Supreme Court corrects “wrong turn” in English law, holding that bribes received by an agent are held on trust for the principal

Who is the rightful owner of a bribe? Is a bribe or secret commission received by an agent “held on trust” for his principal? Or is the principal’s claim against the agent a personal one for equitable compensation equal to the value of the bribe or commission?

The issue is of critical importance. It affects everything in litigation against dishonest agents, from the nature of the injunctive relief available at the outset to the rights in his insolvency. Perhaps most importantly of all, it affects whether the bribe can be “traced” into the hands of third parties and recovered as “trust” property.

After over 100 years of judicial wrangling and academic debate, the Supreme Court decided last week that bribes and secret commissions are held on trust by an agent for his principal: FHR European Ventures LLP and others (Respondents) v Cedar Capital Partners LLC (Appellant) [2014] UKSC 45. In doing so, the Supreme Court overturned various well-known authorities (including Lister v Stubbs and Sinclair v Versailles – see post) and aligned English law with several jurisdictions which long ago broadened the availability of proprietary remedies.

The implications are significant. Most importantly, the principal can claim a proprietary remedy against the bribe/secret commission itself, rather than a personal one against the defaulting agent. Robert Hunter and Tom Wood consider the decision below.  

robert.hunter@hsf.com_LGSRobert Hunter
Partner, Head of Fraud
+44 20 7466 2426
tom.wood@hsf.com_LGSTom Wood
Associate
+44 20 7466 2609
 

Background

FHR European Ventures LLP (“FHR”), along with the other claimants in the proceedings, had purchased the Monte Carlo Grand Hotel (the “Hotel”). The defendant and appellant, Cedar Capital Partners (“Cedar”), had acted as FHR’s agent in negotiating the purchase price of €211 million for the sale and, as such, owed fiduciary duties to FHR. On the side, unknown to FHR, Cedar had entered into an “exclusive brokerage agreement” with the seller of the Hotel, which provided for Cedar to receive a €10 million fee (the “Brokerage Fee”).

FHR brought proceedings to recover the Brokerage Fee from Cedar. At first instance, Simon J agreed that Cedar had not given proper disclosure of the exclusive brokerage agreement to FHR and that, accordingly, Cedar was liable to FHR in the sum of €10 million (i.e. the amount of the Brokerage Fee). The judge refused, however, to award Cedar a proprietary remedy to the Brokerage Fee on the basis that Cedar had received the Brokerage Fee on trust for FHR.

The Court of Appeal unanimously overturned Simon J on the question of whether a proprietary remedy was available. The court noted, however, that the case law was a mess. In conclusion, the Chancellor stated:

If the law is to be made simpler and more coherent then that suggests a need to … provide an overhaul of this entire area of the law of constructive trusts in order to provide a coherent and logical legal framework … If that can be done at all by the courts … it can only be accomplished by the Supreme Court”.

A brief history of the issue

To understand the position in English law, you have to go back to the Court of Appeal decision in Lister v Stubbs (1890) LR 45 Ch D 1. The appeal concerned an application for injunctive relief against three properties owned by Mr Stubbs. Stubbs had bought the properties with secret commissions obtained in the course of his employment with Lister. The Court of Appeal dismissed Lister’s appeal, holding there was no basis in law or policy which justified granting it a claim to the properties. The claim against Stubbs was a personal one for compensation equal to the amount of the original commissions. Lister established (or confirmed, depending on how you interpret the preceding cases) the proposition that a principal has no proprietary claim to his agent’s bribes or secret commissions.

The court in Lister seemed most concerned by the policy implications of granting a proprietary remedy. If Lister could assert title to Stubbs’ properties, it would not only get a windfall (through any increased value in the properties) but it would also take the properties as secured creditor of Stubbs to the prejudice of any unsecured creditors on Stubbs’ bankruptcy.

