THE SCOPE OF THE NO PROFIT RULE
The no profit rule is by no means new: it was recognised in Keech v Sandford (1726) Sel Cas Ch 61, and has thus been applied for some three centuries. Nonetheless, there has been considerable uncertainty over the years as to the extent of the restriction it imposes, partly due to the various ways that the courts have expressed it over the years and partly because it applies to a variety of fiduciary relationships and the question of whether there has been a breach in any case will be highly fact-sensitive.
In Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134, Lord Russell explained, at 144-145, that the no profit rule applies to any profits made by a fiduciary “by reason and in the course of that fiduciary relationship”,[1] subject (as explained above) to the principal having given its informed consent. Formulated in that way, the principle would appear relatively straightforward to apply, but it raises the question as to what amounts to having made a profit in that way, i.e. by reason and in the course of that fiduciary relationship. In the same case, at 153E, Lord Macmillan considered that, in order to succeed on a claim for breach of the no profit rule in the corporate context:
‘‘The plaintiff company has to establish two things: (i) that what the directors did was so related to the affairs of the company that it can properly be said to have been done in the course of their management and in utilisation of their opportunities and special knowledge as directors; and (ii) that what they did resulted in a profit to themselves’’ (emphasis added).
In the trust case of Boardman v Phipps (above), at 123, Lord Upjohn expressed what may be the most frequently cited exposition of the principle as follows:
“The relevant rule… is the fundamental rule of equity that a person in a fiduciary capacity must not make a profit out of his trust which is part of the wider rule that a trustee must not place himself in a position where his duty and his interest may conflict. I believe the rule is best stated in Bray v Ford [1896] AC 44, 51-52] by Lord Herschell, who plainly recognised its limitations:
‘It is an inflexible rule of a Court of Equity that a person in a fiduciary position, such as the respondent’s, is not, unless otherwise expressly provided, entitled to make a profit; he is not allowed to put himself in a position where his interest and duty conflict. It does not appear to me that this rule is, as has been said, founded upon principles of morality. I regard it rather as based on the consideration that, human nature being what it is, there is danger, in such circumstances, of the person holding a fiduciary position being swayed by interest rather than by duty, and thus prejudicing those whom he was bound to protect. It has, therefore, been deemed expedient to lay down this positive rule…” (emphasis added).
Those approaches were also consistent with the leading English authority in the partnership context, Aas v Benham [1891] 2 Ch 244, in which a strong Court of Appeal (including Lindley LJ) held that the defendant partner had not breached the no profit rule in circumstances where he made use of information that he had obtained as a partner when he set up a company because the nature of that company’s business and thus the purposes for which the defendant partner had used the company’s information were wholly outside the scope of the partnership’s business. Bowen LJ observed at 257-258 that the partnership could only be entitled to profits arising from information which they (the partnership) could put to valuable use, and in the use of which they would therefore have a vested interest.
It is unsurprising, in the light of those authorities, that the no profit rule has been regarded by many jurists and practitioners as a mere sub-rule of the no conflict rule,[2] and that the fiduciary must have acted in breach of the no conflict rule in order for any liability to account for profits to arise. On that approach, if, for example, a person serving as a director of a shipping company took advantage of an opportunity to acquire a dairy farm for himself without the company’s consent, there should be no liability to account to the company for any profits derived from that opportunity, even if he learnt of the opportunity whilst dealing with company business or as a result of non-public information that the company possessed. But many similarly eminent jurists and practitioners have also held and argued that the rules are distinct,[3] being the view which ultimately commended itself to the Supreme Court in Rukhadze itself.
In Rukhadze, Lord Briggs (with whom Lord Reed, Lord Hodge and Lord Richards agreed) explained at [25] that:
“Important though it is to understand that a fiduciary’s obligation to account for profits (other than those which he has been authorised to retain for his personal benefit) is a duty arising on the receipt of the profits, rather than just a remedy for breach of fiduciary duty, it does not of itself answer the sometimes difficult question whether a particular profit made, before or after termination of the fiduciary relationship, falls within the duty to account. Undertaking the role of a fiduciary does not, of itself, prohibit the fiduciary from carrying on other profitable activities which have nothing to do with the subject matter of the fiduciary relationship. The director of a company making cars may perfectly legitimately carry on an activity of betting on horse races out of working hours, and keep any profits he makes for himself. But the opposite would be true of an executive director of a company operating a horse racing stable, if his betting was informed by what he learned while at work, unless the company gives its consent. Similarly (subject of course to any contractual restraint) the director of a company may, after resignation, set up and make profit from carrying on a similar business to that of the company, provided that he does not use information, or pursue opportunities that came to him, from his fiduciary position in the company. The duty, which may well extend beyond the end of the fiduciary relationship, is to account for profits made from, out of, or otherwise sufficiently connected with, the fiduciary relationship” (emphasis added).
