Compulsory Moot ResearchQuestion 1: Whether Urban Living can obtain constructive trust over Sloppys Sheung Wan properties?

Did Sloppy breach his fiduciary duty owed to Urban Living? If yes, what is the remedy?

General rule

Re Smith and Fawcett Ltd [1942] Ch 304Fiduciaries must act in what they consider not what a court may consider is in the interests of the company and not for any collateral purpose.

No conflict rule

Bhullar v Bhullar[2003] 2 BCLC 241, CA

Facts: A property development company acquired an investment property. Subsequently two of the directors of the company discovered on a bowling trip - that an adjacent property was on the market and purchased it. The Court of Appeal applied the no conflict rule as explained byLord Upjohn in Boardman v Phipps, namely whether: the reasonable man looking at the relevant facts and circumstances of the particular case would think that there was a real sensible possibility of conflict; not that you could imagine some situation arising which might, in some conceivable possibility in events not contemplated as real sensible possibilities by any reasonable person, result in conflict.

Held: Dismissing the directors appeal, the directors were in breach of the no conflict rule.Whether the company could or would have taken that opportunity, had it been made aware of it, was not to the point: the existence of the opportunity was information which it was relevant for the company to know, and it followed that the directors were under a duty to communicate it to the company.

Crown Dilmun v Sutton [2004] 1 BCLC 468

Facts: D1 was the managing director of CD. In the course of his duties he received details of a development opportunity for a football ground which he rejected on behalf of CD. Subsequently he entered into negotiations in respect of a revised project for the development. D2 was incorporated for the purposes of the development. The opportunity, negotiations and subsequent agreement were not disclosed to CD nor was D1s involvement in D2.

Held: Peter Smith J. held that D1 was in breach of the no conflict rule. As a director D1 had a duty to exploit every opportunity that he became aware of for the benefit of CD. The only exception was if CD permitted him to take such opportunities after he had made full and frank disclosure and CD had given full and informed consent. D1 was in breach even if CD would not want the opportunity or the third party would never have given it to CD. As a fiduciary D1 also had a positive duty to disclose his own misconduct.

No Conflict Rule: Positive duty on fiduciaries to disclose their own wrongful activity and the wrongful activity of others

Item Software (UK) Ltd v Fassihi and others [2005] ICR 450

Facts: The defendant was the sales and marketing director of the plaintiff company whose business included the distribution of software for a company called Isograph. Following the termination of contractual relations between the plaintiff and Isograph, the defendant secretly approached Isograph with proposals to establish his own company and take over the distribution contract. On discovering the defendants misconduct, the plaintiff summarily dismissed him and brought proceedings alleging breach of duty as a director and employee. The judge at first instance held that there was no breach in seeking to divert the contract as it had in fact already terminated but that the defendant had been in breach of duty by failing to disclose his own misconduct.

Held: By the Court of Appeal, that the fundamental duties that a director owes to act in good faith and in the best interests of the company included a requirement to disclose his own misconduct. On the basis of the facts, there were no grounds on which the defendant could have concluded that it was not in the best interests of the plaintiff to know of his breach of duty. The defendant could not fulfill his duty of loyalty to the plaintiff except by informing it about his plan to acquire the Isograph contract for himself.

No profit rule

Don King Productions

That which requires the fiduciary to account for any benefit or gain obtained or received by reason of or by use of his fiduciary position or of opportunity or knowledge resulting from it: the objective is to preclude the fiduciary from actually misusing his position for his personal advantage. The no profit rule applies to unauthorised profits even where the fiduciary has acted in good faith.

Diversion of business opportunity

Ultraframe (supra)

Lewison J reviewed a number of the authorities and concluded: 1355. The law relating to the accountability of a director (or former director) for profits derived from the diversion of corporate opportunities is still developing. As the cases stand it is I think possible to draw the following conclusions: i) If a person diverts to himself a business opportunity while in office, he may be liable to account for profits under the "no conflict rule" or the "no profit rule" or both;ii) The application of the "no conflict rule" does not depend on establishing that the company has a proprietary interest in the business opportunity that has been diverted;iii) After a person ceases to be in office, he may be liable for the diversion of a business opportunity either under the "no profit rule"; or because the business opportunity itself is to be treated as the property of the company (in the sense of an intangible asset) and hence is treated for this purpose as trust property.

