Seminar 7 - Fiduciary Duties and Breach of Trust PDF

Preview

Summary

Fiduciary Duties and Breach of Trust...

Description

The Law of Trusts

Law 3241 Seminar 7 Fiduciary Duties and Breach of Trust

Learning Outcomes: By the end of this seminar, you should be able to:  analyse the concepts of “fiduciary duties” and “breach of trust”  explain the remedies available for breach of fiduciary duty and breach of trust  outline the defences available against claims of breach of fiduciary duty and breach of trust Essential Reading:    

Jamie Glister and James Lee, Hanbury and Martin: Modern Equity (21st edn., Sweet and Maxwell 2018), paras 22-008–22-033, 24-007–24-013, 24-029–24033, 24-037–24-0038; or Graham Virgo, The Principles of Equity and Trusts (3rd edn., OUP 2018), 418421, 431-456, 471-473, 491-493, 510-520; or Gary Watt, Trusts and Equity (8th edn., OUP 2018), 326-352, 428-437; or Charlie Webb and Tim Akkouh, Trusts Law (5th edn., Palgrave 2017), 260-271, 274-277, 310-320.

Supplementary Reading:          

Paul Davies, ‘Remedies for Breach of Trust’ (2015) 78 Modern Law Review 681. James Edelman, ‘When do Fiduciary Duties Arise?’ (2010) 126 Law Quarterly Review 302. Sir Roy Goode, ‘Proprietary Liability for Secret Profits – A Reply’ (2011) 127 Law Quarterly Review 493. David Hayton, ‘Proprietary Liability for Secret Profits’ (2011) 127 Law Quarterly Review 487. Jie Li, ‘The Peso Silver Case: An Opportunity to Soften the Rigid Approach of the English Courts on the Problem of Corporate Opportunity’ (2011) 32 Company Lawyer 68. John Lowry and Rod Edmunds, ‘The No Conflict-No Profit Rules and the Corporate Fiduciary: Challenging the Orthodoxy of Absolutism’ [2000] Journal of Business Law 122. Lord Millett, ‘Bribes and Secret Commissions Again’ (2012) 71 Cambridge Law Journal 583. Duncan Sheehan, ‘Secret Profits, Breach of Fiduciary Duty and the Constructive Trust in the Supreme Court’ (2014) 22 Restitution Law Review 101. Lionel Smith, ‘Constructive Trusts and the No-Profit Rule’ (2013) 72 Cambridge Law Journal 260. Sarah Worthington, ‘Fiduciary Duties and Proprietary Remedies: Addressing the Failure of Equitable Formulae’ (2013) 72 Cambridge Law Journal 720. 1

1.

Introduction

1.1.

The trustee is expected to fulfil several different types of duties. There are three broad types of breach of duty that a trustee may commit: (a) breach of duty of care – a duty to act carefully; (b) breach of fiduciary duty – a duty to act loyally or with proper motives; or (c) breach of trust – a duty to abide by the express provisions of the trust. We considered the duty of care in the previous seminar and will be examining fiduciary duties and breach of trust in this seminar.

1.2.

As in the case of breach of duty of care, one of the central policy considerations in relation to other trustee duties is the attempt to balance the aim of regulating trustees so they operate for the benefit of the beneficiaries with the aim of permitting trustees (particularly professional trustees) the required discretion to operate effectively.

2.

Fiduciary Duties

2.1.

There is no universally accepted definition of a fiduciary, although there have been attempts to describe the nature of fiduciary duties, focusing on the significance of loyalty or faithfulness. For instance, Millett LJ has noted: “A fiduciary is someone who has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence. The distinguishing obligation of a fiduciary is the obligation of loyalty. The principal is entitled to the single-minded loyalty of his fiduciary” (Bristol & West Building Society v Mothew, [1998] Ch 1 at 18). The fiduciary undertakes to act in the principal’s best interests rather than their own interests.

2.2.

Trustees are the classic type of fiduciary; indeed, the word “fiduciary” is derived from the Latin “fiducia,” meaning trust. However, there is some controversy over whether all trustees are subject to fiduciary duties. Some scholars, such as James Edelman, have argued that a fiduciary relationship arises on the basis of voluntary undertakings. If voluntary assumption of a relationship of trust with a principal is necessary, it follows that it would be impossible for a constructive trustee to be subject to fiduciary duties.

