Ripping off your business partners – how you might be brought to account

3 May 2021

Rating system:
Reading time (mins): 3
Sophistication level (1 (idiot) – 10 (expert)): 6
Entertainment value (1 (turgid) – 10 (side-splitting)): 5

Background

If you have a business relationship with someone which involves you owing fiduciary duties to them, you can be made liable to account to them for any benefit you get out of opportunities arising from that relationship without having obtained their informed consent.

For more on this, see my earlier article agents and secret commissions.

But how do you work out exactly what kinds of things you have to account for?

Recent Court of Appeal case

Mr de Clare operated as an enabler who was trying to put deals together whereby a special purpose vehicle (SPV) could eventually be set up by investors to acquire old oil wells and use a new ultrasound technology which aimed to scrape more of the last dregs out of them. He operated through his company, Global Energy Horizons Corporation (‘GEHC’). Mr Gray joined the team in 2004 on the understanding that he and Mr de Clare would benefit equally from any income generated by the venture. Their focus was on getting access to the technology and seeking funding to test it, with a view to then putting things through the SPV.

In a separate arrangement, in December 2005 Mr Gray was appointed as the manager of the ‘RegEnersys’ fund, which was looking to fund similar technology. It initially looked as though he would be able to help GEHC and RegEnersys work together, and to get GEHC a share in the proposed new SPV as a reward for its advisory role.

However, Mr Gray wangled things so that in due course at the end of the day when all was said and done it was he rather than GEHC who ended up with an indirect share (ie not held directly by him, but indirectly through a complex network of corporate and trust vehicles) in the SPV. This was on top of him also being paid several millions of pounds for his role in managing RegEnersys. Mr de Clare/GEHC was a bit upset and in 2010 took Mr Gray to court, claiming that Mr Gray had owed GEHC fiduciary duties, and had acted in breach of these by benefitting personally from the business opportunities that GEHC had brought to him, to the exclusion of GEHC.

Over the next 7 years there were a number of different court hearings about different aspects of this case. In 2012 a court ruled that Mr Gray had indeed through his work for RegEnersys managed to get for himself (albeit indirectly) a personal stake in the SPV, which was what GEHC had hoped to get; and that he had done so by taking advantage of the business opportunities belonging to GEHC which had been presented to him. This was in breach of his fiduciary duties to GEHC, so by law he should not expect to receive any benefits as a result of such breach. As a result, the court ordered Mr Gray to account to GEHC for all payments and benefits he had received directly or indirectly arising out of his breaches. When they argued over what exactly Mr Gray had to account for, it went back to court again. The court said he had to account for fees he had received to manage RegEnergys, and for the business interests he had received in the SPV. This went to court again to establish the value of these interests. This court said that those interests were in fact worth nothing (clearly the whole oil well extraction ultrasound technology venture hadn’t proved to be too successful), and so it refused to order Mr Gray to arrange to hand over those interests as it would be too much hard work trying to track down the complex network of corporate and trust vehicles which were involved..

Anyway, all quite messy and complicated, and both sides appealed to the Court of Appeal against various decisions reached by the various courts.

What did the Court of Appeal say?

1. Mr Gray argued that there wasn’t a sufficient connection between the breaches of fiduciary duty and his receipt of the fees and the business interests to justify him having to hand anything over.

The Court of Appeal said that you didn’t have to go to great lengths to show cause and effect (as you would if making a claim for breach of contract). The law requiring fiduciaries to account for unauthorised benefits is a strict one, involving the law of equity rather than contract law, and all you need to show is that there is some sort of link or nexus, such as a ‘reasonable relationship’, between the breach of duty and the benefits for which an account is to be ordered.

2. Mr Gray argued that he should be entitled to deduct from the RegEnersy fees which he had been ordered to hand over an ‘equitable sum’ to reflect the work he had actually done.

The Court of Appeal said that the standard rule was that a fiduciary should not be entitled to deduct such sums. It confirmed that the court has a discretion to do so, but said that such discretion should only be exercised in exceptional circumstances, because otherwise fiduciaries might be tempted to put themselves in positions of conflict knowing there was still a good chance of getting paid for the work they did anyway. There were definitely no such exceptional circumstances here, as the court thought that Mr Gray had been rather naughty.

The court did however confirm that Mr Gray was entitled to deduct expenditure he had legitimately incurred in earning the fees, whether that expenditure was incurred before or after he received the fee payments.

3. Mr Gray argued that because he did not actually hold any business interests surrounding the SPV himself, and the court hadn’t identified who actually held them (because they were held through a ‘complex network of corporate or trust vehicles’), the court could not order them to be handed over.

The Court of Appeal said that was rubbish, as the ‘enforcement of fiduciary duties by the court would be seriously impeded’ if you took that approach.

4. GEHC appealed against the most recent court’s decision not to order all steps to be taken to transfer all the business interests relating to the indirect interests of Mr Gray in the SPV.

The Court of Appeal said the judge had been entitled to exercise his discretion not to give this order, as he was entitled to factor in 1/ the overwhelming obstacles which would be encountered in trying to enforce such an order; 2/the fact that the interests had been valued as worthless; and 3/ the risk that the orders sought here by GEHC could be used in an ‘oppressive manner’ against Mr Gray.

Comments and tips:

• This equitable law requiring defaulting fiduciaries to account for unauthorised profits is designed to be quite tough, to discourage people from taking advantage of conflict of interest situations.

• If you are feeling guilty (or think that someone else in your shoes might feel guilty…) about whether you should be informing someone with whom you have a business relationship of opportunities that you are thinking of working on which wouldn’t have arisen without that relationship, then the safe bet is to assume (because you are feeling guilty) that you are a ‘fiduciary’ and owe them fiduciary duties, to tell them about it, and probably to get their consent before you go ahead. Unless you are happy to be shady about it and take the risks…

Case: Gray v Global Energy Horizons Corp [2020] EWCA Civ 1668.