Fraud and more than Barnes v Addy – VSCA on accessorial liability for breach of fiduciary duty or trust

In the wake of a fraud the missing money has sometimes vanished for good – spirited overseas perhaps or lost to the fraudster’s gambling habit. There may be a lack of other assets held by the fraudster against which any judgment could be executed. This is why claims that can be made against third parties who were not the fraudsters themselves but were sufficiently involved in what happened, can be so important. In some circumstances, even where they did not receive the stolen or misappropriated money, the third party’s involvement as an accessory is such as to make them liable, and losses can be recovered from them.

On Tuesday the Victorian Court of Appeal handed down its decision in Harstedt Pty Ltd v Tomanek [2018] VSCA 84. It is a significant judgment for their Honours’ remarks as to the different forms of accessorial liability for breach of fiduciary duty – it is not confined only to the second limb of Barnes v Addy (knowing assistance). Further, the judgment is significant for the principles it identifies as to what will constitute “assistance” for the purposes of the second limb (knowing assistance). There is also useful guidance in relation to the five Baden catetogories of knowledge relevant to knowing assistance.

The judgment was unanimous. The bench comprised their Honours Santamaria, McLeish and Niall JJA. I will briefly summarise the facts and decision in this case, before laying out the learnings to be gained from this judgment.

The facts

The appellant Harstedt Pty Ltd had invested $250,000 in one of those investment schemes which in hindsight was probably too good to be true. Investors were promised sizeable profits to be generated by the investment of capital by a humanitarian organisation. Investors deposited money into a CBA account in the name of the corporate vehicle Apollo Development Enterprises Pty Ltd, which they were told was a ‘non-depleting amount’; the funds were to be held inviolate and were not to leave the account.  They were told CBA had agreed to lend three times the amount held in the account, which presumably was to be used to generate profits via the investment platform. In the event, however, the funds (over $4m) were transferred to an account in Spain where they vanished without a trace.

Harstedt sued the company Apollo and others associated with Apollo, including the company secretary Mr Tomanek. Harstedt made various claims, including fraudulent breach of trust by Apollo and a claim against Mr Tomanek for knowing assistance under the second limb of Barnes v Addy. Harstedt was successful at trial against Apollo, but dismissed the claim against Mr Tomanek. Harstedt appealed.

On appeal the Court of Appeal held that Mr Tomanek knew of the essential facts which constituted the dishonest and fraudulent breach of trust by Apollo (see [105]-[108]). However the appeal failed, primarily on the basis that Harstedt had not established “assistance” on the part of Mr Tomanek. Their Honours held that on the evidence, and on the case as advanced (see below), Harstedt had not established anything beyond knowledge on the part of Mr Tomanek of Apollo’s dishonest and fraudulent design. That knowledge, in and of itself, did not facilitate Apollo’s breach of trust and cause the loss arising therefrom. On the evidence, it was insufficient to constitute “assistance” in the relevant sense (see [119]-[121]).

1.Fraud may give rise to different claims against third party accessories 

Note that on the facts of this case, the claim of knowing receipt (first limb of Barnes v Addy) was not considered, nor was there any question of tracing or following the money. This appeal decision only considered the case where a third party may be liable as an accessory to another’s breach of trust or fiduciary duty.

As their Honours acknowledged, the state of the law on accessorial liability in this context has been riddled with uncertainty and disunity; they set out the relevant authorities and case law in footnotes which I have not reproduced here.

Their Honours observed at [68] that there are different forms of accessorial liability for breach of fiduciary duty, which must be kept distinct. Their Honours identified two forms of liability and went on to describe two other situations in which accessorial liability for breach of fiduciary duty may arise. The two forms of accessorial liability their Honours set out were –

  1. Knowing assistance in the breach – the second limb of Barnes v Addy. This was the claim brought in this case. To be liable under this form, the breach of duty or trust must amount to a ‘dishonest and fraudulent design’ (see [68] and the elements set out at [70]). Note, however, that the dishonesty required is on the part of the fraudster, not the third party (see [97] and see also Farah Constructions Pty Ltd v Say-Dee Pty Ltd [2007] HCA 22; (2007) 230 CLR 89 at [160], [163] and [179]).
  2. Knowing inducement or immediate procurement of the breach. The High Court in Farah drew attention to a line of cases preceding Barnes v Addy in which it was accepted that a third party might be liable as an accessory to a breach of trust (or, their Honours noted, fiduciary duty) on this basis. Procuring or inducing a breach of fiduciary duty is distinct from participating in it (see [68]). The Full Federal Court in Grimaldi v Chameleon Mining NL (No 2) [2012] FCAFC 6; (2012) 200 FCR 296 observed that for this head, as with corporate alter ego cases (see next) it is not necessary to show any dishonest or fraudulent design here, or improper purpose on the part of the trustee or fiduciary (see [245] of Grimaldi; see [161] of Farah). Their Honours in Harstedt sets out the cases under this head at footnote 28 and 29, but see also Marriner v Australian Super Developments Pty Ltd [2016] VSCA 141 and the decision of Sloss J at first instance in Australian Super Developments Pty Ltd [2014] VSC 464 from [274].

The two “other situations” their Honours discussed at [69] in which accessorial liability for another’s breach of fiduciary duty may arise were –

  1. Alter ego of the wrongdoer. Their Honours described this as where a company is the corporate creature, vehicle, or alter ego of a wrongdoing fiduciary or trustee, and the wrongdoer uses the company to secure the profits or inflict the losses of their breach (see [69], citing Grimaldi at [243]). In these cases the corporate vehicle is fully liable for the profits made from, and the losses inflicted by, the fiduciary’s wrong. I note that as the Full Federal Court observed in Grimaldi, the basis for third party liability in these cases is said to be that the company had full (imputed) knowledge of all of the facts, and either has a “transmitted fiduciary obligation” or “jointly participated” in the breach. Liability does not turn on the need to show dishonesty, although it often provides the reason for the interposition of the company. (See [243] of Grimaldi.)
  2. Trustee de son tortThis is where the third party is not a trustee but nevertheless presumes to act as a trustee and then commits a breach or profits from the position. In those circumstances the third party can be liable as a trustee de son tort (see [69], citing Mara v Browne [1896] 1 Ch 199, Nolan v Nolan [2004] VSCA 109 at [25]-[29]).