Lord Leggatt also stated, in a similar vein, at [117] that:
“The duty not to exploit information and opportunities which are treated as property of the principal… serves a similar prophylactic purpose [to the no conflict rule]. It recognises that, human nature being what it is, there is a danger that a fiduciary may strive less hard to obtain a desirable business opportunity for the principal if, in case of failure to obtain it for the principal, the fiduciary is free to acquire it for himself. This is the risk to which Lord King LC referred in Keech v Sandford… The prohibition on a fiduciary entering into such a subsequent transaction is thus designed to remove or neutralise what would otherwise be a potentially conflicting interest when the fiduciary is exercising her fiduciary powers. Knowing that any relevant property, information or opportunity may be exploited only for the benefit of the principal is calculated to ensure single-minded pursuit of the principal’s interests. It thus shares the same aim as the rule which requires the fiduciary to avoid, and disqualifies the fiduciary from acting in, a situation of conflict of interest. In this way the two rules are related. The two duties, however, are not the same nor is the latter duty an instance of the former. This must be so, as transactions in which a fiduciary exploits relevant information or a business opportunity for personal gain do not necessarily involve a conflict of interest” (emphasis added);
and further, at [122], that:
“the principle [is] that [the fiduciary] must not use for their own purposes information or an opportunity which, as between them, the principal has the exclusive right to exploit”.
It is thus clear, in light of Rukhadze, that it is unnecessary to establish a breach of the no conflict rule in order for a breach of the no profit rule to be found: a fiduciary may be liable to account for profits that it has made personally as a result of using the principal’s private information, or apparently even time that was to be spent working for the principal, to pursue a particular opportunity, regardless of whether that opportunity was wholly-unrelated to the business or activity which the principal had entrusted the fiduciary to pursue, if the principal did not properly consent to it.
IS THIS THE END OF THE DEBATE?
Whilst that is the current state of English (and most probably Cayman Islands) law as regards the application of the no profit rule, and indeed provides much-needed clarity and certainty as to when a fiduciary requires the consent of its principal to take advantage of an opportunity personally, Rukhadze also indicates that the decision in that case may well not be the end of the debate. As Lord Leggatt observed at [139]:
“An argument can be made that in Boardman v Phipps and Regal (Hastings) the House of Lords cast the net of liability too wide”,
since those cases had been extensively criticised for having held the defendant fiduciaries liable in circumstances where they had acted honestly and in the best interests of their principals; their conduct had positively benefited their principals by generating profits for them (from the principals’ own shareholdings) which they would and could not otherwise have made; and the only way of obtaining that benefit for the principal was by the defendants investing their own money alongside that of the principal.
Lord Leggatt considered that “Those features might today reasonably be regarded as material… it is hard to see what policy is served by discouraging fiduciaries from making profits for their principals in such circumstances” and noted that, had those features been present in Rukhadze, and had it been argued that they justified a departure from Regal (Hastings) and Boardman v Phipps, “that argument would… have deserved serious consideration”.
It would certainly be desirable if a case involving those features were to arise and be appealed to the UK Supreme Court or the Privy Council, providing that more appropriate opportunity for further refinement of the rule, and perhaps to further limit the room for this particular equitable principle to produce arguably inequitable results. But it is of course impossible to predict when that might occur, and history suggests that final appeals on cases of this nature are very few and far between.
THE PRACTICAL CONSEQUENCES IN THE MEANTIME
Pending any further refinement of the no profit rule, it is therefore essential that persons holding fiduciary positions properly understand the restriction that it imposes on their personal endeavours, as well as those that they may undertake for parties other than the particular principal, unless the document(s) governing the relationship provide otherwise. It will be apparent from the discussion above that the rule is quite capable of operating as a painful trap for the unwary, with even the most well-meaning fiduciaries having been required to disgorge substantial fruits of their efforts (or compensate a principal for its loss of an opportunity).
Whilst many of the professional persons who occupy fiduciary positions (perhaps most notably in the context of investment funds and their management) typically ensure that they do not run that risk in the first place – by having the governing document(s) sufficiently attenuate their fiduciary obligations to enable them to engage in activities that might otherwise breach the duty – the lesson which the authorities collectively provide is that anyone occupying a fiduciary position will be well-advised to ensure that their responsibilities to the relevant principal are sufficiently spelt out in the document(s) governing the relationship. Rukhadze itself shows that the terms should go as far as to specify the time(s) at which the fiduciary is expected to serve the principal; or perhaps more appropriately, that the no profit rule is disapplied as regards any matter falling outside the range of business or activity that the principal requires the fiduciary to pursue. Taking that approach should substantially reduce both the risk of any surprises and the complexity of any claim for breach of the rule that might nonetheless arise.
[1] Lord Guest expressed the rule in very similar terms in Boardman v Phipps (above) at 117F.
[2] Including Lord Burrows in Rukhadze at [264].
[3] See e.g. Rukhadze at [113]-[114], where Lord Leggatt gave examples of cases and commentary on both sides of the divide.
