Clark v Cutland

This is an appeal against the order of His Honour Judge Norris QC sitting in the High Court of Justice, Chancery Division, Birmingham District Registry, on 12 July 2002. In the proceedings the appellant, Mr Clark, has claimed relief under section 459 of the Companies Act 1985 in respect of unfairly prejudicial conduct by his fellow shareholder, Mr Cutland, in the management of the affairs of Tulgrove Limited (“the company”). Mr Clark succeeded in showing unfair prejudice and an order was made for the acquisition of Mr Cutland’s shares.

So far as material, Mr Clark and Mr Cutland were equal shareholders in the the company. At all material times, they were also the only directors of the company. The judge found that, without Mr Clark’s knowledge, Mr Cutland had misappropriated from the company sums totalling £517,734. The exact method of his misappropriation is not material for present purposes. When the misappropriation came to light, Mr Clark commenced a derivative action on behalf of the company against the trustees to recover the monies which had been misapplied. Later he commenced unfair prejudice proceedings under section 459 of the Companies Act 1985. The derivative action was in due course consolidated with the unfair prejudice proceedings but it was in the latter proceedings that relief was ultimately granted.

The judge also found that Mr Cutland had taken from the company, without authority, remuneration in the form of salary, pension contributions and other benefits in the further sum of £432,432. This sum included contributions of £45,000 and £50,000 made in 1998 and 1999 out of the company’s assets and a further contribution of £50,000 made in 2000, which Mr Cutland paid personally but then recouped out of the company’s funds. These payments were made to Mr Cutland’s pension fund and were included in the judgment given against Mr Cutland in favour of the company in the sum of £1,150,753.

The judge also found that the company was indebted to the pension fund in the sum of £100,000. The circumstances in which this debt arose are not relevant for the purposes of this appeal. This appeal is only against the judge’s refusal to order that that debt should be set against the contributions totalling £145,000 which Mr Cutland paid or caused to be paid on his behalf to the fund.

The judge rejected a defence to Mr Cutland’s unauthorised drawings based on the alleged unanimous consent of both shareholders. The drawings were included in a balance sheet item for directors’ remuneration in the annual accounts for the relevant years, and if Mr Clark had analysed the global figures, he would have appreciated that Mr Cutland was drawing remuneration which he had not approved. The judge held:

“… [T]o say that, because Mr Clark did not carry out that calculation he is bound by his ‘approval’, would be to substitute a test of non–objection to the test of positive approval which Re Duomatic lays down and I decline to do so.

This is all the more the case where, not only was the attention of the shareholders not drawn to the remuneration being paid to Mr Cutland, but their attention was specifically diverted away by the clear statement that he was not making any drawings. I am satisfied that taking money in pension contributions whilst not disclosing that he was doing so, and indeed asserting that he was not doing so, amounts to ‘unfair prejudice’ as well as being unlawful. It may well be that if Mr Clark had been asked, he would have approved some level of remuneration related to his own. However, that does not stop the fact that the money was taken without his being asked as ‘unfair prejudice’” (judgment, page 17).

It is common ground that the trustees of the pension fund made loans to the company and that at the date of the trial the company was indebted to the trustees in the sum of £100,000. The only beneficiaries of the pension fund are Mr Cutland and his wife and dependants. The trustees of the pension fund are Mr Cutland and the third respondent. Neither the company nor the third respondent has played any part in these proceedings. Neither appeared before the judge or on this appeal. They have, however, been duly served.

The judge also found that there was unfair prejudice in that Mr Cutland obtained an allotment of shares intended for a new director. We are not concerned with that allegation. The judge directed that these shares should be acquired by the company. The judge ordered a purchase by Mr Clark of Mr Cutland’s remaining shares on terms which are not material. The judge rejected a number of other allegations of unfair prejudice but we are not concerned with them and accordingly it is unnecessary for me to set them out.

