Moore Stephens (a firm) v Stone Rolls Ltd

Factual and Procedural Background

Company A was controlled and effectively owned by “Director X.” Acting as its sole directing mind, Director X used Company A to obtain money from several banks—most notably “The Bank”—by presenting false documentation in support of letters of credit. The proceeds were immediately transferred to parties connected with the fraud, leaving Company A without assets. When the fraud surfaced, The Bank secured a judgment for more than US $94 million against both Company A and Director X. Company A entered liquidation.

Company B, a firm of auditors, had audited Company A’s financial statements for the years 1996-1999. Liquidators of Company A sued Company B in contract and tort, alleging that negligent audits prolonged the fraud and caused further loss to Company A. Company B applied to strike out the claim, contending that it was barred by the doctrine ex turpi causa non oritur actio (“ex turpi causa”). The lower court dismissed the strike-out application; the Court of Appeal reversed that decision. Company A appealed to the supreme appellate court, which delivered the opinion summarised below.

Legal Issues Presented

1. Does the doctrine of ex turpi causa bar a company, used as a vehicle for fraud by its sole directing mind, from suing its auditors for negligent failure to detect that fraud?
2. In applying ex turpi causa, is the fraud of Director X attributable to Company A when Director X is also its sole beneficial owner?
3. What is the scope of an auditor’s duty where the company is insolvent and creditors—not shareholders—stand to benefit from any recovery?
4. Does the so-called “Hampshire Land” principle (which prevents attribution of an agent’s fraud to a principal in certain circumstances) protect Company A in this context?
5. Is the claim nevertheless sustainable because preventing the fraud was “the very thing” Company B had undertaken to do?

Arguments of the Parties

Appellant’s Arguments (Company A)

• Hampshire Land: Director X’s fraud should not be imputed to Company A; the company is, at least secondarily, a victim.
• Auditors owed a duty to detect and report fraud; failure to do so was negligence. Preventing that fraud was “the very thing” they were retained to accomplish.
• Ex turpi causa is a discretionary, policy-based defence; it should not apply where the defendant’s duty was to prevent the wrongdoing.
• Once insolvent, Company A’s interests aligned with creditors, bringing them within the scope of the auditor’s duty.
• Even if some attribution is possible, equity would prevent fraudulent shareholders (here, Director X) from benefiting, so the action should proceed.

Respondent’s Arguments (Company B)

• Under Tinsley v Milligan, a claimant who must plead and rely on its own illegality cannot succeed; Company A’s case inevitably relies on the fraud it perpetrated.
• Director X was Company A’s sole directing mind and sole shareholder; his knowledge and dishonesty are automatically attributed to the company (“sole-actor” rule).
• Hampshire Land applies only where the company is the victim of the agent’s fraud, which is not the position here; the real victims were the banks.
• Auditors owe duties to shareholders, not to an indeterminate class of creditors; once all shareholders were complicit, the auditors owed no actionable duty.
• Permitting recovery would affront legal coherence by allowing a company to profit from its own fraud and undermine the public-policy basis of ex turpi causa.

Table of Precedents Cited

Court's Reasoning and Analysis

Majority (Judge Walker, Judge Phillips, Judge Brown):

• Director X was the sole directing mind and sole beneficial owner; his fraud is inseparable from Company A.
• Ex turpi causa operates automatically: Company A must plead its fraud to establish causation; claim therefore barred.
• Hampshire Land applies only where the company is the deceived party; Company A was the deceiver, not the victim.
• The auditors’ statutory duty is aimed at protecting shareholders; once shareholders and management are identical, no duty actionable by the company remains. Insolvency does not enlarge that duty to creditors.
• Permitting recovery would indirectly reward wrongdoing and create an “intolerable fissure” in the law’s coherence.

Minority (Judge Scott, Judge Mance):

• Company and shareholder are distinct legal persons; Director X’s breach of fiduciary duty is not automatically attributable to Company A for this purpose.
• Hampshire Land prevents attribution where the company suffers detriment; Company A was stripped of assets and is a victim despite being used as a fraud vehicle.
• A creditor-focused duty arises once the company is insolvent; auditors owed Company A a duty that encompassed creditor interests.
• Denying a remedy emasculates the audit function; auditors should not escape liability precisely because management was fraudulent.

Holding and Implications

FINAL DISPOSITION: APPEAL DISMISSED.

The court held that the doctrine of ex turpi causa bars Company A’s negligence claim. Because Company A was wholly controlled by Director X, its fraud is legally inseparable from its own acts; the auditors owed no actionable duty once all shareholders were complicit. The decision limits a company’s ability to sue its auditors where the company is a “one-person” vehicle for fraud, reaffirming strict application of ex turpi causa and narrowing the reach of the Hampshire Land principle. Broader implications for auditor liability were raised in dissent but not adopted by the majority, leaving auditors generally insulated from claims brought by companies wholly owned and controlled by fraudulent actors.