Most fraud claims that are set to go before the High Court are usually subject to an interlocutory application before trial. Worldwide freezing orders (WFOs) and proprietary injunctions are the most common, and are used to freeze assets and give the applicant the opportunity to assert their interest in the assets which have allegedly been misappropriated.

It is common for such injunctions to contain provisions that make it possible for the defendant to spend a reasonable amount of the funds that have been frozen on legal expenses. Yet while such provisions are a routine feature of injunctions, they are not necessarily straightforward.

The issues involved and the court’s rule in scrutinising any application to obtain such funds was highlighted in the Cum-Ex-related case of Skatteforvaltningen (The Danish Customs and Tax Administration) v Edo Barac & Others. The case of Kea Investments Ltd v Watson and others [2020] EWHC 472 (Ch) is also of value in illustrating the courts’ approach to less straightforward applications.

Skatteforvaltningen v Edo Barac & Others

Case background

Skatteforvalttningen (SKAT) alleged that there was a fraud relating to the refund of dividend taxes, which is most commonly known now as Cum-Ex. From 2012 to 2015, SKAT said it received applications for refunds from tax reclaim agents who purported to be acting on behalf of organisations in the US, UK and Luxembourg. SKAT paid out refunds totalling more than £1.44 billion – refunds it says it was persuaded to make as a result of fraudulent misrepresentations relating to what appeared to be an elaborate network of share sales.

In May 2018, SKAT brought four claims against more than 80 defendants (including Mr Barac) who they allege knowingly took part in the conspiracy. In June 2018, Jacobs J made a WFO against Mr Barac (and other respondents), including a proprietary injunction. This was continued in July 2018 and October 2018.

In February 2020, Mr Barac sought a variation to the proprietary injunction so that he could gain access to funds in order to meet his living and legal expenses. His WFO and proprietary injunction included a provision that said he could spend “reasonable sums on legal advice and representation. But, before spending any money the Respondent’s legal representatives must tell the Applicant’s legal representatives where the money is to come from.”

The three-stage test for releasing funds

When considering whether to vary a proprietary injunction to release funds to cover living or legal expenses, the court must apply the three-stage test; as set out in GFH Capital Limited v Haigh [2018] EWHC 1187 (Comm).

The three stages are:

  • Before there can be any question of using funds to which a claimant has a strong proprietary claim, the defendant must show that he has an arguable case for denying they belong to the claimant.

  • Where there are assets which may belong to the claimant, the defendant should not be entitled to use those funds unless the court is convinced that the defendant has no other assets to use for this purpose. The onus is firmly on the defendant to satisfy the court of this - and where there are any other assets, they should be expended before there is any question of expending funds subject to a proprietary claim.

  • If the court can be satisfied that there are no assets other than those subject to a proprietary claim, the court must nevertheless still weigh whether the balance of justice militates in favour of permitting or refusing the payment.

Application of the test

The court was satisfied in the case of Mr Barac that he had a good arguable case, which meant that the requirement of the first stage had been met.

The court then had to consider the second and third stages of the test. Mr Barac was seeking a variation to release funds to cover his living expenses and legal costs out of monies subject to the proprietary injunction. Until this point, he had used funds not covered by the orders to meet these expenses. Yet even if a defendant can show they have no assets unaffected by proprietary claims against him that can be used to meet these expenses, it is for the court to balance the considerations of justice on both sides.

In the case of Mr Barac, the court stated that the expenses that Mr Barac would require to continue to be legally represented exceeded the funds he had access to without any variation of the proprietary injunction. It added that it was in the court’s interest for Mr Barac to continue to be legally represented and, accordingly, allowed the variation.

Legal representatives’ obligations

Defendants and their legal representatives should be aware that any funds made available to a defendant via such a variation may be claimed back at a later stage.

Complying with the terms of an order does not necessarily prevent a legal representative from becoming liable, as they could be considered to be:

* constructive trustee for proprietary funds which are still held by them; and/or

* in unconscionable (knowing) receipt in respect of proprietary funds which have passed through their hands.

The implications of this were illustrated in the Court of Appeal case Carl Zeiss Stiftung v Herbert Smith & Co [1969] 2 Ch 276. In this case, it was claimed that all the assets of the defendant belonged to or were held on trust for the claimants and, therefore, the defendant’s solicitors – necessarily on notice of that claim – were accountable to the claimants for sums received from those assets as payment for their legal services. This argument was unsuccessful, with the court holding that a solicitor cannot ordinarily be expected to resolve the contradictory cases of the parties as to the existence of fraud or a trust.