To its detractors, Lister represented a “wrong turn” in English law, unsupported by prior authority (bar another Court of Appeal decision in Metropolitan Bank v Heiron (1880) 5 Ex D 319) and cutting across the 19th century theory of fiduciary duties. To its supporters, however, Lister confirmed an important breakwater between the scope of liability founded upon fiduciary obligations and the “hard-nosed rights” central to the English law of property. In no sense could bribes or secret commissions – originating from a third-party – be considered a principal’s “property”, so why should a principal be able to claim them as his own?

This more conservative view grew unfashionable in the late 20th century. While several English cases upheld the rule in Lister, there was growing dissent outside the courts. One of the most vocal critics was Sir Peter Millett (writing extrajudicially), who argued that it is integral to the law of fiduciary duties that equity will not allow an agent to keep a bribe/secret commission received in violation of duty.

Further noises off came from other common-law jurisdictions, including Singapore, Canada and Australia all of which rejected Lister and Heiron. Most notably, in Attorney General v Reid [1994] 1 AC 324 – a Privy Council case involving a Hong Kong public official – Lord Templeman refused to follow Lister, holding that the availability of proprietary remedies was essential in the fight against bribery, “an evil practice which threatens the foundations of any civil society”.

Sinclair v Versailles

Despite this trend, when the issue arose again before the English Court of Appeal in Sinclair v Versailles [2011] EWCA Civ 347, Neuberger LJ (as he was then) criticised the reasoning in Reid, and roundly rejected submissions that it should be followed in preference to Lister. In defining the scope of proprietary remedies, he set down a two-category test. A principal would have a proprietary claim against an agent where:

  • the bribe/secret commission is or came from the principal’s own property (Category 1); or
  • the bribe/secret commission was derived from some “opportunity or right” which was “properly” or “beneficially” that of the principal (Category 2).  

If the bribe/secret commission did not fall into Categories 1 or 2, then the principal would be left with only a personal claim against the agent. The problem with this formulation (as subsequent courts discovered) was that it proved exceptionally difficult to apply in practice.

With Category 1, a proprietary claim might turn on the narrow and arbitrary factor of how the bribe/secret commission was accounted for. For example, if the bribe came to the agent directly from the principal (e.g. the agent took money from the principal, pocketed his share and passed on the remainder to a third party), the principal would have a proprietary claim. If, however, the agent passed all of a payment from his principal to a third party, who then transferred a bribe to the agent, the claim would be merely personal.

In respect of Category 2, the test was even harder to apply. First of all, what did it mean? An agent may be charged with obtaining various opportunities for his principal as part of his office. In FHR European Ventures itself, Cedar was appointed to obtain the “benefit” of the Hotel for FHR. However, was it not also part of that benefit (or an “opportunity” within that benefit) that FHR should obtain the lowest possible price? If the seller was prepared to sell the Hotel for €211 million, on the basis it would have to pay the Brokerage Fee to Cedar, then surely it would have been prepared to sell the Hotel for less if no Brokerage Fee had been payable?  

As the Court of Appeal in FHR European Ventures concluded, following the “very considerable difficulties” of applying the test, the effect of Sinclair had been to make the law “more complex and uncertain … dependant on very fine factual distinctions”. An overhaul was clearly in order.

Supreme Court decision

If ever a close-run decision, with several dissenting judgements, was to be expected, it was on this issue. The Supreme Court doubtless recognised, however, that after so many years of confusion, certainty in the law was required. The clear, unanimous and concise judgment provides a conclusive final chapter to the debate (at least, as far as the courts are concerned).

The Supreme Court started by identifying the basic proposition that in some cases where an agent acquires a benefit coming to his notice as a result of his fiduciary position or pursuant to an opportunity resulting from his position, the equitable rule is that he is to be treated as having acquired the benefit on behalf of his principal so that it is beneficially owned by the principal (“the Rule”). The question was whether, as a matter of authority and policy, the Rule applied (or should apply) to bribes/secret commissions.

After reviewing the case law, the Supreme Court concluded “it was not possible to identify any plainly right or plainly wrong answer to the issue … as a matter of pure legal authority”. Instead, the conclusion was necessarily one which must be based on principle, practicality and policy.

