Granting an Equitable Allowance to the Defendant

On 6 September 2006 the Supreme Court released its important and controversial judgment in Chirnside v Fay [1] . Elias CJ and Tipping and Blanchard JJ took very different approaches to the issue of whether or not to grant an equitable allowance to the defendant. This essay’s primary aim is to provide a detailed description of their Honours differing opinions as to that issue and also outline the author’s own opinion as to what approach should be adopted. This essay starts with a brief description of the fact situation and the general law behind equitable allowances. It then describes the differing approaches taken in Chirnside [2] . Next, the author makes a principled argument that the broad approach should be preferred when considering whether or not to grant an allowance.

II Analysis of Chirnside v Fay

A Fact Situation

The plaintiff, Mr Fay (MF), and the defendant, Mr Chirnside (MC), were both property developers. They had known each other since the early 1980s and in 1997 decided to enter into a project together in respect of an old building. They had Harvey Norman (HN) in mind as the potential anchor tenant. Although MF made the initial contact with HN MC became almost solely responsible for dealing with them and entered into a conditional contract in his name only. HN made the final commitment to the project on 7 July 2000. By that time MC had “gone cold” on MF, largely due to his limited involvement. Instead of telling MF this MC intended to complete all the transactions through Rattray Ltd while convincing MF that he himself was no longer involved. MF argued that there had been a partnership and that he was entitled to proceeds, which was denied by MC. The project was ultimately completed. MF sued.

By the time this case got to the Supreme Court the only viable cause of action that MF had was breach of fiduciary duty. The Supreme Court was unanimous in finding that MC had breached his fiduciary obligations.

B Equitable Allowance

There is a presumptive requirement that once a breach of fiduciary duty has been established the errant fiduciary must disgorge all profits made by dint of the breach. [3] That is commonly referred to as the “no-profit rule”. There are two main exceptions to that rule. The first is where there has been some antecedent agreement for profit sharing. [4] The second is where the court decides to exercise its discretion to grant the errant fiduciary an allowance for their skill, labour or expertise in making the profits. [5] The onus is on the defendant to satisfy the court that an allowance should be made. [6]

In Chirnside there was an antecedent profit-sharing arrangement between the parties. [7] Because of that agreement MC was entitled to a deduction of 50 per cent to the amount he had to account to MF. [8] In addition to that, MC argued that he was entitled to an allowance due to the effort he exerted in gaining the profit from the joint venture. [9] There were two different approaches taken to this issue both in regards to the actual law itself and the application of it.

1 Elias CJ

Elias CJ took a strict approach to the issue of when an allowance should be granted. Her Honour’s main point was that allowances should remain exceptional, as Lord Templeman and Lord Goff in Guinness Plc v Saunders [10] suggested they should be. [11] She expressed the view that an allowance should generally only be permitted if the fiduciary’s breach was wholly innocent and the beneficiary was-wholly undeserving, as in Boardman v Phipps [12] . [13] She accepted, however, that there had been cases where allowances had been granted despite the fiduciary not being blameless. [14] She was of the opinion that the allowances were granted in such cases due to the fiduciary creating extraordinary profits outside the scope of what was envisaged in the fiduciary relationship while not having committed any significant wrongdoing. [15] To evidence this point she analysed the cases of O’Sullivan v Management Agency [16] , Estate Realties v Wignall [17] , Badfinger Music v Evans [18] , and Say-Dee v Farah Constructions [19] . [20] She suggested that in those cases the fiduciary had created substantial and unexpected profits and in most of them the wrongdoing was mere non-disclosure, which supported her proposition. [21] Thus, she was of the view that an allowance could only be granted here if MC could show that he was wholly innocent and MF was-wholly undeserving or that he created extraordinary profits, essentially outside the scope of the fiduciary undertaking, while not having committed any significant wrongdoing.

