How contractual terms determine fiduciary duties: a two-stage process

David Gibbs-Kneller and Derek Whayman

How to determine the scope of the duty of loyalty, or fiduciary duty, is clouded in uncertainty. The cases yield little more than vague dicta holding that the fiduciary relationship must be consistent with the terms of the contract and must accommodate itself to them. The conventional wisdom is thus that the duty of loyalty is determined in a single-stage process. One starts with a blank slate, and then positively implies the duty of loyalty if the nature of the engagement – defined by the terms of the contract – demands it.

In our article in the Northern Ireland Legal Quarterly, we consider exactly how the process of determining the scope of the duty of loyalty works and add some definition, rigour and detail to the analysis. We take two distinct, but complementary, approaches. The first is normative. We consider, from first principles, how the underlying nature of the duty of loyalty drives the law into a particular structure. It is the only way to resolve the fiduciary duty’s internal tension between controlling the fiduciary’s self-interest and the principal’s autonomy to authorise, when fully informed, what would otherwise be a self-interested act if the principal considers it advantageous to do so. The second approach is descriptive. We examine the case law to see how judges have been inching towards the very same position as they feel their way case by case. It is a textbook example of ‘slow-growing wisdom’ in the law, or the law ‘working itself pure’.

Our conclusion is that the process of scoping the duty of loyalty is a two-stage process. In a first stage, the duty of loyalty is raised in a multi-factorial enquiry that considers the nature of the engagement, just as the conventional wisdom dictates. In this stage, it is a balancing exercise and no single factor is conclusive. However, there is then a second stage, which uses the contractual doctrines of interpretation and implication. This stage is akin to the non-contractual process of authorisation of what would otherwise be a breach of fiduciary duty. This second stage can only reduce, not enlarge, the scope of the duty of loyalty. It is sharply logical and ordered. If the conditions in the authorising terms are met, the duty of loyalty is reduced accordingly. There is no balancing and weighing in the second stage.

To illustrate the difference between the stages, consider the following two cases. In the stage-one case of University of Nottingham v Fishel [2000] ICR 1462 (QB), the question was to which interests of his employer, if any, Dr Fishel was responsible as a fiduciary. The scope of his duty was determined by considering the many factors. Against the existence of the duty of loyalty stood his employer’s encouragement of outside consultancy and that he was merely an employee. In favour was the business-like structure of his academic unit and that he had a key role. The court held that he was subject to the duty of loyalty in managing a team of embryologists for his employer. He should have directed them to work for his employer and so he incurred liability for using them for his own personal benefit. Nonetheless, he was not under a fiduciary duty for work conducted outside of the UK, since he was not acting for his employer there.

In Ross River Ltd v Waveley Commercial Ltd [2013] EWCA Civ 910, the key issue – at stage two – was under what terms payment could be made without it being a breach of fiduciary duty. The answer was that it had to be precisely in accordance with clause 10.5 of the contract, providing that the development profit be paid by the fiduciary to Ross River before it could pay itself except: (i) in respect of proper expenses incurred; or (ii) with the agreement of Ross River. The different character of the two enquiries is immediately apparent. In particular, in stage two the terms of the contract have a much more direct effect on the duty of loyalty.

The central normative argument to support our case for a two-stage process, in brief, is as follows. The protective nature of the duty of loyalty positively demands a multifactorial approach because a sharply logical approach is too susceptible to evasion. The trade-off is that this stage must be relatively uncertain. Conversely, once the duty of loyalty has been raised, there must be a relatively certain, sharply logical second phase to authorise what would otherwise be a breach of fiduciary duty. This is so that a fiduciary is not caught out and subject to swingeing liability where fully informed authorisation has been obtained. This is the quid pro quo for the relatively uncertain first stage. It also means that the contractual doctrines are appropriate in the second stage, although they are still subject to overriding fiduciary principles. Exactly how is explored in the article.

Understanding the structure of the law makes it easier to apply and makes it less likely to fall into error. We illustrate this with some recent cases, show the mistakes in outcome, and the near-misses where the outcome was right but the reasoning flawed.