SUPPOSE a trustee misapplies trust funds to purchase property for his own benefit. If the acquired property increases in value, what is the nature of the beneficiaries’ claim in respect of those gains? This was recently considered by the Hong Kong Court of Final Appeal in Tang v Tang [2017] HKCFA 3. In 2003 the administrator of an estate (the defendant) purchased property (the “Property”). The purchase was partly funded by the unauthorised use of HK $11.48 m from the estate. Shortly afterwards, the defendant executed a declaration of trust over the Property in favour of his corporate vehicle, Tri-Strong Investment Ltd. The Property was subsequently transferred to this company. Seven months after acquiring the Property, the defendant paid the estate the full amount that had been withdrawn together with interest. In 2005 the estate beneficiaries discovered the defendant's misuse of estate money and commenced proceedings alleging breach of fiduciary duty. By the time the matter was heard, the Property had increased significantly in value.
The defendant argued that the sum withdrawn from the estate was a bridging loan and that he had discharged his liability to the estate by repaying this sum in full. The trial judge accepted that the transaction was a loan. However, the defendant was in breach of fiduciary duty and was ordered to account to the estate for the value of gains attributable to use of the estate funds. The trial judge refused to grant proprietary relief and this was not pursued on appeal. Instead, the plaintiff claimed a proportionate share of the defendant's profits. The Hong Kong Court of Appeal ([2015] HKCA 523; [2016] 1 H.K.L.R.D. 302) rejected the trial judge's finding that the transaction was a loan but affirmed that the defendant had breached his fiduciary duty to the trust.
The Court of Appeal characterised the defendant's gain as profit deriving from a breach of fiduciary duty. Liability was conditional on establishing a causal nexus between the breach of duty and the defendant's gain. Citing authorities such as Target Holdings Ltd. v Redferns [1996] 1 A.C. 421, it was noted that in granting equitable compensation the court must be satisfied that the loss would not have occurred but for the breach. By analogy, a similar rule applied where the fiduciary had made a profit (see R.A. Havelock, “Account of Profits and Mixed Funds” [2016] L.M.C.L.Q. 332, where this reasoning is persuasively challenged). On the present facts there was sufficient proximity and the defendant's appeal was dismissed.
The defendant's further appeal to the Hong Kong Court of Final Appeal was also dismissed. Writing the judgment of the Court (Ma C.J., Ribeiro and Fok P.JJ., Chan and Lord Millett N.P.JJ.), Lord Millett N.P.J. considered that the Court of Appeal had misconceived the nature of the case. It was erroneous to treat this as a claim for secret profits, which typically involves the diversion of a business opportunity from the principal or the receipt of a benefit, such as a bribe, from a third party. Such conduct gives rise to a conflict of interest or a breach of the profit rule (at [14]). His Lordship stated that Tang can be understood on a much simpler basis. This was a straightforward case of a breach of trust by a fiduciary who had made a personal profit by using the principal's funds for his own purposes (at [15], [27]). Causation was not relevant. The enquiry, properly framed, is that where trust funds have been misapplied, the defrauded beneficiaries can elect whether to reject or affirm the transaction. In Tang the Property had increased in value. The plaintiff affirmed the transaction and claimed a proportionate share of the gain.
Several points arise. First, the rejection of the defendant's attempt to categorise the misappropriation as a loan is entirely consistent with principle. Absent the beneficiaries’ informed consent, a trustee cannot unilaterally extract a personal benefit from the trust. To rule otherwise would be to ignore the strictures of the profit rule. Moreover, on the facts of Tang, this would stultify the trust's ability to claim profits attributable to the use of its own assets or their substitutes.
Secondly, the Court of Appeal's reasoning reflected the uncertainties surrounding pecuniary relief in equity. Since Nocton v Ashburton [1914] A.C. 932 much has been said about the nature of equitable compensation. The role of causation and limiting principles has attracted intense scrutiny (see for example, AIB Group (UK) plc v Mark Redler & Co. [2014] UKSC 58; [2015] A.C. 1503). Less attention has been directed to the nature of gain-based relief, although it is generally held that causation is irrelevant or at least profoundly marginalised with respect to an account of profits (Gwembe Valley Development Co. Ltd. v Koshy [2003] EWCA Civ 1048; [2004] B.C.L.C 131, at [145], Stevens v Premium Real Estate Ltd. [2009] NZSC 15; [2009] 2 N.Z.L.R. 384, at [32]). However, such considerations must be set aside where gains derive from misuse of trust property. The Court of Appeal's failure to draw this distinction produced the right answer to the wrong question. As noted, where trust money has been misapplied to purchase property, the beneficiaries can elect to reject or affirm the transaction (Tang, Court of Final Appeal at [18]). In affirming the transaction, the purchase is essentially treated as an authorised act. By definition, gains deriving from the claimant's property, or interest in property, belong to the claimant.