She then applied that reasoning to the facts. She held that MC had committed significant wrongdoing because by actively concealing his breach of duty at a vital time he had directly undermined the obligation of loyalty which is the cornerstone fiduciary obligation. [22] Moreover, she was of the opinion that the work which MC had done was expected of him and thus was within the scope of the joint venture giving rise to the fiduciary obligations. [23] Based on those two findings she denied MC an allowance. [24] She did, however, make two additional points. Firstly, she saw no significance in the fact that MC’s work had been undertaken before he had committed the breach because he was required to account for all profits made through the opportunities he obtained as a fiduciary which covered the whole joint venture. [25] Secondly, the fact that MC was entitled to a 50 per cent deduction by dint of the antecedent agreement was important to her because she felt that if an allowance were to be granted he would essentially be receiving the full benefit he might have expected had he been wholly loyal which would significantly undermine the obligation of loyalty. [26]

2 Tipping and Blanchard JJ

Tipping and Blanchard JJ took a broad approach to the issue of when an allowance should be granted. They expressed the view that what a court should consider is whether, on the overall balance of the equities between the parties, it is fair and just to grant an allowance. [27] In considering that, all the relevant circumstances must be taken into account. [28] The essence of this exercise was to come to a fair conclusion as to what the fiduciary had to account. [29] Thus, unlike Elias CJ they were of the opinion that the significance of the defendant’s breach and the personal input that they put into creating the profits were only factors to be taken into account rather than criteria that had to be satisfied. However, they did emphasise the need for restraint when calculating the amount of an allowance. [30] That is, they expressed the view that the amount of allowances should generally not be liberal in order to deter others from committing breaches of fiduciary duty. [31] Their main authority for this approach was O’Sullivan [32] , Warman International [33] , Estate Realities [34] , and Murad v Al-Saraj [35] . [36] They analysed Saunders [37] , which was a crucial case for Elias CJ, and distinguished it based on the finding that the obligations in that case were expressly accepted whereas in this case the obligations were imposed. [38] They stated that it would be unfair and conflict with the pillars of equity to apply such a strict approach as was done in Saunders [39] in a case such as this. [40]

They then applied that reasoning to the facts. There were four key factors which led to them ruling that it was fair and just to grant MC an allowance. Firstly, they held that MC’s breach was not significant because it was not fraudulent or dishonest and MC genuinely believed he was entitled to act as he did. [41] Secondly, they held that most of MC’s work was done prior to his breach of duty and as such the breach did not facilitate in any way the making of the relevant profit. [42] This was relevant to them because due to that ruling there could be no suggestion in their minds that by granting an allowance the fiduciary relationship would be undermined by encouraging fiduciaries to act in breach of duty. [43] Thirdly, they held that MC had contributed far more effort in bringing the joint venture to profit than MF. [44] In particular, MC had incurred all legal and financial liability and engaged in most of the negotiations with HN on his own. Fourthly, had the project been completed with MF then it was clear that he would have agreed to recognise MC’s disproportionate contribution in a reasonable way which would have probably included an element of disproportionate profit sharing. [45] Having found that an allowance was suitable they then exercised restraint in calculating the amount of the allowance, which they ultimately considered to-be $100,000. [46]

3 Conclusion

Thus, the key distinction between these two approaches is that while Elias CJ believed it was necessary to keep allowances exceptional by adopting a strict approach based on general elements Tipping and Blanchard JJ considered the issue by asking a much broader question based on notions of fairness.

