Restructuring & Insolvency

Dishonesty claims in insolvency cases – part 2

Part 2 of 2

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This is the second of a two part law bite that considers Insolvency claims involving dishonesty. The general perception is that claims involving an element of dishonesty are too difficult and uncertain to pursue. This perception appears to be based on a misunderstanding of what the Court requires to make a finding of dishonesty.

The aim of these law bites is to address two of the key hurdles in establishing ‘dishonesty’ in order to:

  • Highlight the viability of bringing these actions; and
  • Demonstrate the depth of expertise that Clarke Willmott can bring to such proceedings.

What constitutes “dishonesty” in civil claims?

There is a large body of case law dealing with dishonesty in civil claims, with significant judicial consideration of the concept in recent years by the Court of Appeal and House of Lords (now The Supreme Court).

The most recent summary of the law on dishonesty in breach of trust claims is the decision of Mr Justice Morgan in Aerostar Maintenance International Limited and another v Christopher Wilson and others (2010) EWHC 2032 (Ch). Morgan J summarised the test as to dishonesty as follows:

“Dishonesty is synonymous with a lack of probity. It means not acting as an honest person would in the circumstances. The standard is an objective one. The application of the standard requires one to put oneself in the shoes of the defendant to the extent that his conduct is to be assessed in the light of what he knew at the relevant time, as distinct from what a reasonable person would have known or appreciated. For the most part dishonesty is to be equated with conscious impropriety. But a person is not free to set his own standard of dishonesty. This is what is meant by saying that the standard is objective. If by ordinary objective standards, the defendant’s mental state would be judged to be dishonest, it is irrelevant that the defendant has adopted a different standard or can see nothing wrong in his behaviour”.

Gaudron J in the High Court of Australia’s decision in McCann v Switzerland Insurance Australia Limited (1998) commented that:

“…dishonesty is an ordinary concept, not a term of art”.

Generally accepted standards of business morality are widely recognised and this should provide IPs comfort when identifying conduct which appears to be ‘dishonest’. In applying an objective standard to the dishonesty test, the Courts of England and Wales generally have little difficulty in identifying what constitutes dishonest conduct and what does not.

It has long been recognised that the perpetrator of the action does not have to possess dishonest purpose to be held liable. Viscount Haldane LC in the 1914 decision of the House of Lords in Nocton v Lord Ashburton (1914) A.C. 932 said:

“…it is a mistake to suppose that an actual intention to cheat must always be proved. A man may misconceive the extent of the obligation which a Court of equity imposes on him. His fault is that he has violated, however innocently because of his ignorance, an obligation which he must be taken by the Court to have known, and his conduct has in that sense always been called fraudulent, even in such a case as a technical fraud on a power. It was thus that the expression “constructive fraud” came into existence…. What it really means in this connection is not moral fraud in the ordinary sense, but breach of the sort of obligation which is enforced by a Court that from the beginning regarded itself as a Court of conscience”.

This basic principle has received much more recent judicial support in Abou-Rahmah v Abacha [2006] EWCA civ 1492 where Arden LJ conceded that:

“There is no overriding reason why in respect of dishonesty in the context of civil liability (as opposed to criminal responsibility) the law should take account of the defendant’s views as to the morality of his actions”.

Dishonesty in the context of civil claims is a much more flexible concept than that applied in the criminal Courts and can therefore be applied to many different situations where loss has been caused:

  • It can include failing to act, as in cases where it is alleged that the respondent has turned a blind eye to facts or events.
  • The Courts are equally alive to factually correct statements being made out of context in order to mislead. In one case the Court has referred to an adviser not “being prepared to tell a direct lie” but to him being “a master of what Kipling called ‘the truthful well weighed answer that tells the blacker lie'”.
  • Whilst gross negligence is not sufficient to sustain an allegation of dishonesty, being reckless as to the consequences of one’s actions can amount to dishonesty.

The offensive conduct of which complaint is made, normally arises from one party (more often than not connected in some way to the insolvent) being enriched to the detriment of the unsecured creditors. To many, the impropriety of such conduct will be obvious but it will not be readily admitted by respondents. If, on advice or otherwise, steps have been taken to avoid the transactions falling within criteria for challenge as TUVs or preferences, finding dishonest conduct may be the only way to make a recovery.

Similarly, if third parties have been complicit in the performance of the offensive conduct, either by active participation or failing to act in circumstances where the Court deems that they should, if it can be shown on an objective basis that their conduct amounts to dishonesty, a claim may exist against that third party.

A requirement to prove dishonesty should not dissuade IPs from pursuing such cases as the Courts are much more familiar with such situations than might be apparent from a cursory analysis of the cases typically referred to in the mainstream insolvency texts.

If the Court is satisfied that dishonest conduct has caused loss to the estate, the Courts will be keen to remedy the situation.