Karl Suleman Enterprizes v George

IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION

1446/02 KARL SULEMAN ENTERPRIZES PTY LIMITED & ORS V JESSIE GEORGE & ORS JUDGMENT 1 This is an application by the fifth defendant that those parts of the statement of claim as relate to him be dismissed or struck out. Statement of claim 2 Apart from some court orders the only evidence on the application was the statement of claim. It pleads general facts which relate to all defendants and then specific facts relating to each of the specific claims against the individual defendants. The general facts, and the specific facts pleaded against the fifth defendant, must be treated as true for the purposes of this application. The general facts pleaded can be summarized as follows:

A. Karl Suleman Enterprizes Pty Limited (In Liquidation) (KSE), the first plaintiff, was placed into liquidation by creditors resolution on 7 December 2001 following appointment of administrators to the company. Messrs. Weston and Cussen, the second and third plaintiffs, were appointed liquidators.

B. KSE was controlled by Mr Karl Suleman. He and his wife were the only directors and shareholders of KSE.

C. KSE conducted an unregistered managed investment scheme in breach of the Corporations Law and later the Corporations Act .

D. KSE appointed agents including the applicant, Sam Babanour, the fifth defendant, to introduce investors to KSE and to the investment scheme and to promote the scheme. The investors either invested in a largely fictitious trolley collection service or on loan to KSE. The scheme was a Ponzi scheme under which funds raised from new investors were used to pay out existing investors or to pay interest on moneys advanced by existing investors. There was no control, no proper records, and no real business. Funds not so applied to service existing investors were used for the benefit of Karl Suleman and/or applied to his benefit or to his benefit of the agents.

E. The agents received from KSE one or more of lump sums, percentage of amounts invested, or commission on amounts invested, together with other benefits. The scheme was not only in breach of the Corporations Act but was in fact a giant fraud enabling Karl Suleman to live the life of riley on investors' funds. The statement of claim pleads various matters against Karl Suleman but as he is not a defendant they are of no further importance. In essence the claim is that Karl Suleman used KSE to defraud investors and then Karl Suleman defrauded KSE by misappropriating its funds.

F. By order dated 10 December 2001 this Court ordered, pursuant to s601EE of the Corporations Act that the fund - being the unregistered managed investment fund - be wound up and that Messrs Weston and Cussen be appointed as receivers for the purpose of winding up the fund with "all powers necessary for the purpose of preserving the property and protecting investors, including the powers identified in s420(1) and (2) of the (Corporations) Act". 3 The specific facts pleaded relating to the fifth defendant appear in paragraphs 172 to 188 of the statement of claim. In those paragraphs it is alleged that in May 2000, KSE appointed Babanour as agent for the purposes previously set out, that he had a duty to KSE to act with good faith, loyalty and fidelity, and being an agent as a fiduciary as regards his principal was bound not to use for his own benefit, money received from investors in KSE, and that he knew of and participated in the unregistered and thereby illegal managed investment scheme. Paragraphs 176 and 177 are as follows: 176. In the premises, Babanour at all times owed a duty to act honestly and to exercise a reasonable degree of care and diligence in carrying out his duties and the discharge of his functions and further he owed the following fiduciary obligations to KSE: (i) a duty to act bona fide in the best interests of KSE as a whole; (ii) a duty to avoid placing himself in a position where his duties as an agent conflicted with his personal interests or the interests of other persons or companies of which he was a director or in which he was a substantial shareholder or otherwise associated; and (iii) a duty not to use his position in KSE to gain an advantage for himself or for any other person. 177. In the course of carrying out his functions as an agent for KSE, Babanour: (i) assisted with the operation of the Scheme; (ii) advised investors investing in the Scheme; (iii) prepared investment contracts on behalf of KSE; (iv) kept custody of cash, belonging to KSE; (v) on occasions attended to banking investor funds for KSE; (vi) under the authority of Karl Suleman filled in blank KSE cheques, which Karl Suleman would subsequently sign; (vii) introduced investors to the Scheme, the details of such investors introduced by Babanour are contained in the Schedule of Particulars; (viii) promoted the Scheme; (ix) provided information to investors about the Scheme; (x) assisted investors to prepare and execute the investment contractors; (xi) provided investors with, and assisted them to complete a form styled "Investment Details, Karl Suleman Enterprizes Pty Ltd Preliminary Loan Agreement" for the purpose of facilitating those investors participating in the Scheme; (xii) was instrumental in and drafted or caused to be drafted, the form referred to in paragraph (xi) above; (xiii) obtained from the investors their investment money, both in cash and cheque; (xiv) made payments to investors their periodical return payments in cash; and (xv) attended the offices of KSE for the purposes of carrying out the tasks set out above.

