Jersey &
Guernsey Law Review – February 2008
RESTITUTIONARY
WEAPONS IN THE FIGHT AGAINST FRAUD
Sinéad Agnew
INTRODUCTION
1 Most
discussions about the civil remedies available to a victim of fraud against
third party recipients centre on the claimant's ability to prove that the third
party received the claimant's property or its traceable proceeds or substitutes
(in law or in equity). The ability
to trace or follow fraudulently misappropriated property, its proceeds or
substitutes - although essentially an evidential process - is key to establishing the claimant's right to relief. Little mention is made of what remedies
may be available to a victim of fraud when the tracing process breaks down, so
that he cannot establish that his property or its proceeds or substitutes have
made its way into the recipient's hands.
2 The
purpose of this article is to analyse recent developments in Jersey law,
dealing with personal remedies against third party recipients, both where the
victim can prove receipt of his property or its proceeds or substitutes by the
third party and in cases where the tracing trail runs cold but the victim can
show that the fraudster transferred his own assets to the recipient in order to
defeat his claim. It is proposed to compare the
personal remedies offered under English and Jersey
law against third party recipients of: first, the traceable substitutes or
proceeds of the victim's property; and, second, the fraudster's own
assets. Volunteers and purchasers
are dealt with separately. It will
be seen that Jersey law may offer a victim an
easier path to establishing the personal liability of the recipient in both
cases. This may make it more
attractive for claimants in multi-jurisdictional fraud cases involving Jersey assets, trusts and/or trustees to argue, if at all
possible, that Jersey law should be the
applicable law. As a matter of
principle, the Jersey approach also suggests a
move towards a more coherent response to fraud, which is grounded in the law of
restitution. A detailed
consideration of dishonest assistance is beyond the scope of this article,
which focuses on receipt by third parties of either the subject-matter of the
fraud or the fraudster’s own property.
THE ESTEEM JUDGMENT
3 Sheikh
Fahad was the director of Grupo
Torras SA ("GT"), a company owned by the
Kuwait Investment office. Between
1988 and 1990, Sheikh Fahad conspired with others to
defraud GT of some US $430 million of which his own personal share was
approximately $120 million. During
this period, he paid some of his own money and the stolen money to the trustees
of trusts he had set up around the world between 1981 and 1994, most notably to
Abacus (CI) Ltd ("Abacus"), the trustee of two Jersey
settlements, the Esteem Settlement and the No. 52 Trust and the administrator
of Ceyla, a Liechtenstein Anstalt. Within a few months of March 1990,
Sheikh Fahad had become hopelessly insolvent. On 14 April 1993, GT issued a
writ in England
alleging conspiracy to defraud against Sheikh Fahad
and others. GT obtained judgment
against Sheikh Fahad for approximately $800 million
in the English High Court on 24
June 1999. GT then
brought an action in Jersey, which included an equitable proprietary claim in
respect of £1.276 million, an alternative claim in restitution for the
same sum and a claim to set aside all transfers made into the Esteem
Settlement, the No. 52 Trust and Ceyla at any time
after the fraud began in May 1988, on the basis that these transfers were made
in fraud of GT as a creditor of Sheikh Fahad
("the Pauline Action").
4 Birt, Deputy Bailiff, allowed the equitable proprietary
claim to the extent that GT’s money was still traceable into two
properties in London. Because it had allowed the equitable
proprietary claim, the Court did not need to express a view on the restitutionary claim, but the Deputy Bailiff took the
opportunity to state that where an innocent third party receives the subject-matter
of a breach of trust or fraud or its traceable substitute, he must make
restitution to the victim of the breach or fraud, subject to the defence of
change of position. He also allowed the Pauline Action in
respect of some of the transfers by Sheikh Fahad of
his own money and the proceeds of the fraud to Abacus of the
Esteem Settlement, subject to the defence of change of position. The judgment shows how Jersey
law has developed to deal with third party recipients where they have received
the traceable proceeds of fraud or assets transferred by the fraudster in order
to defeat the victim's claims. In
order to see clearly the difference between the English and Jersey
approaches, it is useful to look first at the position of recipients of the
victim's property or its traceable proceeds and then at the position of
recipients of money transferred by the fraudster into which the victim's
property is not traceable.
PERSONAL LIABILITY OF RECIPIENTS OF THE VICTIM'S PROPERTY
OR ITS TRACEABLE PROCEEDS OR SUBSTITUTES
(a) English
law – knowing receipt
5 Under
English law, a knowing receipt claim will lie against a third party recipient
of the victim's property or its traceable proceeds or substitutes, but only if
the victim can prove that the third party received it with knowledge that it
was transferred in breach of trust/fraudulently. The test is whether the recipient's
state of knowledge is such as to make it unconscionable for him to retain the
benefit of the receipt. Once knowledge has been proved, the
recipient becomes personally liable as a constructive trustee of the assets
received. The element of knowledge
must be proved in the case of volunteers and purchasers alike, as English law
does not distinguish between them for the purposes of a knowing receipt claim.
6 If
the victim can prove receipt but not knowledge, then no claim at all will lie
against the recipient. This means
that in a case where the victim can
trace the proceeds of fraud into the hands of the recipient but not beyond, and
even though he can prove receipt, in the absence of proof of knowledge on the
part of the recipient the victim will be left with no remedy (because the
tracing trail has run cold). The
requirement of knowledge as a constituent part of the cause of action in every
case has been criticised: it is difficult to see why recipients of
the traceable proceeds of fraud to which they are not
entitled - irrespective of their state of knowledge at the time of receipt -
should not come under a personal liability to make restitution to the
victim. Whether they should also be
treated as constructive trustees is a separate question and the two issues
should not be elided.
(b) Jersey law – personal restitutionary
liability
(i) Volunteers
7 In
Esteem the Deputy Bailiff rejected knowledge
or fault as a necessary prerequisite for the imposition of a personal
receipt-based liability on a recipient who did not give value in exchange for
receipt of the victim’s property or its traceable proceeds or
substitutes. This development will make
it easier for victims of fraud to recover against remote volunteer recipients
whose state of mind it may be difficult to prove. The Deputy Bailiff explicitly recognised
that the basis of recovery is restitutionary; the aim
is to prevent the volunteer recipient from being enriched through receipt of
the proceeds of the fraud at the expense of the victim. According to the Deputy Bailiff,
“the state of mind required for a ‘knowing receipt’ claim is
not required in Jersey. It is a strict restitutionary
liability.” The liability is a personal one only: in
order to impose liability as a constructive trustee on the recipient it will
remain necessary to prove fault or knowledge. This approach keeps separate the
question whether the volunteer recipient should make restitution from the
question whether he should be treated as a constructive trustee with all the
consequences that follow from that status.
