Most people will have a general idea of what is meant by fraud but it is worthwhile looking generally at what constitutes fraud in England and Wales.
Fraud is both a crime and a civil wrong. The crime of fraud was redefined by the Fraud Act 2006. There are now three different ways in which the criminal offence can be committed. The first is by dishonestly making a false representation with the intention of making a gain or causing a loss.
An example would be when a person dishonestly puts himself forward as the individual named on a stolen credit card which he presents to a shopkeeper as the means of paying for goods.
The second is by dishonestly failing to disclose to another person information which the defendant is under a legal duty to disclose, with the intention of making a gain or causing a loss.
An example would be when a professional investment adviser is under a duty to disclose a poor growth record to a client, but dishonestly fails to do so with the intention of persuading the client to buy a particular investment which pays a high rate of commission.
The third way of committing the criminal offence is by a person dishonestly abusing a position in which he is expected to safeguard, or not to act against, the financial interests of another person, with the intention of making a gain or causing a loss.
The abuse may be by an omission as well as by a positive act. An obvious example is of a trustee who dishonestly transfers trust funds to his own account and for his own benefit when he has no right to do so.
The civil wrong is generally referred to by lawyers as deceit. Put simply, a person (A) will be liable to another (B) for the civil wrong of deceit if A makes a false statement of fact without an honest belief in its truth, and intending that B should act in reliance on it, and B does so act and suffers loss as a result.
The leading case on deceit was Derry v Peek which was decided by the House of Lords in 1889. In that case, a tramway company was incorporated by special Act of Parliament. The act provided that the carriages might be moved by animal power, and, with the consent of the Board of Trade, by steam power. The directors issued a prospectus containing a statement that by their special act the company had the right to use steam power instead of horses.
Was it necessary to establish what the defendant’s mental state was in relation to the transaction in question, and also his views about generally acceptable standards of honesty?
The plaintiff took shares on the faith of this statement. The Board of Trade, however, afterwards refused their consent to the use of steam power and the company was wound up. The claimant brought an action for deceit against the directors based upon the false statement.
The House of Lords decided that although the statement in the prospectus was false, the honest belief of the directors in the truth of that statement meant that they could not be guilty of deceit. Lord Herschell said, in a classic and much quoted passage, that to sustain an action for deceit, it must be proved that “a false representation has been made (1) knowingly, or (2) without belief in its truth, or (3) recklessly, careless whether it be true or false.”
He went on to add, “Although I have treated the second and third as distinct cases, I think the third is but an instance of the second, for one who makes a statement under such circumstances can have no real belief in the truth of what he states. To prevent a false statement being fraudulent, there must, I think, always be an honest belief in its truth.”
It is clear that if a person acts with scrupulous honesty, he or she will never be guilty of either the criminal offence or the civil wrong. But what does dishonesty mean?
As far as the criminal law is concerned, the courts have left that question to juries, who decide in every case involving dishonesty whether the conduct of the defendant in that case was, or was not, dishonest. Juries apply their own experience of life and standards when doing so.
On the other hand, the courts have had to grapple with what dishonesty means in the civil context. In 2006, the Privy Council decided an appeal from the Isle of Man arising out of the Barlow Clowes’ affair. Lord Hoffmann delivered the judgment of the Privy Council. The following is a summary of the facts taken from the judgment.
In the mid-1980s, Mr Peter Clowes, through a Gibraltar company called Barlow Clowes International Ltd, operated a fraudulent offshore investment scheme purporting to offer high returns from the skilled investment of funds in UK gilt-edged securities. He attracted about £140m, mainly from small UK investors. Most of the money was dissipated in the personal business ventures and extravagant living of Mr Clowes and his associates.
In 1988, the scheme collapsed and Mr Clowes was afterwards convicted and sent to prison. Some of the investors’ funds were paid away during 1987 through bank accounts maintained by companies administered from the Isle of Man by a company then called International Trust Corporation (Isle of Man) Ltd (ITC), which provided offshore financial services.
In the High Court of the Isle of Man, the liquidators of Barlow Clowes claimed that the principal directors of ITC and, through them, ITC, dishonestly assisted Mr Clowes and one of his principal associates to misappropriate the investors’ funds.
What did dishonesty mean in this context? Was it necessary to establish what the defendant’s mental state was in relation to the transaction in question, and also his views about generally acceptable standards of honesty?
In other words, if the defendant thought that he was acting honestly by his own standards, should he be acquitted of dishonesty?
The Privy Council said no. Lord Hoffmann said: “Although a dishonest state of mind is a subjective mental state, the standard by which the law determines whether it is dishonest is objective. If by ordinary standards a defendant’s mental state would be characterised as dishonest, it is irrelevant that the defendant judges by different standards.”
Having established that the defendant made the representation without at least an honest belief in its truth, the claimant in a civil fraud case would have to go on and prove that he relied on it as intended by the defendant, and suffered loss as a result.
If he can prove all those elements, he will be entitled to damages in an amount which will put him back in the position he would have been in had the fraudulent misrepresentation not been made.
Peter Hamilton is a barrister specialising in financial services at 4 Pump Court