The judge acceded to the submission that there was a wide jurisdiction under section 461 to give relief against third parties which could have been granted in a derivative action. The judge cited inter alia Re Hailey Group Ltd [1993] BCLC 459 and Lowe v Fahey [1996] 1 BCLC 262 and concluded that it was appropriate for him to treat the petition as if it were a derivative action, particularly as there was a derivative action in the background with which the petition had been consolidated. The same view of the law was taken by the Inner House of the Court of Session in Anderson v Hogg [2002] BCC 933.

A preliminary point arises as to whether the appeal in this case can proceed at all. Mr Thomas Seymour, for Mr Cutland, contends that the remedy now sought on appeal was not pleaded below. Only very brief reference was made to it by the appellant in his opening and closing submissions at trial. What is sought on appeal is an order setting the amounts which Mr Cutland paid into the pension fund from the company’s assets without authority against the loan owed by the company to the trustees of the pension fund. This order is at variance with Mr Clark’s case in that in his petition Mr Clark accepted that he would have been content if Mr Cutland had drawn about the same remuneration as he did. In fact, Mr Cutland had only drawn about £128,000 in all more than Mr Clark.

Mr Seymour makes a number of further submissions. First, the order now sought is not set out in the petition; Mr Clark could not rely on the fact that the prayer in the petitions sought unspecified “further or other relief”. To allow unpleaded points to be raised on an appeal would be to turn the appeal into a fresh hearing when it should in general be no more than a review of the judge’s order (CPR 52.11). Second, Mr Seymour submits that the judge refused the relief now sought on appeal specifically on the grounds that no such relief had been sought. Third, Mr Seymour submits that an unpleaded point should not have been taken against Mr Cutland who was representing himself. Mr Cave did not appear. The trustees were effectively third parties. Fourth, Mr Seymour submits that an action has been started by the trustees for repayment of the sums due to the trustees, in which it is open to the company to plead as a defence that it is entitled to a proprietary remedy against the pension fund by reason of the matters found in this action. He concedes, however, that if the company takes that course, it might be open to the trustees to rely on abuse of process (Henderson v Henderson (1843) Hare 100). Likewise, if the appeal were dismissed and the company were to start a new action seeking to recover assets from the pension fund, the trustees might be entitled to have the proceedings dismissed as an abuse of process.

Mr David Stockill, for Mr Clark, submits that the relief now sought was in fact sought in the court below. He refers to his written submissions which he submitted on 8 July 2002 before making his closing speech. The written submissions state in material part as follows:-

“3.10

The company has, it is submitted, a straightforward case for recovery of the unauthorised pension contributions in the sum of £145,000. Clearly these funds remain in the pension scheme.

3.11

They should be used to offset the loan liability …”

Mr Stockill submits that, although arguments were addressed to the judge on set off, the judge did not deal with the point in his judgment. According to the transcript of the discussion after judgment, Mr Stockill pointed out to the judge that his judgment did not deal with the question of a proprietary remedy against the pension fund trustees and the judge replied that, as the monies were paid without authority, and the trustees had no notice of the lack of authority, the company could not retain title to the monies and accordingly no proprietary remedy lay against the pension fund trustees. Mr Stockill applied for permission to appeal against this ruling. The judge’s reasons for refusing permission to appeal were that that relief had not been claimed in the petition and that there was no real prospect of success on appeal.

Mr Stockill submits that Section 461 of the Companies Act 1985 is wide enough to encompass relief of this nature, and the petition sought “further other relief”. Moreover, if the judge was concerned that the third respondent was not before the court, he could have been given a right to apply to discharge the order within a specific period after service of the order.

