Partner remuneration and fiduciary breaches – forfeiture, penalties and unlawful deductions after Hosking v Marathon: what can firms and partners do to protect themselves?
Overview
In the recent case of Hosking v Marathon Asset Management LLP [2016] the High Court in London, on appeal from an arbitration award, held that if a partner or LLP member breaches their fiduciary duties, they can forfeit their right to some or all of their profit share, whether or not it has already been paid to them.
In this alert we summarise the Marathon case and discuss how partnerships and LLPs might apply the forfeiture principle in practice (or choose not to as the case may be), the related risks and how they might consider reducing them as far as possible. We also consider potential steps that a partner or LLP member might consider taking in response to a firm’s attempt to forfeit their profit share, including whether an LLP member may potentially rely on statutory worker claims, such as an unlawful deductions claim, to challenge the forfeiture of their profit share.
The Marathon case is an important decision for partners or LLP members (referred to interchangeably as partners in this alert, unless stated otherwise) in England who may be involved, for example, in a team move or in setting up a business in competition with their current firm where those actions breach their fiduciary duties. They may not only find themselves potentially at the wrong end of a claim or injunction proceedings, damages or an account of profits (which are the usual remedies for breach of duties in a partnership or LLP context), but may now also risk forfeiting profit share which has already been paid, or which is due to be paid, if the court finds that such a remedy is proportionate and equitable.
Fiduciary Duties
Fiduciary duties are owed by persons who act in the capacity of a fiduciary, on the behalf of others and occur “where a person assumes responsibility for the management of another’s property or affairs” (see F&C Alternative Investments (Holdings) Ltd v Barthelemy and others [2011]). One example is an agent, who owes fiduciary duties to their principal. Another example is a board director, who owes fiduciary duties to the company of which they are a director. The main fiduciary duties are not to act in conflict, not to compete, to give undivided loyalty and not to profit at the expense of the person to whom the duties are owed (this list is not exhaustive). The duties which arise in each fiduciary relationship will be different depending on that relationship, and duties can be modified by agreement.
Case Summary
The Marathon case concerned Marathon Asset Management LLP (“Marathon”), an investment management fund, which provided for two types of LLP members in its LLP Agreement: “Executive Members” and “Non-Executive Members”. Executive Members were “required to diligently employ [themselves] in [Marathon’s] business” and devote all their time to that business and received a full share of income profits. Whereas, Non-Executive Members were founding LLP members who no longer worked in the business, and who received a half share of income profits.
Mr Hosking was a founding member of Marathon and an Executive Member. He gave notice to retire which took effect on 11 December 2012, and thereafter became a Non-Executive Member. Prior to retiring, however, and in breach of his contractual and fiduciary duties, Mr Hosking had engaged in discussions with four of Marathon’s employees about the possibility of starting a new business which would compete with Marathon and produced a plan outlining his thoughts. Those employees left the business.
Marathon commenced arbitration proceedings against Mr Hosking. The arbitrator found, having been significantly influenced by the terms of the LLP Agreement, that the 50% additional profit share received by Executive Members (compared to the Non-Executive Members) was actually remuneration for their performance of executive duties, including fiduciary duties. As the arbitrator found that Mr Hosking had seriously breached his fiduciary duties, and it is well-established that a fiduciary who acts in breach of their fiduciary duties to their principal can lose their right to remuneration, he decided accordingly that Mr Hosking should forfeit the 50% additional proportion of Executive Member profit share paid to him in respect of the period in which he was in breach of his duties. This amounted to £10,389,957.50.
Mr Hosking appealed to the High Court arguing that the forfeiture principle has no application to profit share, as it is payable to the LLP member in consequence of his interest in the partnership and not as remuneration for services. The High Court dismissed the appeal and confirmed the arbitrator’s view that the forfeiture principle could potentially apply to a partner’s profit share where it was proportionate and equitable to do so in the circumstances. It was held that the key consideration when deciding whether or not a payment made to a partner is susceptible to forfeiture for breach of fiduciary duty is the substance of the payment, rather than the form. Although it may often be difficult to characterise all of, or any particular part of, a partner’s or LLP member’s profit share as remuneration, that did not mean that it could never be the case.
What are the implications of the Marathon case for Partnerships and LLPs?
Some firms may welcome the decision in Marathon as providing an additional remedy for, and therefore deterrent against, breaches of fiduciary duties by misbehaving partners, on top of the potential remedies already available, which include an injunction, damages, or an account of profits.
Firms will need to consider carefully whether they should seek to rely on the forfeiture principle and if so how they might reduce so far as possible the risk of any potential successful challenge by an affected partner. In this regard firms may wish to consider taking the following steps (non-exhaustive and not mutually exclusive):
- Consider whether it may be appropriate for the Partnership or LLP Agreement (“the Agreement”) to set out what proportion of profit share is to be considered as remuneration for specific duties undertaken on behalf of the firm and what proportion relates to the partner’s membership or ownership interests in the firm. The proportion that has been identified as relating to remuneration may then potentially be liable to forfeiture.
- Include an express and clear contractual right of forfeiture of all or part of an individual’s profit share in the Agreement for breach of fiduciary duties. A firm would have to consider carefully how they calculate the amount of profit share the partner should forfeit. Will it be all profit share due throughout any period of breach? Or a proportion of profit share in line with the severity of the breach, or perhaps a fixed percentage? Each method of calculation may be potentially open to different legal challenges. Forfeiture cases have suggested in the past that although it may be proportionate and equitable to forfeit all or a significant proportion of a fiduciary’s remuneration in some circumstances, in others, for example, in an employment relationship it may be less likely to be held to be proportionate and equitable to do the same in the context of a single breach which takes place during a longer relationship.
