4.4    Breach of Duty: “Conflict of interest” and “improper gain”

•    The Doctrine in Keech v Sandford

There is a strict duty to avoid conflict of interest between fiduciary and principal.
Fiduciary is accountable for any benefit acquired by virtue of his position.

Keech v Sandford
Facts: A lease had been held upon trust, but a lessor refused to renew the lease to the trust, because the beneficiaries were infants, and the lessor had concerns about their ability to comply with the terms of the lease. The trustee sought and was granted a renewal of the lease in his own name.
Issue: Was the trustee entitled to hold the lease personally, or was his renewal of the lease a breach of the conflicts rule?
Decision: The trustee held the new lease upon trust for his beneficiary. Despite the rigour of the rule, Lord Chancellor King said that it was better that the lease be allowed to run out than to allow a trustee to take such a benefit for himself or herself.

The rule is said to apply to the renewal of a lease by anyone who has occupied a fiduciary position: Re Biss [1903] The rule is confined in its operation to cases involving leases.

Once a fiduciary relationship has been established, the next question is whether the fiduciary is n breach of their duty which is established by the scope of the duty involved.

Two circumstances in which a fiduciary could be in breach of his or her duty is outlined in Chan v Zacharia
Facts: Two doctors previously in partnership in suburbs of Adelaide. Partnership terminated. Carried on in different practices in different suburbs. Lease in one suburb was about to run out. The option to renew was in the name of the two doctors. Dr Chan approached landlord – without telling Dr Zacharia – and obtained the lease in his name.
Held: Chan was a constructive trustee for himself and Zacharia of the new lease which was an asset of the partnership. Dean J said that the general principle of equity requiring a fiduciary to account for personal benefit or gain embodied two themes:
1.    appropriated for the principal any benefit or gain obtained or received by the fiduciary in circumstances where there existed a conflict of personal interest and fiduciary duty, or a significant possibility of such conflict;
2.    required the fiduciary to account for any benefit or gain obtained or received by reason of or by use of his or her fiduciary position, or of some opportunity or knowledge resulting from it.
Rule in Keech v Sandford was applied.

Clay v Clay [2001] 
Facts: Stepmother bought house from dead husband’s estate for market value. Stepmother was guardian for all stepchildren. Later three children from husband’s first marriage and then current trustee tried to have sale set aside or to get 3/4ths of house to be in trust for step-children.
Held: NO; There was no conflict between duty as guardian and that of buying house in her own name. Market price helped greatly.
Also the then trustee had a power of sale. Mrs Clay did not deal in property or with her wards. She dealt in good faith in trying to be a good mother and provide shelter for children.

4.5    Defences: The Duty of Disclosure and Informed Consent
The ONLY way for a fiduciary to enter into an arrangement where there might be a conflict of interest and duty or some benefit arrived at through the fiduciary position is with the informed consent of the principal/s. This placed heavy emphasis on the need for disclosure.
-    Informed consent;
-    Full and relevant disclosure of all information pertinent to the transaction and, if need be, to provide some adequate explanation of that information. 
-    Duty of disclosure does not extend to facts the fiduciary is unaware of. Even though enquiry might reveal such.

BLB Corporation of Australia v Jacobsen (1974)
Facts: The director of a company supplying yarn was also manager of Bel-Knit, a customer of the company. He allowed Bel-Knit to purchase a large amount of yarn from the defendant on credit at a time when Bel-knit was insolvent. The accounts of Bel-Knit were not prepared until the end of the year and he had not known of the substantial trading loss incurred at the relevant time. He had advised the company of BK debts and that it was struggling to establish itself in the market.
Held: This was a sufficient discharge of duty and his duty had not been breached.

There is some suggestion that disclosure will not be necessary where the information which would otherwise have been provided would not have effected the result: Walden Properties Ltd v Beaver Properties Ltd [1973].

It is no defence to show that the fiduciary has acted honestly or with good faith in the transaction: Boardman v Phipps where their Lordships were anxious to stress Boardman’s integrity.

Brickenden v London Loan and Savings Co [1934]
Facts: Bickenden, a solicitor for a finance company, benefited by a loan made by the finance company to a Mr Biggs, by receiving from the moneys loaned payment out of several mortgages given to him by Biggs, together with certain commissions and fees in connection with the mortgages. Bickenden failed to disclose to the finance company.

Held: Bickenden had breached his fiduciary duty to the finance company by that non-disclosure. Their Lordships also said that, once the undisclosed facts were found to be material, the question of what the principal might have done had the facts been disclosed were mere speculation and irrelevant.  Applied in Gemstone Corporation v Grasso.

4.6    Remedies for breaches of fiduciary duty

A fiduciary will be held to be accountable far any benefit or gain acquired through breach of his or her duty, but the nature of the remedy awarded will vary according to the circumstances of the case.

