Three for the price of one: good news for auditors of smaller companies, bad news for the bankrolling of litigation and the end of the House of Lords as a judicial body.
AUGUST 2009
The recent decision of the House of Lords in the case of Stone & Rolls Limited (in liquidation) v. Moore Stephens is the sort of case that finds favour with law students, providing them with material to answer several different questions, whilst only requiring the effort of memorising one decision.
Good news for auditors of smaller companies
The outline of the case was that:
- Stone & Rolls Limited’s sole director and shareholder committed a major fraud against a bank in the name of the company;
- The bank sued the company, forcing it into liquidation;
- The liquidators, acting on behalf of the company, sued the company’s auditors, Moore Stephens, alleging that they had been negligent in not detecting the fraud, and claimed damages approaching £90 million.
The House of Lords, by a majority decision, upheld the decision of the Court of Appeal that the claim fell foul of the legal principle that one cannot obtain compensation for damage caused by one’s own wrongdoing (“ex turpi causa”, to give it its Latin name). The basis for this decision was that:
- The fraudulent conduct of the director and shareholder was to be treated as that of his company. The company, through its liquidators, was therefore seeking damages for loss caused by its own fraud;
- Auditors’ duties to take reasonable care in auditing accounts are owed to a company in the interests of its shareholders, but not to the company’s creditors. In this case, aside from the company itself, the only person for whose benefit such duties could therefore be owed was the sole director and shareholder, who had himself carried out the fraud.
The decision is of comfort to auditors (and the insurers of auditors) of smaller companies, which are often corporate vehicles for owner managers. However, it is likely to have less impact in the case of larger companies, where the separation between the corporate entity, its directors and its shareholders is one of substance, rather than legal form. Where, for instance, a fraud has been perpetrated by one of several directors and/or where there are shareholders who are not directors, an auditor which has carelessly failed to identify a fraud is perhaps unlikely to find that the grounds for the Stone & Rolls decision offer it a route to escape liability.
Third party funding of litigation
The claimant liquidators in the Stone & Rolls case are reported to have been funded by a company which specialises in providing funding for litigation, in return for a share of the damages if a case succeeds. This is sometimes referred to as “third party litigation funding”. The business model usually works as follows:
- The third party funder (“funder”) agrees to pay the claimant’s legal costs of pursuing the litigation and any costs orders made against the claimant;
- The funder will usually wish the claimant’s lawyers to share risk by agreeing to a partial conditional fee agreement (under which the lawyers will be paid, say, 60% of their usual fees whatever the outcome and the other 40%, plus an uplift, in the event of the claim succeeding);
- The funder may decide to take out insurance against the risk of losing and having to pay the defendant’s legal costs;
- The claimant agrees to cede to the funder an agreed proportion of any damages recovered;
- The funder will only invest in cases in which:
- The perceived chance of success is at least 70%;
- The defendant(s) is/are “good for the money”;
- The likely damages will be large enough to make the investment an attractive one, especially having regard to the legal costs likely to be incurred.
The business model was first developed to enable liquidators to pursue strong claims which otherwise could not have been pursued, for want of funds. It has since been extended to the funding of claims generally, where claimants either do not have the funds to pursue causes of action (giving rise to the sometimes justified assertion that third party litigation funding gives access to justice) or simply wish to reduce or exclude risk in return for giving up part of any compensation recovered (a purely commercial motivation).
The third party litigation funding market is still at an early stage of development and this case is said to have been one of the largest so far to have been pursued in the UK. Its failure and the resulting large burden of legal costs that has therefore fallen on the funder has led to suggestions that it has dealt a body blow to the funding market. Such speculation is probably misplaced, but the outcome will no doubt cause funders to be even more cautious about which horses to back, the amount of the wager and arrangements for laying off risk.
The future development of third party litigation funding is also likely to depend to a significant extent on the outcome of Lord Justice Jackson’s review of litigation costs, which is expected to be the subject of a final report and recommendations before the end of this year.
So. Farewell then the Appellate Committee of the House of Lords…
The decision in Stone & Rolls was delivered at the end of July, on the last day of the House of Lords’ existence as a judicial body. From the beginning of October 2009, the new Supreme Court of the United Kingdom will assume jurisdiction as the highest appeal court in the UK, hearing all eligible final stage appeals in the UK except for Scottish criminal cases.
If you would like any other information about the issues raised in this article please contact Jonathan Haydn-Williams on 020-7421-7936 or jhw@gdlaw.co.uk.
This guide is for general use and interest only and should not be relied upon as providing specific advice.
|