8 It
is also clear from the Deputy Bailiff’s judgment that innocent
volunteers, who have acted in good faith and changed their position in reliance
on the receipt will be able to rely on the change of position as a defence (in
whole or in part) to the receipt-based liability. For example, if a fraudster transferred
stolen gold to his niece by way of gift and she used part of it to finance a
holiday which she would not otherwise have been able to take, she would only be
liable to return the gold still in her hands and could rely on the change of
position defence in respect of the gold which she had sold
to pay for her holiday, as long as she could demonstrate that she had acted in
good faith so that her conscience was untouched by the fraud. Although the Deputy Bailiff confirmed
the principle that the concept of relative fault is not to be introduced into
the Jersey law on change of position, his judgment provides little guidance as to when a recipient will
be deemed not to have acted in good faith so as to be denied the defence.
9 In
Lipkin Gorman Lord Goff thought that a
recipient who pays away the money received with knowledge of the facts
entitling the plaintiff to restitution would be acting in bad faith. The quality of knowledge required
in order to constitute bad faith was discussed further by the Court of Appeal
in Niru Battery Mfg Co v Milestone Trading Ltd, which held that the touchstone of bad faith is not merely
dishonesty (although the defence of change of position would be lost in those
circumstances): the focus is on whether it would be unjust to allow
restitution. The key to the
principle of change of position is that it involves a balance between the
interests of the payer and those of the payee. The Court of Appeal drew parallels with
the degree of knowledge required to support a knowing receipt claim - the
recipient's state of knowledge must be such as to make it unconscionable for
him to retain the benefit of the receipt. This does not require him to act
dishonestly; it can include a failure to act in a commercially acceptable way
and sharp practice. For example,
where the payee has grounds for believing that a payment may have been made by
mistake, but cannot be sure, good faith may well dictate that he should make
enquiry; a person who has, or thinks he has, good reason to believe that he has
been paid by mistake is unlikely to have been found to have acted in good faith
if he pays the money away without first making enquiries of the person from
whom he received it. Thus, actual and definite knowledge of
the plaintiff’s right to restitution is not always necessary: if the
recipient is put on enquiry as to the circumstances surrounding the transfer of
assets to him, the principle of good faith requires him not to dispose of them
without making further enquiry.
10 If
the Niru Battery test were to be adopted in
Jersey, its effect combined with that of the recognition of strict personal restitutionary liability on the part of a volunteer
recipient would be to relocate knowledge as an element of the cause of action
to an element of any defence. This would cause the burden of proof to shift
from the claimant - who would need to prove that the recipient had knowledge in
order to fix him with personal liability for knowing receipt under English law
- to the recipient who, under Jersey law, would need to prove that he did not
have sufficient knowledge to render unconscionable his retention of the
benefit. If the recipient could
show that he did not have such knowledge as to make it unconscionable for him
to retain the benefit of the receipt in circumstances where he had changed his
position in reliance on it, he would not be personally liable to the extent of
his legitimate change of position.
11 This
strikes a sensible balance between the interests of the victim of a fraud and
the third party recipient who acts in good faith because it will usually be
more difficult for a victim to prove knowledge on the part of a remote third
party recipient than it will be for that recipient to prove his own lack of
knowledge and change of position.
If the victim can prove knowledge, the recipient will hold the proceeds
of fraud as constructive trustee under both English and Jersey
law. If, however, the victim cannot
prove knowledge, no personal remedy will be available against the recipient
under English law, whereas under Jersey law
the restitutionary remedy will be available. It follows that where a victim is likely
to experience such difficulties of proof against a volunteer recipient, if it
is possible to argue for the application of Jersey
law rather than English law, it would be advantageous to do so.
(ii) Purchasers
12 In
his judgment in Esteem, the Deputy
Bailiff made no mention of the position of recipients who have given
value. On the facts, GT was an
innocent volunteer and it follows that any comments made by the Deputy Bailiff
on this point would have been obiter. Nevertheless, his judgment begs the
question whether strict restitutionary liability
should also be imposed on recipients who give value for what they receive. If not and they are to be treated
differently, the distinction has the following consequences. In the case of purchasers, the
requirement of knowledge would remain an element of the
cause of action, so that the burden of proof of knowledge would rest on the
victim of the fraud. In the case of
volunteers, the availability of the receipt-based restitutionary
claim would require the location of the issue of knowledge in the context of
the defence of change of position, so that the burden of proof of lack of
knowledge would rest on the recipient.
In the absence of any sound reason for the distinction it is difficult
to see why the incidence of the burden of proof should be different in each
case.
13 Purchasers
and volunteers are treated differently under English law to the extent that the
defence of bona fide purchase is available
only to recipients who have given value for what they have received in good
faith and without notice of the plaintiff’s equitable title to it. Continuing the example set out at
paragraph 8 above, if the fraudster’s niece paid him for some of the gold
and did so in good faith and without notice of the fraud, the bona fide purchaser defence would
operate in respect of the part of the gold for which she had given value, so
that she would only have to return the remainder still in her hands. The availability of the bona fide purchase defence in the
context of transfers of personal property appears to be predicated upon the
need not only to protect individual recipients who have, as a consequence of
receipt, sustained losses which it would be inequitable to force them to bear,
but also to facilitate trade by protecting transactional security in exchange
dealings with the primary economic objective of facilitating the free transfer
of wealth. It is this second objective – to
protect the market – which is unique to the bona fide purchase defence and does not form part of the rationale
for the defence of change of position.
