High Court dismisses fraudulent misrepresentation claim relating to loan notes investment on limitation grounds

The High Court has dismissed a claim by the assignee of an investment fund against a financial advisory firm (and associated parties) for losses arising out of alleged fraudulent misrepresentations made in relation to the financial position and prospects of a business which had induced the investment fund to subscribe for £11 million in loan notes in 2011 and to later make a follow-on investment of £4.25 million: European Real Estate Debt Fund v Treon [2021] EWHC 2866 (Ch).

The decision will be of interest to financial institutions faced with fraudulent misrepresentation claims in relation to certain investments which: (i) have been brought more than 6 years after the date of the disputed investment; and (ii) seek to postpone the start of the statutory limitation period. It highlights the difficulties for claimants in pursuing fraudulent misrepresentation claims where they do not satisfy the requirements of section 32(1) Limitation Act 1980 (LA 1980), especially where it is clear that the claimant discovered the fraud or could with reasonable diligence have discovered it before the expiry of the statutory limitation period.

In the present case, the court found that the claim was statute-barred. The court highlighted that although it is well known that fraudsters cannot avoid liability for fraud by pleading that their victim failed to take reasonable care to detect the fraud, this did not necessarily mean that claims based on fraud brought outside the primary limitation period were entitled to invoke the special statutory postponement of the limitation period. If a claimant could reasonably have discovered the fraud by virtue of events and circumstances occurring before it actually suffered a loss, there was no principled rationale for allowing it the indulgence of more than the normal six years’ period to bring its claim. The court said that a reasonably diligent investor, such as one in the position of the investment fund's adviser, in reviewing the financial information provided to it before the investment was made, would have been put sufficiently on inquiry to ask some basic questions and demand further information. The court also noted that if the investment fund's advisers had asked the further questions it would have discovered sufficient facts to enable the investment fund to plead a statement of claim within the primary limitation period of six years.

We consider the court's decision in more detail below.

Background

In 2011, an investment fund (the Fund) made a principal investment of £11 million in a care homes business. The Fund's advisers then discovered in early March 2012 that the financial information about the business and its prospects that had been provided as part of the discussions leading up to the investment was false and misleading. In July 2012, in order to mitigate its losses, the Fund made a follow-on investment of £4.25 million in the business. The business went into administration in 2014 and the Fund lost the entire value of its investment.

Subsequently, the assignee of the Fund (the claimant) brought a damages claim against the founder of the business, a financial advisory firm, and a director of the financial advisory firm (together, the defendants). The claimant alleged that the defendants had fraudulently misrepresented the financial position of business and had induced the Fund to subscribe for £11 million in loan notes in June 2011. The claimant's case was that the Fund and its advisers had relied on certain trading numbers and projections as accurate and current, and that defendants conspired to mislead the Fund. In addition, the claimant also alleged that the business' founder was responsible for various representations made by the issuer of the notes in a loan note agreement of June 2011. The claimant also relied on section 32(1) LA 1980 in seeking to postpone the start of the limitation period for its claim.

The defendants denied all liability and in addition said that the action was statute-barred given that it had been commenced more than six years after the date of the principal investment.

Decision

The High Court found in favour of the defendant and dismissed the claim for the reasons explained below.

Limitation legal principles

In its consideration as to whether the claim was statute barred the court noted that section 32(1) LA 1980 had been considered in a number of cases which were reviewed in OT Computers Limited v Infineon Technologies AF [2021] EWCA Civ 501 and highlighted the following key principles:

