The English Court of Appeal has considered whether a defendant is required to give up the profits made from a transaction where he has dishonestly assisted another to breach fiduciary duties owed to the claimant. The case, Novoship (UK) Ltd and others v Nikitin and others, concerned various bribery schemes. Its reasoning would be directly applicable to bribery involving senior public officials. The Court decided that such a remedy is in principle available, even where the claimant has suffered no loss. However, the Court also decided that:
it is necessary for the profits to have been caused by the dishonest assistance that had been given;
it also has a discretion whether to grant or withhold the remedy of an account of profits; and
that discretion would not be exercised where it would be a disproportionate response to the wrong-doing.
The judgment is available here.
What are knowing receipt and dishonest assistance claims?
“Knowing receipt” and “dishonest assistance” are two important types of claim in cases of fraud and corruption. They are primarily targeted at third parties that have received the proceeds of corruption or who have dishonestly assisted with the wrongdoing. Those third parties could include companies or trusts controlled by the wrongdoing. In some circumstances, a defendant may be liable for both knowing receipt and dishonest assistance.
Both claims require some breach of “fiduciary duty”. For example, a senior public official in a common law jurisdiction will owe a duty of loyalty and fidelity; a duty to act in good faith and in the best interests of the state; a duty not to put himself in a position where personal interest conflicts with duties and responsibilities owed to the state; a duty not to prefer his own interests or the interests of others to the interests of the state, or to make any undisclosed profit from his position; as well as a duty not to solicit or accept bribes.
Knowing receipt is a claim to recover stolen assets or assets which have been transferred in breach of a fiduciary duty. A claimant state, for example, must demonstrate that:
assets have been transferred to the defendant in breach of a fiduciary duty owed by a public official, for example, the illegitimate payment away of funds belong to a state, or the transfer of an asset belonging to the state;
- the defendant knew of the breach of duty;
- it would be unconscionable for the defendant to retain the assets.
For dishonest assistance, a claimant must demonstrate that:
- there was a breach of fiduciary duty by a public official
- the third party defendant dishonestly induced or assisted with that breach of duty.
The bribery schemes in Novoship
Mr Mikhaylyuk was the General and Commercial Manager of NOUK, a company in the Novoship group, and a director. Amongst other things he was responsible for negotiating the charter (leasing) of ships owned by companies in the Novoship group (for simplicity, we will simply call these companies “Novoship” in this article). The trial Judge decided that he owed “fiduciary duties” to Novoship, and repeatedly breached these duties by receiving bribes from those chartering Novoship’s vessels. In return, he was found to have arranged a series of schemes by which he defrauded Novoship and enriched others. He also arranged charters of ships to Henriot Finance Ltd, a company owned by Mr Nikitin (the “Henriot Charters”).
The most interesting issue that arose in the Court of Appeal was whether Henriot and Mr Nikitin were liable to pay the profits it had made on those charters to Novoship (there were a series of other factual and other issues which are not of wider interest). The Judge hearing the trial decided that the Henriot Charters were entered into at the appropriate market rate and were not, in themselves, financially disadvantageous to Novoship. However, Mr Mikhaylyuk was negotiating the Henriot Charters at the same time as he was dishonestly arranging a separate scheme which included the payment of substantial bribes both to himself and also to a different company owned by Mr Nikitin.
At the trial, the Judge decided that this meant that Mr Mikhaylyuk was in breach of his fiduciary duties when negotiating the Henriot Charters because there was a realistic possibility of a conflict between his duty of loyalty to Novoship and his personal interest in favouring Mr Nikitin. Further, the Judge decided that Mr Nikitin must have known of this conflict of interest and that he was “continuing a relationship which was corrupt at inception and had not been cleansed”. The conclusion was that Mr Nikitin had dishonestly assisted with Mr Mikhaylyuk’s breach of duty in relation to the Henriot Charters and, as a result, was personally liable for the profit of US$109m that had been made from them by Henriot.
The decision of the Court of Appeal
Mr Nikitin appealed. His appeal raised the following issues:
- is the remedy of an account of profits available against a dishonest assistant?
- if so, is it necessary for the dishonest assistance to have caused the profit?
- if so, what is the nature of that causal connection?
- if there is a requirement for a causal connection, was it satisfied on the facts of this case?
- if it is, would it be right, on the facts of this case, to order an account of profits?
Mr Nikitin argued that the intention of the English Courts is to require the fraudster to compensate the victim for loss that he has suffered, not to strip the fraudster of his gain. That was the position in a claim for the tort of fraud. For example, the Court of Appeal had said in a previous case “Neither the law of restitution nor the law of damages is in the business of transferring monetary gains from one undeserving recipient to another undeserving recipient even if the former has acted illegally while the latter has not.”.
