigeria Ltd and a subsidiary of the oil company Shell. These disputes were settled pursuant to various settlement agreements. Under the terms of settlement, Shell was required to pay US$ 1 billion into a depository account in the name of the FRN, which would then be used by the FRN to pay Malabu.

The Bank subsequently paid out the whole of the deposited sum on the instruction of authorised signatories of the FRN under the terms governing the operation of the depository account. However, the FRN asserts that these requested transfers were part of a corrupt scheme by which the FRN was defrauded, and the money transferred out of the depository account was used to pay off corrupt former and contemporary Nigerian government officials and/or their proxies and used to make other illegitimate payments.

Claim

The FRN brought a claim against the Bank to recover the sums held in the depository account on the basis that the payments were made in breach of the Quincecare duty of care, named after the case of Barclays Bank plc v Quincecare Ltd [1992] 4 All ER 363 in which this duty of care was first described.

It was alleged by the FRN that the fraudulent and corrupt scheme of which these payments were part reached the very highest levels in the Nigerian state. There was no allegation that the Bank knew about or was in any way involved in the alleged fraud, but it was said that the Bank should have realised that it could not trust the senior Nigerian officials from whom it took instructions. The FRN claimed that the Bank should not have made the payments it was instructed to make and is therefore liable to pay damages to the FRN in the same sum as the payments that were made.

The Bank applied for reverse summary judgment and/or strike out on various grounds, including that there was no Quincecare duty of care applicable on the facts because such a duty was inconsistent with, or was excluded by, the express terms of the depository agreement. The judgments considered below relate to that application.

High Court decision

The High Court held that the express terms of the depository agreement between the Bank and the FRN did not exclude, and were not inconsistent with, the imposition of the Quincecare duty. The High Court also refused the application on various further ancillary grounds which are beyond the scope of this blog post.

The High Court summarised the relevant law on the Quincecare duty before considering the interpretation of certain clauses of the depository agreement.

Scope of the Quincecare duty

The High Court noted that the Quincecare duty of care was very carefully formulated and explained in Barclays v Quincecare as a duty on a bank to refrain from executing a customer’s order if, and for so long as, the bank is “put on inquiry” in the sense that the bank has reasonable grounds for believing – assessed according to the standards of an ordinary prudent banker – that the order is an attempt to defraud the customer. In the present case, the High Court said it is an aspect of the bank’s duty of reasonable skill and care in or about executing the customer’s orders and therefore arises by reason of an implied term of the contract or under a coextensive duty of care in the tort of negligence. Although Quincecare considered the duty in the context of a current account, in the High Court’s view, there was no good reason of principle or policy why a Quincecare duty of care should be confined to current accounts and not apply to depository accounts.

In terms of the scope of the duty, the High Court held that the core of the Quincecare duty was the negative duty on a bank to refrain from making a payment (despite an instruction on behalf of its customer to do so) where it has reasonable grounds for believing that that payment is part of a scheme to defraud the customer. The High Court inclined to the view that, in addition to this core negative duty, there was a positive duty on the bank to make reasonable enquiries so as to ascertain whether or not there is substance to those reasonable grounds.

The High Court said that this would not be an “unduly onerous” duty, because it would always be limited by what an ordinary prudent banker would regard as reasonable enquiries in a situation where there are reasonable grounds for believing that the customer is being defrauded. There was no discussion of what these enquiries might be on the facts of the case or more generally, although the word “enquiry” was used interchangeably with “investigation”.

The High Court noted that it did not need to decide finally the point on whether the scope of the Quincecare duty included an additional positive duty, because of its conclusions on the interpretation of the depository agreement (below), and therefore these comments were made on an obiter basis.

Express clauses of the depository agreement

The High Court applied the now well-established principles of contractual interpretation to consider the terms of the depository agreement, finding that none of the clauses expressly excluded the Quincecare duty of care, either under the entire agreement clause or exemption clauses in the depository agreement. In particular, the High Court noted that clear words were required to exclude a valuable right such as the Quincecare duty, and there were no such clear words on the facts of this case.