Fiduciarys duty of loyalty may require him to disclose his own competitive intentions and/or misconduct, for example, his intention to divert away his principals maturing business opportunities. The leading case on the obligation of disclosure is Item Software (UK) Ltd v Fassihi [2005] ICR 450, where Arden LJ said at [63] that the effect of this duty: is not to make any substantive extension of the duties of directors [fiduciaries], such as would be involved for example if the courts held that a director of one company could not hold a directorship of another company. It is simply a duty which makes the remedy for an existing liability of a director to account for secret profits and for the diversion of corporate opportunities more effective.

** Remedies**

Crucially, the victim of a breach of fiduciary obligation is entitled to gain based remedies, requiring the fiduciary to disgorge what he has gained, independent of any proof of loss to the principal: see Reading v A-G [1951] 1 All ER 617 and Industrial Development Consultants v Cooley [1972] 1 WLR 443.

The gain based remedy may be either proprietary or personal (depending on the circumstances). The delinquent fiduciary is liable to account for any property he retains belonging to his principal (or its traceable substitute) (a proprietary remedy) and/or for any profits he makes from a breach of his fiduciary obligation (a personal remedy). The proprietary remedy depends on being able to identify his property (or its traceable substitute) in the hands of the defendant. If the claimant cannot do this, or at his election (for example where the value of the traceable asset has fallen), he can pursue his personal remedy for an account and/or equitable compensation.

Privy Council put it in AG v Reid [1994] 1 AC 324 (a bribes/secret profits case) at 336E-G: if a trustee [fiduciary] accepts a bribe which he ought to pay over to his cestui que trust, the bribe and any profit therefrom should be withdrawn from the unsecured creditors as soon as the crime is discovered the fiduciary should account for the bribe as soon as he receives it and equity regards as done that which ought to be done the bribe and the property from time to time representing the bribe are held on constructive trust for the person injured. A fiduciary remains personally liable for the amount of the bribe if, in the event, the value of the property then recovered by the injured person proved to be less than that amount

An account of profits is not a compensatory remedy, in the sense that the victim need not demonstrate that he would have made the relevant profits had the breach not occurred. The purpose is to remove from the party in breach the benefit of the breach, although the remedy is not punitive in nature. 27.2. It is no defence to a claim for an account of profits for breach of fiduciary duty that the fiduciary has acted honestly and openly: see Boardman v Phipps [1967] 2 AC 46.

In the context of diversion of a business opportunity, the burden would appear to lie on the defendant to establish that it would be inequitable to order an account of the entire profits: see Warman International Ltd v Dwyer (1995) 182 CLR 544 at [34]. It is accordingly the defendant who bears the consequences of mingling the profits attributable to his breach of fiduciary duty and those attributable to his own efforts and investment.

Unclear whether the period of an account of profits should be limited to reflect the likelihood that at some stage the diverted business would either have been lost by the defendant or won by the claimant irrespective of the breach of fiduciary duty. Whilst the Australian case of Warman International Ltd v Dwyer (supra) and the Hong Kong case of Kao Lee & Yip v Koo Hong Kong CFI, 2 April 2003 endorse such an approach, it seems inconsistent with the basic principle that an account of profits is not a compensatory remedy: see, for example, Industrial Development Consultants Ltd v Cooley [1972] 1 WLR 443 per Roskill J at 453F. It is unclear, therefore, whether any limitation in time of the account would be ordered by the English courts on this basis.

AG V REID: Before this case, the CA in LISTER V STUBBS said that where an agent receives a bribe, he has a duty to account for the bribe by an in-personam equitable debt. If the fiduciary goes bankrupt, the beneficiary has to share with general creditors. The FY could thus easily escape his duty by giving the money to someone else! In this case, the FY bought properties in New Zealand in the name of his wife using bribe money. If the court had applied LISTER V STUBBS, the government claimant would not have been able enforce any proprietary interest.

