ALASTAIR E H SALVESEN v JOHN SIMONS [1993] UKEAT 451_93_2210

EMPLOYMENT APPEAL TRIBUNAL
BAILII case number: [1993] UKEAT 451_93_2210Case No Appeal No. UKEAT/451/93
Between
ALASTAIR E H SALVESENAPPELLANTJOHN SIMONSRESPONDENT
Before
Lord Coulsfield Mr J Langan Mr A J RamsdenDate 22 October 1993

LORD COULSFIELD :

[1]This is an appeal by an employer against a majority decision of an Industrial Tribunal, dated 3 1 March 1993, by which it was held that the respondent had been unfairly dismissed, and was entitled to a monetary award. The sole ground of the appeal is that the contract between the appellant and the respondent amounted to a fraud on the Revenue, rendering it contrary to public policy, and illegal. The respondent was employed at Whitburgh Estate, near Pathhead, Midlothian, from 5 April 1983 until 29 February 1992. He was originally employed with the title of Farm Manager but, with effect from October 1987, his job title was changed to Estate Manager. He was employed by Whitburgh Mains Limited until mid-July 1991, at which date the appellant purchased the estate and obtained entry to it. By virtue of Regulation 5 of the Transfer of Undertakings (Protection of Employment) Regulations 1981, the respondent's employment was continued with the new employer. In addition to his employment, the respondent operated, with his wife, a partnership called Jonor Services, which owned and obtained income from certain properties and also provided a farming consultancy service. As at January 1987, the respondent's salary, as farm manager, amounted to £12,200. At his request, his then employers agreed that, with effect from 1 January 1987, his current remuneration would be paid as to £10,000 as salary, subject to normal deductions in respect of tax and national insurance, and as to £2,200 as a management fee, to be paid to Jonor Services. It was further agreed that the salary would be paid monthly, as before, and that the partnership would invoice the employers in the normal way, and that the respondent would be responsible for any taxation and national insurance liabilities which might arise on the management fee. That arrangement was acted upon. By the time when the appellant became the employer, the respondent was entitled to total remuneration of £18,374, divided into salary of £15,770, which was subject to the usual deductions, and a management fee of £2,604 payable to Jonor Services, without deductions. The nature of these arrangements, and the understanding of the parties to them, was the subject of a considerable amount of evidence before the Industrial Tribunal. The Industrial Tribunal find that Jonor Services is a partnership organised under the law of Scotland, which keeps such books and records as are required, makes tax returns, and pays such tax as may be required of it by the Inland Revenue. However, they also find that neither Jonor Services nor either of its partners provided any services, either to the appellant or to his predecessors as owners of the estate, other than that the respondent worked, in accordance with his contract of employment, as farm manager and, latterly, as estate manager. The contract of employment required the respondent to devote his full-time persona! attention to his job. The Industrial Tribunal also find that all the parties to the original arrangement, i.e. the persons concerned with the management of the estate before it was acquired by the appellant and the present respondent, genuinely believed that the arrangements were legitimate and above-board, and that there was nothing illegal about the method of payment of the remuneration due under the contract of employment. The Industrial Tribunal point out that the effect of the arrangement was that the employers did not deduct tax or national insurance contributions from the management fee which was actually paid to Jonor Services; that the payment of any tax on that proportion would be deferred because the partnership would be taxed under Schedule D of the income tax legislation rather than under the PAYE system; and that legitimate business expenses could be allowable against income taxed under Schedule D which could not have been allowed against the proportion of the respondent's remuneration paid to Jonor Services if it had been paid to him and taxed under Schedule E. The respondent and the appellant's predecessors were all clearly aware of the arrangement which had been made and put into effect, but none of them knew, believed, nor suspected that the arrangement was in contravention of the legislation for the management of taxation, and, to that extent, illegal. The Industrial Tribunal also find that the question of the payment to Jonor Services was raised with the appellant after he became owner of the estate and that, contrary to certain evidence given by the appellant, he had not troubled to make enquiries about the legitimacy of that payment. The Industrial Tribunal set out in some detail the events which occurred after the appellant's acquisition of the property, but it is not necessary for us to enter into all these matters for the purposes of this appeal. One matter which did arise, however, concerned the management fee to Jonor Services, which the appellant did not, in fact, pay. That was one of the circumstances which led the respondent to submit his resignation on 29 November 1991, leading to the termination of his employment at the end of February 1992. Having considered the evidence, the Industrial Tribunal unanimously found that the appellant was in material breach of contract in failing to pay the part of the remuneration attributable to the management fee; and they were further unanimously of the opinion that the appellant's behaviour after the transfer was calculated to, and did, damage the relationship of trust and confidence between the parties. The Industrial Tribunal, therefore, unanimously held that there was a repudiatory breach by the appellant of the terms of the contract, and that the respondent had been constructively dismissed. With regard to the issue of illegality, the Industrial Tribunal first consider whether the arrangements, after January 1987, were illegal. They reached a unanimous view on this point also. They expressed their view as follows:- "The first issue, logically, is whether the contractual arrangements which commenced in or about January 1987 and continued thereafter until the time of the transfer, were in fact illegal. We are driven to the conclusion that, in the technical sense, they were. The whole sum payable for the work undertaken by the applicant at Whitburgh Estate was, in our view, properly to be regarded as the emoluments of his employment as Estate Manager. As a result, in our opinion, the whole sum was then subject to Schedule E taxation including the PAYE system under the primary and subordinate legislation which Mr Dobie (who appeared for the employer) drew to our attention. Accordingly, it follows that the arrangement which was reached in January 1987 was calculated to, and did, amount to a breach of the statutory provisions for the management and collection of Income Tax. It was a scheme which, as we have found, had at least the result of deferral of tax and, it would seem, at least potential evasion of tax which would have been lawfully due under Schedule E and payable via the PAYE Regulations." The Industrial Tribunal then consider in detail the arguments and authorities which were drawn to their attention; it is not necessary to repeat these arguments because the authorities referred to were, substantially, those which were canvassed in the submissions before us. The majority paid particular regard to the decisions in Newcastle Catering Ltd -v- Ahmed & Elkamah [1991] IRLR 473 and Newland -v- Simons & Wilier (Hairdressers) Ltd [1981] IRLR 359 , and concluded:- "Even allowing for the fact that it is plain that it was the applicant's suggestion that the financial incidents of the contract should be dealt with in the manner in which they were, the majority consider that, since the technical illegality of the contract of employment was an illegality which was as a matter of fact not known to any of the parties then to it, that does not preclude this Tribunal granting a remedy to this applicant in these circumstances on the facts which we have found. They consider that the necessity of looking at the applicant subjectively (Newland) enables the Tribunal to distinguish in the case of this highly technical breach of statutory regulations in relation to the collection of tax, the proposition that ignorance of the law is of no importance. There was never any intention to do anything which was illegal. The arrangements were made in good faith. The contract was not operated in knowledge by either party to it of any illegality. The minor and technical breach of the tax collection rules is not sufficient to preclude our awarding compensation. It was not certain that any tax was actually evaded, as opposed to its payment being deferred. In any event, any loss to the Inland Revenue would be of a small amount. Further, the Jonor Services' money was a relatively small proportion of the whole remuneration contractually due to the applicant under his employment contract. There was no moral turpitude whatsoever which would lead to the necessary application of the public policy rule." The Chairman took a different view. He drew a distinction between cases in which a contract which, if performed according to its terms, is capable only of being performed so as to lead to evasion or improper deferral of tax, and a contract which, according to its terms, need not necessarily involve such evasion or improper deferral. He held that the employee's knowledge of the illegality was irrelevant in the first case, but relevant in the second. He went on:- "Applying those principles to the facts of this case as found, there is a statutory illegality, however technical, arising from the agreement between the applicant and the respondent's predecessors which had, as its effect, evasion or improper deferral of tax. The agreement, operated according to its terms, necessarily had that result." He went on to hold.-in accordance with the principles previously set out, that the lack of knowledge on the part of all those concerned, of the illegality of the arrangements, made no difference to the employee's inability to recover; and that there were no public policy issues which could be applied to moderate the application of the principle that action would not be available on an illegal contract. Before us, the appellant contended that the Chairman had reached the correct conclusion. The appellant was represented by counsel, while the respondent appeared on his own behalf and made little attempt to grapple with the legal technicalities of the argument. In the circumstances, we do not think there is any value in attempting to summarise the competing contentions of the parties. The basic principle upon which the question depends is expressed by Gloag (Contract, 2nd edition, p. 585) as follows.