Equity and Trust Law: Bribes and the Institutional Constructive Trust

This essay explores the analytical reasons for arguing that a bribe or a secret commission received by a fiduciary is held on a Constructive trust for the Claimant. Further, its questions the idea that Remedial forms of Constructive Trust should always be rejected in favor of the Institutional Constructive Trust recognized by English law. 

 

Can one claim a proprietary Constructive Trust rather than equitable compensation in cases involving bribes received by a Fiduciary? 

The landmark case of FHR European Ventures v Cedar Capital Partners [2014] UKSC 45 involved a secret commission acquired in relation to the sale of the Monte Carlo Grand Hotel.
 
The Claimants, FHR, were involved in the acquisition of share capital of the hotel while Cedar acted as their  agent in respect of the purchase, therefore owing fiduciary duties to the Claimant.
 
Cedar subsequently entered into an secret agreement with the vendors of the hotel involving the receipt of 10 Million Euros upon completion of the sale. This agreement between Cedar and the hotel was not disclosed to FHR, therefore constituting a breach of Cedar’s fiduciary duty.
 
 
The legal issue on appeal before the UK Supreme Court was this:
 
whether property, in this case the secret commission of 10 Million Euros, that was neither originally an asset of the principal nor the exploitation of an opportunity properly belonging to the principal could be the subject of a proprietary remedy. 
 
The significance of the answer to this question as Lord Neuberger noted would have profound implications for a Fiduciary’s unsecured creditors: 
 
”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.”
 
(per Lord Neuberger in FHR European Ventures LLP and others v Cedar Capital Partners LLC [2014] UKSC 45)
 
 
His Lordship, delivering the judgment of the Supreme Court of UK, affirmed the approach adopted by Lord Templemann in the case of AG for HK v Reid [1994] 1AC 324 in the Privy Council, stating that: 
 
 

“the notion that the rule should not apply to a bribe or secret commission received by an agent because it could not have been received by, or on behalf of , the principal seems unattractive.  The whole reason that the agent should not have accepted the bribe or commission is that it put him in conflict with his duty to his principal”

 
 
In giving judgment for the Claimant, Lord Neuberger unequivocally recognized the equitable principle that a bribe or secret commission accepted by an agent is to be held on trust for his or her principal on the basis that: 
 
 
”….where an agent acquires a benefit which came to his notice as a result of his fiduciary position, or pursuant to an opportunity which results from his fiduciary position,—
 
the equitable rule (“the 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.
 
In such cases, the principal has a proprietary remedy in addition to his personal remedy against the agent, and the principal can elect between the two remedies.”
 
 
Lord Neuberger’s dictum that the fiduciary) ‘is to be treated as having acquired the benefit on behalf of his principal, so that it is beneficially owned by the principal’
 
mirrors Lord Templeman’s words in the Privy Council case of Reid,  that ‘as soon as the bribe was received it should have been paid or transferred instanter to the person who suffered from the breach of duty’. 
 
Equity therefore proceeds on the basis of a fiction that —
 
since bribes received by a Fiduciary ought to have been handed over to her Principal  by virtue of the Fiduciary’s obligations, but were not done so in actual fact,–
 
Equity considers as done that which ought to have been done’ (Per Lord Templeman, AG for HK v Reid [1994] 1AC 324) —
 
with the device of the proprietary Constructive trust arising by law as the Equitable means by which such bribes are held on trust by the Fiduciary for her Claimant. 
 
Such a proprietary Constructive trust would hold not only the original bribes or its traceable proceeds on trust for the Claimant, but also any profits made by the fiduciary as a result of the receipt of the bribes: 
 
As Lord Templeman previously opined: 
 
The false fiduciary will receive a benefit from his breach of duty unless he is accountable not only for the original amount or value of the bribe but also for the increased value of the property representing the bribe. (AG for HK v Reid [1994]
 
 
 
Justifying a Constructive Trust arising by law: Breaches of Fiduciary Duty 
 
Prof. Graham Virgo points out that the species of constructive trust recognized by Lord Neuberger in the Supreme Court was—
 
an institutional rather than a remedial constructive trust; one that automatically arose by law and was: 
 
justified because the fiduciary is treated as though they had acquired the bribe or secret commission on behalf of the principal, who therefore has an equitable proprietary interest in it.‘ ( Virgo 2020, p. 482) 
 
 
What is not entirely clear from Lord Neuberger’s opinion, however, is the question of how property–in this case, bribes which neither emanated from the Vendor, nor which previously represented the traceable beneficial proceeds of the claimant—
 
could be treated as having been acquired by the Fiduciary —
 
for the benefit on behalf of his principal, so that it is beneficially owned by the principal and subject to a proprietary constructive trust.
 
