Disclosing misconduct

Does an employee have a responsibility to reveal their own misconduct to their employer?

The recent Court of Appeal decision in Item Software (UK) Limited v Fassihi and others [2004] EWCA Civ 1244 has shed some light on this difficult issue.

Historically, case law has been unclear, leaving unanswered the tricky question of balancing the individual’s right not to incriminate themselves on the one hand, with the employer’s interests on the other. Item Software has now clarified certain aspects of the duty, although a definitive answer is still some way off.

Item Software was a supplier of reliability software. At the relevant time, a substantial part of its business involved distributing software products produced by another company, Isograph. Fassihi, the sales and marketing director of Item Software, secretly approached Isograph with a view to diverting Isograph’s contract with Item Software to his own company, and he also encouraged Item Software to negotiate with Isograph for improved terms. These negotiations failed and Isograph terminated its contract with Item Software.

When Item Software discovered Fassihi’s misconduct, he was summarily dismissed. Item Software brought proceedings against Fassihi and alleged that he had been in breach of duty in failing to disclose his own wrongdoing.

The Court of Appeal held that Fassihi’s position as a director and his fiduciary relationship with his employer meant he had a duty to act in what he, in good faith, considered to be the best interests of the company. This duty included an obligation to disclose his misconduct to his employer.

In her leading judgment, the appeal court judge made the following comment: “One route by which it might be concluded that Fassihi had a duty to disclose his own wrongdoing is that no logical distinction can be drawn between a rule that an employee must disclose his own wrongdoing and a rule that he should disclose the wrongdoing of fellow employees even if that involves disclosing his own wrongdoing too.” And in fact, more than 20 years ago the Court of Appeal in Sybron Corporation v Rochem Limited [1983] 2 All ER 707 established that in some circumstances, a senior employee may be under a duty to disclose the misconduct of other employees to their employer, even if this means revealing their own misconduct in the process.

In Sybron, Roques, a senior manager (but not a director) employed by Sybron, colluded with other employees to set up a business actively competing with Sybron, and worked for the competing company while still employed by Sybron. Following his early retirement, Roques was paid money by Sybron pursuant to the terms of a life assurance policy. Under the terms governing the policy, Roques would not have been entitled to the payment had he been dismissed for fraud or serious misconduct.

On discovering Roques’s misconduct, Sybron sought to recover the money paid under the life assurance policy. The Court of Appeal held that Sybron could rely on the term disentitling the employee to this benefit if he had been dismissed for fraud or serious misconduct. The court found that Roques was under, and in breach of, a duty to report the misconduct of the other employees involved in the competing business because of his position within the company as a senior manager and his knowledge of the continuing fraud by the employees.

The fact that compliance by Roques with his duty in this regard would inevitably have revealed his own fraudulent complicity was irrelevant. This principle was affirmed in the recent case of British Midland Tool Limited v Midland International Tooling Limited and others [2003] All ER (D) 174.
Apart from mentioning the rule that an employee should disclose any wrongdoing of fellow employees, the court in Item Software did not consider whether an employee who was not a director would have an obligation to disclose his own misconduct. However, another recent case, Tesco Stores Limited v Pook and others [2004] IRLR 618, suggests that a senior employee is probably under the same duty as a director. The comments of the High Court in Tesco v Pook do not form part of the decision and so are not legally binding. However, they do indicate the direction in which the law on this subject is likely to evolve.

Pook was employed by Tesco in a senior management position (he was not a director). During his employment, he concocted false invoices on behalf of a company owned and controlled by him, approved them for payment and accepted a bribe from a customer. On learning of this, Tesco suspended Pook and later dismissed him following a disciplinary hearing. However, the day before his employment was terminated, Pook applied to exercise options which he held under the employee share option scheme. Tesco refused to allow the options to be exercised. Tesco brought proceedings to recover the sums paid out under the false invoices and Pook counter-claimed that he was entitled to exercise his options.

The High Court implied a term into the employee share option scheme rules to the effect that options would not be exercisable if the employee had breached his contract to the extent that the employer would have been able to end his employment. Pook was therefore not entitled to exercise his share options.

However, the court also considered that Pook owed a duty to disclose his misconduct to Tesco. If he had disclosed his own breach he would have been dismissed summarily without disciplinary proceedings, and his contract of employment would have been immediately terminated. In these circumstances, the question of him exercising his share options would not have arisen, as it was a term of the share option scheme that rights to exercise options are terminated when employees cease to be employed, for whatever reason.

The court commented that senior employees also have fiduciary duties to their employer which impose a positive obligation to disclose their own wrongdoing. Judge Peter Smith observed that it would be a “very bizarre result” if senior employees were not subject to such a duty.
From these rulings it is clear that a director’s duty to act in what they, in good faith, consider to be the best interests of the company, requires the director to disclose theirown misconduct (Item Software).

A director or an employee may owe a duty to disclose any misconduct of other employees, even where that entails disclosing their own misconduct (Sybron v Rochem). The court in Pook accepted that this was the case and suggested that a senior employee may also owe an obligation to disclose their own misconduct as a result of fiduciary duties which they owe to their employer.

It remains unclear whether a less senior employee will owe their employer a duty to disclose their own wrongdoing, but these cases, and the continuing development of the law on the duty of trust and confidence that an employer and employee mutually owe, suggest that the courts will extend the application of the duty to less senior employees when they consider the circumstances justify it.

Tony Thompson is a partner and Rebecca Peedell a trainee solicitor in the employment, pensions and benefits department at City law firm Macfarlanes

Case list

Bell v Lever Brothers Limited [1932] AC 161

Sybron Corporation v Rochem Limited [1983] 2 All ER 707

Horcal Limited v Gatland [1983] IRLR 459

Mahmud v BCCI [1998] AC 20

British Midland Tool Limited v Midland International Tooling Limited [2003] 2 BCLC 523

Tesco Stores Limited v Pook and others [2004] IRLR 618

Item Software v Fassihi and others [2004] EWCA Civ 1244

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