- "Where a contract involves an element of illegality, as distinguished from the case where it is merely declared void by statute, the effect is to debar the parties concerned from the right to appeal to Courts of Justice. The effect of the maxims ex turpi causa non oritur actio and in turpi causa melior est conditio possiddentis is, where they are fully applicable, that one wrongdoer may with impunity take any advantage of the others of which the circumstances admit. Where the action is not an attempt to enforce the commission of an illegal act, but is a demand connected with such an act, the general test of whether it is capable of being enforced is whether the pursuer acquires the aid of the illegal act to establish his case." The same author said, at p.564:- "It is assumed in all the cases that in order to make a contract, in itself innocent, unlawful on the ground that it was designed to serve an illegal purpose, it must be shewn that the party suing upon it was aware of that purpose. But it is not necessary to prove that he was aware that the purpose was illegal; he is presumed to know the law." The principles there set out are, it is agreed, subject to two limitations or qualifications. The first is that if a contract is in itself legal, in that it does not necessarily involve any illegal act or purpose, the fact that something illegal is done in the course of carrying out the contract does not render the contract invalid. The second is that the existence of a relationship between two parties founded on an illegal contract may not prevent one party suing the other, provided that he can do so upon a ground independent of the contract. Both these qualifications may, in some circumstances, have to be read in the light of the views expressed by Nicholls LJ in Saunders -v- Edwards [1987] 1 WLR 1116 , but, for the present purpose, they can be accepted. The principal authority cited by Gloag in support of the proposition that ignorance of the illegal character of a contract does not prevent the application of the ex turpi causa rule is Smith's Advertising Agency -v-Leeds Laboratory Co [1910] 26 TLR 64 and 335 . In that case, the plaintiffs were employed to advertise certain competitions which were later held to be illegal lotteries. The defendants contended that they were not obliged to pay for the advertisements, and that contention was upheld, both at first instance and on appeal. At first instance, Walton J observed that the ruling that the plaintiffs could not recover their remuneration for what they had done might seem hard, because, at the time of the insertion of the advertisements, it had been quite an open question whether a competition of the kind was a lottery or not, but he continued:- "Hard as it might be, however, he did not think that it was disputed that if in fact the competition advertised here was a lottery, and the advertisement was in fact an invitation to the public to compete in a lottery, then although the plaintiffs might not have realized when they issued the advertisements that they were doing that which was illegal, yet as every one must be taken to know the law, in advertising the lottery they had committed an illegal act." On appeal, Farwell LJ put the point simply, by saying:- "If on the construction the advertisements were held to be a lottery, it did not matter what the parties thought." It is, in our opinion, clear that, if that authority is applied to the present case, the fact that all the parties to the contract between the appellant, and his predecessors, and the respondent thought that what they were doing was lawful would be entirely irrelevant. There are several later authorities which directly favour the appellant's contention that the contract in the present case was unlawful. The first is Miller -v- Karlinski [1945] TLR 85 , in which the plaintiff was employed by the defendant under a contract which provided that he should receive a salary of £10 per week, and should also recover from the defendant the amount of income tax payable thereon, by including it in an account for travelling expenses. The contract, therefore, involved direct and obvious fraud on the Inland Revenue, since it involved representations both that the actual remuneration being paid to the plaintiff was less than it truly was, and that certain sums were paid as reimbursement of expenses when, in fact, they were nothing of the kind. It was held, in the Court of Appeal, that the contract was unlawful. Du Parcq LJ said:- "There is nothing necessarily wrong or illegal in agreeing to pay to an employee a sum free of income-tax. The matter can lawfully be arranged in such a way that the employee gets the agreed amount free of tax." He then went on to point out that the method of payment ordinarily adopted had disadvantages to the employer; that the extra amount was not, in truth, expenses at all; that the method of remuneration was one by which the Revenue was defrauded; and that it would be unlawful to enforce such an agreement. His Lordship went on to observe some surprise at a finding, made by the county court judge, that the parties did not anticipate any loss to the Revenue, and to say that, in any event, it made no difference whether the parties were ignorant that what they were doing was illegal. He then said that it was too plain for argument that the agreement to charge tax to expenses was against public policy, and concluded:- "I find it impossible to say that where a man agrees to work and to be paid according to a scheme devised, as was that in the present case, so as to defraud the Revenue the whole agreement is not an illegal agreement which the Courts will not enforce. It is as well that people who enter into this kind of agreement should know that if either party fails to observe any of its terms the Courts will not entertain an action to enforce them. As I have said, 1 feel some sympathy with the plaintiff. None the less the duty of this Court is clear." The second of the authorities to which we have referred is Napier -v- National Business Agency Ltd [1951] 2 All ER 264 . In that case, the contract of employment provided that the employee should receive a salary of £13 per week, together with £6 per week for expenses. Both parties, however, were aware that the employee's expenses could never amount to £6 per week. The employee, in fact, disclosed the arrangement to the tax authorities, and the payment of the sum of expenses was also disclosed, in the form of an endorsement, on the employers' PAYE return. The Court of Appeal held that the judge was not disentitled from finding, as he did, that the employee and the employers, together, made a bargain, knowing well that the figure of £6 per week was a sham figure which bore no relation to the expenses which, in fact, would be incurred. Evershed MR said, at p.266.- EAT/45I/93 -g. "If those were the facts, what is the inference? It must surely be that, by making an agreement in that form the parties to it were doing that which they must be taken to know would be liable to defeat the proper claims of the Inland Revenue and to avoid altogether, or at least to postpone, the proper payment of income tax. If that is the right conclusion, it seems to me equally clear (subject to one point which I will mention in a moment) that the agreement must be regarded as contrary to public policy. There is a strong legal obligation placed on all citizens to make true and faithful returns for tax purposes, and, if parties make an agreement which is designed to do the contrary, i.e., to mislead and to delay, it seems to me impossible for this court to enforce that contract at the suit of one party to it." The point to which the Master of the Rolls referred was the question whether the contract was severable, and he went on to reject that possibility. Denning LJ said:- "In these days of high income tax there is a great temptation for employers and servants to describe remuneration as being in part salary and in part expenses. This is done in the hope of evading tax on the part described as expenses, and the temptation must be resisted. In order that an expense allowance should be valid, it must be a genuine estimate of the expenses to be incurred. The insertion of a fictitious figure for expenses in order to defraud the revenue is illegal. It vitiates the whole remuneration and disentitles the servant from recovering any part of it. He cannot recover either the part described as expenses or even the part described as salary. I think that the decision of the judge was quite right. It will have a very salutary effect if it stops people putting in fictitious figures for expenses." The next of the cases to which we have referred is Corby -v- Morrison t/a The Card Shop [1980] IRLR 218, a decision of the Employment Appeal Tribunal, presided over by May J. In that case, the employee received a basic wage, as fixed by a relevant Wages Council Order, and, in addition, received a sum of £5 per week, paid gross. The method of payment was that the £5 was put into the employee's wage packet, but did not appear in the total written on the front of the packet, and was not subjected to any deduction, either for income tax or for social security liability. May J discussed the general principle, and the case of Miller -v- Karlinski supra, and held that the agreement was unenforceable for the reasons given by du Parcq LJ. He went on to discuss, obiter, an alternative argument, on the basis that the contract was ex facie legal, and to express the view that any reasonable person in the position of the employee would have appreciated that the purpose of the agreement was to avoid the payment of tax. In Newland -v- Simons & Wilier (Hairdressers) Ltd supra , the Employment Appeal Tribunal, again presided over by May J, reaffirmed the views expressed in Corby supra , and rejected an argument that Parliament could not have intended that an employee should lose his rights under a contract of employment because the contract, on its face or in performance, involved a fraud on the Revenue. In Newland , the employee had received wages of a certain amount in cash, while the employer had recorded a different, and lower, amount in his records and his returns to the Inland Revenue. It was not clear, on the findings, whether the employee knew that the employer had been making false records and returns. In the Employment Appeal Tribunal judgment, May J said that it was clear that the employer was disentitled from relying on the contract, and continued:- "......the, question whether the employee is in her turn in such circumstances also affected by the illegal performance of the contract by the employer depends upon whether she was a party to or knew of her employer's illegality." Because the facts in that case were not sufficiently ascertained, the case was remitted to an Industrial Tribunal to allow more precise findings to be made. In the present case, the F majority of the Industrial Tribunal took Newland as support for the view that a subjective approach should be taken and that, if the employee did not know that the contract was illegal, he could enforce it. The ignorance with which the Employment Appeal Tribunal were concerned in Newland , however, was the employee's ignorance of what the employer was, in fact, doing, and the case does not, in our view, weaken the principle, established in Miller and the other cases, that, if a party knew what was being done, it is irrelevant that he did not know that it was illegal. We should add that it has also been held, in Tomlinson -v- Dick Evans U Drive Ltd [1978] IRLR 77, that an agreement which was a fraud on the Revenue could not be enforced, but in that case both parties to the employment contract were aware of the illegality. That was also the position in Hyland -v- .JII Barker (North West) Ltd [1985] IRLR 403 , in which the argument that Parliament could not have intended that an employee should lose his statutory rights because of illegality in his contract was again rejected. In some of these cases it was suggested that the illegal part of the contract could be severed, leaving the remainder enforceable, but that argument was uniformly rejected, following Napier supra . It seems to us to be clear that if these authorities are directly applicable to the present case, the appeal must succeed. There are, really, only two ways by which that