In my judgment it is quite clear from the written submissions and transcript of proceedings quoted above that the question of the entitlement of the company to a tracing remedy was before the judge and that he did deal with it. The case had complications and the question of the appropriate remedy is one which naturally fell to be developed after judgment because it depended on the judge’s findings of fact. For my own part, I have no doubt that it can properly be raised in this court. It raises a question of law on which Mr Cutland now has the benefit of an experienced Chancery junior. Accordingly, he is at no disadvantage even if he was taken by surprise below. All the relevant facts have been found. The only alternative would be for this court to order an enquiry, or for a separate set of proceedings to take place in which the company would seek to resist liability for the loan on the basis that it should be set against the sums which were paid into the pension fund. I do not see that any purpose would be served by those separate proceedings and indeed Mr Seymour has very properly intimated that, if the question of set off was raised in separate proceedings, it would be open to the pension fund trustees to raise a question of an abuse of process and have the proceedings dismissed. Further proceedings would lead to a duplication of costs and entail delay. They could also prejudice the company’s claim to a proprietary remedy. Accordingly, I would dismiss the preliminary point. I now turn to deal with the detailed submissions on the substantive questions raised by this appeal.

Mr Stockill accepts that a personal remedy for breach of trust would not be available as against the pension fund trustees because they received the contributions made by the company without notice of Mr Cutland’s want of authority to make them. However, he submits that where money subject to one express trust is paid improperly and without valuable consideration to the trustees of another trust, that money or its traceable proceeds still belongs in equity to the first trust and its trustees have a proprietary claim to recover them. He cites Allan v Rea Brothers [2002] EWCA Civ 85 and Foskett v McKeown [2001] 1 AC 102 as authority for this proposition.

Mr Stockill submits that in order to establish an equitable proprietary remedy, he must establish a fiduciary relationship and traceable trust property. In this case, the fiduciary relationship was that between Mr Cutland and the company. In misappropriating its funds he breached that duty (see, for example, at first instance Millett J in Agip (Africa) v Jackson [1990] Ch.265 at 290 D-F and in the Court of Appeal per Fox LJ (with whom Butler-Sloss and Beldam LJJ agreed) [1991] Ch.566.

He further submits that the company can trace the contributions which Mr Cutland made to his pension fund without authority out of the company’s assets into the hands of the trustees and that the company has an option whether to claim a proportionate share of the fund or a lien on its assets (see Foskett v McKeown). The remedy sought by the company is a charge, and the most appropriate assets on which to impose this charge are the benefit of the loans from the pension fund trustees to the company, and, as to any balance, the cash held by the pension fund trustees. The loan and the sums traceable by the company can then (pro tanto) be set off against each other. Amounts recovered from the pension fund trustees would be credited against Mr Cutland’s judgment debt. Interest should be added to the loan and judgment debt at the appropriate rates.

Mr Stockill argues that, if necessary, the funds paid to the trustees should be treated as having been routed through Mr Cutland so that the legal and beneficial interest in the monies becomes divided.

Mr Seymour accepts that the right to trace will exist if there was an equitable interest in the monies. However, he submits that such an equitable interest only exists if money is taken fraudulently and without any disclosure in the accounts. Here the unauthorised remuneration was disclosed in the accounts within the global item for directors’ remuneration. The drawing of unauthorised remuneration was thus not embezzlement or theft. The petition stated that Mr Clark would have been content for Mr Cutland to receive equal remuneration. Mr Seymour submits that on this basis the legal and beneficial interest in the monies paid without authority passed to the pension fund trustees: see per Lord Browne-Wilkinson in Westdeutsche Landesbank Girozentrale v Islington LBC [1996] AC 669, 707 D-E. Alternatively, the payments were void. Moreover, if as is conceded, the trustees are not personally liable as constructive trustees there can be no equitable proprietary remedy as against them. In the circumstances, there is simply a personal liability to account on the part of Mr Cutland.

Mr Seymour submits that the final £50,000 was paid out of Mr Cutland’s own funds and not out of company funds.

