The judgment concerns the circumstances in which fiduciaries must account to their principals for the profits they make from their fiduciary relationships.
The UK Supreme Court in Rukhadze v. Recovery Partners GP Ltd has unanimously rejected an attempt to introduce a caveat to the longstanding “profit rule” that such fiduciaries could retain their secret profits if it could be shown that they would have earned them without breaching the duties to their principal.1
The profit rule provides that any profit that a fiduciary makes during the course of their fiduciary undertaking is to be treated as if it belongs to the principal. Self-interested fiduciaries who keep those gains for themselves may be liable to a court order for an account of profits.
Fiduciaries and the Profit Rule
A fiduciary relationship arises when there is a special relationship of trust and confidence, usually arising from contractual undertakings. Well-established categories of fiduciary relationships include those between a trustee and a beneficiary, and between companies and their directors by virtue of the control and powers they possess over the company’s affairs and property.
The characteristic feature of a fiduciary relationship is that fiduciaries must act with single-minded loyalty toward their principals. Resulting from this obligation, a fiduciary must “account” for any profits they have received from their fiduciary role. This so-called “profit rule” requires fiduciaries not only to reveal the existence of such profit, but also to pay it back to the principal as if it was the principal’s property.2
Under the current law, a fiduciary can only seek to retain these profits by showing that the principal has provided fully informed consent for the fiduciary to keep them. Saying that the fiduciary would have earned those profits anyway is not a plausible defence, even if they had not breached their duties to the principal. Fiduciaries cannot avoid an account of profits through this form of counterfactual reasoning, for example, by claiming that their principals would have consented if asked or that they would have achieved the same profit without a breach of fiduciary obligation.
Factual Background
The case arose from a lucrative asset recovery opportunity following the death of a wealthy businessman, including to locate and recover assets held in complex structures and to resist claims to them by states and other parties. The recovery services were initially handled by a company, but key individuals eventually left to pursue the opportunity directly with the businessman’s family, all while disparaging the company in the process. At trial, these individuals were found to have committed breaches of their fiduciary duties to the company or an affiliate entity and were ordered to pay back the profits they gained.
The individuals appealed, arguing that previous decisions on this issue were wrongly decided, such that they should be entitled to retain the profits that they would hypothetically have earned if they had not breached their fiduciary duties.
Decision: Causation Defence Rejected
Lord Briggs, who gave the leading judgment of the Supreme Court, held that no compelling justification was offered for departing from the current law. The rationale behind the rule is to deter fiduciaries from voluntarily putting themselves in a position where their interests and duties may conflict. The suggested approach would dilute the straightforward duty of not engaging in certain actions without the principal’s informed consent, transforming it into a duty merely to avoid making and retaining profits from a conflict situation unless it can be demonstrated that such profits could have been earned regardless, for instance, through an earlier resignation or by proving that the principal would have consented if asked.3
The Supreme Court acknowledged that an element of attribution analysis would invariably be necessary in determining whether a profit has been made “out of” the fiduciary relationship. This involves asking whether “the profit owes its existence to a significant extent to the application by the fiduciary of property, information or some other advantage which he enjoyed as a result of his fiduciary position”.4 Importantly, however, this is not a “but for”-type analysis which asks whether the profit would have been made even if there had not been a breach of fiduciary duty. Although this counterfactual analysis is typically seen in other areas of law (for example, in calculating damages for breach of contract or tort), the Supreme Court was clear that it has no place in the equitable protection of principals from self-interested fiduciaries.
Takeaways
The Supreme Court’s decision is an important reminder to all fiduciaries and company directors to be constantly mindful of their duty of loyalty when engaging in profit-making activities. If they intend to proceed with such affairs, fiduciaries should ask themselves if doing so would place this duty in conflict with their own interests, and if so, they must first obtain consent from their principals. Both companies and their directors should consider carefully the extent to which their constitutional documents provide fully informed consent for profits made. They should also consider whether their corporate structures contain the necessary processes and safeguards to deal with conflicts if and when they arise.
If principal consent is withheld and the fiduciary intends to pursue the profit-making activity, then prompt resignation and the passage of time will assist the fiduciary in absolving themselves from allegations that their success was unscrupulously earned by advantages gained while they were a fiduciary.
As was the case in Rukhadze v. Recovery Partners, a fiduciary who is found to have used their position to make profits may still be able to keep a portion by way of “equitable allowance” for their time and skill. As such, best practice suggests that fiduciaries should ensure their efforts and decision-making processes have been properly documented.
In response to an argument that the current law is too harsh on modern commercial fiduciaries, Lord Briggs commented that the “answer to perceived ignorance of these basic and relatively simple principles” lies in “better education training for those embarking upon a fiduciary undertaking”.5
This post was prepared with the assistance of John (Ching Jack) Choi in the London office of Latham & Watkins.
