Syed Rahman of Rahman Ravelli considers two recent cases that focus on a defendant’s ability to vary a proprietary injunction.
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  EWHC 472 (Ch) is also of value in illustrating the courts’ approach to less straightforward applications.
Skatteforvaltningen v Edo Barac & Others
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  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  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
The case of Kea Investments Ltd v Watson and others  EWHC 472 (Ch) is also notable for defining the parameters when it comes to varying an injunction.
Kea had brought proceedings against Watson and was awarded compensation totalling £43.5 million. In seeking to trace and claim assets, Kea said that Watson’s accountant William Gibson was part of a trust owning Ivory Castle. Ivory Castle was a company - of which Kea said Watson was a beneficial owner - that was due to be paid £2 million by an associated company, Aegean LP. A short-term injunction was granted against Ivory Castle until 1 February 2019, restraining payment to it of the Aegean £2 million and restricting disposition of its other assets but allowing it to spend up to £150,000 from other sources on legal representation. This injunction was extended and, after submissions from Ivory Castle, the cap on expenditure from other sources on legal representation was removed (with Gibson granted a similar injunction).
Ivory Castle and Gibson applied for permission to also use the Aegean money for legal expenses for them both. Kea opposed this, saying it amounted to a proprietary claim. Ivory Castle and Gibson argued that the court could not rule in favour of Kea on this because of issue estoppel, saying the court had already ruled against Kea when it removed the expenditure cap on the injunction relating to expenditure from other sources.
Nugee J considered that:
- There is a distinction between the cases of an ordinary (non-proprietary) freezing injunction and a proprietary injunction.
- The “ordinary rule” for freezing injunctions is that frozen assets are owned by a defendant, who would be entitled to use them for legal representation, as long as they can show they have no other assets that can be used to fund the litigation.
- Regarding a proprietary injunction, however, the frozen asset is said to belong to the claimant – meaning there is no presumption in favour of allowing a defendant to use the asset to fund its legal expenses.
Nugee J compared this case with JSC BTA Bank v Ablyazov and agreed with Kea that Ivory Castle and Gibson’s claim was similar to a proprietary claim – meaning the same principles applied, and so there could be no presumption in favour of allowing frozen assets to be spent on legal fees. Nugee J also held that Kea was able to rely on its arguments challenging Ivory Castle and Gibson’s claims on the basis of issue estoppel or abuse of process. The judge said there was nothing abusive in doing so, as it had been Ivory Castle that wanted a re-examination of whether the company could spend the Aegean money on legal fees. Although Nugee J did say that in cases that are finely balanced, where the defendant has access to no other funds for 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”.
It is a judgement that illustrates that where a claimant claims ownership of frozen assets over which the defendant holds beneficial ownership, such a claim will be considered in the same way as a proprietary claim. Assets in these claims will not (in normal circumstances) be made available to cover legal expenses.
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