conclusion could be avoided. The first would be to hold that the contract in the present case cannot properly be regarded as a fraud on the Revenue, in the same sense, or to the same extent, as the contracts considered in the authorities above mentioned. The second would be to hold, in reliance upon observations in recent cases in the Court of Appeal, that the ex turpi causa principle is not always to be applied according to its fullest rigour, and that in this case it should not be so applied. With regard to the first of these possibilities, it is clear, in our view, that in each of the cases, and in particular in Miller , Napier and Corby, the contract involved a fraud on the Revenue in a direct and immediate sense. That is, perhaps, most obvious in Corby , in which a payment was made without being declared at all. It is, however, equally the case in Napier , in which a payment was made which was obviously, on the facts found, one of remuneration but which was misrepresented as a payment of expenses. The same can be said of the case of Miller . In the present case it might be said that, according to the findings of the Industrial Tribunal, there was not such a direct or obvious fraud as in the three cases above referred to. The fact that the payment to Jonor Services was being made was disclosed by the appellant's predecessors, and the fact that it was being received was disclosed by the partnership itself. The effect of the arrangement was not to take any part of the respondent's remuneration out of a charge to tax altogether, but merely to transfer it, or attempt to transfer it, to Schedule D. We have, however, come to the conclusion that the arrangement made between the respondent and his employers did involve a misrepresentation, namely, that there was some proper basis, or consideration, for the payment to Jonor Services. It is not impossible that, where a member of a partnership performs services outwith the scope of the partnership business, a payment may properly be made to the partnership in compensation for the diversion of the partner's time from its business. In the present case, there was, however, no basis for any arrangement of that kind. The position, all along, was that the respondent was obliged to, and did, devote his whole time to his duties with the appellant and his predecessors, and that any work which he undertook for Jonor Services was performed outwith his normal working hours. It is also clear that Jonor Services did not provide any service to the employer. In these circumstances, there was a misrepresentation of the character of the payment made to Jonor Services. It was not truly a payment to Jonor Services at all, but was a diversion of part of the respondent's remuneration. Although, therefore, the position is not so immediately plain as it was in the three cases to which we have referred, we cannot escape the conclusion that there was here a misrepresentation to the Revenue, and, to that extent, a fraud upon the Revenue. In the argument on behalf of the appellant, we were very properly referred to two Court of Appeal decisions which may go some way to mitigate the rigour of the ex turpi causa rule. Those cases were Saunders -v- Edwards supra and Hewcastle Catering Ltd -v- Ahmed and Elkamah supra. It will be necessary for us to say something about those cases, but, in our view, it is appropriate to begin our consideration of this part of the question with the decision in Shelley -v- Paddock & Another [1980] 1 All ER 1009 . In that case, the plaintiff agreed to purchase a house in Spain from the defendants, who were English nationals resident in Spain. The defendants represented that they had authority to sell the house, which they did not in fact have. The plaintiff paid certain sums, which payments were made in contravention of the then exchange control legislation, although the plaintiff was unaware of the illegality. At first instance, it was held that the plaintiff was entitled to recover damages for fraud, and that decision was affirmed on appeal. Lord Denning MR, at p.1011, set out the defendants' argument that the plaintiffs action was barred by the exjurpi causa principle.. Lord Denning then narrates the findings cf the trial judge that the defendants were guilty of a fraud all the way through, and went on to say:- "In those circumstances, it seems to me that the principle stated by Lord Mansfield CJ does not apply. I know that there are some cases where a person has not been able to recover when he has been guilty of evading the exchange control regulations or similar regulations: see Boissevain v Weil [1950] AC 327 and Shaw v Shaw [1965] 1 WLR 537 . In those cases both parties were participating in the illegal act and there was nothing to choose between them. But it seems to me altogether different when the parties are not in pari delicto. I ventured to summarise such cases in Kiriri Cotton Co Ltd v Dewani [I960} AC 192. In the instant case the properly was never conveyed to .Miss Shelley. As J said in the Kiriri cane, in circumstances like that - ".....it was better to allow the plaintiff to resile from it before it was completed, and to award restitution to him rather than to allow the defendant to remain in possession of his illegal gains." It is better to allow Miss Shelley to recover here rather than to allow the Paddocks to remain in possession of their unlawful gains. I went on to say:
"If there is something more in addition to a mistake of law - if there is something in the defendant's conduct which shows that, of the two of them he is the one primarily responsible for the mistake - then it may be recovered back."
It seems to me plain on each of those principles that these parties are not in pari delicto." Brightman LJ concurred, as did Brandon LJ although he expressed some doubts about the decision. The next case which should be mentioned is Saunders -v- Edwards [1987] 1 WLR 1116 , to which reference has already been made. That case arose out of a contract for the sale of a flat, and its contents, in which the parties agreed to apportion the cumulo price, upon which they had also agreed, between the real property and the contents, in a fictitious manner. Subsequently, the purchasers claimed damages from the seller on the basis of fraudulent misrepresentation, and damages were awarded, at first instance. On appeal, there was some variation in the damages, but an argument that the purchasers should be debarred from recovering anything, on the ex turpi causa principle, was rejected. It is, we think, clear that the basis on which that argument was rejected was that, in Saunders -v- Edwards , the plaintiffs were not suing on the contract, but upon a fraudulent misrepresentation independent of the contract. The case does, however, contain some observations about the application of the ex turpi causa principle. At p.1125, Kerr LJ said:- "However, the present action, unlike Alexander -v- Rayson , is not brought on the contract, but on the tort of deceit based on the defendant's fraudulent misrepresentation. I therefore do not propose to consider what would have been the position if, for instance, the defendant had declined to complete in this case and the plaintiffs had sought to sue on the contract, either for specific performance or for damages." Later, on the same page, Kerr LJ said that the approach which he favoured was supported by a number of authorities which showed that the relevance of the ex turpi causa defence lay mainly in the field of contractual claims, and only rarely in tort, and referred to a number of authorities dealing with the distinction between relying upon illegal contract and relying upon some independent cause of action. At p. 1127, however, he went on to say:- "But the full picture is more complex, as shown by two more recent cases to which we were also referred. I will not analyse them in detail, but they show that there are no rigid rules for or against the application of the ex turpi causa defence. This is not surprising, since it involves issues of public policy. To some extent these must depend on the circumstances of each case." Kerr LJ then went on to refer to Shelley -v- Paddock supra , and Thackwell -v- Barclays Bank plc [1986] 1 All ER 676 , and observed:- "These cases show that the conduct and relative moral culpability of the parties may be relevant in determining whether or not the ex turpi causa defence falls to be applied as a matter of public policy." Nicholls LJ, at p. 1132, observed that the claim was not one to enforce the contract nor, strictly, based on the contract, although the contract was a material part of the history, but one on fraudulent misrepresentation; and that, although one of the provisions of the contract had an unlawful purpose, the plaintiffs did not, strictly speaking, rely on that contract in their present proceedings. He continued:- "But I do not think that that is an end of the matter. The refusal of the court to enforce an agreement entered into in a particular form for an unlawful purpose is based on public policy, and public policy is not a blunt, inflexible instrument. I do not regard all questions of illegality and public policy as flying out of the window once it is seen that the claim is not to enforce the contract. In this case, in answer to the defendant's reliance on the agreed apportionment of £5,000 as evidence of the value of the chattels which were handed over on completion, the plaintiffs ask the court to disregard that agreed apportionment as not being a genuine assessment of the value of the chattels. Honest mistake is not suggested. Thus what the plaintiffs are doing involves asserting, as the explanation for the apportionment, an unlawful purpose." He also referred to Thackwell -v- Barclays Bank plc supra , and approved an observation by Hutchison J that the principle:- "....involved the court looking at the quality of the illegality relied on by the defendant and all the surrounding circumstances, without fine distinctions, and seeking to answer two questions: first, whether there had been illegality of which the court should take notice and, second, whether in all the circumstances it would be an affront to the public conscience if by affording him the relief sought the court was seen to be indirectly assisting or encouraging the plaintiff in his criminal act". Nicholls LJ went on to say that he thought that a useful and valuable test, summarising neatly and explicitly the task on which the court was involved in applying public policy. In applying the test to the case before him, he said:- "Applying that test, in this case there has been illegality of which the court should take notice. It is not a matter to which the court should turn a blind eye. However, when one comes to weigh, on the one hand, the extent to which it might seem that by granting these plaintiffs relief the court is indirectly encouraging these plaintiffs in their tax evasion activity, or indirectly encouraging others in other cases to proceed similarly when apportioning a purchase price, against, on the other hand, permitting a fraudulent defendant to retain money which he has received from the plaintiffs and which represents a financial loss suffered by the plaintiff's directly as a result of the fraudulent misrepresentation, I have no doubt on which side the scales fall. I have no hesitation in concluding that, on the facts of this case, granting to these plaintiffs relief against the defendant would not be an affront to the public conscience." The third member of the Court of Appeal, Bingham LJ, agreed with both the previous judgments, and added only some observations on illegality. At p. 1134 , he said:- "Where issues of illegality are raised, the