Three reasons were advanced as to why a dishonest assistant could not be required to account for the profits he had made. First, an account of profits could not be ordered against a dishonest assistant that has not himself assumed fiduciary obligations to the claimant. Secondly, an account of profits could not be ordered against a third party whose liability arose only because of his dishonest assistance in a breach of fiduciary duty. Thirdly, an account of profits could not be ordered against a third party unless there had been some misapplication of trust property (i.e. payment away of funds or the transfer of an asset, which the time charter of a ship was not).
In relation to the first point:
- The Court noted that there is now a “body of modern case-law at first instance which recognises that the court has the power to order an account of profits against a dishonest assistant, even where no corresponding loss has been suffered by the beneficiary”.
- Here, Mr Nikitin submitted that these cases were all wrong, and further that this argument was supported by a historic decision of the Privy Council (which is effectively the UK Supreme Court sitting as the final Court of Appeal for the UK Overseas Territories and Crown dependencies, and for certain other Commonwealth countries).
- However, in that decision the Privy Council had been concerned with two discrete issues. First, whether liability for assistance in a breach of trust required the breach itself to be dishonest, or whether liability existed when the breach was honest and the assistance dishonest. Secondly, in that case the claimant was seeking only to recover its actual loss from the dishonest assistant.
- In recent times the liability of a dishonest assistant has been described as “accountable in equity”. The Court decided that this must mean both a liability to make good any loss that a claimant has suffered and also a liability to account for profits that had been made. That position, it was said, was supported both by policy and decisions in previous cases. In relation to policy, the Court of Appeal quoted with approval the following comments of the Court in Consul Development Pty Ltd v. DPC Estates Pty Ltd:
“If the maintenance of a very high standard of conduct on the part of fiduciaries [i.e. those owing fiduciary duties, such as senior public officials] is the purpose of the rule it would seem equally necessary to deter other persons from knowingly assisting those in a fiduciary position to violate their duties.
If, on the other hand, the rule is to be explained simply because it would be contrary to equitable principles to allow a person to retain a benefit that he had gained from a breach of his fiduciary duty, it would appear equally inequitable that one who knowingly took part in the breach should retain a benefit that resulted therefrom.
I therefore conclude, on principle, that a person who knowingly participates in a breach of fiduciary duty is liable to account to the person to whom the duty was owed for any benefit he has received as a result of such participation.”
- The Court also noted that the cases consistent with this rule appeared to decide that the knowing recipient or dishonest assistant has, in principle, the responsibility of an express trustee. That responsibility would include, in an appropriate case, a liability to account for profits. That disposed of Mr Nikitin’s first argument.
Further, the Court decided that it would be inappropriate, as Mr Nikitin suggested, to differentiate between the availability of remedies relating to profits made by a knowing recipient on the one hand and profits made by a dishonest assistant on the other. That disposed of his second argument.
The Court also disagreed that the misapplication of “trust property” (i.e. here, the transfer away of assets belonging to Novoship) was a necessary condition for the availability of an account of profits:
- This was argued in two ways. First, since the Henriot charters were time charters they were no more than a contract to provide services with no transfer of ownership of the ships.
- The second way in which the point was put is that although Mr Mikhaylyuk was a fiduciary, he had no power to transfer away his principal's property (unlike a trustee in whom trust property is vested, or a company director, who has power to dispose of the company's property). The leading textbook on Trusts says that in such a case it is an open question whether a misapplication of trust property is a necessary pre-condition to an order for an account of profits.
- The Court said it would be surprised if the outcome was radically different according to whether a charter was a time charter or a demise charter (or if the dishonest assistant took a licence of land rather than a lease).
- The Court decided that there is no requirement for there to be trust property to permit a claim for an account of profits for dishonest assistance: “Dishonest assistance does not involve a trust. It involves providing dishonest assistance to somebody else who is in a fiduciary capacity and has committed a breach of his fiduciary duties. The consequences of those breaches (as this case shows) might have different consequences. One might be that the fiduciary has received a bribe. Another is that the fiduciary has made a profit in breach of his fiduciary duty. Another possibility is that assets are available into which it can be shown were acquired in breach of the fiduciary duty. Third party recipients are also potential candidates. Finally the breach of fiduciary duty might only sound in damages. In all of those cases I can see no logic or grave difficulty where the fiduciary is involved who has committed a breach of his fiduciary duty that an accessory who acts dishonestly in relation to those breaches should not be liable. It must not be forgotten that in most cases the breach can only occur as a result of the activities of the assistor.”
- In addition, the Court said that it would be a triumph of form over substance if a dishonest assistant escaped liability by entering into a time charter but not if he entered into a demise charter, or took a licence of land rather than a lease. The only question is whether liability as a dishonest assistant in a breach of fiduciary duty has been established. If it has, then an account of profits is one possible remedy.
