June 16 2009
The recent decision of Mr Justice Flaux in Parabola Investments Limited v Browallia Cal Limited has cast new light on the measure of damages available in fraud cases, while the size of the award has brought litigation risk to the forefront of the minds of many compliance professionals. Although the decision may yet be the subject of an appeal, the discussion on the quantum of damages merits closer examination.
The claimants were special purpose vehicles set up by Mr Rajesh Gill for the purpose of trading on the stock markets. Following several years of exceptionally successful trading, in January 2001 Gill moved his trading account to the first defendant, Browallia Cal Limited, and later to the second defendant, Man Financial, which took over the first defendant's business. The third defendant, Mr Bomford, was the senior broker who conducted most of the claimants' trades at Browallia Cal and later at Man Financial when his desk was transferred.
By the time of trial, the court was concerned only with the claims by the second claimant, Tangent, against the second and third defendants in respect of the period after the transfer of Bomford's team to Man Financial, from June 30 2001 until March 2002.
The claim in deceit was essentially that over a period of nearly eight months until February 13 2002, Bomford fraudulently misrepresented to Gill and thereby to Tangent, on a daily basis, that the trading being conducted by Gill was profitable, whereas it was not. It was also alleged that Bomford made a series of fraudulent misrepresentations as to the amount of the funds in the account with Man. The judge stated that:
"The overall effect was to create the intricate web of deceit, perpetrated over a lengthy period, that the trading being carried out was profitable and was building up a fund worth approaching £10 million by the time the truth came out, whereas in fact the fund was diminishing rapidly throughout the period of the deceit. By the deceit, [Bomford]... create[d] the parallel universe in which [Gill] thought he was trading profitably, whereas the truth was, as [Bomford] described it in conversations with others, [that Gill] was 'haemorrhaging money'."
The defendants admitted the allegations of deceit following Bomford's cross-examination, but continued to deny that the fraud had caused loss to the claimant, arguing that the deceit had not induced the claimants to trade.
Deciding as a matter of fact and law that the claimant had been induced by the defendants' behaviour, the court was left with two issues to determine: the identifiable heads of loss suffered as a consequence of the fraud and the measure of damages recoverable as a direct result of the fraud.
Tangent's claim was made under two heads.
First, it claimed for the diminution in the value of its trading fund during the period of the fraud from £4.25 million at the start of the relationship with Man Financial to just over £500,000 at the end.
Second, it claimed for loss of the profits that it argued it would have made on trading had it not been for the fraud.
By this second limb, the claimant sought to recover damages for loss of the profits which it claimed it would have made on alternative trading, both during the period of the fraud and for the period between the end of the relationship and the trial (during which time, the judge accepted, Tangent continued to suffer from the fraud).
The defendants accepted that if inducement were shown, it would be liable in damages to reimburse Tangent for the difference between the value of the trading fund at the beginning of the Man Financial period on June 30 2001 and its value at the termination of the relationship with Man in March 2002, less withdrawals and plus interest.
The defendants disagreed that they were liable for lost profits and challenged both aspects of this claim on the second head. They sought to divide the loss of profits into: (i) the duration of the trading relationship with the defendants, which they termed 'stage 1'; and (ii) the period from the end of the trading relationship to judgment, which they termed 'stage 2'. As regards stage 1, they argued that cases in which loss of profits had been held to be recoverable involved the loss of profits on a specific alternative transaction into which the claimant would have entered but for the fraud. In contrast, in this case the claimant had proposed a series of hypothetical alternative transactions. The defendants also argued that the financial products in which the claimant traded and which he had used as the basis for his claim were too speculative to be recoverable.
The defendants raised the same objection in respect of stage 2, but added that the claim for loss of profits after the end of the relationship amounted to a claim for what they termed 'profits on profits'. They contended that this went beyond what the law considered recoverable in damages. In other words, trading that had occurred after the end of the relationship was not an 'alternative trades' as understood in deceit cases concerning loss of profits, but rather alternative trades which Tangent claimed that it would have undertaken during the period of the fraud. Therefore, stage 2 was for loss of profits on transactions which the claimant would have entered after the fraud, which was entirely speculative and did not flow directly from the fraud. Instead, the defendants argued that interest on the damages for the trading period was appropriate to compensate the claimant for stage 2.
In a methodical and reasoned judgment, the judge found in the claimant's favour, holding that there are no hard and fast rules in determining damages recoverable in deceit beyond the overriding principle that the court should strive to award damages which compensate the claimant fully for loss flowing directly from the fraud.
The judge held that in deceit cases the recovery of lost profits is not limited to cases where the claimant could point to a specific alternative transaction into which it would have entered but for the fraud. Furthermore, there is no requirement that the alternative transaction necessarily be profitable. The judge also dismissed the notion that because the financial products contained an element of uncertainty, the court should regard them as a non-recoverable loss.
In this context, the judge accepted the evidence that but for the fraud, the claimant would have continued to trade successfully in the shares of smaller companies, which it had done successfully both before and after the relationship with the defendants. The judge noted that:
"[this] is what distinguishes this case from cases like Bailey and Ata, in neither of which was there any evidence that the claimant had made money in the alternative trades in which he was contending he would have engaged."
