Forget who owns the client who owns the trail

							U P F R O N T LEGAL BRIEF




          Forget who owns the client,                                                                                                                   who
             What happens if an adviser leaves and the trail income follows?


           Who owns the client is a concept that            could take his one third of the assets of         A chose-in-action is an asset or
           has hit a new high in the financial              the company net of liabilities. If he took    property and, subject to the law relating
           services industry. The tax office is keen        more in value he had to pay for it.           to maintenance, may be secured in the
           to know. It believes the answer is the               What then happened? He moved out          same way as another asset or property
           dealer. This, it argues, is why the new          and certain clients transferred. Some         although not all choses-in-action are
           Alienation of Personal Services Income           weeks later there was a refusal to pay        capable of assignment.
           Taxation Rules apply to the income               for the more than one-third of assets             The ability to assign a chose-in-action
           earned by a financial planner. Unless, of        (including trail commission flow of           is, of course, important for valuing it. A
           course, the planner has sold their               clients) that left to a new dealer            chose-in-action that is not capable of
           business in which case the tax office            relationship. By number of clients, few       assignment has less value than one that
           wants capital gains tax from the planner         left but those that did were among the        is capable. Common Law does not
           for their goodwill represented in the            most valuable to the financial services       permit the assignment of any but a few
           clients they own.                                business. And the remaining liabilities       types of legal choses-in-action, which do
               Can anybody own the client other             left the business in a near crippled state.   not include trailing commissions, with
           than the client? This is the wrong way to            Can anything be done? The starting        the result that an assignee under any
           look at the issue. Are you interested in         point is to understand at law whether         attempt to assign the entitlement to
           owning the client or are you interested          trail commission is an asset. The             trailing commissions at law is not
           in earning the fees that result from the         departing adviser argued that the fact        entitled, without more, to sue at law in
           client relationship? If it is the latter, then   that clients followed him was not a           the assignee’s own name to enforce
           aren’t you really interested in the trail        matter for the control of anybody but         rights under the assignment.
           income? If the answer is yes, this begs          the client. At best, they followed because        Equity, however, comes to the
           the question as to whether you can               of his personality and personal skill as an   assistance of the assignee of a legal
           control and own trail income. Is it an           adviser, both of which are not attributes     chose-in-action where the assignor
           asset in its own right? If it is, it can be      that can be regarded as assets that he        refuses to do whatever is necessary to
           transferred, in which case it can be sold        should pay for. Besides, he said, where is    enable the assignee to get the benefit of
           and other rights can be made to arise in         the agreement that requires me to pay?        a purported assignment. From the
           respect of it.                                       It is clear that trail commission is      above, the entitlement to trail
               This issue arose recently in the             income but can it also represent an asset     commission is, unless some element of
           following sequence of events: in July            in its own right? This question turns         the agreement that gives rise to it
           1992, two advisers formed a partnership          largely on whether the rights and             impacts on the issue, an assignable
           and bought another’s financial services          entitlements that the trail commission        chose-in-action and as such it is an asset.
           business, the price was predominantly a          represents amounts to a chose-in-action.          Others have drawn the same
           capitalisation of the trail commissions.             A chose-in-action is used to refer to     conclusion based on similar analysis of
           In July 1996, a third adviser joined the         all property rights of which it is            the legal principles. This is the reasoning
           business. They all decided it was right          impossible to take physical possession.       behind the comments of the Australian
           for them to incorporate and all three            “Present” or “existing” choses may            Securities and Investment Commission
           became directors and held other                  include listed rights that can only be        (ASIC) in interim policy statement 161
           statutory roles in the company.                  enforced, or even precisely determined        at paragraph 37: “If a person is
               In April 2000, one of them had had           upon the happening of a future                providing broking services to clients as a
           enough. He gave notice that he wanted            contingency. A “future” chose is the          representative of a registered broker, the
           to leave at the end of the financial year,       prospect or possibility of becoming           clients remain at all times the clients of
           and that he wanted to take his clients           entitled in the future to a proprietary       that broker. It is the registered broker
           with him. Following the announcement,            right, such as a right to dividends not       who provides broking services to the
           there was some heated discussions that           yet recommended or declared, that may         clients, although the service is provided
           led to an in-principle agreement that he         arise in the future.                          through a representative. Therefore, all
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ent,   who owns the trail?                                                                                                   PETER BOBBIN


