We had earlier considered the question of whether there exist proprietary remedies for breaches of directors’ duties. The question of whether a remedy is proprietary or personal makes a difference most importantly in the context of insolvency. If a remedy against the fiduciary is merely personal, the beneficiary will only be able to claim along with other unsecured creditors. If the remedy is proprietary, the relevant asset acquired in breach of duty will not be available to the general pool of creditors.
There was an assumption underlying the earlier post that there is in general a proprietary remedy provided under s. 88 of the Indian Trusts Act 1882. S. 88 of the Trusts Act provides:
Advantage gained by fiduciary.- Where a trustee, executor, partner, agent, director of a company, legal adviser, or other person bound in a fiduciary character to protect the interests of another person, by availing himself of his character, gains for himself any pecuniary advantage, or where any person so bound enters into any dealings under circumstances in which his own interests are, or may be, adverse to those of such other person and thereby gains for himself a pecuniary advantage, he must hold for the benefit of such other person the advantage so gained.
The assumption was that the text (“must hold for the benefit of such other person”) automatically imposes a constructive trust on the undue benefits gained by the defaulting fiduciary. This assumption is supported by the decision of the Bombay High Court in CIT v. Tanubhai Desai. A solicitor earned interest from moneys deposited by him with the bank. A client had entrusted the moneys, to be kept in a separate account, for conducting litigation. The Court held that the interest was not to be taxed in the solicitor’s hands. The interest was held in trust for the client, such trust arising automatically at the time the moneys were diverted from the client account in breach of fiduciary duty:
A solicitor has, therefore, in view of the provisions of the said s. 95, to perform the same duties and is subject to the same liabilities and disabilities as if he were a trustee in respect of the said moneys, his clients to whom the said moneys belong being the beneficiaries. The provisions of s. 51 of the Indian Trusts Act would apply and a solicitor being a trustee of such a quasi-trust cannot use or deal with the trust property for his own profit or for any other purpose unconnected with the trust. He can deal with them only to the extent provided for under the said rules of this High Court. The corpus, i.e., the moneys credited in the client’s account, is held by a solicitor in his fiduciary capacity and the income or interest derived from such corpus is equally held by him subject to such fiduciary relationship existing between the solicitor and his clients…
What the solicitor actually does with the income, i.e., whether he appropriates it to himself or not, is, in our opinion, a matter of no consequence. If he appropriates it to himself, it would simply amount to a breach of his fiduciary relationship and whatever may be the consequences in law would follow. But his unauthorised act of converting any part of the corpus or even the income derived therefrom which is not in accordance with the provisions of the rules of this High Court would not convert those amounts held by him in a fiduciary capacity into moneys held by him beneficially for himself…
Section 95 of the Act, referred to by the High Court above, says:
Obligor’s duties, liabilities and disabilities.-The person holding property in accordance with any of the preceding sections of this Chapter must, so far as may be, perform the same duties, and is subject, so far as may be, to the same liabilities and disabilities, as if he were a trustee of the property for the person for whose benefit he holds it…
Section 51 of the Act provides that a trustee cannot use the trust property for her own use or for anything except the purposes of the trust. The Bombay High Court in Tanubhai read section 88 together with sections 95 and 51 to consider that the moment there is any advantage derived by a fiduciary, that advantage is effectively held on trust by operation of law. This view also finds support in the decision of the Calcutta High Court in CIT v. Sanderson & Morgan 75 ITR 433. On the other hand, other authority suggests that there is no such automatic trust. The Madras High Court held in Rajah of Ramnad v. Chettiar AIR 1916 Mad 350 (per Sadasiva Ayyar J., concurring):
The wide phrases ‘hold the property’ (Section 86) or ‘hold the advantage’ (Section 89) ‘for the benefit’ of the transferor, cannot be held to create at once an enforceable as distinguished from an establishable (sic) trust in favour of the transferor… If a trust obligation has to be created and if the law requires that the creation of the trust itself (note an inchoate obligation in the nature of a trust) should be purpose the person who wants to benefit by the provisions of the Trusts Act ought to so invoke the aid of the Court for the effective creation of the trust within the time limited by law…
Property in the hands of a mere constructive trustee does not become the property of the beneficiary under the constructive trust so as to enable him to treat it as such without a judicial declaration of the trust. As said in Lewin on Trusts, Chapter X, paragraph 18; ‘Until some judgment or decree has been obtained, the money’ (in the possession of the person who obtained a pecuniary advantage by unfair use of fiduciary relation) ‘cannot be said to be the money of the principal’. As said by Lindley, L.J., in Lister v. Stubbs of such an argument, ‘the unsoundness of it consists in confounding ownership with obligation’.
The Court left open the possibility that there may be some instances where an automatic trust arises, but did not specify those instances. Lister v. Stubbs (1890) 45 Ch D 1, cited with agreement, was a judgment where the English Court held that secret commissions received by an agent were not held in constructive trust. The Lister approach was not followed by the Privy Council in Attorney-General v. Reid. It was overruled by the UK Supreme Court in FHR v. Cedar Capital.
The Madras High Court also suggests that there is no immediate trust arising by the operation of law, but that a trust could be imposed by the Court as a remedy. This means that Indian law considers the constructive trust arising in these situations to be a ‘remedial’ constructive trust (imposed by the Court as a remedy) rather than an ‘institutional’ constructive trust (arising automatically). The Bombay and Calcutta views are to the contrary. The result of the Bombay and Calcutta cases of Tanubhai and Sanderson can be best explained if there is an automatic trust arising immediately when the fiduciary derived an advantage in breach of duty. Only then can one say that the advantage was never part of the fiduciary’s income.
Whether there can be ‘remedial’ constructive trusts is debated across the common law world. For one example of the recent scholarship on this issue, see this article. The English position presently seems only to recognise the institutional (i.e. automatic) constructive trust, while other jurisdictions recognise the remedial model. A remedial constructive trust perhaps allows a Court to consider all the circumstances of the case – including the effect on creditors and third parties – before declaring the trust. On the other hand, one could say that the exact criteria for when to impose a remedial trust are unclear.
Now is an especially opportune time to consider these questions in India, in light of the Insolvency and Bankruptcy Code (discussed previously on this blog in a similar context in Mr. Aditya Swarup’s post here). For instance, the Code excludes “assets held in trust for any third party” from the liquidation estate. One question could be whether “trust” in this provision includes ‘constructive trusts’, or whether it only includes express trusts. Sections 88 and 95 are part of the chapter dealing with ‘obligations in the nature of trust’. It is possible (and in keeping with the practice of other common law jurisdictions) to interpret the word “trust” in the Code as encompassing these obligations in the nature of trust too. The second question is whether Indian law is best understood as following the institutional or the remedial model. As we saw above, there is no uniformity in the decisions. The third question is what criteria should Courts use in balancing the interests of beneficiaries as against the interests of third party creditors in the context of gains derived by an insolvent trustee/constructive trustee in breach of duty.
Going ahead, it will be interesting to examine the approach of the Indian Courts to these issues.