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Farrer & Co | The Court of Appeal confirms members of charitable companies can owe fiduciary duties

The Court of Appeal issued its judgment in the Children’s Investment Fund Foundation (UK) (CIFF) case on 6 July 2018. The Court of Appeal agreed with the High Court that the members of CIFF (but not necessarily all members of charitable companies) owe fiduciary duties but, like the High Court, found it unnecessary to rule on their scope. The Court clarified that the nature of the duty owed by members of CIFF was comparable to the duty of the members of a CIO (as defined in the Charities Act 2011). The duty requires a member to exercise their powers in the way that they decide, in good faith, would be most likely to further the charity’s purposes. 

Although the Court of Appeal declined to find that all members of charitable companies owe fiduciary duties, it is now clear that members of charitable companies with small memberships do owe such duties. While the judgment notes that the position may differ for mass-membership charities, little comfort is offered that this is the case.

The appeal was allowed on the issue of whether the Court was entitled to direct a member of CIFF to vote in a particular way on a resolution. The Court of Appeal found that the Court’s jurisdiction over charities did not extend to allowing it to direct fiduciaries to exercise their discretion in a particular way where there was no breach of duty on the part of the fiduciary. 

It remains to be seen if there is any appeal to the Supreme Court by any party to the case, although it seems likely that any appeal would not challenge the finding that the members of CIFF owed it fiduciary duties.

The judgment will be of interest to those operating structures where a subsidiary charitable entity has another charity as its sole member. It will also be closely studied by corporate foundations where the business is the sole member of the foundation. That is not to say it will not be relevant to many other charitable and not-for-profit organisations with memberships who have no proprietary interest in the organisation in question.  

The background to the case

This case was an unusual one in that the backdrop to it was the divorce of two of the countries' wealthiest and most generous philanthropists – Sir Chris Hohn and Jamie Cooper. 

Back in 2002, the couple created CIFF, which for a considerable period received a proportion of the proceeds of the hedge fund, the Children's Investment Fund.

Unfortunately, relations between the two deteriorated and the two divorced in 2014. By this time, CIFF was one of the country’s largest charities with assets over US$4bn and income of approximately US$250 million.  

The charity was established as a company limited by guarantee and both Sir Chris and Ms Cooper were trustees and members of the charitable company. While the Board of Trustees numbered eight, there was only one other member, Dr Marko Lehtimäki, a friend from university.
  
Relations between Sir Chris and Ms Cooper were understandably difficult in the lead up to and following their divorce, and to resolve these difficulties a solution was identified that would result in Ms Cooper stepping away from CIFF as member and trustee and:   

  • Sir Chris and Ms Cooper each contributing US$40 million to a new charity (to be run by Ms Cooper and called Big Win Philanthropy)

  • CIFF granting US$360 million to Big Win Philanthropy (the Grant) There was broad agreement in principle to this solution, although the non-conflicted charity trustees of CIFF made their approval conditional on Charity Commission or Court approval. It was subsequently agreed that the approval of the Court should be sought to the grant. 

The High Court’s judgment

The High Court issued its judgment on 9 June 2017 and our briefing on the judgment is available here.

In short, the High Court determined that:

  • Members of CIFF owed the charity fiduciary duties;

  • The Grant was a payment requiring approval of the members under company law because it fell within the definition of a payment to compensate for loss of office;

  • It approved the Grant and directed Dr Lehtimäki (the sole member of CIFF able to vote on the members’ resolution because Sir Chris and Ms Cooper had agreed contractually not to participate in any vote) to vote in favour of any resolution approving the Grant.   

The main factors identified by the Court as to why the grant was in CIFF’s interests were as follows:

  • Agreements entered into by Sir Chris and Ms Cooper were done so in good faith and the parties should not be permitted to renege on the deal unless there were “strong reasons requiring the Court to do so in the interests of CIFF and charity”.

  • A further US$40m would be secured for charity if the grant was made;

  • The governance problems of CIFF would be resolved. 

