21st Century Logistic Solutions Ltd v Madysen Ltd

Neutral Citation No [2004] EWHC 231 (QB). IN THE HIGH COURT OF JUSTICE QUEENS BENCH DIVISION Case No: HQ03X1643 Royal Courts of Justice Strand, London, WC2A 2LL Date: 17 February 2004 Before : THE HONOURABLE MR JUSTICE FIELD - - - - - - - - - - Between : 21St CENTURY LOGISTIC SOLUTIONS LIMITED (IN LIQUIDATION) Claimant - and - MADYSEN LIMITED Defendant - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - Mr. John Briggs (instructed by Boyes Turner) for the Claimant. Mr. Gerard McMeel (instructed by Simon F H Holmes) for the Defendant. Hearing date: 29th January 2004 - - - - - - - - - - - - - - - - - - - - - Judgment Mr Justice Field: Introduction 1. This is a claim by 21st Century Logistic Solutions Limited ("21stC") suing by its Liquidator, Ms Louise Brittain, for the price of goods sold and delivered. The goods in question are 7,220 Intel 2.4 533 mhz computer processor units ("CPUs"). The price was £770,400 plus £134,820 VAT, making a total of £905,220. The buyer, Madysen Limited ("Madysen"), does not dispute delivery or quality. It contends that it is not liable for the price on grounds of illegality. This is therefore yet another case where it is appropriate to quote Lord Mansfield’s famous dictum in Holman v Johnson (1775) 1 Cowp 341, at 343: "The objection, that a contract is immoral or illegal as between plaintiff and defendant, sounds at all times very ill in the mouth of the defendant. It is not for his sake, however, that the objection is ever allowed; but is founded on general principles of policy, which the defendant has the advantage of, contrary to the real justice, as between him and the plaintiff, by accident, if I may say so. The principle of public policy is this; ex dolo malo non oritur actio. No Court will lend its aid to a man who founds his cause of action upon an immoral or an illegal act. If, from the plaintiff’s own stating or otherwise, the cause of action appears to arise ex turpi causa or the transgression of a positive law of this country, there the Court says he has no right to be assisted." 2. The facts giving rise to this plea of illegality are agreed. 21stC was incorporated by an individual using the name Darren King on 20 March 2002 as part of "a missing trader fraud" or "carousel fraud" designed to defraud HM Customs & Excise ("HMCE") of VAT. In this type of fraud a trading entity (the "missing trader") is incorporated and registered for VAT in the UK. It then purchases high value, low volume goods, eg CPUs, from suppliers outside the UK but within the EU, effectively free of VAT. The missing trader then sells the goods on in the UK, charging VAT. The goods are often passed down a chain of contracts, VAT being charged on each supply but with the intermediate suppliers setting off the output tax arising on the onward supply against the input tax arising on the acquisition. The missing trader, however, has no intention of accounting for the output tax due on the supply it makes to the first buyer in the chain. Instead, it pockets the price, including the VAT, and then disappears without paying anything to HMCE. 3. HMCE maintain that the same person who incorporated 21stC had earlier incorporated another missing trader called Simtru Ltd ("Simtru") which he used to implement a substantial missing trader fraud. He then abandoned Simtru to its fate and incorporated 21stC as a "phoenix company" to carry on where Simtru left off. 4. At a date unknown, Darren King caused 21stC to purchase a consignment of 7,200 CPUs from Phoenix Technology, a foreign supplier operating from Luxembourg. The price agreed was £864,000 (£120 per unit) and no VAT was charged. The consignment entered the UK and was stored by 21stC at the premises of Shurgard Storage Centres UK Ltd ("Shurgard") in Essex. Sometime in December 2002, a man calling himself Darren King telephoned a Mr Patrick of Madysen. Darren King purported to be acting on behalf of 21stC. The two men agreed that Madysen would buy the 7,200 CPUs from 21stC for £107 per unit, plus VAT, and then sell them immediately on to a company called Pycom Limited ("Pycom") at £108 per unit, plus VAT. It was explained to Mr Patrick that 21stC were not allowed to deal with Pycom because of a territorial issue. The goods were to be delivered by 21stC direct to Pycom. By an invoice dated 10th December 2002, ("the VAT invoice") 21stC invoiced Madysen for the sale of the 7,200 CPUs at a cost of £770,400, plus VAT of £134,820, making a total price of £905,220. By an invoice dated 11th December 2002, Madysen invoiced Pycom for the sale of the 7,200 CPUs at a price of £777,600 plus £136,080 VAT and on 12 December 2002 Madysen received £913,680 from Pycom for the sale of the CPUs. 5. Madysen received payment instructions from 21stC in the form of a faxed letter on 21stC letterhead dated 11 December 2002 from Darren King (described as "Managing Director"). These instructions split the price into two tranches and required each tranche to be paid outside the UK. This appeared to Mr Patrick to be suspicious and he reported his concerns to HMCE on 13 December 2002. 