The Bank also argued that certain clauses of the depository agreement were inconsistent with a Quincecare duty of care. The High Court said that it is trite common law that an implied term cannot be inconsistent with an express term, and similarly a duty of care in tort may be shaped by, and can be excluded by, contractual terms. Given that the Quincecare duty arises by way of either an implied contractual term or concurrent tortious duty, the High Court proceeded to consider whether the clauses identified by the Bank were inconsistent with the Quincecare duty (in which case it would have supported the Bank’s argument that no Quincecare duty arose).

The most important express terms which the Bank relied on as being inconsistent with the duty were clauses 7.2 and 7.4:

7.2 The Depository shall be under no duty to enquire into or investigate the validity, accuracy or content of any instruction or other communication…

7.4 The Depository need not act upon instructions which it reasonably believes to be contrary to law, regulation or market practice but is under no duty to investigate whether any instructions comply with any applicable law, regulation or market practice.

The High Court held that these clauses were consistent with (at least) the core of the Quincecare duty of care (i.e. the negative duty to refrain from making payment where it has reasonable grounds for believing that the payment is part of a scheme to defraud the customer).

It held that the correct interpretation of clauses 7.2 and 7.4 was that – apart from the opening part of clause 7.4 (which it said was plainly consistent with a Quincecare duty of care) – they did not apply at all where the Bank had reasonable grounds for believing that the customer was being defrauded. In other words, the references to there being no duty to enquire or investigate were making clear that there was no duty of care to enquire or investigate prior to the point at which the Bank had the relevant reasonable grounds for belief. It therefore found that clauses 7.2 and 7.4 were consistent with the Quincecare duty even if it imposes an additional positive duty to enquire/investigate along with the core negative duty not to pay.

Although this was an interlocutory application, the High Court heard full legal argument and decided this issue finally (and not on the basis of whether the claimant had a realistic prospect of success). It was common ground between the parties that the High Court should “grasp the nettle” and decide this point on the application rather than at trial, because the issue was concerned with questions of law as to the contractual interpretation of the depository agreement and the nature of a Quincecare duty of care.

The Bank appealed.

Court of Appeal decision

The Court of Appeal upheld the High Court’s decision. There are three particularly significant points arising from the judgment, discussed below.

1. Scope of Quincecare duty

As to the scope of the Quincecare duty, the Court of Appeal said that, in most cases, the duty will require “something more” from the bank than simply pausing and refusing to pay out on the mandate when put on enquiry that the order is an attempt to misappropriate funds. It commented that the question of what a bank should do will vary according to the particular facts of the case. In the present case, the Court of Appeal said that the trial judge will be in a better position to determine what the Bank should have done if it had decided not to execute the instructions it was given to transfer funds. It did not think it would be helpful to give an indication as to what factors are likely to be relevant to the trial judge’s overall assessment of what the Bank should have done.

In contrast to the High Court, the Court of Appeal did not find it useful to describe some parts of the Quincecare duty as being core and some parts of it as being separate of subsidiary or additional.

It is worth noting that the Court of Appeal’s comments on the scope of the Quincecare duty were obiter, because it held that this was an issue for the trial judge, and arose on an issue which both the High Court and Court of Appeal found did need to be resolved in order for to dispose of the application.

2. Exclusion of the Quincecare duty is possible

The Court of Appeal endorsed the High Court’s view that it is possible for a bank and its client to agree to exclude the Quincecare duty (subject to any statutory restrictions, such as the clause being reasonable under Unfair Contract Terms Act 1977). However, both the High Court and Court of Appeal emphasised that such an exclusion would have to be sufficiently clear (which was not the position on the facts of the present case). In the Court of Appeal’s words, the clause must make clear:

“…that the bank should be entitled to pay out on instruction of the authorised signatory even if it suspects the payment is in furtherance of a fraud which that signatory is seeking to perpetrate on its client.”

3. Whether the Quincecare duty was inconsistent with express terms of the depository agreement

The Court of Appeal found that, as a matter of contractual interpretation, clauses 7.2 and 7.4 were not inconsistent with the existence of the Quincecare duty, agreeing with the reasons given by the High Court.

The Court of Appeal therefore found that the High Court was right to dismiss the summary judgment application and refused the Bank’s appeal.