courts have (as it seems to me) to steer a middle course between two unacceptable positions. On the one hand . it is unacceptable that any court of law should aid or lend its authority to a party seeking to pursue or enforce an object or agreement which the law prohibits. On the other hand, it is unacceptable that the court should, on the first indication of unlawfulness affecting any aspect of a transaction, draw up its skirts and refuse all assistance to the plaintiff, no matter how serious his loss nor how disproportionate his loss to the unlawfulness of his conduct. The cases to, which Kerr and Nicholls L.JJ have referred are valuable, both for the statements of principle which they contain and for the illustrations which they give of the courses which courts have in fact steered in different factual situations. But I think that on the whole the courts have tended to adopt a pragmatic approach to these problems, seeking where possible to see that genuine wrongs are righted so long as the court does not thereby promote or countenance a nefarious object or bargain which it is bound to condemn. Where the plaintiffs action in truth arises directly ex litrpi causa, he is likely to fail. Where the plaintiff had suffered a genuine wrong, to which allegedly unlawful conduct is incidental, he is likely to succeed...." We should next refer to Euro-Diam Ltd -v- Batliurst [1988] 2 All ER 23 . It is not necessary to enter into the somewhat complex facts of that case. It is sufficient to say that, in the end, the defence of ex turpi causa was rejected, on the grounds that there was no direct or proximate connection between the claim made by the plaintiffs and a certain illegality arising from an understated invoice. Kerr LJ, however, set out the relevant principles of law fully. (In quoting from his judgment, we abbreviate by omitting most of the case references cited.) Kerr LJ said, at p.28 :- "(1) The ex turpi causa defence ultimately rests on a principle of public policy that the courts will not assist a plaintiff who has been guilty of illegal (or immoral) conduct of which the courts should take notice. It applies if, in all the circumstances, it would be an affront to the public conscience to grant the plaintiff the relief which he seeks because the court would thereby appear to assist or encourage the plaintiff in his illegal conduct or to encourage others in similar acts: see para (2)(iii) below. The problem is not only to apply this principle, but also to respect its limits, in relation to the facts of particular cases in the light of the authorities. (2) The authorities showed that in a number of situations the ex turpi causa defence will prima facie succeed. The main ones are as follows. (i) Where the plaintiff seeks to, or is forced to, found his claim on an illegal contract or to plead its illegality in order to support his claim. For that purpose it makes no difference whether the illegality is raised in the plaintiffs claim or by way of reply to a ground of defence. (ii) Where the grant of relief to the plaintiff would enable him to benefit from his criminal conduct. (iii) Where, even though neither (i) nor (ii) is applicable to the plaintiffs claim, the situation is nevertheless residually covered by the general principle summarised in (i) above. This is most recently illustrated by the judgment of Hutchison J in ThackwcU v Barclays Bank pic, as approved by this court in Sounders v Edwards. (3) However, the ex turpi causa defence must be approached pragmatically and with caution, depending on the circumstances. This applies in particular to cases which at first sight appear to fall within para (2)(i) or (ii) above. Thus: (i) Situations covered by para (2)(i) above must be distinguished from others where the plaintiffs claim is not founded on any illegal act, but where some reprehensible conduct on his part is disclosed in the course of the proceedings, whether by the plaintiff himself or otherwise. In such cases the ex turpi causa defence will not succeed. Nor will it succeed where the defendant's conduct in participating in an illegal contract on which the plaintiff sues is so reprehensible, in comparison with that of the plaintiff, that it would be wrong to allow the defendant to rely on it: see eg Shelley v Paddock . But where both parties are equally privy to the illegality the plaintiffs claim will fail, whether raised in contract or tort, for potior est condicio defendentis. And an action on a contract the terms of which are falsely recorded in documents intended to conceal the true agreement between the parties may be defeated by the ex turpi causa defence. (ii) In situations covered by para 2(i) and (ii) above the ex turpi causa defence will also fail if the plaintiffs claim is for the delivery up of his goods, or for damages for their wrongful conversion, and if he is able to assert a proprietary or possessory title to them even if this is derived from an illegal contract." Russell LJ and Sir Denys Buckley concurred in the judgment of Kerr LJ. The remaining case is Hewcastle Catering Ltd -v- Ahmed & Elkamah supra . In that case, the employers owned a club where the employees worked as waiters. The employers devised a scheme by which they would evade payment of VAT on services provided to customers who paid their bills by cash. The waiters were instructed to inform a manager if a customer did wish to pay in cash, and, on such occasions, the manager would arrange for the issue of a different type of bill, which would be presented to the customer. The amounts received in cash were not included in returns for VAT purposes. Following a Customs & Excise raid, the system was changed so that the waiters were no longer involved in the VAT fraud. However, the fraud continued, organised by the managers of the club, and a further visit by Customs & Excise officers led to statements being made by the employee waiters about the manner in which bills had in the past been paid. In consequence, two of the managers were charged with offences, and committal proceedings took place, for which four of the waiters were called as witnesses. Within a short time thereafter, the waiters who had given evidence were dismissed, and, in due course, a prosecution took place at which the managers were convicted. After sundry proceedings before Industrial Tribunals and the Employment Appeal Tribunal, the matter eventually came before the Court of Appeal. In his judgment, Beldam LJ reviewed the authorities, including those cited previously in this judgment, and also referred to Coral Leisure Group Ltd -v- Burnett [1981] IRLR 204 . He quoted, with approval, a passage from the judgment of the Vice-Chancellor, Browne-Wilkinson J, in the Coral Leisure Group Ltd case, where he said:- "We accordingly think the law to be this. The fact that a party has in the course of performing a contract committed an unlawful or immoral act will not by itself prevent him from further enforcing that contract unless the contract was entered into for the purpose of doing that unlawful or immoral act or the contract itself (as opposed to the mode of his performance) is prohibited by law." Beldam LJ further quoted from the judgment of Kerr LJ in Euro-Diam Ltd supra, and continued:- "Taking that approach in the present case, in my judgment any Tribunal considering the facts would be bound to conclude that public policy did not in the circumstances preclude the claim of the respondents. There are, as it seems to me, a number of factors which a court would take into account in those circumstances which would lead it to that conclusion." Beldam LJ then referred to a number of factors, including the fact that the contract of employment was not one in which the employees were engaged on the basis that they would assist in fraud, that the employees themselves only took part in the fraud by telling the managers when a customer wished to pay in cash, and by carrying to the customer the bill which they were given to take, and returning the cash to the cashier. He, further, referred to the desirability of encouraging disclosure of such frauds, and concluded by expressing the view that conscience would not be affronted by allowing the claim of the employees in this case. The recent cases, which we have summarised, do clearly stress that the foundation of the ex turpi causa rule is public policy, and that, that being so, the rule must be applied pragmatically and flexibly, rather than rigidly and automatically. If so, it is difficult to see why there should not be room for a pragmatic and flexible approach to cases in which the claim is directly founded upon a contract which is tainted with illegality, as well as to cases in which it is not. The observations of Nicholls LJ in Saunders -v- Edwards supra seem to us to give some support to the view that no clear distinction can be drawn, in this respect, between the different types of case. The same might, we think, be said of the summary of the law set out by Kerr LJ in Euro-Diam Ltd -v- Bathurst supra . The position does, however, remain that, as Kerr LJ said in that case, the rule prim a facie applies where E a plaintiff seeks to, or is forced to, found his claim on an illegal contract, and the only case in which, so far as we can see, the defence has, so far, not been sustained in such a situation was Shelley -v- Paddock supra . That was a case in which, undoubtedly, the illegality in which the plaintiff was involved paled into insignificance compared with the F outright fraud practised by the defendants. Further, in considering what was said by Lord Denning in Shelley -v- Paddock , and its relevance to the present case, it is necessary to bear in mind the equally trenchant observations by the same judge in Napier -v- National Business Agency supra . In the present case, there is nothing to indicate that the employers bore any greater share of responsibility for the illegality than did the respondent; nor is there any evidence of unlawful conduct on their part which could be compared to the fraudulent conduct of the defendants in Shelley -v- Paddock . Indeed, the respondent seems to have suggested the arrangement which was made in the present case and, although he was innocent of any deliberate illegality, it must be assumed that he did so with some advantage, or purpose, in mind. In these circumstances, we have come to the conclusion that there is nothing in the recent series of decisions to which we have referred which would justify us in treating the present case otherwise than is required by the application of the very clear statements to be found in Napier -v- National Business Agency and Miller -v-Karlinski supra, as, well as the uniform practice of the Employment Appeal Tribunal demonstrated by the other cases cited above. It seems to us, therefore, to follow that we must allow the appeal and, in agreement with the view taken by the Chairman, dismiss the application. Even if it were open to us to consider whether public policy did require that-the ex turpi causa defence should apply in a case such as this, it would be very difficult for us, in the face of the views which have been expressed already in the Court of Appeal, to reach the conclusion that public policy did not require that the contract in the present case should be treated as unenforceable. It may be said that the consequence is that the respondent suffers a severe penalty for a minor illegality which cannot, in all probability, have cost the Revenue any significant sum in lost tax: but we agree with the Chairman that it is difficult to imagine that the respondent did not appreciate that the contractual arrangement which was made did involve some effects on the taxation position, and that