I will not launch into a doctrinal debate about these forms of liability here, although I note that pleadings in these cases need to be carefully considered and framed. However it is worth pausing to comment further on the basis of liability  for number 1 immediately above – where the third party is the corporate alter ego of the wrongdoer. Regarding that type of case, it has been noted it is ‘rather artificial’ to use Barnes v Addy to explain this liability (see [243] of Grimaldi.) Having said that, in Grimaldi, Mr Grimaldi’s company Murchison Pty Ltd was found liable for Mr Grimaldi and Mr Barnes’ diversions of money away from Chameleon Pty Ltd…under both limbs of Barnes v Addy (knowing assistance and knowing receipt). Murchison Pty Ltd was also found liable for aiding and abetting the contraventions of ss181 and 182 of the Corporations Act committed by Mr Barnes as was Mr Grimaldi. (See [312]-[321] where the trial judge’s findings are set out, and the Full Court’s agreement with those findings at [322]-[345] of Grimaldi). As an aside, I note that the defendants had claimed the diverted funds were payments properly posted to their loan accounts – see what the Full Federal Court had to say about that at [336] – the funds were not stolen but they were misappropriated.

I note too that in 2012 in Grimaldi, the Full Federal Court outlined four “quite different manifestations of [third party] participation” in another’s breach of fiduciary duty or breach of trust, rendering them liable in equity. These were framed somewhat differently to those identified here by the Victorian Court of Appeal; for those interested, see Grimaldi at [243]-[248]. My 2012 article discussing the Full Federal Court’s decision in Grimaldi may be read here, and my 2012 discussion of the issue of de facto directors and officers as dealt with in the judgment may be read here. Mr Grimaldi was unsuccessful in obtaining special leave to appeal to the High Court – see here.

2.Assistance  

As noted above, this week’s judgment in Harstedt is also significant for the principles it identifies as to what will constitute “assistance” in the breach of trust or fiduciary duty for the purposes of the second limb (knowing assistance).

Their Honours acknowledged that the authorities offer little guidance, and that plainly whether a third party has assisted relevantly is a question of fact for each case. However their Honours distilled two principles as having emerged from the authorities and commentary on this point (at [116]-[118]) –

  1. There will be assistance where, but for the action or inaction of the third party, the breach of fiduciary duty would not have occurred. Their Honours observed that a common example is the role of a bank or other financial intermediary the function of which is essential to effect a transaction that amounts to a breach of trust.
  2. There may also be assistance where the third party has facilitated a breach of fiduciary duty that would have occurred in any event. (emphasis added)

Before any bankers reading this sit up in alarm at their Honours’ comment under principle 1 immediately above, it should be noted that a finding of assistance alone will not be enough to found liability as an accessory. Indeed there are four necessary elements of liability under the second (knowing assistance) limb of Barnes v Addy. These were set out by their Honours at [70], citing Farah and Grimaldi, and are –

  1. The existence of a fiduciary duty owed by the fiduciary (trustee or otherwise),
  2. A ‘dishonest and fraudulent design’ on the part of the fiduciary,
  3. Assistance by the third party in that design, and
  4. Knowledge on the part of the third party of the circumstances constituting that design.

Turning briefly then to the last of these – knowledge.

3.The Baden categories of knowledge

Their Honours’ judgment in Harstedt also provides useful guidance in relation to the five Baden categories of knowledge relevant to ‘knowing assistance’ at [85]-[87].

The Baden categories are –

  1. Actual knowledge
  2. Wilfully shutting one’s eyes to the obvious
  3. Wilfully and recklessly failing to make such inquiries as an honest and reasonable person would make,
  4. Knowledge of circumstances which would indicate the facts to an honest and reasonable person, and
  5. Knowledge of circumstances which would put an honest and reasonable person on inquiry.

Their Honours noted that the first two speak for themselves. In Harstedt, their Honours’ findings as to Mr Tomanek’s knowledge of the three essential facts which constituted the dishonest and fraudulent breach of trust by the company Apollo fell into the first and second categories (see [105]-[108]).

As to the third category – wilfully and recklessly failing to make inquiries as an honest and reasonable person would make – their Honours observed that this ‘involves such a calculated abstention from inquiry as would disentitle the third party to rely upon lack of actual knowledge of the trustee’s or fiduciary’s wrongdoing’ (see [86]).

I pause to note that last year in Sino Iron Pty Ltd v Worldwide Wagering Pty Ltd [2017] VSC 101, Hargrave J found the third category of knowledge on the part of the director and general manager of the betting company which had unknowingly received over $2m in stolen funds, as at the date they then credited it to the fraudster’s betting account. His Honour took the view that based on what (little) they did know, the inquiries they made were manifestly inadequate. He held that they ought to have made the ‘simple inquiry’ of identifying and contacting the depositors of the stolen funds, and asking if they intended to pay the money to the sports betting company for the benefit of the customer claiming it. My article reviewing and analysing that case can be read here.

As to the fourth category – knowledge of circumstances which would indicate the facts to an honest and reasonable person- their Honours observed that this category ‘is designed to prevent a third party setting up his or her own “moral obtuseness” as the reason for not recognising an impropriety that would have been apparent to an ordinary person’ (see [86]).

The fifth category derives from the doctrine of bona fide purchaser for value without notice (see [86]).

The Court of Appeal noted that the High Court in Farah endorsed the Baden scale and indicated that knowledge falling within any of the first four categories, but not the fifth, represents the law in Australia (see [87]).

Conclusion…and a window left open – omission/acquiescence

The Victorian Court of Appeal’s judgment in Harstedt is worthwhile for practitioners to be across. Their Honours’ remarks as to the different forms of third party liability as an accessory to breaches of fiduciary duty or trust are instructive. Further, the judgment contains useful guidance as to what will constitute “assistance” for the purposes of the second limb (knowing assistance), and as to the five Baden catetogories of knowledge.

One final aspect: Their Honours noted that Harstedt advanced its case as to “assistance” as one of active involvement by Mr Tomanek. Their Honours remarked that Harstedt did not contend that Mr Tomanek’s “assistance” comprised his acquiescence with the breach, which acquiescence caused the loss. Therefore, so their Honours noted, it was unnecessary to decide whether an omission or acquiescence may amount to “assistance” under the second limb (see [119]). Their Honours observed that the authorities on this point appear to be in disharmony. They set out a list of such cases at footnote 84.