Paragraphs 178 and 179 appear under a heading of "Knowingly Assisted" and allege that during the course of being an agent Babanour received and retained cash and cash cheques endorsed payable to himself drawn on the accounts of KSE or Mr and Mrs Suleman; that he knew of the fraudulent nature of the scheme insofar as he was in receipt of funds to which he had no entitlement, that he kept no record of funds paid to him and he did not remit funds paid to him to KSE. 4 Under the heading of "Fiduciary Duties" it is pleaded in paragraph 180 that in breach of his duties Babanour promoted the scheme in the knowledge that he was in receipt of payments from KSE to which he had no entitlement, made false representations to potential investors as to the gains to be made from the scheme, received lump sum payments under the guise of gifts from KSE, retained cash payments made to KSE and accepted and retained payment of moneys to which he was not legally entitled and used for his own benefit investors' funds belonging to KSE. 5 Paragraph 181 is a further claim under a heading of "Knowing assistance" in that it is alleged that by participating in the scheme and retaining investors' money Babanour knowingly assisted Karl Suleman to misappropriate funds from KSE and thereby perpetrated a fraud upon KSE. 6 Paragraph 182 pleads the same facts relating to knowing receipt and a claim of wilful blindness, but this is really meaningless. 7 Finally there are claims of unjust enrichment and money had and received, these being that Babanour as agent was unjustly enriched at the expense of and to the detriment of KSE and that he received and retained moneys had and received to the use of KSE. 8 In a schedule of particulars to the statement of claim there is a list of investors said to have been introduced to KSE by Babanour, a list of cheques apparently endorsed to cash and received by Babanour from KSE and a total of moneys paid into Babanour's accounts with banks which presumably are said to include KSE moneys.

Comment 9 The extraordinary thing about this action is that KSE, having been engaged in what is pleaded to be a thoroughly fraudulent and illegal operation and having entered into a contract with various persons to assist it in this operation, is seeking to recover back from those persons moneys received by them from KSE as a result of their agency operations, or perhaps in some cases some moneys paid to them by investors in their capacity as agents for KSE and not passed on to KSE. As Mr Angyal, counsel for the fifth defendant, pointed out had those moneys been passed on, if it is in fact established that they were not passed on, they would have been lost to the investors just as they are now lost. All that KSE lost was the opportunity of using those moneys, at the expense of the later investors either to pay out existing investors making demands or to make funds available to Mr Karl Suleman and his wife for purposes not connected with the business of KSE, whether the managed investment business or otherwise. Claim of Weston and Cussen 10 Messrs Weston and Cussen are liquidators of KSE. They have, however, no standing to bring this action in their own names as liquidators. It must be brought in the name of the company in liquidation. While paragraph 23 of the statement of claim pleads the appointment of Weston and Cussen as receivers of the scheme, no other facts are alleged, giving rise to the claim for any order in their favour as such receivers against Babanour or for that matter against any of the other defendants. Under the heading of "Damages" for claims relating to Babanour, paragraphs 186 to 188 of the statement plead as follows:

Damages 186. In consequence of the breaches of duty aforesaid, KSE had suffered loss and damage. PARTICULARS KSE lost: (i) the money belonging to KSE received by Babanour, as set forth in the Schedule of Particulars referred to in Paragraph 183; and. (ii) further particulars of loss to be provided in due course. 187. By virtue of Babanour's knowing participation in the said breaches of fiduciary duty, good faith and fraudulent behaviour, Babanour is also liable to account to KSE in respect of the said losses. 188. Further, by virtue of being the beneficiary and recipient of KSE funds with notice of the breaches aforesaid, Babanour is liable to account to KSE for all benefits received by him or those associated with him, directly or indirectly for the significant payments made including: (i) the amounts payable to Babanour in cheques as set forth in the Schedule of Particulars; and (ii) other payments received by him as set forth in the Schedule of Particulars.