III Author’s Opinion as to the Appropriate Approach to Allowances

Every court of equity has the broad aim of doing justice between the parties. [47] Indeed, equity was originally developed in order to address the injustices that resulted from the strict application of common law rules and since then it has been consistently stated that equitable remedies must be fashioned to fit the nature of the case and its particular facts. [48] It would be more consistent with these broad goals for the decision of whether to grant an allowance to not be based on general rules but rather on an overall assessment of the particular facts and the merits and claims of the defendant. That is because a court is much more able to come to a decision that is fair between the parties if it is able to take account of all the circumstances of the case and not be limited to discussing a couple of general issues as courts that adopt the strict approach are. While the major issues in deciding whether to grant an allowance will often be the moral blameworthiness of the defendant and the personal input that they put into creating the profits, which are the two issues addressed under the strict approach, there are other important issues that can only be properly taken into account under a broad approach. For example, the circumstances in which the breach occurred [49] , the circumstances in which the gains or profits were derived [50] , the beneficiary’s reliance on the fiduciary’s involvement in the arrangement [51] , and the extent to which the defendant has already been compensated through professional fees [52] . The case of Chirnside [53] illustrates this point that in taking a broad approach the court is more likely to come to a decision that is fair and just. In Chirnside [54] it was clear that although the plaintiff had breached his fiduciary obligations it would be unfair if he was not granted an allowance. That was because the defendant had almost singlehandedly brought the joint venture to profit and the plaintiff was originally going to compensate him for his significant efforts. [55] Elias CJ took a strict approach to the case and due to its rigid nature she was unable to do justice between the parties. However, in taking a broad approach the main judgment was able to take account of all the circumstances and reach a fair and just decision. Thus, courts should use the broad approach because they will be more able to reach fair and just decisions and be more in line with foundational aspects of equity.

Furthermore, a broad approach is more consistent with the important equitable maxim of he who seeks equity must do equity. That is, under a broad approach the court will always be able to recognise whether the profits to which the beneficiary is entitled are in the nature of a windfall and as such rule that the beneficiary should provide some recompense for the work that has produced it because equity is not in the business of unjustly enriching plaintiffs.

Furthermore, the broad approach is a lot more flexible than the stricter approach and as Tipping J stated in Chirnside it is undesirable to adopt rigid equitable approaches unless the justification for such an approach is compelling. [56] The reason for that is that one of the foundational aspects of equity was its remedial flexibility in that it was first developed to address the rigour and rigidity of the common law. [57] The way in which one typically makes such an argument is to suggest that the rigidity of the stricter approach tends towards much greater certainty, which is particularly desirable due to the significant vulnerability and broad liability involved in the application of the approach, and as such it is necessary in the overall interests of justice to adopt a rigid approach. [58] In this case, while adopting the stricter approach would create more certainty it is not particularly important to do so here because the burden of proof is on defendants who will have breached some of their obligations and allowances are usually modest. [59] Accordingly, there is no compelling reason in this regard to adopt a stricter approach.

An argument that is frequently postulated in favour of a stricter approach is that such an approach will be more effective in deterring fiduciaries from acting in breach of their duties. It seems farfetched to suggest that a defaulting fiduciary will not engage in certain behaviour for fear that it will be unremunerated. Indeed, many cases show that a fiduciary will engage in conduct in breach of duty regardless of the potential sanction. [60] Moreover, if equity’s true goal was deterrence then a defaulting trustee would not be allowed to retain a proportion of the profit made from acquiring an asset with mixed funds. [61] Also, courts that adopt the broad approach still pay regard to this concern by exercising restraint when they calculate the allowance. [62] Thus, it seems unsound to not adopt a broad approach based on notions of deterrence.

It is sometimes argued that allowances should never be granted because the making of an allowance means that there is no sanction for the defendant’s conduct. This argument is ill-conceived. The purpose of an allowance is to properly fix compensation or damages on the basis of disgorgement of profits properly analysed, not to apply a sanction or punishment for the breach of duty. [63]

IV Conclusion

In conclusion, it is clear that the approaches taken by Elias CJ and Tipping and Blanchard JJ are very distinct and will reasonably frequently lead to differing results, as in Chirnside [64] itself. It is this author’s opinion that the broad approach used by Tipping and Blanchard JJ is the more appropriate approach because it is more in line with foundational aspects of equity and the arguments in favour of the strict approach are not compelling enough to go against that. Given the main judgment in Chirnside [65] , and Estate Realities [66] , it is likely that the broad approach will be used in New Zealand for the foreseeable future.