Clearly their Honours have left this matter open. It raises interesting questions as to whether a failure to stop a fraud could constitute “assistance”; whether sitting on one’s hands could be held to be enough to facilitate a fraud, sufficiently to amount to “assistance” and satisfy that element of a claim for liability in respect of the fraud against a third party. I would speculate that may depend upon the knowledge of the third party. If the third party’s level of knowledge of the fraud reaches a high enough Baden category, then a failure to take any action to stop the fraud may be more likely to be found to constitute sufficient “assistance” in the fraud. It will be interesting to see what happens in the cases to come.

Sino Iron v Worldwide Wagering – a case of fraud and restitution “with the lot”

It has not been a good week in Australian courts for sports betting enterprises. On Thursday Tabcorp was fined $45million for breaching anti-money laundering and counter-terrorism financing laws. To less publicity, the day prior, the Victorian Supreme Court found another sports betting company and individuals and companies associated with it were liable for the consequences of receipt of stolen funds of over $2million. The case is Sino Iron Pty Ltd v Worldwide Wagering Pty Ltd [2017] VSC 101.

This was a case of fraud and restitution “with the lot” – the issues raised by the fraud and addressed in the judgment include money had and received (the stolen funds), Black v Freedman trusts and when they arise, Barnes v Addy claims against third parties for knowing receipt of trust funds and knowing assistance in breaches of trust, the Baden categories of knowledge, when knowledge of an agent will be imputed to the principal, the change of position defence, indefeasibility of title and the fraud and in personam exceptions, tracing issues, and more.

The facts as found by the Court

The two plaintiff companies were involved in the development of Australia’s largest magnetite mining and processing project, the Sino Iron Project, conducted at Cape Preston in the Pilbara, Western Australia. They incurred large debts to a company called Monadelphous Engineering Associates Pty Ltd.

The fraudster, pretending to be an authorised representative of Monadelphous, contacted the plaintiffs and directed payment of Monadelphous’ invoices to be paid into a new bank account. The bank account details given were those of the fourth defendant, a company incorporated in Norfolk Island called Worldwide Wagering Pty Ltd. Worldwide carried on an international sports betting business under the name “Pinnaclebet”.

The plaintiffs paid a total of $2,147,689 into Worldwide’s ANZ bank account on 30 May 2016. Worldwide’s sole director Mr H (the fifth defendant), and its general manager Mr O (the sixth defendant), initially suspected fraud when the funds were paid into their company’s account, as there had been a similar theft from La Trobe University about two weeks earlier. They reported it to the police. However they then spoke with a Worldwide customer known to them, a Mr S, who claimed an entitlement to bet with the funds, and on 1 June 2016 they arranged for Worldwide to credit the stolen funds to Mr S’s betting account. Mr O and Mr H gave evidence this was after checking by email with the police (see [140]-[142]), although the judge found on the evidence that the emails to the police excluded important information including Mr S’s surname, to protect Mr S from further enquiries by the detective (see [193]-[200]).

The stolen funds were then gambled on international sporting events. Most bets were lost. Worldwide paid out $550,000 to Mr S on winning bets. The Court found that most of the approximately $2million was used by Worldwide, Mr H, or related companies. The defendants admitted they had actual knowledge of the fraud at 1.13pm on 7 June 2016, six days after crediting the funds to Mr S’s betting account, and after Mr S had placed his last bet. However after that time, the stolen funds continued to be used by the defendants or related companies (see [8]). This included a sum of nearly $796,000 which passed through a related company The Odds Broker and was used by Mr H to purchase a bank cheque, which was then used to settle the purchase by Mr H and Mr O as tenants in common in equal shares of a property at Bondi Junction. See [6] – [12] of the judgment for summary details of the application of the funds. After Mr S’s last bet, the remaining credit in Mr S’s betting account was $70,479.40, which was later repaid to the plaintiffs.

The plaintiffs claimed the balance of the stolen funds ($2,077,210) or their specific traceable proceeds, on multiple grounds. See the list of claims held to have been successfully made out, in the next section below .

The defendants’ arguments included that prior to the time they had actual knowledge of the fraud, they were entitled to rely on Mr S’s statements that the stolen funds belonged to him or those for whom he acted as agent and were legally obtained. Hence, so they contended, the stolen funds were received by Worldwide, and thereafter dealt with by it and the other defendants, as a bona fide purchasers for value without notice of the fraud. They argued the change of position defence (see below). They also argued that Worldwide did not receive the stolen funds on trust as alleged, because at the time of receipt it had no knowledge of the fraud. (See [23]) They succeeded in this last contention, although it only delayed the arising of the trust for 48 hours after receipt of the funds. The question of when the Black v Freedman trust arose is discussed below.

THE SHORT VERSION 

For those wanting a short summary of the outcome of the decision, here it is: The Court held the plaintiffs had established an entitlement to relief on the following (co-existing and overlapping) grounds –

First, for $2,077,210 against Worldwide on the basis of:

  1. the common law claim for money had and received;
  2. the proprietary claim under Foskett v McKeown principles; and
  3. breach of its Black v Freedman trust obligations.

Second, against Mr H and Mr O for $2,077,210 for knowingly assisting Worldwide to breach its Black v Freedman trust obligations.

Third, against Mr O for knowingly assisting Worldwide, The Odds Broker and Mr H to breach their respective Black v Freedman trusts by disposing of the traceable proceeds of the stolen funds comprised in the $800,000 transferred from Worldwide’s ANZ account to a bank account of The Odds Broker, from whence it was transferred to personal bank accounts of Mr H.

Fourth, against Mr H for the traceable proceeds of the stolen funds comprised in the $800,000 on the basis of:

  1. money had and received; and
  2. knowing receipt of trust property.

Fifth, against Mr H and Mr O for the traceable proceeds of the stolen funds comprised in the $345,000, for knowingly assisting Worldwide to breach its Black v Freedman trust obligations.

Sixth, against Worldwide for proprietary relief in the form of an equitable charge over the Worldwide ANZ account to secure the traceable proceeds of the stolen funds remaining in that account.

Seventh, against Mr H and Mr O for proprietary relief in the form of an equitable charge over the Bondi Junction property to secure the traceable proceeds of the stolen funds used to purchase that property.

Eighth, against Worldwide for $8,500 as an account of profits made from its breach of trust.

