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For over 150 years, it has been a principle of English law that if an agent takes a bribe or a secret commission, he is liable to account to his principal for the amount received. However, there has been conflicting authority and academic debate as to whether the principal merely has a personal claim against the agent or whether he can assert a proprietary claim to the monies received and any profits made therefrom.
In an insolvency context, the point may be very significant. Can an administrator be wholly comfortable that what appear to be company assets are not vulnerable to a claim by a third party? Will a secured lender’s security be trumped by a proprietary claim?
In FHR European Ventures LLP and others v. Cedar Capital Partners LLC  UKSC 45, the Supreme Court has clarified – and arguably extended – the law as to the ownership of assets derived from a bribe or secret commission. It held that a bribe or secret commission received by an agent is held on constructive trust for his principal, and as such the principal has a proprietary claim to the bribe itself (and therefore to any assets acquired with the proceeds of the bribe). In doing so the Supreme Court overruled its own decision (in its previous guise as the House of Lords) in Tyrell v. Bank of London (1862) 10 HL Cas 26 and(1862) and the subsequent cases that had followed it. Few of those cases were decided in an insolvency context, but the most recent before FHR, the case of Sinclair Investments Ltd v. Versailles Trade Ltd  Ch 453, had been. The outcome in Sinclair provided important guidance to insolvency practitioners and banks in determining whether or not they have been put ‘on notice’ of proprietary claims.
In December 2004, FHR purchased a company that owned the long lease of the Monte Carlo Grand Hotel for €211.5m. Cedar had acted as FHR’s purchase agent, and in this capacity owed fiduciary duties to FHR. Cedar had also entered into an exclusive brokerage agreement with the seller, which had paid Cedar a €10m brokerage fee on completion of the sale in January 2005.
FHR alleged that Cedar had not disclosed the exclusive brokerage agreement to it, and brought proceedings against Cedar for recovery of the fee. The primary issue was whether such disclosure had been given, and the judge at first instance concluded that it had not been. After a further hearing, the judge declared that Cedar’s non-disclosure was a breach of its fiduciary duty as FHR’s agent, and ordered Cedar to compensate FHR for the €10m it had received. However, the judge refused to grant FHR a proprietary remedy in respect of that sum. On FHR’s appeal, the Court of Appeal declared that Cedar had received the fee on constructive trust, holding it for FHR absolutely. Therefore, FHR had a proprietary right to the €10m.
On Cedar’s further appeal, the sole point in issue before the Supreme Court was whether FHR was entitled to a proprietary right or merely a personal right against Cedar.
There is a well-established equitable rule that, where a fiduciary acquires a benefit or takes advantage of an opportunity that came to his attention as a result of his fiduciary position, he is to be treated as having acquired that benefit on behalf of his principal. In such cases, equity treats the benefit as belonging to the principal, who is entitled to a proprietary remedy against the fiduciary accordingly. However, that line of authority is traditionally premised on the principle that the property or opportunity is something that ‘belonged to’ or was otherwise available to the principal. As such, it is an easy leap to say that the asset in question should be held on trust for the principal.
However, it has been said that this analysis does not lend itself so easily to a bribe or secret commission paid to an agent, because that cannot be said to have been intended to be, or otherwise derived from, the property of the principal. This was the crux of the decision of the House of Lords in Tyrell back in the 1800s. Relying on Tyrell, Cedar argued that there was no basis for finding a proprietary claim with regard to a secret commission.
FHR argued in favour of a broader application, contending that, in any case where an agent receives a benefit amounting to, or resulting from, a breach of fiduciary duty, the agent holds the benefit on trust for the principal.
In delivering the leading judgment of the Supreme Court, Lord Neuberger acknowledged that previous legal authorities did not provide a plainly right or wrong answer to determine the scope of the equitable rule. He acknowledged that a bribe or secret commission could be looked at as different in quality to, for example, a secret profit made on a transaction on which the agent is acting for his principal where it might properly be said to have been a benefit the agent should have obtained for his principal. How could the same be said of a bribe that the agent receives from a third party? If that benefit never belonged to the principal, then, it might be said, he could have no proprietary right in respect of it.
In the absence of an obviously correct answer, Lord Neuberger thought it was right to approach the issue as a matter of clarity and simplicity. That approach would be the application of the equitable rule in all cases, to avoid uncertainty as to its scope. He held that the argument put forward by Cedar that a principal has no proprietary right to his agent’s bribe or secret commission was unattractive for four primary reasons:
In reaching his conclusion Lord Neuberger acknowledged that the application of the rule in all circumstances would provide a principal with a proprietary right, with priority over unsecured creditors in the event of his agent’s insolvency. However, his Lordship felt that the unsecured creditors would suffer no real prejudice for two reasons. First, because the proceeds of a bribe or secret commission comprise property that should never have been in the agent’s estate at all. Secondly, because (as mentioned above) the bribe or commission may have reduced the benefit received by the principal from the underlying transaction.