The change of position defence is more individualistic in nature: it is
concerned to protect individual recipients who have, as a consequence of
receipt, sustained losses which it would be inequitable to force them to bear,
and so it is available to purchasers and volunteers alike. It may be that the wider rationale for
the bona fide purchase defence
justifies its wider ambit; in contradistinction to the change of position
defence, it operates as a complete bar to the claim, is not limited to
post-receipt losses and protects not only the initial purchaser but also those
who derive property from him.
14 In
circumstances where the need to facilitate trade and the interests of the
individual are both protected by the existence of the bona fide purchase and change of position defences, there is no
obvious justification for the burden of proof of knowledge resting on the
victim of the fraud simply because the recipient is a purchaser rather than a
volunteer. In the absence of any
principled reason to the contrary it makes sense for the cause of action to be
the same whether the recipient is a volunteer or a purchaser and for knowledge
or lack of it to be a relevant element of any available defences rather than of
the cause of action itself. In those circumstances, there is
no logical impediment to the recognition of the personal restitutionary
liability on the part of a third party recipient who has given value for what
he has received.
15 This
prompts the question whether Jersey law
recognises the operation of the bona fide
purchase defence. If it does,
then the requirements of security of receipt and freedom of trade could be
regarded as being adequately protected, so that there would be no apparent
difficulty with the extension of the strict personal restitutionary
liability to both categories of recipient.
If on the other hand Jersey law recognises only change of position as a
defence to a receipt-based restitutionary claim, then
consideration must be given as to whether the requirements of exchange
transactions and security of receipt require purchasers to be treated
differently from volunteers, so that the personal restitutionary
remedy should only be available against the latter and victims of fraud would
still have to prove knowing receipt on the part of the former.
16 Unfortunately,
the position in Jersey is unclear. In Esteem
the Deputy Bailiff appears to have assumed (without deciding) that the bona fide purchaser principle is
recognised in Jersey, at least in the context of equitable proprietary claims,
in so far as he held that where an innocent volunteer has a wholly owned
company into which the proceeds of fraud are injected, e.g. through a loan account, it is artificial to treat the company
as a bona fide purchaser for value so
that the tracing stops at the relationship between the volunteer and his
company – the tracing exercise must be continued into what the company
did with the proceeds. The
principle was also recognised in the Golder case in the
context of a Pauline Action (as to which more below) and, more recently, as a factor which could possibly circumscribe the operation of the Hastings Bass principle. The Golder case was, however, subsequently distinguished by the Royal Court in Mendonca v Le Boutillier. In that
case, it was held that although a transferee acting in good faith receiving
chattels from a transferor who did not have good title did acquire: (a) the
right to receive any income and benefits from these movables without having to
account for them to the owner; and (b) civil possession followed by eventual
ownership if the owner did not reclaim the chattels within a period of ten
years, bona fide purchase without
notice would not of itself suffice to prevent the original owner from being
entitled to reclaim the chattels.
The Court stated that the Jersey law of
contract was based on Roman law and distinguished Golder on the basis that it related to a Pauline Action rather than a
straightforward contractual claim.
17 It
may be that Mendonca itself can be distinguished as relating
to a contractual claim, while the operation of the bona fide purchase defence could be recognised extra-contractually
in the context of equitable proprietary claims, Pauline Actions and personal restitutionary claims based upon the receipt of
misappropriated funds. Further
examination of this point by the Royal
Court would be welcome. In the absence of a clear statement as
to whether the bona fide purchaser
principle operates in Jersey at least in relation to equitable proprietary
and/or restitutionary claims so sufficiently as to
protect transactional security, it is difficult to say with any certainty
whether Jersey law can or should allow victims of fraud to invoke the
receipt-based restitutionary claim against recipients
who have given value for what they have received or whether victims of fraud
would still have to prove knowing receipt against purchasers.
(iii) Liability
for profits
18 In
Esteem the Deputy Bailiff held that
third party recipients of the proceeds of fraud could be deemed constructive
trustees of those proceeds if they were at fault, i.e. had knowledge of the provenance of the funds/the
plaintiff’s title to them. In
other words, in order to hold a third party recipient liable as constructive trustee (rather than simply liable to make restitution), it is
legitimate to require the victim of the fraud to prove knowledge (rather than
allowing strict liability subject to defences). The location of the requirement of
knowledge in the context of the cause of action - rather than in the context of
any defences - in such a case is justifiable in light of the burdens imposed
and advantages gained by the treatment of the recipient as a constructive
trustee. For example,
constructive trustees will be liable to pay compound interest; and the victim will be able to claim any increase in value in the
trust property from a constructive trustee. Thus, the
arguments justifying the shifting of the burden of proof in relation to
knowledge to the defendant where it is merely sought to impose a personal restitutionary remedy upon him are not sufficient to do the
same where it is sought to impose upon him the more onerous obligations of
constructive trusteeship.
(c) Conclusion
19 In
cases where the defendant has received the property of the victim of a fraud or
its traceable proceeds or substitutes, the introduction of a receipt-based restitutionary remedy into Jersey
law is to be welcomed. In cases
where the recipient is a volunteer, it makes sense to locate the element of
knowledge in the context of any defence of which he may avail, rather than
requiring the victim of a fraud to prove knowledge. In cases where there is a
question as to whether or not Jersey law or
English law should govern the dispute, this new development should encourage
plaintiffs to argue that Jersey law is the
applicable law. The position of
purchasers is less clear. In the
absence of clarification as to the existence and ambit of the bona fide purchase defence in Jersey law, it is difficult to predict whether the Royal Court will
impose a personal restitutionary liability on
purchasers in the same way. Where
it is sought to compel a recipient – be he volunteer or purchaser - to
disgorge any profits made out of the proceeds of the fraud, the victim will
still have to prove knowledge as an element of the cause of action in order to
impose the more onerous obligations of constructive trusteeship. This is consistent with principle and in
line with English law. In the next
part of this article consideration will be given to the different approaches of
English and Jersey law to
recovery by the victim of a fraud when the tracing trail runs cold.