Each of these findings involved rejection of the change of position and bona fide purchaser for value without notice defences, on the ground that the defendants did not act in good faith at relevant times because of their knowledge of the fraud to the level of the third Baden category (wilfully and recklessly failing to make such inquiries as an honest and reasonable person would make). The indefeasibility defence also failed.See [452]-[462] for these conclusions. The proceeding was adjourned to allow further evidence and submissions before determining tracing issues.

For those interested in reading more about the claims and defences argued in this case, and a discussion of the legal principles involved, read on.

THE LONG VERSION

1. Knowledge of the fraud

In making his findings as to knowledge, Hargrave J first set out the 5 so-called “Baden categories of knowledge” at [27], derived from the well-known 1993 UK decision. The level of knowledge required to be proven to succeed in a relevant claim or defence varies according to the particular claim or defence. The Baden categories of knowledge are –

(1) actual knowledge;

(2) wilfully shutting one’s eyes to the obvious;

(3) wilfully and recklessly failing to make such inquiries as an honest and reasonable person would make;

(4) knowledge of circumstances which would indicate the facts to an honest and reasonable person; and

(5) knowledge of circumstances which would put an honest and reasonable person on inquiry.

(For a further discussion of these categories, see my 2012 article on Grimaldi v Chameleon Mining here.)

None of the parties alleged that Mr S was a party to the fraud. His Honour remarked that that remained an open question (see [63]), and applied the rule in Jones v Dunkel to drew an adverse inference from the defendants’ failure to call Mr S to give evidence (see [201]-[203]).

The defendants admitted they had actual knowledge of ‘a suspicion of’ the fraud at approximately 1.13pm on 7 June 2016, several hours after an ANZ officer initially told Mr H of it. By 1.13pm Mr H believed the stolen funds were ‘likely’ to have been fraudulent deposits and instructed a staff member to freeze Mr S’s betting account. The Court found that Mr H had actual knowledge of the fraud in the first Baden category from the time he gave that instruction on 7 June. (See [98]-[99])

Worldwide, Mr H and Mr O contended that at the time the stolen funds were credited to Mr S’s betting account 6 days prior, on 1 June 2016, they had made all reasonable inquiries to satisfy themselves that Mr S was entitled to bet with the funds (see [157]). Hargrove J did not accept these submissions.

His Honour took the view  that the knowledge that they had admitted to having at that time constituted circumstances which would have led an honest and reasonable person in their position to have made further inquiries before crediting Mr S’s account with the stolen funds. Thus they should have made those inquiries, including the ‘simple inquiry‘ of ascertaining the identities of the depositors of the stolen funds (the plaintiffs) from the internet bank statements, and contacting them to ask if the deposits had been made by the plaintiffs for the purpose of the international sports betting customer claiming the funds. His Honour found that had they done so, the fraud would have been revealed and Mr S’s betting account would not have been credited (see [158]-[159]).

That finding is suggestive of Baden category 5, possibly 4. However the Court went further, and held that Mr H and Mr H acted wilfully and recklessly in failing to make the ‘simple inquiry’ – see Baden category 3 above. His Honour observed that they also had a commercial motive to want to believe Mr S’s claims, being their plan to expand the business’s turnover and customer base to ready it for sale from which they each stood to profit. As a result, his Honour found, they accepted as true flimsy information from a man with, at best, a mixed reputation, and made only superficial inquiries (see [168]-[179]).

His Honour made his findings to the Briginshaw standard (see [180]-[182]). He found that the defendants had knowledge of the fraud in the third Baden category at the time Mr H and Mr O issued the instructions for Mr S’s betting account to be credited with the stolen funds, and thus before any bets were placed. If that were wrong, his Honour held that the defendants had that level of knowledge after the account was credited but before any bets were placed, or alternatively, prior to the final $1.3m in bets were placed on the morning of 7 June (see [272]).

2. Claims in restitution based on mistaken payments, money had and received

The principles his Honour identified from the authorities were these (see [275]-[279], [286]- [288]) –

  1. When money is paid under a mistake of fact, the person paying the money may recover it from the recipient in a common law action for money had and received. Recovery depends upon whether it would be inequitable for the recipient to retain the benefit. Retention may not be inequitable if the recipient has changed its position on the faith of the receipt and thereby suffered a detriment:  Australian Financial Services Leasing Pty Ltd v Hills Industries Ltd [2014] HCA 14; (2014) 253 CLR 250, 568 per French CJ;
  2. Direct receipt is unnecessary; indirect receipt by a volunteer of traceable proceeds of the money paid by mistake is enough: Fistar v Riverwood Legion & Community Club Ltd [2016] NSWCA 81; (2016) 91 NSWLR 732, 746 [62]-[64];
  3. In a common law action based on money paid by mistake, it is not necessary for the plaintiff to allege or prove that the retention of the money received by the defendant would be inequitable. That is a matter for defence, on which the defendant bears the onus: ASFL v Hills Industries at 593 [66]-[67]; David Securities Pty Ltd v CBA [1992] HCA 48; (1992) 175 CLR 353, 379;
  4. One such defence is change of position. Gageler J in AFSL v Hills Industries proposed two conditions for proof of this defence –
    1. That the defendant has acted or refrained from acting in good faith on the assumption that he/she/it was entitled to deal with the payment received. The defendant need not have relied on knowledge derived from the payer.
    2. That by reason of having so acted or retained from acting, the defendant would be placed in a worse position if ordered to make restitution of the payment than if the defendant had not received the payment at all. The detriment need not always be financial. If it is, it need not be established with precision. It can be an opportunity forgone. However it must, in every case, be shown by the defendant to be substantial: ASFL v Hills Industries at 625-626 [157];
  5. This formulation has been accepted by the Victorian Court of Appeal as consistent with the defence and the principles on which it is based as set out by the majority in AFSL v HillsSouthage PL v Vescovi [2015] VSCA 117; (2015) 321 ALR 383, 399 [65].
  6. A defendant relying on a change of position defence who, prior to the change of position, wilfully and recklessly fails to make such inquiries as an honest and reasonable person would make in all the circumstances (i.e. once they have knowledge to the 3rd Baden category), does not act in good faith on the assumption that he, she or it is entitled to deal with the mistaken payment (which is the 1st of Gageler J’s two conditions for this defence): Macquarie Bank Ltd v Sixty Fourth Throne PL [1998] 3 VR 133, 143-144.