These claims are claims on behalf of KSE and not on behalf of the receivers. 11 The receivers get no mention after the allegation of fact of their appointment, unless they are included in the claims at the end of the statement of claim, namely the following statement: And the Plaintiffs Claim: 1. damages; 2. damages pursuant to s.1317H of the Corporations Act, 2001; 3. equitable Compensation; 4. taking of Accounts; 5. tracing into accounts; and 6. further complete details as to the Orders sought and Declarations sought as against each and every defendant will be provided in due course. 12 On the present pleaded facts nothing can relate any of these claims to the mere fact that Messrs Weston and Cussen were appointed receivers of the managed investment fund even if one takes into account the form of the court orders which have been placed into evidence. The claimed relief under s 1317H cannot be relevant because it relates to compensation in favour of a corporation or registered scheme and the scheme here was not registered. Generally speaking receivers cannot commence actions in their own names to recover property as title does not vest in them so that the normal action is to apply to the court for leave to bring an action in the name of the person in whom the cause of action is vested: Wilton v Commonwealth Trading Bank [1974] 2 NSWLR 96. Thus if receivers are receivers of property belonging to a class of investors or beneficiaries then unless there is some order to the contrary proceedings would have to be taken, if leave were obtained, in the name of those investors or beneficiaries. It would not, I think, have been possible pursuant to the powers under Pt29 r6 of the Supreme Court Rules for the court to authorise the receivers to sue in their own names, as it would not be on behalf of a party. Nevertheless I consider that it might have been possible for the court in making appropriate orders for the winding up of the scheme to authorise the receivers in their own names, but on behalf of the scheme investors although not able to all be named or perhaps in the name of one investor as representative of all investors to take whatever actions are necessary by way of litigation to recover investors' moneys. Barrett J referred to the ability of the Court to make whatever orders are necessary to wind up a scheme in ASIC v Takaran (No 2) [2002] NSWSC 987. The fact is however that no such power has been given and it is not necessary here to decide if such a power could be given. The appropriate course is to strike out the claims of the second and third plaintiffs and to remove them as plaintiffs, no facts being pleaded which would give rise to a cause of action by them. Claim of the company 13 The claim of the company, put simply, is that having conducted an illegal and fraudulent operation under which investors, - whom I should say would not necessarily all be innocent people - paid money to it, and having passed on some of those moneys to agents engaged to assist in the fraudulent and illegal operation or having allowed those agents to keep some of the moneys collected by them as recompense for their efforts, it should now recover from those agents the amounts which they received through their agency efforts. In other words the agents having performed in accordance with their contract of agency are to be required to disgorge to the company which instituted the fraudulent operation because that company has now had an unpleaded change of heart and instead of denuding investors, innocent or not, of their funds, now intends to restore them so far as possible to the victims of the fraudulent operation. 14 The argument of the applicant/fifth defendant is that in whatever guise the claim is made, whether breach of agency contract, breach of fiduciary duty, unjust enrichment or anything else insofar as the claim is equitable it must be defeated by the doctrine of unclean hands and illegality and insofar as the claim is not equitable it must be defeated by illegality. On its face that is an attractive argument. The question is however, whether or not the claims of the company are doomed to fail so that it is pointless to have a trial. There is a subsidiary question of whether they should be struck out with leave to replead. 15 When one considers the pleaded claim which is being made, it might appear to the casual observer to be one which would only be made in cuckoo land. That is because in the real world a court does not give much time to an action brought by a thief against an accessory to the theft who has got his hands on some of the stolen funds. Leaving aside the question of liquidation that is really what is happening here. KSE having obtained moneys from members of the public by fraud and having sought the assistance of agents in the obtaining of such moneys is seeking to recover from the agents either moneys which KSE actually paid to those agents for their services or moneys which those agents themselves have retained out of moneys collected from the investors. The persons whom one would expect to be bringing such a claim for the moneys obtained by fraud would be the people deceived by the fraud; the persons who would be expected to be taking action to recover moneys which they had invested in a managed investment fund which was illegal because it was not registered would be the people who had invested in that fund. It might even be possible to have a representative action brought on behalf of those investors. In particular, claims which appear to be brought under Barnes v Addy (1874) 9 ChApp 244 relating to knowing receipt of trust funds or knowing assistance in breach of fiduciary duty are by the person who was assisted or the person who was in breach of the duty. Without going into the matter in any detail it is difficult to understand why any equitable claim of the plaintiff would not be defeated by a defence of lack of clean hands and illegality and why any claim for breach of contract would not be defeated by a defence of illegality. Insofar as the claim which appears to be based on unjust enrichment might be thought to fall within the two, it is clearly unsustainable. To make all this as clear as possible I set out with the headings, paragraphs 184 to 188 of the statement of claim:

