Supreme Court Declares Constructive Trust Over Bribes & Secret Commissions

On 16th July 2014 the Supreme Court handed down its judgment in FHR European Ventures LLP and others v Cedar Capital Partners LLC [2014] UKSC 45. This decision settles a long-running argument in English law as to whether a principal has a proprietary or a merely personal claim against an agent who takes a bribe or secret commission.

The significance of the distinction between a person and proprietary remedy is twofold; if the wrongdoer becomes insolvent the person asserting a proprietary interest will maintain their priority over the wrongdoer’s unsecured creditors to the extent of the particular property. Secondly a proprietary remedy permits the principal to trace the proceeds of the bribe or secret commission.

This issue was decided last year by the Jersey Royal Court, in Lloyds Trust Company (Channel Islands) Limited v Fragoso and Ors [2013] JRC 211. The proceeds of bribes were held to be subject to a proprietary rather than a personal claim. Federal Republic of Brazil v Durant International Corporation & Ors [2012] JCA 071significantly restated Jersey’s rules on equitable tracing. The combined effect of the Fragoso and Durant decisions is to better enable defrauded principals to recover assets through the Jersey courts.

Background to the Supreme Court’s Decision

FHR European Ventures LLP (“FHR”) purchased the share capital of Monte Carlo Grand Hotel SAM from Monte Carlo Grand Hotel Limited. Cedar Capital Partners LLC (“Cedar”) acted as FHR’s agent in negotiating the purchase. Unknown to FHR, Cedar had a contact with Monte Carlo Grand Hotel Limited under which Cedar would be paid a fee of €10m following the successful completion of the sale and of the share capital in Monte Carlo Grand Hotel SAM. FHR sought recovery of the €10m as an undisclosed secret commission contrary to Cedar’s fiduciary duty as agent for FHR.

The Fiduciary Nature of Agency

As a matter of Jersey law, as in English law, an agent owes a fiduciary duty to his principal because he has undertaken to act on behalf of his principal in a particular matter in circumstances that give rise to a relationship of trust and confidence. An agent must not make a profit from his trust and must not place himself in a position in which his duty and interest conflict. A fiduciary who acts for two principals with actual or potentially conflicting interests without the informed consent of both is in breach of the obligation of undivided loyalty. Informed consent can only be effective if the agent gives full disclosure to each principal. An agent who receives a benefit in breach of his fiduciary duty is obliged to account to the principal for such a benefit and to pay a sum equal to the profit by way of equitable compensation.

The effect of the judgments firstly in Fragoso in Jersey and now in FHR in England is that where an agent acquires a benefit that comes to him as a result of his fiduciary position or pursuant to an opportunity which results from his fiduciary position, he is to be treated as having acquired the benefit on behalf of his principal and not himself, so that the benefit is beneficially owned by the principal and not the agent. This produces a two-pronged approach for a plaintiff who may pursue a proprietary remedy in addition to his personal remedy for an account. The principal may elect which remedy he wishes to pursue.

The Arguments

The Supreme Court heard arguments from leading English counsel as to the correct treatment of bribes and secret commissions paid to agents.

On behalf of Cedar it was argued that a bribe or a secret commission cannot be subject to a proprietary remedy in favour of a principal because it cannot properly be described as the property of the principal in the first place as it did not flow from an asset beneficially owned by the principal nor was it asset that was intended for the principal. Nor can it said to be derived from an activity of the agent which if he chose to undertake it for himself in his own interests, he was under an equitable duty to undertaken for the principal.

A further objection to a proprietary remedy that was developed at Court of Appeal level but dismissed by the Supreme Court was based upon the prejudice suffered if an asset of the wrongdoer was effectively ring-fenced beyond the reach of the wrongdoers creditors.

On behalf of FHR it was argued than an agent ought to account in specie to his principle for any benefit he has obtained from his agency in breach of his fiduciary duty – the benefit is rightly to be regarded as the property of the principal. Equity should not permit the agent to rely on his own breach of fiduciary duty to justify retaining the benefit on the ground that it was a bribe or secret commission. The Court must assume that the agent acted in accordance with his duty, so that the benefit must belong to the principal.

The Supreme Court decided that where an agent takes a secret commission or bribe, a proprietary remedy was available (in addition to a personal one).

Practicality, policy and principle

A considerable part of the Supreme Court judgment reviews the law as pronounced in previous cases. None of those cases are binding in Jersey and so this part of the judgment is not directly relevant to litigation in Jersey. The Court overturned the basis upon which the Court of appeal in Sinclair Investments Ltd v Versailles Trade Finance Ltd [2012] Ch 453 held that a proprietary remedy was not available. The Court also departed from 19th Century house of Lords authority to the same effect.