PERSONAL LIABILITY OF RECIPIENTS OF THE FRAUDSTER’S
PROPERTY BY WAY OF A TRANSFER OF WHICH A SUBSTANTIAL OBJECTIVE IS TO DEFEAT THE
VICTIM’S CLAIM
(a) The
principle
20 Where
the victim of a fraud cannot establish a proprietary connection between the
subject-matter of the fraud and any assets received by the third party
recipient, he will not be able to advance a knowing receipt claim (England) or
a receipt-based personal restitutionary claim
(Jersey). Nevertheless, if the
victim can show that the fraudster transferred his own assets to the third
party recipient with the intention to defeat the claims of creditors, he may be
entitled to revoke the transfer, irrespective of his inability to trace into
its subject-matter. The principle
is not new: it derives from the Roman law actio Pauliana and can be traced through the
Statute of Elizabeth 1571 into section 172 of the English Law of Property Act
1925 and, most recently, into sections 423-5 of the Insolvency Act 1986, article 17 of the Bankruptcy (Désastre) Law 1998, and
the Pauline Action, which forms part of Jersey customary law.
21 The
rationale of the actio Pauliana is
that -
"… if a person has
alienated his property in fraud of creditors who have been put in possession by
order of the governor, they are allowed to bring an action cancelling the
alienation, that is alleging that the property has not been alienated and
therefore remains an item in the debtor's estate."
In form the action resembles rescission, save that the
party entitled to trigger the rescission or revocation of the transaction is
the creditor whose interests have been prejudiced, rather than the person who
has made the transfer (the fraudster).
(b) English
law – Section 423 of the Insolvency Act and transactions at an undervalue
22 This
principle is expressed in English law through the operation of Section 423 of
the Insolvency Act 1986, which entitles creditors to set aside transactions at
an undervalue which are made by a debtor, where a substantial purpose of the
transaction is to put assets beyond the reach of a person who is making or may
make a claim against him or otherwise prejudicing the interests of such a
person. It is axiomatic to say that transactions
at an undervalue may include transfers of assets in respect of which no value
is given. An application to set
aside such a transaction will be treated as having been made on behalf of every
victim of it, and the court has a wide discretion as to the sort of order it
may make (e.g. vesting orders,
discharge or release of securities, etc.) There is no requirement
to prove insolvency at the time of or as a result of the transaction and it
extends to persons who may be future creditors. Section 423 is the first provision in
Part XVI of the Insolvency Act, which is entitled “Provisions Against
Debt Avoidance”. A
declaration of bankruptcy/insolvency is not a prerequisite for Section 423 to
operate. Sections 238 and 339 deal
with the position where transactions at an undervalue have been entered into by
an insolvent company or a bankrupt individual and how they may be set aside.
(c) Jersey statute - Article 17 of the Bankruptcy (Désastre) Law 1990, as amended
23 Article
17 of the Bankruptcy (Désastre)
Law 1990 (as amended by the Bankruptcy (Désastre) (Amendment) Law 2006). permits a transaction at an undervalue
to be set aside, where the transaction has been entered into by a person in
respect of whose property a declaration of désastre has been made, unless the debtor
entered into it in good faith for the purpose of carrying on a business and
there were reasonable grounds for believing that the transaction would be of
benefit to the debtor. A parallel
provision which operates in the context of a creditors’winding
up is to be found in Article 176 of the Companies (Jersey)
Law 1991. These Jersey
provisions were based on sections 238 and 339 of the English
Insolvency Act. It follows that athough it is also premised on the notion of a transaction
at an undervalue, Article 17 does not operate as a direct statutory equivalent
of Section 423, not least because it is only applicable where a declaration of désastre has already been made. The nearest thing to Section 423 under Jersey law appears to be the Pauline Action.
(d) Jersey customary law – the Pauline Action
24 The
Pauline Action also provides a victim of fraud with the right to revoke a
transfer by the fraudster of his assets to a third party recipient if the
transfer causes the victim to become a creditor of the fraudster and it renders
the fraudster insolvent or is made at a time when he is already insolvent. The action derives from Jersey customary
law and the elements of the cause of action differ depending on whether the recipient
is a volunteer or has made payment at an undervalue (when the transfer is known
as an aliénation lucrative) or is a purchaser who has
given full value (when the transfer is known as an aliénation onéreuse). If the cause of action is established,
the transfer of assets is revoked so that the assets then become available to
satisfy the victim’s claim.
(i) Personal liability of volunteers
– aliénations lucratives
25 A
volunteer recipient’s liability to return the benefit depends on the
victim being able to demonstrate the following:
(a) a transfer of assets
from the fraudster to the recipient which was made at a time when the fraudster
was insolvent or which rendered him insolvent in the sense that his liabilities
exceeded his assets. If the victim can prove insolvency in
this sense at the time of the Pauline Action, the burden of proof will shift to
the fraudster to prove that he was not insolvent at the time of the transfer. Where a fraudster has
misappropriated and dissipated funds which exceed the value of his own assets
(as will often be the case with large frauds), insolvency will not be difficult
to prove;
(b) that
the victim was a creditor at the time of the transfer. A victim of fraud will become a creditor
at the time the facts giving rise to his cause of action occur, even if the
validity of the cause of action is not established until later. In practice the debtor/creditor
relationship will be easy to establish;
(c) that a substantial
intention of the fraudster in making the transfer was to defraud his
creditors. This need not be his
only or dominant purpose but it must be a substantial purpose; and
(d) that the victim of the
fraud was actually prejudiced by the transfer. Again, this
should be relatively easy to prove: the transfer of assets coupled with
insolvency will have the effect of rendering the fraudster unable to meet the
victim’s claim. It would only
be if the victim were able to trace the proceeds of the frauds to other
defendants, who retained them or were good for the money, and make successful
personal or proprietary claims against them that it might be said that he had
not been prejudiced by the transfer of assets.
26 The
Deputy Bailiff described the Pauline Action against Abacus, an innocent
volunteer, as revocatory in nature and
"essentially a restitutionary action seeking to
place the parties back into the position in which they would have been before
the transaction." He stated that when the recipient
is an innocent volunteer, the creditor is not entitled to compensation –
he is merely entitled to claim the property itself, subject to the operation of
the defence of change of position.