it is not necessarily inequitable that persons who seek to take advantage out of the tax system, misguidedly or otherwise, should not be entitled to be treated as if they were employed under a normal contract of employment. For these reasons, we shall allow the appeal, and dismiss the application. The respondent was employed at Whitburgh Estate, near Pathhead, Midlothian, from 5 April 1983 until 29 February 1992. He was originally employed with the title of Farm Manager but, with effect from October 1987, his job title was changed to Estate Manager. He was employed by Whitburgh Mains Limited until mid-July 1991, at which date the appellant purchased the estate and obtained entry to it. By virtue of Regulation 5 of the Transfer of Undertakings (Protection of Employment) Regulations 1981, the respondent's employment was continued with the new employer. In addition to his employment, the respondent operated, with his wife, a partnership called Jonor Services, which owned and obtained income from certain properties and also provided a farming consultancy service. As at January 1987, the respondent's salary, as farm manager, amounted to £12,200. At his request, his then employers agreed that, with effect from 1 January 1987, his current remuneration would be paid as to £10,000 as salary, subject to normal deductions in respect of tax and national insurance, and as to £2,200 as a management fee, to be paid to Jonor Services. It was further agreed that the salary would be paid monthly, as before, and that the partnership would invoice the employers in the normal way, and that the respondent would be responsible for any taxation and national insurance liabilities which might arise on the management fee. That arrangement was acted upon. By the time when the appellant became the employer, the respondent was entitled to total remuneration of £18,374, divided into salary of £15,770, which was subject to the usual deductions, and a management fee of £2,604 payable to Jonor Services, without deductions. The nature of these arrangements, and the understanding of the parties to them, was the subject of a considerable amount of evidence before the Industrial Tribunal. The Industrial Tribunal find that Jonor Services is a partnership organised under the law of Scotland, which keeps such books and records as are required, makes tax returns, and pays such tax as may be required of it by the Inland Revenue. However, they also find that neither Jonor Services nor either of its partners provided any services, either to the appellant or to his predecessors as owners of the estate, other than that the respondent worked, in accordance with his contract of employment, as farm manager and, latterly, as estate manager. The contract of employment required the respondent to devote his full-time persona! attention to his job. The Industrial Tribunal also find that all the parties to the original arrangement, i.e. the persons concerned with the management of the estate before it was acquired by the appellant and the present respondent, genuinely believed that the arrangements were legitimate and above-board, and that there was nothing illegal about the method of payment of the remuneration due under the contract of employment. The Industrial Tribunal point out that the effect of the arrangement was that the employers did not deduct tax or national insurance contributions from the management fee which was actually paid to Jonor Services; that the payment of any tax on that proportion would be deferred because the partnership would be taxed under Schedule D of the income tax legislation rather than under the PAYE system; and that legitimate business expenses could be allowable against income taxed under Schedule D which could not have been allowed against the proportion of the respondent's remuneration paid to Jonor Services if it had been paid to him and taxed under Schedule E. The respondent and the appellant's predecessors were all clearly aware of the arrangement which had been made and put into effect, but none of them knew, believed, nor suspected that the arrangement was in contravention of the legislation for the management of taxation, and, to that extent, illegal. The Industrial Tribunal also find that the question of the payment to Jonor Services was raised with the appellant after he became owner of the estate and that, contrary to certain evidence given by the appellant, he had not troubled to make enquiries about the legitimacy of that payment. The Industrial Tribunal set out in some detail the events which occurred after the appellant's acquisition of the property, but it is not necessary for us to enter into all these matters for the purposes of this appeal. One matter which did arise, however, concerned the management fee to Jonor Services, which the appellant did not, in fact, pay. That was one of the circumstances which led the respondent to submit his resignation on 29 November 1991, leading to the termination of his employment at the end of February 1992. Having considered the evidence, the Industrial Tribunal unanimously found that the appellant was in material breach of contract in failing to pay the part of the remuneration attributable to the management fee; and they were further unanimously of the opinion that the appellant's behaviour after the transfer was calculated to, and did, damage the relationship of trust and confidence between the parties. The Industrial Tribunal, therefore, unanimously held that there was a repudiatory breach by the appellant of the terms of the contract, and that the respondent had been constructively dismissed.[2]With regard to the issue of illegality, the Industrial Tribunal first consider whether the arrangements, after January 1987, were illegal. They reached a unanimous view on this point also. They expressed their view as follows:- "The first issue, logically, is whether the contractual arrangements which commenced in or about January 1987 and continued thereafter until the time of the transfer, were in fact illegal. We are driven to the conclusion that, in the technical sense, they were. The whole sum payable for the work undertaken by the applicant at Whitburgh Estate was, in our view, properly to be regarded as the emoluments of his employment as Estate Manager. As a result, in our opinion, the whole sum was then subject to Schedule E taxation including the PAYE system under the primary and subordinate legislation which Mr Dobie (who appeared for the employer) drew to our attention. Accordingly, it follows that the arrangement which was reached in January 1987 was calculated to, and did, amount to a breach of the statutory provisions for the management and collection of Income Tax. It was a scheme which, as we have found, had at least the result of deferral of tax and, it would seem, at least potential evasion of tax which would have been lawfully due under Schedule E and payable via the PAYE Regulations."[3]The Industrial Tribunal then consider in detail the arguments and authorities which were[4]drawn to their attention; it is not necessary to repeat these arguments because the authorities[5]referred to were, substantially, those which were canvassed in the submissions before us. The majority paid particular regard to the decisions in Newcastle Catering Ltd -v- Ahmed & Elkamah [1991] IRLR 473 and Newland -v- Simons & Wilier (Hairdressers) Ltd [1981] IRLR 359 , and concluded:- "Even allowing for the fact that it is plain that it was the applicant's suggestion that the financial incidents of the contract should be dealt with in the manner in which they were, the majority consider that, since the technical illegality of the contract of employment was an illegality which was as a matter of fact not known to any of the parties then to it, that does not preclude this Tribunal granting a remedy to this applicant in these circumstances on the facts which we have found. They consider that the necessity of looking at the applicant subjectively (Newland) enables the Tribunal to distinguish in the case of this highly technical breach of statutory regulations in relation to the collection of tax, the proposition that ignorance of the law is of no importance. There was never any intention to do anything which was illegal. The arrangements were made in good faith. The contract was not operated in knowledge by either party to it of any illegality. The minor and technical breach of the tax collection rules is not sufficient to preclude our awarding compensation. It was not certain that any tax was actually evaded, as opposed to its payment being deferred. In any event, any loss to the Inland Revenue would be of a small amount. Further, the Jonor Services' money was a relatively small proportion of the whole remuneration contractually due to the applicant under his employment contract. There was no moral turpitude whatsoever which would lead to the necessary application of the public policy rule."[6]The Chairman took a different view. He drew a distinction between cases in which a contract which, if performed according to its terms, is capable only of being performed so as to lead to evasion or improper deferral of tax, and a contract which, according to its terms, need not necessarily involve such evasion or improper deferral. He held that the employee's knowledge of the illegality was irrelevant in the first case, but relevant in the second. He went on:- "Applying those principles to the facts of this case as found, there is a statutory illegality, however technical, arising from the agreement between the applicant and the respondent's predecessors which had, as its effect, evasion or improper deferral of tax. The agreement, operated according to its terms, necessarily had that result."[7]He went on to hold.-in accordance with the principles previously set out, that the lack of knowledge on the part of all those concerned, of the illegality of the arrangements, made no difference to the employee's inability to recover; and that there were no public policy issues which could be applied to moderate the application of the principle that action would not be available on an illegal contract.[8]Before us, the appellant contended that the Chairman had reached the correct conclusion. The appellant was represented by counsel, while the respondent appeared on his own behalf and made little attempt to grapple with the legal technicalities of the argument. In the circumstances, we do not think there is any value in attempting to summarise the competing contentions of the parties.[9]The basic principle upon which the question depends is expressed by Gloag (Contract, 2nd edition, p. 585) as follows.- "Where a contract involves an element of illegality, as distinguished from the case where it is merely declared void by statute, the effect is to debar the parties concerned from the right to appeal to Courts of Justice. The effect of the maxims ex turpi causa non oritur actio and in turpi causa melior est conditio possiddentis is, where they are fully applicable, that one wrongdoer may with impunity take any advantage of the others of which the circumstances admit. Where the action is not an attempt to enforce the commission of an illegal act, but is a demand connected with such an act, the general test of whether it is capable of being enforced is whether the pursuer acquires the aid of the illegal act to establish his case."[10]The same author said, at p.564:- "It is assumed in all the cases that in order to make a contract, in itself innocent, unlawful on the ground that it was designed to serve an illegal purpose, it must be shewn that the party suing upon it was aware of that purpose. But it is not necessary to prove that he was aware that the purpose was illegal; he is presumed to know the law."