Breach of Fiduciary Duty

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In practical terms, there are two ways a fiduciary can breach its duty (:Chan v Zacharia[1]):

  • Being in a position of a conflict of interest. A person is in a position of conflict if:
    • 'A reasonable man looking at the relevant facts...would think that there was a real sensible possibility of conflict': Boardman v Phipps.[2]
    • Fraud, dishonesty or bad faith are irrelevant: Regal (Hastings) Ltd v Gulliver.[3]
    • Conflict may arise between duties owed to different principals: Beach Petroleum NL v Kennedy.[4]
  • Making an improper gain from his position.
    • Making any sort of gain is prohibited, regardless of whether it harmed the principal, whether it was even available to the principal or, whether it actually benefited the principal as well: Keech v Sandford; Parker v McKenna; Boardman v Phipps.[5]


The only defence available to the fiduciary who has breached his duty is that he did so with the informed consent of the principal:Parker v McKenna; Boardman v Phipps.[6]

  • The extent of what is required for a fully informed consent is determined on a case by cases basis: Maguire v Makaronis.[7]
  • A 'full and frank' disclosure of all the material information known to the fiduciary (including any information the fiduciary has deliberately refrained from acquiring) is usually required for an informed consent: Boardman v Phipps.[8]


There are a number of remedies used in the case of a breach of fiduciary duties:

  • Account of profits - a restitutionary remedy based on profits made by the fiduciary.
    • A partial account of profits can be ordered, with an equitable allowance made for the fiduciaries time and effort: Warnam International Ltd v Dwyer.[9]
  • Equitable compensation - a compensatory remedy based on the losses suffered by the principal: Gemstone Corporation of Australia v Grasso.[10]
    • No remoteness test, and damages are assessed at the time of judgment: Youyang v Minter Ellison.[11]
    • The principal may elect between an account of profits or equitable compensation: Warnam International Ltd v Dwyer.[12]
  • Constructive trusts - a decree by the court that the profits held by the fiduciary are held on a constructive trust for the principal.
    • Most severe remedy, should only be imposed when other remedies are inappropriate: Bathurst City Council v PWC Properties.[13]
  • Rescission - rescission of the contract entered into by the fiduciary: Maguire v Makaronis.[14]

This article is a topic within the subject Property, Equity and Trusts 1.

Contents

Required Reading

Evans, Equity and Trusts, 3rd edition, Lexis Nexis, 2012, pp. 169-183 (Chapter 13)

Introduction

As mentioned in the topic fiduciary obligations, a fiduciary has three core duties which are all interrelated:

  • Not to place oneself in a position of conflict of duties relating to the principal and the fiduciary’s interests;
  • Not to make a profit out of the principal’s trust;
  • Not act for one’s own benefit or the benefit of third parties, without the consent of the principal.

Looking at these duties, a breach can take two forms: a 'conflict of interest' and an 'improper gain' .[15]

Improper Gain

[16] The general rule seems to be that a fiduciary who profits through his or her position is automatically liable to account to the principal for that benefit, regardless of whether the benefit was available to the principal.[17] This rule is instituted to prevent the other type of breach (conflict of interest):

  • Because the fiduciary is held to account no matter what, it discourages him from engaging in activities which might cause a conflict of interest.

The question arises whether fiduciaries are ever allowed to profit from their position as a fiduciary. Technically, a fiduciary is only allowed to profit if it obtained the fully informed consent of the principal (this is called the defence of 'informed consent' and is discussed below).[18] It was reaffirmed in Parker v McKenna

  • The court’s only duty is to simply examine whether a profit was made without knowledge of the principal, not whether this harmed the principal in any way.
  • If a fiduciary made a profit whilst acting as a fiduciary and without knowledge of the principal, he is accountable for those profits to the principal.

In practical terms, many fiduciaries profit out of their positions, because it is a part of their job (eg, solicitors, directors etc).

Conflict of Interest

[19] A fiduciary will be in breach if he has put himself in a position of conflict. A fiduciary will be deemed to have placed himself in a position of conflict and thus breach his duty if:

  • 'A reasonable man looking at the relevant facts...would think that there was a real sensible possibility of conflict'.[20]
    • Note that this is an objective test - what would the reasonable man think?
    • Note that actual conflict is not required - only mere real, sensible possibility of conflict.
  • It is unnecessary to establish fraud, dishonesty or bad faith.[21]

This same test applies when there is a conflict between two duties (ie, when a solicitor has two clients, he cannot place himself in a position where his duties conflict).[22]

Defences

[23] The informed consent of the principal is a defence against a breach of duty, and it applies to both improper gain as well as a conflict of interests. In order for the consent to be 'informed', the consent must be given on the basis of a full and frank disclosure of all the material facts.

