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13 October 2015
The High Court has ruled that a principal may elect to take the value of assets rather than the assets themselves following a breach of fiduciary duty, and that the burden of proof lies with the fiduciary to prove that he or she has no interest in an asset. The case serves as a reminder to directors and agents of their fiduciary duties and, more generally, of the courts' willingness to allow principals to recover against those fiduciaries who have attempted to disguise benefits received in breach of their duties.
The High Court held that Global Energy Horizons Corporation (GEHC) was entitled as principal to require its shareholder and fiduciary, Mr Gray, to account for either the value of the assets acquired following his breach of fiduciary duty or the assets themselves, and that this choice was at GEHC's election. The burden of proof lay with Gray as fiduciary to prove that he did not need to account for an asset because he had no interest in it. The court held that only once there is documentary evidence to support an assertion by the fiduciary that he or she has no interest will the burden shift to the principal to displace it.
GEHC was established to pursue the development of ultrasound technology which was being developed by a Chilean inventor and a group of Russian scientists as a means to increase the production of oil and gas wells. Gray was offered an opportunity to obtain rights in the technology and participate in its exploitation by pursuing a strategy of acquiring late-life and underperforming oil wells.
In the liability trial, the court found that Gray had agreed to being treated as a member of GEHC's acquisition team in return for revenues that the strategy produced and so owed GEHC a duty of loyalty. Soon thereafter, Gray accepted a role with a third-party fund business, with which he shared details of GEHC's acquisition strategy and the ultrasound technology in return for fees and an interest in the fund. The court found that, by offering the third-party fund business opportunities that had come to him as GEHC's fiduciary agent, Gray had breached his duty of good faith to GEHC. The court also found that he had breached two principles identified in Bristol & West Building Society v Mothew ( 1 Ch 1):
The court held – following the Supreme Court's decision in FHR European Ventures LLP v Cedar Capital Holdings LLC ( UKSC 45) – that Gray was liable to account to GEHC as a constructive trustee for all moneys and benefits received by him directly or indirectly arising from the mere fact that his profit had been made in breach of duty. This included all sums due to GEHC in respect of moneys and benefits received by Gray directly or indirectly as a result of his breaches of fiduciary duty. The court also declared that Gray was liable to GEHC in equity for all losses that it suffered as a result of his breaches of fiduciary duty. The court ordered Gray to account to his principal for the benefits and secret profits that he had received.
At the end of its judgment on liability, the court ordered the present proceedings in order to establish the profits and benefits that Gray had received and which of these fell within the scope of the order made against Gray in the liability proceedings.
The court first engaged in a factual enquiry to establish whether Gray held assets obtained as a result of his breaches of fiduciary duty. Gray claimed that he:
Further, Gray claimed that the ultrasound technology had proved to be a disastrous investment, because the technology was not commercially viable and remained unproved and experimental.
However, the court found that this state of affairs had been artificially created by Gray to hide his interest in the exploitation of the technology following the involvement of entities owned by the parties in Chilean arbitration proceedings. The court found that Gray had provided significant sums to the Russian scientists developing the technology in the expectation that he would gain an interest in their work. The court found that, following commencement of the Chilean arbitration proceedings, the funding provided by Gray had become more indirect. In addition, Gray and various parties with which he had contact had restructured the entities holding an interest in the ultrasound technology to render Gray's interests more indirect.
The court's analysis of which assets fell within the scope of the order made in the liability trial proceeded in stages.
First, the court held that the assets in which Gray had an interest needed to be identified. Following its factual enquiry, the court had little difficulty in identifying a number of Gray's assets.
Second, the court held that it had to establish whether there was some causal link between the asset obtained and the breach of fiduciary duty. The court held that once it was established that Gray had an interest in an asset within the scope of the order made at the liability trial, the evidential burden fell on Gray to establish that there was no sufficient causal relationship with his breaches of fiduciary duty. However, once Gray – as the accounting party – had succeeded in providing documentary evidence in support of his assertion that he had no interest in an asset, the evidential burden shifted to GEHC to displace it.
An issue raised by counsel for Gray was that his activities for the third-party fund were only partly concerned with exploiting the ultrasound technology. In fact, Gray argued that he should not have to account for the majority of his income and assets deriving from activities on behalf of the third-party fund, because many of the services that he provided did not relate to the exploitation of the ultrasound technology and the fees that he was paid for his services were agreed without reference to the ultrasound technology. However, the court concluded that – to the extent that an asset in relation to which there is sufficient causal link has become mixed with other assets without such a connection – the accepted principles in relation to mixed funds apply. A number of the payments received by Gray were found to be causally linked to his breaches of fiduciary duty.
Once the court had identified assets that fell within the scope of the order made at the liability trial, it considered how Gray should account to GEHC for his breaches of fiduciary duty. The key case which the court considered was FHR European Ventures LLP v Cedar Capital Holdings LLC ( AC 250), in which the Supreme Court unanimously decided that where an agent acquires a benefit which came to his or her notice as a result of his or her fiduciary position – or pursuant to an opportunity which resulted from his or her fiduciary position – the equitable rule is that the agent is to be treated as having acquired the benefit on behalf of his or her principal, so that it is beneficially owned by the principal and the principal has a proprietary remedy in addition to its personal remedy against the agent, and can elect between the two remedies. This precedent led the court in the present proceedings to find that GEHC could recover the value of shares or their traceable proceeds, which were no longer in Gray's hands.
Gray contested that the ultrasound technology was still experimental and had not been commercially successful, so that the assets which he held indirectly had no value. The court concluded that it had to do justice in the circumstances and, where necessary, it can attribute value to shares or an opportunity other than their value at the date of judgment if – on the facts of the case – such a value would not reflect the value of the opportunity diverted which the defaulting fiduciary should have had in his or her possession. The court held that the opportunity of which Gray had availed himself could be traced back to his initial interest in the third-party fund structures established following his breaches of fiduciary duty, prior to his restructuring efforts to distance himself from his interests during the Chilean arbitration proceedings.
As the final stage, the court considered whether it should exercise its discretion to apply an equitable allowance as to both disbursements and the skill and effort of the defaulting fiduciary. It noted that exercise of the discretion to award an equitable allowance for skill and effort is limited to "exceptional" or "unusual" circumstances where it cannot have the effect of encouraging fiduciaries in any way to put themselves in a position where their interests conflict with their duties (Guinness plc v Saunders  2 AC 663 (HL)). The court decided that – given Gray's conduct in the litigation proceedings and that he had failed to account at all in respect of his benefit from his breaches of fiduciary duty – no allowance should be granted to him.
The present proceedings merely identified the assets that fell within the scope of the order made at the liability trial for Gray to account to GEHC. A future hearing will determine the exact value of the assets and the amount that Gray must pay to account to GEHC.
This case provides insight into how the courts will apply the principles established in the Supreme Court case of FHR European Ventures LLP v Cedar Capital Holdings LLC ( AC 250). Should fiduciaries attempt to disguise or hide assets which they have obtained in breach of their duties and should these assets decline in value in their hands, the court will allow a principal to elect to require a fiduciary to account for the value of assets that the fiduciary no longer holds and for a value that reflects the value of the opportunity which was diverted from the principal. Notably, the conduct of the defaulting fiduciary during litigation proceedings may also be taken into account when considering the value for which that fiduciary is forced to account.
For further information on this topic please contact Simon Hart or Sam Bishop at RPC by telephone (+44 20 3060 6000) or email (firstname.lastname@example.org or email@example.com). The RPC website can be accessed at www.rpc.co.uk.
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