6. On the same day, Mr Patrick received a telephone call from Darren King requesting him to refund the sale proceeds to Pycom. He refused to do this. Pycom claims that on 13th December 2002 an impostor claiming to be Mr Patrick at Madysen falsely represented over the telephone that Madysen wanted to cancel the contract with Pycom because 21stC was being investigated for VAT fraud and Madysen wished to return the goods to 21stC. Pycom claims that it was then agreed that if it made available 7,200 equivalent units for collection by 21stC, Madysen would reimburse to Pycom the £913,680. Relying on this agreement, Pycom allowed 21stC to collect 7,200 equivalent units from Shurgard. 7. On 16 January 2003, HMCE obtained a freezing injunction against 21stC and Darren King which inter alia required Madysen to pay to HMCE the debt of £905,220. That order was then varied to allow Madysen to pay that sum into a joint solicitors’ account and £828,220 is now secured in this way. On 5th February 2003, HMCE served a notice of direction on 21stC following which they claimed that 21stC owed £134,820 in VAT. On 31st March 2003, pursuant to a winding up petition presented on 20th March 2003 by Pycom (HMCE consenting), Ms Brittain was appointed Provisional Liquidator of 21stC on the application of HMCE and Pycom. 8. HMCE and Pycom have each proved in 21stC’s liquidation. HMCE claim to be entitled to the output tax payable on the supply to Madysen and also to be able to look to the assets of 21stC to satisfy their claims against Simtru and Darren King for fraudulent evasion of VAT. Pycom’s claim is for damages arising out of the alleged re-delivery of CPUs to 21stC. Given the timing of the VAT invoice and the winding up order, it seems that HMCE is a preferred creditor for the VAT owed by 21stC, and thus if the plea of illegality fails HMCE will be paid the VAT due from 21stC on the supply of the CPUs to Madysen. 9. HMCE have agreed with Madysen that they may set off the input tax payable on the acquisition of the CPUs against the output tax due on the supply to Pycom. However, if Madysen’s illegality defence succeeds, this agreement will be reversed and Madysen will account to HMCE for the output tax without the benefit of the set-off. Even so, 21stC will be still be in default of its obligation to account to HMCE for the VAT due on the supply to Madysen. 10. It is agreed for the purposes of this hearing that at the time of the contract between 21stC and Madysen, Darren King had no intention of causing 21stC to pay to HMCE the VAT arising from that supply and intended 21stC to "go missing". It also agreed that Madysen was unaware that Darren King had this intention. There can be no doubt that Darren King was the directing mind and will of 21stC at the time of the contract with Madysen. It follows that I must decide this case on the basis that at the time the contract was made, 21stC dishonestly intended to defraud HMCE by not accounting for or paying the VAT and Madysen was unaware of this intention. Is the contract unenforceable on grounds of illegality? 11. It is often said that a party who enters into a contract for a fraudulent purpose is disabled from enforcing the contract. Thus, the authors of Chitty on Contracts (28th ed) refer in paragraph 17-158 to "the general common law principle that one who knowingly enters into a contract with an improper object cannot enforce his rights thereunder" and in Skilton v Sullivan CA 18th March 1994; The Times, 25th March 1994, Beldam LJ said: In a case in which one party to a contract seeks performance of an obligation under the contract by the other party, it is now well established that the contract entered into with the object of committing an illegal act is unenforceable. If both parties enter that contract with that objective, neither can enforce it. If one of the parties does so and the other is unaware of the illegal purpose the party whose object is illegal cannot enforce the obligation of the other. A similar statement is to be found in Hall v Woolston Hall Leisure Limited [2001] 1 WLR 225 in para 30 where Gibson LJ said: In two types of case it is well established that illegality renders a contract unenforceable from the outset. One is where the contract is entered into with the intention of committing an illegal act; the other is where the contract is expressly or implicitly prohibited by statute: St John Shipping Corpn v Joseph Rank Ltd [1957] 1 QB 267, 283 per Devlin J. 12. Mr. McMeel who appeared for Madysen relies on these statements of principle. He submits that 21stC entered into the contract with Madysen for the purpose of defrauding HMCE and thus cannot now rely on that contract to enforce Madysen’s obligation to pay the price. If Mr. McMeel is right Madysen will be left with a windfall of at least of £777,600 and 21stC’s liability to account to HMCE for the VAT due on the supply of the CPUs will not be discharged. But as Lord Goff said of the principle ex turpi causa non oritur actio in Tinsley v Milligan [1994] 1AC 340 at 355 B-C: It is important to observe that, as Lord Mansfield made clear, the principle is not a principle of justice; it is a principle of policy, whose application is indiscriminate and so can lead to unfair consequences as between the parties to litigation. Moreover, the principle allows no room for the exercise of any discretion by the court in favour of one party or the other. 