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A Redefined Equitable Remedy

About The Author

Thomas Horton (Former Writer)

Thomas studied Law at the University of Birmingham, and graduated with a 2:1 in July 2013. In the elapsed time, Thomas has worked for law firm HowardKennedyFsi LLP as a paralegal in the property department. Thomas has also been awarded a Major Scholarship by the Honourable Society of the Inner Temple and will begin the BPTC with City Law School in September 2014.

Introduction

‘…You are not to pocket other people’s pounds, shillings, and pence and escape scot-free.’

(Charles Dickens, Bleak House, Chapter XXXIV)

The inexorable Mr. Tulkinghorn presents us with a fair point, yet even he lets Mr. Bagnet and Mr. Rouncewell off the hook once they present him with the handwriting he so desperately required; and we all know how that turned out (he gets murdered). Nonetheless, the principle seems to ring true following the UK Supreme Court’s (“UKSC”) recent decision in FHR European Ventures LLP v Cedar Capital Partners LLC [2014] UKSC 45 (“FHR European”). The UKSC held that a bribe received by an agent was held on constructive trust for their principal from the moment that the agent acquires it. The UKSC’s decision provides an interesting clarification of the preexisting common law understanding of bribes received by those owing fiduciary duties to their principal. This article will discuss the effect that the decision has for the recovery by a principal of such bribes, and whether this available remedy puts a sword in equity’s hands.

Fiduciary duties

Summarily, a fiduciary is someone who holds a position of trust or confidence with respect to someone else, known as their principal, who is therefore obliged to act altruistically for their principal (see Bristol and West Building Society v Mothew [1998] Ch 1). Fiduciary duties can arise in several instances, including between trustees and their beneficiaries; company directors and company shareholders (albeit now codified in the Companies Act 2006, Chapter 2); and solicitors and their clients.

The general principle that follows this position is that fiduciaries are not to make a profit from their position, whether they have acted honestly or not (see Boardman v Phipps [1967] 2 AC 46). If trustees do make a profit from their position, then it is generally understood that they will become accountable for that profit by way of equitable compensation (see Regal (Hastings) Ltd v Gulliver [1942] UKHL 1).

Fiduciary duties are a creature of equity (for those that are new to ‘equity’, a Lord Neuberger speech is never too far away to assist in your understanding). The equitable remedy available for the principal in a situation where the fiduciary has benefited from their position is ‘primarily restitutionary or restorative rather than compensatory’ (Millet LJ in Mothew). Moreover, in instances where the fiduciary acquires a profit by way of them being in a fiduciary position, the equitable rule (“the Rule”) is that this profit is seen to have been acquired on behalf of their principal. The application of the Rule (alternatively known as the ‘disgorgement remedy’) is not designed to repair the principal’s harm, but to deter the fiduciary’s breach (S. Worthington, ‘Equity’ 2nd edn (Clarendon Law Series, Oxford, 2006) ch 5, 131).

For example, the historic case of Keech v Sandford (1726) Sel Cas Ch 61 established that a profit gained by a trustee who owes a fiduciary duty to the beneficiary holds the received profits on constructive trust to the beneficiary. Accordingly, rather than simply granting a compensatory award, i.e. specific performance that the profit is paid to the principal, equity considers the profit gained to be beneficially owned by the principal. The establishment of the beneficial ownership, which amounts to a proprietary interest in the profit, is the crucial and differential aspect of this available remedy. The UKSC pointed out this important feature in the first paragraph of their judgment in FHR European:

The distinction is significant for two main reasons. First, if the agent becomes insolvent, a proprietary claim would effectively give the principal priority over the agent’s unsecured creditors, whereas the principal would rank pari passu [(with an equal footing)], i.e. equally, with other unsecured creditors if he only has a claim for compensation. Secondly, if the principal has a proprietary claim to the bribe or commission, he can trace and follow it in equity, whereas (unless we develop the law of equitable tracing beyond its current boundaries) a principal with a right only to equitable compensation would have no such equitable right to trace or follow.

In FHR European the UKSC were tasked with determining the scope and application, or the ‘limits and boundaries’, of the Rule when a fiduciary is in receipt of a bribe or secret commission because of their fiduciary position. The case provided the perfect opportunity for the UKSC to clarify an area of law that had until now appeared bleak.