At the heart of Mr Seymour’s submissions on behalf of Mr Cutland is a submission that there is a difference in legal consequence between (on the one hand) a breach of duty which consists of making a payment out of the company’s funds which could have been lawfully made if procedures for obtaining approval under the company’s constitution had been followed and (on the other hand) a payment which was in effect a theft. Both such payments are, however, breaches of duty. It is the duty of directors to follow the appropriate procedures in the company’s constitution as much as it is their duty to apply corporate property only for proper purposes. Failure to obtain appropriate approval and insufficient disclosure is a serious matter. Disclosure plays an important role in company law and the quality of disclosure is important. Disclosure is required for many purposes and it performs at least two valuable functions. It ensures that information is passed from the directors to the shareholders or from one director to another. It also acts as a deterrent against self-dealing. As Brandeis J (a justice of the US Supreme Court) said extrajudicially, “sunlight can be the best of disinfectants”. Meaningless disclosure does not perform these functions and inadequate disclosure is often little better than no disclosure at all. Thus in Kaye v Croydon Tramways & Co Ltd [1898] 1 Ch. 358, a notice of meeting was held to give insufficient notice of a resolution which (among other purposes) was to approve directors’ benefits when the fact of such benefits under the resolution was not fairly and candidly disclosed. The present case is not a case where a person who was entitled to receive certain information was, in fact, given that information in some other way so that his claim not to have had appropriate disclosure can be seen to be unmeritorious and the non-disclosure merely technical. The judge here concluded that the disclosure of Mr Cutland’s remuneration within a global sum for remuneration in the accounts, seen against the context of statements by Mr Cutland that he was not taking any remuneration, was inadequate disclosure. I would add that there is no cross-appeal against his rejection of the defence based on unanimous consent, often referred to as “the Duomatic principle” following the decision of Buckley J in Re Duomatic Ltd [1969] 2 Ch.365.

The difference in legal consequence which Mr Seymour seeks to draw between unauthorised and stolen payments is (on his main submission) based on a passage from the judgment of Lord Browne-Wilkinson in Westdeutsche Landesbank Girozentrale v Islington LBC. In that case the bank lent money to the local authority for the purposes of a transaction which was outside its powers. The question was whether the bank was entitled to compound interest on the ground that the local authority was a trustee of the monies lent to it. The bank argued that it only intended to part with its beneficial ownership of the monies lent in the performance of a valid contract and accordingly neither the legal interest nor the equitable interest passed the local authority at the date of the payment. Lord Browne-Wilkinson rejected this argument. He held:-

“A person solely entitled to the full beneficial ownership of money or property, both at law and in equity, does not enjoy an equitable interest in that property. The legal title carries with it all rights. Unless and until there is a separation of the legal and equitable estates, there is no separate equitable title. Therefore, to talk about the bank ‘retaining’ its equitable interest is meaningless. The only question is whether the circumstances under which the money was paid were such as, in equity, to impose a trust on the local authority. If so, an equitable interest arose for the first time under that trust.”

In my judgment, this passage does not apply in the present situation. The payment made to the local authority was intended to be made by the bank when it was made. By contrast in this case, there was no organ of the company which was duly authorised to form any intention about making the payments. Mr Cutland made the payments as an agent lacking the authority. Accordingly this is not a situation where the full legal and beneficial ownership in the pension contributions passed.

Mr Stockill relied on the following extracts from a passage headed “Establishing a proprietary claim” by Graham Virgo in Buckley on theCompanies Acts, 15ed, (2000) vol.3:

“Establishing a proprietary claim

T[A70.229B]

Regardless of whether the company seeks a personal or proprietary restitutionary remedy, whenever its claim is founded on the defendant’s interference with the company’s property rights it is necessary for the company to establish that the defendant has, at the very least, received property in which the company has a property interest. This property interest may arise either at law or in equity. The recognition of proprietary interests is a matter of law and does not involve the discretion of the court.

T[A70.229C]

(1)

Retention of a legal property interest: Generally, where property is transferred from one party to another legal title in the property will also pass because this is what the parties intended. However, in certain limited circumstances title will not pass because the transferor’s intention was vitiated in some way. For example, where the company’s property has been stolen, it will not have intended title to pass and so it will retain title to the property, at least as long as the property can still be identified. … In other circumstances title may have passed but it will be revested in the company, as will occur where a transaction is voidable at law and has been rescinded. In certain circumstances title will pass even though the nature of the transfer may be suspect for some reason. For example, if property has been transferred pursuant to a void transaction, then title will pass despite the invalidity of the transaction. Similarly, where property has been transferred pursuant to an illegal transaction then title will pass despite the invalidity of the transaction itself.