  • The extent of what is required for a fully informed consent is determined on a case by cases basis.[24]
  • The extent of what is required for a 'full and frank' disclosure can be summed up as all material information known to the fiduciary , including any information the fiduciary has deliberately refrained from acquiring.

The defence of informed consent is the only defence. It is important to remember that:

  • Showing that the defendant acted in good faith or with honesty is not a defence.[25]
  • A fiduciary cannot escape a breach of duty by resigning as a fiduciary and then making a profit for which they otherwise would be accountable - the fiduciarY duties continue to exist.[26]
  • Showing that proving a full and frank disclosure would not have any effect on the principal is also irrelevant.[27]

A good example of a breach of fiduciary duty is Boardman v Phipps.

  • The court made the defendant accountable for his profits despite that he acted in good faith and that the benefit he obtained also benefited the principal.
  • He only obtained some partial consent which did not amount to informed consent. The court held that the defendant's disclosure fell short of the full and frank disclosure which was required. This was done innocently - he did not mean to conceal anything.
  • Still, he was held accountable.

Remedies

[28] There are a number of remedies used in the case of a breach of fiduciary duties:

Account of Profits

An account of profits is a restitutionary whereby the fiduciary hands over all profits made, regardless of whether the principal incurred a loss (as opposed to compensatory remedies which merely compensate for a loss)

  • An account of profits is usually the appropriate remedy.[29]
  • The court can modify the remedy by ordering an account of profits over a a certain period (ie, only the profits made in the first 6 months) if full account of profits is more than what is equitable.[30]

It was discussed in Warnam International Ltd v Dwyer:[31]

  • Facts: Dwyer was the general of Warnam. He didn't like their policies and especially their refusal to enter a joint-venture with one of their manufactures. He resigned and then entered the joint-venture with the manufacturer.
  • Held: by appropriating the business with the manufacturer, Dwyer breached his fiduciary duty. In terms of damages, the court held that:
    • Where there is breach of a fiduciary duty, the principal may elect to have either an account of profits or equitable compensation (the choice which the principal makes will obviously depend on which sum is the greater).
    • An account of profit is probably the most appropriate remedy despite its harshness. If the profits are more than is required to achieve fairness, the court can limit it by:
    • Ordering 'partial' account of profits (eg, account of profits over a certain time period).
    • Discounting from the sum to be paid by the defendant an 'equitable allowance' to compensate for the expenses, skill, effort and resources required to make the profit.

Equitable Compensation

Equitable compensation are compensatory damages based on the loss of the principal, like damages in common law.[32]

  • This remedy is appropriate where the breach has resulted in the principal suffering a loss but the fiduciary has not gained so much profit.
  • It is distinct from common law damages in that there is no remoteness test, and damages are assessed at the time of judgment.[33]

Equitable Compensation are discussed in Gemstone Corporation of Australia v Grasso:[34]

  • Facts: Grasso was a director of Gemstone. He purchased parts of shares under a nominee company which didn't have any actual assets, and eventually couldn't pay for the shares. This resulted in a loss to Gemstone.
  • Held: by not disclosing the inability of his nominee to pay for the shares, Grasso breached his fiduciary duty. The remedy used here will be equitable compensation, since the principal has suffered a loss whilst the fiduciary has hardly made a profit (making account of profits inappropriate).

Constructive Trusts

Constructive trusts are trusts imposed by the courts to remedy a situation. In this context, the court would decree that the gains acquired out of the breach are held on trust for the benefit of the principal.[35]

  • It is considered the most severe remedy because it means that none of the gains of the fiduciary are actually his. The principal has proprietary rights to the gains.
  • It then follows that the principal gets an unfair priority over other creditors despite maybe not even suffering a real loss. He can sue third parties etc.
  • It should therefore only be imposed when other remedies are inappropriate.[36]

Rescission

Rescission is the act of setting aside a contract and restoring the parties to their original positions. In this context, it would be an appropriate remedy when a fiduciary enters a contract which might lead to a breach of fiduciary duty. All the normal rules, requirements and limitations of rescission apply.