27 The
Deputy Bailiff did not analyse in detail why the Pauline Action – at
least in the case of an aliénation lucrative – should be treated as restitutionary in nature. Indeed, a Pauline
Action against a volunteer is not easily described as an action requiring the
recipient to make restitution to the creditor for a benefit gained at his expense (in the subtractive sense) because the volunteer
need not have received the creditor’s money or its traceable proceeds to
be liable; nor is the action properly categorised as one which grants
restitution for a wrong because the innocent volunteer recipient has committed
no wrong. Even so, Birks describes
this type of action as a restitutionary action, which
is recognised directly in response to the need to protect creditors and
investors from this sort of malpractice. Although it does not fit into the usual
categories of restitution to reverse subtractive unjust enrichment (e.g. mistake, duress, ignorance) or
restitution for wrongs, the policy of creditor protection appears to drive the
need for a restitutionary remedy to be recognised.
28 According
to the Deputy Bailiff, the Pauline Action is best regarded as a personal action
in order to prevent the unjust enrichment of the recipient. He confirmed that the creditor has no
title in the thing alienated from the fraudster to the volunteer recipient, and
went on to say that the creditor is not asserting any claim to the thing
itself: he is simply actioning the recipient to return it (if he still has it)
to the fraudster’s patrimony or to return such value originating from the
thing as may remain in the recipient’s hands. When read in conjunction with the Deputy
Bailiff’s earlier statement that the creditor claims the property itself
subject to the defence of change of position, this statement could lead to
confusion, as it tends to suggest that the claim is in fact proprietary (for
the value retained by the recipient) rather than personal (for the full amount
transferred).
29 The
distinguishing feature of the Pauline Action is that it does not assert any
pre-existing proprietary right or title on the part of the creditor in the
assets or money transferred to the recipient. The creditor is not seeking to re-vest property in himself, which has
made its way through the fraudster into the hands of the volunteer recipient
and may be identified as having been received by him. He is simply asserting an entitlement to
revoke the transfer from the fraudster to the recipient on the basis that it
was made by the fraudster at a time when he was insolvent in order to defeat
his (the creditor’s) claim.
It is therefore not a proprietary claim (in the legal or equitable
sense). If, as the Deputy Bailiff
seems to have intended, the claim is to be treated as a personal one, it would
perhaps be clearer to say that the recipient comes under a personal liability to make restitution of what he has received, save and
in so far as he may rely on any change of position made in good faith and in
reliance on the receipt.
30 If
it is right to say that the Pauline Action – at least in the case of an aliénation
lucrative – is restitutionary in nature, it follows that in a case of
fraud, where the victim becomes a creditor of the fraudster because the
fraudster has misappropriated the creditor’s money, dissipated it (at
least in part) to a volunteer and has insufficient assets to repay it, the
Pauline Action mirrors the receipt-based restitutionary
claim which now forms part of Jersey law.
In both cases the volunteer recipient will be held personally liable to
make restitution of the funds received, subject to the availability of the
change of position defence. Logic
dictates that the test for establishing good faith change of position should be
the same, whatever the cause of action.
On this basis, if the Niru Battery test
is to be applied in Jersey (and there is no reason why it should not be applied
here), the test for establishing the defence in all cases will be whether the
recipient’s knowledge is such that it would be unconscionable for him to
retain the benefit of the receipt.
It follows that knowledge should not be a pre-requisite to establishing
the cause of action in either case: rather, it becomes relevant in establishing
whether the recipient changed his position in good faith and in reliance on the
receipt. The difference between the
two causes of action is then only that in order to establish the receipt-based restitutionary claim, the creditor needs to use the tracing
process to identify the stolen property or its traceable substitutes or
proceeds in the hands of the volunteer recipient.
31 If
this analysis is correct and were to be adopted in Jersey,
it might be said that Jersey law provides a
seamless response to fraud where the proceeds of the fraud and/or the
fraudster’s own assets are transferred to a volunteer recipient. Where the victim can trace his property
into the hands of the recipient, the recipient will be strictly liable to make
restitution of the benefit, subject only to the operation of the change of
position defence. Where the victim
cannot trace, but can show that the fraudster transferred assets to the
recipient with the substantial intention of defeating the rights of his
creditors, and that transfer rendered the fraudster insolvent or was made at a
time when he was already insolvent, he can bring a Pauline Action to reverse
the transaction and again, the recipient will be strictly liable to make
restitution subject to being able to establish a good faith
change of position in reliance on the receipt of the assets.
32 By
way of contrast, although it may be easier for a victim to establish a case
under Section 423 of the Insolvency Act (e.g.
because there is no need to prove insolvency and/or because Section 423 is also
available to creditors with future claims), the unavailability of the purely
receipt-based restitutionary remedy in the UK and the
fact that it will often be relatively easy to prove insolvency in large-scale
fraud cases makes the application of Jersey law and the Pauline Action more
attractive to victims of fraud.
(ii) Purchasers
33 As
discussed in paragraphs 22-3 above, Section 423 of the Insolvency Act is
limited in the sense that it applies only to transactions at an
undervalue. It does not catch
transfers of assets by the fraudster to a third party recipient who gives full
value for them, even if the recipient had knowledge of or shared the
fraudster’s intention to defeat creditors. This is in contradistinction to the
terms of the predecessors of Section 423, i.e.
s. 172 of the Law of Property Act 1925 and the Fraudulent Conveyances Act 1571,
both of which allowed a disposition made with intent to defraud creditors to a
transferee who had notice of that intent to be set aside even where the
transferee had given value. Section 423 provides no remedy for
victims of fraud in cases where the tracing trail stops and the fraudster
transfers his own assets to a third party for full value in order to defeat the
victim’s claim.
34 Section
423 does not deal with the situation where a fraudster (who has become
insolvent as a result of the fraud) transfers his own assets to a third party
for value in order to defeat the claim of the victim of the fraud. The Pauline Action can, however, provide
the victim with a remedy in those circumstances.
35 In
circumstances where the debtor/fraudster has transferred his assets to a third
party for value (known as an aliénation onéreuse) and that third party is privy to the
real nature of the transaction, i.e. that it was being made in order to defeat creditors'
interests, the Pauline Action operates to set aside the transfer of assets to
the third party. It follows that
even when the tracing trail runs cold, a victim of fraud may still be able to
reverse a transfer by the debtor of his own assets to a third party for value. This makes the Pauline Action a powerful
weapon against fraud in circumstances where the fraud renders the fraudster
insolvent.
