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In the case of Hosking v Marathon Asset Management LLP [2016] EWHC 2418 (Ch) the court had to answer the question, “Whether the share of profits of a partner of a partnership or a member of an LLP, paid out pursuant to and in accordance with a partnership or LLP deed, can be subject to the principle of forfeiture on the basis of the partner’s/member’s breach of fiduciary duties.”

Arbitration

The case was an appeal on a point of law from the decision of an arbitrator who had found that Mr Hosking had breached contractual and fiduciary duties that he had owed to Marathon by discussing with four of its employees the possibility of starting a new business and producing a business plan outlining his thoughts.

The arbitrator decided that, in addition to being liable to pay equitable compensation of some £1.38 million, Mr Hosking should forfeit and return to Marathon 50% of his profit share arising during the period in which his breaches of duty were committed, amounting to over £10 million.

The law

Partners of a partnership, and members of a limited liability partnership (LLP), are agents of the partnership or LLP (from here onwards I will refer to both partnerships and LLPs as “partnerships”, and to both partners and LLP members as “partners”).

As an agent, every partner is a “fiduciary”. This status imposes a very high standard of conduct onto the partner, not unlike the conduct expected of trustees of a trust. Partners must act with utmost good faith in all of their dealings with the partnership, which includes avoiding situations in which their own interests are in conflict with those of the partnership. These very strict obligations are known as “fiduciary duties”.

Hitherto, breaches of fiduciary duty had usually been rectified by requiring the partner to repay or account for the profits that he had made by virtue of the breach and/or to pay damages for the partnerships loss. As will be seen below, Mr Hosking’s case was that making him repay profit share as well was a step too far.

Review of case law on forfeiture of profit share for breach of fiduciary duty

Mr Justice Newey reviewed a number of cases that had been drawn to his attention, and highlighted the following passages:

In Imageview Management Ltd v Jack [2009] EWCA Civ 63, [2009] Bus LR 1034 the purpose of the strict regime relating to fiduciary duties was explained as follows:

“We are here concerned not with merely damages such as those for a tort or breach of contract but with what the remedy should be when the agent has betrayed the trust reposed in him – notions of equity and conscience are brought into play. Necessarily such a betrayal may not come to light. If all the agent has to pay if and when he is found out are damages the temptation to betray the trust reposed in him is all the greater. So the strict rule is there as a real deterrent to betrayal.”

In Helmore v Smith (1) (1886) 35 Ch D 436, Bacon V-C said (at 444):

“If fiduciary relation means anything I cannot conceive a stronger case of fiduciary relation than that which exists between partners. Their mutual confidence is the life blood of the concern. It is because they trust one another that they are partners in the first instance; it is because they continue to trust one another that the business goes on.”

In Erikson v Carr (1945) 46 SR (NSW) 9, a New South Wales case, an individual was alleged to have forfeited his commission as a result of a breach of duty. The court in that case thought that, amongst other things, the outcome depended on “whether it was partnership or agency”. It was observed that “if a partner in a subsisting partnership finds that his co-partner has made a secret profit for which he is accountable to the firm, this does not entitle him to rescind the partnership ab initio” but rather “to require the amount to be brought into the partnership account so that he may receive his proper share of it”, while “[i]f a person, acting as agent under a subsisting contract of commission agency, accepts a secret commission in relation to an agency transaction, he must account for it to his principal” and “[o]rdinarily he also forfeits his right to commission” (thus contrasting partnership with ordinary agency, and finding that the forfeiture principle does not apply to the former).

In F & C Alternative Investments (Holdings) Ltd v Barthelemy (No 2) [2011] EWHC 1731 (Ch), [2012] Ch 613 Mr Justice Sales stated:

“Fiduciary obligations may arise in a wide range of business relationships, where a substantial degree of control over the property or affairs of one person is given to another person. Very often, of course, a contract may lie at the heart of such a business relationship, and then a question arises about the way in which fiduciary obligations may be imposed alongside the obligations spelled out in the contract. In making their contract, the parties will have bargained for a distribution of risk and for the main standards of conduct to be applied between them. In commercial contexts, care has to be taken in identifying any fiduciary obligations which may arise that the court does not distort the bargain made by the parties…The touchstone is to ask what obligations of a fiduciary character may reasonably be expected to apply in the particular context, where the contract between the parties will usually provide the major part of the contextual framework in which that question arises.”