[11]The principles there set out are, it is agreed, subject to two limitations or qualifications. The first is that if a contract is in itself legal, in that it does not necessarily involve any illegal act or purpose, the fact that something illegal is done in the course of carrying out the contract does not render the contract invalid. The second is that the existence of a relationship between two parties founded on an illegal contract may not prevent one party suing the other, provided that he can do so upon a ground independent of the contract. Both these qualifications may, in some circumstances, have to be read in the light of the views expressed by Nicholls LJ in Saunders -v- Edwards [1987] 1 WLR 1116 , but, for the present purpose, they can be accepted. The principal authority cited by Gloag in support of the proposition that ignorance of the illegal character of a contract does not prevent the application of the ex turpi causa rule is Smith's Advertising Agency -v-Leeds Laboratory Co [1910] 26 TLR 64 and 335 . In that case, the plaintiffs were employed to advertise certain competitions which were later held to be illegal lotteries. The defendants contended that they were not obliged to pay for the advertisements, and that contention was upheld, both at first instance and on appeal. At first instance, Walton J observed that the ruling that the plaintiffs could not recover their remuneration for what they had done might seem hard, because, at the time of the insertion of the advertisements, it had been quite an open question whether a competition of the kind was a lottery or not, but he continued:- "Hard as it might be, however, he did not think that it was disputed that if in fact the competition advertised here was a lottery, and the advertisement was in fact an invitation to the public to compete in a lottery, then although the plaintiffs might not have realized when they issued the advertisements that they were doing that which was illegal, yet as every one must be taken to know the law, in advertising the lottery they had committed an illegal act."[12]On appeal, Farwell LJ put the point simply, by saying:- "If on the construction the advertisements were held to be a lottery, it did not matter what the parties thought."[13]It is, in our opinion, clear that, if that authority is applied to the present case, the fact that all the parties to the contract between the appellant, and his predecessors, and the respondent thought that what they were doing was lawful would be entirely irrelevant.[14]There are several later authorities which directly favour the appellant's contention that the contract in the present case was unlawful. The first is Miller -v- Karlinski [1945] TLR 85 , in which the plaintiff was employed by the defendant under a contract which provided that he should receive a salary of £10 per week, and should also recover from the defendant the amount of income tax payable thereon, by including it in an account for travelling expenses. The contract, therefore, involved direct and obvious fraud on the Inland Revenue, since it involved representations both that the actual remuneration being paid to the plaintiff was less than it truly was, and that certain sums were paid as reimbursement of expenses when, in fact, they were nothing of the kind. It was held, in the Court of Appeal, that the contract was unlawful. Du Parcq LJ said:- "There is nothing necessarily wrong or illegal in agreeing to pay to an employee a sum free of income-tax. The matter can lawfully be arranged in such a way that the employee gets the agreed amount free of tax."[15]He then went on to point out that the method of payment ordinarily adopted had disadvantages to the employer; that the extra amount was not, in truth, expenses at all; that the method of remuneration was one by which the Revenue was defrauded; and that it would be unlawful to enforce such an agreement. His Lordship went on to observe some surprise at a finding, made by the county court judge, that the parties did not anticipate any loss to the Revenue, and to say that, in any event, it made no difference whether the parties were ignorant that what they were doing was illegal. He then said that it was too plain for argument that the agreement to charge tax to expenses was against public policy, and concluded:- "I find it impossible to say that where a man agrees to work and to be paid according to a scheme devised, as was that in the present case, so as to defraud the Revenue the whole agreement is not an illegal agreement which the Courts will not enforce. It is as well that people who enter into this kind of agreement should know that if either party fails to observe any of its terms the Courts will not entertain an action to enforce them. As I have said, 1 feel some sympathy with the plaintiff. None the less the duty of this Court is clear."[16]The second of the authorities to which we have referred is Napier -v- National Business Agency Ltd [1951] 2 All ER 264 . In that case, the contract of employment provided that the employee should receive a salary of £13 per week, together with £6 per week for expenses. Both parties, however, were aware that the employee's expenses could never amount to £6 per week. The employee, in fact, disclosed the arrangement to the tax authorities, and the payment of the sum of expenses was also disclosed, in the form of an endorsement, on the employers' PAYE return. The Court of Appeal held that the judge was not disentitled from finding, as he did, that the employee and the employers, together, made[17]a bargain, knowing well that the figure of £6 per week was a sham figure which bore no relation to the expenses which, in fact, would be incurred. Evershed MR said, at p.266.-[18]EAT/45I/93 -g. "If those were the facts, what is the inference? It must surely be that, by making an agreement in that form the parties to it were doing that which they must be taken to know would be liable to defeat the proper claims of the Inland Revenue and to avoid altogether, or at least to postpone, the proper payment of income tax. If that is the right conclusion, it seems to me equally clear (subject to one point which I will mention in a moment) that the agreement must be regarded as contrary to public policy. There is a strong legal obligation placed on all citizens to make true and faithful returns for tax purposes, and, if parties make an agreement which is designed to do the contrary, i.e., to mislead and to delay, it seems to me impossible for this court to enforce that contract at the suit of one party to it."[19]The point to which the Master of the Rolls referred was the question whether the contract was severable, and he went on to reject that possibility. Denning LJ said:- "In these days of high income tax there is a great temptation for employers and servants to describe remuneration as being in part salary and in part expenses. This is done in the hope of evading tax on the part described as expenses, and the temptation must be resisted. In order that an expense allowance should be valid, it must be a genuine estimate of the expenses to be incurred. The insertion of a fictitious figure for expenses in order to defraud the revenue is illegal. It vitiates the whole remuneration and disentitles the servant from recovering any part of it. He cannot recover either the part described as expenses or even the part described as salary. I think that the decision of the judge was quite right. It will have a very salutary effect if it stops people putting in fictitious figures for expenses."[20]The next of the cases to which we have referred is Corby -v- Morrison t/a The Card Shop [1980] IRLR 218, a decision of the Employment Appeal Tribunal, presided over by May J. In that case, the employee received a basic wage, as fixed by a relevant Wages Council Order, and, in addition, received a sum of £5 per week, paid gross. The method of payment was that the £5 was put into the employee's wage packet, but did not appear in the total written on the front of the packet, and was not subjected to any deduction, either for income tax or for social security liability. May J discussed the general principle, and the case of Miller -v- Karlinski supra, and held that the agreement was unenforceable for the reasons given by du Parcq LJ. He went on to discuss, obiter, an alternative argument, on the basis that the contract was ex facie legal, and to express the view that any reasonable person in the position of the employee would have appreciated that the purpose of the agreement was to avoid the payment of tax. In Newland -v- Simons & Wilier (Hairdressers) Ltd supra , the Employment Appeal Tribunal, again presided over by May J, reaffirmed the views expressed in Corby supra , and rejected an argument that Parliament could not have intended that an employee should lose his rights under a contract of employment because the contract, on its face or in performance, involved a fraud on the Revenue. In Newland , the employee had received wages of a certain amount in cash, while the employer had recorded a different, and lower, amount in his records and his returns to the Inland Revenue. It was not clear, on the findings, whether the employee knew that the employer had been making false records and returns. In the Employment Appeal Tribunal judgment, May J said that it was clear that the employer was disentitled from relying on the contract, and continued:- "......the, question whether the employee is in her turn in such circumstances also affected by the illegal performance of the contract by the employer depends upon whether she was a party to or knew of her employer's illegality."[21]Because the facts in that case were not sufficiently ascertained, the case was remitted to an[22]Industrial Tribunal to allow more precise findings to be made. In the present case, the F[23]majority of the Industrial Tribunal took Newland as support for the view that a subjective approach should be taken and that, if the employee did not know that the contract was illegal, he could enforce it. The ignorance with which the Employment Appeal Tribunal were concerned in Newland , however, was the employee's ignorance of what the employer was, in fact, doing, and the case does not, in our view, weaken the principle, established in Miller and the other cases, that, if a party knew what was being done, it is irrelevant that he did not know that it was illegal. We should add that it has also been held, in Tomlinson -v- Dick Evans U Drive Ltd [1978] IRLR 77, that an agreement which was a fraud on the Revenue could not be enforced, but in that case both parties to the employment contract were aware of the illegality. That was also the position in Hyland -v- .JII Barker (North West) Ltd [1985] IRLR 403 , in which the argument that Parliament could not have intended that an employee should lose his statutory rights because of illegality in his contract was again rejected. In some of these cases it was suggested that the illegal part of the contract could be severed, leaving the remainder enforceable, but that argument was uniformly rejected, following Napier supra .[24]It seems to us to be clear that if these authorities are directly applicable to the present case, the appeal must succeed. There are, really, only two ways by which that conclusion could be avoided. The first would be to hold that the contract in the present case cannot properly be regarded as a fraud on the Revenue, in the same sense, or to the same extent, as the contracts considered in the authorities above mentioned. The second would be to hold, in reliance upon observations in recent cases in the Court of Appeal, that the ex turpi causa principle is not always to be applied according to its fullest rigour, and that in this case it should not be so applied.