Court rules that normal limitation periods do not apply to claims against directors for fraudulent breach of duty

The Court of Appeal has found that claims against directors for breach of their fiduciary duties will not be subject to the usual six year limitation period where that breach was fraudulent. It does not matter for these purposes whether or not the breach involved handling any property belonging to the company.  This applies equally to executive and non-executive directors.

What was the dispute about?

In Subsea v Balltec and others, Subsea brought claims against various defendants, one of whom was a former non-executive director of the company, Mr Emmett.  Subsea claimed, and the trial judge found, that Mr Emmett had, amongst other things, breached his fiduciary duties to Subsea.  The breaches related to the preparation and making of bids for contracts in competition with Subsea, via a new, rival company that Mr Emmett had been involved in setting up.

The breaches of duty occurred more than six years before the claim was issued, so would ordinarily be statute-barred under the Limitation Act 1980. However, the trial judge accepted that the claim fell under one of the exceptions from the six year period, which relates to a claim by a beneficiary of a trust in respect of a fraudulent breach of trust by a trustee (section 21(1)(a) Limitation Act 1980).

Mr Emmett appealed that finding, arguing that section 21 of the Limitation Act only applied to a director where the claim related to the recovery from the director of property belonging to the company (under section 21(1)(b)), rather than for any other breach of fiduciary duty by the director.

What did the court decide?

The Court of Appeal found in favour of the claimant, Subsea, dismissing the appeal.

Patten LJ reviewed the “much-litigated provisions of s.21 of the Limitation Act 1980”. It is well-established that directors will be regarded as trustees for the purposes of the Limitation Act.  However, previous case law had arguably established a difference for the purposes of the Limitation Act between two different categories of trustees:

• Those who had already assumed fiduciary duties before the transaction or action in contention (who could be considered “true trustees” or “fiduciaries”); and
• Those who only become trustees by virtue of a constructive trust being implied after the event (for example, where they receive a secret commission or bribe that is later found to rightfully be due to be paid over to another person) (“de facto trustees” or “non-fiduciaries”).

The second category of trustees will only be subject to the indefinite limitation period under the Limitation Act if the claim relates to the recovery of trust property held by them (in other words, section 21(1)(b) applies to them but section 21(1)(a) does not).

Mr Emmett had argued that, where a claim did not relate to the misappropriation by a director of company property, but to some other breach of fiduciary duty, the director in those circumstances should be considered as falling into the second class of trustees (de facto trustees).  If so, the mere fact that their breach of duty had been fraudulent would not be enough for the exceptions in the Limitation Act to apply.

The judge disagreed. He found that a director at all times falls within the first category as a true fiduciary, even when their breach of duty does not involve the misappropriation of company property.  They are not in the same position as a stranger to the company who only becomes a trustee in the limited sense of having to account for the profits of their fraud.  The judge went on to state that:

“It seems to me to follow from this that if a director is a trustee for the purposes of s.21 then the phrase ‘breach of trust’ must encompass any breach of his fiduciary duties as such a director towards the company. If he causes loss to the company as in this case he is accountable in precisely the same way as a trustee would be for any loss caused by his breach of duty to the trust.”

On that basis, any fraudulent breach of Mr Emmett’s director’s duties would be subject to the exception in section 21(1)(a) Limitation Act, so the six year limitation period would not apply.

Was the trial judge right to make a finding of fraud?

The second point that Mr Emmett appealed was the trial judge’s finding that his breach of his director’s duties had been fraudulent. Mr Emmett argued that the claimant had not clearly pleaded a fraud claim, and this had not been put to him in cross-examination, in which case the trial judge was not entitled to make a finding of fraud.

Patten LJ emphasised that for a breach of trust to be fraudulent, it is not enough to show that it was deliberate. There must also be an absence of honesty or good faith, but this could include being reckless as to the consequences of the individual’s actions.

The judge found that:

“it was fairly put to Mr Emmett that he was aware that he was acting contrary to the interests of [Subsea] and that he knew what he was doing was wrong. The judge in my view had evidence from which he could properly decide whether the breaches of duty alleged against Mr Emmett were dishonest and therefore fraudulent.”

The judge also found that there was nothing wrong with the way that the claim was pleaded, and therefore that the trial judge was entitled to make a finding that the breaches of fiduciary duty had been fraudulent.

The appeal was therefore dismissed and the claims against Mr Emmett were upheld, despite being brought more than six years after the conduct complained of.

Osborne Clarke comment

Limitation periods often throw up difficult issues, not least when it comes to fiduciary duties and constructive trusts. This decision is a welcome clarification of how the exception to the usual six year limitation period applies to fraudulent breaches of directors duties.

It is not uncommon for former directors’ conduct to come to light some time after the event. Where that conduct amounts to a breach of the director’s duties that was carried out fraudulently, this case establishes that the six year limitation period does not apply, regardless of whether the breach involved misappropriation of the company’s property.

This decision increases the risk profile for directors and is a reminder that ‘fraudulent’ conduct can be interpreted widely. The conduct complained of in this case was dishonest in the sense of being contrary to the interests of the company and knowing it was wrong or being reckless about that – rather than involving ‘fraud’ in the way that the term is commonly used.

The director in this case was a non-executive director, who appears to have been on the way out, but delayed resigning his directorship to avoid triggering bad leaver provisions. That delay meant that he was still under a fiduciary duty when setting up a competitor, which ultimately amounted to a fraudulent breach of fiduciary duty, for which he was liable potentially indefinitely.

This can also be seen against a trend in business regulation of an increasing focus on personal liability, which we focus on as part of our Regulatory Outlook.