2.3.

Further, not all fiduciaries are trustees as a wide range of commercial relationships have been considered to be fiduciary relationships. Examples include agent and principal; company director and company; executor and beneficiary under the estate; partners (in a partnership, such as a solicitors’ or accountancy firm); and solicitor and client. Different jurisdictions have different lists of fiduciary relationships. In Canada, the relationship of doctor and patient has been described as fiduciary ( Norberg v Wynrib , [1992] 2 SCR 226), but this is not accepted in England.

2.4.

It is significant to note that “not every breach of duty by a fiduciary is a breach of fiduciary duty” (Bristol & West Building Society v Mothew, [1998] Ch 1 at 16). For instance, trustees are also subject to the duty of care, i.e.

2

the obligation to use proper skill and care in the discharge of their duties; the breach of this obligation is not a breach of fiduciary duty. 2.5.

The obligation of loyalty associated with a fiduciary relationship brings with it two broad duties, recognized by Lord Heschell in this statement: “It is an inflexible rule of a Court of Equity that a person in a fiduciary position … is not, unless otherwise expressly provided, entitled to make a profit; he is not allowed to put himself in a position where his interest and duty conflict” (Bray v Ford, [1896] AC 44 at 51). These duties are termed the “no-profit” and the “no-conflict” duties.

2.6.

The “No-Conflict” Duty

2.6.1.

The essence of the no-conflict duty is captured in this statement: “it is a rule of universal application, that no one having [fiduciary] duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting, or which may possibly conflict, with the interests of those whom he is bound to protect” (Aberdeen Railway Company v Blaikie Bros, (1854) 1 Macq 461 at 471). The fiduciary must not operate in a manner to take any benefit for themselves in circumstances where there is a possible conflict between their personal interests and those of the principal. Further, the fiduciary is also under the obligation to avoid placing themselves into situation in which their personal interests conflict with those of their principal. The operation of the no-conflict duty can be seen in the rules on self-dealing and fair-dealing as well as the rule in relation to principalprincipal conflicts.

2.6.2.

Self-Dealing

2.6.2.1. The self-dealing rule is that “if a trustee sells the trust property to himself, the sale is voidable by any beneficiary ex debito justitiae , however fair the transaction” (Tito v Waddell (no 2), [1977] Ch 106 at 241, per Megarry VC). So a person acting in fiduciary capacity cannot sell trust property to themselves in personal capacity. The rationale for this bar is that as a fiduciary they are under the duty to get the best possible price for the property, while in their personal capacity their interest lies in obtaining the cheapest possible price, which is a conflict between their duty and their interest. This risk exists regardless of the substantive fairness of the transaction. Fiduciaries must not merely act with proper motives but be seen to act with the proper motives. So, even if the price is a fair one, the contract of sale is voidable and may be rescinded. This re-vests title to the property in the principal. 2.6.2.2. The self-dealing rule is illustrated by Wright v Morgan ([1926] AC 788), where the Privy Council decided that that the trustees of an estate were not permitted to sell parts of the land to each other. This ruling was despite the stipulation for an independent valuation of the property before sale and even though the purchasing trustee had resigned as trustee prior to the purchase. The rationale for the decision was that the potential conflict of interest could

3

not be ruled out as the auction for the sale of the property had been arranged prior to the trustee’s resignation. 2.6.2.3. The decision in Wright may be compared with the more liberal interpretation of the self-dealing rule in Holder v Holder ([1968] Ch 353), where the sale of property to the executor of a will was held to be valid. The sale was completed after the purchaser sought to renounce his position as executor of the will (even though the renunciation was ineffective). It appears that the sale was permitted since he had not assumed any of the duties of executor and had taken no active part in arranging the auction at which the property had been sold to him. 2.6.3.