- Include a clear and express contractual right of set off in the Agreement, drafted widely enough to allow the firm to set off the amount of forfeited profit share (which has already been paid to the partner or member) against any other sums due to the partner on their exit, for example return of capital (subject to any undertakings from the firm to the bank in respect of a related partner capital loan) or tax reserves, without first having to bring litigation and obtain a judgment for forfeiture of profit share.
- Collate any evidence and produce written reasons showing the firm’s grounds for believing that the partner is in breach of their fiduciary duties, together with an explanation of how the sum forfeited was determined. Ideally the partner should be allowed an opportunity to make representations (which should be taken into account) before a conclusion is reached and applied, as to whether profit share will be forfeited and how much. This may make it more difficult for a partner who has been acting in breach of their fiduciary duties to challenge later the grounds for the firm’s withholding of their monies.
On the other hand some firms may find the uncertainty and potential risks of relying on the forfeiture principle too great, as doing so could lead, for example, to a legal challenge from the affected partner (see more on potential claims from partners below). Therefore, such firms may wish to reduce the possibility of the forfeiture principle applying at all by including drafting in their Agreement which makes it clear that all of a partner’s profit share relates to their ownership interest only and no proportion of it is to be deemed as remuneration for services provided to the firm.
An additional, or alternative option, is to contractually exclude the operation of the forfeiture principle: an option referenced in the Marathon case itself.
What are the implications of the Marathon case for partners and LLPs members?
For departing partners who are allegedly or actually acting in breach of their fiduciary duties, by for example co-ordinating a team move or diverting clients to a new firm, the Marathon case may provide a way for the firm to avoid paying their profit share. Or in the event that all or the majority of a partner’s profit share has already been paid out before any alleged breach of fiduciary duty is discovered, the firm may seek to rely on a contractual right of set-off to deduct any sums they consider should be forfeited for breach from other sums held and owed to the partner, such as capital, and other balances.
So what options might a partner have to mitigate the risk of or resist such action as far as possible?
- A partner may seek an indemnity from any potential new firm, to reimburse them for any loss they may suffer if they join the firm by way of withholding of profit share or any other balances owed to them and held by their old firm. The new firm will need to take their own advice on the appropriateness and substance of a requested indemnity, as there are inevitably pros and cons to this.
- A contractual forfeiture provision in an Agreement, depending on how it is formulated and applied, may be open to challenge as a penalty clause. However partners and LLP members may find it more difficult to establish this argument following the decision in Cavendish Square Holding BV v Talal El Makdessi [2015] as they now have to show that the detriment imposed by the contract (in this case, forfeiture) is out of all proportion to any legitimate interest the firm may have in the enforcement of the relevant primary obligation. Given the importance of fiduciary duties to the partnership and LLP relationship and the relatively equal footing of the parties, it may be arguable by the firm that the forfeiture clause is proportionate to ensuring a partner’s compliance with their fiduciary duties and therefore not a penalty.
- A partner may also seek to argue that the manner in which the firm applied the forfeiture rule was disproportionate and inequitable, and that relief from forfeiture should be granted.
- If the partner is an LLP member, and accordingly has worker status, they might consider bringing statutory worker claims to seek to recover some or all of the withheld profit share:
- Unlawful deduction from wages claim – if the firm does not have authority to withhold monies in their Agreement or other contractual agreement with the member, it may be arguable that any deduction made from a partner’s profit share without first obtaining a court order is an unlawful deduction from wages. There is little guidance as to whether and the extent to which an LLP member’s profit share would amount to remuneration for the purposes of an unlawful deductions claim; it would no doubt depend on the particular circumstances of the case as to whether the profit share falls within the wide definition of “remuneration” for the purpose of the Employment Rights Act 1996 (ERA). Notably ERA provides that where an order is made against an employer (which would include the LLP) in an unlawful deductions case, the employer is barred from later attempting to recover that money in another way by, for example, bringing an action for forfeiture in the civil courts. Additionally short limitation periods apply to such a claim and there is no opportunity for the firm to counterclaim in an unlawful deductions claim.
- National Minimum Wage claim – as workers, LLP Members should be receiving the appropriate level of national minimum wage, so if a firm sought to withhold all or a substantial amount of annual profit share, it may be that the LLP Member would no longer be receiving the national minimum wage. The LLP Member may therefore seek to enforce their right to the national minimum wage by way of an unlawful deductions of wages claim or a breach of contract claim. The firm may also be subject to enforcement action.
- Holiday Pay – equally as a worker an LLP Member is likely to be entitled to paid holiday. If all of their profit share is withheld and that has the effect that they do not receive payment in respect of holiday pay the partner may be able to bring a claim for the holiday pay due.
Conclusion
The Marathon decision will require that firms, exiting partners and LLP Members tread carefully when it comes to breach of fiduciary duties and the remedy of forfeiture. Firms should be careful not to be too heavy handed when seeking to rely on forfeiture provisions and protect themselves as far as possible by including appropriate contractual provisions giving them the right and scope to do what they seek to do. Partners would be well advised to ensure they are fully aware of and have regard to their fiduciary duties (as well as their express and any implied duties), particularly if they are contemplating a new venture which may be in competition with their present firm.
Wonu Sanda and Sarah Chilton
CM Murray LLP
Sarah Chilton is a partner at CM Murray LLP, specialist partnership and employment lawyers regularly advising international employers with UK operations, and UK employees on a variety of employment law issues. She advises on English and Scottish employment law issues.
Wonu Sanda is a Trainee Solicitor at CM Murray LLP and specialises in partnership and employment law. Wonu has a background from the Bar, having been called to the Bar of England and Wales in 2012, and regularly helps Partners to advise on a range of issues in employment and partnership disputes and exits.
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