Auditors' Liability For Failure To 'Blow Whistle' On Fraud

In an important decision, the Commercial Court considered whether or not a company which had perpetrated a fraud could claim against its auditors for failing to detect and report that fraud. Even though this involved the company relying on its own fraud, the Court nevertheless held that it could continue with its claim against the auditors. This was, according to the Court, because the fraud was "the very thing" that the auditors were under a duty to identify, and the "ordinary citizen" would not find anything repugnant in allowing the company to make a recovery in such circumstances.

The facts

In this case, an individual, S was the directing mind and will of the claimant company which was used throughout as a "vehicle for fraud". The company's fraud consisted of collusion with a third party to create artificial commodity sales and the generation of documents relating to those artificial sales, for the purpose of obtaining funds under letters of credit issued by a bank for the company's benefit. The money received by the company was then passed on to the third party or to companies connected with the third party.

The bank had succeeded in a prior claim against both the company and S. The company went into liquidation and the judgment was unsatisfied. The liquidator, through the company, then claimed against the company's auditors, although the principal beneficiary of any award would be the bank. The company alleged that the auditors were in breach of duty in failing to detect the fraud. They further alleged that had the fraud been detected the auditors would have "blown the whistle" and it would not have continued. The Court acknowledged that the company was not alleging that the accountants were under a duty to prevent the fraud, and nor could the company do so.

The strike out application

The defendant auditors sought to strike out the company's claim. It was an established principle (Ex Turpi Causa) that an individual could not rely on his own criminal conduct to make a claim. The issue that fell to be decided here was whether the company would similarly be prevented from making a claim as a result of the fraudulent conduct of S, the company's directing mind and will. For the purposes of the application, the Court was obliged to assume that the allegations made by the company against the auditors were true.

The decision

The Court refused to grant the auditors' application and made the following points.

For the Ex Turpi Causa principle to...