For Fear of Learning an Inconvenient Truth: Third-Party Liability in Fraudulent Trading

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Latham & Watkins LLPParties within a chain of transactions may face liability for dishonesty and assistance, even if they do not have actual knowledge of fraud.

The recent judgment in Bilta (UK) Limited (in liquidation) & ors v. NatWest Markets plc & Anor [2020] EWHC 546 (Ch) provides a timely illustration of how the concepts of dishonesty and assistance may apply in a chain of transactions in which not all parties have actual knowledge of the fraud. In the case, the defendant bank and its subsidiary were found to be vicariously liable for dishonest assistance to fiduciary breaches by the directors of the insolvent claimant companies, despite not having actual knowledge of the directors’ fraud. The directors were found liable on account of their participation in trades executed by two employee traders in a carbon credit based carousel fraud scheme.

Background

The directors of the claimant companies participated in a fraudulent scheme whereby they purchased EU carbon credits (EUAs) in VAT-exempt EU Member States and sold the EUAs through an intermediary, CarbonDesk, in the United Kingdom, inclusive of VAT. The directors then failed to account to HMRC for the VAT payable and misappropriated the funds for their own use.

The claim against NatWest plc (formerly the Royal Bank of Scotland, RBS) and its subsidiary RBS Sempra Energy Europe (RBS SEEL) centred around the actions of two traders employed by RBS SEEL. The claimants argued that despite an abundance of evidence suggesting VAT fraud was at play, the traders caused RBS to purchase substantial amounts of EUAs from CarbonDesk, who sourced them from the claimant companies. In doing so, the claimants alleged that the traders dishonestly assisted the claimants’ directors’ breaches of fiduciary duty. The defendants denied liability on the basis that (i) the relevant trades could not amount to assistance, as they were several degrees removed from the directors’ breaches of fiduciary duty, and (ii) the traders could not have acted dishonestly as they had no knowledge of the directors’ fraud.

The court ultimately held both defendants jointly and severally liable for dishonest assistance and fraudulent trading, despite the fact that the relevant trades were several degrees removed from the directors’ fraud and the traders did not have actual knowledge of that fraud. Its judgment provides a timely illustration of how, even absent actual knowledge of another party’s fraud, the English courts may find dishonesty and assistance such as to impose liability on parties across a chain of commercial transactions.

Dishonest Assistance

The basic requirements for dishonest assistance are set out in Royal Brunei Airlines v. Tan [1995] 2 AC 378: (i) a breach of fiduciary duty; (ii) assistance by the defendant in the breach; and (iii) dishonesty by the defendant.

“Assistance” given a broad meaning in a chain of transactions

As the traders did not have any direct dealings with the fraudulent directors, the defendants argued that the traders’ conduct was too far removed from the fraudulent activity to be deemed “assistance” in the breach, and claimed that such a finding would potentially render “nearly the entire secondary market of EUAs liable for dishonest assistance to the fraud”.

The court disagreed, relying on Alpha Sim v. CAZ Distribution Services [2014] EWHC 207 (Ch) for authority that assistance could be found even if a defendant’s actions are separated from the breach by intermediary transactions. In such a scenario, the requirement for dishonesty would act as an essential filter and limit to the scope of dishonest assistance to ensure that parties who participate in the market in good faith are not held liable.

“Dishonesty” without full knowledge of the fraud

“Dishonesty” is determined using the two-stage test in Ivey v. Genting Casinos (UK) Limited [2017] 3 WLR 1212, which requires the court to (i) determine what a defendant actually knew or believed, and (ii) appraise his conduct in light of that knowledge or belief against the objective standards of ordinary decent people. Therefore, dishonesty could be found if an assister does not actually know all the relevant facts, and dishonesty could entail “suspicion of the true facts, combined with a conscious decision not to make inquiries which might result in actual knowledge of those facts”.

Ultimately, the court found that, contrary to the traders’ evidence, the traders were well aware at all times that VAT was chargeable on the EUA trades with CarbonDesk. The court also found that because CarbonDesk was a small company, the traders would have appreciated that the situation was suspiciously unclear as to how CarbonDesk was able to obtain a seemingly endless supply of EUAs to sell to RBS. The exceptional increase in the volume of trading with CarbonDesk, coupled with the traders’ knowledge of VAT fraud in the sector, should have raised the suspicion that CarbonDesk may be a conduit for VAT fraud. Applying the test in Ivey, the court concluded that in turning a blind eye and continuing with their highly profitable trading, the traders had acted dishonestly. It did not consider a detailed understanding of the mechanics of the fraud necessary for a finding of dishonesty.

Dual vicarious liability and attribution

The facts gave rise to what the judge described as a “paradigm case for the imposition of dual vicarious liability”. RBS SEEL was found vicariously liable as the legal employer of the traders, who were subject to RBS SEEL’s supervision and control. RBS was found vicariously liable on the basis that the traders were authorised to trade as agents on RBS’ behalf, and RBS had the power to direct its agents not to enter into certain trades. As an alternative to vicarious liability, the court also considered the principles of attribution, and determined that it was “perfectly clear” that the traders’ knowledge could be attributed to RBS, on the basis that the traders were given the authority to conduct the trades on behalf of RBS.

Comment

Bilta (UK) Limited (in liquidation) & ors v. NatWest Markets plc & Anor serves as a valuable reminder for businesses of the importance of developing sophisticated and effective fraud detection and reporting procedures at all levels within an organisation. Employees should be encouraged to look beyond individual transactions and flag suspicious activity even in regards to a suspected indirect link to fraud. Crucially, businesses should ensure that employees and agents understand the consequences of ignoring inconvenient suspicions regarding fraudulent activity in the pursuit of profit. While lengthy and complex chains of transactions are common in the commercial environment, being several steps removed from the actual perpetrator of fraud does not constitute a valid defence for an individual, and by extension for an individual’s employer, who suspects fraudulent activity but chooses to turn a blind eye.

This post was prepared with the assistance of Michelle Taylor in the London office of Latham & Watkins.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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