In this issue we focus on partners who breach their fiduciary duties to their firm, and whether the firm can reclaim any of the partner's profit-share in compensation.
MEMBER OF AN LLP IS REQUIRED TO FORFEIT PART OF HIS PROFITSHARE
The High Court has held in Hosking v Marathon Asset Management LLP that a member of a limited liability partnership (LLP) who breached his duties to the LLP forfeited part of his profit-share.
Marathon Asset Management LLP ("Marathon") was established as an LLP to carry on an investment management business. In 2004, Marathon's membership was restructured to allow for "Executive Members" and "Non-Executive Members".
Executive Members were essentially founders who continued to work in the business. Non-Executive Members were founders who had ceased to do so due to retirement, death or incapacity. They were all entitled to share in Marathon's profits, but each Non-Executive Member was to receive only half of the profitshare of each Executive Member.
In 2012, Mr Hosking retired and became a Non-Executive Member. At the same time, Marathon successfully brought arbitration proceedings against him for breach of his fiduciary duties to Marathon. While still an Executive Member, Mr Hosking had been preparing to set up a competing business and had discussed those plans with four of Marathon's employees.
The claim in the High Court was an appeal against the original arbitral award. It concerned the remedy to be awarded to Marathon. Marathon claimed that, because Mr Hosking had breached his fiduciary duties, he should forfeit his profit-share in the LLP to Marathon. Mr Hosking claimed that the remedy of forfeiture could only be used to seize remuneration, not a share of profits in a partnership or LLP.
An agent owes fiduciary duties to his principal, and every member of an LLP is an agent of the LLP. Each member of an LLP therefore owes fiduciary duties to the LLP itself.
It has long been a principle of English law that an agent who acts dishonestly in breach of his fiduciary duty forfeits his right to remuneration.
Traditionally, forfeiture applies only to an agent's remuneration. The courts, both in England and across the Commonwealth, have historically drawn a distinction between profit-share, which is not capable of being forfeited, even for a dishonest breach of fiduciary duty, and remuneration or commission, which can be subject to forfeiture. However, this distinction has not always been clear.
In this case, the court had to consider whether it had the power to order the forfeiture of part of Mr Hosking's profit-share in Marathon on account of his breach of fiduciary duty to the LLP.
Mr Justice Newey deftly drew a distinction between profit-share that reflects the interest of a partner in a firm, and profit-share that represents remuneration for services provided to the firm. To the extent profit-share is really remuneration for a partner's services, it can be subject to forfeiture.
On the facts, the judge noted that the Executive Members, who provided services to Marathon, were entitled to receive twice the profits of Non-Executive Members. He surmised that 50 per cent of the Executive Members' profit-share was essentially remuneration that was subject to the possibility of forfeiture.
Mr Justice Newey therefore upheld the arbitrator's decision requiring Mr Hosking to repay 50 per cent of his profit-share to Marathon.
Instances of breach of fiduciary duty are not common, but they shine a light on the potential problems that can occur and should be catered for when planning a partnership or joint venture.
This decision is helpful for LLPs and consistent with the trend to hold fiduciaries to account for breach of duty. The possibility of having to repay large sums of profit-share (in this case, some 10m) will act as a deterrent to partners seeking to set up a rival venture and co-ordinate a team move.
The distinction between pure profit-share and profit-share representing remuneration is important. Historically, some LLP structures have distinguished between equity members and salaried members. The distinction may also arise between "equity partners" and "salaried partners" in professional services firms. Forfeiture will only be available for the element of the profit-share which amounts to remuneration for services.
It may be possible to limit the potential for forfeiture by attributing a larger proportion of a partner's profit-share to his risk in a venture and a smaller proportion to the services he is to provide. It may be clearer still to separate remuneration from profit-share, although this may have tax consequences.
Profit-share mechanisms are constructed and modified over time, and many firms and LLPs will have done so without regard to the potential for breach of fiduciary duty and forfeiture. Firms may wish to review their structures to decide whether the judgment in Hosking may be relevant to them.
The judge helpfully confirmed that partners in a firm can exclude the remedy of forfeiture by contract.
Whether partners will want to minimise or exclude their firm's ability to claim forfeiture is another matter. Indeed, this decision is likely to be welcomed by LLPs as a means of ensuring that partners are held to account when they act contrary to the firm's interests. Nonetheless, this remains an issue to consider when forming a partnership or LLP.
Co-written with Joanna Constantis, a senior solicitor in our litigation and dispute resolution practice.
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