Can a breach of fiduciary duty affect your profit share?

Article

08 November, 2016

In Hosking v Marathon Asset Management LLP [2016] EWGC 2418 (Ch), a landmark decision, the High Court has ruled that in the aftermath of a breach of fiduciary duties the principle of forfeiture of profits can apply to Limited Liability Partnerships in some instances. Whilst this is readily accepted within the realms of company law, this is the first time that this issue has been adjudicated on in relation to a partnership, in which each partner acts as an agent for the partnership and as such owes their fellow partners fiduciary duties.

Background to the dispute

Marathon Asset Management LLP (Marathon) operated primarily as an asset management business, which was originally formed by Mr Hosking (the Claimant here) and another. An important aspect of the partnership deed was that Hosking was classed as a "Class A Member", of which there can be "Non-Executive Members" or "Executive Members". The deed further stated that Non-Executive Members are only able to receive 50 per cent of the income profits payable to Executive Members, as they are a Founding Member that no longer takes an active role within the day-to-day running of the business. In accordance with his position as an Executive Member, Hosking was required to devote all of his time to the Partnership's business and the High Court had to find whether or not Hosking's behaviour following a set of circumstances amounted to a breach of fiduciary duty owed by him to his fellow partners.

The High Court's decision

The High Court held that Hosking breached the contractual and fiduciary duties that he owed to Marathon and his fellow partners by discussing with four of Marathon's employees the possibility of starting a new business and furthermore producing a business plan in the process. This agency principle is well established within partnership law, particularly as each partner has the power to bind their fellow partners and also the business as a whole. However, this is the first time that the laws relating to forfeiture have been applied within this setting, and as a result Hosking was ordered to pay £10.38 million to his principle, Marathon, which equates to the 50 per cent extra remuneration that he was entitled to as an Executive Member of the partnership.

Newey J passed the judgment of the court and made a distinction between profit shares - to which all partners are entitled - and remuneration for work done. It was held that whilst profit shares normally reflect the interest of a partner or member in the firm, there are cases where it may reflect compensation for certain services. When this is the case, profit share can fairly be viewed as remuneration and fall within the forfeiture principle. In the present case this is apparent because as an Executive Member, Hosking was entitled to 50 per cent more of the profit share than Non-Executive Members, and this was seen to reflect the active role he played during the day-to-day running of the business. As he breached his fiduciary duties during this period, Newey J found it to be just for him to compensate Marathon for the 50 per cent remuneration that he received. However, he did not have to pay the other 50 per cent of the profit share to which he would be entitled as a Non-Executive Member. Here, a key distinction has been drawn.

Comment

The decision in Marathon identifies that the forfeiture principle applies to partnership law but only when a partner's profit share reflects remuneration for an additional service provided by them to the firm. If Marathon's partnership profits were distributed to all of the partners equally, with remuneration being an additional fixed figure, then it would be likely that the rule within this case would not apply. The crux of the problem in Marathon was that the extra remuneration could not be separated from Hosking's profit share. Separating these two sources of income completely would have prevented this dispute arising.

The decision in Marathon demonstrates the need to properly draft your partnership agreement to cater for this eventuality, and protect your partnership should one of the partners breach their fiduciary duties in this manner. In order to provide clarity it should distinguish between profit share entitlements and fixed remuneration that partners could additionally receive. Partners may decide that they wish to exclude the forfeiture principle entirely.

The Corporate & Restructuring team at Forbes Solicitors have extensive experience relating to partnership agreements. If you have any queries relating to this article or partnership law more generally, you can call our Corporate and Restructuring team directly on 0800 689 0831. Alternatively you can contact use via our online Contact Form.

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