Companies that fall victim to employee fraud can improve their recovery prospects by holding employees liable as fiduciaries and trustees

The recent case of Glenea Contracts Limited v Philip Friel [2024] EWHC 1243 (Ch) serves as a useful reminder of the additional protections afforded to employers when employees entrusted with full access to financial accounts and documents abuse their position and misappropriate company funds.

In this case:

• The Claimant, Glenea Contracts Limited (the “Company”), had a sole director and secretary (husband and wife), and had employed the Defendant as a Commercial Manager in September 2011. At the time, the Defendant was a recovering gambling addict.

• There was no written contract of employment between the Company and the Defendant, but the Defendant’s net salary entitlement was not in dispute. What was disputed was a purported assurance by the Company with regards to the Defendant’s contractual entitlement to overtime payments and a share in the Company or its profits, subject to Company performance.

• As a Commercial Manager, the Defendant had unrestricted access to the Company’s bank account and was responsible for making all payments from that account on behalf of the Company; he accepted that he had been trusted absolutely.

• The Company had an internal accountant. Due to the Defendant being authorised to have total access to the Company’s bank account and records, the internal accountant accepted any comments made by the Defendant at face value with respect to authorised expenses etc.

• In January 2022 the Defendant handed in his notice. It was only after the Company’s secretary began taking over his responsibilities that she became suspicious of various transactions, particularly when she asked what his salary was, and he responded that he did not know. It was at this moment it became clear that the Defendant had been paying himself significantly more than he was entitled to and following further investigation, a claim was issued against the Defendant.

• The Company’s director, and external and internal accountants, all gave consistent evidence to the effect that the Defendant was “completely trusted” by those in the Company.

• Unusually, the sole director had access to the Company’s bank statements and accounts but never looked at them as he placed trust and reliance on the Defendant, and that was what he was employed to do.

• It was claimed by the Company that the Defendant, by the nature of his role, owed fiduciary duties and therefore sought a declaration that the Defendant was a constructive trustee. The Company also made various other claims against the Defendant including with respect to him disclosing confidential information.

• Whilst the Defendant explained that he was entitled to some of these sums as a result of working overtime or profit share, he provided no evidence of this and failed to disclose any records of overtime worked. He also explained that he intended to repay some of the sums back.

• Eventually the Defendant accepted that he had taken money to fund his gambling addiction and that between 2014 to 2022, the total amount he received was £961,571.11, of which £394,864 was his net salary entitlement.

• The main issue considered by the Court was whether the circumstances in which the Defendant undertook to operate the Company’s bank account and financial affairs generally gave rise to a relationship of trust and confidence; this is because employment is not a fiduciary relationship as such, but it can provide the context in which fiduciary duties arise from surrounding circumstances. In considering the case law it was identified that a key feature in determining whether fiduciary obligations arise is an obligation of loyalty.

• The Court found that:
  • It was more likely than not that the internal accountant reported to the Defendant, and that the Defendant was in a position of great trust and confidence – he was entrusted with practical control of the operation of the Company’s bank accounts.
  • there was a relationship of trust and confidence, and a legitimate expectation that the Defendant would not abuse his position in a way which was adverse to the Company’s interests. Therefore, he owed fiduciary duties in respect of the Company’s bank accounts in particular, and its financial affairs more generally, and was a constructive trustee of all sums which were paid to him by the Company which cannot be justified as his net salary or as bonuses or expenses. The Defendant was deemed a ‘true trustee’ by reason of the Defendant “not receiving the trust property in his own right but by a transaction by which both parties intend to create a trust from the outset and which is not impugned by the [Defendant]” (see Millett LJ in Paragon Finance v D B Thakerar & Co [1999] 1 All ER 400 at 409).
  • the Defendant’s intention to pay the sums back was no defence.
  • despite the payments being made over numerous years there was no limitation issue as the Company could rely on section 21(1)(b) Limitation Act 1980 as no limitation period applies to constructive trusts arising when a fiduciary is in control of property belonging to another.

• The Defendant has the burden of justifying the payments made to him, either by showing he was entitled to them or because he had the Company’s informed consent. Save for his net salary entitlement, plus various authorised bonus payments (which the Company would usually make) and some payments deemed to be legitimate expenses, the Defendant failed to discharge that burden. This meant that the Defendant wrongly paid himself £552,993.86.

• The Company ran an alternative breach of contract claim. The Court could not accept reliance on section 32(1) Limitation Act 1980 due to ‘concealment’ as the Company’s director (1) knew of the Defendant’s previous issues with gambling, and (2) could have identified the issues with reasonable diligence.

Comments

Whilst fact specific, this case serves as a useful reminder that employees in a position of considerable trust and control, particularly over a company’s finances and who cannot be said to be acting as a director (of whichever type), can be deemed fiduciaries and true trustees. This provides additional protections to companies as:

• The employee must justify the payments made to them.
• Categorising them as such ensures that the sums can be recovered without the limitation of time whereas this is not the case when claiming a breach of the employment contract, including the duty of fidelity. It may also be argued that a company’s directors should have identified the unlawful payments earlier.
• A proprietary remedy is available which means that steps can be taken to trace the money taken into the assets purchased using those funds and is of most assistance where the defendant is either insolvent or no longer has the property.

Whilst such decisions are welcomed, it goes without a saying that directors must be cautious when delegating responsibilities to employees and should have safeguards in place to ensure that they are not entirely unsupervised. Such safeguards may include having:

• Transactions above a certain amount approved by another member of staff.
• Financial documents, particularly bank statements, regularly examined by directors or accountants to identify any discrepancies or inconsistencies.

Furthermore, it would be prudent for a company to include these safeguards whenever any individual, including a director, has unrestricted access to bank accounts, as there has been an increase in director fraud in recent years.