       client information [the chose-in-action    commission is an asset of the company,        trust and confidence. A person under a
       rights] such as client files and lists     it is appropriate to review the               fiduciary obligation must not allow his
       generally belongs to the registered        obligations of the officers of the            personal interest to conflict with his
       broker and not to the representative.”     company in respect of its assets.             duty. The very nature of a fiduciary
           The same reasoning was applied by                                                    obligation is to place a greater
       the tax office in Taxation Ruling IT       Fiduciary duties of directors                 responsibility upon the fiduciary because
       2000/1 at paragraph seven:                 to a company: general                         he has a special opportunity to exercise
           “In Taxation Ruling IT 2408 we         It is well established in law that partners   a power or discretion to the detriment of
       accepted that an insurance register was    in a partnership owe each other               the other person.
       an income-producing asset in its own       fiduciary obligations in relation to the         Similarly, directors owe fiduciary
       right. Consequently, a register            conduct of the business and in respect of     obligations to the company. A director
       [comprising the right to future renewal,   the assets of the partnership. The exact      cannot appropriate for himself an
       CPI and orphan policy commissions]         subject matter of the mutual obligations      opportunity or benefit that arises from
       could be effectively assigned for income   will be determined by the venture or          his position as a director. Fiduciaries
       tax purposes.”                             undertaking for which the partnership         must avoid situations of conflict of
           Once it is determined that trail       exists. Fiduciary obligations are duties of   interest between the personal interest of




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U P F R O N T LEGAL BRIEF




           the director and
           interest of the
           company. Work
           performed in the
           course of an
           employee’s employment                                        for a person who is an
           is property of the company.                               executive director and/or an    the existence
              It is also well established that                   original promoter of the            of explicit contractual
           directors have a fiduciary duty to avoid    company. The prohibition also continues       arrangements, however, in the
           conflicts of interest. Lord Cranworth       where the director resigned to pursue the     absence of such information, there is
           LC expresses the principle that directors   opportunity.                                  legal reason why the entitlement to
           cannot allow their own interests to            There is yet further support for the       receive trailing commission is an asset
           conflict with their duties to the           above comments in Saxby Bridge                of the company and any activity
           company in a classic speech in Aberdeen     Mortgages Pty Ltd v Saxby Bridge Pty          designed to divert that income is, if
           Railway Co v Blaikie Brothers:              Ltd. The court in that case examined the      without consent, a potentially
              “…it is a rule of universal              fiduciary duties owed by parties to a         actionable breach of fiduciary duty to
           application that no one, having such        commercial agreement who were                 the company.
           duties to discharge, shall be allowed to    separate legal entities.                         Given the low threshold set by
           enter into engagements in which he has,        In that case, Hamilton J alluded to        Hamilton J in Saxby for conduct to
           or can have, a personal interest            the possibility of a fiduciary relationship   constitute a breach of fiduciary duty
           conflicting, or which possibly may          between separate legal entities that were     owed by unrelated legal entities, in the
           conflict, with the interests of those       parties to a commercial agreement in          example of inter-related relationships
           whom he is bound to protect.”               which the defendant intermediary agreed       built firstly on joint purchase from a
              Apart from the equitable duty to         to recommend to its clients that they use     third party, then mutual ownership
           avoid conflicts of interest, the            the services of the plaintiff mortgage        through a partnership and finally
           Corporations Law also regulates misuse      provider.                                     entitlement within a company, it seems
           of position and company information;           His honor relies upon the High             that the onus on the departing adviser
           see sections 182 and 183 of the             Court’s decision in United Dominions          to prove his alleged entitlement will be
           Corporations Law.                           Corporation Ltd v Brian Pty Ltd to find       a heavy one.
                                                       that: “there is an arguable case that            Notwithstanding that no written
           Fiduciary duties of directors to the        there is a fiduciary relationship between     document appears the law looks at the
           company: corporate opportunity principle    the plaintiff and the defendant in            subject matter of the relationship and is
           Directors who exploit an opportunity or     relation to this income stream [the           likely to conclude that the trail
           knowledge gained as a result of their       income stream being trail commissions]        commission was a company asset not
           office breach their fiduciary duty to the   and that the fiduciary obligation in          subject to a prior or greater right of any
           company and may be liable to account        relation to that income stream may be         of the advisers, indeed, all had an
           for any profit made or to compensate        breached if the defendant were to seek        obligation in respect of it to the benefit
           the company for any loss it has suffered.   to divert that stream from the plaintiff.”    of the company and fellow directors
           This is the case even where the company                                                   and shareholders.                          q
           itself was unable to take advantage of      Where does this leave us?
           the opportunity. It has also been held      There are a range of other facts that                      Peter Bobbin is a partner with the
           that the nature of this burden is greater   may impact on the final views, notably                           Argyle Partnership lawyers

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