Fair-Dealing

2.6.3.1. The fair-dealing rule is that “if a trustee purchases the beneficial interest of any of his beneficiaries, the transaction is not voidable ex debito justitiae, but can be set aside by the beneficiary unless the trustee can show that he has taken no advantage of his position and has made full disclosure to the beneficiary, and that the transaction is fair and honest” (Tito v Waddell (no 2), [1977] Ch 106 at 241, per Megarry VC). So when a fiduciary personally transacts with the principal in order to purchase the principal’s beneficial interest in the fund, the sale may be upheld if the fiduciary is able to show that they did not abuse their position in any way, that they paid a fair price, and that they made full disclosure of all relevant facts to the principal; the onus to prove all this lies on the fiduciary ( Thomson v Eastwood , (1877) 2 App Cas 215). 2.6.3.2. Like with the self-dealing rule, there exists the risk of a conflict of interest on account of the fiduciary’s personal interest in obtaining the beneficial interest at the cheapest possible price while also remaining loyal to the principal. However, since there are two different parties in the transaction (the fiduciary and the principal), the fair-dealing rule allows for the transaction to go ahead if it is substantively fair, unlike in the case of self-dealing. So while the selfdealing rule is prohibitory, the fair-dealing rule is regulatory. 2.6.4.

Principal-Principal Conflicts

2.6.4.1. In addition to conflicts between a fiduciary’s personal interest and duty to the principal, there may also be situations where a fiduciary’s duties towards different principals conflict or potentially conflict with each other. This constitutes a breach of fiduciary duty as the fiduciary is unable to be absolutely loyal to either of the principals. 2.6.4.2. Principal-principal conflicts are possible in the case of professional fiduciaries, such as solicitors, who act for multiple clients simultaneously. Such situations are not altogether unusual; hence, it is permissible for a fiduciary to act for two principals with potentially conflicting interests if there is fully informed consent by both parties (Bristol & West Building Society v Mothew, [1998] Ch 1). In the case of solicitors, the words of Lord Jauncey are instructive: “[i]nformed consent means consent given in the knowledge 4

that there is a conflict between the parties and that as a result the solicitor may be disabled from disclosing to each party the full knowledge which he possesses as to the transaction or may be disabled from giving advice to one party which conflicts with the interests of the other. If the parties are content to proceed upon this basis the solicitor may properly act” (Clark Boyce v Mouat, [1994] 1 AC 428 at 435). 2.6.4.3. The potential for conflict when a fiduciary acts for multiple principals is illustrated by the decision in Hilton v Barker Booth & Eastwood ([2005] 1 WLR 567), where the defendant solicitors’ firm acted for both sides in a property development transaction that had disastrous consequences, ultimately resulting in the collapse of the claimant’s business. The firm knew that the purchaser had criminal convictions for fraud and a history of bankruptcy, having represented him in criminal proceedings in the past, but did not disclose these facts to the claimant. The claimant successfully pursued a breach of contract claim, but Lord Walker recognized that “a solicitor's duty of single-minded loyalty to his client's interest, and his duty to respect his client's confidences, do have their roots in the fiduciary nature of the solicitor-client relationship” (ibid at 574). So when approached by the claimant, the solicitors ought to have informed him that they could not act for him and also given him clear advice that he ought to seek legal advice from other solicitors (ibid at 575). Further, once they had agreed to act for the claimant, the defendants also committed a breach of duty when they failed to disclose their knowledge about the purchaser’s antecedents to the claimant (ibid at 577). 2.6.4.4. If fiduciaries decide to act for multiple principals after obtaining their informed consent, they also have the responsibility to protect the clients’ confidential information by putting in place effective information barriers. Such measures could include requiring separate teams to handle the matters, hosting information on separate servers, and requiring information to be passwordprotected. It is important to note that such information barriers need to be established as part of the organizational structure of a firm to be effective. The House of Lords has taken a strict view on protecting client information, holding that ad hoc barriers are difficult to enforce and would not protect client confidentiality (Prince Jefri Bolkiah v KPMG, [1999] 2 AC 222). 2.6.4.5. Paragraph 6 of the Code of Conduct for Solicitors, RELs, and RFLs and the Code of Conduct for Firms issued by the Solicitors Regulation Authority provides more specific obligations for solicitors and firms relating to conflicts of interest and confidentiality of client information. 2.7.

The “No-Profit” Duty

2.7.1.

