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Partners profit share can be forfeited for breach of duty

30 November 2016

The High Court has recently ruled that a partner or LLP member, who commits a breach of fiduciary duty, may forfeit any part of his profit share which constitutes remuneration.

Arbitrator's decision

Mr Hosking, a member of Marathon Asset Management LLP, was found to be in breach of his contractual and fiduciary duties to the LLP due to his plans to set up a competing business. The LLP successfully brought an arbitration case against Mr Hosking. In the arbitration award, the LLP was awarded equitable compensation for the losses it suffered and Mr Hosking was to forfeit 50% of the profit share payments that he received from the LLP whilst he was acting in breach of his fiduciary duties.

Grounds of appeal to the High Court

The appeal to the High Court was founded on the basis that profit share was not remuneration and therefore could not be subject to forfeiture. It was argued that there was a conceptual difference between remuneration, which is in exchange for services rendered, and profit share, which reflected an individual's ownership stake of the business.

This LLP distinguished between executive and non-executive members. Executive members were those founding members who continued to work in the business and non-executive members were those founding members who did not. Non-executive members were entitled to 50% of the profit share they would have been entitled to receive had they been executive members.

With this in mind, the arbitrator had come to the conclusion that that the additional 50% profit share executive members were entitled to receive was remuneration in return for services to the LLP. The other 50%, which was payable to all members, reflected the members' ownership stake in the business as the "retired non-executive member... receives a lesser share, reflecting his past contribution to, and an ownership interest in, the business".

High Court decision

In the High Court, the judge upheld the arbitrator's decision and refused Mr Hosking permission to appeal. He maintained that, where profit share is compensation for services, it is appropriate to consider it remuneration which is capable of being subject to forfeiture.

The full High Court judgment in Hosking v. Marathon Asset Management LLP can be read here.

What we think about this decision

In this case, there was a clear distinction between the profit share received in connection with ownership of the business and that in return for the provision of services. If the facts had been different, and the distinction less obvious, it could be significantly more difficult to ascertain the portion of profit share that would qualify as remuneration, and thus be liable to forfeiture.

This decision is to be welcomed by partnerships and LLPs. It gives firms further recourse against partners or members who act in breach of their obligations. From an individual's perspective, one would be well advised to take note of this case to avoid a hefty repayment of profit share!

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