13. Contracts to defraud the Revenue are often cited as examples of contracts that are unenforceable because their object is illegal and fraudulent. In Miller v Karlinski (1945) 62 T. L. R. 85 the Court of Appeal held it to be too plain for argument that a contract of employment under which the employee was paid a salary and also "expenses" that included the income tax payable on the salary was against public policy and therefore unenforceable. In Napier v National Business Agency Ltd [1951] 2 All E. R. 264 the Court of Appeal took the same approach. Here, the plaintiff sought to sue for wrongful dismissal on a contract of employment under which he was paid £13 salary per week and £6 "expenses", when his expenses could never exceed £1 per week. The Court of Appeal held that the parties had made this bargain knowing well that the expenses figure was a sham figure and that by making the agreement in that form they were intending to defeat the proper claims of the Revenue. The contract was therefore against public policy and unenforceable. 14. Napier v National Business Agency Ltd was referred to in Skilton v Sullivan (above). Here the seller of a quantity of Koi carp sent the buyer an invoice for trout. The supply of Koi carp is chargeable to VAT but the supply of trout is not. When the seller sued for the price, he was met with a plea that the contract was illegal as being a fraud on the Revenue. The Court of Appeal, however, rejected the defence of illegality. They found that at the time the contract was entered into there was no intention to defraud the Revenue and although the subsequent sending of the invoice for trout was an unlawful act, the seller was not relying on that act to recover the price. Rather, he was relying on the contract and that was not a contract entered into for the purpose of committing an illegal act. However, as Simon Brown LJ observed: Had the plaintiff here, within the contractual document or for the purposes of the contract itself, described the subject matter as "trout zero rated" rather than "carp zero rated" in order to evade his liability for VAT, I have no doubt that such conduct would indeed have involved his performing the contract in an unlawful manner. The case would then have been on all fours with Napier v National Business Agency Ltd [1951] 2 All E. R. 264, except only that the unlawful intent would have been unilateral rather than mutual – a distinction which could not have availed him: see St. John Shipping Corp. v Joseph Rank Ltd [1957] 1 Q. B. 267. 15. Another case often cited as an example of the court refusing to enforce a contract whose object was the committing of an illegal act (defrauding the Revenue) is Alexander v Rayson [1936] 1 K. B. 169. This authority is of some importance in determining whether Madysen’s plea of illegality is made out. The action was for arrears of rent. The evidence at trial was that the plaintiff granted a lease to the defendant at a rent of £1200 and contracted that certain services in connection with the flat would be performed. The plaintiff sent the defendant two documents. One was a lease with the benefit of certain services at a rent of £450 pa. The other was an agreement for services in connection with the flat for a consideration of £750. The plaintiff used these two documents because he planned to defraud the local Assessment Committee by representing that the total rent was £450. The flat had been assessed at £720 gross, £597 net but when the plaintiff submitted just the lease to the Assessment Committee the gross valuation was reduced to £270. However, the valuation authority learned about the other agreement from the tenant and restored the original figures of £720 gross and £597 net. Sometime later, the plaintiff sued for arrears of rent and was met by the defence of illegality. At trial, the defendant was allowed to open and called evidence showing how the two documents had been used in an attempt to mislead the Assessment Committee. The plaintiff then sought a ruling that the evidence called by the defendant did not found a defence of illegality. The ruling of the trial judge, du Parcq J., is reported as follows (p 171): Upon [the evidence] Mr Pritt, for the defendant, said that if an agreement, although legal on the face of it, was entered into for an unlawful purpose it could not be enforced by the guilty party. There was, however, in his Lordship’s opinion, no case which decided that where one of the parties to a contract meant to make a misrepresentation to a third party about the document containing the contract, the contract itself or its ulterior purpose was illegal. The lease and the agreement were ex facie legal. The plaintiff could fulfil his part towards the defendant without doing anything wrong. All that could be said was that he intended to take advantage of the peculiar form of the documents to suppress the fact of the agreement and not bring it to the knowledge of a third person. In his view that circumstance was too remote from the contract itself for it to be said that it was illegal or entered into for an illegal purpose, that purpose being not for something to be done under it, but as to the use of the document in which the contract was recorded. In this case the contract between the two parties could be performed lawfully; there was no suggestion that the plaintiff intended to perform it in an unlawful manner. For those reasons he held that the point as to illegality failed. 