FHR v Cedar: Bribes and Secret Profits

It has long been recognised that a defaulting agent must disgorge to his principal any wrongful gain received in the course of his agency. But should the law go further and find that the defaulting agent holds the bribe or secret commission on trust for the principal? This question stirs “passions of a force uncommon in the legal world” between those advocating a proprietary remedy and those who favour a purely personal one. The question has been finally answered by the Supreme Court in FHR v Cedar Capital, which found that an agent who receives a bribe or secret commission holds it on constructive trust for his principal. The very real practical significance of this technical-sounding question was explained by Lord Neuberger, in his leading judgment for the Supreme Court, as follows:

"If the bribe or commission is held on trust, the principal has a proprietary claim to it, whereas if the principal merely has a claim for equitable compensation, the claim is not proprietary. The distinction is significant for two main reasons. First, if the agent becomes insolvent, a proprietary claim would effectively give the principal priority over the agent's unsecured creditors, whereas the principal would rank pari passu, ie equally, with other unsecured creditors if he only has a claim for compensation. Secondly, if the principal has a proprietary claim to the bribe or commission, he can trace and follow it in equity, whereas (unless we develop the law of equitable tracing beyond its current boundaries) a principal with a right only to equitable compensation would have no such equitable right to trace or follow".

Facts

Cedar Capital Partners LLC (Cedar) advised and assisted FHR in the purchase of the Monte Carlo Grand Hotel for €211.5 million. Unbeknown to FHR Cedar had entered into an agreement with the hotel's owner to find a buyer, in return for a fee of €10 million. FHR discovered this and commenced proceedings seeking recovery of this sum.

The trial judge's decision

Simon J concluded that the Cedar had failed to provide FHR with adequate disclosure of the arrangements with the hotel owners and that those arrangements resulted in a breach of the no conflict rule. As to remedies, Simon J considered himself bound by the Court of Appeal's decision in Sinclair v Versailles which established that a principal could not claim a proprietary interest in money or assets acquired by their fiduciary, unless one of two exceptions applied: first, the asset or money was acquired through a misuse of the principal’s property; or second, it was acquired "by taking advantage of an opportunity or right which was properly that of the beneficiary". He considered it would be "artificial" to describe the secret commission as an opportunity properly belonging to FHR and therefore refused to grant FHR a proprietary remedy. FHR appealed on this one issue, contending the appropriate remedy was proprietary.

The Court of Appeal

The Court of Appeal considered that the payment to Cedar of €10 million deprived FHR of the opportunity to purchase the hotel at a price lower than €211.5 million, and allowed the appeal holding that Cedar received the €10 million fee on constructive trust for FHR absolutely. Cedar appealed, arguing that the case fell outside the Sinclair exceptions.

The Supreme Court decision

The Supreme Court hearing took place between 17 and 19 June 2014. Lord Neuberger gave the judgment of the court on 16 July 2014 conclusively dismissing Cedar's appeal. He referred to "inconsistent judicial decisions over the past 200 years" which meant "it is not possible to identify any plainly right or wrong answer to the issue". He nevertheless considered that Lister represented the "wrong turn", and stated that this and other cases that followed should be overruled. He concluded that "practical and policy considerations" favour a proprietary remedy.

One such practical consideration was simplicity. There was a growing consensus that the Sinclair exceptions contended for by Cedar were artificial and unworkable. Moreover, there was no obvious justification for a proprietary remedy in relation to some breaches of fiduciary duty but not others. On the contrary, it is undesirable for the most egregious form of a fiduciary breach (receiving bribes and secret commission) to attract a personal remedy while other less serious breaches (where the agent acted honesty) are subject to a proprietary remedy. Keech v Sandford was an example of an agent acting honestly who was nevertheless subject to a proprietary remedy (even where the principal could not have acquired the benefit). This has come to be viewed as some kind of divine ordinance. Keech concerned a trustee who held the lease of a market for the benefit of an infant. The trustee applied for the lease to be renewed but the lessor refused because he was dissatisfied with the security provided by the infant. The trustee then applied for the renewal to be made in his name, which was granted. Lord King LC concluded – adding “though I do not say there is a fraud in this case” and though it “may seem hard” – the infant was entitled to an assignment of the new lease and an account of the profits made in the meantime: a conclusion that could only be justified on the basis that the new lease had been beneficially acquired for the infant beneficiary. This decision was followed and applied in Boardman v Phipps. Boardman was a solicitor to trustees of a will trust. He (and a beneficiary) purchased shares in a company in which the trust already had a substantial holding. The trustees were prevented from purchasing any further shares as they were not authorised investments under the terms of the will. Boardman acquired the shares without the consent of all the trustees and made a profit. Another beneficiary sought an account of the profit. The court found that Boardman held the shares as constructive trustee.

Lord Neuberger considered that a proprietary remedy would bring this area of law into line with the analogous liability of an employer for his employee's wrongs: "The principal is entitled to the benefit of the agent’s unauthorised acts in the course of his agency, in just the same way as, at law, an employer is vicariously liable to bear the burden of an employee’s unauthorised breaches of duty in the course of his employment." Similarly, Lord Neuberger was conscious that courts in Australia, New Zealand, Singapore and Canada had adopted proprietary remedy:

As Finn J who gave the judgment of the court [in Grimali] said, at para 582 (after describing Heiron and Lister as imposing “an anomalous limitation… on the reach of Keech v Sandford”, at para 569), “Australian law” in this connection “matches that of New Zealand… Singapore, United States jurisdictions… and Canada”. As overseas countries secede from the jurisdiction of the Privy Council, it is inevitable that inconsistencies in the common law will develop between different jurisdictions. However, it seems to us highly desirable for all those jurisdictions to learn from each other, and at least to lean in favour of harmonising the development of the common law round the world.

Moreover, Lord Neuberger referred to national and supranational initiatives to combat corruption and bribery and concluded: "Accordingly, one would expect the law to be particularly stringent in relation to a claim against an agent who has received a bribe or secret commission".

Lord Neuberger recognised that a proprietary remedy could prejudice the agent's creditors as it would reduce the estate of the agent estate if he becomes insolvent. He acknowledged that this had been a factor in his decision in Sinclair. Lord Neuberger held:

While the point has considerable force in some contexts, it appears to us to have limited force in the context of a bribe or secret commission. In the first place, the proceeds of a bribe or secret commission consists of property which should not be in the agent's estate at all… (although it is fair to add that insolvent estates not infrequently include assets which would not be there if the insolvent had honoured his obligations). Secondly, as discussed in para 37 above, at any rate in many cases, the bribe or commission will very often have reduced the benefit from the relevant transaction which the principal will have obtained, and therefore can fairly be said to be his property. Nonetheless, the appellant's argument based on potential prejudice to the agent's unsecured creditors has some force, but it is, as we see it, balanced by the fact that it appears to be just that a principal whose agent has obtained a bribe or secret commission should be able to trace the proceeds of the bribe or commission into other assets and to follow them into the hands of knowing recipients (as in Reid).

Such tracing would only be possible on orthodox principles if the court recognised a proprietary interest.

Conclusion

The clarification of the law in relation to bribes and secret commissions is to be welcomed, though the judgment lacks a clear doctrinal rationale for imposing a trust, leading to some uncertainty as to its scope. This may result in litigants seeking to apply the principle established in FHR v Cedar to other unauthorised gains. It remains to be seen whether the law will develop in this direction.