The plaintiffs’ claim under this head was against Worldwide for all of the $2.14 million stolen funds (less the approx $70,000 balance at the end, already repaid), and against related company The Odds Broker for $800,000, and against Mr H for $800,000.

The Court held that the defendants could not avail themselves of the defence here because they had sufficient (Baden category 3) knowledge of the fraud at the time each bet was accepted (see [282]). Worldwide was held liable to the plaintiffs for money had and received for the approx $2million.

The Odds Broker and Mr H argued they were not direct recipients of the stolen funds from the plaintiffs. As regards The Odds Broker, $800,000 was paid to it from the Worldwide ANZ account which was substantially comprised of traceable proceeds of the stolen funds (see [290]). There was no evidence The Odds Broker provided any consideration for the payment or changed its position on the faith of the receipt. On the evidence, it did not act in good faith. It was held liable to the plaintiffs for the traceable proceeds of the $800,000 as money had and received.

As regards Mr H and the $800,000 on-paid by The Odds Broker to Mr H’s personal accounts and applied towards the purchase of the Bondi Junction property, the tracing exercise was not straightforward. However even on the defendants’ case, $731,349.45 of the $800,000 was traceable to the Bondi Junction property. The Court found Mr H did not act in good faith because he had the requisite degree of knowledge. Mr H was held liable to the plaintiffs for $800,000 (or its traceable proceeds) as money had and received. ( See [286]-[294])

3. The Black v Freedman trust on which Worldwide held the funds for the plaintiffs – and when it arose

Hargrove J considered the nature of the trust created by receipt of stolen moneys under the Black v S Freedman & Co [1910] HCA 58; (1910) 12 CLR 105 line of authorities from [306]. His Honour discusses these principles –

  1. Black v Freedman has been treated in Australia as a settled law that a thief holds stolen property on trust for the victim: Levy v Watt [2014] VSCA 60; (2014) 308 ALR 748, 766 [65] (see [313]);
  2. For volunteer recipients of stolen money from the fraudster:  a person entirely innocent of a fraud who comes to know that he or she has received and still retains the proceeds of, or taken advantage of, a fraud to which he or she was not party, cannot knowingly seek to retain those proceeds or that advantage without, in effect, becoming a party to that fraud and liable accordingly: Heperu Pty Ltd v Belle [2009] NSWCA 252; (2009) 76 NSWLR 230, 253 [92] (see [314]);
  3. The innocent recipient’s liability is limited to the amount of the stolen funds (or their traceable proceeds) remaining in the hands of the innocent recipient at the time sufficient knowledge of the theft is obtained: Heperu at 264-268 (145]-[163] (see [315]);
  4. In summary, a third party who receives stolen money as a volunteer is only obliged to account to the beneficial owner of the stolen property on Black v Freedman principles to the extent the recipient holds the stolen property or its traceable proceeds at the time the recipient obtains sufficient knowledge of the theft (see [316]).

(In relation to the first principle above, I note in passing that whilst that proposition is settled law, there has been much controversy about whether this is indeed the correct proposition for which Black v Freedman stands. In Fistar v Riverwood Legion and Community Club Ltd [2016] NSWCA 81; (2016) 91 NSWLR 732 at [37] Leeming JA noted this and discussed the cases and academic writings . Leeming JA noted the principal perceived difficulty is that it is said that a thief can have no title to stolen property and so cannot become a trustee for the true owner. His Honour preferred the view on this of Dr Fox expressed in his 2008 book Property Rights in Money, that what the thief is treated as having is legal possession, and therefore a possessory legal title which is capable of being held on trust. A mere finder of a chattel who has nothing more than possession, has a right against other putative possessors who lack better title. This extends even to thieves. But the thief’s right to possess is exigible only against others, not against the true owner: see Bride v Shire of Katanning [2013] WASCA 154 at [72] per Edelman J (with whom Newnes JA agreed). I note that there are other points of controversy concerning Black v Freedman, including whether the reasons there were confined to property disposed of by those in a fiduciary position.)

His Honour concluded that a trust did not arise upon Worldwide’s receipt of the stolen funds. It had not been proven it had sufficient knowledge of the fraud when it received them on 30 May 2016 (see [316]). However, when the defendants did acquire sufficient knowledge of the fraud on 1 June 2016, Worldwide became liable in equity to account to the plaintiffs for the stolen funds, all of which were still in its hands. The Court held that from that time, Worldwide was a trustee of those funds for the plaintiffs under either a constructive or resulting trust (see [325] and the citations of Heperu at [154]-[155] and Sze Tu v Lowe [2014] NSWCA 462 at [141]-[162]).

4. Knowing receipt – Barnes v Addy first limb

On the findings of knowledge already made, it was held The Odds Broker knowingly received the $800,000 with sufficient knowledge of the fraud. The Odds Broker thus became liable to account to the plaintiffs for that amount as a constructive trustee. It breached that trust by paying the $800,000 or its traceable proceeds to Mr H (see [326]).

Similarly, Mr H received the on-payment from The Odds Broker with knowledge of the fraud. Mr H gave evidence he did not know the money was sourced from the stolen funds when he received it into his bank account. However it was held this made no difference, because Mr O knew all the relevant facts and acted as Mr H’s agent in arranging the transfer of the $800,000 to Mr H’s account to enable the purchase of the property. Mr O’s knowledge was attributable to Mr H, so Mr H knowingly received the traceable proceeds of the $800,000 and thus became liable to account to the plaintiffs as a constructive trustee for that amount. He beached that trust when Mr O, as Mr H’s agent, used the traceable proceeds to purchase the Bondi Junction property (see [327]).

5. Knowing assistance – Barnes v Addy second limb

To be liable under the second limb of Barnes v Addy for knowing assistance, his Honour pointed out at [331] that it must be established that –

  1. The defendant assisted a trustee or fiduciary in a breach of trust or fiduciary obligation;
  2. That breach of trust or fiduciary obligation is characterised by the Court as a ‘dishonest and fraudulent design’, and
  3. The assistance was given with the requisite degree of knowledge of that dishonest and fraudulent design.