[25]With regard to the first of these possibilities, it is clear, in our view, that in each of the cases, and in particular in Miller , Napier and Corby, the contract involved a fraud on the Revenue in a direct and immediate sense. That is, perhaps, most obvious in Corby , in which a payment was made without being declared at all. It is, however, equally the case in Napier , in which a payment was made which was obviously, on the facts found, one of remuneration but which was misrepresented as a payment of expenses. The same can be said of the case of Miller . In the present case it might be said that, according to the findings of the Industrial Tribunal, there was not such a direct or obvious fraud as in the three cases above referred to. The fact that the payment to Jonor Services was being made was disclosed by the appellant's predecessors, and the fact that it was being received was disclosed by the partnership itself. The effect of the arrangement was not to take any part of the respondent's remuneration out of a charge to tax altogether, but merely to transfer it, or attempt to transfer it, to Schedule D. We have, however, come to the conclusion that the arrangement made between the respondent and his employers did involve a misrepresentation, namely, that there was some proper basis, or consideration, for the payment to Jonor Services. It is not impossible that, where a member of a partnership performs services outwith the scope of the partnership business, a payment may properly be made to the partnership in compensation for the diversion of the partner's time from its business. In the present case, there was, however, no basis for any arrangement of that kind. The position, all along, was that the respondent was obliged to, and did, devote his whole time to his duties with the appellant and his predecessors, and that any work which he undertook for Jonor Services was performed outwith his normal working hours. It is also clear that Jonor Services did not provide any service to the employer. In these circumstances, there was a misrepresentation of the character of the payment made to Jonor[26]Services. It was not truly a payment to Jonor Services at all, but was a diversion of part of the respondent's remuneration. Although, therefore, the position is not so immediately plain as it was in the three cases to which we have referred, we cannot escape the conclusion that there was here a misrepresentation to the Revenue, and, to that extent, a fraud upon the Revenue.[27]In the argument on behalf of the appellant, we were very properly referred to two Court of Appeal decisions which may go some way to mitigate the rigour of the ex turpi causa rule. Those cases were Saunders -v- Edwards supra and Hewcastle Catering Ltd -v- Ahmed and Elkamah supra. It will be necessary for us to say something about those cases, but, in our view, it is appropriate to begin our consideration of this part of the question with the decision in Shelley -v- Paddock & Another [1980] 1 All ER 1009 . In that case, the plaintiff agreed to purchase a house in Spain from the defendants, who were English nationals resident in Spain. The defendants represented that they had authority to sell the house, which they did not in fact have. The plaintiff paid certain sums, which payments were made in contravention of the then exchange control legislation, although the plaintiff was unaware of the illegality. At first instance, it was held that the plaintiff was entitled to recover damages for fraud, and that decision was affirmed on appeal. Lord Denning MR, at p.1011, set out the defendants' argument that the plaintiffs action was barred by the exjurpi causa principle.. Lord Denning then narrates the findings cf the trial judge that the defendants were guilty of a fraud all the way through, and went on to say:- "In those circumstances, it seems to me that the principle stated by Lord Mansfield CJ does not apply. I know that there are some cases where a person has not been able to recover when he has been guilty of evading the exchange control regulations or similar regulations: see Boissevain v Weil [1950] AC 327 and Shaw v Shaw [1965] 1 WLR 537 . In those cases both parties were participating in the illegal act and there was nothing to choose between them. But it seems to me altogether different when the parties are not in pari delicto. I ventured to summarise such cases in Kiriri Cotton Co Ltd v Dewani [I960} AC 192. In the instant case the properly was never conveyed to .Miss Shelley. As J said in the Kiriri cane, in circumstances like that - ".....it was better to allow the plaintiff to resile from it before it was completed, and to award restitution to him rather than to allow the defendant to remain in possession of his illegal gains." It is better to allow Miss Shelley to recover here rather than to allow the Paddocks to remain in possession of their unlawful gains. I went on to say:
"If there is something more in addition to a mistake of law - if there is something in the defendant's conduct which shows that, of the two of them he is the one primarily responsible for the mistake - then it may be recovered back."
It seems to me plain on each of those principles that these parties are not in pari delicto."[28]Brightman LJ concurred, as did Brandon LJ although he expressed some doubts about the decision.[29]The next case which should be mentioned is Saunders -v- Edwards [1987] 1 WLR 1116 , to which reference has already been made. That case arose out of a contract for the sale of a flat, and its contents, in which the parties agreed to apportion the cumulo price, upon which they had also agreed, between the real property and the contents, in a fictitious manner. Subsequently, the purchasers claimed damages from the seller on the basis of fraudulent misrepresentation, and damages were awarded, at first instance. On appeal, there was some variation in the damages, but an argument that the purchasers should be debarred from recovering anything, on the ex turpi causa principle, was rejected. It is, we think, clear that the basis on which that argument was rejected was that, in Saunders -v- Edwards , the plaintiffs were not suing on the contract, but upon a fraudulent misrepresentation independent of the contract. The case does, however, contain some observations about the application of the ex turpi causa principle. At p.1125, Kerr LJ said:- "However, the present action, unlike Alexander -v- Rayson , is not brought on the contract, but on the tort of deceit based on the defendant's fraudulent misrepresentation. I therefore do not propose to consider what would have been the position if, for instance, the defendant had declined to complete in this case and the plaintiffs had sought to sue on the contract, either for specific performance or for damages."[30]Later, on the same page, Kerr LJ said that the approach which he favoured was supported by a number of authorities which showed that the relevance of the ex turpi causa defence lay mainly in the field of contractual claims, and only rarely in tort, and referred to a number of authorities dealing with the distinction between relying upon illegal contract and relying upon some independent cause of action. At p. 1127, however, he went on to say:- "But the full picture is more complex, as shown by two more recent cases to which we were also referred. I will not analyse them in detail, but they show that there are no rigid rules for or against the application of the ex turpi causa defence. This is not surprising, since it involves issues of public policy. To some extent these must depend on the circumstances of each case."[31]Kerr LJ then went on to refer to Shelley -v- Paddock supra , and Thackwell -v- Barclays Bank plc [1986] 1 All ER 676 , and observed:- "These cases show that the conduct and relative moral culpability of the parties may be relevant in determining whether or not the ex turpi causa defence falls to be applied as a matter of public policy."[32]Nicholls LJ, at p. 1132, observed that the claim was not one to enforce the contract nor, strictly, based on the contract, although the contract was a material part of the history, but one on fraudulent misrepresentation; and that, although one of the provisions of the contract had an unlawful purpose, the plaintiffs did not, strictly speaking, rely on that contract in their present proceedings. He continued:- "But I do not think that that is an end of the matter. The refusal of the court to enforce an agreement entered into in a particular form for an unlawful purpose is based on public policy, and public policy is not a blunt, inflexible instrument. I do not regard all questions of illegality and public policy as flying out of the window once it is seen that the claim is not to enforce the contract. In this case, in answer to the defendant's reliance on the agreed apportionment of £5,000 as evidence of the value of the chattels which were handed over on completion, the plaintiffs ask the court to disregard that agreed apportionment as not being a genuine assessment of the value of the chattels. Honest mistake is not suggested. Thus what the plaintiffs are doing involves asserting, as the explanation for the apportionment, an unlawful purpose."[33]He also referred to Thackwell -v- Barclays Bank plc supra , and approved an observation by Hutchison J that the principle:- "....involved the court looking at the quality of the illegality relied on by the defendant and all the surrounding circumstances, without fine distinctions, and seeking to answer two questions: first, whether there had been illegality of which the court should take notice and, second, whether in all the circumstances it would be an affront to the public conscience if by affording him the relief sought the court was seen to be indirectly assisting or encouraging the plaintiff in his criminal act".[34]Nicholls LJ went on to say that he thought that a useful and valuable test, summarising neatly and explicitly the task on which the court was involved in applying public policy. In applying the test to the case before him, he said:- "Applying that test, in this case there has been illegality of which the court should take notice. It is not a matter to which the court should turn a blind eye. However, when one comes to weigh, on the one hand, the extent to which it might seem that by granting these plaintiffs relief the court is indirectly encouraging these plaintiffs in their tax evasion activity, or indirectly encouraging others in other cases to proceed similarly when apportioning a purchase price, against, on the other hand, permitting a fraudulent defendant to retain money which he has received from the plaintiffs and which represents a financial loss suffered by the plaintiff's directly as a result of the fraudulent misrepresentation, I have no doubt on which side the scales fall. I have no hesitation in concluding that, on the facts of this case, granting to these plaintiffs relief against the defendant would not be an affront to the public conscience."