Changing Attitudes On The Illegality Defence

Two recent decisions of UK appellate courts — one concerning a misfeasance claim against a liquidator and another involving an attempt to recover monies intended for insider trading — illustrate a new, more flexible approach to the "illegality defence". While common sense has prevailed, the new approach will make it harder for legal advisors to predict outcomes when an illegality defence is asserted.

At the heart of the illegality defence in civil claims lies the maxim: no court will lend its aid to a person whose cause of action relies on an illegal act. This principle is based upon public policy that no person should benefit from wrongdoing and that the law should not condone illegal activity. However, while it is clear that no court will give effect to an illegal agreement, this is where the certainty ends and it remains unclear as to where parties to such agreements are left when the agreement unravels.

The traditional test for determining whether illegality can successfully be pleaded as a defence is the 'reliance test' set out in Tinsley v Milligan [1994] 1 AC 340. The reliance test will bar a claim if the claimant relies on the illegality in order to bring a claim. Two recent cases, however, have reduced the scope of the defence, broadened the courts' discretion and abolished the reliance test altogether.

Sharma v Top Brands

In Sharma (as former Liquidator of Mama Milla Ltd) v Top Brands Ltd & Anor [2015] EWCA Civ 1140, the English Court of Appeal refused to allow a liquidator of a fraudulent company to rely on illegality in defending a claim for breach of duty under the Insolvency Act 1986 (UK) (Act).

Background

Mama Milla Ltd (MML) was a UK company that imported toiletry products and sold them within the UK without accounting for VAT, essentially committing VAT fraud. Top Brands and Lemione Services Ltd (LSL) supplied products to MML, and also agreed with MML to deliver goods directly to one of MML's customers, SERT Plc (SERT). SERT would typically pay MML for these deliveries and MML would then compensate

Top Brands and LSL. On the relevant occasion, however, MML was paid £548,074 from SERT but failed to make an onward payment to Top Brands and LSL before entering into a creditors' voluntary liquidation. Mrs Gagen Sharma was appointed as MML's liquidator. The liquidator incorrectly believed that SERT had not received the relevant goods from Top Brands and LSL and, accordingly, she instituted a number of refunds from MML to SERT...