Powerful equitable remedies on the breakdown of business partnerships: a review of some important 2016 judgments

During 2016 there were a number of significant judgments under which business proprietors have been deprived, or stood at risk of being deprived, of very significant value by virtue of breach of fiduciary duty or proprietary estoppel.

Forfeiture of partnership profits for breach of fiduciary duty

In the case of Hosking v Marathon Asset Management LLP, the court had to answer the question whether the share of profits of a partner of a partnership or a member of an LLP could be forfeited because of the partner’s/member’s breach of fiduciary duties.

The court decided that it could and confirmed that, in addition to being liable to pay compensation of some £1.38 million, Mr Hosking should forfeit and return to Marathon 50% of his profit share arising during the period in which his breaches of duty were committed, amounting to over £10 million.

While forfeiture of an agent’s fee or commission for breach of fiduciary duty is a well-established remedy, this case is believed to be the first English case in which an LLP member (or partner) has been required to forfeit profit share.

This judgment is further cause for partners and LLP members to avoid taking any steps that might constitute breach of fiduciary duty, for example being concerned in a competing business, giving confidential information to a competing business, soliciting clients/customers or partners/staff to leave the business, or otherwise acting contrary to the best interests of the partnership/LLP.

Such breaches are commonplace when individuals and teams are contemplating a change of firm/LLP.

What is also notable about the Hosking case is that the forfeited profits greatly exceeded the actual financial loss of the LLP arising from the breaches of duty.

Forfeiture of salary and profits in a competing business

It is easier than many people think for company directors (and partners and LLP members) to commit breaches of their fiduciary duties to their company (partnership or LLP). For example, it is commonly believed that a director is free to plan and take preparatory steps to set up a competing business, provided that he resigns his directorship before commencing to trade.

In fact, a director’s duty is either to resign before he makes a final decision to set up a competing business (and before he takes any preparatory steps), or otherwise (at the very least) to report his intentions to the board of his company at the earliest opportunity (and there may be additional obligations).

The remedies for failure to comply with these obligations can be more extensive than might be expected, as demonstrated by the case of Gamatronic v Henderson.

In that case, directors of a company set up a competing business. In doing so the directors committed a number of breaches of their fiduciary duties, including secretly setting up, and holding interests in, the competing business, compiling its price list and approaching customers. In addition to other remedies, such as damages to reflect the losses incurred by the company, the company sought forfeiture (return) of the salary paid by the company to the directors during the period when they were acting in breach of their fiduciary obligations (akin to Mr Hosking’s 50% profit share in the Hosking case above), and in addition forfeiture of their salaries received from their competing business and the profits of that business.

In the event, the court did not award forfeiture of salaries or profits in the two businesses, but this was only because of factual findings to the effect that the time spent by the directors on the competing business had been minimal, they had continued diligently in their day-to-day duties for the company, there was a long period of time between the breaches and the profits claimed, and the breaches had not given the competing business a significant advantage.

But it was not doubted by the court that in a suitable case the scope of potential remedies could be as wide as those claimed.

Court-ordered transfer of farm partnership interest following repeated promises

Courts have extensive powers to do justice between parties when promises (falling short of a contract) have been made and have been relied upon, but are then broken. This power can be used to create valuable ownership rights in a business, and/or can lead to a transfer in ownership of land.

In the case of Moore v Moore, over a period of four decades a father repeatedly told his son (who was one of two children) that the son would inherit the father’s share of a farming partnership business and farm. During that period the son based his life on the farm, worked long hours, and received only modest income. There was evidence to the effect that he could have earned considerably more elsewhere. This is not an unusual situation in many farming families.

The farm was worth several million pounds.

At the end of the four decades, the father and son fell out, and the father decided to disinherit his son. By this time the father and the son (and a company which they jointly owned holding farm assets) were the partners in the farm partnership. The father executed a will which gifted his share of the farm partnership, company and farm land to his son-in-law rather than to his son. He later served notice of dissolution of the partnership with his son.

By the time proceedings were issued the father was suffering from moderate to severe dementia, and his wife (the son’s mother) was appointed by the court to conduct the litigation for him.

Based on the father’s repeated promises and the son’s detrimental reliance on those promises, the court found that on the father’s death in due course the son would indeed become entitled to his father’s share of the partnership assets, thus overriding the intended gift by will to the son-in-law. The father’s repeated promises and the detriments suffered by his son had gone on for such a long time that the father had lost the right to change his mind.

And because the partnership share was subject to the promise, the partnership was not a partnership at will which the father could dissolve by notice, but instead had become a partnership for the joint lives of the father and son.

However, in view of the father having by the time of the trial lost mental incapacity, the court dissolved the partnership by order, and the son was given sole ownership of the entirety of the partnership assets including the farm and the house in which his father and mother lived, but subject to an obligation to allow the father all of the benefits that the father would have enjoyed as a partner during his lifetime had the court not dissolved the partnership. Those benefits included allowing the father and mother to remain in the house where they lived, paying the father the same income as he currently received, and making reasonable payments for health care for the father and mother.

The son-in-law (and his wife, the other child) were not entitled to claim any recompense for having, in effect, been disinherited by the court.

This case is believed to be the first time a court has applied a proprietary estoppel remedy to a partnership interest, and is a clear reminder that long-established equitable principles can give rise to significant outcomes in the modern world. Telling one of your children (or anyone else) that “one day all of this will be yours” can have fundamental consequences that can lead to a bitter family dispute and an outcome which is detrimental to other family members.

Very short periods over which promises are made may suffice

While in the Moore case the period of time over which promises were made was four decades, promises made over a very much shorter period can, in the right circumstances, give rise to remedies.

Substantial award to another child of a farmer

In another 2016 case (Davies v Davies), a farming couple’s daughter, who had been promised by her parents that she would inherit their entire farm and farm business, worked on and off on the farm for a total of 15 years, at less than full remuneration, interspersed with periods when she was not involved with the farm owing to fallings out with her parents. There were two other daughters who were never involved in the running of the farm.

The (farming) daughter incorrectly believed for 3 years that she was a partner in the farm business (after signing a draft partnership agreement), only to discover later that she was not a partner, and she had been promised a 49% interest in the family farming company, which did not materialise.

When the parents came to consider wills, instead of leaving the whole farm and farm business to their daughter as promised, they considered dividing the farm into three equal gifts, one to each of the other daughters and the third to the (farming) daughter’s children, or putting the farm and business into a discretionary trust for all of them. This was largely out of concern as to the (farming) daughter’s choice of husband and the fragility of her marriage, which ultimately did end in divorce.

After the parties fell out for the final time, the daughter pursued a claim in court, seeking confirmation of her right to be left the entire farm and farm business. Instead of having that right confirmed, the court awarded her £1.3 million, to be paid to her by her parents, though that sum was later reduced on appeal to £500,000.

As well as being notable for the size of the award, this case demonstrates the court’s discretion to do justice in a particular case by awarding a sum of money rather than declaring an interest in land or business assets.