Negligence: an illegal defence?

Last year saw the well-reported House of Lords’ decision in Stone &
Rolls v Moore Stephens, striking out an audit claim on the basis of the
illegality principle. One might have thought that case, and the Lords’ earlier
2009 decision of Gray v Thames Trains, would have added clarity to this area of
the law.

Far from it. Since then, there have been further decisions, each highlighting
potential uncertainties in how the illegality defence works; for example, in
claims involving solicitors (Nayyar v Denton Wilde Sapte), the recovery of fines
for breaches of the Competition Act (Safeway v Twigger) and, most recently,
accountants again.

Griffin v UHY Hacker Young was an attempt to strike out a case about
insolvency advice and an apple juice called Saxon 1050. Mr Griffin’s case
against Hacker Young is that the insolvency practitioner failed to advise him
that his conduct might be in breach of section 216 of the Insolvency Act 1986,
which prohibits a director of a company in insolvent liquidation from becoming a
director, or being involved in the management of a company reusing the same or
similar name, without giving notice to creditors of the insolvent company or
seeking the court’s permission.

Mr Griffin was the sole director of Saxon Drinks Ltd which went into
creditors’ voluntary liquidation. He subsequently became involved in the
incorporation of a new company which took over the marketing of the Saxon 1050
apple juice. As a result, he was convicted and fined £1,000. He brought
proceedings against Hacker Young, not just to recover the penalty, but also for
additional damages said to flow from the failure to advise. His damages claim
included the loss of a shareholding which, following his criminal conviction, he
could not retain because of SEC disclosure rules.

Hacker Young applied to strike out the claim on the basis that, even if Mr
Griffin’s claim was made out (which they deny), it would be barred on the
illegality principle. It would be a claim for loss flowing from Mr Griffin’s own
criminal conduct. That argument failed for a number of reasons.

First, illegality in itself is not enough for the defence to succeed. There
also has to be some element of “moral culpability” on the claimant’s part. In Mr
Griffin’s case, the offence under section 216 of the Insolvency Act 1986 was one
of strict liability. It was possible Mr Griffin could show he had committed the
offence ‘innocently’. Indeed, his case was that he wanted to comply with the law
but he was not told what he was doing was an offence. That would all depend on
the facts.

Secondly, the courts need to differentiate between losses arising as a
consequence of the sentence enforced by law, and losses suffered as a result of
a conviction. The distinction was clear here: the fine of £1,000 was loss
flowing directly from the sentence; the loss of the shareholding was not imposed
by law but arose as a consequence of the criminal act. With this latter category
of losses, a claimant can argue that the defendant’s negligence, rather than his
own wrongdoing, legally caused the loss.

Thirdly, none of these issues could properly be resolved at a summary
hearing. This is a developing area of law, and one which the judge felt would be
far better considered at a full trial.

The Griffin case is a reminder of the point, made in the Stone & Rolls
judgment, that a strike out or summary judgment on illegality grounds will be
difficult to come by. But it also highlights a key area of uncertainty in the
law, where the claimant’s illegality might fall short of fraud. The Safeway
case, a claim for recovery of regulatory fines from former executives,
highlights another – how to determine whether a corporate claimant is itself
guilty of the illegality, rather than just its employees or officers.

With a high proportion of claims against accountants in the current
environment apparently stemming from fraud of one sort or another, the potential
for the illegality defence will often be well worth considering. If the defence
succeeds, that is the end of the claim regardless of the quality of the
underlying work. But that, in itself, raises an obvious tension. Why should a
professional escape liability altogether in the very cases where the illegality
or fraud in question is at its most far-reaching?

It is perhaps for that reason that the courts appear to be stepping carefully
to ensure that the defence remains of limited scope.

Illegality principle

The illegality principle can be used as a defence by professional advisers
against negligence claims when the claimant has been involved in illegal
activities. It hinges on the tenet that a party cannot claim for losses suffered
because of its own actions.

Andrew Howell is a partner and Kieran Hamill an associate in Barlow Lyde
& Gilbert LLP’s Accountants Liability Team.

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