The conclusion, therefore, was that the remedy of an account of profits is available against one who dishonestly assists a fiduciary to breach his fiduciary obligations, even if that breach does not involve a misapplication of trust property.
The Court then considered the question of causation. It was noted that a fiduciary's liability to account for a secret profit does not depend on any notion of causation. It is sufficient that the profit falls within the scope of his duty of loyalty to the beneficiary. The Court quoted with approval the following passage from a previous Court of Appeal judgment: “If there is a fiduciary duty of loyalty and if the conduct complained of falls within the scope of that fiduciary duty… then I see no justification for any further requirement that the profit shall have been obtained by the fiduciary “by virtue of his position”. Such a condition suggests an element of causation which neither principle nor the authorities require. Likewise it is not in doubt that the object of the equitable remedies of an account or the imposition of a constructive trust is to ensure that the defaulting fiduciary does not retain the profit; it is not to compensate the beneficiary for any loss. Accordingly comparison with the remedy in damages is unhelpful.”
The Court identified a number of previous cases that required the profits earned by a dishonest assistant to have been caused by the assistance that had been given, and sought to resolve an apparent conflict between them. In particular, the Court of Appeal referred to the cases of Regal, Fyffes and Murad.
The Regal case established the following principle: “The rule of equity which insists on those, who by use of a fiduciary position make a profit, being liable to account for that profit, in no way depends on fraud…; or upon such questions or considerations as whether the profit would or should otherwise have gone to the [claimant], or whether the profiteer was under a duty to obtain the source of the profit for the [claimant], or whether he took a risk or acted as he did for the benefit of the [claimant], or whether the [claimant], has in fact been damaged or benefited by his action. The liability arises from the mere fact of a profit having, in the stated circumstances , been made.” (Emphasis added)
The claimant employed Mr Templeman as its chartering manager. He negotiated a contract with Seatrade under which Seatrade was to provide shipping services to Fyffes.
- However, unknown to Fyffes, Seatrade had agreed to bribe Mr Templeman by paying him a percentage of the freight earned.
- That was dishonest assistance by Seatrade in Mr Templeman's breach of fiduciary duty to Fyffes.
- The question was whether Fyffes could require Seatrade to account for the profit that it had made in providing the shipping services under the service agreement. The Judge said that there were “cogent grounds, in principle and in practical justice, for [doing so]”. He therefore decided that “the briber of an agent may be required to account to the principal for benefits obtained from the corruption of the agent”.
- The Judge decided on the facts that he should not order an account. First, he said that Seatrade would have entered into a service agreement with Fyffes, even if Mr Templeman had not been dishonest. Second, he said that the ordinary profit that Seatrade made under the service agreement was not “caused by the bribery of Mr Templeman”. Third, he did not regard it as fair for make Seatrade pay Fyffes the whole of its profit, because that would amount to the unjust enrichment of Fyffes. The Court of Appeal noted that the first two reasons for refusing to order an account related to the question of causation; and the third to the overall fairness (“equity”) of the result.
In Murad, the Court of Appeal struggled to reconcile these decisions. Lady Justice Arden stated: “Reliance has been placed … on the Fyffes case where [the Judge] declined to make an order for an account of profits in favour of the principal of a bribed agent as against the briber because the transaction with the defrauded principal was one into which the defrauded principal would have entered in any event. [The Judge] held that those profits were attributable to the provision of services under the agreement, not the payment of the bribe. On the face of it, this holding is precluded by the Regal case. However, while it is not entirely clear, it may be that this should be treated as a case where the wrongdoer was held to be entitled to an allowance for its services despite his fraudulent conduct.”
noted that Fyffes was not dealing with the case of a fiduciary; but with a dishonest assistant, so the decisions were not inconsistent;
also noted that where the dishonest assistant is sued for losses that have been suffered, the cases do show that a causal connection is required;
stated “It is important to appreciate the special position in which a fiduciary finds himself. The essence of the relationship between a fiduciary and beneficiary is that the latter has placed his trust in the former. The core duty of the fiduciary is single minded loyalty to his beneficiary. Thus the breach of duty does not consist in the making of a profit by the fiduciary, but in the keeping of it for himself. That is not a breach of a personal obligation; it is an abuse of the trust and confidence placed in him by his principal who put him in a position to make the profit because he trusted him not to serve his own interests. Equity's response to the breach of this trust is not to give redress for the breach in the form of equitable compensation but to enforce the duty…”;
agreed with Mr Nikitin’s case that this approach is inappropriate in relation to a dishonest assistant, as he has no pre-existing duty whose scope can be determined and enforced;
noted that in the case of a claim against a fiduciary for compensation in respect of a breach of duty a court of equity will apply a “but for” test of causation, thus precluding recovery for loss that would have occurred even if the breach of duty had not taken place: “… compensation for breach of trust is designed to achieve exactly what the word compensation suggests: to make good a loss in fact suffered by the beneficiaries and which, using hindsight and common sense, can be seen to have been caused by the breach.”
decided there that the rules of causation should be applied by analogy;
noted that the common law distinguishes between a breach which is the effective cause of a loss and one which is merely the occasion for the loss.