I argue that the essence of the agent/fiduciary role and its correlative obligations and duties go to very heart of the UK Supreme Court’s analysis in FHR;
 
‘The fundamental principles of the law of agency’ were invoked by Lord Neuberger in recognizing the legal duty owed by an agent to her principal-
 
that of undivided loyalty, which if breached entitles the Principal ‘to the 
entire benefit of the agent’s acts in the course of his agency’–
 
an obligation analogous to that owed by an employer who ‘is vicariously liable to bear the burden of an employee’s unauthorised breaches of duty in the course of his employment.’  (Lord Neuberger [2014] UKSC 45)  
 
 
Additionally, an agent who breaches her loyalty owed to her Principal by accepting and retaining secret commissions or bribes —
 
could be described as acting unconscionably in respect of the property in her hands, thereby triggering a constructive trust over such property; 

Prof Alastair Hudson argues:

‘The judgment of Lord Browne-Wilkinson in Westdeutsche Landesbank v Islington reminded us that “conscience” is, and always has been, at the heart of trusts law in England and Wales as well as at the heart of equity” (Hudson 2016, p.22 )
 
This ‘heart of equity’ as Prof Hudson terms it gives Equitable principles their distinctiveness as a form of superior justice that ‘corrects Men’s consciences for frauds, breach of trust, wrongs and oppressions…’ ( Lord Ellesmere, the Earl of Oxford’s Case (1615) 21 ER 485)
 
Lord Browne Wilkinson went on to clarify in Westdeutsche Landesbank v Islington that a defendant’s conscience would be affected if he or she had knowledge that the property in her hands was meant to be held for the benefit of another: 
 
 “Equity operates on the conscience of the owner of the legal interest ….he cannot be a trustee of the property if and so long as he is ignorant of the facts alleged to affect his conscience, —
 
ie until he is aware that he is intended to hold the property for the benefit of others ….in the case of a constructive trust, of the factors which are alleged to affect his conscience.” (WestdeutscheLandesbank Girozentrale v Islington LBC [1996] UKHL 12) 
 
Following this analysis, the consequence of such a constructive trust fastening itself on the bribes in the hands of the agent who possessed the requisite knowledge that such bribes was to be held for the benefit of her Principal—
 
would be a proprietary constructive trust in favor or her principal rather than a mere obligation to provide monetary compensation.
 
As Lord Neuberger opined: 
 
”The agent’s duty is accordingly to deliver up to his principal the benefit which he has obtained, and not simply to pay compensation for having obtained it in excess of his authority.
 
The only way that legal effect can be given to an obligation to deliver up specific property to the principal is by treating the principal as specifically entitled to it.” ( Lord Neuberger [2014] UKSC 45
 
 
The idea that a Constructive could not arise in respect of property acquired by a Fiduciary on behalf of her Principal was rejected by Lord Neuberger as inconsistent with existing case law authorities:
 
The notion that an agent should not hold a bribe or commission on trust because he could not have acquired it on behalf of his principal is somewhat inconsistent with the long-standing decision in Keech, the decision in Phipps approved by the House of Lords, and the Privy Council decision in Bowes. In each of those three cases, a person acquired property as a result of his fiduciary or quasi-fiduciary position, in circumstances in which the principal could not have acquired it: yet the court held that the property concerned was held on trust for the beneficiary” (Lord Neuberger [2014] UKSC 45
 
 
An Institutional or Remedial Constructive Trust? Doubting the orthodox approach 
 
Further analysis reveals that an equitable proprietary right acquired under a constructive trust of such bribes arises on the basis of ‘two core principles’–
 
‘that a fiduciary is is disabled from acquiring profits made in breach of fiduciary undertaking and that the fiduciary must also act in the best interests of the principal’ ( Virgo 2020, p.482)  
 
 
Such an analysis rejects the remedial model of constructive trust which permits property rights to be modified by an invoking judicial discretion to ensure that justice is upheld;
 
After all, property rights do not just materialize automatically without a cause of action recognized by law, no matter how sympathetic a Court may be towards a litigant seeking equitable remedies. 
 
