Alternative defendants in fraud claims

The identification of parties other than the fraudster who may be liable in damages following a
fraud.

The legal tools available to victims of fraud are becoming ever more sophisticated and effective, and
with increasingly tight money laundering regulations and rules regulating the proceeds of crime
around the world, fraudsters are undoubtedly finding it more difficult to hold on to their ill-gotten
gains. However, no matter how effective these measures are, it is often not worth the time and
effort pursuing a cause of action against a fraudster who may have absconded or dissipated has no
apparentthe assets. Fortunately for the victim, liability does not always end with the primarymain
perpetrators. Even if it is not possible to claim against the fraudster, it may be possible to claim
against certain other actorsparties, many of whom may not even have been implicated in the fraud
itself. This article examines some of these alternative defendants.

Professional advisers

In many cases of fraud, the fraudulent designs of the perpetrator are carried out despite the victim
benefiting from the expert advice of a team of professional advisers. In some of those cases, the
fraudster may have covered his tracks so well that it would have been difficult for anyone to identify
and prevent before it is too late, in which case the advisers may not be to blame. In other cases, the
warning signs may have been more clear, and it may be that the victim’s professional advisers had
failed in their duty by not noticing the obvious and bringing it to their client’s attention. In these
cases, accountants, lawyers, investment managers and other professionals may find that they are
liable in damages for professional negligence. The benefit to the victim of pursuing a claim against
those who provided professional advice is that such professionals are usually covered under a
compulsory insurance policy, meaning that their claim, if successful, is more likely to be satisfied.

Sasea Finance Ltd v. KPMG (a firm) [2000] 1 All ER 676 is a good illustration of the potential appeal of
looking to your professional advisers for compensation. The claimant was one of a group of
companies that had gone into liquidation. During the liquidation it became apparent that the
claimant had been the victim of four fraudulent transactions perpetrated by one of its directors. The
defendant, who had prepared the company’s accounts prior to it going into liquidation, failed to
notice the fraud in circumstances that the claimant alleged showed that it had carried out its work
negligently. The claimant argued that had the defendant not been negligent, it would have noticed
the fraud, and would have immediately come under a duty to notify the company’s management, in
which case the fraudulent transactions, and therefore the misappropriations, might have been
avoided.
The Court of Appeal held that the duty of the auditors was to “exercise an appropriate level of skill
and care to produce fair and accurate accounts within a reasonable time.” It also decided that in
certain circumstances, a different type of obligation can arise, such as a duty to inform the board or
other suitable employees of the company as when they discover that a senior employee of the
company has been defrauding it on a grand scale and is in a position to continue to do so.

As to when such athe duty to “whistle-blow” arisesose, it was held in Sasea Finance that the auditors
should notify either the directors or a relevant third party of any irregularity with a “reasonable
degree of promptitude” rather than waiting until they were to sign off on the accounts, in which case
it might be too late to prevent further losses.

Executives

Where a transaction has been entered into by Company A, and it later becomes apparent that entry
into the transaction was procured by fraud on the part of Company B, Company A has a claim
against Company B and can recover the amount that it has lost. However, where Company B no
longer has, or never did have, sufficient assets to cover the claim, who does the victim look to for
compensation? It may be possible that the director of Company B is personally liable for the actions
of Company A, so that the victim may pursue a claim against him. This was the case in Contex
Drouzhba v. Wiseman and Lucci Del Marco Ltd [2006] EWHC 2708 (QB). The first defendant had made
representations about the credit worthiness of the second defendant, a company of which the first
defendant was a director, which induced the claimant to enter into a credit agreement with the
second defendant, on which it promptly defaulted. The second defendant was liable under the
contract, but would not have been able to satisfy any claim, so the claimants pursued the first
defendant as well. It was held that where an individual may be liable for carrying out acts which go
beyond director goes beyond his the individual’s constitutional role in the governance of thea
company, there was no reason why he may not be held personally liable as a joint tortfeasor. The
mere fact that the individual is a director or a shareholder and so could have procured those same
acts through the exercise of constitutional control of the company does not mean that he should
escape liability.he may be held personally liable. So, for example, a director voting in a board
meeting is unlikely to be held personally liable for the subsequent acts of the company, w hereas a
director who exercises control other than through the constitutional organs of the company may be
held responsible. So, in this example, the first defendant had made the representations both on his
own behalf (so outside of his constitutional role as a director of the company) and on behalf of the
company. No other analysis was possible on the facts because if the first defendant had made the
representations but not the company, they would not have been relied upon. The judge held that
the fact that he could have made the representations solely on behalf of the company by, for
example, procuring the company to resolve to make the representations, did not mean that personal
liability should be excluded.

Another aspect of this case worthy of note is that an attempt to rely on a technical defence in s. 6 of
the Statute of Frauds Amendment Act 1828 (also known as Lord Tenterden’s Act) was rejected. This
legislation provided that no action could be brought against a person who has made representations
about the character, conduct, credit, ability, trade or dealings of any other person with the intention
of obtaining credit, money or goods unless such representation was made in writing and signed by
the party making such representations. The judge had two reactions to this. First of all he held that
the act did not apply because the first defendant had made the representations about the company
which was a joint tortfeasor and did not, therefore, satisfy the requirement that the representations
be made about “any other person”. Secondly, even if this was incorrect, the first defendant had
signed the credit agreement and many other key documents representing the credit-worthiness of
the company, and these documents were sufficient to put the case outside the ambit of the statute.