A matter of precedent and principle: FHR European

I hope that the following fictitious scene will assist in your understanding of the facts in FHR European:

FADE IN:

INT. LOCATION #1 – DAY

Cedar enters Monte’s office. Monte is sitting at his desk gazing out of the rear window of his office. Cedar is standing before the desk looking towards Monte.

MR. CEDAR CAPITAL

Boss, I got your call, and I hear what you’re sayin’. But I’m acting as an agent for Mrs. F.H.R. European’s purchase of some share capital linked to the Monte Carlo Grand Hotel, boss; how can I work for you too – you own the Monte Carlo?

MR. MONTE CARLO

Cedar, how does a commission payment sound? I know you’re providing consultancy to Mrs. European, but if you work for me too, I’ll give you ten million when the sale goes through – I know you can close the deal for me. Have we got a deal?

Monte turns to face Cedar and offers his hand. Cedar, following a moment’s hesitation, shakes Monte’s hand.

                                                                                                                                                                                                              FADE OUT.

In continuation to that scene: Cedar failed to adequately disclose their position to FHR European (the principal), the sale completed, and Cedar received a £10m (secret commission) payment accordingly. Considering Cedar’s breach of their fiduciary duty owed to FHR European, and the remedy that should therefore be available to FHR European, should there be, simply, a granting of equitable compensation, and, if so, should the Rule apply to grant FHR European a proprietary interest in the £10m that Cedar received? There are two lines of argument that stem from this question:

  1. The Rule should not apply to a bribe or secret commission because it cannot properly be held that the profit is the property of the principal. There can no be no granting of a proprietary interest in a benefit that did not derive from some property owned, at least beneficially, by the principal; and
  2. Alternatively, when a fiduciary receives a profit resulting from a breach of their fiduciary duty, the fiduciary holds this profit on trust for the principal. This understanding is a development of the equitable principle that “equity treats as done that which ought to be done”.

Whilst both lines present strong arguments, I err on the side of the second. By granting the proprietary interest in the profit received by the fiduciary in breach of their duties to the principal, the disgorgement remedy achieves its true effect of acting as a deterrent whilst concurrently ensuring that any actions of a fiduciary are for the benefit of the principal, upholding the expectation of a fiduciary acting altruistically for their principal. Indeed, this understanding correlates to the case law referred to by the UKSC in paragraphs 13-20 of their judgment, and there is a lot of it (in particular, see Morison v Thompson (1874) LR 9 QBD 480), which evidently gives the understanding some ‘great weight’ (FHR European, paragraph 21). Why should a principal not be entitled to a profit received by their fiduciary that has the ramification of affecting the manner in which the fiduciary carries out (or, effecting the manner in which the fiduciary fails to carry out) their duties?

The Court of Appeal’s decision in Lister v Stubbs [1890] 45 Ch D 1 (“Lister”) is the authority that threw the most unnecessary spanner in the works. Lister concerned the receipt of secret commission by an employee that their employer sought to establish a proprietary right to. The Court of Appeal, in agreement with the High Court, held that the plaintiffs were not entitled to a proprietary interest in the secret commission. The alternative prospect left Lindley LJ startled and of the opinion that to allow the claim would ‘be [a] very great mischief’, yet from one’s reading of this judgment it is difficult to find a substantial principle of why the granting of a proprietary interest should startle. Moreover, the approach of the Court of Appeal demonstrates a very great mischief of the equitable principle that “one must not rely on their wrong to justify retaining a benefit”.

Understandably, in the Privy Council (“PC”) decision of Attorney General for Hong Kong v Reid [1993] UKPC 2, Lord Templeman, delivering the judgment of the Board, reiterated the aforementioned equitable principle that “equity treats as done that which ought to be done”: ‘it is unconscionable for a fiduciary to obtain and retain a benefit in breach of duty’ (emphasis added). Accordingly, the bribes received by the fiduciary were traceable to the properties that had consequently been purchased from the bribes as a result of the principal’s proprietary interest that had been discovered in those bribes.

Perhaps it was the particular facts of Reid that contributed to the PC’s decision; as the profit that had been acquired by the fiduciary in breach of their duties had been used to purchase properties, there was a more compelling case for that profit to be traced into those properties in order to prevent any overall profit being made by the fiduciary. This understanding similarly resembles the decision in Keech.

