In the long-awaited decision in Ahmad Hamad Algosaibi and Brothers Company (AHAB) v SAAD Investments Company Limited (In Official Liquidation) (SICL),(1) the Cayman court dismissed AHAB's claims of fraud against Mr Al Sanea's Cayman companies. In so doing, the court considered numerous complex areas of the law concerning commercial fraud and the ability to trace assets through corporate groups and into sophisticated financial products. This article discusses the court's findings regarding the illegality defence and the lessons which can be derived for future Cayman cases in which this defence might be engaged.
The court found that AHAB and Al Sanea had acted in concert in order to fraudulently obtain billions of dollars in borrowings. The loans would not have been made had the banks known the true financial position of the Money Exchange, an unincorporated division of the AHAB partnership of which Al Sanea was managing director. The court found that:
- the fraud perpetrated by AHAB and Al Sanea was an enormous, longstanding scheme (effectively a Ponzi scheme), which had defrauded more than 100 banks; and
- the Money Exchange had been, from its very inception, a criminal enterprise.
This decision has recently been appealed on very wide-ranging grounds.
As the court found that the fraudulent actions of Al Sanea had been either explicitly or implicitly authorised by AHAB, there was no factual basis on which AHAB could show that it had been defrauded. As such, there was no need for the court to find that the defendant Cayman companies (represented by several different official liquidators) could invoke an illegality defence. However, the court, no doubt in anticipation of the inevitable appeal (to be heard in May 2019), held that if its factual finding of complicity was overturned, the illegality defence would be engaged. Consequently, the court gave useful guidance on how to approach the 'notoriously knotty'(2) illegality defence.
The illegality defence is underpinned by the principle that parties should not be able to use the justice system to benefit from their wrongdoing. Claims or counterclaims which fall foul of this principle will not be enforced. While the aim of the doctrine is simple to state, the law of illegality has been in a state of flux for many years primarily due to the inconsistent judicial approaches adopted by the English Supreme Court justices grappling with its application in practice. It has long been difficult to discern a principled approach to the application of the doctrine in the various factual contexts in which it has been invoked.
AHAB has confirmed the court's view that Lord Toulson's majority speech in the nine-judge panel Supreme Court case Patel v Mirza(3) represents an authoritative statement of law on the illegality defence(4) and that – as a result of that decision – the proper approach for the courts in respect of the illegality defence is to consider the new tripartite test as articulated by Lord Toulson in Patel.(5)
Therefore, the circumstances in which the illegality defence can be invoked should become somewhat easier to distinguish and apply.
Previously, it was commonly accepted that where a claim or counterclaim necessarily relied on any illegal conduct, it would not be permitted to proceed. This was known as the 'reliance test' or the rule in Tinsley v Milligan(6) and was famously applied by the English Court of Appeal in Stone & Rolls Ltd v Moore Stephens.(7) In the Cayman case of TCB Creditor Recoveries Ltd v Arthur Andresen,(8) allegedly negligent auditors successfully relied on the illegality defence to defeat a professional negligence claim against them for failing to detect that TCB Creditor Recoveries Ltd, an investment fund, had been used by its director to defraud investors. Arthur Anderson argued that in bringing the claim, TCB had relied on its own illegal publication of false financial statements as part of its pleaded claim and that therefore the claim was barred. The court agreed and, applying the reliance test, ruled that the illegality defence was engaged so as to bar TCB's claim.
The reliance test applied in TCB has been the subject of significant criticism. Commentators have suggested that it produced arbitrary results and created significant scope for injustice.(9) Lord Toulson in Patel endorsed the English Law Commission's view that the reliance test led to uncertainty, stating that:
because there was much confusion over what exactly amounted to 'reliance' which had the potential to force the court into unjust decisions because, focusing on procedural matters, the reliance principle precluded the court from paying attention to the policies that justified the existence of the defence, or taking into account such matters as the seriousness of the illegality and the value of the interest at stake.(10)
Lord Toulson rejected this strict rule-based approach in favour of a more flexible application of a framework of clear principles so as to take into account the particular circumstances of the case.