The judgment makes clear this was not an easy decision to take but that in the Court’s view “exceptional situations demand exceptional solutions”. The judgment goes on to note that it did not consider making the grant would damage the reputation of CIFF or the charitable sector.  

The issues before the Court of Appeal

Dr Lehtimäki was granted leave to appeal and his appeal concerned whether the Court was entitled to direct him, as a member of CIFF, to vote in favour of a resolution approving the Grant. In considering this question, the Court of Appeal considered whether:

  1.  Dr Lehtimaki, as a member of a charitable company, was subject to any fiduciary duties and, if so, what these were; and

  2. The Court’s inherent jurisdiction in relation to charities allowed it to order a member to exercise discretion in a particular way irrespective of whether there is any breach of duty by that member.  

The Court of Appeal’s findings on issue (1) – Members of charitable companies as fiduciaries

The Court of Appeal agreed with the judgment of the High Court that the members of CIFF owe fiduciary duties to it.

The position of members of charitable companies were distinguished from that of members of commercial companies (who may exercise their rights as members in their own selfish interests) on the basis that: 

  1. Membership of a charitable company confers no proprietary rights as the charity’s assets must be used for exclusively charitable purposes and therefore membership is concerned with functions rather than property;

  2. There is a strong rationale for seeing membership as existing for the charity’s benefit rather than the member’s benefit; 

  3. The limits of members’ powers (in contrast with the powers of charity trustees) and the ability of the Charity Commission to intervene do not take away the responsibility of members in relation to the exercise of those powers.  

In reaching its conclusions the Court of Appeal was influenced by considering the question posed by Justice Paul Finn, an Australian academic jurist, who has written extensively on the nature of fiduciary obligations and advised asking “for what purpose one party has acquired rights, powers and duties in the relationship: to promote his own interests, the joint interest, or the interests of the other party alone”. Where the relationship indicates it is the second or third of these circumstances that Finn J notes this indicates a fiduciary relationship.

The Court of Appeal considered a series of cases concerned with private trusts and the nature of those able to exercise powers under those trusts who were not trustees. This line of cases identified those powers as of a fiduciary nature because holding the power imposed an obligation to exercise only in a way that is in good faith in the interests of the trust’s beneficiaries.  

The judgment notes that “it does not necessarily follow that members of charities such as the National Trust also have fiduciary obligations.” The basis for this is the possibility of arguing that it is less reasonable to expect members of mass-membership charities to act in the interests of the charity alone.

That said, it is not straight forward to see why the rationale for finding that members of CIFF owe fiduciary duties would differ for mass-membership charities and the judgment notes that “it is far from clear that it should be legitimate for members of, say, the National Trust to vote to obtain benefits for themselves from an entity with exclusively charitable objects.

Somewhat frustratingly, the Court of Appeal did not consider it necessary to rule on the scope of the fiduciary duties owed by CIFF’s member. It noted only that its view was that the duty on members corresponded with the duty on members of a Charitable Incorporated Organisation (CIO), which requires a member to exercise their powers “in the way that the member decides, in good faith, would be most likely to further the purposes of the CIO.” The nature and scope of this obligation has never been tested in the Courts and of course the CIO structure has only been available since 2013.  

This duty is subjective and is a question of the member’s state of mind. The judgment refers to the decision in Regentcrest plc v Cohen [2001] 2 BCLC 80 in relation to company directors, which comments: “where it is clear that the act or omission [of the director] under challenge resulted in substantial detriment to the company, the director will have a harder task persuading the Court that he honestly believed it to be in the company’s interest; but that does not detract from the subjective nature of the test.

The Court of Appeal’s findings on issue (2) – The Court’s jurisdiction to compel a member to vote on a resolution in a particular way

The Court of Appeal disagreed with the High Court’s findings on this point and found the Court could not compel a member to vote in favour of a resolution where there was no evidence of a breach of duty by the member. The Court of Appeal considered (and no arguments to the contrary were forwarded by any party to the proceedings) that there was no significant evidence that Dr Lehtimäki was acting or proposing to act in breach of duty.   

