Having your slice and eating it
A partner can potentially forfeit all part of his profit
share if he breaches his fiduciary duties, according to a recent decision of
the High Court. That comes as a surprise to many partnership lawyers, and has
some interesting implications for partnerships and LLPs.
Hosking v Marathon
Asset Management LLP was an appeal on a point of law from the decision of
an arbitrator, so the court was only asked whether forfeiture was possible in
principle. The court did not have to decide on the details of how it would
work, either generally or in this particular case, so there is a lot of room
for interpretation. The judge
did quote with approval Snell’s Equity
saying “a fiduciary's fees may not be forfeit if the betrayal of trust has not
been in respect of the entire subject matter of the fiduciary relationship and
where forfeiture would be disproportionate and inequitable.”
A fiduciary is a person in a particular position of
trust, such as a trustee, a director or an agent. In other contexts, it has
been held that a fiduciary who breaches his fiduciary duties forfeits any right
to remuneration for performing them. Most of the cases concerned agents, as in Imageview
Management Ltd v Jack, where a footballer’s agent negotiating for a player to
join Dundee United made a secret deal with the club for his own benefit, and
forfeited his commission. Most of the cases concerned dishonesty.
In Hosking the
arbitrator found Mr Hosking guilty of a series of serious breaches of his
fiduciary duties to his LLP, largely by making preparations to leave and compete
with the LLP. In that particular LLP, full-time working partners got twice the
profit share of non-executive partners. Because of this, the arbitrator concluded
that 50% of the profit share should be regarded as remuneration for executive
services, and ordered it to be forfeited for the entire period in which Mr
Hosking was in breach of fiduciary duty. This amounted to over £10 million.
The effect on partnerships and LLPs may be surprising:
- Unlike a straightforward agency, the roles and responsibilities of partners are very complex. Everything a partner does is governed by his fiduciary duties to his partners or his firm. The arbitrator equated the whole of a partner’s share attributable to his work in the LLP with remuneration for performing his fiduciary duties, and said it was "proportionate and equitable" that he should forfeit the whole amount. As well as acting in breach of his fiduciary duties, Mr Hosking must also have performed his duties to a very considerable extent during that period, for the benefit of the LLP and his partners. He got no credit for that work. Was the betrayal of trust really “in respect of the entire subject matter of the fiduciary relationship”? Did it really “go to the whole contract”?
- The compensation awarded against him for the actual breach seems to have been £1.38 million, so the forfeiture was worth many times the proven financial loss. Can that really be "proportionate and equitable"?
- The forfeiture period was only four months. What if the breach of fiduciary duties had lasted much longer, perhaps his entire career with the LLP? Would he still have lost all his remuneration for the entire period?
- Is it fair or realistic to characterise a profit share at a rate of over £30 million a year as remuneration for executive services? Where do you apply for a job like that?
- A partnership or LLP agreement will not normally attribute a proportion of profit share to remuneration of working partners. It may have a formula which appears to show working partners getting more than others, but the reasons behind that may be varied and complex. Even if the profit share includes a fixed salary, you cannot always conclude that it represents the partner’s remuneration for performing fiduciary duties, or for working for the LLP. Some partners contribute their work, some capital, some contacts or know-how, or in most cases a mixture of all of them; the maths of how their shares are calculated will rarely be a guide to valuing these separate contributions.
- Does the operation of forfeiture really depend on how partners structure their agreements? If there is a fixed share, often called a “salary”, is that going to be seized upon as remuneration? If partners get interest on their capital, is the rest of their share “remuneration”? If all partners get different shares, can you infer “remuneration”? What if they all get the same, but some do more work than others? What if shares depend on personal contribution, such as personal billings, or on management responsibilities?
- In a partnership or LLP, the profit shares must go somewhere. They must still add up to 100%. If the profit share is forfeited, what happens to it? In this case the arbitrator said that it would fall into the general pool and be shared, including by Mr Hosking, according to the partners’ remaining entitlements. That result is a bit random: if there had been only one other partner, Mr Hosking would have received back half the amount he forfeited, under his remaining profit share. But if the arbitrator had held that he forfeited only half his remuneration, or that the “remuneration” element was less, he would then have got back a larger proportion of the forfeited amount.
- What if the partnership or LLP agreement makes no provision for the sharing of the amount forfeited? What if all other partners were on fixed shares?
- Partnership disputes typically involve a wide range of allegations and counter-allegations. What if all the partners had been in breach of fiduciary duties, perhaps in different ways and different degrees of seriousness? Would they all forfeit their profit shares, and where would they go? The potential for forfeiture is likely to create enormous arguments in partnership disputes as each partner claims that the others should forfeit all or part of their profit shares.
- What if some partners are complicit in the breach of duty? Do partners forfeit their shares as against some partners but not others? Do they forfeit shares to each other? If all but one of the partners are guilty, does the innocent partner get 100%?
- We seem to have slipped from forfeiture for “dishonesty” in the early cases to forfeiture for any breach of fiduciary duty in Hosking. In a commercial context, such as partnerships and LLPs, there really has to be more allowance for the realities of business life. Forfeiture is a punitive measure, not a compensatory one, and gives a windfall to the injured party even if all his losses have been made good. Bad behaviour, short of criminal fraud, does not normally have this effect.
At least the judge accepted that the partnership deed or
LLP agreement can exclude forfeiture. I have already modified my standard forms
(I immodestly think my LLP agreement is the best there is!) with a clause you
can have for free: “Without prejudice to any other remedy for any breach of
fiduciary duty or of this agreement, no part of the profit share of any Member
is liable to be forfeited under the principle of equity that a fiduciary may
forfeit remuneration due to his breach of fiduciary duty.”