Simon Clarke

Simon Clarke
Partner
+44 20 7466 2508

Harry Edwards

Harry Edwards
Partner
+44 20 7466 2221

Chris Bushell

Chris Bushell
Partner
+44 20 7466 2187

Ceri Morgan

Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948

High Court endorses use of CPR Part 86 interpleader application by financial services firm seeking court guidance

The High Court has endorsed the use of an interpleader application pursuant to CPR Part 86 by a financial services firm seeking guidance from the court to determine the appropriate recipient of funds which are subject to potentially competing claims: Global Currency Exchange Network Ltd  v Osage 1 Ltd [2019] EWHC 1375 (Comm).

Part 86 allows (among other things) a stakeholder to apply to the court for a direction as to where it should pay a debt or money when competing claims are made (or expected to be made) by two or more persons in respect of that debt or money. In the present case, the claimant financial services firm had suspicions that one of its customers was engaged in alleged fraudulent activity using its accounts with the firm (including operating a suspected Ponzi scheme). After freezing its customer’s accounts, the firm made an application under Part 86 seeking guidance from the court as to where it should pay the frozen funds.

The judgment will provide financial institutions with some comfort that the court will assist them to determine the appropriate recipient of funds where the firm expects competing claims, including where the firm has reasonable grounds to suspect criminal conduct (even if there is ultimately no finding of fraud or other criminal conduct).

This was a particularly interesting decision in circumstances where:

  • At the time of the hearing, there was no indication of any potential competing claims being brought by the alleged victims. The court considered that such claims were still “expected”, because the firm had coherent reasons for its concerns regarding alleged fraudulent activity, and as such there were reasonable grounds to believe that – once appraised of the facts – the alleged victims would make claims in respect of the funds.
  • Another key battleground was the nature of the competing claims which could be brought. This was an unusual case in the sense that, because competing claims over the funds had not yet been made, the financial services firm was in the position of having to suggest the potential legal basis on which those claims might, in due course, rely.
  • It provides a procedural alternative to a claim for declaratory relief. Both Part 86 and a claim for declaratory relief (under Parts 7 or 8) are procedural mechanisms which may be pursued by parties seeking clarity from the court as to the legal/factual position. One of the key differences between these procedural tools is the potential costs consequences for the applicant. Part 86 expressly provides that the court may make any costs order it thinks “just”, departing from the general rule on costs (i.e. that the loser will pay the winner’s costs, subject to the court’s discretion). With no particular weight given to whether the applicant is successful, this suggests an increased flexibility on costs under Part 86 in comparison to a claim for declaratory relief (where the general rule will apply). This follows, given that the claimant under Part 86 is a stakeholder who will (almost always) be a neutral party seeking protection from liability, rather than looking to make a financial gain. Part 86 also provides that the court may summarily assess the stakeholder’s costs, if the respondent fails to appear at the hearing.

The impact of this decision is not limited to situations where a financial services provider has reasonable grounds for suspecting fraud. It may also assist financial institutions in other circumstances, for example where the authority of an institution or client is uncertain or vulnerable to future challenge. In this scenario, a bank or other financial services provider which wishes to pay money to its customer could potentially use Part 86 to limit the possibility of a claim that it has paid funds to the “wrong party” (i.e. a party which was not authorised to represent the customer). Such application could, in certain circumstances, be made by consent with the claimant as a neutral party requesting the court’s assistance and the “defendant” setting out coherently why it is entitled to the funds.

Background

The defendant (“Osage”) was a company formed in 2014 for the purpose of raising capital through the sale of non-voting shares, in order to acquire and develop the rights to drill for oil in Oklahoma. It received foreign exchange and payment services from the claimant (“GCEN”), which was an FCA-registered payment institution. Prospective shareholder investors paid funds directly into Osage’s accounts at GCEN.

In September 2015, GCEN froze all of Osage’s account facilities because of concerns they were obtained by means of fraudulent misrepresentation. The funds remained frozen for over three years, during which period there was no indication of any potential investor claim.

