Moore Stephens (a firm) v Stone Rolls Limited (in liquidation)

The House of Lords considered whether the public policy illegality defence, commonly expressed as ex turpi causa non oritur actio, barred a company in liquidation (Stone & Rolls Ltd) from recovering loss from its auditors (Moore Stephens) where the company's directing mind and sole beneficial owner had used the company as a vehicle for a large-scale fraud. The court reaffirmed that ex turpi causa prevents a claimant obtaining relief for the consequences of its own illegal conduct but emphasised that the application of the defence depends on attribution, the scope of the defendant's duty (notably the auditors' duties under the Companies Act and auditing standards) and the context (including insolvency).

The majority held that on the facts of this case the fraud of Mr Stojevic was properly attributable to S&R and that S&R therefore sought to recover for the consequences of its own illegality; accordingly ex turpi causa provided a complete defence. The decision was influenced by (i) the identification of Mr Stojevic as the company's directing mind and sole effective beneficiary, (ii) the limited scope of auditors' duties established in Caparo v Dickman and related authorities, and (iii) the danger of permitting recovery that would operate to the benefit of those responsible for the wrongdoing.

The appellant company, Stone & Rolls Ltd (S&R), controlled and in effect operated by Mr Stojevic, was used as the vehicle for a large fraud perpetrated against banks by presenting false documents under letters of credit. Komercni Banka obtained a judgment in deceit against S&R and Mr Stojevic for over US$94m and S&R went into liquidation. The liquidators sued S&R's auditors, Moore Stephens, alleging that negligent audits prolonged the fraud and caused further loss to the company. Moore Stephens accepted for the purposes of the strike-out application that they owed S&R a duty of reasonable care and that, if proved, their breach had caused further loss, but pleaded the defence of ex turpi causa.

The procedural history was: judgment at first instance by Langley J, a Court of Appeal appeal allowing Moore Stephens' strike-out application ([2008] EWCA Civ 644) and an appeal to the House of Lords ([2009] UKHL 39).

The central issues before the House were:

• whether the company's claim was barred by ex turpi causa because it relied on, or sought compensation for, the consequences of its own illegality;
• whether the fraudulent conduct of Mr Stojevic was to be attributed to S&R for this purpose, having regard to the Hampshire Land principle and the rules of attribution in Meridian;
• whether the principle that a claimant cannot recover for "the very thing" the defendant was under a duty to prevent (eg Reeves) meant the defence could not apply where the defendant's duty was to prevent the claimant's illegality; and
• whether the auditors' duty extended to protecting creditors and whether insolvency altered the analysis.

The House was divided. The majority concluded that attribution principles and the fact that Mr Stojevic was the company's directing mind and sole effective beneficiary meant that S&R's losses claimed were the consequences of its own fraud and were therefore barred by ex turpi causa. The majority also relied on the limited scope of auditors' duties recognised in Caparo and related cases and on policy considerations about opening auditors to indeterminate liability to defrauded third parties through a company's claim. Two members of the committee (Lord Mance and Lord Scott) would have allowed the claim to proceed (at least to trial) on the basis that auditors owe duties to the company which can, in insolvent cases, be for the benefit of creditors and that where auditors negligently fail to detect the very fraud they ought to have detected the company should be able to recover for the continuation of that fraud.

The House therefore decided the preliminary issue in favour of Moore Stephens: on the facts of this case ex turpi causa bars the company's claim and the striking-out of the claim was justified.

Appeal dismissed. The House held by a majority that ex turpi causa prevents a company from recovering compensation for losses which are the immediate consequence of its own fraud where the fraud of the directing mind was properly attributable to the company. On the facts S&R was a "one-man" company effectively controlled and beneficially owned by the fraudster Mr Stojevic; the auditors' duty did not extend so as to permit the company to recover for losses that were the product of its own illegality, so ex turpi causa provided a defence.

First instance: Langley J, Commercial Court (striking-out application) [2007] EWHC 1826 (Comm). Court of Appeal allowed Moore Stephens' appeal and struck out the claim: [2008] EWCA Civ 644. House of Lords (Appellate Committee) dismissed the appeal: [2009] UKHL 39.