1.    Constructive trust
High Court is reluctant to find a constructive trust exists. They will only do so in particular circumstances and when there is no other appropriate remedy.
A constructive trust declares the wrongdoer as holding the wrongfully obtained assets in trust for the principal.
This remedy will usually clean out the wrongdoer – sometimes a fair result.

This remedy was applied in Timber Engineering Co Pty Ltd v Anderson against two officers of a company who had set up another business in competition to that of their employer.
A constructive trust may be imposed where the fiduciary has acted dishonestly, as in Timber Engineering, or honestly, as in Boardman v Phipps, provided a breach of duty can be shown. This remedy is discretionary.

2.    An Account of Profits
Courts may award a lesser relief, such as an account of profits covering a certain period.

This was the approach used in Hospital Products at first instance in the HC, his honour preferring an account of profits to a constructive trust because of the narrower scope of the appellant’s fiduciary obligation, and because he felt some allowance should be made for the appellant’s diligence in building up the Australian business.

An approach which was approved in Warman International Ltd v Dwyer, in the case of a business it may well be inappropriate and inequitable to compel an errant fiduciary to account for the whole of the profit of his conduct of the business or his exploitation of his principal’s goodwill over an indefinite period of time. It may be appropriate to allow the fiduciary a proportion of the profits, depending upon the particular circumstances. This may well be the case when it appears that a significant proportion of the profits has been generated by the skill, efforts, property and resources of the fiduciary, the capital which was introduced and the risks he has taken, so long as they are not risks to which the principal’s property has been exposed.

In Chan v Zacharia it is outlined that, the liability to account for a personal benefit or gain obtained or received by use of or by reason of fiduciary position, opportunity or knowledge will not arise in circumstances where it would be unconscientious to assert it…

The fiduciary will be ordered to render an account of the profits made within the scope and ambit of his or her duty. If the loss suffered by the plaintiff
exceeds the profit made by the fiduciary, the plaintiff may elect to have a compensatory remedy against the fiduciary.

3.    Damages or equitable compensation

Warman International Ltd v Dwyer
Facts: Dwyer was general manager of the qld branch of Warman International Ltd whose business included distribution of gearboxes and other products manufactured by the Bonfiglioli group. Bongiglioli wanted to set up a joint venture with Warman for the assembly of B products in Australia. Warman’s made it clear that they would not be interested. Dwyer entered into a secret negotiation with B and arranged for two companied to be formed: BTA, in which Dwyer, his wife and B interests held shares and ETA, which was wholly owned by Dwyer and his wife.

Later B terminated its agency with Warman and Dwyer left Warman. BTA and B entered into a joint venture which provided for the assembly and distribution of B gearboxes in Australia. ETA also did so in conjunction with the joint venture. BTA took over agency business in Australia which was very successful over the 4 years proceeding the trial. Warman commenced proceedings against Dwyer seeking relief including an account of profits.

Dwyer was found to have breached his fiduciary duty to Warman by effectively appropriating the agency business previously conducted by Warman. The trial judge held that Warman was entitled to ‘equitable damages’ for the loss of the Warman’s chance of retaining the agencies business, even though the agencies were likely to be lost.
Held: The court of Appeal upheld the finding of breach of fiduciary duty but, by a majority, held that Warman was not entitled to an account of profits but only to its losses flowing from its breach of duty. HC preferred that an account of profit’s was the appropriate remedy. They had to account for the entirety of the net profits of the businesses before tax over the first two years of their operation, less an appropriate allowance for expenses, skill, expertise, effort and resources contributed by them.

A fiduciary in breach may be ordered to pay equitable compensation by way of restitution to the principal where the principal has suffered a loss as a result of the fiduciary’s breach, even though the fiduciary has not received any corresponding profit or gain.
A fiduciary in breach may be ordered to pay equitable compensation by way of restitution to the principal where the principal has suffered a loss as a result of the fiduciary’s breach, even though the fiduciary has not received any corresponding profit or gain.

In Gemstone Corporation of Australia Ltd v Grasso (1994), it was held Grasso a director had breached his fiduciary duty by not making proper disclosure to the board. Grasso was liable to make good the loss which flowed from that breach. The court held that accountability for breach of fiduciary duty arises immediately upon breach; that is, immediately the fiduciary enters into an engagement in which there is a possibility of a conflict of interest. It was held that it is irrelevant speculation to inquire into what might have been the outcome had there been appropriate disclosure of the true situation when the issue of partly paid shares was mooted.