Part 86 Application

In March 2018, GCEN issued a Part 8 claim in the form of an interpleader application pursuant to Part 86, which allows (among other things) a stakeholder to apply to the court for a direction as to whom it should pay a debt or money where competing claims are made or expected to be made against the stakeholder in respect of that debt or money by two or more persons.

GCEN accepted that the funds did not belong to it and confirmed it would pay the funds to whichever party or parties the court may direct. It anticipated competing claims because:

  • Osage claimed the funds and previously threatened an injunction and proceedings to recover them; and
  • If investors were made aware of the details of Osage’s investment scheme, GCEN expected that they too would make claims against it for the return of the funds.

GCEN sought directions for the service of its application and evidence on various investors to allow them the opportunity to make legal claims to the funds. Osage complained that GCEN was unilaterally withholding payment of monies GCEN held on Osage’s behalf and seeking, via its Part 86 application, an indemnity to which it was not entitled.

Decision

The court held that the case fell within Part 86 and gave directions for the investors to be notified of the proceedings.

Applicability of Part 86

The court looked first at the wording of Part 86, which applies where a person is under a liability in respect of debt, and competing claims are made (or expected to be made) against that person in respect of that debt by two or more persons.

The court then approached the question of whether Part 86 was applicable by considering whether: (1) there was any legal basis for prospective investors claims; and (2) whether competing claims were expected.

Legal basis for prospective investor claims

The court found that investors might bring claims against the funds on two bases (rejecting numerous other legal bases asserted by GCEN), each of which is considered in further detail below.

  1. Investors’ right to rescind and claim the funds

On the evidence before the court, it found that investors may have a claim in fraudulent misrepresentation, and concluded that this meant the subscription agreements between the investors and Osage were voidable rather than void, following the general rule summarised in In the Matter of Crown Holdings (London) Limited (in Liquidation) [2015] EWHC 1876 (Ch).

The court rejected GCEN’s attempt to rely on an exception to this principle where the contract itself is the instrument of fraud (i.e. the purported transaction is in effect unreal, a pure instrument of fraud): see Halley v Law Society [2003] EWCA Civ 97. Under this exception, there would be no need for the investors to rescind their investment contracts because they would still own the funds in equity. The court found the evidence did not go that far, meaning that the investors did not have a proprietary claim based on fraudulent misrepresentation unless and until they rescinded their contracts with Osage.

However, the court held that because investors had the right to rescind their subscription agreements with Osage (which would give rise to proprietary claims against the funds), this meant that Osage would then hold the funds on constructive trust for the investors. In the court’s view, a claim which could be brought provided the claimant took a prior legal step (here rescission) was still a competing claim, which was sufficient to satisfy the requirement of Part 86 for expected competing claims (subject to such claims actually being ‘expected’ – see below).

  1. Quistclose trust

It was common ground that pending GCEN’s completion of money laundering checks, it received and held payments made by investors on a Quistclose trust, to hold the funds on behalf of the investor. Thereafter GCEN was to pay those funds to Osage to enable the investor to become a non-voting shareholder in Osage.

The court held that GCEN was unable to fulfil the purpose of the Quistclose trust by making payment to Osage. This would put GCEN at risk of committing a criminal offence contrary to section 327 or 328 of the Proceeds of Crime Act 2002, because it suspected that the funds represented a benefit obtained by Osage from criminal conduct (such as a fraud by false representation contrary to section 2 of the Fraud Act 2006). As a result, the court found that GCEN held the funds on resulting trust for the investors, which would provide the investors with a legal basis for a claim against the funds.

In considering this legal basis, the court made a number of interesting observations, in particular:

