Employee Representation on Boards: Meaningful reform or a palatable policitcal response?

Theresa May has reignited the debate about whether boards should have employee representation. This will be similar to the practice on the continent in countries such as Germany, where worker participation is the norm in larger companies.

It is a response to tackle what many see going on in the corporate world as corporate greed, self-interest, malpractice and the like. Employee representation can help tackle this problem of immediate profit above all else by putting stakeholder interests at the heart of the company's decision making, referred to as the 'relational company' model. To this end, it is hoped we would see far fewer instances of the 'unacceptable face of capitalism'.

This is not all, it is part of an ongoing trend in company law reform to shift the burden from the state to internal measures to remedy corporate misfeasance. By placing control and decision making in the hands of those interested in the company they can rectify and/or remedy instances of corporate failure internally without the need for state interference.

So will employee representation really bring an end to profit above all else and radically reform corporate law? Here are some considerations as to why I think that answer would be 'no'.

One must first begin with 'what is the company'. It is a separate legal entity. It is the same as you or I are, legally speaking. Its differences are only practical. The same could be said of two natural persons, whereby legally they are treated the same as individuals but consist of practical differences. The end result is that the law seeks to adapt to those practical differences to remedy any potential unfairness whereby those practical differences cause an imbalance in any relationships one holds with another party. For example, a parent and a child are legally treated the same as individuals but hold practical differences. So when the two individuals engage in a relationship the law responds to account for those practical differences between the two individuals i.e. through aspects of family law.

Therefore, a company is able to own property, enforce its legal rights, have legal rights enforced against it and so on just as any other individual. But it cannot do this itself due to its practical limitations. It has no eyes to see, no ears to hear, no hands to write. It requires individuals to act for it. The right to do so is traditionally given to the directors. The right is derived from the company's constitution. Therefore it is the company, exercising its right, to allow another to act for it. Again, this is no different from, say, a natural person who does not have the capacity to act and requires someone to act for them, such as an individual with a severe disability.

So, how does the law respond to the practical differences where one is required to act for another? Anyone who undertakes to act for another's interests is recognised as owing them duties. A trustee will owe duties to beneficiaries. A director owes duties to the company. Equity imposes these duties to ensure the power the person has over the other is exercised in a manner society deems as 'proper'. In most instances this involves four key duties: 1) proper performance; 2) best interests; 3) care and skill; 4) loyalty. Arguably (1) is not a duty as it is simply an interpretation of the powers given to determine if they were exercised for the purpose given. But I do not want to get side tracked...

Therefore, the individual acting for the other, in this case our director, is acting in the other's interests, the company. Here we have the first issue with a relational model of the company. If one is to put the interests of the stakeholders at the heart of decision making, the law will only allow you to do that insofar as it is in the best interests of the company. Otherwise it would be treating the company differently from a natural person, which is not allowed. You could not legally force the company to put the interests of the stakeholders at the heart of the decision making process because it is tantamount to someone telling a natural person to put another's interests at the heart of their decision making process. The governance reform would then have no legal teeth. The law requires the directors to put the company's interests at the heart of the decision making process, not the stakeholders.

This then leads to the second problem. With its one-tier board the UK imposes the same duties on every director, whether they are an employee representative or not. Therefore, an employee representative can only put the employee's interests at the heart of the decision making process where it is in the interests of the company to do so. This further leads on to how an employee representative will be incentivised. The current remuneration packages of directors are all based on profit metrics that favour a shareholder-centric model of board governance. If employee's are incentivised in the same way, agency theory would tell us that they would only prefer the employee's interests as long as it favoured their own. If they are incentivised the same way as other directors, group-think would undoubtedly set in, as relying on the representative to make the decisions in the employee's interests where they stand to gain by making decisions against them is going to cause a considerable conflict of interests. The alternative is to incentivise them differently, which would artificially create a two tier board, which may very well cause division and split on the board rather than unity and cohesion.

This also shows that in the UK, we technically do have employee representation on boards already. The board are required to act in the company's best interests. What is the company's best interests will often involve a consideration of the effect decisions will have on stakeholders. But this is only one consideration for the board, as it would be for you or me when we make decisions. Ultimately it comes down to what is best for the company, but to legally require anything else would be a major shift in the way the company is perceived and treated.