But the obligations imposed by the Money Laundering Regulations 2007 make it imperative that each solicitor investigates the source of any funds paid to them – although this of itself will not absolve a solicitor of liability as a constructive trustee in respect of proprietary funds.

In fraud cases where proprietary claims are advanced, due diligence will be dictated by the allegations at the centre of the case and the information that arises from asset disclosure – yet even this will not remove all uncertainty. Which is why both defendants and their legal representatives need to make a thorough, detailed assessment of the situation before making an application for the release of legal expenses.

Kea Investments Ltd v Watson and others

Case background

The case of Kea Investments Ltd v Watson and others [2020] EWHC 472 (Ch) is also notable for defining the parameters when it comes to varying a proprietary injunction.

The claimant Kea had brought proceedings against Watson for fraud and breach of fiduciary duty. In July 2018, Nugee J handed down judgment for Kea for the payment of equitable compensation up to £43.5 million, together with an entitlement for Kea to trace – and decide elect whether to claim - assets acquired by Watson, for the purposes of enforcing the judgment.

Kea had identified that William Gibson, Watson’s accountant, was a beneficiary of a trust that owned the company Ivory Castle, which Kea contended was beneficially-owned by Watson. Kea identified that Ivory Castle was due to be paid approximately £2 million by an associated company, Aegean LP. On application by Kea, Nugee J granted a short-term injunction against Ivory Castle until 1 February 2019, restraining payment to it of the money due from Aegean and restricting the disposition of its other assets. The injunction order allowed Ivory Castle to spend up to £150,000 from its other assets on legal representation.

On 1 February 2019, the injunction was extended to trial. However, following submissions from Ivory Castle, Nugee J removed the cap on spending on legal representation from its other assets. An injunction was later granted against Gibson on similar terms.

Ivory Castle and Gibson applied for an order permitting Ivory Castle to also use the Aegean monies on an uncapped basis for legal fees and representation for both Ivory Castle and Gibson. Their application was opposed by Kea on the basis that the claim in question was analogous to a proprietary claim. Ivory Castle and Gibson contended that the court was unable to rule in favour of Kea on that point due to issue estoppel, asserting that the court had already ruled against Kea by not imposing a cap on the existing injunction in relation to its other assets.

Judgement

In reaching his decision, Nugee J considered the legal principles with regard to injunctions and the courts’ jurisdiction to allow payment of legal expenses from frozen assets, namely the following:

  • There is a well-established distinction in law between the cases of an ordinary (non-proprietary) freezing injunction and a proprietary injunction.
  • The “ordinary rule” for freezing injunctions is that the frozen assets are owned by the defendant, who would, therefore, be entitled to use the frozen assets for legal representation, subject to demonstrating that it has no other assets with which to fund the litigation.
  • However, in respect of a proprietary injunction, the frozen asset is said to belong to the claimant. There is, therefore, no presumption in favour of allowing a defendant to use the asset to fund its legal expenses.

Nugee J, noting the similarities with the case of JSC BTA Bank v Ablyazov, agreed with Kea that Ivory Castle and Gibson’s claim was analogous to a proprietary claim and, as such, the same principles applied of there being no presumption in favour of allowing frozen assets to be spent on legal fees.

Nugee J also held that Kea was not prohibited from relying on its arguments in resisting Ivory Castle and Gibson’s claims on the basis of issue estoppel or abuse of process: as it was not Kea but Ivory Castle that sought the re-examination of whether Ivory Castle could access the Aegean monies for its legal fees. There was, therefore, nothing abusive in Kea resisting such an application.

Analysis and practical advice

The judgment demonstrates that “quasi-proprietary” claims - where a claimant claims ownership over frozen assets over which the defendant holds beneficial ownership - are likely to be considered in the same manner as a proprietary claim. And assets in such claims will not be subject to use for reasonable legal expenses in normal circumstances. Nugee J clarified in his judgment that in finely-balanced cases where the defendant has no other funds available to fund legal expenses, the court will consider “whether the injustice of permitting the use of the funds held by defendant is outweighed by the possible injustice to the defendant if he is denied the opportunity of advancing what may turn out to be a successful defence”.