Dr Andrew D Hicks

Does a constructive trust of unauthorised fiduciary gain turn more would-be wrongdoers away from breaches of fiduciary obligation than an account of profits? Many judges and jurists believe that it does. They assert that a constructive trust of fiduciary gain is therefore necessary and justified. This is the case even where the fiduciary’s gain is neither subtracted from nor intercepted on its way to the principal and notwithstanding the potential impact of a constructive trust on innocent third parties, most notably the fiduciary’s unsecured creditors.

The basic idea behind the deterrence theory underlying this position is simple. The constructive trust (a proprietary claim) possesses superior disgorgement properties relative to an account of profits (a personal claim). The recognition of a constructive trust of fiduciary gain therefore reduces the expected benefit of and incentive for fiduciary disloyalty. Consequently, we can expect its recognition to result in fewer breaches of fiduciary obligation, thereby strengthening the integrity of fiduciary relationships.

I am not and never have been entirely convinced by this well-worn but ultimately untested justification for the constructive trust, particularly in relation to bribe and commission-taking by fiduciaries (the contexts in which calls for the recognition of a constructive trust on deterrence grounds have been at their loudest). The problem, as I see it, is that few fiduciaries will seek to understand the remedial implications of a breach of fiduciary obligation at such a level of detail as to appreciate the implications of proprietary disgorgement. They may broadly understand that they will not be permitted to retain any unauthorised gain, but they are unlikely to consider the matter any deeper than this. If fiduciaries do not perceive the implications of proprietary disgorgement, they cannot be influenced by them. Those invoking the deterrence justification simply assume fiduciaries are well informed (if not perfectly informed).

The issue is how we can test the proposition that fiduciaries are unlikely to be informed about the proprietary implications of a breach of fiduciary obligation. A general poll of fiduciaries, to ascertain what they know of the remedial consequences of a breach of fiduciary obligation, is unlikely to be useful. Even if the results show fiduciaries generally know nothing of the proprietary implications of a breach of fiduciary obligation, it may be that fiduciaries become informed, but only if and when incentivised to do so (when actually contemplating a breach of fiduciary obligation). Neither would it be useful (even if it were possible) to come at the matter the other way and poll fiduciaries who have acquired a gain in breach of fiduciary obligation (but have been caught). Even if, at the time the breach was committed, such wrongdoers knew nothing of the proprietary implications of their breach, it would not rule out the existence of an unmeasured group of fiduciaries who contemplated disloyalty but were deterred, having informed themselves of the possible consequences of their contemplated actions. How, then, can it be demonstrated (rather than merely asserted) that constructive trusts of fiduciary gain do not deter disloyalty?

The developing field of behavioural economics offers a way forward. Behavioural economics has two central features. First, it identifies how human behaviour departs, in systematic and predictable ways, from the behavioural assumptions of classical rational-choice economics (the economic theory relied upon, even if only implicitly, by those who invoke the argument of deterrence). Secondly, the claims of behavioural economics are empirical in the sense that they are informed by scientific insights about actual human behaviour.

In my recent article in the Northern Ireland Legal Quarterly I apply the more nuanced behavioural tools developed by behavioural scientists to identify that which a fiduciary is likely to know and understand about the implications of his or her contemplated breach of duty. I find that the influence of the constructive trust on fiduciary behaviour is likely to be negligible. Fiduciaries cannot be influenced by sanctions they do not know and few fiduciaries will be cognisant of the implications of the constructive trust. A number of reasons for this are explored in the article, including biased fiduciary perceptions about the level of their own knowledge, information search strategies and the challenging information environment faced by fiduciaries. Of course, this is not to deny the existence of a small number of fiduciaries who are well informed about the legal implications of engaging in a profitable breach of fiduciary obligation. However, even here the deterrence value of the constructive trust will be small. This is because the risk that a breach of fiduciary obligation will be detected is likely to be perceived as low. There is much evidence to suggest that a small risk will often be treated as a zero risk. In such circumstances, it follows that even a fiduciary who is perfectly informed about the remedial implications of a breach of fiduciary obligation will not be responsive to those implications.

Ironically, a more realistic understanding of fiduciary behaviour demonstrates that the deterrence prospects of the constructive trust are bleakest in cases of bribe and commission-taking. Detection rates for bribery and commission-taking are particularly likely to be perceived as low, leaving fiduciaries with little incentive to become informed about the sanctions for such behaviour and unresponsive to known sanctions. Contrary to recent judicial and academic opinion, there is little to suggest that the constructive trust and associated doctrines such as tracing deter much disloyalty.