The UK approach to the company is pragmatic. The company is a separate legal entity and anyone acting for it has to put its interests first to account for its practical limitations. It shows that May's proposal is a palatable political response in an attempt to shift company regulation away from the state to internal measures by giving workers a voice on corporate boards. The end result is that when the next corporate scandal hits, government can blame the company rather than the system. However, this shows that the governance reform is unlikely to do much to change the way a company is run and for whom because the law would not facilitate this change. If you want to less of the unacceptable face of capitalism, May needs to recognise the company as a separate legal entity and take measures to strengthen the rights of those involved with the company i.e. special legislation on zero-hour contracts; enforcing existing employee rights; easier means to enforce consumer rights; better standards on environment pollution; better standards on community projects and infrastructure. Simply expecting all these things to happen by putting an employee on the board and doing nothing else is beggar's belief.

A final thought is that developing employee representation in the UK on the basis of analogy, overlooks the corporate governance failings those jurisdictions have seen. It was only last year the Volkswagen scandal broke. No amount of employee or stakeholder representation stopped what the legal rules did little to prevent. Governance reform is not meaningful reform. If you want change you need to make it in the individual's interests to chose that method of behaviour. Plastic bags, smoking, alcohol, even Pokémon Go are recent examples of modifying behaviour and none of these changes relied on just telling people to behave in a different way.

Fiduciary duties of investment intermediaries: Commission Report published

Today, the Law Commission published its report after consultation on fiduciary duties of investment intermediaries. The four documents published today as well as previous documents leading to the report can be found here. 

Eckerle & Ors v Wickeder Westfalenstahl GmbH [2013] EWHC 68

Introduction
The decision in Eckerle is of some significance to company law. It concerned the ability of a beneficiary in an investment chain being able to enforce rights within the company as a member within the definition of the Companies Act 2006, s. 112. The decision reached by Norris J caused him to remark that he had not reached 'a particularly comfortable conclusion, but reaching any other conclusion would involve an impermissible form of judicial legislation'. This has lead to debate about the role of investment intermediaries and their legal obligations with recent discussion on how if at all the law should be reformed to allow the ultimate beneficiary in an investment chain to exercise rights against issuers of securities.

Here I will give a brief summary of the case and discussion.

Facts and judgment
DNick Holding plc, registered in England but operated in Germany, was owned by Wickeder GmbH who acquired 75.005% of the company's shares (albeit through an intermediary, the significance of which is detailed below) giving it enough control to pass a special resolution (75%), which is required to make certain changes within the company.

The board of DNick proposed to cancel its shares and re-register as a private limited company (Ltd) for a public limited company (plc). This caused a drop in value of DNick's shares. A meeting was called and a special resolution was passed to re-register with Wickeder using its 75.005% ownership to secure it. The meeting was attended by shareholders (or their proxies) representing 83.71% of the vote.

Eckerle and Ors were claimed (claimed being the operative word) to be minority shareholders owning 6% of the issued shares. They commenced proceedings against Wickeder under section 98 of the Companies Act 2006 to have the resolution cancelled on the basis that they had standing to do so.

The Act under section 97 provides a company may re-register as a private company provided the conditions are met in this section and no application under section 98 has been made to cancel the resolution to re-register. Section 98 itself provides who may make such an application for cancellation and this includes: (a) the holders of not less in the aggregate than 5% in nominal value of the company's issued share capital; (b) ...; (c) ...; but (2) not by a person consented to or voted in favour of the resolution. Under subsection (3) the court may then make an order either cancelling or confirming the resolution.

Wickeder sought to strike this claim out, inter alia (see para [11]), on the basis there was no reasonable grounds on which the claim could be brought; or alternatively for summary judgment. The decision focused on the considerations set out for summary judgment and the dispute about the construction of the provisions in section 98 (see para [12]).

The key/common facts were laid out in para [14]. An important fact to note was that according to the share register DNick only had two registered shareholders who held the 5,671,318 issued ordinary shares. Dr Platt (CEO of Wickeder) held 1 share and the Bank of New York Depository (nominees) Ltd (BNY) the remainder. BNY acted as a depository of the issued shares, holding those shares on trust for account holders with Clearstream according to the account holder's respective holdings in Clearstream Interests (CI). Clearsteam was the settlement division of Desutsche Borse. Through Desutsche Borse trades on the relevant exchange between Clearstream account holders are transacted electronically. These account holders could not be individuals and could only be banks or financial institutions. What was traded on Desutsche Borse was the underlying ownership rights in DNick shares the CIs but not shares in DNick themselves. The trades were between Clearstream account holders, concluded on behalf of the customers of those account holders, who could be described as the end investor or ultimate beneficiary. Thus Eckerle and Ors plead to have 7.2% in the nominal value of the issued share capital but, in truth, they only have the ultimate economic interest in those securities which amounts to a specified percentage of the shares held by BNY on trust for Clearstream account holders whose customers Eckerle and Ors are.

