14 August 2014
Unravelling the fiduciary tangle, as applied to joint ventures, partnerships and directors of companies
The recent High Court case of Howard v Commissioner of Taxation provides a useful summary of aspects of the law relating to fiduciary duties and circumstances where they may be breached by diversion of an available commercial opportunity.
The case is interesting because it arises in the taxation context. The appellant, Mr Howard, argued that equitable compensation awarded to him was not assessable income because it was held on constructive trust for a company of which he was a director and he had, in effect, breached his fiduciary duties to that company by receiving the compensation.
1. Mr Howard was one of six participants in a joint venture established in or about July 1999. The concept for the joint venture was that a golf course would be acquired, after which an arrangement would be entered to lease the golf course to an operator. The golf course would then be sold to a third party. The expected profit of the joint venture would arise from the difference between the initial purchase price paid by the joint venture and the price paid by the ultimate purchaser.
2. Whilst the joint venture was being implemented, Mr Howard and two other joint venturers decided that investment in the golf course with an existing lease would be an attractive investment for a company that they controlled, being Disctronics. They discussed terms on which Disctronics might be able to purchase the golf course when the joint venture entity that held it was in a position to sell.
3. The suggestion that Disctronics might be the purchaser caused issues within the joint venture because the proposal that was put by Disctronics meant that less than the expected profit would be realised. However, the opportunity for Disctronics to be the purchaser was lost.
4. Instead, two of the other joint venturers and another party purchased the golf course without the knowledge of Mr Howard and his associates and entered into a lease with an operator, thereby diverting the opportunity from the joint venture to themselves.
5. Litigation ensued in the Supreme Court of Victoria and the Court of Appeal in Victoria, with the outcome confirming that the joint venture opportunity had been wrongly diverted and ordering payment of equitable compensation to Mr Howard and the other wronged joint venturers.
6. Following this, the Commissioner of Taxation assessed the equitable compensation awarded to Mr Howard as assessable income, even though he had directed payment of the compensation to Disctronics pursuant to a litigation funding agreement.
7. The issue for consideration in the High Court was whether Mr Howard had wrongly received the equitable compensation and therefore held it as constructive trustee for Disctronics.
Reasons and Decision
In deciding the issue, the High Court summarised aspects of the law in Australia as it relates to fiduciary duties. It was noted that the relationships of director and company and of joint venture participant are both classes of relationship that attract proscriptive fiduciary duties, including the duty not to obtain any unauthorised benefit from the relationship and not to be in a position of conflict. The fiduciary must account for the profit or benefit if it was obtained when there was a possible conflict between fiduciary duty and personal interest, or from taking advantage of an opportunity with knowledge derived from a fiduciary position.
The High Court noted that fiduciary duties have a broad judicial formulation but are not “infinitely extensible”. In the context of a partnership for instance, the limits of the fiduciary duties owed are to be determined by the character of the venture for which the partnership exists, the express agreement of the parties and the course of dealings actually pursued by the partnership. The scope of the fiduciary duty generally must be consistent with and conform to the “scope and limits of that relationship”.
In this context, the High Court stated by way of example that in the circumstance where company directors are also shareholders of a company, decisions the directors take as directors may affect their personal interests and they do not breach their fiduciary obligations merely because in promoting the interest of the company they are also promoting their own interests. That said, it was made clear that “…a decision taken by directors to advantage themselves other than as members of the general body of shareholders would constitute an abuse of the fiduciary powers”.
Hence, in a complex situation such as that presented in this case, it is necessary to identify with precision the various relationships that attract fiduciary duties and then determine for each of those relationships whether there has been a conflict between personal interest and the fiduciary duty and whether any gain or benefit was obtained by use or by reason of the fiduciary position.
Here, Mr Howard owed fiduciary duties to his fellow joint venturers. Those duties related to the joint endeavour of acquiring the golf course, securing the operating lease and then securing a purchaser to realise a profit. The High Court was of the view that Mr Howard complied with these fiduciary duties at all times. It was the other joint venturers who diverted the opportunity and breached those obligations.
Mr Howard attempted to argue that the opportunity available to Disctronics was an opportunity that he somehow diverted or prevented Disctronics from obtaining, in breach of his fiduciary duties owed as a director. The High Court found that this was not the case. The unanimous view was that Mr Howard had at all times acted in accordance with his duties as director to attempt to secure the opportunity to invest in the golf course by Disctronics.
In effect, the fiduciary duties owed by Mr Howard to his fellow joint venturers were not inconsistent with the fiduciary duties he owed to Disctronics as a director. The opportunity for Disctronics to invest in the golf course was lost when the joint venturers as a whole could not agree on Disctronics being the purchaser, not by any conduct of Mr Howard’s.
In discussing this aspect, the High Court confirmed that if a director diverts an opportunity that came to the director in the course of or as a result of holding office as director, in order to give rise to a liability on the director’s part for breach of his or her obligations to the company, it does not matter whether the company could not or would not have exploited the opportunity.
Hence, as Mr Howard had not breached any relevant fiduciary duties to Disctronics, he did not earn or ever hold the equitable compensation awarded to him on constructive trust for that company.
The consideration of fiduciary duties as applied to joint ventures, partnerships and directors of companies is a potentially complex area of law, even though these structures are commonly used in commerce to conduct business.
It is important that people conducting business have an understanding of the duties and obligations that arise in respect of the separate and distinct relationships in which they may be involved, often simultaneously.
In circumstances where business arrangements break down and the interests of the participants diverge, it is important to pay special attention to possible breaches of fiduciary duties for diversion of any relevant commercial opportunity. As the Howard case demonstrates, other significant and potentially unconsidered liabilities can also arise, such as tax liability on income earned but not benefited from.
Author: Gavin Stuart