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Fair A Lease? Newman v Clarke and the Strictness of the Self-Dealing Rule

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About The Author

Keir Baker (Consulting Editor)

Keir is a Trainee Solicitor currently sitting in the Finance department at a major US law firm. A law graduate from Selwyn College, Cambridge University, his main areas of interest are Employment, Discrimination and Competition law. Outside the law, Keir is an accomplished goalkeeper in both football and hockey, as well as a keen actor and pianist. He is a long-suffering supporter of Middlesbrough FC.

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Nothing is more noble, nothing more venerable, than loyalty.

Cicero

The bedrock of a fiduciary relationship is loyalty. Fiduciaries – whether they be trustees, company directors, agents or solicitors – are under one key obligation: single-minded loyalty to their principal. It follows that the rules that govern what constitutes a breach of this obligation are particularly stringent: imposed is a regime of strict liability that, as confirmed in Regal (Hastings) Ltd v Gulliver [1942], means a fiduciary will be liable for breach of duty even though they were acting honestly and to the best of their ability.

In the classic case of Bray v Ford [1896] AC 44, Lord Herschell recognised that the key obligation of loyalty could be divided into two fundamental duties: the no-conflict and no-profit duties. The former, as summarised by Lord Cranworth in Aberdeen Railway Company v Blakie Brothers [1854], requires that a fiduciary cannot:

[E]nter into engagements in which he has, or can have, a personal interest conflicting, or which possibly may conflict, with the interests of those whom he is bound to protect.

In order to help the rationalisation and policing of this duty in a number of particular situations, Equity has developed a number of rules. One such example – the rule against self-dealing – was examined, and seemingly limited somewhat, by the High Court in the case of Newman & Ors v Clarke & Anor [2016] from late last year. This article will examine the decision in the case, scrutinising the acceptability of this slight deviation from the typical severity with which the self-dealing rule is applied.

The Self-Dealing Rule

The self-dealing rule is applied most often in relation to trusts; namely, where – during their administration of a trust – a trustee wishes to purchase the trust property or a beneficiary’s interest under the trust. As Megarry V-C described in Tito v Waddell (No. 2) [1977] Ch 106, the rule states that a fiduciary is barred from dealing on behalf of themselves and the principal in the same transaction. In short, the trustee cannot sell their own property to the trust or sell trust property to themselves.

It is a rule not confined to the sale of property: it has been applied to the taking of shares and, in Re Thompson [1986] Ch 99, it was applied to the assignment of leases.

In Wright v. Morgan [1926] AC 788, it was held that breach of the self-dealing rule renders the transaction voidable, allowing the principal to rescind it – subject to the usual bars, such as affirmation of the transaction – without needing to prove it unfair. Indeed, this can mean that a beneficiary can even elect to set aside a transaction that is ostensibly and manifestly fair. Furthermore, after rescission, the fiduciary is liable to account to the principal for any profits that were made from the transaction.

While a number of different reasons have been offered by academics for the stringency of the rules governing fiduciary duties, there is a common underlying idea: the idea that fiduciary duties are prophylactic, in that they exist to prevent a particular state of affairs – disloyalty – from occurring. As Iris Samet summarises:

[T]he remedy [for breach of fiduciary duty] is not meant as an incentive to sincere and honest action in conditions of conflict of interest. Rather, it is a warning against getting involved in such situations in the first place.

Strictness and Leniency? The Nature and Application of the Rule

The strictness of the rule against fair dealing is evident from its nature as a rule of strict liability. As noted above, this means a fiduciary will be in breach of duty even though they were acting honestly and to the best of their ability, even where the breach grants some form of benefit to the principal.

However, the rigorousness of the rule against self-dealing is perhaps not quite as stringent as it may first appear. Indeed, the way in which courts have tended to apply the rule suggests a realisation that to apply the rule indiscriminately in all circumstances where the fiduciary could be considered to be potentially engaging in some form of self-dealing would be impractical and overly harsh.

For example, while the rule against self-dealing will apply to trustees who have retired from the trust, the court in Re Boles and British Land Co.'s Contract [1902] 1 Ch 244 was prepared to be realistic and accept that a trustee who had retired from their position twelve years ago was not subject to the duty of loyalty.

The decision in Re Holder’s Investment Trust [1971] 1 WLR 583 can be considered the high watermark of relaxation here. In this case, an executor who had started to administer an estate was held not to be liable for breaching the rule against self-dealing despite having renounced his executorship and purchased the farms at an auction for a fair price. The Court of Appeal – with Danckwerts LJ confirming the court’s discretion to sanction a transaction even though it was made in breach of the self-dealing rule – justified their decision by noting that, during his time as a fiduciary, he had not acquired any special knowledge in relation to the transaction and had also never made any secret of the fact he wanted to purchase the farms.