36 The
judgment of the Royal Court
in the case of Golder v Société
des Magasins Concorde Ltd sets out the elements of the cause of action where there has been
an aliénation onéreuse. As in the case of an aliénation lucrative, the victim of the fraud/the
creditor does not have to prove that the recipient received the
creditor’s property or its identifiable proceeds or substitutes. The conditions for the victim’s
success in the case of a transaction for value (an alienation onéreuse) are the same
as those outlined in relation to aliénations lucractives save that the victim must also show a
degree of complicity on the part of the recipient. Importantly, an aliénation does not become onéreuse simply because some cause or value is given; if the
transaction is at an undervalue, it will still be deemed to be an aliénation lucrative. The victim
of a fraud will only need to go on to prove the complicity of the third party
recipient if the recipient has given full value for what he has received.
37 According
to the Royal Court
in Golder,
the liability of the recipient in the case of a Pauline Action based on an aliénation onéreuse is
to make restitution. In Golder a Guernsey
company bought the business of a Jersey
company after judgment had been entered against the Jersey
company in an unfair dismissal claim.
The personnel in both companies were related and the Royal Court found that the sale had been
engineered in order to defeat the claim of the former employee of the Jersey company, who had brought the wrongful dismissal
claim. It turned out that the
business of the Jersey company had then been
sold on by the Guernsey company to a third
party. The Royal Court found that the third party
was a bona fide purchaser for value
without notice of the fraudulent nature of the sale and whose title could not
therefore be impugned. The net
proceeds of sale remained in the hands of the Guernsey
company. The Bailiff referred to
the writings of Domat and held that
the true nature of the obligation on the Guernsey
company was to make restitution to the plaintiff. The Court declared that the purported
sale as between the Guernsey company and the Jersey company was void and obliged the Guernsey
company to make restitution to the plaintiff in the amount of the award of
compensation and costs.
38 In
Esteem the Deputy Bailiff
characterised the liability arising in the case of an aliénation onéreuse
as having its basis in fraud.
He did not go on to discuss whether in such a case the Pauline Action
would be characterised as restitutionary in
nature. It may be possible to
characterise the cause of action in the case of an aliénation onéreuse
as one giving rise to a liability to make restitution for a wrong. In a Pauline Action against a recipient
who has given value, the defendant’s wrong is his acceptance of the
fraudster’s assets in circumstances where he was privy to the real nature
of the transaction, i.e. that a
substantial purpose of it was to defeat the victim’s claim. The recipient can be said to have acted
unconscionably and neither the defence of change of position nor the bona fide purchase defence will be
available, as the recipient will be unable to prove good faith. Further analysis from the Royal Court of
the juridical nature of the cause of action in the case of an aliénation onereuse
would be welcome.
39 It
is also possible to identify parallels between the Pauline Action in the case
of an aliénation onéreuse and
knowing receipt under English law.
In a knowing receipt claim the recipient’s wrong is his acceptance
of the assets of the victim or their traceable proceeds with sufficient
knowledge of their provenance such as to make it unconscionable for him to
retain them. In a Pauline claim
against a recipient who has given value, the wrong is similar in nature and in
both cases, the recipient can be said to have acted unconscionably. However the cause of action is
characterised (as restitutionary or otherwise), in
neither case is the defence of change of position or the bona fide purchase defence available because the recipient cannot
prove good faith. In both
cases the state of mind and knowledge of the recipient is crucial.
40 Neither
of the judgments in Golder
or Esteem stipulate precisely the
degree of knowledge required on the part of the recipient so that the victim
can use the Pauline Action to set aside a transaction for full value. In Esteem, the Deputy Bailiff simply repeated the phrase used in Golder, i.e. that in order to be liable, the recipient must have been privy to the real nature of the
transaction. This phrase gives
little guidance as to the state of mind required.
41 Some
explication of the degree of knowledge required can, however, be found in the
French commentaries referred to by the Royal Court in Golder. Pothier stated
that in cases where the debtor is insolvent and makes a transfer in defeasance
of his creditor's interest -
"[J]e [the creditor]
pourrais agir contre le tiers acquéreur pour faire rescinder
l'aliénation qui lui en a été faite en fraude de ma
créance, pourvu qu'il ait été participant de la fraude, conscius fraudis, s'il
était acquéreur à titre gratuit."
[I could take action against the recipient in order to rescind the
transfer which was made to him fraudulently in order to defeat my claim,
provided that he was a participant in the fraud, conscius
fraudis, if he acquired the title onerously, i.e.
by giving value for it.]
Pothier's
emphasis is on participation by the recipient, conscious fraudis, i.e. with consciousness of the fraud. This suggests that knowledge of the
fraudulent intent is required, but neither the degree of knowledge nor the
level of participation is stipulated.
42 Domat also focused on the fact of participation by the
recipient in a fraud on creditors, stating that:
"Celui qui aura participé
à une fraude faite à des créanciers, sera tenu de render tout ce qu'il se trouvera avoir reçu par une
telle voie, après les fruits ou autre revenues, & les
intérêt, si ce sont des deniers, à compter depuis le jour
qu'il les aura reçus. Et
toutes choses seront remises au même état où elles
étaient avant cette fraude."
[Anyone
who has participated in a fraud on creditors, will be obliged to return all
that he is found to have received in this way, after the fruits or other
profits, and the interests, if they take the form of money,
are to be counted from the date on which he received them. And all things shall be given back in
the same state in which they were before this fraud.]
43 In the absence of any
express description of the degree of participation and/or
knowledge/consciousness of the fraud on the part of the recipient, it is
difficult to assess what is required.
Shortly after judgment was given on liability in
the wrongful dismissal claim in Golder, the Guernsey
company offered to buy the business of the Jersey
company for market value, which offer was accepted. Formal agreements of sale were entered
into in July 1966, after the judgment on quantum was delivered. The court referred to the relationship
between the board members of both companies (they were closely related by
marriage), the admission that the board members of the Jersey
company hated the plaintiff and the fact that the sale was shrouded in
secrecy. This was all sufficient to
demonstrate that the Guernsey company was
"privy to the real nature of the transaction" and "had knowledge
of" the intention to defraud the plaintiff. Although there was no real discussion of
the type or extent of knowledge required, it was clear on the facts that the
board members of the Guernsey company had
knowledge of the Jersey company’s
intention to defraud the plaintiff.