As to the third element – the requisite degree of knowledge by the recipient – it was accepted that Baden categories 1 to 4, but not category 5, are sufficient for both the first and second limbs of Barnes v Addy. This is consistent with authority: Farah Constructions (2007) 230 CLR 89, 163-4 [177]; Grimaldi v Chameleon Mining NL (No 2) [2012] FCAFC 6; (2012) 200 FCR 296, 362 [262]; Mathieson Nominees v Aero Developments [2016] VSC 131 [166]. Category 5 is a form of constructive notice, rather than knowledge, and is considered insufficient. (See [332])

The Court concluded at [359] that –

  1. Mr H and Mr O knowingly assisted Worldwide to breach its trust obligations in respect of the whole of the stolen funds and hence each was liable to the plaintiffs for equitable compensation for the unpaid balance of that amount (just over $2million),
  2. Mr H and Mr O were also liable for knowing assistance in respect of the traceable proceeds of the stolen funds comprised in payments totalling $345,000,
  3. Mr O was liable for knowingly assisting Worldwide and The Odds Broker to breach their respective trust obligations regarding the traceable proceeds of the stolen funds comprised in the $800,000,
  4. Mr O was also liable for the traceable proceeds of the stolen funds comprised in the $800,000 for knowingly assisting Mr H to breach his Black v Freedman trust obligations, by using those proceeds to purchase the Bondi Junction property.

These liabilities overlapped with each other and other grounds of liability.

The plaintiffs also made proprietary claims over assets which remained to hand, including the Bondi Junction property.

6. Traceable into the Bondi Junction property?

The plaintiffs claimed entitlement to a proprietary remedy against the property in the form of a charge or equitable lien. This was on the basis that the Bondi Junction property was purchased with a bank cheque sourced from the traceable proceeds of the stolen funds comprised in the $800,000. (Hargrove J noted here that the plaintiffs’ claims against the Bondi Junction property were also established on the basis that Mr H funded the purchase of it in breach of his Black v Freedman obligations, with Mr O’s knowing assistance. See [364])

His Honour noted the following tracing principles –

  1. The beneficial owner of misappropriated property can recover it or its traceable proceeds from the person holding the asset, subject only to the defence that the holder is a bona fide purchaser for value without notice: Foskett v McKeown [2000] 1 AC 102, 129, 108-9, 115;
  2. Where a trustee wrongfully uses trust money to provide part of the cost of acquiring an asset, the beneficiary is entitled at his option either to claim a proportionate share of the asset or to enforce a lien upon it to secure his personal claim against the trustee for the amount of the misapplied money. It does not matter whether the trustee mixed the trust money with his own in a single fund before using it to acquire the asset, or made separate payments (whether simultaneously or sequentially) out of the differently owned funds to acquire a single asset: Foskett v McKeown, the ‘basic rule’ stated by Lord Millett at 131.

Here, the plaintiffs’ property was constituted by their choses in action against their bank representing funds held to their account, including the stolen funds. When their bank mistakenly paid the amount of the stolen funds to Worldwide, the plaintiffs’ property was extinguished and Worldwide obtained a chose in action against its bank ANZ, which became the traceable substitute for the plaintiffs’ former property. In turn, further traceable substitutes for lesser amounts were created by the subsequent movement of the $800,000 (or its traceable proceeds) to the bank accounts of The Odds Broker and Mr H and, subsequently, the relevant bank cheque and the Bondi Junction property (see [365]).

In accordance with Lord Millett’s ‘basic rule’, the plaintiffs had elected to claim a charge on the Bondi Junction property to secure their personal claims against Mr H and Mr O for the traceable proceeds of the stolen funds comprised in the $800,000. Subject to the defendants’ defence based on indefeasibility of title, the Court held those claims should succeed (see [367]).

7. Is this claim against the property defeated by indefeasibility of title?

The defendants argued that Mr H and Mr O’s title to the Bondi Junction property was indefeasible by operation of s 42 of the Real Property Act 1900 (NSW). The merits of this argument turned on whether the events in this case brought it within the fraud exception to indefeasibility of title, as provided in s 42(1).

Hargrove J noted it has been held that –

  1. ‘Fraud’ in s 42(1) means ‘actual fraud, moral turpitude’ or ‘dishonesty of some sort’: Farah Constructions (2007) 230 CLR 89, 169 [192]; Bahr v Nicolay (No 2) (1988) 164 CLR 604, 614 (see [373]);
  2. The 3rd Baden category of knowledge is a species of actual knowledge (as opposed to constructive knowledge): Farah Constructions (2007) CLR 89, 163 [174] (see [375]);
  3. Causing registration on title in circumstances of wilful blindness (failing to make such enquiries as an honest and reasonable person would make) may be dishonest, and was categorised by Tadgell JA as fraudulent in Macquarie Bank Ltd v Sixty Fourth Throne Pty Ltd [1998] 3 VR 133, 143-4 (see [375]).

The Court found that Mr O’s actions in causing his registration as an equal proprietor of the Bondi Junction property were dishonest (at [375]). It found he wilfully and recklessly failed to make such enquiries as an honest and reasonable person would make before instructing a staff member to credit the stolen funds to Mr S’s betting account on 1 June 2016, thus allowing the stolen funds to be used to place bets on that account. This fell within the 3rd Baden category of knowledge. Other evidence of Mr O’s showed that the $800,000 transferred from Worldwide to The Odds Broker  was directly referable to the stolen funds (see [376]). Moreover, on the defendants’ admissions of when they acquired actual knowledge of the fraud at 1.13pm on 7 June 2016, Mr O completed the purchase after obtaining this actual knowledge. He nevertheless proceeded to do so.

Notably, his Honour observed at [378]: “Although Mr O… may not have appreciated that his actions were dishonest, they were.” His Honour so found based on the evidence, and on the High Court’s observation in Farah Constructions at [173] that: “As a matter of ordinary understanding, and as reflected in the criminal law in Australia, a person may have acted dishonestly, judged by the standards or ordinary, decent people, without appreciating that the act in question was dishonest by those standards.

The Court also found that Mr H’s registration as an equal proprietor of the Bondi Junction property was procured by fraud for which he was responsible (from [379]). The plaintiffs contended that even if Mr H did not know the money in his personal bank account used to purchase the bank cheque to buy the property was sourced from the stolen funds, he had authorised Mr O to act as his agent in obtaining the moneys required for settlement of the purchase and that Mr O’s knowing use of the stolen funds should be imputed or “brought home” to Mr H as principal.