The no-profit rule prohibits the fiduciary from obtaining a benefit by virtue of their position as fiduciary (Bray v Ford, [1896] AC 44). The rule is interpreted strictly, so for example, a fiduciary is not permitted to make any profit from information or opportunities that come to them in their capacity as fiduciary. The foundational case in this regard is Keech v Sandford ((1726) Sel Cas 61, 25 ER 223), where a trustee held legal title to a lease on trust for the 5

beneficiary. The lease ran out and the freehold owner refused to renew the lease for the benefit of the beneficiary but allowed the trustee to renew it for his own benefit. The Lord Chancellor held that the trustee ought to have let the lease run out rather than have it leased to himself; consequently, the lease was assigned to the beneficiary. The rationale behind the rule’s strictness seems to be that the trustee must be deterred from taking personal gains from their position as trustee. 2.7.2.

Many contemporary cases on the no-profit rule deal with situations in which company directors exploit opportunities to make a profit when the opportunity came in their capacity as a director. For instance, in Industrial Development Consultants v Cooley ([1972] 1 WLR 443), the defendant was the managing director of the claimant company and first negotiated with a third party on behalf of the company. When it became clear that the third party was unwilling to deal with the company, he claimed to be ill, resigned from the company, and secured the contract in his personal capacity. He was held to be in breach of his fiduciary duty since it was “plain that it was his duty once he got this information to pass it to his employers and not to guard it for his own personal purposes and profit” (ibid at 453). By contrast, in Island Export Finance v Umunna ([1986] BCLC 460), the defendant resigned as director of a company that made post boxes for the West African market and later obtained a contract to supply post boxes in his personal capacity. He was not held to be in breach of his fiduciary duty as he had resigned on account of dissatisfaction at the way he was being treated rather than being motivated by a desire to pursue business opportunities sought by the company or of using confidential information belonging to them.

2.7.3.

A fiduciary is strictly liable if they exploit an opportunity obtained in their position as fiduciary even if they acted reasonably and in good faith. The strictness of the rule is illustrated by the House of Lords decision in Regal (Hastings) Ltd v Gulliver ([1967] 2 AC 134), where the directors of a company bought shares in a subsidiary of the claimant company; the company itself did not have the funds to purchase the shares. When the directors sold the shares at a profit, the company successfully claimed for breach of fiduciary duty, with Lord Macmillan stating: “[w]e must take it that they entered into the transaction lawfully, in good faith and indeed avowedly in the interests of the company. However, that does not absolve them from accountability for any profit which they made, if it was by reason and in virtue of their fiduciary office as directors that they entered into the transaction” (ibid at 153).

2.7.4.

This strict nature of the rule was further cemented by the House of Lords decision in Boardman v Phipps ([1967] 2 AC 46), involving a trust that held shares in a private company. The trustees obtained information suggesting that the purchase of further shares would benefit the trust. However, the trust was unable to do so on account of lack of funds, the risk that the purchase was not authorized by the investment clause of the trust instrument, and the opposition of one of the trustees. Boardman, the solicitor to the trust, along with others, purchased the rest of the company’s shares and reorganized the business, making it very profitable. Both the trust, which continued to hold a 6

significant shareholding in the company, and Boardman benefitted financially from the turnaround. The claimant, one of the beneficiaries of the trust, sought to call Boardman to account for the profits he had made as a result of the transaction. The House of Lords held that Boardman had breached his fiduciary duty as he had made a personal profit by virtue of his position as fiduciary and was liable to account for the profit made. 2.7.5.

There was considerable discussion on whether confidential information could constitute trust property (the lords were split on this), but ultimately, the issue did not matter as a majority held that Boardman had violated his fiduciary duty in obtaining a profit by exploiting information that he obtained while acting as a fiduciary. In the words of Lord Guest: “In the present case the knowledge and information obtained by Boardman was obtained in the course of the fiduciary position in which he had placed himself. The only defence available to a person in such a fiduciary position is that he made the profits with the knowledge and assent of the trustees. It is not contended that the trustees had such knowledge or gave such consent” (ibid at 117). The fact that the trust itself did not intend to and was also financially unable to purchase additional shares in the company was irrelevant.

2.7.6.

For the dissent, Viscount Dilhorne held “there was no conflict between the interests and duties of the appellants or between the interests of the trust and the appellants at any time” (ibid at 92). He went on to state: “Liability to account must depend on there being some breach of duty, some impropriety of conduct on the part of those in a fiduciary position. On the facts of this case I do not consider that there was any breach of duty or impropriety of conduct on the part of the appellants” (ibid at 94).<...