Wednesday, 19 November 2014

Constructive Trust as a remedy for Breach of Fiduciary Obligations

1.     Introduction

It is uncontroversial that a defaulting fiduciary may be required to disgorge unauthorized gains by means of an account of profits. However, the nature of the underlying obligation and the scope of the remedial response are less clear. This problem can be attributed to the extension of fiduciary principle to relationships that are not inherently fiduciary. The disgorgement remedy, whether by a constructive trust or by account of profits, is a claim for the benefit made through a wrong based on the principle that the wrongdoer should not benefit from the wrong.

The remedial constructive trust can be seen as one of new products of judges’ long journey towards remedialism. When it is awarded, the principal is able to trace the proceeds of the bribe into other assets and follow them into the hands of knowing recipients (as in Reid).

This essay will discuss the extent of which such remedy is called and will argue that disgorgement by constructive trust should only be justified in exceptional cases.

2.     UK v Australia: A comparison.

2.1        UK

Lister v Stubbs: P employed D to buy certain materials for their business. D, under a corrupt bargain, took large commissions from one of the firms he bought from. He then invested a portion of that money. P brought action against D to recover monies paid to him by commission, claiming to be entitled to follow such monies into the investments.

HELD: No injunction granted since L had no equitable interest in the secret commissions received by S. The relationship between L and S with regards to the secret commissions was one of debtor and creditor so L had no proprietary right to secret commissions. They only had a personal claim for the proceeds of S’s dishonesty. Therefore, they had no interest in the investments that could be protected by the injunction.

Attorney-General for Hong Kong v Reid (1993): A crown prosecutor employed by the government of Hong Kong received bribes from criminals. He used the money to buy land in New Zealand. The land appreciated in value so that the benefit held now was greater than that received because of the breach.

HELD: The court held that there was a constructive trust over the properties. Lord Templeman held that a false fiduciary, who receives the bribe in breach of duty, must pay an account. That duty applies as soon as the bribe is received. Equity considers done as ought to be done. Thus as soon as the bribe is received, the false fiduciary held the bribe on constructive trust for the person injured. In other words, the approach is to recognise a proprietary right to value procured by the disloyal fiduciary.

What is the implication? The significant implication is that bribes can be ‘traced’ into the hands of third parities and recovered as ‘trust property’.

The Court of Appeal in Sinclair Investments v Versailles (2012) critiqued the outcome and held that constructive trust should only be imposed where:
·       money or asset constituting the profit is or has been beneficially the property of the beneficiary;
·        or is property which the trustee acquired by taking advantage of an opportunity or right which was properly that of the beneficiary.

If the above categories do not apply, then the remedy should be limited to a personal liability to account.

Sinclair’s Case did not concern bribed money (like Reid) but was concerned with the liability of a company director. The director breached his fiduciary duties and manipulated the assets of company assets, making the value of his own shares inflated. The court imposed a constructive trust on the profitable proceeds of sale of shares.

But again, the Reid approach received support and approval (therefore Sinclair and Lister v Stubbs no longer authoritative) from the Supreme Court of UK (2014) in the case of FHR Ventures LLP v Cedar taking principle and practicality approach which involved a bribery case.
·       Policy consideration: bribes and secret commissions received by an agent should be treated as the property of his principal, rather than merely giving rise to a claim for equitable compensation: ‘bribery is an evil practice which threatens the foundations of any civilized society’ (Lord Templeman).

Reasoning of Supreme Court: the categories laid by Sinclair were exceptionally difficult to apply in practice and the Court was concerned with stating a simple law. The current approach does indeed have the merit of simplicity.

2.2        Australia

In the Australian case of Daly v Sydney Stock Exchange, the court refused to recognise a proprietary relationship between an investor and a stockbroking firm despite the firm breaching their fiduciary duty by depositing the client’s money without informing the investor of poor financial status.

Later, the Full Federal Court in Grimaldi expressed the view that Sincalir should not be followed and that Reid was preferred. The court imposed a constructive trust in respect of secret commissions which the defendant had received in breach of fiduciary obligation. The Court further stated that the Australia courts can impose a remedial constructive trust, which is a concept rejected in England. Furthermore, the Court in Bell Group also made repeated reference to the same concept.

            Grimaldi case concerned breaches of fiduciary and statutory duties by company directors resulting in the receipt of company funds and other property by third parties. The claims were brought against the directors (or officers of corporation) and third parties who had received corporate funds, thereby enabling the third parties to acquire valuable mining assets.

The remedial nature of constructive trust is different to institutional constructive trust in that the court, by its discretion, orders the constructive trust to be imposed; it does not recognise a pre-existing proprietary right.

In Grimaldi, the refenreces to ‘remedialism’ were intended to highlight the flexibility of remedy exercisable against the recipient by a court of equity.

[If relevant] Remedial constructive trust is imposed as of the date of judgment, not from the date which the defendant wrongfully acquired the property (cf. AG for Hong Kong v Reid) (Deane J in Muschinski v Dodds). But there are limited cases which apply the postponement effect.

In Muschinski v Dodds, the constructive trust which was awarded was remedial because it resembled other remedies in taking effect from the date on which the Court delivered judgment. This was done ‘lest the legitimate claims of third parties be adversely affected.’

More recently, the High Court in John Alexander’s Clubs recognised the concept of remedial constructive trust. The High Court further held that any person who would be affected by making of a proprietary order is a necessary party who must be joined to the litigation and the High Court has established a process for enabling parties affected by the imposition of trust to argue against the imposition. This part of the judgment is unabashedly consequentialist.