As Virgo asserts:
 
But the problem with the recognition of the remedial constructive trust is that the remedy must be triggered by a cause of action’ ( Virgo 2020, p.295).
 
Merely claiming that a defendant as been unjustly enriched at the expense of the claimant may not be justification enough to recognize a equitable proprietary right in the claimant’s favor over a personal remedy. ( Virgo 2020, p.295) 
 
Such perceived arbitrariness involving the variation of property rights to uphold a modicum of justice is frowned upon by leading Trust scholars and judges.
 
For instance,  Peter Birks characterized the remedial constructive trust as as a remedy that is —
 
ugly, repugnant alike to legal certainty , the sanctity of property and the rule of law’ ( Quoted in Virgo 2020, p. 294) 
 
While Professor Penner depicts the common intention constructive trust and proprietary estoppel as—
 
”more like an equitable mushroom that arises from the legal mycelium whenever conditions are right, not so much by the operation of rules governing title transactions, but as a remedy that is afforded on the basis of parties ongoing behavior, with particular attention to expectation and detrimental reliance.” ( Penner 2016, p, 127) 
 
Similarly, Lord Neuberger, speaking extra-judicially opposed the acceptance of the remedial constructive trust not only because—
 
‘ it would render the law unpredictable’, but that it would also ‘involve the courts usurping the role of the legislature; the creation of new property rights should be left to Parliament.” (Virgo 2020, p. 294).
 
And yet, English judges themselves have at times engaged in the variation of property rights of litigants when giving effect to the the existence of a  constructive trust arising by operation of law under specific circumstances. 
 
 
As Prof. Virgo notes: 
 
But the Supreme Court in FHR European Ventures LLP v Cedar Capital Partners LLC 2014 surely did create a new property right in bribe money which had not existed previously .” ( Virgo 2020, p. 294)
 
 
The Court did this by recognizing that equitable rights in the bribery money that was once beneficially the Vendors rather than the defendant’s was now vested in the Claimant despite the absence of any pre-existing proprietary rights in the same property enjoyed by them. 
 
What is clear is that the Institutional constructive trust arises by operation of law rather than any judicial discretion if a particular property transaction falls within the ‘recognized categories of constructive trust’ (Virgo 2020, p. 295) —
 
such as within the context a the vendor purchaser agreement. Such a principled approach to recognizing property rights is desirable within a jurisprudential development of the law that is defensible,  and continues to be given credence by English courts.
 
Yet, the rigidity of the institutional constructive arising by virtue of a defendant’s unconscionable dealings with a Claimant’s property may involve a failure to recognize the property ‘rights of third parties, such as the defendant’s creditors’. ( Virgo 2020, p.296). 
 
As Virgo clarifies: 
 
‘……third parties such as creditors of the defendant , should not be considered to be tainted by the defendant’s unconscionable conduct and so should not be disadvantaged by the constructive trust.” (Virgo 2020) 
 
 
I argue that Principles of Equity should be supple enough to recognize not just the enduring pre-existing proprietary  rights of a claimant whose property has been the subject of unconscionable dealings by a defendant who may have stolen it or received it under a mistaken belief that it was his or hers’; 
 
Equitable remedies should be flexible enough to allow for a just approach to the variation of property rights;
 
In this respect, Graham Virgo argues:
 
“It is possible to identify a model of the constructive trust which is principled but also flexible, without recourse to arbitrary choice.
 
This model builds on the orthodox institutional constructive trust…..by virtue of which the trust arises automatically by operation of law if the case fall within one of the  recognized categories of constructive trust.
 
This trust should, however, be capable of of modification by the judge to qualify some of the proprietary implications of a constructive being recognized.” ( Virgo 2020, p. 295) 
 
 
A more equitable allocation of property rights could possibly be achieved in situations involving the receipt of a Claimant’ property by innocent third parties or their creditors without abandoning the institutional model of the Constructive trust.
 
This could be achieved through the application of judicial discretion in allocating property rights only once such rights have come into existence by law through the operation of the institutional Constructive Trust. 
 
As Virgo argues, the recognition of such a modified constructive trust model ”is not necessarily inconsistent with authority, including the decision of the Supreme Court in FHR itself.” ( Virgo 2020, p. 295) 
 
 
 
 
References:
 
Alastair Hudson, “Conscience as the Organising Concept in Equity” (2016) 2 CJCCL 261-299
 
 
Graham Virgo, ‘ The Principles of Equity and Trusts’, Oxford University Press, 4th Edition, 2020. 
 
 

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