HELD [PC]: government had proprietary interest in the bribe. LISTER V STUBBS overruled. Compared REID to BOARDMAN: If an innocent, bona-fide fiduciary is subjected to a constructive trust for breach of a pure duty, it must be equally so where the FY was committing a deliberate wrong. BUT in Boardman, the FY was not bankrupt. It was also imposed against original wrongdoer. 3rd party interests were not affected. The justification is that why should creditors benefit from a bribe that would not have occurred but for the breach of fiduciary duty? Also, proprietary interest is established at the time of the bribe, it is the property of the fiduciary and creditors should not encroach upon hard-nosed property rights. When a FY has obtained a secret bribe, he should account for the bribe. Equity treats as done what ought to be done therefore equity deems that at the time the bribe is received, it is already returned and so the principle would already have an equitable interest in that amount.

CRITICISM: If the doctrine was broadly used, there would be no in-personam rights. Where there is a bankruptcy, SOLLAND INTERNATIONAL V DARAYDAN HOLDINGS [2004]: This was different from REID since the creditors were innocent and the wife and solicitor in REID were not. Dicta: no problem in applying Reid even in an insolvency situation.

Declarations of trust

Most advantageous remedy available for an unlawful diversion of a corporate opportunity will usually be a declaration that the defendant holds on trust for the claimant either (1) a specific asset which constituted the opportunity, or (2) the benefit of the contract or opportunity in question, or (3) the profits of that contract or opportunity.

The possibility that, in the event of a breach of the rule against diversion of business opportunities, the Court might impose a constructive trust in favour of the wronged party was contemplated expressly by the Privy Council in Cook v Deeks [1916] AC 554 per Lord Buckmaster LC at 563: ...in the circumstances, the defendants ... were guilty of a distinct breach of duty in the course they took to secure the contract, and that they cannot retain the benefit of such contract for themselves, but must be regarded as holding it on behalf of the company.

That reasoning is easy to apply where the opportunity which has been diverted is the opportunity to purchase some identifiable property: 8.1. In Re Bhullar Bros [2003] BCC 711, a declaration was granted that the defendant directors company (which was not a party to the proceedings) held a piece of real property on trust for the company to which the defendant directors had owed their duties: see per Jonathan Parker LJ at [4]. What is more, an order was granted that the defendant directors company must, at the expense of the defendant directors, transfer the property at the price which was paid for it: see per Jonathan Parker LJ at [4].

A penetrating analysis of this issue is to be found in Ultraframe v Fielding [2005] EWHC 1638 (Ch) per Lewison J at [1489], [1491]: ...property will also count as the company's property if it is property which the fiduciary has acquired for his own benefit but which, consistently with his fiduciary duties, he ought to have acquired on behalf of the company.

Account of profits

Next most advantageous remedy. Equitable remedy and therefore rigid rules are few and far between.

The basic position was set out in CMS Dolphin at [97] per Lawrence Collins J:There are no firm rules for determining which is the relevant profit: see Hospital Products Ltd v United States Surgical Corp (1984) 156 CLR 41, at p. 110, per Mason J. Where, as here, the business (to use a neutral term, not distinguishing between Mr Simonet and Blue) is not restricted exclusively to the performance of contracts which were obtained from CMSD, the fiduciary should be accountable for the profits properly attributable to the breach of fiduciary duty, taking into account the expenses connected with those profits and a reasonable allowance for overheads (but not necessarily salary for the wrongdoer), together with a sum to take account of other benefits derived from those contracts. For example, other contracts might not have been won, or profits made on them, without (e.g.) the opportunity or cash-flow benefit which flowed from contracts unlawfully obtained. There must, however, be some reasonable connection between the breach of duty and the profits for which the fiduciary is accountable.

Alternative statement of the principles for fashioning an account was given in Ultraframe at [1588] per Lewison J: i) The fundamental rule is that a fiduciary must not make an unauthorised profit out of his fiduciary position; ii) The fashioning of an account should not be allowed to operate as the unjust enrichment of the claimant; iii) The profits for which an account is ordered must bear a reasonable relationship to the breach of duty proved; iv) It is important to establish exactly what has been acquired; v) Subject to that, the fashioning of the account depends on the facts. In some cases it will be appropriate to order an account limited in time; or limited to profits derived from particular assets or particular customers; or to order an account of all the profits of a business subject to all just allowances for the fiduciary's skill, labour and assumption of business risk. In some cases it may be appropriate to order the making of a payment representing the capital value of the advantage in question, either in place of or in addition to an account of profits.

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