Setback for investors who seek profit from litigation

Lawyers, investors and regulators are meeting next month to devise a " lighttouch" regulation scheme for the rapidly growing market in litigation funding. The all-day conference will be chaired by the Master of the Rolls, Sir Anthony Clarke.

England's senior civil judge is comfortable with letting independent investors support legal claims in exchange for a share in any winnings. But he wants the industry to be properly regulated. Otherwise, funders might disappear when a claim reached an advanced stage. That could force a claimant to withdraw or leave a successful defendant unable to recover his costs.

No decision has been taken on which of the existing regulators might take responsibility for litigation funders. But the preferred option would be to draw up rules of court under which claimants would have to provide security for costs. Funders might not have to hand over the cash at the start of a claim so long as they could show they were good for the money.

Litigation funding took something of a knock last week when the Court of Appeal struck out a case being supported by IM Litigation Funding, one of the first companies to join the market six years ago.

This was a negligence claim for £88 million against the chartered accountants Moore Stephens, who had audited a company called Stone & Rolls before it collapsed. The auditors were accused by the company's liquidators of failing to detect fraudulent behaviour by a Croatian trader called Zvonko Stojevic, who ran Stone & Rolls as a one-man band.

The problem faced by the claimants was that, as liquidators, they had to sue in the name of the company they were liquidating. On the face of it, therefore, Stone & Rolls were trying to claim for losses incurred through their own fraud. And, as the former Lord Chief Justice Lord Mansfield said as long ago as 1775: "No court will lend its aid to a man who founds his cause of action on an...illegal act."

There were two answers to this, according to the liquidators. First, the company was the victim of a fraud by its owner. Not so, said Lord Justice Mummery. The company was the vehicle rather than the victim of fraud and Stojevic was the "fraudulent driver of the fraudulent vehicle". To suggest that the vehicle was the victim "turns the world upside down".

Even so, argued the liquidators, Moore Stephens could not escape liability because detecting fraud was "the very thing" they had been paid to do. That made no difference, said the appeal judge. "No duty of care is owed by the firm to the fraudster company... to take reasonable care to detect its fraud."

This had been an "astounding claim" by the liquidators, said Lord Justice Mummery, sitting with Lords Justices Rimer and Keene. Upholding it would be "contrary to all common sense". Richard Moore, the auditors' senior partner, said afterward that Moore Stephens had always considered the claim "wholly illegitimate".

But Sam Eastwood from Norton Rose, representing the liquidators, said they would be asking the House of Lords for permission to appeal in view of the important point at issue - when an auditor could be sued for negligence in failing to detect fraud.