Unjust enrichment 184. By reason of Babanour accepting and retaining the significant amounts paid to him, Babanour was unjustly enriched at the expense of and to the detriment of KSE, in circumstances where he is obliged to return the funds and compensate KSE for funds he is unable to return. Money had and Received 185. Further, the significant amounts received and retained by Babanour was money had and received to the use of KSE. Damages 186. In consequence of the breaches of duty aforesaid, KSE had suffered loss and damage PARTICULARS KSE lost: (i) the money belonging to KSE received by Babanour, as set forth in the Schedule of Particulars referred to in Paragraph 183; and. (ii) further particulars of loss to be provided in due course. 187. By virtue of Babanour's knowing participation in the said breaches of fiduciary duty, good faith and fraudulent behaviour, Babanour is also liable to account to KSE in respect of the said losses. 188. Further, by virtue of being the beneficiary and recipient of KSE funds with notice of the breaches aforesaid, Babanour is liable to account to KSE for all benefits received by him or those associated with him, directly or indirectly for the significant payments made including: (i) the amounts payable to Babanour in cheques as set forth in the Schedule of Particulars; and (ii) other payments received by him as set forth in the Schedule of Particulars. 16 The only argument of any substance put forward by counsel for the plaintiffs, relied upon the decision of Tipping J in Marshall Futures Limited v Marshall [1992] 1 NZLR 316. In that case the plaintiff company breached the trust upon which certain funds of clients were held by paying those funds to an associated company. The action was brought against that associated company and its directors for knowing assistance in breach of trust. A motion to strike out the statement of claim was heard by Tipping J. At page 330 et seq of his judgment Tipping J said: In the present case Marshall Futures Ltd has since the events in question gone into liquidation and it is now under the control of a liquidator. Although in strictly analytical terms it is the same legal entity as it was when the allegedly fraudulent breaches of trust occurred, the hands controlling it are now those of the liquidator and not those of the directors. There cannot be any suggestion that the liquidator's hands are unclean. In substance the liquidator, through the vehicle of the company, is suing on the first cause of action for the benefit of the clients of Marshall Futures Ltd whose funds have been lost. I agree that at first blush it may appear a little bizarre that the nominal plaintiff is asserting its own fraudulent breach of trust as part of its cause of action against its officers. It seems to me however that in these particular and usual circumstances the corporate veil can reasonably be lifted to reflect the reality of what is going on. There can be no disadvantage or injustice to the defendants is no doing. They cannot of course be bound by any concession the plaintiff may make as is inherent in its cause of action that it was in breach of trust and dishonest. That must be fully proved against the defendants in the ordinary way. The plaintiff must prove that the hands of those who were controlling it at the material times were unclean in such a way as to make it, the plaintiff, fraudulent. It must also be proved that the hands of all those who are alleged to have assisted were also unclean. I am not to be taken in this approach to be saying that a company in liquidation is in law a different person from the company before its liquidation. What I am saying is that in substance in the present case the company now in liquidation raises the first cause of action in essence as the agent of its creditors. Mr Goddard also mentioned the maxim ex turpi causa non oritur actio. That maxim is normally applied to claims at law but is, I agree, the equivalent of the equitable maxim of clean hands. In equity the normal approach is of course that someone seeking the assistance of equity must come with clean hands. However dirty hands are not an absolute bar and the whole circumstances must be taken into account before consideration is given to defeating an equitable claim on the basis that the plaintiff has unclean hands. In the very unusual circumstances which prevail in this case I do not consider it inevitable that the plaintiff's claim must be so defeated and I do not consider it right to strike out the first cause of action on this basis, ie that the wrong plaintiff is suing. 17 This decision was made in a similar application to that which I am now considering, namely a strike out application. His Honour did not consider it inevitable that the plaintiff's claim must be defeated and therefore he did not consider it right to strike it out. It does not seem to me to be possible that there can be a difference in rights where a company is subject to a members voluntary winding up in the case where it is solvent and a case where there is a winding up on insolvency which may or may not ultimately result in some funds being available to the contributories. If a company guilty of fraud under one set of directors comes under the control of an honest set of directors that cannot make a claim which, if made by the company in the control of dishonest directors, would fail, into a claim that could succeed if brought when honest directors were in control. Subject to what I say in paragraph 19 the moneys which the plaintiff company seeks to recover are moneys to which the plaintiff company has no right, those moneys having been obtained through its fraud. The persons having a right to recover such moneys are those persons from whom they were originally received. 