“I would have acted lawfully, had I not acted unlawfully” – a means to escape equitable compensation?
In Auden McKenzie (Pharma Division) Ltd v Patel  EWCA Civ 2291, the English Court of Appeal considered an important issue regarding equitable compensation: whether a defaulting trustee or other fiduciary can resist a claim for compensation for loss caused by his default on the basis that had he not done what he did improperly, he would have achieved the same result properly, so that the position of the trust or other person to whom fiduciary duties were owed, would have been the same.
Here the defendant director of the claimant company operated a scheme whereby the company made payments against false invoices, with the money ultimately landing with the director and his sister (the beneficial owners of the company). The purpose was to evade the tax that would have been payable by him and his sister if the company had made lawful distributions to them.
The director appealed against the first instance grant of summary judgment for compensation in the amount of the improper payments. The issue on appeal was whether the director had a real prospect of successfully defending the case on the assumed fact that he would have procured the payments to be made lawfully by way of dividends (or by some other lawful means), had he not done so unlawfully, meaning the company suffered no loss as it would have been in the same position.
In allowing the appeal, the Court of Appeal – while far from holding that the director will succeed even if he establishes the facts on which he relies – was not prepared to hold that there was no sufficient prospect of the director successfully challenging the amount of damages claimed by the company. The Court of Appeal concluded that this was a developing area of law and that much fuller submissions would be required that are normally appropriate on a summary judgment application.
At trial, the Court will have to consider the extent to which the liability of a defaulting trustee (or company director) to make full restoration to the assets improperly depleted by him, may be relaxed by having regard to the position that the trust (or company) would have been in had there been no breach of duty – that position being assessed as at the date of trial, not the date of the breach of duty. Whilst it may be true that the company suffered no loss compared to the position it would have been in had the director acted lawfully, the equitable nature of the damages affords the court a large degree of flexibility and it remains to be seen whether the court will deter fiduciaries from breaching their duties by granting compensation to the company, even if that puts the company in a better position than it would have been in had the fiduciary acted properly (which would be analogous to awarding damages on a restitutionary basis, rather than a compensatory basis).
Perhaps the more obvious potential liability arising out of the directors’ actions is in relation to non-payment of tax. It is therefore worth noting that the director reached an earlier settlement with HMRC for, inter alia, income and corporation tax that would have been due had the payments been made properly.