Equitable compensation for breach of fiduciary duty: a question of loss?

A director who extracted money from a company by way of sham invoices may have a defence to an equitable compensation claim for misappropriation of the company's funds, if the director could have lawfully transferred the funds to the same recipients for no value. The Court of Appeal explored this possibility in Auden McKenzie (Pharma Division) Ltd v Patel(1)

Background

• Mr Patel, the first defendant, was a director of Auden McKenzie (Pharma Division) Ltd, as was the second defendant, his sister. They were the sole directors and owned all the shares in the company. Between 2009 and 2014, in order to evade corporation tax and income tax, Mr Patel paid out £13.8m against sham invoices raised purportedly for "research and development", for which Auden received no value.

• Following investigations by HMRC which resulted in a settlement, Mr Patel paid £14.6m to HMRC in respect of income tax, national insurance contributions, and corporation tax, together with interest and penalties.

• Meanwhile, the Patels had sold Auden, which pursued them for "[d]amages and/or equitable compensation for breach of fiduciary duties". There was also a claim, among others, for all "such further orders, accounts, inquiries and declarations as shall be necessary or appropriate in order to fully compensate the Claimants for the Defendants' wrongs".

Auden applied for summary judgment in the sum of £13.1m (the aggregate amount paid against the sham invoices, less agreed credit for corporation tax paid by Mr Patel as part of his settlement with HMRC) plus interest on its claim "for damages and/or equitable compensation for breach of statutory fiduciary duties".

While Mr Patel accepted that he had acted in breach of his fiduciary duties as a director, he argued that Auden had suffered no loss — claiming that, if the payments had not been made unlawfully, the shareholders would have caused the company to make equivalent payments to them as dividends or in some other lawful manner.

The High Court held that Mr Patel could not rely on hypothetical payments in resisting summary judgment, when he had taken no steps to make those payments. Mr Patel appealed.

The Court of Appeal considers the "no loss" argument

The Court of Appeal's starting point on the question of equitable compensation was "the basic rule … that a trustee in breach of trust must restore or pay to the trust estate either the assets which have been lost to the estate by reason of the breach or compensation for such loss".₍₂₎  This rule extends to company directors.₍₃₎  Any compensation figure should be reduced by reference to the loss that flowed directly from the breach of trust.₍₄₎

The Court of Appeal held, as to the misappropriation by Mr Patel of Auden’s funds, that a defence might be open to Mr Patel that, if the misappropriation had not occurred, the funds would have been lawfully transferred to the Patels for no value. The Court stressed that it was "far from saying that Mr Patel has a defence that will succeed if he establishes the facts on which he relies", but nor was it "prepared to say that it is unsustainable in law".

The Court accordingly allowed the appeal and set aside the summary judgment.

Comment

This was a summary judgment application — therefore the issues were not fully ventilated — but the decision reveals a tension between an impetus to punish the director for his breach of fiduciary duty, and the fact that the real loss to the company might have been nil. The Court of Appeal described claims for equitable compensation as a developing area of the law. The facts in this case, described by the Court as "striking" and "stark", may test the willingness of the trial court (due to hear the matter later this year) to develop the equitable remedies for breach of fiduciary duty.

(1) [2019] EWCA Civ 2291.

(2) Target Holdings v Redferns (a firm) [1996] AC 421, 434.

(3) Sinclair Investments (UK) Ltd v Versailles Trade Finance Ltd [2011] EWCA Civ 347, [2012] Ch 453 [34].

(4) Target Holdings v Redferns (a firm) [1996] AC 421; AIB Group (UK) plc v Mark Redler & Co [2014] UKSC 58, [2015] AC 1503.