  • The court rejected an alternative argument put forward by GCEN as to why it was unable to fulfil the Quistclose trust. This was on the basis that paying the funds to Osage would breach GCEN’s Quincecare duty of care, which provides that “a banker must refrain from executing an order if and for as long as the banker is ‘put on inquiry’ in the sense that he has reasonable grounds (although not necessarily proof) for believing that the order is an attempt to misappropriate the funds of the company”. Although the Quincecare duty derives from a case of the same name, the only case in which the duty has been found to be owed and breached is in Singularis Holdings (in liquidation) v Daiwa Capital Markets Europe [2018] EWCA Civ 84 (see our banking litigation blog post).
  • The court did not consider Quincecare and Singularis to provide an apt analogy for the present case. It noted that those cases related to a duty to decline to make payments to a third party where any reasonable financial institution would believe the customer was being defrauded. In the present case Osage, not the investors, was GCEN’s customer, and the payment Osage sought was from GCEN to Osage rather than to a third party.
  • Another reason given by GCEN for its inability to fulfil the Quistclose trust was the fact that this could give rise to other civil liability claims by investors against GCEN. In this context, the court commented that it seemed possible that a party which holds funds after receiving notice of grounds for rescission (such as fraudulent misrepresentation) could be bound by the equity which the victim has pending rescission. This would make the party holding funds liable to the holder of the right to rescind if it paid the money away notwithstanding the notice it had been given (even though the equity does not give the victim a proprietary interest in the funds).
  • As an overarching point, the court expressed surprise at the proposition (by Osage) that a person holding funds which it has reason to believe may have been obtained by fraudulent misrepresentation, could escape civil liability by paying them over to the suspected fraudster before the victim of the fraud learned the facts and rescinded the transaction.
  1. Other legal bases

As noted above, the court rejected the other legal bases suggested by GCEN for prospective investors claims. In particular, it is noteworthy that GCEN’s argument that it was the investors’ agent and owed fiduciary duties to them directly (on the basis of receiving investor funds) did not succeed.

Whether competing claims were expected

The court noted that CPR 86.1(1)(b) uses the phrase “claims are made or expected to be made” and not, for example, “claims are made or threatened”. As a matter of ordinary language, the court noted that it is possible for a claim to be “expected” even if it has not yet been asserted.

The court considered that there were reasonable grounds to believe that once appraised of the facts, investors would make claims in respect of the funds, and held that the case therefore fell within Part 86. The court noted that GCEN would be entitled to seek the court’s assistance in any event, for example by suing for a declaration (which would be the only option if none of the investors were to come forward and assert a claim).

Accordingly, the court held that the case fell within Part 86 and gave directions for the investors to be notified of the proceedings.

Simon Clarke

Simon Clarke
Partner
+44 20 7466 2508

Ceri Morgan

Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948

Mark Tanner

Mark Tanner
Senior Associate
+44 20 7466 2412

Court of Appeal rejects bank’s attempt to defeat ‘Quincecare’ claim with illegality defence

In Singularis Holdings Ltd v Daiwa Capital Markets Europe Ltd [2018] EWCA Civ 84, the Court of Appeal found that the defence of illegality was not available to a bank to defeat a claim against it by a corporate customer.

An illegality defence will operate in an appropriate case to prevent a claimant from pursuing a civil claim if the claim arises in connection with some illegal act on the part of the claimant. In this case, the bank had paid away large sums at the instigation of one of the claimant company’s directors, and its sole shareholder. The Court of Appeal found that the illegality defence was not available because the acts of the director/shareholder could not be attributed to the company.

The Court of Appeal’s judgment provides some helpful clarification of the principles applicable to attribution in the context of an illegality defence, emphasising that the leading authority is now Bilta (UK) Ltd (In Liquidation) v Nazir [2015] UKSC 23 and not Stone & Rolls Ltd v Moore Stephens (a firm) [2009] 1 AC 1391 (which should, as per Bilta, be put “on one side in a pile and marked ‘not to be looked at again’…”). Applying Bilta, the following points should be noted where a bank intends to raise the illegality defence against a claim by a corporate customer:

  • The circumstances in which the illegal acts of a director/shareholder will be attributable to a company are fact-sensitive and will always require detailed consideration of the factual context, the nature of the claim being made and the purpose for which attribution is sought.
  • Operation of the illegality defence is likely to require a finding of fact that there were no innocent directors or shareholders of the company.
  • A bank will therefore need to put into evidence the role of any directors or shareholders of the claimant company not directly implicated in the fraud.