[35]The third member of the Court of Appeal, Bingham LJ, agreed with both the previous judgments, and added only some observations on illegality. At p. 1134 , he said:- "Where issues of illegality are raised, the courts have (as it seems to me) to steer a middle course between two unacceptable positions. On the one hand . it is unacceptable that any court of law should aid or lend its authority to a party seeking to pursue or enforce an object or agreement which the law prohibits. On the other hand, it is unacceptable that the court should, on the first indication of unlawfulness affecting any aspect of a transaction, draw up its skirts and refuse all assistance to the plaintiff, no matter how serious his loss nor how disproportionate his loss to the unlawfulness of his conduct. The cases to, which Kerr and Nicholls L.JJ have referred are valuable, both for the statements of principle which they contain and for the illustrations which they give of the courses which courts have in fact steered in different factual situations. But I think that on the whole the courts have tended to adopt a pragmatic approach to these problems, seeking where possible to see that genuine wrongs are righted so long as the court does not thereby promote or countenance a nefarious object or bargain which it is bound to condemn. Where the plaintiffs action in truth arises directly ex litrpi causa, he is likely to fail. Where the plaintiff had suffered a genuine wrong, to which allegedly unlawful conduct is incidental, he is likely to succeed...."[36]We should next refer to Euro-Diam Ltd -v- Batliurst [1988] 2 All ER 23 . It is not necessary to enter into the somewhat complex facts of that case. It is sufficient to say that, in the end, the defence of ex turpi causa was rejected, on the grounds that there was no direct or proximate connection between the claim made by the plaintiffs and a certain illegality arising from an understated invoice. Kerr LJ, however, set out the relevant principles of law fully. (In quoting from his judgment, we abbreviate by omitting most of the case references cited.) Kerr LJ said, at p.28 :- "(1) The ex turpi causa defence ultimately rests on a principle of public policy that the courts will not assist a plaintiff who has been guilty of illegal (or immoral) conduct of which the courts should take notice. It applies if, in all the circumstances, it would be an affront to the public conscience to grant the plaintiff the relief which he seeks because the court would thereby appear to assist or encourage the plaintiff in his illegal conduct or to encourage others in similar acts: see para (2)(iii) below. The problem is not only to apply this principle, but also to respect its limits, in relation to the facts of particular cases in the light of the authorities. (2) The authorities showed that in a number of situations the ex turpi causa defence will prima facie succeed. The main ones are as follows.(i) Where the plaintiff seeks to, or is forced to, found his claim on an illegal contract or to plead its illegality in order to support his claim. For that purpose it makes no difference whether the illegality is raised in the plaintiffs claim or by way of reply to a ground of defence.(ii) Where the grant of relief to the plaintiff would enable him to benefit from his criminal conduct.(iii) Where, even though neither (i) nor (ii) is applicable to the plaintiffs claim, the situation is nevertheless residually covered by the general principle summarised in (i) above. This is most recently illustrated by the judgment of Hutchison J in ThackwcU v Barclays Bank pic, as approved by this court in Sounders v Edwards. (3) However, the ex turpi causa defence must be approached pragmatically and with caution, depending on the circumstances. This applies in particular to cases which at first sight appear to fall within para (2)(i) or (ii) above. Thus: (i) Situations covered by para (2)(i) above must be distinguished from others where the plaintiffs claim is not founded on any illegal act, but where some reprehensible conduct on his part is disclosed in the course of the proceedings, whether by the plaintiff himself or otherwise. In such cases the ex turpi causa defence will not succeed. Nor will it succeed where the defendant's conduct in participating in an illegal contract on which the plaintiff sues is so reprehensible, in comparison with that of the plaintiff, that it would be wrong to allow the defendant to rely on it: see eg Shelley v Paddock . But where both parties are equally privy to the illegality the plaintiffs claim will fail, whether raised in contract or tort, for potior est condicio defendentis. And an action on a contract the terms of which are falsely recorded in documents intended to conceal the true agreement between the parties may be defeated by the ex turpi causa defence. (ii) In situations covered by para 2(i) and (ii) above the ex turpi causa defence will also fail if the plaintiffs claim is for the delivery up of his goods, or for damages for their wrongful conversion, and if he is able to assert a proprietary or possessory title to them even if this is derived from an illegal contract."[37]Russell LJ and Sir Denys Buckley concurred in the judgment of Kerr LJ.[38]The remaining case is Hewcastle Catering Ltd -v- Ahmed & Elkamah supra . In that case, the employers owned a club where the employees worked as waiters. The employers devised a scheme by which they would evade payment of VAT on services provided to customers who paid their bills by cash. The waiters were instructed to inform a manager if a customer did wish to pay in cash, and, on such occasions, the manager would arrange for the issue of a different type of bill, which would be presented to the customer. The amounts received in cash were not included in returns for VAT purposes. Following a Customs & Excise raid, the system was changed so that the waiters were no longer involved in the VAT fraud. However, the fraud continued, organised by the managers of the club, and a further visit by Customs & Excise officers led to statements being made by the employee waiters about the manner in which bills had in the past been paid. In consequence, two of the managers were charged with offences, and committal proceedings took place, for which four of the waiters were called as witnesses. Within a short time thereafter, the waiters who had given evidence were dismissed, and, in due course, a prosecution took place at which the managers were convicted. After sundry proceedings before Industrial Tribunals and the Employment Appeal Tribunal, the matter eventually came before the Court of Appeal. In his judgment, Beldam LJ reviewed the authorities, including those cited previously in this judgment, and also referred to Coral Leisure Group Ltd -v- Burnett [1981] IRLR 204 . He quoted, with approval, a passage from the judgment of the Vice-Chancellor, Browne-Wilkinson J, in the Coral Leisure Group Ltd case, where he said:- "We accordingly think the law to be this. The fact that a party has in the course of performing a contract committed an unlawful or immoral act will not by itself prevent him from further enforcing that contract unless the contract was entered into for the purpose of doing that unlawful or immoral act or the contract itself (as opposed to the mode of his performance) is prohibited by law."[39]Beldam LJ further quoted from the judgment of Kerr LJ in Euro-Diam Ltd supra, and continued:- "Taking that approach in the present case, in my judgment any Tribunal considering the facts would be bound to conclude that public policy did not in the circumstances preclude the claim of the respondents. There are, as it seems to me, a number of factors which a court would take into account in those circumstances which would lead it to that conclusion."[40]Beldam LJ then referred to a number of factors, including the fact that the contract of employment was not one in which the employees were engaged on the basis that they would assist in fraud, that the employees themselves only took part in the fraud by telling the managers when a customer wished to pay in cash, and by carrying to the customer the bill which they were given to take, and returning the cash to the cashier. He, further, referred to the desirability of encouraging disclosure of such frauds, and concluded by expressing the view that conscience would not be affronted by allowing the claim of the employees in this case.[41]The recent cases, which we have summarised, do clearly stress that the foundation of the ex turpi causa rule is public policy, and that, that being so, the rule must be applied pragmatically and flexibly, rather than rigidly and automatically. If so, it is difficult to see why there should not be room for a pragmatic and flexible approach to cases in which the claim is directly founded upon a contract which is tainted with illegality, as well as to cases in which it is not. The observations of Nicholls LJ in Saunders -v- Edwards supra seem to us to give some support to the view that no clear distinction can be drawn, in this respect, between the different types of case. The same might, we think, be said of the summary of the law set out by Kerr LJ in Euro-Diam Ltd -v- Bathurst supra . The position does, however, remain that, as Kerr LJ said in that case, the rule prim a facie applies where E a plaintiff seeks to, or is forced to, found his claim on an illegal contract, and the only case in which, so far as we can see, the defence has, so far, not been sustained in such a situation was Shelley -v- Paddock supra . That was a case in which, undoubtedly, the[42]illegality in which the plaintiff was involved paled into insignificance compared with the F[43]outright fraud practised by the defendants. Further, in considering what was said by Lord Denning in Shelley -v- Paddock , and its relevance to the present case, it is necessary to bear in mind the equally trenchant observations by the same judge in Napier -v- National Business Agency supra . In the present case, there is nothing to indicate that the employers bore any greater share of responsibility for the illegality than did the respondent; nor is there any evidence of unlawful conduct on their part which could be compared to the fraudulent conduct of the defendants in Shelley -v- Paddock . Indeed, the respondent seems to have suggested the arrangement which was made in the present case and, although he was innocent of any deliberate illegality, it must be assumed that he did so with some advantage, or purpose, in mind. In these circumstances, we have come to the conclusion that there is nothing in the recent series of decisions to which we have referred which would justify us in treating the present case otherwise than is required by the application of the very clear statements to be found in Napier -v- National Business Agency and Miller -v-Karlinski supra, as, well as the uniform practice of the Employment Appeal Tribunal demonstrated by the other cases cited above. It seems to us, therefore, to follow that we must allow the appeal and, in agreement with the view taken by the Chairman, dismiss the application. Even if it were open to us to consider whether public policy did require that-the ex turpi causa defence should apply in a case such as this, it would be very difficult for us, in the face of the views which have been expressed already in the Court of Appeal, to reach the conclusion that public policy did not require that the contract in the present case should be treated as unenforceable. It may be said that the consequence is that the respondent suffers a severe penalty for a minor illegality which cannot, in all probability, have cost the Revenue any significant sum in lost tax: but we agree with the Chairman that it is difficult to imagine that the respondent did not appreciate that the contractual arrangement which was made did involve some effects on the taxation position, and that it is not necessarily inequitable that persons who seek to take advantage out of the tax system, misguidedly or otherwise, should not be entitled to be treated as if they were employed under a normal contract of employment.[44]For these reasons, we shall allow the appeal, and dismiss the application.