Rescission was discussed in Maguire v Makaronis:[37]

  • Facts: Maguire was the solicitor of Makaronis and then, trying to secure him some finances, ended up as his mortgagee as well. When Maguire sued Makaronis for some monies, Makaronis counter claimed that Maguire's dual roles put him in a position of conflict.
  • Held: the appellants breached their fiduciary duty and the best thing to do in this case was to completely rescind the mortgage, as far as possible. However, rescission was made available on the condition that the plaintiffs did equity by repaying the loan plus interest as stipulated by the court.

Secret Commissions and Equitable Debt

[38] An employee receiving a ‘kickback’ from a third party in return for some action will be liable in equity to their employer.

  • Under the old authorities, such an employee is liable to the employer in debt, rather than as a constructive trustee.[39] The rationale for this was that the money was not held on trust because the money was never the company’s in the first place. This view has been heavily criticized.
  • Due to the recent expansion of the ambit of constructive trust remedies in cases like Re Stephenson Nominees,[40] this rule will probably not be followed in most cases now.
  • It is already not followed in New Zealand.[41]

End

This is the end of this topic. Click here to go back to the main subject page for Property, Equity and Trusts 1.

References

Property Textbook refers to Edgeworth et all, Sackville and Neave's Property Law Cases and Materials, 8th edition, Lexis Nexis, 2008.

Equity Textbook refers to Evans, Equity and Trusts, 3rd edition, Lexis Nexis, 2012.

  1. (1984) 154 CLR 178.
  2. [1967] 2 AC 46, 124.
  3. [1967] 2 AC 134, 137.
  4. [1999] NSWCA 408, 48.
  5. Keech v Sandford (1726) 25 ER 223; Parker v McKenna (1874) 10 Ch App 96; Boardman v Phipps [1967] 2 AC 46, 124.
  6. Parker v McKenna (1874) 10 Ch App 96; Boardman v Phipps [1967] 2 AC 46, 124.
  7. (1997) 188 CLR 449, 466.
  8. [1967] 2 AC 46, 124.
  9. (1995) 182 CLR 544.
  10. (1994) 13 ACSR 695.
  11. (2003) 212 CLR 484.
  12. (1995) 182 CLR 544.
  13. (1998) 195 CLR 566.
  14. (1997) 188 CLR 449.
  15. Chan v Zacharia (1984) 154 CLR 178.
  16. Equity Textbook, pp. 169-170 [13.1-13.2].
  17. Keech v Sandford(1726) 25 ER 223.
  18. Boardman v Phipps [1967] 2 AC 46, 124.
  19. Equity Textbook, pp. 170- [13.3-].
  20. Boardman v Phipps [1967] 2 AC 46, 124.
  21. Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134, 137.
  22. Beach Petroleum NL v Kennedy [1999] NSWCA 408, 48.
  23. Equity Textbook, pp. 173-5 [13.7-13.10].
  24. Maguire v Makaronis (1997) 188 CLR 449, 466.
  25. Boardman v Phipps [1967] 2 AC 46.
  26. Green & Clara Pty Ltd v Bestobell Industries Pty Ltd [1982] WAR 1.
  27. Furs Ltd v Tomkies (1936) 54 CLR 583, 592.
  28. Equity Textbook, pp. 175-180 [13.11-13.18].
  29. Warnam International Ltd v Dwyer (1995) 182 CLR 544.
  30. Warnam International Ltd v Dwyer (19995) 182 CLR 544.
  31. (19995) 182 CLR 544.
  32. Mordecai v Mordecai (1988) 12 NSWLR 58.
  33. Youyang v Minter Ellison (2003) 212 CLR 484.
  34. (1994) 13 ACSR 695.
  35. Timber Engineering v Anderson [1980] 2 NSWLR 488.
  36. Bathurst City Council v PWC Properties (1998) 195 CLR 566.
  37. (1997) 188 CLR 449.
  38. Equity Textbook, pp. 180-3 [13.19-13.26].
  39. Lister v Stubbs (1890) 45 ChD 1.
  40. (1987) 76 ALR 485, 502-3.
  41. A-G (Hong Kong) v Reid [1994] 1 NZLR 1.
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