The effect of the Court of Appeal’s judgment is that Singularis’ successful claim has been upheld, and remains the first and only case in which a bank has been found liable for breach of its ‘Quincecare’ duty (to refrain from executing an order to make a payment where the bank is ‘put on inquiry’ that the order is an attempt to misappropriate funds). The High Court judgment noted that this was an unusual case because many of the factors previously put forward as to why it would be impractical to impose the duty on banks did not apply: the bank was not “administrating hundreds of bank accounts with thousands of payment instructions every week”. However, financial institutions handling client payments should be aware of the potential risk of the Quincecare duty being imposed and review the safeguards in place to recognise and report factors which may indicate such fraudulent activity.

Background

The claimant, Singularis Holdings Limited (“Singularis”), was incorporated in the Cayman Islands in 2006 for the purpose of managing the personal assets of Mr Al Sanea (the owner of the Saad group, a Saudi Arabian conglomerate), although Singularis was not part of the Saad group. While Mr Al Sanea exercised the dominant influence over Singularis’ affairs, the Singularis board was comprised of several other directors, including a former judge, several former bankers and certain family members of Mr Al Sanea. From 2007, Daiwa Capital Markets Europe Limited (the “Bank”) had provided Singularis with loan financing to enable it to buy shares. Although Singularis had accumulated an equity portfolio valued at more than US$10bn by April 2008, a year later the company encountered serious financial difficulties. The Bank was able to unwind its positions with Singularis amicably. By June 2009, all outstanding sums had been repaid to the Bank. A little over US$200m remained in Singularis’ account with the Bank.

During the course of June and July 2009, Mr Al Sanea instigated the transfer by the bank of large sums to his other business interests. The Bank approved and completed these transfers, despite its Head of Compliance Division having reminded other employees of the Bank to exercise care and caution in connection with any activity on Singularis’ accounts in light of its “well publicised problems”. By this time, the credit rating agencies Moody’s and Standard & Poor’s had cut their ratings on the Saad group to junk and D (default) respectively, before withdrawing them completely due to lack of information. It was common ground at trial that Mr Al Sanea was acting fraudulently when he instigated the transfers and at trial the judge found that Mr Al Sanea must have known that Singularis was on the verge of insolvency at the time the payments were made. In August 2009, Singularis went into liquidation. In July 2014, Singularis (acting by its joint official liquidators) issued a claim against the Bank for US$204m, the total of the sums transferred in June and July 2009.

High Court decision

Singularis put its claim on two alternative bases: (i) that Daiwa dishonestly assisted Mr Al Sanea’s breach of fiduciary duty in removing the money from Singularis for the benefit of himself or other Saad group companies, to the detriment of the company’s creditors; and (ii) that Daiwa breached the duty of care it owed to Singularis, by authorising the payments having negligently failed to realise that Mr Al Sanea was committing a fraud on the company and misappropriating its money.

The High Court held that the first claim of dishonest assistance failed. In relation to the second basis of Singularis’ claim (to which the instant appeal related), the High Court held that the Bank did owe a duty of care to Singularis in respect of the money in its client account (referred to as the ‘Quincecare’ duty, articulated in Barclays Bank plc v. Quincecare Ltd [1992] 4 All ER 363, although no breach of duty was found on the facts of that case). The High Court held that the Bank acted in breach of its Quincecare duty by making the payments in question without proper inquiry, finding that any reasonable banker would have noticed the signs that Mr Al Sanea was perpetrating a fraud on Singularis and that there was a failure at every level within the Bank.

The Bank advanced an illegality defence relying on the legal doctrine of ex turpi causa, which prevents a claimant from pursuing a civil claim if the claim arises in connection with some illegal act on the part of the claimant. In this instance, the claim against the Bank for breach of duty was brought by Singularis, but the illegal acts were carried out by Mr Al Sanea. The focus of the argument before the High Court on the illegality defence was therefore whether Mr Al Sanea’s dishonest conduct should be attributed to Singularis. However, this (and the Bank’s other defences) were rejected (for reasons set out more fully below). The court reduced the damages payable by 25% to account for Singularis’ contributory negligence.

The Bank appealed. The grounds of appeal did not include an appeal against the finding of the Quincecare duty of care, or breach of that duty. The grounds related to the illegality defence and other defences, or alternatively (if remaining unsuccessful on those defences), the amount by which Singularis’ damages should be reduced for contributory negligence.