Accordingly, as regards stage 1, the claimant was entitled in principle to recover loss of profits on the alternative trading it would have carried out but for the fraud.
As regards stage 2, the judge accepted that with a larger fund available to it (ie, in the absence of fraud), the claimant would have made greater profits. If the adverse effects of the fraud carried on to trial, such that the claimant had not yet achieved the profits from its business that it would have made had the fraud not occurred, the judge saw no reason that damages should not be assessed at the date of the trial or that lost profits should not be recoverable as damages for the entire period until the trial. He added that:
"The objection raised by [counsel for the defendants]… that profits [lost] after the period of the deceit are not recoverable, because they do not relate to any relevant alternative transaction or because the law does not recognize such 'profits' because they are too speculative, it seems to me... is unprincipled and wrong."
The overriding reason for the judge's analysis was the notion that the claimant was still suffering from the adverse effects of the fraud at the date of trial - as the judge put it, the claimant remained effectively "locked into the transaction" until trial. The court therefore held that lost profits in stages 1 and 2 were recoverable over and above the damages representing the difference in the fund before and after the relationship with the defendants. The judge assessed quantum in the sum of around £20 million, which represented a considerable uplift on the defendants' assessment.
The court refused the claim for exemplary damages in a further death knell for such awards. Although the judge agreed with the dissenting Lord Scott in Kuddus v Chief Constable of Leicestershire  2 AC 122, that "the time has come to abolish exemplary damages", he felt that he could not ignore their existence, but added that he could not make such an award where, as in the present case, a defendant such as Man Financial was liable vicariously. The judge added that:
"there seems to me something faintly absurd in the suggestion that, in this case where Tangent will recover substantial compensatory damages, the additional award of even £15,000 exemplary damages will express the court's outrage and displeasure at the fraud perpetrated on Tangent and [Gill]."
Further erosion of the doctrine of exemplary damages can be expected soon.
An appeal by the defendants will most probably relate to the lost profits claim in respect of stages 1 or 2 or both, as they have admitted liability and it has been established in fact that their deceitful behaviour induced the claimant. Such an appeal is likely to centre around arguments of remoteness.
The case has brought litigation risk back onto the radar for commodities, futures and options dealers, who frequently receive writs for misrepresentation.
The possibility of recovering what the defendants termed 'profits on profits' should serve as a warning to those who embark on a course of deceitful conduct, as they could face damages significantly greater than the loss directly or foreseeably caused to an innocent claimant. The judge's finding is in line with the reasoning in Smith New Court Securities Ltd, the leading authority on damages for the tort of deceit, and its application to a litigant who was found to have been locked into the fraud for seven years should not have come as a surprise to legal practitioners.
It is difficult to criticize the court's logic in reaching the conclusion that the defendants were liable for the stage 1 and stage 2 losses. Although it is beguiling to follow the defendants' characterization of the lost profits claim as dividing neatly into two stages - during and after the fraud - this may make it too easy for a defendant that has caused the claimant to be in court to escape liability on the basis of its own characterization. If the claimant's usual and proven track record is considered not in terms of stages, but rather as a straight-line graph with the claim period plotted alongside (ie, the defendants' stages 1 and 2), it is easier to appreciate why the court was prepared to accept that the claimant's putative performance (as represented by the straight-line graph) could be achieved only by awarding the 'profits on profits' claim.
This sort of measure may well be exceptional - the court relied on the speech of Lord Browne-Wilkinson in Smith New Court as a departure from the usual rules of valuation. The departure appears to be attributable to the unusually consistent rate of success of the claimant's trading both before and after the fraud. The court noted that Gill, the beneficial owner behind the claimants, was:
"regarded by those who have dealt with him as one of the most successful traders in certain types of stocks and shares and their derivative products on world markets. Over the period of more than 10 years since he left university, other than in one period, [Gill] has consistently made profits from his trading, whether in bull or bear markets, sometimes extraordinarily good profits despite the state of the world markets."
However, does such an ecumenical analysis miss the point of this and other cases dealing with deceit? Even in the absence of Gill's phenomenal trading success, it would seem entirely contrary to the thrust of the judgment in Smith New Court to allow a defendant which has admitted liability for the most egregious kind of deceit to dictate the rules of recovery of the monies of which he caused the defendant to be deprived. In Parabola the court was satisfied that but for the fraud, the claimants would have continued on the straight line, making profit as they always had done before their relationship with the defendants. However, no matter how steep or gentle a claimant's straight line, it would seem at odds with the principles of tortious damage to say that a claimant should not be allowed to ride it, even if that means that the outcome of cases will vary according to the nature of the claimant. Tangent clearly had a single trading strategy based on a discernable formula; the defendants' behaviour knocked it off that strategy. This judgment suggests that a claimant with a strategy can recover, provided that it can point to convincing evidence of the strategy in court.
For further information on this topic please contact Christa Band, Julian Copeman or John Corrie at Herbert Smith LLP by telephone (+44 20 7374 8000) or by fax (+44 20 7374 0888) or by email (email@example.com or firstname.lastname@example.org or email@example.com).
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