The court in AHAB agreed with Lord Toulson's approach in Patel and ruled that the deployment of illegality as a defence should be dependent not on the procedural concept of reliance as applied in Stone & Rolls (and therefore TCB), but rather on a range of factors based on the nature and circumstances of the illegal conduct involved and the purpose behind the public policy violated. Thus, when considering a defence of illegality, the courts should apply the tripartite test, which considers:
- the underlying purpose of the prohibition which has been transgressed and whether that purpose will be enhanced by denial of the claim;
- any other relevant public policy on which the denial of the claim may have an impact; and
- whether denial of the claim would be a proportionate response to the illegality.(11)
Relying on Lord Touslon's judgment, the chief justice accepted that a useful benchmark for the court when considering the application of the illegality defence is to ask:
- how seriously illegal or contrary to public policy the conduct was;
- whether the party seeking enforcement knew of, or intended, the conduct;
- how central to the contract or its performance the conduct was;
- how serious a sanction the denial of enforcement is for the party seeking enforcement;
- whether denying enforcement will further the purpose of the rule which the conduct has infringed;
- whether denying enforcement will act as a deterrent to conduct that is illegal or contrary to public policy;
- whether denying enforcement will ensure that the party seeking enforcement does not profit from the conduct; [and]
- whether denying enforcement will avoid inconsistency in the law thereby maintaining the integrity of the legal system.(12)
While the chief justice's analysis in AHAB has simplified the approach to be adopted where a plaintiff has been a direct party to wrongdoing alleged against a defendant (as in AHAB), the application of the tripartite test has yet to be tested in the Cayman Islands in the various other factual contexts in which the illegality defence has historically been raised.
In particular, a common issue in a corporate context is whether the wrongful conduct of a company insider, such as a fraudulent director, can be attributed to the company and thus, by reason of an application of the illegality defence, bar any claim by the company for redress against either the fraudulent insider or a third party.
In the case of a corporate plaintiff, the state of knowledge of the company's directing mind is usually attributed to the company. If the director dishonestly causes the company to act illegally, prima facie, this results in that dishonesty being attributed to the company, so that the claim will be barred by the illegality defence.
However, where a company brings a claim against a fraudulent director or their accomplices for losses sustained, the director's fraudulent state of mind will not be attributed to the company where the knowledge relates to their own breach of duty to the company.(13) In this scenario, the company tends to be treated as a victim of the fraud and, as such, the illegality defence cannot be invoked to permit the defendant to rely on their own fraud to defeat the company's claim. However, complexities arise where a variety of wrongdoers and innocent parties are involved. It is in these different scenarios where the application of the tripartite test will likely see the courts striving to do justice on behalf of (and to balance the interests of) any innocent parties. The present difficulty is that the tripartite test is new and it is therefore difficult to predict how the Cayman courts will apply it and what broad categories of differing treatment will emerge as a consequence.
As far as claims made by a company against third parties which require reliance on illegal conduct to make good a claim, some guidance can be derived from the recent decision of Singularis Holdings Ltd (In Official Liquidation) v Daiwa Capital Markets Europe Ltd. In Daiwa, the English Court of Appeal applied the new tripartite test in Patel and refused to allow the third party to deploy the illegality defence, whereas it would likely have previously succeeded if the reliance test had been used. ?
The new tripartite test confirmed in AHAB somewhat clarifies the law in an area which has traditionally been marked with considerable confusion.
AHAB makes it clear, albeit obiter, that the illegality defence will be invoked successfully where a claimant is complicit in the wrongful act of a defendant. By contrast, the illegality defence is unlikely to be invoked in circumstances where a company seeks redress against a fraudulent insider and such defence would permit the fraudster to defeat the claim by reliance on their own wrongdoing.
In all other circumstances, the position is less clear and will require a more complex analysis of the factors identified by the court in Patel when applying the new tripartite test. The development of the law in this area and particularly how the tripartite test will be construed in the context of the familiar corporate scenarios which often arise in the Cayman Islands is eagerly awaited. This will hopefully result in the emergence of more obvious (and thus easier to apply) rules and further clarify the role of the illegality defence in each scenario.
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Endnotes
(2) Parking Eye Ltd v Somerfield Stores Ltd [2013] QB 840 at [28].
(4) AHAB (n 1) at Section 7D, Paragraph 46, p1175.
(5) Ibid at Paragraph 58, p1180.
(6) Tinsley v Milligan [1994] 1 AC 340.
(7) Stone & Rolls Ltd v Moore Stephens [2008] 2 WLR 1146; [2008] EWCA Civ 644.
(8) TCB Creditor Recoveries Ltd v Arthur Andresen [2008] CILR 486.
(9) 'The Illegality Defence' (Law Commission Report 320).
(10) Patel v Mirza [2016] UKSC 42 Paragraph 23.
(11) AHAB (n 1) at Section 7D, Paragraph 58, p1180.
(12) Ibid Section 7D, Paragraph 59, p1180.
(13) Moulin Global Eyecare Trading Limited (In liquidation) v Commissioner of Inland Revenue, FACV 5/2013 [2014] HKCFA 22.