Both decisions noted above represent examples whereby the judiciary have been pragmatic in the application of the rule of self-dealing. And this understanding of the need for realism was once again on display in Newman [2016].

Newman v Clarke

The Facts

In the late 1990s, a trust – more specifically, an accumulation and maintenance settlement – was created by the first defendant (W) in favour of a number of beneficiaries, including two of the claimants. W was subsequently granted a lease in the property, which would become ‘active’ following the servicing of a notice under the Leasehold Reform Act 1967 (LRA 1967). Around the same time, the freehold reversion to the property was also sold to the trustees of the settlement W had created. Just under a year later, W became one of the trustees of the settlement which now included the freehold reversion to the property.

The dispute arose in early 2015 when W served a notice under the LRA 1967 that he would be exercising his right to ‘activate the lease’ and acquire a freehold interest in the property. The claimants resisted this, bringing an action alleging that W it was a breach of fiduciary duty, specifically the no-conflict rule.

The Decision

Jonathan Klein QC, sitting as a Deputy High Court Judge, dismissed the claim. He held that the rule against self-dealing did not apply to the unilateral exercise of a right granted to the trustee before the trusteeship came into existence. He confirmed that this exception to the rule applied whether the right was contractual or statutory in nature. Therefore, since W was unilaterally exercising a statutory right under the LRA 1967, and had become a tenant under the lease before he had become a trustee, W could not be taken to have breached the rule against self-dealing.

Comment - A Sound Application of Precedent

The decision can be considered sound in its application of precedent. Upholding W’s right to ‘activate’ his interest in the property that he acquired under statute before becoming a trustee seems a logical extension from the decisions in Re Mulholland's Trust [1949] 1 All ER 460 and Spiro v Glencrown Properties Ltd [1991] Ch 536: in those cases, it was held that a trustee does not breach the self-dealing rule when they exercise the contractual right to purchase trust property that they acquired before becoming a trustee.

Ultimately, this is a decision that upholds the long-standing hierarchy of the three sources of legal rules that exist in English law – statutes reign supreme. While Equity was developed by the Courts of Chancery to mitigate against the harshness of the Common Law, an Act of Parliament will always prevail over a rule from the Common Law or Equity covering the same area.

It is also worth noting that this decision is consistent with a judicial acceptance that there can, and should, be times where the application of the stringent rules governing fiduciary duties can be relaxed. Can it be justified in this case? It is submitted it can on an examination of the facts: if it is recalled that the reason for that strictness is to prevent fiduciaries from allowing their own self-interest to cause them to breach their duty of loyalty to their principal, it follows that there is no need for the law to apply here. This is because the chance for a person in a position like W’s to act on their self-interest has already ended – now their self-interest and their interests of their principal are aligned.

One key question that might be raised is whether the relaxation of the application of the rules governing fiduciary duties by the court could be mirrored so as to apply to the nature of the rules. For example, Jack Langbein has suggested that the strict standards should be relaxed where the fiduciary has acted in the best interests of the principal. In his view, they impose too high a cost by placing an absolute prohibition on transactions that, ultimately, are beneficial to the principal.

There is weight in this argument: it is fair to say that there should be some mechanism in the law that allows self-dealing by the fiduciary where the transaction is beneficial to the principal. But Jack Langbein’s argument overlooks one vital feature of the law of fiduciary duties that renders these duties not absolute – authorisation. In short, a fiduciary can escape being held strictly liable and is not prevented from entering into a transaction that conflicts with their fiduciary duties, so long as they obtain prior authorisation for it from either the principal or from the court.

Conclusion

The approach of the court in Newman [2016] is indicative of the pragmatic approach to the application of fiduciary duty in the context of the self-dealing rule. It shows that courts are prepared to allow fiduciaries to escape being held strictly liable in certain circumstances.

However, it must be noted that, though confirming a slight extension of the reasoning in Re Mulholland and Spiro, Newman [2016] functions merely as an interesting portrayal of the current approach of the judiciary here. Indeed, given its status as a High Court decision and therefore of comparatively low authority, it is unlikely to herald a major change or relaxation of the self-dealing rules. If anything, it is a useful clarification of the extent (or lack thereof) to which the rule apply where the conflict of interest arises after the person became a trustee.

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Tagged: Banking & Finance, Equity, Property Law

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