The Court decided FHR’s arguments had the benefit of firstly being wholly consistent with the principles of the law of agency and secondly had the benefit of simplicity: any benefit acquired by an agent as a result of his agency and in breach of fiduciary duty is held on trust for the principle. The decision also neatly aligns the rules of equitable accounting, which can encompass both personal and proprietary claims. The court considered that any other result would have left the relevant concepts somewhat incongruous. The same test will therefore now apply to whether an agent has to account personally and to whether the principal has a proprietary interest.

This decision in FHR covers both bribes and secret commissions. A secret commission is conceptually distinct from a bribe in that it does not have to be established that the person paying the commission was inducing the recipient to breach their duty. In other words, when seeking a proprietary remedy, it is not necessary to establish the purpose for which the money was paid in order to obtain a proprietary remedy. Nor is it necessary for a plaintiff to prove that the payment actually resulted in the agent doing something he would not otherwise have done.

Wider policy considerations also support [FHR’] case that 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. As Lord Templeman said giving the decision of the Privy Council in Attorney General for Hong Kong v Reid [1994] 1 AC 324, 330H, “[b]ribery is an evil practice which threatens the foundations of any civilised society”. Secret commissions are also objectionable as they inevitably tend to undermine trust in the commercial world. That has always been true, but concern about bribery and corruption generally has never been greater than it is now…]”

paragraph 42

Conclusions

A bribe or secret commission accepted by an agent is held on trust for his principal. The principal is entitled to pursue the agent personally for an account of the amount of benefit of the bribe. To the extent that the agent still holds the proceeds of the bribe, the principal may claim a proprietary interest in it. The principal is also entitled to trace the proceeds of the bribe or secret commission into the agents other assets. The availability of a proprietary remedy also means it is possible to trace into the hands of third parties who may also be knowing recipients, thereby broadening the net in terms of recovery.

The Supreme Court’s judgment is eminently sensible, practical and in accordance with sound policy considerations. While not binding in Jersey, the judgment is a strong endorsement of the approach already adopted in Jersey following Fragoso to aid in the recovery of the proceeds of bribes and secret commissions.

It is important to remember that the Jersey rules of tracing are less restrictive than in English law. Following Durant, Jersey’s tracing rules differ in the following respects:

(1)    No distinction between common law and equitable rules of tracing.

Jersey has declined to follow England in preserving such a technical distinction in Jersey law. Accordingly, it is likely that English rules of equitable tracing will be applicable in Jersey law.

(2)    No ‘first in, first out rule’

Jersey has declined to follow the English rule that where an innocent volunteer mixes misappropriated trust funds with his own money in a current bank account the ‘first in, first out‘ rule should be used to identify the source of withdrawn funds. Jersey does however recognise the presumption in Re Hallett’s Estate whereby a wrongdoer who mixes funds is presumed to spend his own money before the money of which he is a constructive trustee.

(3)    A ‘clear link‘ not always required

While the principle that there should be a clear ‘clear link’ between the plaintiff‘s property and the assets in the hands of the wrongdoer remains good law, a tracing exercise should not fail because the wrongdoer has acted particularly dishonestly or cunningly by creating a maelstrom. Once a plaintiff can prove that his or her assets have moved into a so-called ‘maelstrom’, the burden of proof shifts to the defendant to show what part of the mixed fund is in fact his or hers. The Court of Appeal endorsed this approach noting that ‘in appropriate cases, the necessary links can be inferred from the circumstances, even in the absence of direct evidence’.

(4)    Improvements to property

Where stolen funds are followed into the hands of an innocent recipient who uses them to improve property that he already owns the Jersey tracing rules allows the victim to trace the value inherent in his money into the increase in the property’s value.

(4)  Reverse Tracing

Under Jersey law it is possible to trace fraudulent payments which are made into an account after relevant payments had already been made out of the same account to a third party. The appropriate way to address the subject was not by reference to “what is or not conceptually possible or arguably supported by English authority”, but as a matter of evidence. The question is “simply whether there is sufficient evidence to establish a clear link between the credits and debits in an account, irrespective (within a reasonable time frame) of the order in which they occur or the state of balance of the account”. There is no limitation on how, as a matter of evidence, that link can be proved. Jersey does not restrict the scope of this test by applying the “lowest intermediate balance” principle, on the basis of justice and practicality. It considers that the principle may give a sophisticated fraudster the ability to defeat an otherwise effective tracing claim by manipulating the sequence in which credits and debits are made to and from the fraudster’s bank account.

For trustees holding what may be the proceeds of bribes or secret commissions, advice needs to be sought at an early stage and an application may have to be made to court for a determination as to who the true beneficiary of those proceeds are.

The strong message coming from the UK and Jersey is: a fiduciary that makes an undisclosed profit, has nowhere to hide.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s