Thirdly, the Court of Appeal categorised the defendant's gain as an account of profits to which a “but for” test of causation applied. This is philosophically inconsistent with fiduciary doctrine. A test of causation affords a means of avoiding disgorgement even if profits are made in the course of a fiduciary relationship or derived from trust property. This undermines the function of profit-stripping in deterring breach of fiduciary duty and removing the economic incentive for betraying a position of trust (Boardman v Phipps [1967] 2 A.C 46, Regal (Hastings) Ltd. v Gulliver [1967] 2 A.C. 134n). The imperative is particularly pronounced when a trustee exposes trust property to risk (Warman International Ltd. v Dwyer (1995) 182 C.L.R. 544, 561). Moreover, traditionally, an account of profits is subject to allowances in the court's discretion. This seems anomalous in cases like Tang, where gains are the product of the plaintiff's capital rather than the defendant's labour.
Fourthly, this discussion is underpinned by the parallel narrative of an account of administration. Trustees are accounting parties who can be required to render an account of receipts and disbursements in respect of the administration of the trust. The accounting exercise is not a remedy but a vehicle for enforcing performance of an obligation. Causation and limiting principles are irrelevant because the principal is not alleging loss. This is merely a procedural step to establish the state of accounts. While loss to beneficiaries and a trust account deficit have obvious similarities, they are conceptually distinct. As Lord Millett N.P.J. observed in Libertarian Investments Ltd. v Hall (2013) 16 H.K.C.F.A.R. 681, at [168]: “Where the defendant is ordered to make good the deficit by the payment of money, the award is sometimes described as the payment of equitable compensation; but it is not compensation for loss but restitutionary or restorative.”
If an account of administration discloses an unauthorised disbursement, the principal can falsify or affirm it. Thus, if (contrary to the fact) the trustee in Tang had acquired a wasting asset, the plaintiff could have falsified the unauthorised entry. The disbursement would then be disallowed and the trustee would be required to make good the deficit. An account can also be surcharged on the ground that the trustee has failed to account for the receipt of a trust asset or its fruits (see further M. Conaglen, “Equitable Compensation for Breach of Trust: Off Target” (2016) 40 M.U.L.R. 126, at 130, 143). Alternatively, an account can be challenged on the ground that the trustee failed to obtain all the assets of the estate. In this event, the plaintiff can surcharge the account on the basis of wilful default and obtain a credit for any omissions. Another option, considered above, is that an unauthorised act may be advantageous to the trust, in which case no objection need be taken and the trust may adopt the transaction. Of the various scenarios, only wilful default (irrelevant on the facts of Tang) involves issues of causation and proof of loss (Agricultural Land Management Ltd. v Jackson (No 2) [2014] WASC 102; (2014) 285 F.L.R. 121, at [339], [347]). Thus, the election to falsify or not falsify an account underlies the proprietary reasoning in Tang, where the basic remedial options with respect to an abuse of property rights were to affirm or disaffirm the impugned transaction. Although a similar outcome is achieved, each has a distinct focus. A proprietary interest is the foundation of a substantive claim to recover assets or their value and any derivative gains, whereas an account of administration enforces the personal liability of accounting parties in respect of unauthorised disbursements.
Tang is a further illustration that causation and limiting principles fit uneasily within the scheme of equitable wrongs. This is particularly evident in relation to the unauthorised disbursement of trust property. In this sphere at least, the law's primary focus is the vindication of property rights. This is manifested through a continuing beneficial interest in misapplied funds. Alternatively, when a transaction is falsified, the trustee's liability as an accounting party is strict. The consistent theme is that for well rehearsed policy reasons, the trust's performance interest must be rigorously enforced. Tang is a cogent reminder of this principle.