• The state of knowledge which a claimant must have in order for it to have discovered the concealment has for the most part been regarded as the knowledge sufficient to enable it to plead a claim. This is known as the statement of claim test. Test Claimants in FII Group Litigation v Revenue and Customs Commissioners [2020] UKSC 47 suggested a more liberal test in that time should begin to run from the (possibly earlier) point when the claimant knows, or could with reasonable diligence know, about the mistake with sufficient confidence to justify embarking on the preliminaries to the issue of proceedings.
• As per Paragon Finance Plc v DB Thakerar [1999] 1 ALL ER 400 the question is not whether the claimant should have discovered the fraud sooner but whether they could have done so with reasonable diligence. The claimant must therefore establish that they could not have discovered the fraud without undertaking exceptional measures, which they could not reasonably have been expected to take. In considering what would constitute exceptional measures, the court will consider how a person carrying on a business of the relevant kind would act if they had adequate but not unlimited staff and resources and were motivated by a reasonable but not excessive sense of urgency.
• As per OT Computers, the question of what reasonable diligence requires may have to be asked at two distinct stages: (i) whether there is anything to put the claimant on notice of a need to investigate; and (ii) what a reasonably diligent investigation would then reveal. However, there is a single statutory issue, which is whether the claimant could with reasonable diligence have discovered the concealment.
• Section 32(1) LA 1980 is only relevant once there is a complete cause of action because that is when the primary limitation period would commence, and the purpose of that section is to postpone that period. However, it does not follow that the court investigating the claimant's state of mind must ignore events, communications or things known to the claimant before then. There may be cases where the claimant is aware (or could with reasonable diligence have been aware) of facts before it suffered any loss which would have enabled it to write a letter before action. Consequently, the court must examine all of the facts and should not artificially restrict itself to events or circumstances arising only after the cause of action had completely accrued. As per OT Computers, the ultimate question under the section is whether the claimant has or could have "discovered" the fraud and that may turn on events before as well as after loss was suffered.
• It is well known that a fraudster is not entitled to plead that his victim failed to take reasonable care to detect the fraud (as per Redgrave v Hurd (1881) 20 Ch.D.1.). However, the question under section 32(1) LA 1980 is not whether the claim is defeated by the careless failure of the claimant to spot the fraud. It is quite the distinct issue of whether the claimant who brings his claim outside the primary limitation period for a fraud claim (6 years) is entitled to invoke the special statutory postponement of the limitation period. Such postponement is available to a defrauded claimant who could not normally have discovered the facts, but it is not available to all victims of fraud, however careless they may be in attending to and asserting their rights. If a claimant could reasonably have discovered the fraud by virtue of events and circumstances occurring before it actually suffered a loss, there is no principled rationale for allowing it the indulgence of more than the normal six years’ period to bring its claim.

Application of the limitation principles to the present case

The court held that the claim was statute-barred as the claimant had failed to satisfy the requirements of section 32(1) LA 1980 to postpone the start of the limitation period.

In its analysis, the court commented that in approaching the exercise under section 32(1) LA 1980, it had to be careful to avoid the dangers of hindsight and to examine events as they would have appeared at the time and in their proper context and sequence. The court also noted that a reasonable investor in the Fund's adviser's position could reasonably be expected to approach potential investments with a careful eye and appropriate degree of professional care, i.e. it could be expected to undertake professional due diligence.

The court then examined the financial information that had been provided to the Fund's adviser (whose knowledge was considered to be the same as the Fund) by the business, keeping in mind the two stage test in OT Computers.

With respect to whether there was anything to put the Fund's advisers on notice of a need to investigate, the court's view was that a reasonably diligent investor, when it reviewed the financial information provided to it before the investment, would have been put sufficiently on inquiry to ask some basic questions and demand further information. The court disagreed that there was nothing in the financial information provided to the Fund's advisers to trigger these questions or requests for further information on the basis that these basic questions would have been prompted by the information provided to the Fund's advisers and by the passage of time. Seeking this further information would not have been an exceptional measure which a reasonably diligent investor could not be expected to take. It would have been a routine part of due diligence.

The court then considered what would have happened if the Fund's advisers had raised further questions with the defendants. It concluded that if the Fund's adviser had asked the further questions it would have discovered sufficient facts to enable the Fund to plead a statement of claim within the primary limitation period of six years.

Accordingly, the court dismissed the claim.

Note: In January 2022, the High Court refused the claimant's application for permission to appeal to the Court of Appeal.

In February 2022, the claimant applied to the Court of Appeal for permission to appeal.

In April 2022, the Court of Appeal refused the claimant's application for permission to appeal.