On this question of attributing the knowledge of an agent to the principal, at [389] Hargrave J noted the reasoning of the High Court in Cassegrain v Gerard Cassegrain & Co Pty Ltd [2015] HCA 2; (2015) 254 CLR 425 as follows –

  1. The title of a registered proprietary may be invalidated on the ground of fraud ‘brought home’ to the registered proprietary or to his agents: Cassegrain 436-7 [32], citing Assets Co Ltd v Mere Roihi [1905] AC 176, 210;
  2. Whether fraud by an agent will be brought home to the registered proprietor depends upon the ‘scope of authority and whether the agent’s knowledge of the fraud is to be imputed to the principal [registered proprietor]’: Cassegrain 439 [40]. This involves consideration of why the fraudster’s knowledge should be imputed to the registered proprietor: Cassegrain 439 [41];
  3. It is not sufficient to impute the agent’s fraud to the registered proprietor whether the registered proprietor is ‘no more than the passive recipient of an interest in land’: Cassegrain 439 [41];
  4. In order to bring fraud home to the registered proprietor, it is necessary to show that the agent’s fraud was within the scope of the agent’s authority given by the registered proprietor: Cassegrain 439 [42].

In the present case, the Court found Mr H gave a broad general authority to Mr O to move funds between the relevant accounts and he expected that the money required to complete the purchase of the property would be moved into his personal account from one of the accounts Mr O was authorised to operate. Hargrave J found that Mr O’s authority was sufficiently broad to encompass using the stolen funds if that was the only available source at the time to enable completion of the purchase. The Court found that given that Mr H had the same knowledge of the fraud as Mr O at relevant times, and thus acted dishonestly in instructing Mr O to arrange for Mr S’s betting account to be credited with the stolen funds, the Court was satisfied on the evidence that Mr O’s broad authority encompassed him acting fraudulently by using the stolen funds to complete the purchase if that was necessary. (See [391]-[392])

8. The in personam exception to indefeasibility of title

In addition to the statutory fraud exception to indefeasibility of title under s 42 of the Act, Hargrave J went on to find that indefeasibility also did not accrue as the in personam exception to indefeasibility of title was also made out. His Honour noted that in personam exception was generally described as existing ‘in relation to certain legal or equitable causes of action against the registered proprietor’ in Farah Constructions (2007) 230 CLR 89, 169 [193]. This language echoes the requirement that the in personam exception depends on the establishment of a known legal or equitable cause of action: Macquarie Bank Ltd v Sixty Fourth Throne Pty Ltd [1998] 3 VR 133, 146-7. (See [394]) Hargrave J also noted the statements of Brennan J in Bahr v Nicolay (No 2) (1988) 164 CLR 604, 653 to the effect that the in personam exception does ‘not infringe the indefeasibility provisions of the Act. Those provisions are designed to protect a transferee from defects in the title of the transferor, not to free him from interests with which he has burdened his own title‘.

On the findings in this case, the plaintiffs’ claim for an equitable lien or charge over the Bondi Junction property arises from their establishing the known legal causes of action based on (1) Foskett v McKeown tracing principles, (2) Mr H’s breach of his Black v Freedman trust obligations, and (3) knowing assistance in that breach by Mr O. The Court held that the conduct of Mr H and Mr O, before registration of their interests as proprietors of the Bondi Junction property, had burdened their interests. (See [394]-[397])

(Sidenote: Hargrave J’s seemingly unexamined acceptance here that a knowing assistance Barnes v Addy claim is a personal equity which may defeat indefeasibility of title under the in personam exception appears to be directly inconsistent with obiter in the judgment last year of Vickery J in Mathieson Nominees Pty Ltd v Aero Developments Pty Ltd [2016] VSC 131. In that decision his Honour noted the debate on this point between various courts and confirmed the effect of ratio in Farah Constructions v Say-Dee [2007] HCA 22; 230 CLR 89, 140 [193]-[196] to the effect that a claim under Barnes v Addy is not a personal equity which defeats statutory indefeasibility of title. See my review of the Mathieson Nominees decision and discussion of this issue here.)

9. Traceable into the Worldwide ANZ account? Mixed funds

His Honour discussed the tracing issues that arose here at [398]-[435]. There were complications. He sets out a useful review of the competing tracing rules and principles that may be applied in cases of tracing into (and out of) mixed funds – see in particular at [408]-[422].

In the end Hargrave J concluded more evidence was needed to finally determine the tracing issues, much of which he noted was in the hands of the defendants. His Honour adjourned the proceeding to allow further evidence and submissions as to the remaining tracing issues – see [423]-[430] and [434].

For completion, I should note that an additional claim was made for recovery of the stolen funds under s 2.6.3 of the Gambling Regulation Act 2003, but was unsuccessful (see [440]-[450]).

Conclusion

The judgment is only two days old, so we cannot yet know whether an appeal will be pursued. In the meantime, on a practical level, the case stands as a salient warning to betting companies and those associated with them, and potentially similar entities which may receive questionable deposits into accounts held with them. Each case will turn on its own facts, and certainly here there was, amongst other things, an unusually timely warning of another fraud just 2 weeks prior. However in circumstances where a recipient is put on enquiry in some way, before on-paying or releasing the funds, it may be prudent to make the so-called ‘simple inquiry’ as described by Hargrave J at [158]-[159]: to seek to ascertain the identity of the depositor of the funds, contact them, and inquire as to whether they intended to make the deposit or payment to the benefit and for the purposes of the person or entity claiming to be entitled to access or control the funds. It is worth bearing in mind that whatever the circumstances are, the Baden categories of knowledge (see above) direct attention to what would an honest and reasonable person consider or do in those circumstances and with that awareness. As this case illustrates, a failure to meet that standard may have significant consequences for recipients of suspicious payments

Developments – Mistaken payments due to fraud – change of position defence

1. Citibank v NAB 

In October 2011 I reported on the decision of Hammerschlag J of the NSW Supreme Court in William Co-Buchong v Citigroup Pty Ltd & National Australia Bank Ltd [2011] NSWSC 1199 (link). This was an interesting contest between two banks, neither of which had acted negligently or outside of standard banking practices, and both of which had been the victim of fraud.

