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Interactive Technology Corporation Ltd v Ferster

[2018] EWCA Civ 1594

Neutral Citation Number: [2018] EWCA Civ 1594
Case No: A3/2017/0581
IN THE COURT OF APPEAL (CIVIL DIVISION)

ON APPEAL FROM THE HIGH COURT OF JUSTICE

CHANCERY DIVISION

Mr Justice Morgan

[2017] EWHC 217 (Ch)

Royal Courts of Justice

Strand, London, WC2A 2LL

Date: 5 July 2018

Before:

LORD JUSTICE DAVID RICHARDS

and

LORD JUSTICE NEWEY

Between:

INTERACTIVE TECHNOLOGY CORPORATION LIMITED

Appellant

- and -

JONATHAN FERSTER

Respondent

Graeme McPherson QC and Michael Bowmer (instructed by DAC Beachcroft LLP) for the Appellant

The Respondent did not appear and was not represented

Hearing date: 18 April 2018

Judgment Approved

Lord Justice David Richards :

1.

This appeal concerns the meaning and effect of an order for the assessment of equitable compensation made by Morgan J following the trial of claims for breach of fiduciary duty. The claims were made by the appellant company (ITC) against a former director, the respondent Jonathan Ferster. The respondent has since been made bankrupt and neither he nor his trustee in bankruptcy has appeared on this appeal or taken any part in it.

2.

The relevant claim for the purposes of this appeal was that Mr Ferster had dishonestly caused the company to pay substantial unauthorised remuneration to him in excess of the salary of £120,000 per annum to which he was entitled. Morgan J found this claim to be established. The exact amount of the unauthorised remuneration has yet to be established but Mr Ferster has accepted that it is not less than £4.48 million.

3.

After Morgan J handed down judgment on 15 November 2016, a hearing took place on 19 December 2016 to deal with consequential matters, including the terms of the order to be made. As regards relief in respect of the unauthorised remuneration, each party put forward a draft order which differed marginally but Mr Andrew Thompson QC for Mr Ferster said the differences were immaterial. As Morgan J later recorded in his judgment dated 10 February 2017 (the February judgment), giving his reasons for the Order now under appeal, there was essentially common ground that the court should make an order in the terms of the draft provided by Mr Alan Gourgey QC on behalf of ITC.

4.

The order was as follows:

“Judgment be entered for ITC for equitable compensation to be assessed in respect of the payment to Mr Jonathan Ferster of unauthorised “remuneration” from ITC that was in excess of Mr Jonathan Ferster’s entitlement under Paragraph 6 above (“the Unauthorised Remuneration”).

5.

In his skeleton argument for the hearing on 19 December 2016, Mr Gourgey said:

“ITC is entitled at its option to repayment of the unauthorised remuneration taken by Jonathan or to equitable compensation for breach of fiduciary duty. For the reasons given in the Judgment (Judgment, ¶ [229]), an assessment of equitable compensation will be greater than an order for the repayment of the unauthorised element. ITC’s current intention is to elect at the hearing for the remedy of equitable compensation. The equitable compensation is likely to be made up of (1) the amount of the unauthorised remuneration and (2) national insurance paid by ITC on the unauthorised remuneration. ITC reserves the right to seek in due course by way of consequential relief an order that Jonathan is liable to indemnify ITC in respect of any tax penalties and interest levied by HMRC following the reinstatement of ITC’s accounts to reflect the amount of remuneration that was properly payable to Jonathan.”

6.

After agreement had been reached on the terms of the order, Mr Gourgey made submissions in support of an application for an interim payment in respect of the equitable compensation. Mr Thompson responded that it was far from certain that ITC had suffered any loss which could form the subject of compensation. He submitted that on the evidence given at trial as to the market value of Mr Ferster’s services, the remuneration received by him did not exceed that market value, with the result that ITC had suffered no loss. This was a new argument that had not been pleaded nor mentioned in any previous written or oral submissions. It was, of course, contrary to the position taken by Mr Gourgey in the passage from his skeleton argument that I have quoted and which, it may fairly be said, was his understanding of the effect of the order that he had proposed and that Mr Thompson had agreed on behalf of Mr Ferster.

7.

