The High Court (French CJ, Hayne, Crennan, Gageler and Keane JJ) has yesterday handed down judgment in Stephen James Howard v Commissioner of Taxation [2014] HCA 21, unanimously dismissing Mr Howard's appeal with costs.   The three issues in the appeal were:   

  • the extent to which Mr Howard, as a director of Disctronics Ltd (Disctronics), owed fiduciary duties such that:
    • he could not retain a sum of equitable compensation awarded by the Supreme Court of Victoria (Supreme Court)
    • the equitable compensation was received by him as constructive trustee for Disctronics.
  • if not, whether Mr Howard had assigned the right to receive that amount such that the income was not derived by him beneficially
  • whether Mr Howard incurred liability in respect of the costs of the proceedings in the Supreme Court which should properly have been taken into account in ascertaining the amount of any gain made by the appellant and, alternatively, whether those costs were an outgoing of a revenue nature incurred in gaining the income comprised in the award made by the Supreme Court

The decision highlights the need for fiduciary relationships and obligations to be defined with precision, and cautions against overbroad assertions of fiduciary obligations. An examination of the actual function or responsibility assumed determines the subject matter over which the fiduciary obligations extend.  The forensic purpose for which fiduciary obligations are asserted may also be considered.

The facts

In early 1999, Mr Howard and three associates (Messrs Donovan, Quinert and Bucknall) investigated a proposal for funding, repackaging and selling a golf course. The concept involved acquiring a golf course and thereafter installing an anchor tenant. With the anchor tenant in place the idea was to on-sell the course at a price calculated by capitalisation of the future rent. The purchaser was to acquire the course using borrowed funds secured on the land along with its own "equity" funds. The level of required equity was relevant to the dispute and covered below. Over time the proposal evolved into a joint venture involving two other persons (Messrs Edmonds and Cahill) who had initially been consultants to the project. However, due to disagreements amongst the joint venturers, the venture ultimately disintegrated and a deal was executed by Edmonds and Cahill acting alone. Howard, Donovan, Quinert and Bucknall appealed to the Supreme Court alleging breach of the fiduciary duties owed by Edmonds and Cahill to their fellow joint venturers.

At the heart of the dispute in the Supreme Court was the alleged entitlement of Disctronics, the company that the taxpayer argued had an option to acquire the golf course. Four early project members, with the exception of Bucknall, were directors of Disctronics which was at the time sitting on $1.5 million of investible funds. Prior to the formation of the joint venture with Edmonds and Cahill, these directors had agreed amongst themselves that if the equity required by a purchaser was less than $1.5 million, then Disctronics should become the purchaser of the golf course. On the dissolution of the venture, Disctronics was joined as co-plaintiff to the Supreme Court action but it was ultimately denied relief.  

Just prior to commencement of the Supreme Court proceedings, the four early project members, including Bucknall, all entered into a "Litigation Agreement" with Disctronics according to which they agreed to assign to the company any fruits of the litigation in consideration for the company funding the costs of such litigation. Ultimately compensation was awarded by the Supreme Court, but it was awarded to Howard, Donovan, Quinert and Bucknall in their personal capacities as members of the failed joint venture (Disctronics was found not to be a member). On appeal by Edmonds and Cahill, the Supreme Court of Appeal upheld the primary judge's decision.

Howard's fiduciary obligation to Disctronics

French CJ and Keane J concluded that Mr Howard's   

"….obligation to Disctronics, as one of its directors, did not extend beyond taking appropriate steps to give effect to a decision of the directors to try to bring the company in as the ultimate purchaser from the joint venture and, in that event, to rebate to it their entitlements flowing from the joint venture. The company was not and was never intended to be a member of the joint venture. There was no relevant fiduciary obligation preventing the appellant from taking a share of the profits of the joint venture on his own account."

