A recent English Court decision confirms that members of LLPs who breach their fiduciary duties are at risk of having their remuneration (including that received by way of profit share) forfeited. This is in addition to having to pay damages.

The significance of this principle, confirmed by the recent High Court decision of Jeremy Hosking v Marathon Asset Management LLP, is well demonstrated by the facts of the case where over £10m of profit share was forfeited while the compensatory damages awarded were just under £1.5m. This decision will have ramifications in other areas too, as the forfeiture remedy is potentially available not just in LLP disputes but in any case involving fiduciaries.

Fiduciary Duties and the Forfeiture Principle

All partners in traditional partnerships owe their other partners fiduciary duties. The position is different for LLP members. While LLP members will not ordinarily owe any fiduciary duties to other members, they will usually owe fiduciary duties to the LLP itself. The extent of the duties in any particular case will depend upon that member’s particular rights and obligations, but any member who has assumed a position of trust and responsibility over the affairs and property of the LLP will owe extensive fiduciary obligations. Accordingly, such duties may well be relevant in any dispute involving a member holding a senior position.

The significance in any dispute of members being fiduciaries is twofold. First, it extends the duties which a member owes beyond his or her contractual duties. The essential characteristic of a fiduciary is loyalty and this can impose obligations to put the interests of the LLP above the fiduciary’s own interests as well as giving rise to an obligation to disclose their own wrongdoing. For obvious reasons, these fiduciary duties are often invoked in the context of disputes about team moves and poaching of staff by departing members.

Secondly, claiming a breach of a fiduciary duty can also expand the potential remedies available: for example enabling the LLP to bring claims for equitable compensation or an account of profits. One of the possible remedies for breach of fiduciary duty is forfeiture of the fiduciary’s remuneration. If a fiduciary acts dishonestly he or she will forfeit the right to the fees paid or payable by the principal in the period of breach, subject to such forfeiture not being disproportionate or excessive. Underlying the remedy is a public policy of deterring fiduciaries from betraying the trust placed in them. As an earlier case put it “a principal is entitled to have an honest agent, and it is only the honest agent who is entitled to commission”.

Such forfeitures ordinarily arise in straightforward agency cases and this appears to be the first case where the principle was applied in England in a partnership/LLP context.

The Arbitration

Mr Hosking was one of the founders of an investment management business, Marathon Asset Management LLP (Marathon) and was a “Class A Member”. Class A Members were divided into “Executive Members” and “Non-Executive Members”. While Executive Class A Members had to devote all their time to the business of Marathon, Non-Executive Members were Class A Members who were no longer involved in the business, for example because of retirement or incapacity.

Under the LLP Deed, profits falling to Class A Members were to be shared amongst them equally save that Non-Executive Members only received half as much as Executive Members (the respective entitlements being described in the business as “full rations” and “half-rations”).

In arbitration proceedings brought by Marathon, it was found that Mr Hosking had breached contractual and fiduciary duties that he had owed to Marathon by discussing with four of its employees the possibility of starting a new business and producing a business plan outlining his thoughts. Marathon was awarded £1.38m of compensation in respect of its lost chance of retaining some of the employees.

But in addition to these damages, Mr Hosking was ordered to return over £10m, representing 50% of his profit share for the period in which he had been in breach. The arbitrator held that while the allocation of income profits was not described as remuneration for the performance of executive duties, that was what the additional 50% represented in substance. There was no other explanation for why the Executive Members were receiving twice as much as the Non-Executive Members.

In the context of the scale of Marathon’s annual profits and the seriousness of the breaches, the forfeiture of £10m was not regarded as disproportionate.

The Appeal

Mr Hosking appealed the arbitration decision to the High Court, asking the Court to determine whether the share of profits of an LLP member, paid out in accordance with the LLP Deed, could be subject to forfeiture in the event of the member’s breach of fiduciary duty.

The appeal raised two fundamental questions. Can the forfeiture principle apply to partners/LLP members? If so, can it apply to profit share?

The Court decided that the profit share of a partner or LLP member can potentially be subject to forfeiture. There was no reason to limit the scope of the remedy to particular types of fiduciaries as the same rationale for such a remedy applied to all fiduciaries. In any event the partners/LLP members were also agents and their mere status as partners/LLP members should not preclude the operation of a principle which affects agents more generally.

There was not necessarily a hard and fast distinction between profit share and remuneration. While in many cases it might be impossible to describe any particular part of a profit share as remuneration, this did not always need to be the case. Profit share may usually reflect the ownership interest of the partner/LLP member, but it is possible to envisage cases, as was the position in the Marathon case, in which it rather represents compensation for particular services, in which case it could fairly be viewed as remuneration.

There was nothing in the Acts and Regulations governing partnerships which provided to the contrary. The fact that the relevant LLP Deed was silent does not preclude the application of the principle (although it was accepted that the right of forfeiture could be expressly excluded).

Accordingly, the appeal was dismissed and the forfeiture was upheld.

Consequences

While in many cases profit share will not be treated as remuneration, the key issue is what the relevant payment represents in substance, not how it is described or paid. This case is therefore likely to have significant implications for how remuneration structures are drafted in the future.

Outside the partnership/LLP context, the case confirms that the forfeiture remedy is potentially applicable to all fiduciaries.

This was not an issue on which there was a wealth of authority and the decision may well be subject to challenge in a higher court in the future (although possibly not in the Marathon case itself given the difficulties of pursuing a second appeal). However, pending any further appealable decision, we expect forfeiture of remuneration is now likely to feature more frequently in partnership and other disputes. In appropriate cases forfeiture, or the threat of it, will be a potent weapon for claimants and a mind-focussing deterrent to possible breaches.

Jeremy Hosking v Marathon Asset Management LLP [2016] EWHC 2418 (Ch)