Due to the inside knowledge of and control over the company that is enjoyed by its directors, many
frauds against companies are carried out by its own executives, in which case, of course, a claim can
be pursued against them in the normal way; but what of the executives who “turned a blind eye” or
who failed to spot what they should have spotted, and have therefore in a way facilitated the fraud?
If it is the case that they wilfully and/or dishonestly closed their eyes to the obvious, then that might
be the matter of a claim for dishonest assistance, which is discussed below, but negligently failing to
notice sufficiently clear signs that something untoward was taking place will often be enough to fix
an executive with liability. In some circumstances liability may even extend to the company’s senior
managers. For example, in RBG Resources plc (in liquidation) v. Viren Kumar Rastogi and others
[2002] EWHC 2782 (Ch), the claimant company was the victim of a fraud carried out by a number of
its directors before it went into liquidation. It brought a claim against a former senior manager who
was accused of being a co-conspirator (although this particular point was not decided). The question
was whether he had been under a duty to inform the company’s management. It was held that a
senior employee such as the defendant would owe such a duty, and that this duty could not be
overridden by any duty of confidence to the company. The defendant argued that informing the
board would have been futile as it was the directors themselves who were carrying out the fraud.
The court rejected this argument because there was at least one director who had not been
implicated, and the company also had an advisory board which could have been informed.

Third parties
A claimant who has been the victim of a fraud might also consider whether any third parties have
been involved in the misappropriation of the victim’s assets as, under certain circumstances, a third
party might be liable to the victim through the concepts of knowing receipt or dishonest assistance.
Pursuing a claim under these causes of action could be highly effective, as the claimant may be
allowed to make use of the potent “tracing” exercise, whereby, in some circumstances, he may trace
the assets into the hands of others and, in some cases even where those assets have been
substituted for other assets, he may make a proprietary claim to recover them.

If a third party receives assets which have been transferred in breach of a fiduciary duty and that
third party knows that the assets received are traceable to a breach of a fiduciary duty, then that
third party may be liable to account for those assets. Many cases of corporate fraud involve a breach
of fiduciary duty, such as when a director diverts company assets for his own benefit, or an agent
accepts a bribe in order to enter into a contract on behalf of a principal, so the first requirement is
often satisfied. The requirement that the recipient knows that the assets represent the proceeds of a
breach of duty may be more difficult. However, in order to satisfy the test, the claimant does not
necessarily have to show that the defendant acted dishonestly. Essentially, what the claimant would
need to show is that the “recipient’s state of knowledge [was] such as to make it unconscionable for
him to retain the benefit of the receipt.”(Bank of Credit and Commerce International (Overseas) Ltd
v. Akindele [2001] Ch 437 CA).

In circumstances where the third party did not receive assets as a result of a fraud, it may still be
possible that they are liable as an accessory having dishonestly assisted in a breach of trust or
fiduciary duty. This concept can be used to fix a number of third party actors with liability, such as
investment managers or solicitors who carry out instructions to transfer assets belonging to clients
where such transfer amounts to breach of trust or fiduciary duty. However, the third party’s state of
mind and knowledge is crucial here, as it must be shown that they were dishonest in carrying out
their actions. There is considerable debate as to whether this implies a subjective or an objective
test but it is likely that the test is a combination of the two: the claimant is required to show that the
defendant acted dishonestly according to what a reasonable person would consider dishonest and
that the defendant knew that his action was dishonest.

What the law is doing in these cases is creating a constructive trust in favour of the person whose
property has been misappropriated, imposing duties on the recipient to account for the property as
though he were a trustee, even though the recipient has not agreed to undertake such duties.
However, the recipient cannot really be called a trustee: he never assumes the position of a trustee
and if he receives trust property then it is adverse to the interests of the victim (as opposed to a
trustee proper, who acts on behalf of the beneficiary and consistently with the beneficiary’s
interests. The law merely provides a formula for equitable relief which treats the recipient as if he
were a trustee, meaning that he is liable to account for the property.

As mentioned above, once it has been established that assets have been misappropriated in breach
of trust or fiduciary duty, the claimant may make use of the process of tracing. The case of Foskett v.
McKeown [2001] AC 102 shows just how effective an exercise this can be. The claimant brought a
claim against trustees who held £1 million which represented the proceeds of a life insurance policy
paid on the death of Mr. Murphy, who had, in breach of trust, used the claimant’s money to pay at
least two out of the five premiums. The claimants sought to trace into the proceeds and claim a 40%
share of the £1 million. The defendants argued that, if anything at all, the claimants were only
entitled to the value of the premiums paid with their money plus interest. It was held that the
claimants could trace through the mixed fund which was used to pay the premiums and could
therefore claim a proprietary interest in a proportionate share of the proceeds, and the claimants
recovered £400,000, despite the fact that their actual loss only amounted to around £20,000.

The options open to a claimant who has been a victim of a fraud may be limited in cases where the
perpetrator either cannot be located or does not have the assets to satisfy judgment and, save in
cases covered by insurance, the loss often remains where it lies. However, the above examples show
that this does not always have to be the case. Consideration of alternative defendants such as those
discussed in this article may help to ensure that, when building a fraud claim, the claimant is
exhausting all possible avenues of recovery.