T[A70.229D]

(2)

Creation of an equitable proprietary interest : An equitable proprietary interest cannot be created unless there is some event which enables the equitable title to be separated from the legal title. This can happen in three different circumstances. (1) Where an express trust has been constituted so that the trustee holds the legal title to property and the beneficiary will have an equitable interest in the same property. (2) Where property is held on resulting trust … (3) Where property is held on a constructive trust. A constructive trust arises by operation of law in a number of different circumstances. Two of the most important are where a defendant receives property in breach of a fiduciary duty and where the defendant has acted unconscionably, which will especially be the case where the defendant receives property knowing that it had been stolen or had been transferred by mistake.” (Footnotes omitted).

Mr Stockill contends that the proprietary remedy which he seeks falls within paragraph T[A70.229C] because the payments to the pension fund were voidable as a result of Mr Cutland’s breach of duty in making them and the pension fund had notice of company’s claim. In the alternative, he submits that the court can grant a proprietary remedy because the pension fund trustees now hold the contributions on constructive trust and that category (3) in paragraph T[A70.229D] applies. To these submissions, Mr Seymour responds that the contributions were, on the judge’s findings, paid without authority. They are therefore void. Moreover, he submits that category (3) of paragraph T[A70.229D] does not apply because it is conceded by Mr Stockill there is no personal remedy against the trustees. It is not, however, in doubt but that the pension fund trustees still hold assets representing the contributions totalling £145,000 in question. Moreover, the pension fund trustees are volunteers.

There seems to me to be a basic inconsistency between Mr Seymour’s submission that the payments to the pension fund trustees were void and his main submission. His submission on this point seems to me to accept that the contributions were misapplications of the company’s assets. However that may be, the position is that regulation 76 of table A in the first schedule to the Companies Act 1948 applied to the company. Under this article, directors were not entitled to any remuneration unless it was authorised by the company in general meeting. The judge held that there was no such authorisation in the present case. It follows that the payments of pension contributions to the pension fund trustees were without legal effect and not merely voidable (see Guinness plc v Saunders [1990] 2 AC 663 at 693 per Lord Templeman, with whom Lord Keith, Lord Brandon and Lord Griffiths agreed, and at 698 to 702 per Lord Goff, with whom Lord Griffiths also agreed).

If those payments had merely been made by Mr Cutland in breach of his duty to the company, and he had not also made them without the authority of the company, Mr Stockill’s submission that the payments were voidable would have been correct. However, where an agent carries out a transaction without authority, the consequence is (as I have stated) that the transaction is without legal effect. This consequence is more serious in law than that which attaches to a transaction which is voidable since the right to rescind a voidable transaction can be lost. Because the sanction attaching to an unauthorised transaction is more serious, it must supersede the sanction of voidability that would otherwise attach in the present case.

That still leaves category (3) in paragraph T[A70.229D], namely liability on the basis of constructive trust. For this purpose, it does not matter that the payments were void or without legal effect, rather than voidable: see Guinness v Saunders. What matters is that Mr Cutland acted in breach of his fiduciary duty to the company, as to which there is no doubt, and that the pension fund trustees have received notice of the company’s claim, which again is not disputed. A further passage from the speech of Lord Browne-Wilkinson in the Westdeutsche case at page 707 illustrates those points:

“The bank contended that where, under a pre-existing trust, B is entitled to an equitable interest in the trust property, if the trust property comes into the hands of a third party, X, (not being a purchaser of the value of the legal estate without notice), B is entitled to enforce his equitable interest against the property in the hands of X because X is the trustee for B. In my view the third party, X, is not necessarily a trustee for B; B’s equitable right is enforceable against the property in just the same way as any other specifically enforceable right can be enforced against the third party. Even if the third party, X, is not aware that what he has received is trust property B is entitled to assert his title in that property. If X has the necessary degree of knowledge, X may himself become a trustee for B on the basis of knowing receipt. But unless he has the requisite degree of knowledge he is not personally liable to account as a trustee; in Re Diplock, Diplock v Wintle [1948] Ch. 465, 478 …” (emphasis added in original).