In that case, the customers involved were joint account holders with both Citibank and the NAB. Citibank had transferred money via the SWIFT system from its customers’ account on the basis of a fraudulent faxed instruction, to those customers’ account at the NAB. The NAB then also received fraudulent instructions, by way of three International Transfer Application Forms, and paid out the money in three tranches to accounts held in various names at HSBC Hong Kong Ltd.

Citibank’s claim was put as one for restitution. It had paid the money to NAB on the fundamentally mistaken belief that it had been so instructed by its customers. Absent restitution, claimed Citibank, NAB would be unjustly enriched. NAB’s defence was that it changed its position to its detriment by paying away the funds on the faith of the receipt.

Briefly, NAB won; its defence of change of position succeeded. His Honour considered the earlier decisions of the NSW Court of Appeal in State Bank of New South Wales Ltd v Swiss Bank Corporation (1995) 39 NSWLR 350 and in Perpetual Trustees Australia Ltd v Heperu Pty Ltd [2000] NSWCA 84; (2009) 76 NSWLR 195 and held in favour of NAB. Both banks were duped. However Citibank paid first without the customers’ authority as a result of which NAB credited the customers’ account rendering it vulnerable to the fraud to which it succumbed. His Honour remarked that:

“In these circumstances and where neither party criticises the other for falling for the fraud, it would lead to an inequitable result were Citibank to be made whole at the expense of NAB.”

For a more detailed discussion of the analysis, see my earlier post here.

I did not report on this at the time, but on 4 December last year the NSW Court of Appeal (a five judge bench) unanimously dismissed Citibank’s appeal, upholding his Honour’s decision that NAB had established its change of position defence. NAB, as the recipient of the funds from Citibank, had acted in “detrimental reliance” on the receipt “in good faith”, and had thereby displaced Citibank’s prima facie right of recovery for mistaken payment – Citigroup Pty Ltd v National Australia Bank Limited [2012] NSWCA 381.

It is to be noted that in his judgment Barrett JA discusses Hammerschlag J’s view as to three interconnected requirements emerging from State Bank of NSW Ltd v Swiss Bank Corporation (outlined in my earlier post). At [101] his Honour observes that if Hammerschlag J’s formulation limits the information upon which the relevant recipient (here the NAB) can rely to information received from the payer, it is too narrow. It is true that a payer who instructs that the transferred funds be placed to the credit of a particular customer’s account does not expressly sanction subsequent payment out to that customer. But as Barrett JA observes, such payment out is a natural corollary; and sanctioning of it comes from the context in which the transfer is made and the instruction is given, which must recognise that the customer will have resort to the funds in the customer’s own account. As his Honour then says at [102] –

“This emphasises the point that matters of context already known to the recipient may properly be taken into account. As recognised in Port of Brisbane Corporation v ANZ Securities Ltd, action by the recipient that is inconsistent with the payer’s instruction will not be action taken in reliance on or on the faith of the receipt. But as explained in Perpetual Trustees Australia Ltd v Heperu Pty Ltd, the causal link between the receipt and the subsequent action will exist if that action has a foundation of information obtained in connection with the receipt considered in the attendant circumstances.”

Bathurst CJ, Allsop P and Meagher JA agreed (at [5]).

Citibank was left solely liable to bear the whole loss of repaying the funds to its customers. It is not yet clear whether or not Citibank has lodged an application for special leave to appeal to the High Court of Australia.

Interestingly, of the five judge bench of the NSW Court of Appeal who delivered judgments in that case, Macfarlan JA and Barrett JA (who wrote the initial draft judgment to which the others referred) delivered individual judgments, and there was a joint judgment of the remaining three judges – Bathurst CJ, Allsop P and Meagher JA. Those three judges also delivered judgment on the same day, in the next case I discuss below, and refer to it in their joint judgment in Citigroup v NAB.

2. Hills Industries v Australian Financial Services and Leasing 

On the same day, 4 December last year, the NSW Court of Appeal also handed down its judgment in Hills Industries Ltd v Australian Financial Services and Leasing Pty Ltd [2012] NSWCA 380. This was another case where the Court had to choose between two innocent parties, as to who would bear the loss resulting from mistaken payments due to fraud on the part of a third party.

In order to avoid the collapse of the Total Concept Projects group of companies (TCP) a director sought finance from the Australian Financial Services and Leasing Pty Ltd (ASFL). The TCP director in question approached ASFL and fraudulently claimed to be seeking finance for the acquisition of goods from two suppliers. In fact, TCP already owed those suppliers (Hills Industries Ltd and Bosch Security Systems Pty Ltd) considerable sums of money, and the finance was really sought to pay the debts, in order to stave off liquidation. The director Mr Skarzynski created false invoices and AFSL was convinced to pay the money directly to the suppliers for the non-existent goods. The suppliers had been told by TCP that their old debts were being paid by funds obtained from a third party, and processed the payments accordingly.

On the evidence, it was clear that AFSL had made the payments to the suppliers under a mistake (ie that the money was paid to acquire goods TCP sought to purchase) and that the threshold requirements for restitution for mistaken payment existed. For a useful and learned discussion of the relevant principles of restitution for mistaken payment in Australia, I commend you to read the judgment of Allsop P at [66]-[75], and the passages which follow at [76]-[166], discussing the potential defences to such claims and reviewing the authorities in some depth.

The question on appeal was whether relief should be denied, on the basis that the suppliers had established the change of position defence such that they were entitled to retain the money paid to them by ASFL.

The Court of Appeal held that both suppliers had. Although only Bosch had succeeded on this defence at first instance, their Honours held that the payments were received by the suppliers Hills and Bosch in good faith and in the ordinary course of business as moneys owed to them by the TCP companies. They both gave up, to their detriment and on the faith of the receipt, both the debts owing by the TCP companies, and a real and potentially valuable opportunity to enforce or secure payment from them. Having received the moneys, Hills refrained from taking proceedings it would otherwise have taken against Mr Skarzynski and his companies. It also continued to trade with those companies, albeit at a lower credit limit. Bosch, when it received the funds, consented to the setting aside of default judgements that it had already obtained against the TCP companies and abandoned other proceedings then on foot. It refunded certain overpayments to the TCP companies and continued to trade with them, on a COD basis. Those circumstances were such as to make it unjust to order restitution.

It is rumoured that AFSL may be seeking special leave to appeal to the High Court from this judgment, however that is not yet confirmed on the High Court’s website. I will endeavour to keep an eye on the lists.