Court of Appeal decision

The Court of Appeal upheld the High Court’s finding that Mr Al Sanea’s fraudulent actions could not be attributed to Singularis. As such, the illegality defence was not available to defeat Singularis’ claims for breach of the Quincecare duty.

The Court of Appeal divided the Bank’s appeal into six issues: (1) attribution of knowledge and conduct; (2) illegality defence principles; (3) causation; (4) counterclaim in deceit; (5) application of Quincecare duty in relation to creditors; and (6) contributory negligence. This e-bulletin will focus on the first issue, which was the central ground considered in the appeal.

1. Attribution of knowledge and conduct

One of the elements of the High Court’s decision in finding that Mr Al Sanea’s fraudulent action should not be attributed to Singularis, was that Singularis was not a ‘one-man company’ in the sense used in Stone & Rolls and Bilta. The Bank submitted that the High Court had been wrong in law to hold that Singularis was not a ‘one-man company’ for the purposes of attribution, arguing that the proper construction of the test in those cases was that where the only directors of a company not involved in a fraud were supine, that company was properly to be regarded as a ‘one-man company’.

The Court of Appeal, however, agreed with Singularis that the touchstone was not whether the other directors were merely supine, but whether they were complicit in the fraud. Since the first instance judge had declined to make any finding of fact that the other directors were complicit in the fraud, Singularis could not be said to be a ‘one-man company’, and thus the Bank had not discharged its burden of proof.

The Court of Appeal held that the leading authority on what is meant by a ‘one man company’ was now Bilta, and that earlier cases (particularly Stone & Rolls) needed to be treated with caution. The Court of Appeal found the correct formulation of the ‘one-man company’ test was the one agreed by the majority in Bilta, namely “a company in which, whether there was one or more than one controller, there were no innocent directors or shareholders”. Given the lack of any finding of fact that any of the other directors had been complicit in the misappropriation of the money, applying the test in Bilta, the High Court had therefore not made any error of law.

The Court of Appeal went on to say that (per paragraph 26 of Lord Neuberger’s judgment in Bilta), even where there are no innocent directors or shareholders, the illegality defence will only be available on some occasions. In other words, the outcome will always depend on context. In the context of the current case (and unlike Stone & Rolls), Singularis was not a company created purely to perpetrate a fraud; it had had a large and genuine business carried out over a number of years prior to the relevant events. Further, it was right to consider the nature of the claim and the relationship between the parties, which was the approach taken by the High Court in the following passage (with which the Court of Appeal agreed):

“…it would not be right to [attribute Mr Al Sanea’s knowledge to Singularis] because such an attribution would denude the duty [owed by the Bank] of any value in cases where it is most needed…the existence of the [Quincecare] duty is…predicated on the assumption that the person whose fraud is suspected is a trusted employee or officer. So the duty when it arises is a duty to save the company from the fraudulent conduct of that trusted person.”

Accordingly, the High Court would have been wrong to attribute Mr Al Sanea’s conduct and knowledge to Singularis in the instant circumstances and for the purposes of the illegality defence.

The Court of Appeal commented that – although it was bound by the authorities mentioned above – it did not find the concept of a ‘one-man company’ particularly helpful or illuminating in the context of considering attribution. It said the circumstances in which attribution will be appropriate were fact-specific and evaluation of the facts was not much assisted by trying first to decide whether the company in question fitted within the parameters of various competing definitions of the term ‘one-man company’. In this regard, the reality of the appeal on this ground was a challenge of the High Court’s view of the factual context; those factual findings were open to the High Court and were not formally challenged. There was no error of law.

2. Other issues considered on appeal

None of the remaining issues strictly fell to be considered in the appeal because of the failure of the attribution argument. However, the Court of Appeal dealt briefly with the remaining issues since they were argued before the court. The Court of Appeal agreed with the findings of the High Court and thus these grounds of appeal failed in any event.

Damien Byrne Hill

Damien Byrne Hill
Partner
+44 20 7466 2114

 

Ceri Morgan

Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948

Benjamin Coleman

Benjamin Coleman
Senior Associate
+44 20 7466 2463