The judge pointed out the major point of principle that now appeared to divide the parties. Mr Gourgey submitted that the losses suffered by ITC included the unauthorised sums paid to Mr Ferster and there was no need to search for a counter-factual scenario. The judge said that he did not regard Mr Thompson’s submissions as hopeless and that they bore on what, if any, interim payment he should order. The judge recorded in his February judgment that “Just before the short adjournment, Mr Gourgey stated that he might need to think about simply claiming repayment of the unauthorised remuneration and not claiming compensation for losses”.

8.

In the February judgment, the judge recorded at [38] what transpired after the short adjournment:

“After the short adjournment, Mr Gourgey told the court that ITC maintained its position in relation to the assessment of equitable compensation. I asked Mr Thompson whether he was content with the wording of paragraph 9 of the remuneration order and he stated that he was, subject to it being clear that he would be able to argue his points on causation of loss. Mr Gourgey did not suggest that Mr Thompson could not put forward the argument but, of course, Mr Gourgey had earlier made it clear that he would submit that the argument was unsound.”

9.

At [39] Morgan J set out his view of the position as it then stood:

“With this background, it is clear that both parties were proceeding on the basis that ITC had two potentially available remedies. The two remedies were seen as an order for the repayment of unauthorised remuneration and an order for equitable compensation, meaning compensation for loss resulting from the payment by ITC of unauthorised remuneration. The parties proceeded on the basis that those two remedies were inconsistent and that ITC had a right to elect. It is also clear that the parties did not agree on the relevance of arguments as to causation. There was a clear election by Mr Gourgey between the two remedies. He first made a choice on behalf of ITC when he introduced paragraph 9 of the remuneration order and he maintained his stance having heard Mr Thompson’s arguments on causation.”

10.

Although in the following days the solicitors for ITC pressed the court to seal the order as made on 19 December 2016, there was a change of position in January 2017. On 23 January 2017, they wrote to the court, inviting it to make an order in different terms. The new order would provide in terms that Mr Ferster was obliged to repay the unauthorised remuneration and was liable to account to the company for all payments made out of the assets of the company in connection with the unauthorised remuneration.

11.

In the February judgment, following a hearing on 7 February 2017, Morgan J gave his reasons for declining to make the new order in place of the order made on 19 December 2016. He went on to give his interpretation of that order. There is no appeal against his refusal to make the new order but the appeal is against the declaration setting out the Judge’s interpretation of the order for the assessment of equitable compensation made in December 2016. The judge made three declarations. The first declared that the December order took effect on 19 December 2016. The second declared that it “provides for ITC to recover compensation for losses resulting from the payment to Jonathan Ferster of unauthorised remuneration”. The third declaration is as follows:

“ITC had a right to elect between inconsistent remedies, namely (i) an order against Jonathan Ferster that he repay unauthorised remuneration received by him and (ii) an order against Jonathan Ferster that he pay equitable compensation for ITC’s losses resulting from the payment by ITC of unauthorised remuneration. By no later than the point in time on 19 December 2016 when the Court pronounced the order, ITC made a binding election for (ii).”

12.

In a nutshell, ITC’s challenge to these declarations centres on the words “for losses” in the second declaration and “for ITC’s losses” in the third declaration. There was no reference to “losses” in the December order, which referred simply to “equitable compensation…in respect of the payment to Mr Jonathan Ferster of “unauthorised” remuneration”. ITC submits that equitable compensation, both as a general proposition and in the context of this order, is not confined to compensation for losses (sometimes called “reparation claims”) but includes the recovery of compensation for money or assets disbursed without authority (sometimes called “substitutive claims” or “substitutive performance claims”).

13.

In his February judgment, the judge concluded that, both as a general proposition and in the context of the December order, equitable compensation meant compensation for losses.

14.

Dealing with the meaning generally of equitable compensation, the judge records at [15] Mr Thompson’s submission, in very brief summary, that it “refers to compensation for loss caused by a breach of duty in equity” and that its assessment necessitates an investigation into whether the breach of duty caused the claimed loss or whether the claimant would have been better off if the duty had been performed and not broken. He submitted that there was a difference between a gains-based remedy and a loss-based remedy. While ITC could in principle claim a gains-based remedy for the recovery of the unauthorised remuneration (and, arguably, for the PAYE and NIC paid to HMRC), it could in the alternative, and at its election, claim a loss-based remedy. In that event, the loss recoverable would be restricted to any loss caused by the breach of duty.