Comparatively, there is the importance of establishing a proprietary interest in instances where a company, who is the fiduciary, acquires the profit and then becomes insolvent. If there is no proprietary claim then the principal will be behind secured creditors tied to the company. However, in these instances, it can be deemed equitable that the principal does not require a proprietary interest, as the company will ultimately be left with nothing once all of the creditors have taken all the money that is available in proportion to the money they were owed. Accordingly, the fiduciary would have exhausted any profits made from the breach of their fiduciary duties. Ultimately, it should be a procedural matter of ensuring that any profit made by a fiduciary in breach of their duties is not ultimately retained by the fiduciary. It is for this reason why emphasis was added to Lord Templeman’s reference to ‘unconscionable’ in Reid; it is unconscionable to allow the fiduciary to possibly retain any profit made in breach of their duties. If the determination of a remedy in such cases was to be used on this understanding then the courts are armed with a particularly sharp and nimble sword to deter the fiduciary’s actions. Moreover, by taking this approach one is able to appreciate Lewison LJ’s comments at paragraph 14 of the Court of Appeal’s decision in FHR European: ‘the argument here is really about following and tracing’.

Bizarrely, yet partly as a consequence of an absence of binding authority from a PC judgment, the Court of Appeal in Sinclair Investments Ltd v Versailles Trade Finance Ltd [2012] Ch 453 followed Lister, amongst other Court of Appeal decisions. It was held that a constructive trust for the profit obtained by the fiduciary is imposed only where the profit is, or had been, the beneficial property of the principal, or is a profit that the fiduciary acquired by taking advantage of an opportunity that was properly that of the principal. Whilst Sinclair did not have the factual similarities to that seen in Reid, the handing down of a judgment with such a clear ratio decedendi created a bleak picture.

The aforementioned authorities, however, did not preclude the possibility of the UKSC holding in favour of FHR European; the weighty considerations of practicality and principle provided for the UKSC’s determination that a bribe or secret commission accepted by an agent in breach of their fiduciary duty was held on trust for his principal. The importance of this to FHR European was that the profit that had been acquired by the fiduciary had been transferred into several accounts and it would have to be determined who had benefited from the £10m payment.

The effect of UKSC’s decision in FHR European

The UKSC’s decision overruled the decisions of Lister, Sinclair et al that had been based upon unprincipled reasoning (FHR European, paragraph 50). The UKSC have clearly established the equitable remedy of finding the existence of a constructive trust when a fiduciary is in receipt of a bribe or secret commission in breach of the duties owed to their principal.

Earlier in this article, the idea was posited that the existence of a constructive trust should only be found in matters where it is necessary to do so, i.e. where the profit received by the fiduciary has dissipated into other bank accounts, or invested into other tangible assets as seen in Reid. Whilst this idea correlates to the dictum of Lewison LJ in the Court of Appeal decision in FHR European, the recent extrajudicial comment of Lord Neuberger (who appears to have had a rather loquacious summer) provides a valuable understanding of why a general finding of a constructive trust is preferred. Primarily, it would be ‘inconsistent’ for equity to hold a fiduciary to account for the profit to his principal if only in some cases the principal is found to claim the profit as their own property (FHR European, paragraph 36). Lord Neuberger developed this point in his speech, ‘The Remedial Constructive Trust – Fact or Fiction’ (August 2014):

…[I]n these days of expensive litigation and complex and cross-border commercial transactions, Judges should not be introducing new, unpredictable and controversial remedies particularly if they are only likely to be considered in a small number of cases. The game is not worth the candle.

The equitable remedy still represents ‘a sharp and nimble sword’ whilst serendipitously avoiding the equitable remedy varying with the size of the chancellor’s foot. The development of the Rule in this principled and certain manner provides a sound, reliable equitable development, unlike that seen in the decision of Stack v Dowden [2007] UKHL 17 (see also, R. Butler and T. Horton, ‘Constructive FeedbackNew Law Journal). Equity’s modern day development continues, and the candle that the UKSC decided to light has changed the bleak picture that was.

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Tagged: Commercial Law, Company Law, Equity, Property Law, Supreme Court

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