Proprietary remedies, fiduciary bribes, and dishonest assistants: FHR and Novoship

October 2nd, 2014 by Rupert Paines

Directors and senior employees will often have wide-ranging managerial power over their companies: the ability to commit or disburse company assets, with significant autonomy and limited detailed oversight. Those in such positions will not always act responsibly, and will be attractive targets to others seeking a share of the potential spoils. In two important judgments from July, the Court of Appeal and Supreme Court significantly increased the remedies available against both bribed fiduciaries and those who bribe them.

FHR European Ventures LLP v Cedar Capital Partners LLC [2014] UKSC 45 concerned a transaction related to the sale of the Monte Carlo Grand Hotel. FHR, the purchase vehicle, engaged Cedar as its agent in negotiating the purchase. The purchase was completed, but Cedar in the course of negotiations obtained for itself an “Exclusive Brokerage Agreement” from the vendor, under which Cedar was paid €10m. FHR sued Cedar and claimed, inter alia, that the sum was held on constructive trust.

This presented a discrete issue of considerable importance (and academic interest): where a fiduciary has accepted a bribe or secret commission is his acknowledged liability to account to the principal a personal one only, or does the fiduciary hold the assets comprising the bribe or secret commission on constructive trust for the beneficiary? The difference between the two is practically significant where either (i) the fiduciary has become insolvent, or (ii) the fiduciary has disposed of the bribe/secret commission. Only if the remedy is proprietary will the principal be able to claim priority over unsecured creditors, or use equitable tracing to follow the proceeds into others’ hands.

In FHR the Supreme Court, in a unanimous judgment, decided that a proprietary remedy was available. The argument for a ‘personal only’ remedy was that a constructive trust can be imposed only over benefits which “can properly be said to be the property of the principal” (at [10]): where the fiduciary had misappropriated the principal’s assets or exploited an opportunity which he was under a duty to exploit, if at all, for the principal. However a fiduciary who accepts a bribe is neither misappropriating the principal’s assets, nor exploiting an opportunity: the fiduciary’s duty is not to take a bribe and hold it on his principal’s account, but rather not to take a bribe at all! The principled argument for a proprietary remedy was essentially that equity refuses to allow a fiduciary to rely on his own breach of duty to show that a payment was a bribe, so assumes that a fiduciary holds a bribe on trust for the principal. This was buttressed by practical arguments: the result would be simpler, since it obviates differences in available remedies for the same liability; the notion that a fiduciary should be able to retain the proceeds of a bribe is unattractive; and it would be curious if a fiduciary could do so, while far less opprobrious conduct may create a constructive trust. The Court concluded that the latter arguments won out.

The court’s reasoning is not beyond criticism but the result is, as a matter of policy, unsurprising. The ‘principled’ argument for a proprietary remedy seems flawed. It is never assumed that all assets of a fiduciary (including eg. his house or car) are trust assets. There is therefore an implicit ‘jump’ in the reasoning, which requires the insertion of the fact that the bribe is not the fiduciary’s personal asset, but rather results from his dealing with the trust. However, this ‘jump’ obscures the key issue: what profits for a fiduciary, arising from his dealings with the trust but not involving trust property, attract proprietary remedies? One rationalisation of the outcome may be to consider the ‘opportunity’ represented by the bribe as a new species of ‘fiduciary opportunity’, in line with those cases where a fiduciary has exploited an opportunity which arose in his fiduciary capacity, but which the principal was unable to exploit himself (cf. Keech v Sandford (1726) Sel Cas Ch 61).

The second case, Novoship (UK) Ltd v Nikitin [2014] EWCA Civ 908 (decided a fortnight before FHR) involved a Mr Mihayluk, the General Manager of a shipping company. He had acted in breach of fiduciary duty both by taking bribes for himself and by directing bribes to third parties in negotiating charterparties. The point of interest concerned a set of charters (‘the Henriot charters’) negotiated between himself and a Mr Nikitin, to whom Mr Mihayluk had in other negotiations directed bribes. There was no evidence that the Henriot charters had been concluded otherwise than on market rates, but Christopher Clarke J had held that Mr Nikitin was a dishonest assistant (since he negotiated the Henriot charters when he knew that Mr Mihayluk had made him dishonest payments, and so continued a corrupt relationship). The question which the Court of Appeal considered was whether an account of profits was available against Mr Nikitin.

Mr Nikitin argued that, as a dishonest assistant, he had never been a true fiduciary: he never promised to subordinate his own interests to those of the principal. In that context the account of profits, with its historical root in the obligations of the true fiduciary, was inappropriate. The Court however decided that it was appropriate to consider a dishonest assistant, like a knowing recipient, as someone who has “in principle, the responsibility of an express trustee [which] … would include, in an appropriate case, a liability to account for profits” (at [82]). However, unlike a true fiduciary, the common law concepts of causation and remoteness should be applied by analogy to assess the quantum of profit resulting from the dishonesty. Since the Henriot charters had been entered into on market rates, there had been no such profit, and so Novoship did not recover.

Again, the attraction of the judgment is obvious: where a dishonest assistant has profited from his dishonesty, why should he not be made to disgorge that profit? Again, however, the principled problems are equally obvious. The reason a knowing recipient is liable to account is that he has received trust property. The dishonest assistant is ‘mixed up’ in the fiduciary’s breach of trust, but has undertaken no fiduciary duties: why should he be liable to account (as opposed simply to paying equitable compensation)? The answer seems to be that he is a ‘constructive fiduciary’, but it is unclear what this signifies beyond the imposition of the liability to account. The application of the common law causation/remoteness analysis represents a further departure from trust law orthodoxy.

The two judgments are each individually very significant. They greatly widen the remedies available to employers wishing to pursue claims against bribed senior employees and directors (particularly where insolvent, or where the assets have been squirrelled away), and against those who bribed them. In combination, moreover, they raise an intriguing further question: can a constructive trust be obtained over profits received by a dishonest assistant? The emphasis of FHR on the special status of fiduciary obligation might be thought to tell against this, but in Novoship the Court of Appeal baldly held that the dishonest assistant, as constructive fiduciary, has “the responsibility of an express trustee”. If a fiduciary is a constructive trustee even in respect of assets that were not previously the principal’s assets and which he was not under an obligation to exploit for the principal, could the constructive fiduciary be a constructive trustee of any profits, even where those profits were not previously the principal’s assets nor assets which he was under an obligation to exploit for the principal? Doubtless the appellate courts will, in due course, supply an answer.

Rupert Paines

Tags: , , ,

Comments are closed.