15.

The judge accepted Mr Thompson’s analysis of the division between loss-based and gains-based remedies and that they were inconsistent, so that a claimant was required to elect between them. By seeking and obtaining an order for the assessment of equitable compensation, the judge held that ITC was electing for the assessment of compensation for loss, i.e. a loss-based remedy.

16.

In my judgment, this approach involves a narrow reading of “equitable compensation” that is not in accordance with authority. Equitable compensation is apt to include a payment made to restore to a claimant the value of assets or funds removed without authority by a trustee or other fiduciary, such as a director. It may also include reparation for losses suffered by the claimant, such as in this case any tax penalties and interest resulting from the payment of the unauthorised remuneration. But, it is not restricted to reparation for losses, as the judge appears to have held by his adoption of Mr Thompson’s binary distinction between loss-based and gains-based remedies.

17.

The position is stated in Underhill and Hayton: Law Relating to Trusts and Trustees (19th ed., 2016) at para 87.11:

“Equity recognises two types of compensation claim against trustees, which will be termed substitutive performance claims and reparation claims. Substitutive performance claims are claims for a money payment as a substitute for performance of the trustee’s obligation to produce trust assets in specie when called upon to do so. Claims of this sort are apposite when trust property has been misapplied in an unauthorised transaction, and the amount claimed is the objective value of the property which the trustees should be able to produce. Reparation claims are claims for a money payment to make good the damage caused by a breach of trust, and the amount claimed is measured by reference to the actual loss sustained by the beneficiaries. Claims of this sort are often brought where trustees have carelessly mismanaged trust property, but they lie more generally wherever a trustee has harmed his beneficiaries by committing a breach of duty.”

18.

In the same work, the means by which these two types of equitable compensation are given through an accounting process are explained at para 87.7:

“As discussed below, there are two types of compensatory claim which can lie against trustees: substitutive performance claims and reparation claims. These are mediated through proceedings for an account in different ways. In the case of a substitutive performance claim where the trustees have made an unauthorised distribution of trust property or used trust funds to purchase an authorised investment, the court will not permit the trustees to enter the distribution or expenditure into the accounts as an outgoing because it will not permit the trustees to say that they acted in breach of duty. Instead, they will be treated as though they have spent their own money and kept the trust assets intact. The accounts will be falsified to delete the unauthorised outgoing, and the trustees will be ordered to produce the relevant trust property in specie or pay a money substitute out of their own pockets. Reparation claims are brought into the scheme of the accounts in a different way. The loss claimed by the beneficiaries is translated into an accounting item by surcharging the trustees with the amount of the loss as if they had already received this amount for the beneficiaries. They must then pay this sum into the trust funds out of their own pockets.”

19.

These claims for equitable compensation were described with characteristic lucidity by Lord Millett NPJ in Libertarian Investments Ltd v Hall [2014] 1 HKC 368, a decision of the Court of Final Appeal of Hong Kong. At [168], he referred to substitutive compensation:

“Once the plaintiff has been provided with an account he can falsify and surcharge it. If the account discloses an unauthorised disbursement the plaintiff may falsify it, that is to say ask for the disbursement to be disallowed. This will produce a deficit which the defendant must make good, either in specie or in money. 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. The amount of the award is measured by the objective value of the property lost determined at the date when the account is taken and with the full benefit of hindsight.”

20.

At [170], Lord Millett addressed reparative compensation:

“If on the other hand the account is shown to be defective because it does not include property which the defendant in breach of his duty failed to obtain for the benefit of the trust, the plaintiff can surcharge the account by asking for it to be taken on the basis of ‘wilful default’, that is to say on the basis that the property should be treated as if the defendant had performed his duty and obtained it for the benefit of the trust. Since ex hypothesi the property has not been acquired, the defendant will be ordered to make good the deficiency by the payment of money, and in this case the payment of ‘equitable compensation’ is akin to the payment of damages as compensation for loss.”

21.

Insofar as the judge in the present case treated “equitable compensation” in the December order as necessarily referring to compensation for loss, as a result of the general meaning or ambit of that remedy, he was, in my judgment, wrong.

22.

It may, however, nonetheless be the case that, in the particular context in which the December order was made, “equitable compensation” as it appears in para 9 of the order was confined to compensation for loss.

23.

