Liability Of Company Auditors

The Court of Appeal's unanimous judgment in Moore

Stephens (a firm) v Stone & Rolls Ltd (in

liquidation)1 is a welcome decision for auditors and

their insurers. It confirms that an auditor is not liable for

losses that arise from liabilities incurred by a company towards

third parties caused by a company's fraud, where the fraud is

perpetrated by the "sole directing mind" of the

company.

The longstanding legal principle of ex turpi causa non

oritur actio (the ex turpi

principle), which means that "no court

will lend its aid to a man who founds his cause of action on an

immoral or illegal act"2 , was the subject of

much discussion in the Judgment of the Court of Appeal delivered on

18 June 2008, which overturned the High Court's decision. The

case has received a great deal of publicity as it is one of the

first substantial cases in England and Wales in which the Claimant,

the liquidator, was financed by a third party funder.

Background

Whilst Stone & Rolls Ltd (the Company) was

in operation it was controlled and indirectly owned by Mr Zvonko

Stojevic, a Croatian businessman. It was alleged that Mr Stojevic

used the Company as a means to commit fraud against several banks.

The fraud consisted of the presentation of false documents to the

banks which allowed the Company to draw down on letters of credit.

This enabled large sums of money to be directed through the Company

and applied elsewhere for the benefit of Mr Stojevic (and others).

The frauds gave rise to numerous liabilities by the Company to a

number of banks, including a Czech bank, Komercni Banka AS (the

Bank).

The Bank sued Mr Stojevic and the Company for this alleged

deceit.3 Together, Mr Stojevic and the Company were

found liable for the fraud and ordered to pay substantial damages

to the Bank. Following the Judgment in that case, the Company could

not pay the damages and went into provisional liquidation. The

liquidators of the Company subsequently brought a claim against

Moore Stephens (the Firm), its auditors. Their

principal argument was that the Firm had negligently failed in the

course of its audits to detect and report the fraudulent behaviour

of Mr Stojevic. The Company's claim was for approximately

US$174 million.

The Firm denied any breach of duty and issued an application for

summary judgment on the claim or, alternatively, for the claim to

be struck out. The Firm argued that the Company was essentially

seeking to recover a loss caused by its own fraud and therefore the

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