As you can see, the claimants were far removed from the being the owners of the shares and simply held the economic interest in those securities. BNY held the shares, who held them on trust for Clearstream account holders whose customers the claimants are. They were 3 times removed in summary. This means when dividends are paid they are paid to BNY. Although the Articles did allow direct payment to Clearstream account holders who would ultimately account to its customers.

According to the facts set out at para [14] the company's articles provided that 'each person who is a CI holder at the relevant CI record date' can either direct the registered holder of the share how to exercise the vote attaching to the underlying share or to appoint a proxy to do so (who might be the end investor).

Thus it became important to identify who was the CI holder as it would give them the right to direct a vote or appoint a proxy. A CI holder was interpreted, according to the Articles, to mean 'the holder of [an interest in the shares in the capital of the company traded and settled through Clearsteam]'. They are then identified by the electronic register of CI holders. The only interests traded and settled through Clearstream are the interests of Clearstram account holders which were the banks and/or financial institutions. Only they fitted this description and so the right to appoint or direct would fall to them, not the account holders' customers. The Articles under Article 10 continued that DNick did not recognise beneficial interests and made clear they would not recognise any right except an absolute right to the 'entirety thereof in the registered holder'.

All of this ultimately lead to an initial observation that there is potentially a 'serious loophole in the protection afforded to minority shareholders'.

It was submitted for the claimants that, essentially section 98 should be interpreted widely and construe the provision as to who were holders as those who were shareholders in all but name and not simply those registered as holding the shares. At para [15] it was argued that: (1) section 98 should be construed with regard to the deliberate use of the terms 'holder' and 'person' instead of member; (2) alternatively the provision in section 145 should be approach purposively to enable the claimants to exercise rights otherwise vested in a member to enable that person to protect the economic value of their shares; (3) alternatively the common treatment of the holder of the ultimate economic interest as if he were a shareholder should mean in the present case that the prospects of the claimants showing that they were entitled to the relief they claimed cannot be dismissed as fanciful (required to allow the claim to proceed under the Civil Procedure Rules)

The first point was addressed that member or shareholder is one and only one (para [18]) citing at para [17] National Westminster Bank plc v Inland Revenue Commissioners [1995] 1 A.C. 119, 126. Therefore the claim that the term 'holder' should be interpreted widely was seen as needing an extremely strong reason to do so so as to depart from the orthodox understanding. Norris J continued at para [19] that the whole basis of the 2006 Act proceeds on the this basis as to the definition of a member, which is found in section 112 and concluded that the person who is registered as a member is rightfully deemed the holder of said shares. Thus, the definition does not include the person holding the ultimate economic interest. Norris J, at para [20] did not believe the specific use of the term 'holder' in section 98 should mean the court should look to the holder of the economic interest on the basis the other two subsections in section 98 referred to 'member'. He continued that under section 98 the court can only adjourn to have the shares purchased from the dissenting members. Therefore no relief could be granted to the holder of the ultimate economic interest.

Norris J continued in his reasoning that section 260 makes provisions in respect of rights directly enforceable by non-members, under section 260(5)(c) which states a member includes a person who is not a member but has been transferred shares in the company or has had them transmitted by operation of law. It was stated in Enviroco Ltd v Farstad Supply [2011] UKSC 16 at [37]-[38] that the term member is defined by section 112 and is a fundamental principle of company law and can only be departed from where expression provision allows it. Without such a principle company law would be unworkable.

Therefore section 98 does not apply to anyone expect those who are on the register.

However, Norris J continued to express reasons why summary judgment would not be given in favour of the claimants. He cites the Explanatory Notes for the 2006 Act at paragraph 210 and notes nobody believes on a true construction that section 98 extends to anybody beyond those members on the register.

Norris J further adds that the provisions in the Articles did not protect the claimants. These only provided that account holders i.e. Clearstream account holders (the banks or financial institutions) could direct BNY on how to vote or require BNY to appoint the account holder as proxy. Therefore the account holders could direct BNY as a member how to exercise its votes. As a result no rights are conferred upon the customers of the account holders under the articles.

