Source: Law and Legal Developments
Posted: 11 Feb 2010 09:13 PM PST
An earlier post had discussed the ex turpi causa arising in a recent House of Lords judgment – Stone & Rolls v. Moore Stephens. Another post had stated on the second issue (attribution), “It was held that a directing mind’s fraud will be attributed to the company in all cases, except where the fraud was played directly on the company. If the company is a vehicle of the fraud, as opposed to the victim of the fraud, the directing mind’s fraud will be attributed to the company. This would mean that the fraud of the directing mind is, in law, the fraud of the company. Once such attribution occurs, the principle of ex turpi causa would apply. The auditors were appointed for the very thing of detecting the fraud. Yet, when the company brings a claim against them for negligence in failing to detect the fraud, they can rely on the ex turpi causa rule to prevent the company from pursuing the claim. The only exception to this is if the company shows that it was the direct and primary victim of the fraud. In other words, if a company’s directing mind has committed a fraud using the company as a vehicle, then the company cannot bring a claim in negligence against the auditors for failing to detect the fraud.” This post considers the general law on attribution; and on the fraud exception to attribution.
In certain situations, acts of certain individuals can be attributed directly to the company, instead of vicariously through doctrines of agency. Thus, a company (although acting through the mechanism of individuals) can have certain acts attributed directly to it (Per Lord Hoffman, Meridian Global Funds Management (Asia) Ltd. v. Securities Commission, [1995] 2 AC 500, 506. Acts of the companies “directing mind and will” will be acts of the company itself. (Hence, the issue in Moore Stephens – is the fraud of the directing mind also the fraud of the company, or is there a fraud exception to attribution.) This “directing mind and will” theory can be traced to Viscount Haldane’s words in Lennard’s Carrying Co. Ltd. v. Asiatic Petroleum Co. Ltd., [1914-15] All ER Rep. 280, “… a corporation is an abstraction. It has no mind of its own any more than a body of its own; its active and directing will must consequently be sought in the person of somebody who for some purposes may be called an agent, but who is really the directing mind and will of the corporation, the very ego and centre of the personality of the corporation.”
The Supreme Court of India considered this theory in JK Industries v. Chief Inspector of Factories and Boilers, (1996) 6 SCC 665. The Supreme Court cited and specifically approved of Lennard’s case. It then stated that where the “directing mind and will” test is use, vicarious liability come into play to fasten liability on the company of the acts of the directing mind. With respect, this approach requires a slight clarification. The acts of the “directing mind and will” or the “alter ego” of the company are directly attributed to the company, not vicariously (Tesco Supermarkets Ltd. v. Nattrass, [1972] AC 153). The position on the point is clarified in the leading judgment of Lord Hoffman in the Meridian case. In Lord Hoffman’s view, “Any proposition about a company necessarily involves a reference to a set of rules. A company exists because there is a rule (usually in a statute) which says that a persona ficta shall be deemed to exist and to have certain of the powers, rights and duties of a natural person. But there would be little sense in deeming such a persona ficta to exist unless there were also rules to tell one what acts were to count as acts of the company. It is therefore a necessary part of corporate personality that there should be rules by which acts are attributed to the company. These may be called ‘the rules of attribution’. The company’s primary rules of attribution will generally be found in its constitution, typically the articles of association, and will say things such as ‘for the purpose of appointing members of the board, a majority vote of the shareholders shall be a decision of the company’ or ‘the decisions of the board in managing the company’s business shall be the decisions of the company’. There are also primary rules of attribution which are not expressly stated in the articles but implied by company law…”
The question which arises then, is – once a directing mind is identified, are all acts/knowledge of the directing mind to be attributed to the company? Is the fraud of the directing mind to be treated as the fraud of the company? In Moore Stephens, the House of Lords accepted that there was a fraud exception. In doing so, the Court relied on In re Hampshire Land Company, [1896] 2 Ch 743. I have elaborated on these points in an article forthcoming in the Journal of Business Law. Briefly, Hampshire Land is an agency-case. It deals with when the knowledge of an agent will not be attributed vicariously to the principal. Other cases on the point include Belmont Finance Corporation Ltd v Williams Furniture Ltd., [1979] Ch 250 and Canadian Dredge and Dock v. The Queen, [1985] 1 SCR 662. But, the Hampshire Land line of cases deals not with a directing mind’s knowledge; but with attribution of an agent’s knowledge. They are thus cases of exceptions to vicarious liability. The rationale behind Hampshire Land is restricted to agency; it does not apply to directing minds. The typical explanation for the Hampshire Land exception is, “…general principles of imputation are based on a presumption that there has in fact been communication between agent and principal, a presumption that must be rebutted by the agent's fraud on his principal, since no fraudster will tell his principal information that will reveal his fraud…” (Peter Watts, “Imputed Knowledge in Agency Law – Excising the Fraud Exception”, [2001] 117 Law Quarterly Review 300). But, when dealing with directing minds and wills, the general principles of imputation are not based on any such presumption of communication, they are based on the legal rule that the directing mind “is an embodiment of the company or, one could say, he hears and speaks through the persona of the company, within his appropriate sphere, and his mind is the mind of the company…” Once it is found that ‘X’ is acting as the directing mind, that finding is in itself is sufficient for attribution; no further presumption of any communication is needed. Hence, the Hampshire Land exception – premised as it is on the rationale of communication – is not apposite to cases of the directing mind and will.
There might be an independent fraud exception to attribution of the directing mind’s acts to the company. The Supreme Court of Canada has reached explained a possible basis for this exception: “The identification theory ceases to operate when the directing mind intentionally defrauds the corporation and when his wrongful actions form the substantial part of the regular activities of his office. In such a case, where his entire energies are directed to the destruction of the undertaking of the corporation, the manager cannot realistically be considered to be the directing mind of the corporation.” (emphasis added) See: Canadian Dredge v. The Queen, [1985] 1 SCR 662. This is quite different from the communication rationale of Hampshire Land. With respect, the House of Lords may have reached the right result by applying the Hampshire Land exception; it however adopted reasoning which can be made stronger if one recognises that it is not the Hampshire Land exception, but an independent fraud exception which applies the cases of the directing mind and will. Treating the two exceptions separately will avoid the confusion which is likely from the application of cases from one principle to facts pertaining to the other.
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