16. The Court of Appeal reversed this ruling. The Court referred to a number of cases where the contract in question had been held to be unenforceable because it was intended that the subject matter of the contract was to be used for an unlawful purpose. One such case was the well known authority of Pearce v Brooks (1866) L. R. 1 Ex. 213, where the contract was one for the hire of a brougham to a prostitute which was supplied with knowledge that it would be used "as part of her display". The Court of Appeal then went on to observe that in the present case the plaintiff’s intention was to make use of the contractual documents for an unlawful purpose, rather than the subject matter of the agreement, i.e. the letting of the flat. They held, however, on the authority of Scott v Brown, Doering, McNab & Co [1892] 2 Q. B. 724, that that made no difference. In Scott the plaintiff’s action for rescission of a contract for the purchase of shares failed because the contract had been entered into with the sole object of rigging the market by inducing the public to believe that there was a real market for the shares and that they were at a premium. The intention was not to make use of the shares in an unlawful way but to make use of the share contract to defraud the public. The Court of Appeal distinguished from the case before it the situation where a party enters into a contract with the intention of subsequently altering it and using it for his own fraudulent purposes as posited by du Parcq J below. At page 189 the Court of Appeal said: In the former case the document is a harmless one, and can only be rendered dangerous by a subsequent act. We see no reason why, before the commission of that act, the document should not be used for an innocent purpose. The intention was mental only and no overt act step in carrying out the fraudulent intention was taken in the transaction itself. In the present case, however, the documents themselves were dangerous in the sense that they could be and were intended to be used for a fraudulent purpose, without alteration, and the splitting of the transaction into the two documents was an overt step in carrying out the fraud. We cannot think that the plaintiff is entitled to bring these documents into a court of justice and ask the Court to assist him in carrying them into effect. 17. In an important article in the University of Toronto Law Journal, Professor Furmston says of Alexander v Rayston: It is apparent that the contract did not require either party to do anything which involved a fraud on the revenue and that the contract could have been performed without any such fraud. The factor which caused the Court of Appeal to hold the contract to be illegal was the plaintiff’s unrevealed intention to use the contractual documents to assist in misleading the local assessment committee. It may well be that this decision is correct but it is important to analyse it correctly. The contract was not one to do an act contrary to the policy of the law (defrauding the revenue) but one to do an act in itself legal but intended by one of the parties to provide a setting for an act contrary to the policy of the law (defrauding the revenue). ….. The decision is understandable but it goes near to the limit of the law. Du Parcq J.’s overruled decision merits serious consideration…. He thought that in the present case the plaintiff’s improper intention was too remote from the contract to make it illegal. The Court of Appeal disagreed but it is clear that there must come a point when the connection with the plaintiff’s intention is too remote. Thus Willistson says "If the contract is merely collaterally connected with an unlawful purpose or act, however, the rule generally adopted is that the contract is valid if it is only remotely connected with an unlawful transaction and rests upon an independent and legal consideration, and the plaintiff can establish his case without relying upon the unlawful transaction. 18. I agree with Professor Furmston that there must come a point when the connection with the plaintiff’s intention to the contract is too remote for the contract to be held to be unenforceable. In other words, not every contract entered into with the intention of committing an illegal act is illegal and unenforceable. I think Simon Brown LJ may well have had this proposition in mind when he said in Skilton v Sullivan: Had the plaintiff, however, even at the time when the contract was made, merely harboured an intention not thereafter to account for VAT on the supply, then, whether that intention was achieved by submitting false invoices such as were here submitted or indeed by concealing entirely the making of the supply, I am not myself satisfied that such an intent alone would involve the performance of this contract in an unlawful manner. 