Although Lord Neuberger eschewed the concept of a remedial constructive trust as a principle of English Law, one might be forgiven for thinking that FHR comes close to the line. It is instructive to revisit the Sinclair decision in the light of FHR.
The case emerged from the administrative receivership of the Versailles Trade Finance group. The group had been financed by bank debt together with additional funding from a pool of individual investors through an offshore company Trading Partners Ltd (TPL). TPL was a conduit controlled by the Versailles management. Its agreements with individual investors provided that monies would be held as agent for the investor and would be applied solely for the purpose of making the contemplated investments in Versailles. However, monies raised through TPL were mixed with the bank lending and ultimately misapplied. Following the collapse, the investors lost most of their investment and TPL was placed into liquidation.
The founder and CEO of the group had made a substantial profit in selling his shares in the listed parent shortly before the collapse. Some of that profit had been applied in repaying bank lending and entering into a settlement with the receivers who were pursuing claims against him.
The TPL liquidator assigned various claims to one of the investors, Sinclair, which then brought claims asserting a proprietary right to the profit made by the CEO, which, it claimed, could be traced and followed into the hands of the banks and the receivers.
By virtue of the common control of Versailles and TPL, and the nature of the agreements by which the investors’ money was injected into Versailles, it was unarguable that the CEO had breached his fiduciary duties to TPL and made a profit through the share sale. The key question was whether that gave rise to a personal claim against the CEO alone or whether there existed a tracing right to the proceeds in the hands of the banks and the receivers.
The Court of Appeal dismissed TPL’s proprietary claim. It followed Tyrell and held that because the benefit could not properly be said to be the property of the principal beneficiary (ie TPL), no proprietary claim existed. As such, there was no possibility of following the profit made into the hands of third parties.
Post FHR, the position might very well be different. If we are moving closer to the position where the receipt and misapplication of monies by a fiduciary will always give rise to a proprietary claim, that is a slippery slope. Albeit Lord Neuberger was attracted to the simplicity of the concept, one can see fertile ground for litigation around the scope of the tracing remedy and when an innocent recipient of trust monies is deemed to have had notice of the trust claim.
A recipient of property that is subject to a proprietary claim will nonetheless take the property free of that claim if:
This is the formula to create the archetypal ‘bona fide purchaser for value without notice’. In Sinclair, there was no suggestion that the receivers and the banks were not acting bona fide, and clearly they gave value for the property received from the CEO in terms of the discharge of loans and the settlement of claims. However, notice was a live issue. A key question was whether their investigations did, or should have, given notice of the competing trust claim. A further wrinkle was that, one year into the receivership process, the liquidators of TPL had purported to give notice (albeit without particulars) of a possible trust claim.
Such issues are fact specific and not easily resolvable. In Sinclair the court concluded that neither the receivers nor the banks had notice of a proprietary claim. Rejecting the efforts of the TPL liquidator to fix the receivers and the banks with notice, the court held that, to constitute proper notice, two key elements were required:
Those elements of ‘notice’ include both actual and constructive notice, ie not only what the recipients did know but also what would have been discovered if proper steps had been taken. The ‘proper steps’ required depend on the context – for a bank with the benefit of highly experienced IPs, the steps might have included making further enquiries or seeking specific advice to determine whether a proprietary right existed.
While the fairly unique and extreme circumstances of Sinclair are unlikely to be repeated, in the light of FHR there is undoubtedly greater scope for proprietary rights to disturb the normal course of asset realisation and distribution. It may be tempting for an insolvency practitioner to rely on the high threshold to be put ‘on notice’ as set out in Sinclair, and not to go looking for the facts and seeking legal advice that might support a claim. However, sticking one’s head into the sand would be a dangerous option for an insolvency practitioner to take, particularly as Lord Neuberger openly embraced the supremacy of a simple and coherent rule in all such cases over and above the interests of creditors generally.
Short of direct evidence that a bribe or secret commission has found its way into an insolvent estate, some ‘red flags’ to look out for include:
Beware of unintended consequences remains a good watchword. Lord Neuberger’s aim of achieving ‘simplicity’ may lead to greater complexity in resolving the conflict between trust creditors and estate creditors!
This article first appeared in the Winter 2014 edition of Recovery. Written by Nigel Barnett in Dentons' London office.
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