To continue Norris J cites section 145 that provides anything required or authorised to be done by or in relation to the member shall be done or may instead be done by or in relation to the nominated person... as if he were a member of the company. This generally allows the nominated person to act is if they were a member of the company. However, section 145(4) adds that the section, nor does the Articles, 'confer rights enforceable against the company by anyone other than the member'. Norris J states at para [26] that these provisions were introduced due to investors increasingly holding their shares through intermediaries. Norris J elaborates at para [26], citing Hannigan, that company law 'demands a mechanism whereby the indirect investor can engage with, and be recognised, by the company'. But Hannigan admits such a mechanism, whilst ideal, would, in practice, be difficult. Hannigan, as cited by Norris J, states section 145 is a modest step forward in achieving this but is not a radical departure from recognising the member as the one who is registered as such.

Therefore section 145(4) does not confer enforceable rights on anyone expect for the registered shareholders, which in this case is Dr Platt and BNY. Therefore failure to recognise the nominated person or afford them the same treatment as if they were a member, does not give enforceable rights to that nominated person. The only person who can enforce is the registered shareholder. At para [27] Norris J, citing Buckley, gave the example of failing to notify a nominated individual of a meeting. Whilst the company has to recognise that nomination and inform them accordingly, failure to do so would only allow the registered shareholder to challenge that failure.

Norris J concluded that from the submissions presented none lead to the conclusion that the account holders, let alone the claimants could enforce section 98. He states at para [29] 'These passages simply mean that the statutory rights that are directly exercisable by the nominated person are those which enable the right conferred and transfered by the articles to be effectively transferred'. He notes that this is why section 145(2) operates 'so far as is necessary to give effect [to the provision in the company's articles enabling a member to nominate another person as entitled to enjoy or exercise ... any specified rights of the member in relation to the company]'. Norris J stated that this 'does not mean that if the effective exercise of the transferred right produces a result that is not to the taste of the nominated person then the nominated person can, in order to bring about his desired outcome, himself use any of the provisions of the 2006 Act available to the transferring member'. As a result Norris J concluded the claimants were neither holders within a true construction of section 98, nor did section 145 enable them to bring a claim. Norris J also noted that there was no expectation beyond what the Articles said that would allow the ultimate beneficiaries to enforce said rights on the basis of the well known dicta in Re Astec (BSR) plc [1999] BCC 59, 87 that made clear that such expectations have no place in public listed companies and the public dealing in the market proceed on the basis of what is in the Articles.

Finally, Norris J suggested that it could add BNY as a party to the proceedings but deemed this would not be capable as BNY was a person who had voted in favour of the resolution to re-register the company as private and could not make an application under section 98 which bars those who voted in favour from doing so. This, in itself, was seen as problematic at para [32]. If the holder of the legal interest in the share has been instructed to vote in favour of the resolution it will make them incapable of  commencing proceedings for any ultimate beneficiary dissenting from the resolution.

All of this lead to Norris' J uncomfortable conclusion that the ultimate beneficiary would be deprived of protection, which those who formulated the 2006 Act thought should be extended to.

Summary
In summary, the claimants were not members. They could not apply under section 98 to have the re-registration cancelled, nor could they apply under section 145 to enforce rights as nominees because they were not nominees and by any means this section does not confer enforcement rights on nominees, those are vested in the shareholders only. As well BNY could not commence proceedings on behalf of the ultimate beneficiaries as it had barred itself from doing so by voting in favour of the resolution.

Discussion
It seems quite right to postulate that investment has become so complex that investors are prevented from exercising their rights against the issuer. It is agreed that giving a mechanism to allow the end investor to enforce rights is likely to be impractical, as Hannigan argued, potentially opening up the floodgates to claims including duplicate claims, as well as the increased cost and time in maintaing a accurate share register. However, moving away from the orthodox concept of 'member' may not be catastrophic if approached with the right caution. The 2006 Act itself moved away from another fundamental principle of company law, namely majority rule, with the introduction of the statutory derivative claim, allowing any member to enforce a right vested in the company in respect of a breach of duty, trust, default or negligence. This removed the bar of wrongdoer control and the rule in Foss v Harbottle (1847) 67 ER 189, which only allowed a derivative claim to proceed in the common law where it was shown  the wrongdoers were in control of the company, because where they were not it was for the majority to decide if the company should litigate and not an individual shareholder. This was overcome by putting relevant restrictions in place on allowing a claim, such as mandatory bars where the conduct has been ratified or authorised by an unconnected majority. Further the court is given the discretion to consider whether the conduct is likely to be ratified or authorised as well as taking in to consideration the views of disinterested shareholders. Cases brought under the new statutory claim have also been dismissed at the court's discretion where wrongdoers were not in control, so whilst it is not a bar to a claim, the court may use its discretion when determining whether to allow a claim and consider the issue of wrongdoer control. Therefore, it is tentatively suggested that it may be appropriate to open up derivative claims to end investors, extending section 260(5) or introduce a similar concept that allows end investors to litigate pending court approval. This may eliminate the objection raised by Hannigan about cost and the issue of the floodgates being opened by imposing appropriate safeguards on standing. As well, the law reformers may draw on many areas for inspiration where protection for end users has been developed, which was seemingly difficult if not impossible before intervention such as the Consumer Protection Act 1987, part 1 which protected consumers from defective products put in to the market by manufacturers.