Statutory provisions

Mr Justice Newey also made reference to the fact that under both the Partnership Act 1890 and the Limited Liability Partnerships Regulations 2001 the default position (subject to contrary agreement) is that partners are entitled to share equally in capital and profits, every partner is entitled to take part in management, no partner is entitled to “remuneration” for acting in the business or management of the LLP, and a partner who derives a private profit must account for it.

He also pointed out that, while there is no reference to forfeiture in the Partnership Act 1890, the Limited Liability Partnerships Act 2000 or the Limited Liability Partnership Regulations 2001, section 46 of the Partnership Act 1890 expressly provides for the “rules of equity and of common law applicable to partnership” to “continue in force except so far as they are inconsistent with the express provisions of this Act”, and the Limited Liability Partnerships Regulations 2001 provide that the default rules are “subject to the provisions of the general law”.

Opposing arguments

In his arbitration award the arbitrator had based the forfeiture award on a finding that “50% of the relevant payments received by Mr Hosking was, in substance, remuneration for the performance of executive duties.” This finding was based on the fact that an Executive Member (which Mr Hosking was at the time) was entitled to receive twice the allocation of profits that retired Non-Executive Members received. The arbitrator concluded that this was because Executive Members carried out a range of duties, including fiduciary duties, and were remunerated for that work by entitlement to an allocation of profit which was double the amount received by Non-Executive Members, who had no duties.

Mr Hosking asserted that the forfeiture principle had no application in relation to the share of profits of a partner. He contrasted profit share and remuneration, on the basis that “remuneration” refers to money payable in exchange for services, as an expense prior to the division of profits, and irrespective of the profitability of the business, whereas profit share of a partner reflects his status as a partner and his ownership interest. He claimed that a profit share does not become remuneration merely because the partner is required to provide his services.

Also, there was no provision for forfeiture in the Marathon LLP members’ agreement. Mr Hosking argued that allowing forfeiture would be inconsistent with and alter the commercial bargain between the parties.

Marathon argued that any payment made to a partner in return for services represents remuneration and can be forfeited, and the fact that there was no provision for forfeiture in the Marathon LLP members’ agreement was irrelevant because the forfeiture rule overrides contractual entitlements to remuneration.

Findings

Mr Justice Newey found against Mr Hosking. In doing so he made the following points:

  • The fiduciary principle applies to all agents, including partners and LLP members.
  • He was not bound by Erikson v Carr.
  • The distinction drawn by Mr Hosking between profit share and remuneration was not well-founded. There was no good reason to treat profit share differently from other forms of remuneration where it could be identified as reward for undertaking specific duties.
  • None of the cited cases, legislation or regulations required a different conclusion.
  • While the forfeiture principle could doubtless be excluded by contract, there was ample authority to show that it applies when no mention is made of it, e.g. Imageview (referred to above).

Comments on this case

This case is believed to be the first case in which an LLP member has been required to forfeit profit share. It is further cause (if any should be needed) for partners and LLP members to consider carefully before taking any steps that might constitute breach of fiduciary duty.

This is not the first case in which Mr Justice Newey has made a forfeiture order. In Avrahami v Biran [2013] EWHC 1776 (Ch) he required a joint venturer who was in breach of his fiduciary duties to repay management fees which had accrued over a period of five years. This is further demonstration of the potential width of application of the forfeiture principle.

Another example of modern application of this long-established equitable principle is the case of Gamatronic v Hamilton [2016] EWHC 2225 (QB) in which it was taken as read that company directors can be subject to forfeiture of their salaries for breach of fiduciary duty (becoming concerned with the formation of a competing business), though in that case forfeiture was not awarded on the basis that the forfeiture remedy is only appropriate in exceptional circumstances where the ordinary remedies of damages, specific performance and injunction are inadequate and justice demands it (citing the authority of Attorney-General v Blake [2001] 1 AC 268).

So, as with all remedies, there are limits, as was also seen in the case of Bank of Ireland v Jaffery [2012] EWHC 1377 (Ch) (a senior executive who had acted in breach of fiduciary duty by taking secret interests in projects financed by his employer bank’s lending, taking a bribe and in concealing that wrongdoing from the bank, was not required to repay five years’ salary and bonuses since his employers could be fully and properly compensated by requiring the executive to disgorge his profits or to pay equitable compensation). While helping to delineate one of the limits to the remedy, the Jaffery case also demonstrates that in some cases senior employees have fiduciary duties (as opposed to the usual more limited duties of fidelity).

 

If you are affected by any of the issues raised in this post and would like a confidential, no obligation meeting or telephone discussion to explore how I can assist you, please contact me.

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