Honest governor

Increasingly the courts are faced with issues of dishonesty by professionals and with this trend comes a hike in use of the illegality defence. James Roberts and Chris Dunlop examine its evolution in recent case law

Following the economic downturn claims against professionals increasingly involve dishonesty. This raises the prospect of ­professionals and their insurers seeking to rely upon the public policy defence of ex turpi causa, aka the illegality defence, which potentially bars those engaged in ­criminal activity from recovering in respect of loss arising from that activity. It extends beyond criminal acts to activities involving questionable moral conduct or ’moral ­turpitude’. Recent case law questions what test is to be applied in considering such conduct, particularly where the claimant is liable for strict liability offences or negligence.

In Griffin v UHY Hacker Young & Partners (2010), the sole director of a company was convicted of a strict liability ’phoenix company’ offence under the Insolvency Act 1986. He alleged that his accountants had failed to advise him adequately. The accountants, who denied liability, also sought to rely on the illegality defence.

The High Court refused to strike out the claim on this basis, describing this as a developing area of law. The claimant might negate the illegality defence by showing that he had committed the offence ­’innocently’. Conversely, his conduct might be shown to demonstrate the requisite degree of moral turpitude. Thus the facts of the case demanded a full trial.

So what is the threshold of blameworthiness required for the defence to apply? Is a claimant’s negligent conduct enough to bar a claim on illegality grounds?

Moral stance

In Safeway Stores & Ors v Twigger & Ors (2010), Safeway agreed to a fine for alleged price-fixing contrary to the Competition Act 1998. This is a regulatory sanction, not a criminal offence.

afeway’s civil claim against certain directors alleged that they were responsible for the price-fixing, and so it sought to recover the fine and legal costs, which were most likely recoverable from directors’ and officers’ (D&O) insurers. The directors raised the illegality defence.

The Court of Appeal granted summary judgment for the defendants, ruling that it was sufficient that the company intentionally or negligently infringed the act. Whether the defendants were the directing mind and will of Safeway was irrelevant.

In particular, the court seemed influenced by the fact that the policy of the statute would be undermined if undertakings were able to pass on liability to their employees or D&O insurers. The court considered that contraventions of the act, while not criminal, were sufficiently serious. Thus the illegality defence may apply in cases of non-criminal regulatory fines or penalties for conduct short of intentional wrongdoing.

Bad company?

So how are a company’s actions to be judged? Companies, while legal entities, obviously require human agents to carry out actions. In Moore Stephens v Stone Rolls (2009), the claimant company, controlled and beneficially owned by a single individual, was engaged in credit fraud. Upon liquidation, the liquidators alleged that the auditors ­negligently failed to spot the fraud.

The auditors sought to strike out the claim, arguing the loss claimed arose from the company’s own fraudulent activity. By majority, the House of Lords held that the fraudulent conduct was to be treated as the company’s conduct and the illegality defence therefore applied. In effect, the company as an entity was considered dishonest.

The above case law, Safeway in particular, brought some degree of certainty, suggesting that in cases of intentional or negligent ­conduct the illegality defence is likely to apply. The position, however, remains unclear for cases of strict liability for which the claimant may not be at fault at all (in a moral sense). One might conclude therefore that for the illegality defence to apply there must be a sufficient element of moral turpitude, but does this require dishonesty?

Apparently not. In the patent infringement case of Les Laboratoires Servier & Anor v Apotex Inc & Ors (29 March), the court rejected the suggestion that the defence only applied where the act involved dishonesty. The court stated that the degree of seriousness required would depend on the circumstances of the case, with the key factor in most cases likely to be the claimant’s state of knowledge at the time of the act.

So where does this leave us? A quasi-criminal act committed intentionally or negligently is (probably) sufficiently ­serious to engage the defence. But the question remains whether the defence may be engaged by acts not involving moral ­turpitude, and in particular offences of strict liability. Equally, it does not appear that dishonesty is required, although this may be a relevant factor. Thus the degree of ­unlawfulness or sufficiently serious conduct required to engage the rule will depend upon the circumstances of the case.

This uncertainty has implications both for professional defendants wishing to rely upon the defence and for their insurers. Given the increase in such claims, this is no doubt an area that will be the subject of further judicial comment.

James Roberts is a partner and Chris Dunlop an associate at Barlow Lyde & Gilbert