Lord Browne-Wilkinson confirmed the existence of a proprietary remedy against a third party in his analysis, in a later passage in the Westdeutsche case at pages 714 to 715, of the decision by Goulding J in Chase Manhattan Bank NA v Israel-British Bank (London) Ltd [1981] Ch. 105. In that case, a bank claimed to recover monies paid under a mistake to another bank. Goulding J held that the paying bank retained an equitable property in the payments and that the conscience of the receiving bank was subject to a fiduciary duty to respect that proprietary right. Lord Browne-Wilkinson disagreed with this approach. In his judgment, the receiving bank did not become a trustee for the paying bank until it learnt of the mistake two days after the receipt of the monies. He considered that the case would have been correctly decided on that basis.

Mr Seymour relies on the concession which Mr Stockill has made that the company has no personal remedy against the pension fund trustees. Seen in the context of the company’s claim for a proprietary remedy it is clear that all that concession amounts to is an acceptance by the company that the pension fund trustees received the contributions as innocent volunteers. The concession is clearly not intended to pull the rug from under the proprietary claim. Furthermore, there is no suggestion that the continued retention of the contributions by the pension fund trustees would not be unconscionable.

Accordingly, in my judgment, the company is entitled to trace the payments of pension fund contributions which Mr Cutland made without authority into the pension fund assets. Mr Clark, on behalf of the company, has elected to pursue a proprietary remedy by seeking a charge over the pension fund assets. In my judgment, this is an appropriate form of remedy and it is open to the court to impose it in the way that Mr Stockill submits, namely by imposing a charge on the benefit of the loan to the company so that set off can occur and by declaring that the balance is charged on the cash reserves of the pension fund.

As regards the £50,000 paid in 2000, the judge allowed a deduction from misappropriations in the sum of £50,000:

“I propose to allow this deduction to Mr Cutland. My reason is that the £50,000 pension contribution which he seeks to offset here as having been loaned to the company and paid out again is also the subject of the express remuneration claim, being the £50,000 paid in respect of the pension contribution for the year ending 31 December 2000. It would in my judgment be double counting if I were to refuse payment here and allow the excess remuneration claim …”

In effect, the judge treated the £50,000 as having been lent to the company when it was paid to the pension fund trustees and accordingly it must be treated on the same basis for the purpose of the tracing remedy sought.

As to interest, there is no dispute but that interest should be added to the loan at the contractual rate. Likewise, there is no dispute but that interest should be added to the amount to be recovered by the company. Mr Seymour has not suggested that interest should accrue only from the date when the pension fund trustees acquired notice, which might have been the appropriate course if a personal claim had been made against them.

Accordingly, in my judgment, the court should allow the appeal and grant a proprietary remedy to the company by making orders in the following terms:-

As to costs, in a derivative action it is open to the court to order the company, for whose benefit the action was brought, to indemnify the claimant against the costs reasonably incurred by it (see Buckley on the Companies Acts, para [127.12]). By contrast, in section 459 proceedings, the company is not usually ordered to pay any of the costs (Buckley on the Companies Acts, para [459.33]). My provisional view in this case (subject to any submissions that Mr Cutland may wish to make) is that, although the relief sought is claimed under section 461, it is sought for the benefit of the company and that it is, therefore, open to Mr Clark to seek an order against the company for payment to him of any costs incurred by him on this appeal (and, possibly, with respect to this issue in the court below). Such costs would then be payable by the company unless Mr Clark obtains an order for them against Mr Cutland and recovers them from him. If the company paid Mr Clark’s costs, it would (to that extent) be subrogated to any order for such costs made against Mr Cutland and in favour of Mr Clark.

I agree.

I agree with the orders proposed by my Lady. In particular I agree that