Another concern is the intermediary who acts for multiple beneficiaries. In this case it may have been in the interest of some of its end investors to vote in favour of the resolution but not for others. However, initially it seems, BNY would not have acted against their duties in doing so. They have acted in the interests of the end investors by voting the way they believed to be the best interests of the end investor or were subsequently instructed to do so by Clearstream account holders who equally would have instructed based on what they believed to be the best interests of the end investors. Being barred from applying to the courts was a result of the statute and not mala fides.

Whether there is a fiduciary breach would require deeper analysis. Yes, the position can rightly be described as fiduciary but it is not clear if the duty of loyalty would have been breached. This requires a conflict of interest, which itself requires the fiduciary (i.e. the investment intermediary, in this case BNY and Clearstream account holders) to suspend self-interest and the interest of others and act in the sole interests of the beneficiary. By acting for multiple beneficiaries it is possible a conflict has arisen between the interests of the respected beneficiaries and if that is so the only way the intermediary may immunise themselves from liability is to get authorisation to act or alternatively demonstrate that there was not a conflict. The latter would require the fiduciary to demonstrate that they had not taken responsibility for the particular interest of the beneficiary allowing them to act against it for others. See, for example, Kelly v Cooper [1993] A.C. 205. The question then is whether by acting for multiple beneficiaries and voting on the same resolution, is this a conflict of interest? My answer would be yes. There is a risk that by acting for more than one beneficiary that their loyalty to one may compromise their loyalty to the other, similar to that seen in Extrasure Travel Insurance v Scattergood [2003] 1 BCLC 598. However, a further problem here is that even if it is a breach, the end investor may still be left without a remedy since in duty-duty conflicts the fiduciary may not profit personally. Therefore there is no profit to disgorge to the end investor. They would then have to try and claim equitable compensation but this requires causation i.e. a link between the actions of the fiduciary and the loss suffered. This may be difficult to show that the way they voted caused the loss suffered since one investor (Wickeder) "owned" 75.005% thus the loss would seemingly have been suffered regardless but I think this needs more analysis to be certain on how difficult it would be to prove than this blog post will offer.

As well, claiming this is a breach of fiduciary duty may cause practical problems for investment intermediaries as it would seemingly impact on their ability to act for clients without authorisation, which in turn may increase the cost of engaging with an investment intermediary.

Law Commission Consultation on Fiduciary Duties of Investment Intermediaries with Hogan Lovells

Yesterday I attended a Consultation Workshop at Hogan Lovells LLP on the Law Commission's Consultation on Fiduciary Duties of Investment Intermediaries. The event was attended by a variety of people from different backgrounds including trustees, academics, lawyers and fund managers to name a few. The Panel consisted of three members, David Hertzell - Law Commissioner; Nick Cray - Chief Operating Officer at Hogan Lovells; and Dominic Hill - Partner in the financial services department at Hogan Lovells.

The Consultation was a result of the Kay Review - see here for Consultation paper and Kay Review - that stated that a series of recommendations, particularly recommendation 9 that stated 'The Law Commission should be asked to review the legal concept of fiduciary duty as applied to investment to address uncertainties and misunderstandings on the part of trustees and their advisers'.

I hope to respond to the Consultation in detail but below I outline some initial observations that I wish to explore further at a later date. I intend this blog post to initially be putting my thoughts down from what I know and most would require further investigation to reach substantive conclusions.