The family connection suggests that the knowledge was probably actual,
as opposed to constructive.
44 In
light of Golder and the French authorities, it seems
that the victim of a fraud will need to prove, as a minimum, that the recipient
was conscious of the fraud when he received and gave value for the assets
transferred to him by the fraudster.
It is less clear whether the recipient will be held liable simply
because he was put on enquiry (i.e.
whether unconscionability will suffice); nor is it
clear whether the victim will also need to show that the recipient participated
in the fraud, i.e. shared the fraudster’s
intention to defeat the creditor’s claim and took steps to effect that
intention (i.e. whether dishonesty
must be proved).
45 In
order to assess what degree of knowledge should be required in order to prove
liability in the context of an aliénation onéreuse it may be helpful to draw on the
parallels between the Pauline Action and knowing receipt. In the context of a knowing receipt
claim the touchstone is unconscionability –
does the recipient know enough to make it unconscionable for him to retain the
benefit of the receipt? In knowing
receipt cases, the policy is to protect the victims of a
breach of trust: the defendant who is held to be liable knew or ought to have
known that the property received by him was transferred in breach of
trust. As between himself and the
victim, he is morally culpable and there can be no reason for him to retain the
benefit of what he received. In the
case of dishonest assistance, in order to be personally liable to restore the
value of the trust property to the plaintiff (which may no longer be in his
hands), the defendant's participation in a transaction (which assisted a breach
of trust) must be contrary to normally acceptable standards of honest conduct. The difference in
standard between receipt and assistance may be simply due to the fact that in
cases of receipt the defendant had the trust property in his hands at one point
(at which time his state of mind should have prompted him to return it),
whereas in a case of assistance, he need not have received it at all and could
never have returned it. His role is
slightly more tangential and so, in order to make him liable as constructive
trustee, his conduct must have been worse than that necessary to make him
liable simply for receipt.
46 In
the absence of any additional policy reason which requires the victim to prove
actual knowledge or dishonesty in the context of a Pauline Action, it is
difficult to see why the recipient should not be liable on the basis of the unconscionability test, as expounded in the Niru Battery test: he will be liable to give
up the assets he has received if he has or has good reason to think that the
transaction in which he is involved is being carried out in order to defraud
creditors or the victim’s claim.
In Pauline Actions, the policy is to protect creditors from actions
taken by their debtors to defeat or prejudice their claims. If a recipient of the debtor’s
assets knows or should know that the transfer to him is intended to defeat the
claims of a creditor, as between himself and the creditor he is morally
culpable and should therefore be liable.
The only additional factor in the context of a Pauline Action is that
the creditor may never have had title to the assets transferred by the debtor
to the recipient for value. It may
be possible to justify a higher standard of knowledge or dishonesty in such a
case on the basis that: (i) the third party recipient
never received the property of the victim of the fraud/the creditor or its
traceable proceeds, only the property of the fraudster; and (ii) it may be more
difficult for a recipient to ascertain the debtor’s
state of mind at the time of the transfer and that the intention to defraud
creditors was a substantial purpose out of, quite possibly, several purposes,
than it would be for him to ascertain that assets received were transferred in
breach of trust. On the other hand,
in cases of fraud at least, it may be preferable to standardise the degree of
knowledge required of the recipient so that the same standard applies whether
he received the traceable proceeds of the victim’s property or assets of
the fraudster in order to defeat the victim’s claim. This is a question which will need
further consideration and exposition by the Royal Court.
47 This
leads on to the question whether there is any reason for purchasers to be
treated differently from volunteers in the context of Pauline Actions. The availability of the bona fide purchase defence in English
law makes it easier to argue for a strict restitutionary
response in the case of receipt by third parties of the proceeds of fraud,
subject to the change of position defence (in the case of volunteers) and both
defences (in the case of purchasers); proof of knowledge by the victim only
becoming necessary when it is sought to hold the recipient liable as a
constructive trustee. The fact that
purchasers are treated differently in the context of a Pauline Action, so that
the burden of proof of the recipient’s knowledge rests on the victim, may
be largely due to the fact that under Roman law/Jersey customary law, there
appears to be no complete bona fide purchase
defence, at least in the case of contractual disputes. If the bona fide purchase defence were available to recipients in the
context of Pauline Actions, there might be an argument for extending the strict
restitutionary liability to them too, subject to the
change of position defence. This
would only work if the standard for liability were held to be knowledge/unconscionability rather than dishonesty and, if accepted,
it would create complete symmetry between the receipt-based restitutionary
remedy where the defendant receives the traceable proceeds of the
victim’s property and the Pauline Action. At the moment, however, it is
difficult to say whether such an alignment is desirable because: (i) it is unclear whether the test for knowledge in relation
to aliénations onéreuses is
knowledge or dishonesty; and (ii) if the former, consideration would still have to be
given to whether transactional security can be said to be sufficiently well
protected under Jersey law to allow purchasers to be subjected to strict restitutionary liability and for the question of their
knowledge to be located in the context of any defences upon which
they might seek to rely, rather than as an element of the cause of action
itself.
(iii) Liability
for profits
48 In
Esteem the Deputy Bailiff held that
there was an unbroken line of French commentary to the effect that the innocent
volunteer does not have to account for the profits earned whilst he is the owner
of the thing which has been alienated, “at any rate prior to the
commencement of proceedings.” He rejected the argument that as the
Pauline Action is one grounded in the law of restitution, it would be fairer to
make the recipient account for the fruits of the transferred assets subject to
a change of position defence, stating that the court could not change a
long-established rule simply because some other rule might be fairer. Instead he held that the innocent
recipient is free to do what he pleases with the assets and use their profits
until such times as litigation is commenced seeking to set aside his
title. Once he knows that his title
is under attack, he should act cautiously before deciding to deal with the
profits earned during that period. The decision therefore permits of a
limited liability to give up profits earned on the subject-matter of the
transfer, even though the claim is not a proprietary one, nor is it a claim to
re-vest title to property in the creditor upon rescission (in respect of which
an order for disgorgement of profits could possibly be recognised).
49 Simply
relying on the date of commencement of litigation without more as the relevant
date for determining whether the volunteer recipient should be liable for
profits appears to be a little arbitrary.