Where a fiduciary enters into some contract or other engagement, particularly one with his or her principal, in circumstances where there is an actual or potential conflict between the fiduciary’s personal interest and his or her duty to the principal, the appropriate remedy may be rescission of the contract or other engagement. But an equit entitling the principal to rescission means rescission with restitution, it does not exempt the principal from all obligations under the arrangement as demonstrated in Maguire v Makaronis (1997)
Facts: Maguire was a solicitor and partner to the second appellant, Tansey. The respondants Mr and Mrs Makaronis, were former clients of the appellants. The respondants purchased a poultry business. The appellants were retained to act for the respondants on the purchase of the business and freehold of the farm property on which the business was conducted. The respondents borrowed $250,000 by way of bridging finance which was borrowed by the appellants from the Commonwealth bank and on-lent to the respondents. The loan was secured by a mortgage over the repondent’s property at reservoir and by an executed assignment of Mr Makaronis’ superannuation entitlements.
The poultry business folded and the appellants commenced proceedings seeking to recover the moneys advanced. The respondents counter-claim pleading was breach of fiduciary duty by the appellants. In particular, it was alleged that, by acting for themselves as mortgagees while also acting for the respondents as mortgagors, the appellants had placed themselves in a position of actual or potential conflict of interest.
Held: The HC found that there was a breach of fiduciary duty. It was considered that granting the remedy of rescission should be conditional upon repayment of the moneys advanced plus interest. HC agreed that the whole transaction should be rescinded so far as possible, the parties remitted to their original position. An order was made setting aside the mortgage, conditional upon the respondants paying the money due under the mortgage, plus interest calculated at the rate set by the Supreme Court. In default of such payment, judgement was to be entered for the appellants for the possession of the reservoir property.

4.7    Secret commission and Equitable Debt

An employee who receives a secret commission or ‘kickback’ from a third party in return for carrying out his or her job in a certain way, will be liable in equity to the employer. It is a breach of the employee’s duty of fidelity and in some cases fiduciary duty.

The rule in these circumstances as outlined in the leading case Lister v Stubbs, where kickbacks were paid by suppliers of materials used in the plaintiff’s business to the employee responsible for ordering those materials, is the employee is held liable but only for the sum received.

Also outlined in Metropolitan Bank v Heiron, a director of a bank accepted payment from a debtor to the bank in return for using his influence to secure an arrangement between the bank and the debtor which was favourable to the debtor. The director was held liable, but only for the sum received.

The view in these cases is that while the employer was entitled to be paid the bribe received by the employee in each case, its rights were those of a creditor against a debtor, not of a cestui que trust, as the money was never ‘money of the company’. This is criticized by the NSW court of Appeal being described as anomalous and not to be extended beyond its own facts: DPC Estates Pty Ltd v Grey [1974].

This principle appears to rest on the notion that a constructive trust is only available where assets of the principal can be traced into the hands of the fiduciary or some third party, however, that proposition is contrary to the view in Re Stephenson Nominees (1987) where the judgement stated that the constructive trust may be imposed as a cautionary or deterrent remedy even where there has been no unjust enrichment of the defendant at the expense of the plaintiff and no assets of the plaintiff can be traced into the defendants hands.

It is strongly arguable that Lister v Stubbs is no longer good law. The Privy Council rejected it in A-G (Hong Kong) v Reid [1994].

Facts: The case involved the receipt of bribes by an employee in connection with his employment. The employee in question was a lawyer working for the Crown in Hong Kong. He accepted bribes in return for obstructing criminal prosecution. He allegedly purchased real estate in NZ with the bribe. Caveats placed on these properties by the Crown were challenged on the ground that the Crown had no equitable interest in the properties.

Held: “When a bribe is accepted by a fiduciary in breach of his duty then he holds that bribe in trust for the person to whom the duty is owed. If the property representing the bribe decreases in value the fiduciary must pay the difference between that value and the initial amount of the bribe because he should not have accepted the bribe or incurred the risk of loss. If the property increases in value, the fiduciary is not entitled to any surplus in excess of the initial value of the bribe because he is not allowed by any means to make a profit out of the breach of duty.”

Reading v AG [1951]  adopted the Lister v Stubbs approach.
Facts: R was a Sergeant in British Army in WWII in Egypt. Was into smuggling contraband into Egypt. Caught, prosecuted and loot confiscated. After war he sued the Crown to recover his ill-gotten money.
Held: He failed. Court said R owed fiduciary duties to the crown whilst in uniform and breached that duty in conducting illegal smuggling operations. Held that an employee receiving a secret profit was liable to the extent of the secret profit.

Jirna Ltd v Mister Donut of Canada Ltd (1973)
Facts: Jirna was a franchisee of MrD. Had to buy supplies from particular suppliers. Suppliers paid a commission to MrD. Jirna claimed these were wrongful commissions.
Held: At first instance the court found little of worth in Jirna’s arguments holding that these were purely commercial arrangements.