19. Mr. McMeel contended that there was a sufficient proximity between 21stC’s attributed intention to defraud HMCE and the contract with Madysen for the illegality doctrine to apply. In support of this contention he submitted that the price to be paid by Madysen was the subject matter of the contract and this subject matter was to be used for a fraudulent purpose. He also relied on what he said were six overt acts carried out by 21stC in pursuance of the fraud: (1) acquiring VAT registration; (2) seeking out a buyer for the CPUs and then entering into the contract with Madysen; (3) issuing the VAT invoice; (4) arranging the delivery of the CPUs to Madysen’s sub-buyer, Pycom; (5) issuing the payment instructions to Madysen; and (6) requesting Madysen to refund the sub-sale proceeds to Pycom. I reject Mr. McMeel’s contention. In my opinion 21stC’s fraudulent intention is too remote from the contract for it to be held that the contract is unenforceable on grounds of illegality. The VAT element in the price paid for a supply is not held on trust by the supplier for HMCE. A taxable supplier’s only material obligations under the VAT legislation are to account for VAT at the end of each accounting period and to keep proper records. The use of the VAT element of sale proceeds on some purpose other than payment of VAT due to HMCE is therefore not unlawful. It follows that the fraud on HMCE intended by 21stC would only have been finally committed when 21stC failed to account to HMCE at the end of the relevant accounting period. The contract between 21stC and Madysen was a straightforward agreement for the sale of goods. In and of itself it was a lawful contract. It provided the opportunity for Darren King to profit from the intended fraud but that was all: the crucial act that had to be performed to work the fraud was a failure to account to HMCE. 20. Turning to the overt acts relied on by Mr. McMeel, the first is not closely connected to the contract, is not in itself unlawful, and is only one of a number of acts that must be done for the achievement of the fraud. The last can be dismissed immediately since it was not done in furtherance of the fraud. As to the rest, whilst these relate quite closely to the contract, none is in itself unlawful and, as I have held, the contract too was lawful in itself and merely provided the opportunity for Darren King to profit from the intended fraud. Moreover, none of the acts relied on by Mr. McMeel constituted an overt step in the transaction itself in carrying out the fraud. This case is therefore to be distinguished from Napier v National Business Agency Ltd, Rayson v Alexander and Miller v Karminski, since in the first two of those cases the contracts themselves misrepresented the true position and in the third the parties performed the contract in an unlawful way. 21. The overt acts relied on by Mr. McMeel therefore do not in my opinion establish a sufficient proximity between 21stC’s fraudulent intention and the contract for the contract to be vitiated by illegality. Accordingly, I conclude that the fact that Darren King (and through him 21stC) intended that the contract should be part of a fraudulent design is insufficient for the defence of illegality to be made out. "His act did not o’ertake his bad intent and must be buried but as an intent that perish’d by the way." 22. Mr. McMeel submitted that I had to imagine that Darren King was himself before the court urging it to enforce the contract. It was, he argued, unthinkable that the court would allow Darren King to recover the price when all along he had intended to defraud HMCE. However, if Darren King were before the court and his fraudulent design exposed, the fraud would be stopped dead in its tracks and the court could take steps to protect the interest of HMCE. Moreover, the presence of Darren King before the court would not make the fraudulent intention of his corporate creature any the less remote from the contract. 23. Mr. McMeel also pointed out that 21stC cannot claim a locus poenitentiae on the grounds of repentance because its confession to the fraud was the result of the frustration by others of its fraudulent purpose; see Kearley v Thompson (1890) 24 QBD 742 and Alexander v Rayson (above). I agree that 21stC cannot claim a locus poenitentiae, but it does not need to. The fraud has not been carried out, the position of HMCE is protected and 21stC has established that its fraudulent intent at the time of the contract does not render the contract illegal because it was too remote from the contract. Conclusion 24. Mr. Briggs for 21stC advanced a number of interesting arguments in addition to contending that 21stC’s dishonest intention at the time of the contract was not enough to render the contract unenforceable. These included a submission that the court should take account of the fact that 21stC is now in liquidation with HMCE as a proving creditor. He also produced a written submission arguing that the court should adopt the approach taken by the Australian High Court in Nelson v Nelson (1995) 184 CLR 538 of considering the legislation that deals with the alleged illegal conduct (here ss. 60, 70,72, 73 and 74 of the VAT Act 1994) and deciding whether, given the sanctions the legislation provides for, it is appropriate to hold that the contract is unenforceable. Given my conclusion on Mr. Briggs’s primary submission, it is unnecessary for me to decide whether these additional submissions are well founded and I decline to do so. The question of their correctness must therefore await another case. 25. For the reasons given above, the claimant shall have judgement for the sum of £905,220.