The Supreme Court has declined an invitation to upend centuries of legal precedent and instead reaffirmed the principle – known as the ‘profit rule’ – that if a fiduciary makes a profit out of their position as a fiduciary, they are bound to account for that profit to their principal (unless the principal has given fully informed consent).

In rejecting the argument that the law should be updated to ask whether the same profit could have been made ‘but for’ the breach of the fiduciary duty, the Court has provided an important reminder of the duties placed upon fiduciaries and the potential consequences of breaching them.

Background

The case arose from events following the death of a very wealthy Georgian businessmen, Arkadi Patarkatsishvili (known as ‘Badri’). After Badri’s death, a lucrative business opportunity arose to provide asset recovery services for his family in order to track down and recover his various (often hidden) assets around the world. These services were initially provided on an ad hoc basis by the two defendant/respondent companies. The appellants/defendants had senior positions of responsibility in these companies, meaning that they were able to learn the complex information about the nature and location of Badri’s assets.

However, soon relations between the parties began to break down. The appellants, in the words of the leading judgment, resolved to take over the provision of the recovery services to the family and “embarked upon preparatory steps to that end, including denigrating [the original provider of the services] in the estimation of the family”. Their efforts proved successful, and the family reached an agreement with the appellants for them to provide the recovery services in return for annual management fees and a large capital sum after a threshold of net recoveries was met.

The respondents duly sued the appellants on the basis that the payments made by the family were profits made from the fiduciary relationship. As such, the appellants, as fiduciaries, merely held the money on constructive trust for the respondents (as primaries) and, therefore, ought to account for the profits to the respondents.

The High Court and Court of Appeal

At the High Court, Cockerill J found that the appellants had each committed breaches of fiduciary duty owed to the respondents, and that their resignation from the companies was undertaken in bad faith in order to take for themselves the opportunity of providing the recovery services.

Accordingly, applying the orthodox position as stated in the ‘profit rule’ – that a fiduciary must account to the principal for any profits which the fiduciary makes from the fiduciary relationship (unless the principal has given its fully informed consents to the fiduciary keeping them for himself) – the judge ordered that the appellants account to the respondents an amount exceeding $134 million.

The Court of Appeal upheld the finding of the High Court, but permission was granted for the appellants to appeal on the grounds that, they said, the profit rule was no longer fit for purpose.

The Supreme Court

Given that the lower courts were bound by long-established precedent, it was only at the Supreme Court that the appellants could truly test their arguments and hope to overturn longstanding jurisprudence. No fewer than seven judges sat to listen to the arguments, although ultimately none was persuaded by them.

The appellants’ central argument boiled down to this: that the ‘profit rule’ ought to be replaced since it did not allow a party to defend its retention of any profit for himself by constructing a counterfactual that amounted to his saying that he would have made the profit anyway, even if he had not committed a breach of fiduciary duty.

Therefore, the appellants argued that the legal test should be changed to employ a ‘but-for’ test of causation, asking whether the fiduciary would have made the same profits if he had avoided any breach of fiduciary duty (and if so, he could retain the profits).

Six broad reasons were offered as to why a change in the law was needed:

• The existing law is “draconian” and “works injustice [sic] to honest fiduciaries who have devoted time and skill and risked their own assets in a post-termination profitable business, and serves an objective which is no longer proportionate in modern society”;
• Modern procedural and forensic tools means that the construction of counterfactuals is not uncertain and mere hypothetical speculation;
• The existing mechanism of combatting any injustice in the application of the profit rule by way of an ‘equitable allowance’ which accounts for the fiduciary’s time and skill is too uncertain and unpredictable compared to a “but-for” condition that is applied across the board (save perhaps for instances of fraud or dishonesty);
• Other equitable remedies have recently been improved by the introduction of common law principles of causation, and it is time for the same modernisation to take place in this area;
• English law is lagging behind other common law jurisdictions; and
• More weight should be afforded to academic writing that has criticised the profit rule.

Whilst the Court carefully considered each of these arguments, none found favour. As Lord Briggs put it in the leading judgment, “none of the appellants’ grounds for inviting this court to [reform the law] seems to me, on analysis, to carry significant weight, nor do they add up to anything significant in the aggregate”.

Instead, he reiterated the important principle that lies behind the profit rule, namely that it ensures “adherence by fiduciaries to their undertaking of single-minded loyalty to their principals and beneficiaries”. This, he explained, is the hallmark of a fiduciary undertaking and can be traced back to a case from the early 18^th century. He also issued a reminder that the duty not to exploit any property, information or opportunity of the principal continues after the relationship which gave rise to it ends, much like the duty not to disclose or exploit confidential information.

Finally, Lord Briggs felt it important to note that “the fiduciary duty to account for profits is not to be confused or conflated with the remedy of an account of profits which equity makes available to the owner of (usually) intellectual property which has been infringed, misused or misappropriated by a defendant”. In that case, the account of profits is just a remedy. In the case of a fiduciary’s duty to account for profits, however, Lord Briggs stated that it is not a discretionary equitable remedy, but a rule that exists in its own right, summarising the position as follows:

“[it is] a rule governing the conduct of fiduciaries which exists in its own right. It is a duty or obligation imposed by equity on all fiduciaries, as an inherent aspect of their undertaking of single-minded loyalty to their principals. It is not just a discretionary equitable remedy for the breach of some other duty, such as the conflict rule, nor is it necessarily triggered by some other breach, although it very often is. A fiduciary may come to generate a profit out of his role as such without committing any breach of trust. It may be an authorised use of the trust property, or of his fiduciary powers. But he must then account for that profit if it has been made from or out of his fiduciary position, not keep it for himself. The wrong which may lead to a court order for an account of profits is, in such a case, no more or less than the failure to account itself, by a fiduciary who wishes to keep the profit for himself. The duty to account for profits does not depend upon a demand for an account by the principal, or upon an order of the court. There is simply not the relationship between breach and damages for loss caused by the breach which has to be filled by rules as to causation and remoteness which are routinely applied by the common law, and which almost always involve the erection of a counterfactual”.

To read the judgment in full, click here.