From Kay Review and Consultation Paper two areas could be discussed. First, who in the investment chain owes fiduciary duties. This the Law Commission sees as a difficult question given the flexibility of fiduciary duties, but I believe this is caused by a misconception and a need to separate the two elements of a fiduciary that are first, when does the duty of loyalty arise and second, if so, what is the scope of that duty. This approach can be seen in University of Nottingham v Fishel [2000] I.C.R. 1462, 1494. Failing to do that it can often lead to erroneous statements such as those cited from Henderson and Others v Merret Syndicates Ltd and Others [1995] 2 A.C. 145, 205 that not all fiduciaries will owe the same duties in the same circumstances. This cannot be correct given Lord Millet's judgment in Bristol and West Building Society v Mothew [1998] Ch. 1 that the duty peculiar to fiduciaries is the duty of loyalty. If the duty peculiar to fiduciaries is the duty of loyalty then all fiduciaries must owe the duty of loyalty. Whilst not endorsed specifically, this seems to be supported by Sedley LJ in Plus Group Ltd v Pyke [2002] EWCA Civ 370 at [80]. To ascertain when the duty of loyalty arises one must consider three questions. What is the duty of loyalty, what is the purpose of it and finally when is that purpose fulfilled. If someone is determined to owe the duty of loyalty they are subject to the full expanse of fiduciary jurisdiction. If someone owes the fiduciary duty of loyalty one can turn to the second issue as to the scope of that duty. With this application to investment intermediaries it may become apparent who does and does not owe fiduciary duties in the investment chain.

This leads to another area that needs further consideration in respect of Kelly v Cooper [1993] AC 205, discussed 11.28-11.38, which considers terms of a contract may limit the scope of fiduciary duties. In essence this is true. This limiting of scope is on the basis that equity cannot alter the terms of a contract validly entered in to. As seen in Ranson v Customer Systems plc [2012] EWCA Civ 841 at [68] equity needs something to be "hung from". Therefore the duty is circumscribed by what the parties agree as someone cannot be loyal for something they did not take responsibility for. However, the courts must be careful as to what they imply in to contracts between parties as they did with Kelly v Cooper. There needs to be some differentiation between conflicts and interests in proposed transactions as is the case in the Companies Act 2006 with ss. 175 and 177. s. 177 breaches may be excused where a principal ought reasonably to have been aware of the conflict but s. 175 breaches require full disclosure with authorisation to act. Implied terms that the estate agent is authorised to act for multiple principals is unlikely to amount to full disclosure with authorisation.

The second issue in respect of the Law Commission's consultation concerns best interests. The question/statement I raised was how to promote best interests beyond short-term financial gain? The Commission looks at whether the law allows financial intermediaries and trustees to consider the long-term interests of the ultimate beneficiary through investment beyond the short-term interest of financial gain through transactions. The answer to this question seemed to be a resounding yes that the law does allow intermediaries to consider wider, long-term interests. This was evidenced in Chapter 10 of the Consultation paper by cases such as Cowan v Scargill [1985] Ch. 270; Harries v Church Commissioners [1992] 1 W.L.R. 1241; Martin v City of Edinburgh District Council [1989] Pen. LR 9, 1988 SLT 329; and Buttle v Saunders [1950] 2 All E.R. 193. Whilst this is the status of the Common Law the legislation in this area is not entirely reflective of this ability to consider wider, long-term interests. The Occupational Pension Scheme (Investment) Regulations 2005 SI 2005 No 3378, reg 4 provides that the investment of assets is 'in the best interests of the beneficiaries' and in a manner 'calculated to ensure the security, quality, liquidity and profitability of the portfolio as a whole'. The wording would seemingly focus most people's minds on profit in the short term.

Whilst the law seems to accommodate wider interests, there is an 'accountability gap' in ensuring wider, long-term interests are considered. This was discussed at 3.31-3.32 of the Consultation paper that trustees did not want to dictate to the investment manager what to invest in, but the investment manager believed it was the trustees who should instruct them to consider wider, long-term interests. Arguably the burden should lie with the managers who are the professionals but the incentives have to be right for them to apply the long term interests. Therefore it seems the law has reached a dead-end, and only a few subtle changes may be necessary such as a restatement of Regulation 4 and perhaps a statutory statement of duties for clarity similar to Part 10 of the Companies Act 2006. The law requires the intermediaries, if classified as fiduciary, to remove any self-interest in the performance of their functions to the ultimate beneficiary, and allows the freedom of the intermediary to assess what they believe to be in the best interests of the beneficiary. How to create the right incentives may not be an easy answer but there seems to be strong focus on better shareholder engagement to create trust and confidence in the businesses that are invested in so long-term plans can be supported rather than questioned, but equally there should be appropriate monitoring to prevent that trust being misplaced. Whilst the duties may deter trust being abused such duties are only reactive and some controls ex ante may need to be assessed.

