Today’s sermon comes from the Book of Bankruptcy. It’s a telecoms story of debt and dubious behaviour which ends with a judgement that telcos should take into account when assessing which wholesale carriers they do business with.
In March 2016, Colt UK entered into a bilateral VoIP interconnect agreement under which an Italian company, SG Global Group SRL (SGG), agreed to provide Colt UK with voice services. Colt UK nominated Colt Technology Services SpA (“Colt Italy”) to receive the services and to be invoiced by SGG. During 2016, and early 2017, SGG provided Colt Italy’s business customers with access to its overseas networks outside Italy, mainly in Africa. Seven invoices were submitted to Colt Italy for more than EUR40mn including VAT; these invoices were paid by Colt Italy.
However, in January 2017, Colt UK’s auditors, PriceWaterhouseCoopers, raised concerns over what they considered to be anomalies regarding SGG. Colt UK says that these raised suspicions that SGG was not the true supplier of the services under the agreement, but was a shell company acting as a front for another supplier and was engaged in Missing Trader Intra-Community (MTIC) fraud, a kind of VAT fraud involving a trader that deliberately fails to pay its VAT tax bills. Colt UK made further enquiries and suspended payment of outstanding SGG invoices totalling USD5,108,227.10.
As a consequence, SGG began court action against Colt Italy for payment of the invoices. Colt UK intervened, and then became party to an appeal to the Milan Court of Appeal. Additionally, in January 2018, SGG served a statutory demand on Colt UK for the invoices plus interest, then in December 2019 served a further statutory demand claiming that Colt UK owed it a debt of USD5,442,768.05. With the invoices remaining unpaid, SGG started proceedings to obtain a winding up order against Colt UK. In May 2020 Colt UK responded by applying for a restraining injunction (Colt Technology Services v SG Global Group SRL). This application for an injunction led to the really interesting details coming to light.
Colt contended that its obligation to pay the invoices is unenforceable for illegality. Its arguments hinged on three main points:
- there are significant indications that SGG is part of a missing trader scheme to defraud the Italian tax authorities of VAT charged on the services supplied under the agreement;
- SGG entered into the agreement with the purpose and intention of defrauding the Italian tax authorities, or subsequently developed such a purpose; and
- payment of the invoiced sums would be a criminal offence by Colt UK under Italian law.
Regarding the legality of paying the invoices, Colt UK relies on the precedent in Ralli Bros v Compania Naviera Sota y Aznar that a contractual obligation will not be enforced where it would require the party to commit a criminal offence in the place where that obligation is performed.
That is the overview of the legal fight, but what are the circumstances that led a telco to be engaged in such a convoluted fight over paying its wholesale bills? PriceWaterhouseCoopers initially raised concerns that SGG might be involved in a MTIC fraud and highlighted alleged anomalies, including the absence of corporate filings. Colt UK requested various documents from SGG, some of which were provided, but Colt UK says they only led to further questions about the Italian business they had purchased wholesale services from.
Evidence of SGG’s Illegality
SGG was incorporated in 1995. The agreement with Colt UK was signed by Fernando Biscaioli, who was sole director and shareholder at the time. He was replaced as director by Ms Armanda Rossi on 7 August 2016. On 7 July 2017, after the Milan Proceedings had commenced, Mr Jamie Johnston, who lives in Ireland, purchased Mr Biscaioli’s shareholding in SGG for EUR100 and on 11 July 2017, he replaced Ms Rossi as sole director. Although Mr Johnston purchased Mr Biscaioli’s shareholding, he didn’t sign the transfer in person and the share transfer agreement was executed on his behalf by Mr Biscaioli under a power of attorney. Colt contends that Mr Johnston has no connections with Italy and whilst he claims to be an experienced operator in the telecoms, there are discrepancies between his CV and publicly available information and differences between both his date of birth and his signature on various documents.
Amongst the documents SGG provided to Colt UK were its VAT register for 2016, its 2016 supplier invoices and evidence of their payment. These are said to show that the voice traffic supplied to Colt Italy in 2016 had all been sourced from only one supplier, New Energy Corporation Srl (New Energy). Colt UK says these documents indicate that SGG resold the services received from New Energy to Colt Italy with no mark-up or charge, with the result that SGG had a repayment VAT position for 2016, which is indicative of fraud. SGG’s expert said that SGG made a margin of between 0.27% and 0.35% on traffic received from New Energy and resold to Colt. Jamie Johnston contends that this level of margin is in line with industry standards but Richard Tilbrook, a director of Colt, disagreed, arguing that this margin on EUR40mn of voice traffic is very low for an intermediated activity and is actually too low to allow SGG to cover the expenses of the operating structure required.