In reaching his decision as to the meaning of the December order, the judge rightly took into account the pleadings, the submissions at trial and the submissions made to him at the hearing in December 2016.

24.

I have earlier quoted paragraph 13 of Mr Gourgey’s skeleton argument for the December hearing. The judge stated in the February judgment at [34] that this paragraph was important because it distinguished between two remedies (an order for repayment of the unauthorised remuneration and equitable compensation for breach of fiduciary duty) and stated ITC’s decision to elect for the latter.

25.

After counsel for both parties agreed the terms of the order put forward by ITC, Mr Thompson submitted, as the judge records at [36], that “the compensation payable was for loss resulting from the breach of duty” (emphasis added). At [37], the judge records that there appeared to be a major point of principle between the parties, which in the judge’s own words was “between an order that Jonathan repay to ITC the unauthorised remuneration and an order that he pay compensation for the loss to ITC resulting from the payment of the unauthorised remuneration” (emphasis added). Following these exchanges, Mr Gourgey informed the judge after the short adjournment that ITC was content with the wording of the order that it had proposed. That wording did not, of course, include any reference to loss but extended to “equitable compensation…in respect of the payment…of unauthorised remuneration”.

26.

I have earlier set out paragraph [39] of the February judgment where the judge stated that the order for equitable compensation meant “compensation for loss resulting from the payment of unauthorised remuneration” (emphasis added). With great respect to the judge, given that equitable compensation is not in principle confined to the recovery of reparation for loss, I am unable to read the submissions of Mr Gourgey as leading to that narrowing of the ambit of the order for the assessment of equitable compensation. The order was put forward by Mr Gourgey on behalf of ITC and agreed by Mr Thompson on behalf of Mr Ferster without any qualification by reference to losses. In fact, Mr Gourgey’s submissions had made clear, in the passage quoted by the judge in his February judgment at [33], that the amount recoverable under the order for equitable compensation would be greater than the amount recoverable under an order for repayment of the unauthorised element of the remuneration. There can be no inference that ITC was intending to give up what would be recoverable under the latter type of order; rather, it was intending a wider scope to its recovery.

27.

There is, in my judgment, no sufficient basis in the context of the application heard by the judge on 19 December 2016 for restricting the usual effect of the express terms of paragraph 9 of the order made on that day, by implying a restriction to compensation “for loss”.

28.

For these reasons I would allow the appeal and vary the order made on 10 February 2017 by deleting the second and third declarations in paragraphs 2 and 3 of the order and substituting a declaration largely in the terms sought by ITC, as follows:

“2. At the assessment of the equitable compensation due to ITC pursuant to paragraph 9 of the Remuneration Order, ITC is not prohibited from contending that such equitable compensation should comprise or include (1) the repayment by Mr Jonathan Ferster of (i) the equivalent amount of the “remuneration” that he received from ITC in excess of his entitlement under paragraph 6 of the Remuneration Order (“the Unauthorised Remuneration”) and (ii) the sums paid by ITC to HM Revenue & Customs by way of PAYE and National Insurance contributions associated with the Unauthorised Remuneration, and/or (2) payment of any losses suffered by ITC in respect of (i) any costs of restating its accounts to reflect the repayment by Mr Jonathan Ferster of the Unauthorised Remuneration, PAYE and National Insurance contributions and (ii) any interest and penalties raised by HM Revenue & Customs against ITC consequent on ITC restating its accounts in such regard.”

29.

I would also vary the costs orders as sought by ITC, which it is unnecessary to set out in this judgment.

30.

In paragraph [38] of the February judgment, the judge records that Mr Thompson was content with the terms of paragraph 9 of the December order, subject to it being clear that he would be able to argue his points on causation, and that Mr Gourgey did not suggest otherwise, although he had of course said they were unsound. While the merits of any such points are not before us, I find it difficult to see that they could prevail as an answer to a claim, by way of equitable compensation, for payment of sums dishonestly taken as “remuneration” without authority. The facts bear no relation to those in cases such as Target Holdings Ltd v Redferns [1996] AC 421 and AIB Group (UK) plc v Mark Redler & Co [2014] UKSC 58, [2015] AC 1503.

Lord Justice Newey:

31.

I agree.

Interactive Technology Corporation Ltd v Ferster

[2018] EWCA Civ 1594

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