18 Each party provided detailed written submissions on the motion. It is helpful to set out paragraph 2 of the plaintiffs' submission in response to the applicant's written submissions, which is as follows: 2. The nature of the claim against Mr Babanour is that he assisted Mr Suleman, and his company Karl Suleman Enterprizes Pty Limited (KSE) in running a fraudulent and illegal investment scheme, and received benefits including payments in connection with those activities. The causes of action are knowing receipt or knowing assistance of a breach of fiduciary duty and/or trust under the principles set out in Barnes v Addy , fraud, money had and received, unjust enrichment and breach of fiduciary duties arising from agency. KSE is now in liquidation and the liquidators have also been appointed receivers to the fund of money that comprised the investment scheme. Judgment was entered against Mr Suleman, and a sequestration order has been made against his estate. 19 There seems to be some confusion. It is not pleaded that KSE was a trustee of investors' funds or in some way a fiduciary. The relationship between the investors and KSE was probably one of debtor and creditor. The fiduciary relationship between Babanour and KSE is pleaded to arise as a result of a contract of agency. In those circumstances the principles derived from Barnes v Addy of knowing receipt of trust funds and knowing assistance in breach of fiduciary duty are irrelevant. There is no claim of trust fund; there is no allegation of fiduciary duty to investor. Thus although a trustee in breach of trust can pursue a claim against a co-trustee for the purpose of reinstating the trust fund: see Young v Murphy [1996] 1 VR 279 at 279 et seq and the cases discussed there, that is not the claim made by the plaintiff here. Marshall Futures can be explained as the funds sought to be recovered were trust funds, although I appreciate that is not the basis of the reasoning. 20 While I consider this the clear result of the present pleading, s601FC(2) of the Corporations Act 2001 (Cth) provides, as did its predecessor under the Corporations Law, that "the responsible entity holds scheme property on trust for the members". In such circumstances a defaulting responsible entity might be able to recover against a defaulting co-trustee or against a person in knowing receipt of trust funds. Whether or not some such action should be thought available to KSE I need not determine, as it is not pleaded that the moneys were trust moneys. Nevertheless, the possibility of successfully establishing a case based on KSE being a trustee points in the direction of strike out rather than dismissal. 21 The claims for money had and received, and unjust enrichment and breach of contract if it can be found in the statement of claim, have all the hallmarks of the Highwayman's Case, Everet v Williams (1787) European Mag Vol II page 360; 35 LQR 197, a bill in equity for partnership accounts between highwaymen, the major difference being in the result as there both highwaymen were hanged, the solicitors for the plaintiff were arrested, charged and fined for contempt, and counsel who signed the bill ordered to pay the defendant's costs. These claims must be defeated by the defence of illegality. While that decision could be better made on a pleaded defence and trial of the issue raised it seems to me to be clear. I do not understand it could be suggested that where the purpose of the contract is to engage in an illegal transaction, the plaintiff being the moving party as principal, there is any basis upon which the defence would not succeed. No alleviating fact or consideration of the type considered in Nelson v Nelson (1995) 184 CLR 538 such as public interest or the exceptions considered by McHugh J at page 605 or the discretionary matters he considered at page 611 could allow recovery by a plaintiff principal in an illegal transaction of moneys received by an agent in payment for the agent's participation in the transaction. Insofar as the claims are equitable a defence of lack of clean hands must succeed against the plaintiff even if there might be some doubt were the defendant suing the plaintiff. Repentance or washing of hands could not help in an action where the improper conduct of the plaintiff resulted in payments which the plaintiff seeks to recover. 22 I stated in Cauvin v Philip Morris Limited [2002] NSWSC 736 paragraphs 23 and 24 that I considered a general pleading of unjust enrichment unsustainable unless founded on some distinct category such as failure of consideration or money had and received. I remain of that view but in that case I refused to strike out the relevant paragraphs considering it not unarguable. Here it is illegality which is decisive. 23 I conclude that the plaintiffs cannot succeed on the present pleading against the fifth defendant. I am not dealing with the pleadings as against the other defendants although the same decision would inevitably apply I would think. I am not able to say that a properly pleaded claim by KSE which alleged the investors' moneys were held on trust for them by KSE would not succeed. I consider the first plaintiff should have the opportunity to replead to make such a claim if it so wishes. 24 The receivers cannot succeed for the reasons I have stated. Their claim should be dismissed. I said during the hearing, and I remain of the view, that the receivers should consider taking the course of seeking expanded powers from the court to enable them to bring action in their own names. They would then be entitled to bring the action without the risk that KSE will inevitably still have under any amended pleading. In any event as I have said under the existing pleading there is no cause of action by the receivers. 25 The orders are as follows:

1. Order that the claim of the second and third plaintiffs against the fifth defendant be dismissed.

2. Order that the claim of the first plaintiff against the fifth defendant be struck out with leave to replead that claim within 28 days.

3. Order that in default of such amendment the proceedings against the fifth defendant stand dismissed.

4. Order the plaintiffs pay the fifth defendant's costs of the notice of motion. **********

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