My final point is that the Law Commission must be careful not to classify best interests as a fiduciary duty based on remedial result. Not to go in to great detail but loyalty is about removing the risk of self-interest by banning conflicts of interest. Best-interests is wider than this in that someone may not act in the best-interests of a principal but the decision may have been free from self-interest. This confusion may be seen in ODL Securities Ltd v McGrath [2013] EWHC 1865, which I blogged about here. However, incorrect classification may have wider implications as discussed in Chapter 5, particularly 5.46-5.54. The decision in Mothew discusses the implications of considering all breaches by fiduciary a fiduciary breach. A remedy for breach of fiduciary duty is normally a restitutionary one. This is much more favourable to the claimant than a compensatory one. Whilst compensatory remedies may be available for breach of fiduciary duty as seen in Item Software (UK) Ltd v Fassihi [2004] EWCA Civ 1244, restitutionary remedies may not be used for breaches of best interests.

Fiduciary Duties of Investment Intermediaries

The Law Commission has published its Consultation Paper regarding 'Fiduciary Duties of Investment Intermediaries'. I blogged about the project initially here. The consultation paper and a summary can be found here and here respectively.

The consultation paper, according to para 1.1, sets out to: '... investigate how the law of fiduciary duties applies to investment intermediaries and evaluate whether the law works in the interests of end investors'.

I have only given it a cursory read so far but have initial observations in regards to defining of terms such as fiduciary - however, it is noted that the consultation now seems to have gone wider than fiduciary duties of investment intermediaries in to duties generally of investment intermediaries (see paras 9.15, 14.62 and 14.64). Fiduciary duties prevent any self-interest in the performance of the undertaking. The duty moulds itself to the particular undertaking of the financial intermediary to temper any self-regard in respect of that undertaking. Thus, if they act or omit to act because they are personally interested in what they are doing for their principal, any benefit obtained will be held for the principal. In short all other interests to the undertaking of the fiduciary (financial intermediary) must be subservient to the interests of the principal.

This seems as though it would be in the interests of end investors that there interests are placed first and the fiduciary must remove any self-interest or otherwise before acting. The principal's interests are therefore exclusive. It may be that the specific duties of the financial intermediary are not beneficial to the interests of the investors, which is why I think the consultation is now looking at duties generally, but first impressions would suggest that fiduciary duties are not the issue. However, continued recommendations on fiduciary duties would need a closer consideration regarding the defining of terms and when such a duty is owed.

 

ODL Securities Ltd v McGrath [2013] EWHC 1865 - fiduciary duties

This case of ODL Securities Ltd v McGrath [2013] EWHC 1865 concerned "fiduciary duties" owed by a head of risk for a company. At [17] it was said that 'Although not a director of ODL, Mr McGrath was in a closely analogous position and, as such, in my judgment owed the same fiduciary duties as he would if he had been a director. These duties encompass a duty to disclose matters which it was in the interests of ODL to know, including where appropriate ... his own misconduct'.

This post expresses concerns about the number of potential issues with this statement in respect of fiduciary duties.

1) Describing Mr McGrath's position as analogous to that of a director is particularly unhelpful in respect of fiduciary duties owed by individuals. Reasoning by analogy has been described as dangerous (see Ranson v Customer Systems plc [2012] EWCA Civ 841 at [24]) since the extent or scope of one's fiduciary duties differs from case to case. To describe the head of legal risk and directors as analogous is unhelpful in determining someone's fiduciary liability.

2) The wording says that because the positions of director and head of legal risk are analogous to one another then Mr McGrath owed the same fiduciary duties as if he was a director. The issue here is that all fiduciaries owe the same duty. The duty of loyalty is universal to all fiduciaries (Bristol and West Building Society v Mothew [1998] Ch. 1, 17-18, Plus Group Ltd v Pyke [2002] EWCA Civ 370 at [80]). Whether the fiduciary is a solicitor, trustee, parent, director, partner they all owe the duty of loyalty which is the defining feature of a fiduciary relationship. The premise needs to be whether Mr McGrath owed the duty of loyalty and not simply that he owed the duty because his position was similar to that of a director. A director as a fiduciary will owe the same fiduciary duties as a head of legal risk because they are both fiduciaries.