Colt’s investigations found no evidence that SGG or New Energy were active or trading companies. SGG’s registered address in Rome was a residential apartment; there was no indication that it operated from that location or that anyone connected with the company lived there. All indications were that SGG did not have a physical place of business and had no employees. Its corporate records indicated that it had two secondary units, but investigators found them both to be former phone shops, now abandoned. Colt’s evidence was disputed by Jamie Johnson who says SGG has been active for more than 20 years and is not a shell company. Mr Johnston sets out SGG’s turnover in the financial years 2012-2015, which runs into many millions of Euros. However, if the company was active and financially healthy, why did Mr Biscaioli sell his shares in SGG for only EUR100? And if the company was trading in Italy, why did the invoices request payment into a Californian bank account?
Colt UK points out that Mr Biscaioli was disqualified from acting as a company director between 2002 and 2012, and for a further 10 years from 2012. He was therefore disqualified from acting as a director when he signed the agreement between SGG and Colt in 2016.
In relation to New Energy, Colt points out that the company last filed accounts in 2009, and those accounts showed it had no assets. New Energy is headquartered in Pulsano, at an address which appears to be that of Mr Zizza, SGG’s accountant. New Energy’s trading address is occupied by a clothing shop which has traded at that location for 40 years. A November 2016 report from the Taranto Chambers of Commerce indicated that New Energy’s main business activity was plastering and flooring and that it had no employees. Mr Zizza was formerly New Energy’s sole director and shareholder but this is now Mr Mohammed Saifur Rahman, a 26-year-old who does not appear to have a background in telecoms, having worked as an employee in a laundry in Rome.
The Judge’s Conclusion on SGG’s Illegality
In my judgment Colt UK has a properly arguable case on the evidence that SGG is not an active trading company but is effectively a shell through which others (as yet unidentified) provided VoIP services to Colt Italy; that both SGG and New Energy are buffer companies inserted into the chain to disguise a “missing trader” and that they serve or served in effect as conduits through which the services passed up the chain to Colt Italy and the price and VAT passed back down the chain, with a view to being siphoned off rather than paid to the Italian tax authorities.
Illegality of Performance
The joint statement of the expert witnesses explains that they have considered two criminal offences under the Italian Criminal Code which Colt UK could potentially commit by paying invoices. The first is aiding and abetting a crime (Art. 110) and the second is “favouring an offender” (Art. 379). The primary difference between the expert witnesses on Italian Law relates to the mens rea (guilty knowledge) requirement of both crimes. Even if Colt UK’s directors and employees acted in good faith at the time of entering into the Agreement, they may be guilty of wilful misconduct if they pay the invoices when they are aware of significant indications of fraud. One expert does not consider that Colt UK would reasonably be at risk of criminal liability since payment of the invoices is made under a contractual obligation.
The Judge’s Conclusion on Illegality of Performance
Having decided that SGG was a shell company facilitating MTIC fraud, the Judge also accepted that Colt UK should not be forced to meet the contractual obligation of paying the outstanding invoices to SGG because that would require Colt UK to commit a criminal offence in Italy.
I consider that Colt UK has a properly arguable illegality defence to the sums claimed by SGG based on the Ralli Bros principle.
The Judge concluded that the purpose of invoking this insolvency action was to put pressure on a company where there is a debt dispute and that SGG’s service of a statutory demand was a clear attempt to short-circuit the Milan appeal proceedings. The presentation of a winding-up petition against Colt UK would be an abuse of process so it is right to restrain SGG from taking that step.
The full court record is available here.
On the face of it, this looks like a good win for Colt (and rightly so, in my opinion) and I commend the great job done by the investigators to identify relevant evidence and the lawyers who presented a case which requires any reasonable person to reach the same conclusions as the Judge.
But it’s not all good news, as the case also raises other questions. For example, what does it say about Colt’s supplier due diligence? Did Colt perform MTIC checks before signing the agreement? If so, did they find the red flags identified by the subsequent investigation? If not, why not? If the red flags were identified, who accepted the risk and what other risks did they accept?
Finally, and perhaps most importantly, Colt needs to address the EUR40mn question: if there is compelling evidence that the disputed invoices relate to MTIC fraud, is there VAT exposure from the previous transactions with the same company, because those invoices also relate to MTIC fraud?
In the past, I argued that telcos risked criminal liability if they made payments believing them to be related to fraudulent traffic. Legal opinion at the time concluded that telcos were not liable if they were too far removed from the fraud to ‘know’ a crime had been committed. This appears to be at odds with the legal approach to physical items, where a person can be charged with handling stolen goods because he ‘knows or believes’ them to be stolen – it’s not necessary to prove knowledge of who stole the goods or who they were stolen from.
Telecoms has not been troubled by ‘handling’ charges because:
- law enforcement doesn’t understand telecoms fraud; and
- international transactions are difficult and expensive to investigate.
Sadly, the evidence suggests the risk to fraudsters remains low, and there still seems to be little prospect of law enforcement catching up with the digital world and targeting the proceeds of telecoms crime. On the other hand, USD92bn of telecoms fraud a year is too big a number to ignore. But don’t be surprised if law enforcement respond to the scale of these crimes by placing more blame and burden on honest telcos.