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The illegality defence: an update

In the first of our monthly guest posts written by the members of 11 Stone Buildings, Peter Head looks at the decision in Jetivia v Bilta, which considered the application of the illegality defence.

Introduction

The scope of the illegality defence remains one of the most vexed issues of English law. The Supreme Court has now handed down its much-anticipated decision in Jetivia v Bilta. For practitioners, the decision is helpful in clarifying that the illegality defence will not be available to a director in a claim by the company against him arising out of the director’s own wrongdoing, even if the director was the sole director and shareholder of the company.

The facts in Jetivia v Bilta

The claim in Bilta was brought by the company, through its liquidators, against the company’s former directors and certain third parties in relation to an alleged VAT fraud. The effect of the alleged fraud was to impose an obligation on the company to pay output VAT to HMRC in circumstances where the company was inevitably, as a result of the alleged fraud, insolvent and unable to pay VAT. The company sought to claim for the loss to which it had been exposed against the company’s former directors and certain third parties allegedly involved in the fraud. They, in turn, sought to defend on the basis that their alleged illegality was to be attributed to the company, defeating the claim. The defence failed at first instance, the Court of Appeal, and in the Supreme Court.

What Bilta decides

It is important to appreciate the limited scope of the decision in Bilta. It was not a case in which it was necessary to grapple with each element of the illegality defence. That was because there was no debate as to whether the alleged acts on which the claim was based were sufficiently criminal or dishonest so as to engage the illegality defence. They clearly were. Nor was there any debate about whether there was a sufficient connection between the illegal acts and the claim. The claim was obviously based on the VAT fraud.

The sole issue on the appeal was whether the illegal acts should be attributed to the principal, thereby defeating the claim. On this issue, all seven members of the Supreme Court agreed that the wrongdoing of the directors and third parties could not be attributed to the company. However, they differed in their reasons for reaching this decision. Lord Sumption considered that, prima facie, the directors’ wrongdoing would be attributed to the company, but subject to a ‘breach of duty’ exception where the agent was practising a fraud on the company.

Lords Mance, Toulson and Hodge thought it was not a question of prima facie attribution plus an exception, but whether to attribute in the first place. In their view, the answer to the question depended on the context in which it arose. As between a company and a defrauded third party, the company should indeed be treated as the perpetrator of the fraud. However, in the different context of a claim between the company and the directors, the defaulting directors should not be able to rely on their own breach of duty to defeat the claim.

As Lord Neuberger observed, these approaches are effectively the same in their effect.

What Bilta does not decide

Bilta does not tell us whether the correct overall approach to the illegality defence is the rule of law/reliance test (Tinsley v Milligan) or a more flexible policy-based approach alluded to by the Supreme Court in Hounga v Allen. Nor does it answer what the correct approach should be where a third party auditor is sued for failing to detect the fraud of the company carried out by its sole shareholder and director, i.e. the facts of Moore Stephens v Stone & Rolls. However, Moore Stephens should now be treated with considerable caution. Lord Neuberger said that the time had come for the decision to be put on one side and marked “not to be looked at again”. That may come as some relief to practitioners who had been left to grapple with a decision in which each of the five Law Lords reached different conclusions on how the illegality defence should be applied.

Nor does Bilta decide the correctness of Safeway Foodstores v Twigger. In that case, the illegality defence had succeeded in circumstances where the defendants had procured the company to carry out an infringement of competition law. The Court of Appeal relied on the fact that the statutory scheme that had been infringed had the peculiarity that it was not capable of being committed by the individuals directly responsible. Lords Hodge and Toulson in Bilta appear to have been sceptical as to whether this was a proper basis for the decision. However, the answer will have to await another day.

What next?

It is to be hoped that the Supreme Court will take the opportunity to carry out a root and branch review of the illegality defence sooner rather than later. In the meantime, the courts are continuing to have to grapple, in very different cases, with the nature of the wrongdoing required to engage the defence.

Tesco Stores v Mastercard was another competition case. It was held that it was more than merely arguable that it had to be shown that the claimant had acted negligently or intentionally in carrying out the illegal act before the illegality defence could apply. However, this was merely a strike-out application, and not a final determination.

McCracken v Smith was a personal injury case involving dangerous driving. It was clear that the illegality defence applied, as the claimant was a joint participant in a criminal act. However, the court observed that difficult questions may arise in the future as to the degree of blameworthiness needed for the doctrine to apply. This, and other issues, will need to be clarified by the Supreme Court in due course.

11 Stone Buildings Peter Head (draft)

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