The judgment notes the reluctance of the Court to interfere in the exercise of fiduciaries’ discretion. While the special role of the Courts in supervising and directing charities was considered, it was found that “apart from its scheme-making powers, the Court has no wider jurisdiction to control the action of fiduciaries in the context of charities than, say, private trusts. The Court cannot, accordingly, direct a fiduciary (including a member of CIFF) how to exercise his powers unless he is acting in breach of duty.”  

The subsequent paragraph of the judgment goes on to comment that this does not strike the three presiding justices as a surprising conclusion. The judgment agreed with the submissions of Sir Chris’s counsel that there was a “risk of dis-incentivising not only donors, but also members and trustees, if the Court could order a charity’s trustees and members to exercise their powers in ways that they did not consider appropriate merely because the Court thought that was expedient.

The judgment also notes the risk that allowing the Court to direct Dr Lehtimäki to vote in a particular way may ride roughshod over the express intentions of parliament in entrusting to the members of a company decisions that fell within section 217 of the Companies Act 2006 as representing compensation for loss of office to a company director.   

What might the judgment mean for charities and other not-for-profits?  

The Charity Commission expressed the view that members of charitable companies owe fiduciary duties in their research report published on 1 March 2004 on membership charities (see pages 18-19) available here.  While many leading textbooks on charity law, including Tudor on Charities, disagreed with the Charity Commission’s view at the time it was published (and at that point in time the law was not settled), the conclusion that members must exercise their powers in the way that they consider to be in the charity’s interests will not be a huge surprise to many charity lawyers.

The judgment does not confirm that (a) all members of charitable companies owe fiduciary duties; or (b) the nature of the duties owed. That said, working through the rationale for finding that the members of CIFF owe fiduciary duties, it seems reasonably likely that a Court would reach the same conclusion if asked to opine on the position of members of a mass-membership charity. Consequently, members of mass-membership charities may be well-advised to take the same approach to decision-making as members of charities with small memberships whereby members take the decision that they consider is most likely to further the charity’s purposes.   

If members of charitable companies (or members of some charitable companies) owe fiduciary duties then this may also apply to non-charitable not-for-profits such as community interest companies and companies limited by guarantee that are established for defined purposes and where distributions to members are prohibited (and therefore membership confers no proprietary interest). The duties of members of charitable unincorporated organisations and Royal Charter bodies may also, by analogy, be the same as for CIOs as charitable companies. 

Third parties with powers of appointment or other powers over a charity should also note the Court of Appeal’s view of such powers as being of a fiduciary nature. Third parties holding such powers should ensure that in exercising these powers care is taken to do so in the way that they consider is in the interests of the charity (in the view of the party exercising the power) and there may be some benefit in recording the reasons why it is considered that the decision is in the organisation’s best interests.     

There are scenarios where unpacking the nature of a member’s duties and acting in accordance with these duties will prove complex (for example, where a charity is the sole corporate member of another charity and the interests of the two charities are not aligned in relation to a decision). Other circumstances where this judgment may create considerable uncertainty is where members receive benefits from a charity and where members have interests conflicting with those of the charity given that at the heart of the fiduciary relationship is the notion of undivided loyalty on the part of the fiduciary and a requirement not to profit from that relationship except with authorisation.  

Reconciling the judgment with the powers reserved to members under company law also creates uncertainty, particularly around conflicts of interest. The Companies Act 2006 expressly states that every member has one vote on a written resolution and on a poll and every member present in person at a meeting has one vote on a show of hands. It is unclear whether the fact that members of charitable companies may have fiduciary duties (and therefore may be prevented from participating in a decision where they have a conflict of interest) could override company legislation authorising a member to vote on every ordinary and special resolution.        

It is hoped that the Charity Commission will provide guidance for members of charitable companies (and CIOs) on the nature of their fiduciary duties and what this means in practice in short order, which provides reassurance to members of charitable companies on how to ensure they act in accordance with their fiduciary obligations.

If you require further information on anything covered in this briefing please contact Elizabeth Jones, or your usual contact at the firm on 020 3375 7000.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, July 2018

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