Stone & Rolls Ltd v Moore Stephens (a firm)

The illegality defence requires a reliance test. A claim is barred where it is founded on, arises from, or necessarily depends upon the claimant’s illegal conduct. The defence may defeat only part of a claim or loss. In the case of a company, the wrongdoing and knowledge of its controlling mind may be attributed to the company, subject to the rule that knowledge of fraud committed against the company is not attributed to it. A company used as the vehicle and perpetrator of a fraud cannot ordinarily be treated as its victim. However, a negligent auditor’s failure to detect fraud does not automatically bar the company’s claim where the auditor’s duty, properly understood, would have revealed and ended the fraud. Compound interest requires a properly pleaded and proved basis showing that the loss was within the auditor’s reasonable contemplation.

Stone & Rolls Ltd, later in liquidation, claimed approximately USD 173.6 million from its former auditors, Moore Stephens, alleging negligent audits and a failure to detect or report a letter of credit fraud controlled by Mr Stojevic. The fraud involved obtaining funds from banks through false documents and paying those funds to associated entities. The defendants applied to strike out the claim or obtain summary judgment, relying principally on ex turpi causa non oritur actio. They also challenged a claim for approximately USD 81 million in compound interest.

The central issues were whether Mr Stojevic’s fraud and knowledge were attributable to the company, whether the company was a victim or perpetrator of the fraud, whether the auditor’s duty to detect and report the fraud engaged the “very thing” reasoning, and whether the compound-interest claim disclosed a sustainable cause of action.

1. Illegality. The court adopted a reliance test. The maxim applies where the claim is founded on or arises from the claimant’s illegal act, where the illegality must be pleaded or relied upon to sustain the claim, or where the facts giving rise to the claim are inextricably linked with the illegality. Illegality that is merely collateral, insignificant or incidental does not necessarily bar recovery. The rule may affect only part of a claim or loss.
2. Corporate attribution. A company may be fixed with the knowledge and wrongdoing of its directing mind and will. The relevant question under the “Belmont rule” is whether the company was the victim or perpetrator of the wrongdoing. In this case Mr Stojevic was plainly the directing mind and will of Stone & Rolls. The company was used as a vehicle for the fraud, obtained no money to which it was entitled, and was not properly characterised even as a secondary victim.
3. Auditor’s duty. The court accepted that an auditor’s duty of care included detecting and reporting fraud, although it was not a duty expressed as a duty to prevent fraud. The “very thing” reasoning in Reeves should not be confined to a duty expressly framed as a duty to prevent the precise event. It could apply where proper performance of the auditor’s duty would have revealed and brought the fraud to an end. The claim was therefore not barred at the strike-out or summary-judgment stage.
4. Application. Although the claim would have been barred if pursued by Mr Stojevic personally, the court considered that preventing any recovery benefiting him, including through the company, sufficiently addressed the policy underlying the maxim. The applications to strike out or dismiss the entire claim were refused.
5. Compound interest. The claim was hopeless. It assumed that fraudulently obtained funds would have been legitimately used to repay debts or earn interest, whereas the pleaded and evidenced scheme involved paying the funds away. There was also no sufficient allegation or evidence that the defendants had knowledge making the claimed loss foreseeable. Paragraph 398 of the Particulars of Claim and Schedule 3 were struck out.