So far in Australia, constructive trust remedy can be seen as a discretionary remedy and its principal features can be summarized as follows:
1) It will not be awarded as a proprietary remedy if another remedy can more appropriately do justice to the merits of the case;
2) In assessing the appropriateness of constructive trust, the potential impact of the remedy on identified third parties is a relevant consideration.  

3.     Support

The justification of imposition of a constructive trust in the remedial theory is the principle of improper gain (David Wright).

3.1        Upholding principle of equity and promotes community interest

The remedy of constructive trust is available to prevent assertions of beneficial ownership which are contrary to equitable principle. It promotes the interest of the community as a whole in the fulfillment of legal duties in general, whatever their basis.

3.2        Proprietary interests

Since the constructive trust gives rise to proprietary interests, where the constructive trustee (the defendant) is insolvent, the beneficiary (the plaintiff) will be able to claim priority over the general creditors.

3.3        Support from the case law

In Australia, there appears to be a tendency towards a thoroughly remedial approach advocated in the Australian case law (see e.g. Muschinski v Dodds).

3.4        Although ‘remedial’, constrained by boundaries

Although the notion of remedialism connote discretion, it is important to understand that the court’s power to grant or withhold an equitable remedy is subject to significant constraints in terms of the standards which they exercise their power, and the means of doing it without imposing greater burden upon the defendant than is strictly necessary to that end.

3.4.1     Not strictly judicial activism

Despite the taste of judicial remedialism in the award of constructive trust in breach of fiduciary duty situations, it is difficult to interpret this as judicial activism, or use of judicial power for a purpose other than that for which it was granted.

Albeit uncertainty and the unorthodox way of approaching the issue (i.e. approaching without normative essence), the remedy may be justified by arguing that the rationale of constructive trust is consistent with rationale of private law.

3.6        Elias’ Thesis

Alternatively, it could be argued that constructive trusts are simply ‘means for the rational furtherance of three good aims’; namely the perfection aim, the restitution aim and the reparation aim (Elias’s thesis).

This may be the rationale for constructive trust- it is an entire basket of the consequences of trusteeship in these situations. Adopting this analysis provides a justification and therefore, Jensen’s concern relating to lack of normative essence can be eliminated.

            3.7        Acceptance of risk theory

Furthermore, acceptance of risk theory (David Wright) is relevant. The acceptance of risk theory assumes that the moral position of unsecured creditors is weaker than that of the plaintiff who is seeking a proprietary remedy.

But this has been criticized by Professor Goode who stated that the creditors should be in a better position for they [the creditors] have parted with property against a promised payment whereas the plaintiff has not parted with anything and may not have lost anything.

However, Gummow J in Stephenson v Official Receiver stated that the acceptance of risk theory is justified on the basis that within the nature of a fiduciary relationship, there is a reposition of trust in the honesty of the fiduciary, whilst the general creditors took the risk of his insolvency.
            3.8        Practicality, policy and principle

Lord Millett suggested that on grounds of practicality, policy and principle, a principal should be beneficially entitled to a bribe or secret commission received by his agent.  

4.     Criticisms

4.1        Threat to private law

It may pose a significant threat to the structural coherence of the private law of obligations.

Jensen argues that situations where constructive trusts may be imposed lack the normative essence. Jensen explains that where two or more situations have the same normative essence, those situations resemble one another in terms of the type of injustice which the law must correct. Jensen understands that there are two situations where constructive trust has been imposed when they share no normative essence. First situation is where a constructive trust is imposed to give effect to a pre-existing obligation to transfer particular property to another. The second situation is where a constructive trust is imposed to serve as a medium for the disgorgement of the value which the constructive trustee has acquired by way of breach of duty.

Jensen’s central argument is that this category of ‘constructive trust’ does not fit well with the coherent development of the law. He views that consequences of imposing such trust might not be normatively justified. 

If the above case was to be seen as an extension of constructive trust remedy to novel situation, then it has far-reaching consequences for legal reasoning. Such an extension is not occurring on the basis of factual analogy. It cannot be explained according to a single normative idea.

4.2        Prejudicing the unsecured creditors

When considering an award of constructive trust, the Court of Appeal in Lister v Stubbs questioned whether this is justified at the expense of D’s unsecured creditors (also the view of Professor R. Goode). Although this case is no longer authoritative due to recent ruling in FHR Ventures (2014) case, this policy consideration remains valid. Similarly, Jensen, Allen and others view that full proprietary consequences of trusteeship are not always justified. Where there is a competition between the principal and fiduciary’s third party creditors, their view is that constructive trust should not be easily granted.

In any case, it could be argued that proprietary consequences are justified by classifying the principal’s right to fiduciary’s disgorgement of its gains as an antecedent right to exclusive benefit of the fiduciary’s efforts.

Furthermore, Professor Goode, sharing the concerns expressed in Sinclair, stated that no proprietary interest arises where an agent obtains a benefit in breach of his duty unless benefit either flows from an asset which was beneficially owned by the principal or intended for the principal or was derived from an activity of the agent which, if he chose to undertake it, he was under an equitable uty to undertake for the principal.

4.3        Argument from history

Peter Birks referred to history of judicial practice and stated that where there are different forms of relief, the courts never had an unconstrained choice as to remedies. However, the choice had to be dictated by the law or left to the plaintiff.

5.     Conclusion

The award of monetary deterrents is to strike a balance between a concern for sufficient deterrence and a concern for the liberty of the individual.

Ultimately, the question for the court appears to whether the decision favors of granting enhanced relief to the principal by extending the scope of proprietary remedies so that unsecured creditors may lose out.


  1. This comment has been removed by the author.

  2. Great post!!Thanks for sharing it with us....really needed. We are leading lawyers with the experience, the skill and the dedication to make sure you are guided and supported through the separation and divorce process...Family Lawyers Sydney