On an appeal from an arbitration award, the High Court found that a profit share payable to a member of an LLP was capable of being subject to forfeiture where the member was found to have breached his fiduciary duties to the LLP: Jeremy Hosking v Marathon Asset Management LLP  EWHC 2418 (Ch).
It is an established principle that if a fiduciary breaches his duty he may forfeit his right to fees payable by the principal (provided that forfeiture is proportionate and equitable). This principle was reaffirmed by the Court of Appeal in Imageview Managment Ltd v Jack  EWCA Civ 63. In that case, a footballer's agent was held to have forfeited his commission because he made a secret side deal with a football club when negotiating for his client. However, there are no reported English cases where this principle has been applied to an LLP member's profit share, rather than fees or commission.
The present decision means that if an LLP member's profit share can be characterised as a reward for undertaking fiduciary duties (as opposed to reflecting the member's ownership interest in the firm) then it can potentially be subject to forfeiture. Although the forfeiture principle can be excluded in the LLP agreement, the parties do not need to include it expressly in order for it to apply.
The takeaway message is that when drafting an LLP agreement the parties should make it clear whether any profit share payable to the members is intended to be remuneration for performance of their fiduciary duties and, if so, whether that profit share should be subject to forfeiture if the members breach those duties.
Marathon is an investment management business founded in 1986 by Mr Hosking and two other individuals (the "Founding Members"). In 2004, the Founding Members entered into an LLP deed with Marathon Asset Management LLP which set out, amongst other things, the Founding Members' entitlement to share in the profits of the business.
For present purposes, it is sufficient to note that the profits payable to the Founding Members are shared equally save that if any of the Founding Members becomes a ‘Non-Executive Member’ (ie a Founding Member who no longer works in Marathon's business) he becomes entitled to 50% of the profits to which he would have been entitled if he was still an ‘Executive Member’.
Mr Hosking gave notice of his retirement on 5 April 2012. His retirement was effective on 11 December 2012 and he thereby became a Non-Executive Member and his profit share was reduced accordingly. Marathon subsequently commenced arbitration proceedings against Mr Hosking in which he was found to have breached his contractual and fiduciary duties by having discussions with four of Marathon's employees in July 2012 about the possibility of starting a competing business.
The arbitrator awarded Marathon equitable compensation for losses suffered as a result of Mr Hosking's breaches and also held that Mr Hosking should forfeit 50% of the profit share payments that he received in respect of the period from mid-July to mid-December 2012 (ie the period when he was in breach of his fiduciary duties). The arbitrator found that 50% of the profit share received by ‘Executive Members’ was, in substance, remuneration for the performance of their executive duties. The remaining 50%, received by both ‘Executive Members’ and ‘Non-Executive Members’, reflected the members' ownership interest in the business.
Mr Hosking appealed the arbitrator's decision on the basis that forfeiture could not, as a matter of principle, apply to an LLP member's profit share because it reflects an ownership share in the business rather than remuneration in exchange for performance of fiduciary duties.
The High Court dismissed the appeal and held that a profit share payable to a partner or LLP member could potentially be subject to forfeiture.
Newey J found that while the forfeiture principle has mainly been invoked in relation to agents in the past, the rationale for it extends more widely and it has been taken to be applicable to other fiduciaries as well. The rationale is based on the need to deter fiduciaries from betraying the trust that is placed in them, which will not necessarily be achieved by requiring the fiduciary to pay damages.
Newey J also rejected Mr Hosking's attempt to draw an artificial distinction between remuneration (which could be subject to forfeiture) and a profit share (which, on Mr Hosking's submission, could not). He suggested that while it would often be impossible to characterise an LLP member's profit share as ‘remuneration’, that was not necessarily always the case and the law should be concerned with the substance of the arrangements rather than the form. In those unusual cases where a profit share can be identified as a reward for undertaking specific fiduciary duties, there is no good reason for treating it differently from any other form of remuneration.
Newey J went on to consider the fact that the LLP deed did not provide for forfeiture and found that this did not mean that there was no scope for the forfeiture principle to apply. While the parties can exclude forfeiture in the LLP agreement, the fact that they have not expressly included it is not determinative.
Mr Hosking sought permission to appeal the High Court's decision to the Court of Appeal but this was refused by the judge.
This post comes to us from Herbert Smith Freehills and was originally published on the firm’s Litigation Notes blog. It has been authored by Gary Horlock.