The Supreme Court heard a case relating to the profit rule for fiduciaries and whether it could depend on counterfactual analysis.
Background:
The facts surrounding this case are complicated but can be summarised as follows. The lucrative business opportunity at the heart of this case arose upon the death in February 2008 of an extremely wealthy Georgian businessman, Arkadi Patarkatsishvili. It consisted of providing for a large reward asset recovery services for his family, both recovering his assets from their disorganised and often hidden locations around the world, and resisting the claims of various governments and others to the same assets.
Three key individuals came to be involved in seeking the recovery of the assets. Mr. Jaffe, who owned and managed Salford Capital Partners Inc. (SCPI), a company incorporated in the British Virgin Islands (BVIs). Mr. Rukhadze was a director of SCPI from 2004 until December 2009 but continued to work for or on behalf of SCPI until May 2011. Mr. Alexeev became a partner in Revoker LLP (Revoker) in April 2009. In addition, Mr. Marson, an English solicitor, was employed by Revoker in 2009 and came upon the business opportunity from Revoker. Revoker was incorporated in the UK under the Limited Liability Partnerships Act 2000.
There was a falling-out between Mr. Jaffe and Mr. Rukhadze, Mr. Alexeev, and Mr. Marson, as a result of which they parted ways in May 2011. The three of them decided to seek a contract with the family for the provision of recovery services in place of SCPI and Revoker. They denigrated SCPI and Mr. Jaffe to the family, and, following their respective resignations from SCPI and Revoker, they continued providing services to the family until they reached an agreement in October 2012. That agreement provided for annual management fees and a large capital sum once they passed a threshold of $500 million worth of net recoveries for the family, which they did in 2016. The defendants received profits of $179 million from this work.
The two companies (and their successors) sued Mr. Rukhadze, Mr. Alexeev, and Mr. Marson for a share in the profit. The trial Judge found that the three had committed breaches of fiduciary duty and were liable to account to the companies for the $179 million in profits, less an equitable allowance of 25% for their efforts. The three unsuccessfully appealed to the Court of Appeal (CoA), which upheld the lower Court’s decision. They appealed to the Supreme Court, raising the question of whether the ‘but-for’ causation should apply.
Decision:
The appeal was unanimously dismissed. While the seven members of the Supreme Court differed in their reasoning, they agreed on the outcome. Lord Briggs reiterated that the profit rule reflects the view that the profit belongs to the fiduciary’s principal. They are, from the moment they are made, held on trust for the principal, under a constructive trust, unless the principal has given his informed consent. The fiduciaries hold, therefore, a duty of undivided loyalty to his principal.
The duty of undivided loyalty forms the basis of the no-conflict rule and the separate but related, no-profit rule.
The Court noted that the ‘but-for’ test has no role to play. However, it was noted that the fiduciary is not liable to account if the profit is unrelated to the duty.
Implications:
This is a landmark decision on the liability of trustees and other fiduciaries account to their principal for any profits which they obtain by virtue of their role. This judgement creates a strict liability, one that does not depend on whether the principal would have made the same profit or would have consented to the fiduciary keeping all or part of the profit.
This ruling offers a reminder that fiduciaries have an undivided loyalty to their principal, which results in an obligation to account for profits earned. Any deviation from this rule would lead to severe consequences. It is, therefore, advisable for fiduciaries who owe a fiduciary duty to more than one entity to be as transparent as possible but also to obtain legal advice.