When investment scams cross over with civil and insolvency procedures

Taking legal action

Once victims or creditors are faced with the realisation that the investment which seemed “too good to be true” actually was, they then have to decide what legal action to take to recover or mitigate their losses. They are often faced with a choice between appointing – or supporting the appointment of – insolvency practitioners in their capacity as creditors of the scheme or bringing their own civil claims in their capacity as the victims of fraud.

Appointing insolvency practitioners

Insolvency practitioners have extensive investigatory powers which allow them to obtain information about the fraud from third parties, including under compulsion from the court where necessary. There are also Insolvency Act claims which only insolvency practitioners can bring, such as claims for transactions at an undervalue and preferences. In cross-border cases, the scope for the international recognition of English insolvencies is another significant advantage.

Bringing civil claims

The main advantages of the civil litigation route, on the other hand, is that it gives victims the benefit of having lawyers who act in their sole interests, not those of the wider creditor group, along with control over the litigation process – including settlement negotiations. One of the practical consequences of this is that the first step victims often take in a civil fraud action is to seek proprietary injunctions in respect of the particular assets which represent the proceeds of the fraud on them.

How timing affects victims’ options

The two options are, of course, not mutually exclusive, but it is often not justifiable on a cost-benefit analysis to go down both tracks in parallel. Usually, making the right choice has less to do with weighing up the pros and cons of each route than it has to do with timing.

Late-stage fraud

Insolvency is usually the best option in a case involving an investment scheme where extensive evidence of fraud has entered the public domain, and where the fraudsters have already gone into hiding and dissipated their assets. Additionally, there will be instances where the vehicle used to carry out the fraud might have been a regulated entity, or even worse, an entity that extracted money from elderly or vulnerable individuals and where regulation is urgently needed to protect these investors.

Insolvency practitioners have a wealth of experience liaising with and obtaining the relevant permissions and authorisations from regulators in these instances and can put in suitable protections for victims and client account monies.

Early-stage fraud

Civil claims, meanwhile, are well worth considering at an earlier stage of the fraud. They are useful in situations where there are red flags for fraud but the scheme is still operational – save for perhaps a few early defaults – and the fraudsters are still active and communicating with investors. In such cases, there are often reasons to be confident that sufficient assets could be identified against which an English civil judgment could be enforced.

In the latter scenario, the scheme might be insolvent, but this is not usually the time for appointing insolvency practitioners to interview the fraudsters and witnesses or otherwise to create ‘noise’ around the scheme. The top priority is to locate and freeze the assets before the fraudsters realise that the game is up and start an asset dissipation process. Insolvency processes can then be used later in the asset recovery process to best utilise the skillset and powers an insolvency practitioner has available to them.

This is usually the time for the victims to take matters into their own hands, deploying the classic civil fraud litigation playbook that includes Norwich Pharmacal and Bankers Trust orders as well as gagging orders against any third parties that hold financial information. This should be followed by ‘ex parte’ applications for freezing and proprietary injunctions.

Challenges of bringing group actions

Investment fraud claims by victim groups in the English courts are still relatively rare when compared with the frequency with which large-scale frauds are committed. Most fraudulent investment schemes still seem destined for insolvency, rather than civil action. This is likely to be because investment fraud group actions are extremely difficult.

Building a group action is hard enough in any case, but doing so while keeping the process confidential from the fraudsters is uniquely challenging. On top of this, parties need a claim with good merits, a jurisdictional nexus, a sound enforcement strategy, a galvanised claimant group, and a committed litigation funder. Because of this, parties need a very large claim to make sure the funding model is economically viable.

Crucially, the timing needs to be just right. The claim must be brought late enough to ensure there is good evidence of fraud, but early enough to protect the assets before the scheme collapses. In many cases this window is brief.

The future of investment fraud group claims

Despite this, the ongoing growth of the litigation funding industry, and the judiciary’s gradually increasing willingness – in the absence of opt-out procedures – to be flexible in its use of procedures and remedies will likely lead to a gradual increase in the frequency of investment fraud group actions in future. On top of this, lawyers and other stakeholders are becoming increasingly familiar with technological developments in fraud detection, bookbuilding and claims portals.

There is unlikely to be any radical change overnight, however. Insolvency proceedings will remain the norm for the foreseeable future. Even in those occasional cases where the stars align and a civil action is brought before the collapse of the scheme, insolvency practitioners and receivers will play a vital role in the asset preservation and enforcement processes.