The Supreme Court rejected what might have been two middle-ground alternatives. There would be no revisiting the “remedial constructive trust”, a feature in some common law jurisdictions (e.g. Australia), but long-ago rejected by the English courts. Similarly overlooked was the suggestion that the problem could be bridged simply by extending the scope of equitable accounting to allow personal claims against an agent equal to the value of the original bribe/secret commission and the value of any investments made with it.

Rather, FHR’s argument that the Rule should encompass bribes and secret commissions had the merit of simplicity, and avoided the painstaking factual enquiries as to ownership which the test in Sinclair had provoked. Further, and echoing the views of Lord Templeman in Reid, it was appropriate that the law should be particularly stringent when it came to bribes/secret commissions, which “undermine trust in the commercial world”. Accordingly, FHR’s proprietary claim to Cedar’s Brokerage Fee was allowed.

Comment

The judgment marks a watershed moment in the law governing proprietary remedies and signals a significant departure from a position in English law which – while widely criticised and somewhat unclear – had a line of continuity in the Court of Appeal. The decision overrules that authority, placing English law in line with other common law jurisdictions, and also endorses the Privy Council decision in Reid. There is also the intriguing personal sub-text of Lord Neuberger effectively overruling himself in Sinclair.

The practical implications are significant.

Firstly, the rule is not confined to agents and principals. It encompasses all manner of fiduciary relationships, including employer-employee (e.g. Lister v Stubbs), company-director (e.g. Sinclair v Versailles), some categories of public official (e.g. AG v Reid) and – of course – trustee-beneficiary.

Secondly, the availability of a proprietary claim to a bribe/secret commission provides a claimant principal with a nuclear weapon in any litigation against a corrupt agent. Granting a proprietary base in bribes/secret commissions will enable the principal to trace into the agent’s assets (and into the assets of any third-party knowing recipients) and claim any fruits of the fraud (e.g. lucrative investments). If, of course, the agent’s investments have tanked, the principal can elect to pursue a personal claim against the agent equal to the amount of the original bribe/secret commission instead.

Thirdly, the bolt-on to these proprietary missiles will be an extended arsenal of ancillary relief. In addition to any freezing injunction against an agent, the principal may also be able to obtain proprietary injunctions to freeze bribes/secret commissions and their traceable proceeds. Chabra relief may also be available against third parties holding bribes/secret commissions for the agent.

Fourthly, proprietary claims to bribes/secret commissions may not be timed barred. Because the fiduciary holds the bribe/secret commission “on trust” for the beneficiary, any proprietary claim to it may amount to an action “to recover…trust property or the proceeds of trust property in the possession of the trustee” (within the meaning of section 21(1)(b) of the Limitation Act 1980).

Fifthly, the ruling will further shift the emphasis in civil bribery cases towards factual enquiries concerning the circumstances surrounding secret payments. It will be more important than ever for agents to ensure any conflict of interest or side deal which might compromise their duties of loyalty are properly disclosed and approved in writing by their principals.  

Finally, and perhaps most significantly, the availability of proprietary remedies has the potential to pose problems for insolvency practitioners. As claimant-principals will now be able to assert title to bribes/secret commissions in their agent’s hands, unsecured creditors may lose out. While this was one of the primary reasons for the reluctance of the courts since Lister to extend the scope of proprietary remedies, the Supreme Court considered the concerns were outweighed by the arguments in favour of granting enhanced relief to the principal.

There will certainly be critics of the decision. Lister and Sinclair had their supporters, particularly among property lawyers. There will be concerns that, with no discretion to avoid “the Rule” in relation to bribes/secret commissions, it has the potential to prejudice creditors on the insolvency of an agent/trustee, or unduly penalise unscrupulous agents whose principals may not in fact have suffered at all from their breach of duty. All this remains to be seen. What can be said for now is that – at long last – the position in English law is certain.


Disclaimer

Herbert Smith Freehills LLP is licensed to operate as a foreign law practice in Singapore. Where advice on Singapore law is required, we will refer the matter to and work with licensed Singapore law practices where necessary.

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