Commonwealth Oil & Gas Company Ltd. v Baxter [2009] CSIH 75

Introduction

The Inner House decision in Commonwealth Oil & Gas Company Ltd. v Baxter [2009] CSIH 75 raises a great number of interesting issues which are deserving of analysis and comment. The issues straddle trust law, company law and bankruptcy law. However, due to constraints of space, this blog attempts to limit itself to scratching the surface of some of the issues which gripped the attention of the blogger as he read through the respective judgments of the Inner House. The leading judgment was delivered by Lord Nimmo Smith and the Lord President also delivered a judgment which concentrated more on the legal issues in hand, rather than the facts.

The case concerned the exploitation of a corporate opportunity by a director and whether that director was in breach of his fiduciary duty to avoid a situation of conflict of interest and duty. The company sought to disgorge the profits which the director had personally made from the misappropriation of the opportunity. More significantly, the company sought to hold the third party to whom the opportunity had been directed liable on the basis that any profits it had made were held on constructive trust for the company on the basis that the third party was in ‘knowing receipt’. The ‘knowing receipt’ point was pled as the director was also the president and CEO director of the third party which it was thought may have been sufficient to establish the requisite linkage between the director and the third party. As articulated accurately by the Lord President, the position of Scots law on the latter point ‘is sparse’ (para. [15]).

Director’s Fiduciary duty to avoid a conflict of duty and interest

Of particular interest was the obiter statement of the Lord President on the scope of a director’s fiduciary duty to avoid a situation of conflict of interest and duty (formerly a common law duty, but now codified in section 175 of the Companies Act 2006). His Lordship was of the view that the extent of that duty may fluctuate depending on the facts of the case at para. [10]:
 
“This reflected the analysis favoured by Lord Upjohn in Boardman v Phipps at page 107. As Rix LJ put it in Foster Bryant Surveying Limited v Bryant [2007] 2 BCLC 239 at para.[65] (a case where the director had intimated his resignation but it had not yet taken effect), "… although [the] general principle is not in doubt, the extent of a director's duty in particular situations may depend on the circumstances". In the same way, if a director were to draw to the attention of his company a particular commercial opportunity, whether in an embryonic or developed state, and to obtain the company's consent to pursue that opportunity on his own personal behalf, his duty to avoid a possible conflict of interest would not extend to that opportunity. Similarly, it seems to me that if, without the identification of any particular opportunity, the company, expressly or implicitly, were to give its prior consent to a director pursuing possibly competing interests, his duty would not extend to avoiding such conflicts. If, for example, in the present case agreement had been reached between [the director] and [the company] that some opportunities (say, any onshore) would be brought to [the company] but that others (say, offshore) could be exploited by [the director] for his own interest and benefit, the scope of [the director]'s duties would have been modified by that arrangement. Even without express agreement, the actings of parties could in some circumstances have given rise to a modification of [the director]'s duties. However, the [director] did not argue that what might otherwise have been his fiduciary duties had in fact been modified by the actings of the parties. Accordingly, I need say nothing further about this possible approach.”

Thus, in terms of the underlined text above, where the company’s actions are such that they expressly or implicitly provide their consent to the director exploiting an opportunity, the director will not be deemed to be in breach of duty. Express consent is one thing, but the difficulty lies in determining how and whether the company has implicitly consented to the director’s personal exploitation of the opportunity. For example, one might argue that common sense dictates that there must be a presumption that a company will be taken to have implicitly consented to the director personally exploiting an opportunity where that opportunity (i) falls outside the scope of [the company’s] business activities and (ii) was not actually taken up by the company. However, such a presumption would clearly conflict with (i) section 175(2) of the Companies Act 2006 (“…it is immaterial whether the company could take advantage of the property, information or opportunity”) and (ii) the recent judgment of Rimer LJ in the Court of Appeal in O’Donnell v Shanahan [2009] EWCA Civ 751 at paras. [70]-[71] which takes a particularly uncompromising approach to the director’s power of personal exploitation. Here, Rimer LJ stated that:

“The statements of principle in the authorities about directors' fiduciary duties make it clear that any inquiry as to whether the company could, would or might have taken up the opportunity itself is irrelevant; so also, therefore, must be a 'scope of business' inquiry. The point is that the existence of the opportunity is one that it is relevant for the company to know and of which the director has a duty to inform it. It is not for the director to make his own decision that the company will not be interested and to proceed, without more, to appropriate the opportunity for himself. His duty is one of undivided loyalty and this is one manifestation of how that duty is required to be discharged. This was a case in which, in the course of acting as directors on behalf of the company in an estate agency capacity, the [directors] obtained information relating to the [opportunity] and were given the opportunity of personally sharing in the opportunity… It may have been improbable that the company could or would want or be able to take up the opportunity itself. But the opportunity was there for the company to consider and, if so advised, to reject and it was no answer to the claimed breach of the 'no profit' rule that [the opportunity] was something that the company did not do… There was no bright line marking off [of] what [the company] did and did not do. ”

In the blogger’s opinion, there can be no such thing as a presumption of implicit consent in such circumstances. Instead, it is suggested that something akin to a form of personal bar through conduct on the part of the company may require to be established by the director to demonstrate such implicit consent. It is submitted that the situations where the appropriate quality of conduct is present will be rare and so this must represent a high hurdle for a party to negotiate.

