Is the knowledge of a director that of the company

A UK Supreme Court decision at the end of last year, which refers to a 1990s Privy Council appeal from the New Zealand courts, on the issue attribution of knowledge is worth mention.

At issue was the attribution of a director’s knowledge to the company.  The judgment refers to the ‘classic’ summary of the status of a company from the New Zealand decision in Meridian Global Funds Management Asia Ltd v Securities Commission (1995) as a fictional person, which must act through the medium of real human beings.  So the issue is when the acts and intentions of real human beings are to be treated as the acts and intentions of the company.

Whilst companies are often held (vicariously) liable for the acts of their directors and employees and directors, in Singularis Holdings Ltd v. Daiwa Capital Markets Europe Ltd [2019] UKSC 5, the UK Supreme Court had to address the question of when the acts, knowledge and intentions of a director able to be treated as the acts, knowledge and intentions of the company itself.

Background

Singularis, was a company registered in the Cayman Islands which was set up to manage the assets of a Saudi Arabian businessman (Mr Al Senea).  Mr Al Senea was the sole shareholder, a director and chairman of a board which comprised 6 other directors – who did not exercise any influence over the management of the company.  Extensive powers were delegated to Mr Al Senea including that of exercising the signing powers over the company’s bank accounts.  Singularis is described as having a substantial and legitimate business, carried out over a number of years before the relevant events, for which it borrowed substantial sums of money under a variety of funding arrangements.

Daiwa, is the UK subsidiary of a Japanese investment and brokerage firm.  In 2007, it entered into a stock financing arrangement with Singularis in terms of which it provided Singularis with loan financing to enable it to purchase shares which were the security for the repayment of the loan.  In June 2009, all the shares were sold, the loan was repaid, and Daiwa was left holding a cash surplus for the account of Singularis.  Together with a sum of US$80m deposited by Singularis in June 2009, the total held to Singularis’ account was approximately US$204m. 

On Mr Al Sanea’s instructions, Daiwa paid the entire surplus to other companies in Mr Al Sanea’s business group.  Those payments were held to be a misappropriation of Singularis’ funds and had the effect of leaving Singularis unable to meet the claims of its creditors.

The liquidators of Singularis ultimately brought a claim against Daiwa for the full amount of the payments on the basis that Daiwa was in breach of what is known as its ‘Quincecare duty’ to the company when it made the payments.

Quincecare duty

The so-called ‘Quincecare duty’ is derived by a 1990s UK High Court decision in relation to the banker-customer relationship, and in particular in connection with the bank’s duties in relation to payment instructions which give rise, or ought to give rise, to a suspicion of fraud. 

It balances the bank’s obligation to execute its customer’s orders in a timely manner with a duty not to execute such orders if it knows or suspects that the order has been given dishonestly.  As a result, a bank can be liable for damages if it implements a customer order knowing it to have been dishonestly given, or shut its eyes to the obvious fact of the dishonesty, or acts recklessly in failing to make such enquiries as an honest and reasonable man would make.

Central issue – attribution

In the context of Singularis, Daiwa was well aware that Mr Al Sanea and the other companies under his control were in dire financial straits at the time of the Daiwa payments in 2009.  A lower court held that any reasonable banker would have realised that there were many obvious, even glaring, signs that Mr Al Sanea was perpetrating a fraud on Singularis.

The issue for the Supreme Court were whether that fraud could be attributed to the company.

In the lower courts, the claim that Daiwa has dishonestly assisted Mr Al Sanea was dismissed – on the basis that Daiwa’s employees had acted honestly.  However, a finding of negligence was upheld against Daiwa, while making a deduction of 25% to reflect the contributory fault of Mr Al Sanea and Singularity’s inactive directors, for which the company was responsible.

The Supreme Court held that Mr Al Sanea’s fraud was his alone and not that of Singularis.

Daiwa argues that, as Singularis was effectively a one-man company and Mr Al Sanea was its controlling mind, his fraud is to be attributed to the company, with the consequence that its Quincecare claim against Daiwa was defeated, either by illegality, or for lack of causation, or because of an equal and opposite claim for the company’s deceit.  In doing so, Daiwa attempted to rely on a UK House of Lords decision (Stone & Rolls Ltd v Moore Stephens (2009)) that has a bit of a chequered history.  In Stone & Rolls, the controlling mind of the company’s knowledge of fraudulent activities was attributed to the company – with the result that the company was unable to claim against its auditors for negligently failing to detect the fraud.  Stone & Rolls was distinguished in the later UK Supreme Court case of Bilta (UK) Ltd v Nazir (No 2) (2015) which held that where a company has been the victim of wrongdoing by its directors, the wrongdoing of the directors cannot be attributed to the company as a defence to a claim brought against the directors by the company’s liquidator for the loss suffered by the company as a result of the wrongdoing.

Here, the Court referred to the decision of the Privy Council decision in Meridian Global Funds Management Asia Ltd v Securities Commission identifying three levels of attribution:  First, the primary rule is contained in the company’s constitution – which typically says that the decisions of the shareholders or of the Board are to be the decision of the company on certain matters.  Secondly, because the primary rule will not cover the whole field of the company’s decision-making, the ordinary rules of agency and vicarious liability, which apply to natural persons just as much as to companies, will normally supply the answer.  Thirdly, because there will be some particular rules of law to which neither of these principles supplies the answer – the question is not then one of metaphysics but of construction of the particular rule in question.

In the Singularis decision, the UK Supreme Court explained that the key to any question of attribution of the knowledge of a fraudulent direct to the company is always to be found in consideration of the context and the purpose for which the attribution was relevant.  The context of this case was the breach by the company’s investment bank and broker of its Quincecare duty of care towards the company.  The purpose of that duty is to protect the company against just the sort of misappropriation of its funds as took place here.  By definition, this is done by a trusted agent of the company who is authorised to withdraw its money from its account.  Adopting the words of the judge at first instance, by attributing the fraud of that person to the company would be to “denude the duty of any value in cases where it is most needed”.

As a result, the UK Supreme Court rejected Daiwa’s attempt to rely on the unlawfulness that it had a duty to protect against, as a reason for avoiding its liability for failing to detect that same unlawfulness.  

This case also provides a reminder that even the sole director of a company can steal from it, but that does not mean that the company should necessarily be prevented from bringing a claim against a third party who had negligently facilitated the theft.  The company’s funds do not also belong to its ‘controlling mind’ – such as a sole director.  

This decision is seen as being significant in the insolvency context – so that insolvency practitioners can bring proceedings against directors of a company without the possibility of such claims being defeated on the basis that a director’s wrongdoing should be attributed to the company.  And it may encourage claims against banks and other financial institutions which have facilitated the misappropriation of company funds.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.