3) The duty of loyalty is designed to regulate the problem of opportunism where one has access to another's property and affairs for the exclusive benefit of that person. It prevents the fiduciary from obtaining an unauthorised benefit from their position that would conflict with the interests of the principal. Best interests are wider than this. It is possible to not act for the best interests of the principal without being personally conflicted. As Millet LJ explained in Mothew at [18] in respect of the duty to act with reasonable skill and care that 'mere incompetence is not enough [to breach your fiduciary duty]. A servant who loyally does his incompetent best for his master is not unfaithful and is not guilty of a breach of fiduciary duty'. Thus, there is only a breach if that incompetence is based on a conflict of interest. The same applies to the duty to act in the company's best interests. It would have been accurate of Flaux J to say Mr McGrath owed similar duties to that of a director, but not fiduciary duties. As Millet LJ said in Mothew at [16] 'unless the expression [fiduciary] is so limited it is lacking in practical utility'.

As another note this confusion with respect of fiduciary duties is also noted earlier at paragraph [15] where Flaux J describes a duty to disclose as part of a duty to avoid a conflict.

4) Equally the duty is proscriptive in that it bans conflicts of interest. It is not prescriptive in requiring positive action on behalf of the fiduciary. Therefore saying there is a fiduciary duty to disclose misconduct is mudding the waters of fiduciary jurisdiction.

5) The normal remedy for a breach of fiduciary duty is for the fiduciary to disgorge any personal benefit derived from the conflict and have it held on trust for the beneficiary who has a proprietary right to the benefit obtained. Simply failing to disclose misconduct, would potentially breach the duty to act in the best interests of the company if it was its best interests to know as was the case in Item Software v Fassihi [2004] EWCA Civ 1244 which was cited at paragraph [17] in this case. But the appropriate remedy was not to disgorge the benefit because there is no benefit to disgorge. It is possible a claim may be brought for equitable compensation (and indeed was the case here) if causation can be established between failure to disclose misconduct and harm done to the company but this is not like strict liability for breach of fiduciary duty which would simply require the disgorgement of the benefit once it is established that there was a conflict.

The facts concerned Mr McGrath who made a series of commercial loans who knew, at all materials times, was not the business of ODL. The loans were made by Mr McGrath of ODL to a company, or connected to a company, called A1 Holdings Ltd, which Mr Clements was personally interested in and a substantial creditor and shareholder; but Mr Clements was also the person who operated ODL's separate corporate finance business. When A1 Holdings Ltd went in to administration, Mr Clements was owed in excess of £3m. ODL sought equitable compensation/damages for the unauthorised loans made to A1 Holdings.

Some of the loans made were made without security, one was made to a company ran by a man Mr McGrath had only just met, and one was made with a promise of a personal payment of $1m to Mr McGrath from A1 Holdings. It is difficult to see how the failure to disclose his misconduct in authorising such loans that he was not authorised to make would be a breach of fiduciary duty. It is clearly a breach of the company's best interests to not disclose because the loans on any objective assessment were unlikely to be repaid, exposed the company to more risk when it was its business to be exposed to less risk, and it was not the nature of the company to make such loans. But without a conflict of interest it is not a breach of fiduciary duty, and even with the conflict in the third loan as to the personal benefit offered to Mr McGrath it is not the failure to disclose that gives rise to the breach of fiduciary duty but the benefit itself.

The judgment makes a series of references to dishonesty and fraud to demonstrate that Mr McGrath knew the loans were not in the interests of the company and had breached his fiduciary duty. This does nothing to add to his fiduciary liability. Liability is strict. Once there is a conflict, liability is established. It does not have to be established that the fiduciary acted fraudulently, dishonestly, acted in bad faith or did not try their hardest, for example. The fact he was dishonest and/or fraudulent in hiding the unauthorised loans did not matter. The loan where he was offered a personal benefit evidenced a conflict and he would have been in breach whether he honestly believed to be acting for the interests of the company or not. This is not to say the dishonesty and fraud does not demonstrate his breach of duty of care or best interests, but as stated, these are not fiduciary duties.

Therefore it seems in respect of breaches of fiduciary duty, Mr McGrath would have only done so in respect of those loans in which he was offered a personal benefit since he acted opportunistically for his own benefit creating the risk that he would not be loyal to the interests of ODL. The other loans, whilst breaches of his duty of care and duty to act in the best interests of the company, were not fiduciary breaches.