French CJ and Keane J note that Mr Howard and the other directors of Disctronics were acting in their personal capacities when they conceived of the profit-making venture, were to be involved in their personal capacities, and did not use any knowledge or opportunity derived from their directorships. The decision of the directors to seek to bring Disctronics in as ultimate purchaser of the golf course did not establish any basis to impress their personal interests in the venture with fiduciary obligations to Disctronics. Once the venture ended, Mr Howard's duty to pursue the opportunity for Disctronics to become purchaser could not be further performed.

Hayne and Crennan JJ agreed that Mr Howard's proposition that the amount received as equitable compensation was a gain arising from a venture belonging to Disctronics was not established, and noted that "asserting that Disctronics 'sought' or 'desired' to invest in 'the project' does not demonstrate that Mr Howard's gain or profit was an unauthorised gain or profit which he held on trust for Disctronics."

Hayne and Crennan JJ found that the award of compensation was for the diversion by the defaulting venturers of the joint venturers' (not Disctronics') opportunity to pursue a profitable venture. The opportunity diverted was that of the joint venturers, and the obligation of Mr Howard not to obtain an unauthorised benefit from the fiduciary relationship was not engaged and no conflict thereafter between Mr Howard's duties or between his duty and his interests.  Further, there was no real possibility of conflict.

Gageler J noted that Disctronics never became a party to the joint venture and was never pursuing a business opportunity commensurate with that which was being pursued by the joint venture to which Mr Howard in this personal capacity had always been a party. His Honour found that the compensation awarded was not for any loss to Disctronics, it was for Mr Howard on account of the breach of fiduciary duties owed by Edmonds and Cahill to him personally. Gageler J concludes that there was no conflict or possibility of conflict between Mr Howard's personal interests and his fiduciary obligations to Disctronics.

French CJ and Keane J cautioned that broad judicial formulations of fiduciary duties are not infinitely extensible, and that overbroad assertions of fiduciary duties, which are not informed by a close examination of the particular factual context, are sometimes made for reasons which have nothing to do with the protective rationale of those duties. They criticised Mr Howard's forensic purpose in attempting to cover his personal or commercial dealings with a fiduciary mantle in order to defeat a claim that he was liable to pay income tax on the equitable compensation.

Hayne and Crennan JJ agree that the rule prohibiting a fiduciary from placing himself in a position of conflict with his fiduciary duties cannot be applied by the bare repetition of the terms of the rule. Closer attention to the duties, interests and alleged conflict is required.

Assignment of income

French CJ and Keane J conclude that, on the basis that Mr Howard was not under a broadly formulated fiduciary obligation to Disctronics, there was no constructive trust of the equitable compensation awarded to him.

Mr Howard argued in the alternative that what he assigned via the Litigation Agreement was a right to the amount of equitable compensation ultimately received in 2005, rather than the sum itself. This was not accepted. It was not regarded by the High Court as an assignment of Mr Howard's interest in the joint venture, nor of the cause of action arising out of the breach of fiduciary duties the subject of the Supreme Court proceedings. It did not involve an assignment of a chose in action. French CJ and Keane J relied on Federal Commissioner of Taxation v Everett (1980) 143 CLR 440 in concluding that the assignment was not effective to prevent the income being derived or being deemed to be derived by Mr Howard as assignor. It was an assignment of the future judgment debt only, not Mr Howard's rights under the judgment.

Hayne & Crennan JJ found that:  

"The better construction of the litigation agreement is that it provided for the assignment of any proceeds of the action, not for the assignment of the appellant's rights under any judgment obtained in the proceedings. The reference to 'on revenue or capital account', coupled with the reference to the 'ultimate outcome' of the proceedings, more readily fits with understanding the expression 'any award of damages ... costs or interest made in their favour' as referring to sums received rather than the underlying rights to receive those sums."

Gageler J agreed with Hayne & Crennan JJ's analysis of the Litigation Agreement.

Deductibility of legal costs

French CJ and Keane J could see no basis upon which the Court could conclude that Mr Howard had incurred any liability in relation to the legal costs. Gageler J agreed with them. Hayne and Crennan JJ did not address the issue of deductibility of legal costs.