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Essay question
In his book, Property and Justice (Clarendon Press, Oxford, 1996), Professor J. W. Harris observed that the strict rule that a fiduciary must account for unauthorised profit ‘confers the windfall constituted by the fiduciary’s profit, not on the community, but on his principal’, with the result that the principal is entitled to claim it in preference to the fiduciary’s creditors. Professor Harris asks: ‘Why should the principal take a windfall in priority to those to whom the fiduciary owes purchased obligations?’
Can you answer Professor Harris’ question?
Guidance
In AG for Hong Kong v Reid [1994] 1 All ER 1, the Privy Council held that whenever a fiduciary receives property of his principal in breach of his fiduciary duty, he is a constructive trustee of it, and of any traceable profit from and proceeds of it. Mr Reid was acting Director of Public Prosecutions in Hong Kong. In breach of his fiduciary duty to the Crown he received substantial bribes in consideration of which he obstructed the prosecution of certain criminals. The Crown was able to trace the bribe monies through to three freehold properties in New Zealand, and to assert a restitutionary claim to them under a constructive trust. Lord Templeman held: ‘Equity considers as done that which ought to be done. As soon as the bribe was received, whether in cash or in kind, the false fiduciary held the bribe on a constructive trust for the person injured.’ But in what sense did the constructive trust in this case operate to vindicate the Crown’s pre-existing proprietary entitlement to the bribe? The Crown was surely no more entitled to the bribe prior to its receipt by Reid than was he himself. Despite this concern, and overruling the decision of the Court of Appeal in Sinclair Investments (UK) Ltd v Versailles Trade Finance Ltd (In Administration) [2011] EWCA Civ 347, the Supreme Court has now confirmed the authority of AG for Hong Kong v Reid.
The decision of the Privy Council in Reid has now been approved by the Supreme Court in FHR European Ventures LLP v. Cedar Capital Partners LLC [2014] UKSC 45. FHR purchased a Monte Carlo hotel company for €211.5 million. Cedar was FHR’s agent in the negotiation, but Cedar had secretly entered into a brokerage agreement with the vendor under which it received €10m. FHR argued that any unauthorized benefit (such as a bribe or secret commission) that is received by an agent by reason of his agency and in breach of fiduciary duty should be held on constructive trust for the principal. Lord Neuberger approved FHR’s argument as having ‘the merit of simplicity’, and the Supreme Court confirmed the High Court’s decision that Cedar held the €10m subject to a constructive trust in favour of FHR. The decision has the merit of ensuring that a fiduciary must disgorge any unauthorized gains in full. The most radical element of the decision is to regard the fiduciary as a constructive trustee of the principal’s equitable property even though the principal was never property owner of the ‘bribe’ and never wished to be owner of any bribe. It means that when a bribed fiduciary becomes insolvent the fiduciary will be permitted to go to the front of the queue to claim its property right in the bribe under a constructive trust when ordinary trade creditors of the fiduciary will have to fight between themselves over the remnant of the insolvent fiduciary’s personal estate. So when Professor J. W. Harris asked ‘[w]hy should the principal take a windfall in priority to those to whom the fiduciary owes purchased obligations?’(Property and Justice (Oxford: Clarendon Press, 1996) at 338). The answer given in FHR is that to remove wealth in the form of bribes and secret commissions does not reduce the insolvent fiduciary’s estate because such assets should never have been considered part of that estate.
Another interesting case is Boardman v Phipps [1967] 2 AC 46. There, Boardman (the solicitor to the trust) wrote to the beneficiaries outlining his plans to take a personal interest in the company, thus giving them an opportunity to raise any objections they might have to his so doing. No objectors having come forward, Boardman proceeded with the take-over. In the event the take-over was very successful and the value of all the shares in the company increased in value. The present action was brought by Phipps, a beneficiary under the trust, for an account of profits made by Boardman in his fiduciary capacity. The trial judge found as a fact that Phipps had not been fully informed by Boardman as to the precise nature of his plans. A bare majority of their Lordships (Viscount Dilhorne and Lord Upjohn dissenting) held that Boardman had placed himself in a fiduciary position in relation to the trust and would therefore be accountable for the profits that he had made on information obtained in his fiduciary capacity. There was only a slight suggestion in their Lordships’ speeches that the inside information had itself been property of the trust. In fact, Boardman was held to be a constructive trustee, not to vindicate the beneficiary’s pre-existing rights in property held by Boardman (he had not held any such property), but ‘by reason of the fiduciary position in which [he] stood’ (emphasis added).
Professor Birks has suggested ((1988) LMCLQ 128) that the use of constructive trust language was inappropriate to the facts of this case. For Birks, Boardman v Phipps was a case which should have been disposed of as a straightforward personal claim against the principal, and that in essence, despite the occasional unconvincing reference to constructive trusteeship, this is how the case was disposed of. It is true that the House of Lords made no order requiring that the defendants should transfer the shares to the plaintiff. Against this Professor Andrew Burrows points out that a declaration that the defendant held the shares on constructive trust was made at first instance, and (that judgment having been upheld) ‘it must follow that the plaintiffs would have been entitled to proprietary remedies, affording priority, had the defendants been insolvent’ (The Law of Restitution (1993), p. 413). The decision in Sinclair v Versailles does not resolve the debate in Boardman v Phipps, partly because it was in the very different context of bribery and partly because it was decided in a lower court.
It is suggested that the right approach would be for the courts to find a constructive trust in favour of the principal where the unauthorized profits were made through the use of the principal’s property in the hands of the fiduciary, but in other cases to allow the creditors to prove their claims ahead of any windfall to the principal in the guise of a constructive trust.