How to distinguish between an effective cause and the occasion for a loss is often a difficult question. Like many difficult questions it is said to be a question of common sense, allowing Judges to apply their common sense on a case by-by-case basis.
Here, the trial Judge had decided that “In the present case, a sufficiently direct casual connection between the assistance and the profit is to be found given that the profit from the deployment of the vessels the subject of the Henriot Finance charters could not have been earned unless those charters had been entered into, and is, thus, a profit which results from Henriot Finance entering into those charters – which, itself, constitutes the dishonest assistance given to Mr Mikhaylyuk's breach of fiduciary duty.”
The trial Judge also decided that the same test should apply to the dishonest assistant as applies to a fiduciary; and that: “It is no defence to say that the charters were at commercial rates and not disadvantageous to the owners; or that, if there had been no breach of fiduciary duty, they would have been made anyway and at the same rates or that Henriot Finance would have made the same profit anyway by the charter of other vessels.”
The Court overruled the trial Judge’s decision that the same considerations apply to a fiduciary as apply to a dishonest assistant who has no fiduciary duties. They agreed with the judge that if Mr Nikitin (or his companies) had not entered into the Henriot charters, the profits would not have been made. In other words, “but for” entry into the charters the profits would not have been made.
However, the Court decided that was not the appropriate test. What Mr Nikitin acquired as a result of his dishonest assistance (and also as a result of Mr Mikhaylyuk's breach of fiduciary duty) was the use of the vessels at the market rate. That was merely the occasion for him to make a profit. The real or effective cause of the profits was an unexpected change in market price. Mr Nikitin had made the profits “because he judged the market well”.
The Court therefore decided that there was an insufficient direct causal connection between entry into the Henriot charters and the resulting profits (whilst stressing that had Mr Nikitin himself owed fiduciary duties to Novoship, and had entry into the Henriot Charters been a breach of that fiduciary duty, then the causation test it adopted would not have applied).
The Court also decided that where a claim for an account of profits is made against one who is not a fiduciary, and does not owe fiduciary duties, then the court has discretion to grant or withhold the remedy.
One ground on which the court may withhold the remedy, it was decided, is that an account of profits would be disproportionate in relation to the particular form and extent of wrongdoing.
Here, the remedy would have been withheld. What Novoship wanted to do was to charter their vessels on time charters at market rates. That is what Novoship achieved. Since the ship owning companies wished to avoid the risk of fluctuating rates for freight, and wished to secure a long term income, they necessarily wished to lay off the risk on to the charterer.
Thus the profits that Mr Nikitin in fact made were the kind of profits that the ship owning companies deliberately decided to forgo. The Court decided that they cannot be described as profits which ought to have been made for Novoship and therefore that they fell outside the rationale for the ordering of an account of profits. Novoship relied on the rule hat where a fiduciary has made an unauthorised profit within the scope of his duty he is bound to account for it to his principal. The Court reiterated that it did not wish to cast any doubt on that well-established principle. But it also reiterated that Mr Nikitin was not a fiduciary and was not sued for any breach of fiduciary duty.
The outcome was that Mr Nikitin overturned a judgment against him for US$109 million.
This is the first clear confirmation from the Court of Appeal that a dishonest assister can be required to pay up the profits it has received from his participation in a breach of fiduciary duty. Although, here, the claimant was not successful, the decision does demonstrate that seeking an account of profits from third parties is another potential claim available to a state whose public official has misappropriated assets, received bribes for the award of a contract or otherwise breached the duties he owes.
The dishonest assister could be a professional who has helped to create a complicated web of legal entities knowing they will be used to receive and launder corrupt funds. Or it could be a company that has paid a bribe to win a contract.
However, the need to prove the dishonest assistance caused the profit, in the sense used by the Court of Appeal, and to show that disgorgement of profits would be a proportionate outcome will temper the scope of such claims. There will undoubtedly be cases where a state can argue with force that it should be entitled to the profits earned by a bribe-payer on contracts procured by bribes.
That might particularly be so where the payment of the bribe led to shoddy work, or to the successful bidder being unqualified, or to excessive profits above market rates. The argument might also be capable of being put when the contract was properly executed. That would arguably be consistent with the decision of the Court of Appeal, under the Proceeds of Crime Act 2002 following conviction for bribery, that a proportionate order confiscating the benefit from criminal conduct would be for the profits gained under the taited contracts together, amongst other financial advantages, with the value of excluding competitors from the bidding process: R v John Peter Sale.