For example, the creditor might have been in correspondence with the
recipients for months before commencing litigation and in the course of that
correspondence may have put the recipient on notice that the transfer of assets
by the fraudster was made with the intention of defrauding the creditor’s
claim and that the recipient’s title to the assets was under
challenge. In that case, is it
difficult to see why the creditor should still receive all the interest/profits
up to the date on which litigation was commenced. Similarly, would the settlement of a
Pauline Action before the commencement of proceedings preclude a claim for
profits? A better
way of rationalising the French commentaries on the obligation to give up the
fruits of the assets transferred to the volunteer recipient may be to say that
from the date on which the action was commenced in the Esteem case, Abacus’ knowledge was such to make it
unconscionable for it to generate and keep any profits made after that date. On that basis, the touchstone of unconscionability as set out in Akindele could be applied to Pauline Actions for profits against
volunteers. An account of profits
would be ordered only from the date on which the recipient had sufficient
knowledge of the victim’s challenge to his title to the assets so as to
make it unconscionable for him to retain the benefit of any profits generated
on those assets. Applying the
touchstone of unconscionability in this way would
mirror the use of the concept to distinguish between the personal liability of
an innocent volunteer for receipt of the traceable proceeds of the
victim’s property and the liability as constructive trustee of a
volunteer who has knowledge of the fraud.
This would provide an attractive symmetry between the claims predicated
on receipt of the traceable proceeds of the victim’s property and the
Pauline Action in the case of an aliénation
lucrative. The proper
distinction would be not between volunteers and purchasers but between
recipients who had the requisite knowledge and those who did not.
50 Whatever
the test for establishing the state of mind of a guilty recipient in the case
of an aliénation onéreuse,
it seems likely that such a recipient will be liable for profits. If, as discussed, it is thought right to
compel a volunteer recipient to disgorge any profits (either from the date on
which litigation has been commenced or from the date on which his conscience is
touched with the awareness that his title to the assets is subject to challenge),
it is arguable that in circumstances where the recipient has accepted the
transfer of the assets from the fraudster at a time when he was privy to the
real nature of the transaction, from that point on he should be obliged to
disgorge any profits made from the tainted assets.
51 The
French commentators do not expressly state that profits are to be disgorged,
but the view that they should be appears to gain some support from the writings
of Domat, as cited in the Golder case -
"Celui qui aura participé
à une fraude faite à des créanciers, sera tenu de render tout ce qu'il se trouvera avoir reçu par une telle voie, après les fruits ou autre revenues,
& les intérêt, si ce sont des deniers, à compter depuis
le jour qu'il les aura reçus.
Et toutes choses seront remises au même état où
elles étaient avant cette fraude."
[Anyone
who has participated in a fraud on creditors, will be obliged to return all
that he is found to have received in this way, after the fruits or other
profits, and the interests, if they
take the form of money, are to be counted from the date on which he received
them. And all things shall be given
back in the same state in which they were before this fraud.]
The use of the word, “after” in relation to the
fruits or profits suggests that those fruits are profits are also to be
returned.
52 If
recipients of aliénations onéreuses are
always liable to disgorge profits, care must be taken to delineate clearly the
state of mind required in order to establish liability on their part. For this reason, further clarification
on the meaning of the phrase “privy to the real nature of the
transaction” would be welcome.
If the test is knowledge/unconscionability,
then there is a clear parallel with the obligation to give up profits earned by
a defendant guilty of knowing receipt.
(c) Conclusion
53 As
a result of the Deputy Bailiff’s judgment in Esteem a victim of fraud seeking to recover assets under Jersey law now has powerful weapons at his disposal. As against third party volunteer
recipients, he may assert the strict liability receipt-based restitutionary remedy in order to recover the traceable
proceeds or substitutes of his property and, where this leaves a shortfall, the
Pauline Action in order to recover any of the fraudster’s own property
which has been transferred away for less than full value in order to defeat his
claim. In neither case will the
victim need to prove knowledge on the part of the volunteer recipient as an
element of the cause of action: the recipient’s state of mind will be
relevant only in so far as he seeks to rely on the good faith change of
position defence. It is argued that
the touchstone for knowledge/good faith against which the recipient’s
state of mind should be measured is that of unconscionability
as explained in the Niru Battery case. As regards profits, an innocent
volunteer does not have to account for profits prior to the commencement of
proceedings seeking to set aside his title. Arguably, the law can and should be
modernised so that the touchstone is unconscionability
rather than the date on which proceedings are commenced.
54 The
position of third party purchasers is less clear. A victim of fraud may certainly recover
the traceable proceeds of substitutes of his property if he can prove knowing
receipt on the part of the third party purchaser, but as yet it is unclear
whether Jersey law will recognise a strict
liability restitutionary remedy subject only to the
change of position and/or bona fide purchase
defences. This depends on whether
it is thought that the element of knowledge should continue to be treated as
part of the relevant cause of action or whether it should be relocated as a
requirement of any defence to a strict liability receipt-based claim. Careful consideration also needs to be
given to whether and if so, how and to what extent the bona fide purchase defence should operate under Jersey law and if
not, how the need to protect transactional security can be met.
55 Where
a fraudster has mixed the proceeds of fraud with his own assets and transferred
both away to third parties, when the tracing trail runs cold the Pauline Action
may provide an effective remedy against purchasers for full value. It offers a victim more protection than
either the English or Jersey statutory
remedies but, as in the case of a knowing receipt claim, the victim must prove
knowledge on the part of a purchaser as an element of the cause of action. Again, the standard of knowledge is
unclear and there are arguments which can be made in favour of both the unconscionability standard and a higher standard of
dishonesty. In the absence of clear
analysis as to the operation of the bona
fide purchase defence under Jersey law, it
is difficult to see how arguments can be made for strict restitutionary
liability on the part of purchasers.
In view of the fact that a purchaser for full value must have a guilty
mind before he will be liable to a claim by way of Pauline Action, there is no
reason why he should not also be accountable for profits.
Sinéad Agnew, Ll.B
(hons) (Dub), M. Juris (Oxon), M.Phil
(Cantab), is a Senior Associate in the litigation
department at Ogier.