Director’s Fiduciary duty to disclose his/her own misconduct

Another interesting point to emerge from Lord Nimmo Smith’s and the Lord President’s judgments is the fact that (i) Lord Nimmo Smith and counsel for the parties were of the view that there was no duty incumbent on the director to disclose his own misconduct or wrongdoing to the company and (ii) the Lord President reserved his opinion as to whether Scots law recognised such a duty on the part of a director to disclose his or her own wrongdoing. In the case of Item Software (UK) Limited v Fassihi [2004] IRLR 928, in the Court of Appeal, Arden LJ ruled that a director had a positive "duty to disclose … information of relevance and concern" to the company. Whilst this is clearly the position in English law, both Lord Nimmo Smith and the Lord President were clear to the effect that their judgments should not be taken as endorsing the proposition in Item Software as one which applies to Scots law. Indeed, they were positively circumspect (Lord Nimmo Smith slightly more so than the Lord President) regarding its applicability in Scots law. Perhaps their Lordships were subconsciously influenced by the classic exhortation of Lord Atkin in Bell v Lever Bros. [1932] AC 161, 228 that 'to imply such a duty would be a departure from the well established usage of mankind and would be to create obligations entirely outside the normal contemplation of the parties concerned.'

The ‘Knowing receipt’ and ‘constructive trust’ issue

The case also casts light on the applicability of the doctrine of ‘knowing receipt’ and the role of constructive trusts in Scots law where an asset is transferred to, or secured by, a third party pursuant to, or in connection with, a director’s breach of duty. In such circumstances, to what extent can that third party be held liable to the company who has suffered loss as a result of the director’s breach of duty, i.e. to what extent does a 'right to trace' exist in such circumstances in Scots law? At paras. [16]-17], the Lord President stated:-

“Authority in Scotland on the requisites of liability for knowing receipt is sparse. It is, however, clear that its foundation lies in the law of trusts, under which a stranger to a trust may in certain circumstances become liable to the trustees (or the beneficiaries) in respect of trust property. Menzies on Trustees (2nd ed.) at para.1271 in a section headed "Following Trust Estate" identifies the second situation where a constructive trust may arise as "… where funds affected with a trust come into the hands of another than the beneficiary, either gratuitously or with knowledge of a breach of trust, the transferee is a constructive trustee". The cited passage imports that prior to their coming into the hands of a stranger there are funds affected with the trust, that is, trust property. It has been recognised in Scotland that remedies based on the misapplication of funds may be afforded where a fiduciary relationship arises commercially. In Style Financial Services Limited v Bank of Scotland 1996 S.L.T. 421 the court observed at page 426J-K:

"If the defenders were aware of the existence of this fiduciary relationship and that the funds paid into Goldberg's account were the pursuers' funds, then we are satisfied that sufficient has been averred to entitle the pursuers to seek to make out a case based on recompense."

Again the passage describes pre-existing funds – in that case monies collected from debtors.

In England, where the law on knowing receipt is more developed, the classic statement of its requisites is that of Hoffmann L.J. (as he then was) in El Ajou v Dollar Land Holdings plc [1994] 2 All E.R. 685 at page 700 where he said:

"This is a claim to enforce a constructive trust on the basis of knowing receipt. For this purpose the plaintiff must show, first, a disposal of his assets in breach of fiduciary duty; secondly, the beneficial receipt by the defendant of assets which are traceable as representing the assets of the plaintiff; and thirdly, knowledge on the part of the defendant that the assets he received are traceable through a breach of fiduciary duty."

That statement appears to me to be consistent with Scots law. Again the passage proceeds upon the basis that there are assets [of the plaintiff], that they are disposed of and that they are, with certain knowledge, beneficially received by the defendant. The assets in that case comprised a large sum of money. The cited passage from El Ajou was endorsed by Nourse L.J. in BCCI (Overseas) Limited v Akindele [2001] Ch. 437 at page 448 (the pre-existing funds again being a sum of money). At page 450, in introducing a passage on knowledge, Nourse L.J. speaks of "misapplied assets of companies" and "assets received … traceable to a breach of trust". There is no support there for the view that liability in knowing receipt may arise when assets are created, as distinct from transferred, in breach of trust.”

For the purposes of the facts of Commonwealth Oil & Gas, the last sentence from the above passage was crucial. Since the third party entered into an agreement and this could not be classified as the transfer of an asset, and instead was treated as the creation of an asset/property, the company was unsuccessful in its cross-appeal which sought to secure a remedy to the effect that the profits enjoyed by the third party would be held on constructive trust for it on the basis of knowing receipt. Neither was it deemed to be obvious that a claim in damages would be open to the company by reason of the receipt itself, since the remedy was restitutionary in nature (which, of course, stems from the fiduciary nature of the obligation).

What is particularly noteworthy is the assertion by both Lord Nimmo Smith and the Lord President that Scots law and English law are both at one on the establishment of a constructive trust in terms of knowing receipt. At this juncture, it would be extremely remiss of me not to mention my erstwhile colleague, Professor George Gretton and his influential views on the institution of the constructive trust in Scots law. In a series of articles written in the Edinburgh Law Review and elsewhere, Gretton has argued cogently that the constructive trust only operates at the margins of Scots law and that it is an unhelpful doctrine which can serve to generate injustice. Indeed, Gretton demonstrates how cases which are labelled as raising constructive trust issues are nothing of the sort. These articles do not appear to have been considered by the Inner House. The Inner House’s judgments may perhaps suggest that the Scottish courts are generally not averse to doctrines which empower parties a right to trace, i.e. recover assets and monies dissipated in breach of fiduciary obligation. That proposition, in itself, is worthy of rigorous analysis in a journal article, since the equitable nature of the tracing mechanism is such that the full ramifications of its recognition for the laws of bankruptcy and property really ought to be worked out in full.

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