Breach of Fiduciary Duty
Certain types of business relationships can create fiduciary duties between parties. The existence of a fiduciary duty is significant because it imposes heightened responsibilities upon one party (the “fiduciary”) towards the party owed the duty, and subsequent liability in the event of a breach.
What Is a Fiduciary Duty?
A fiduciary duty is an obligation that one person act in the best interests of another person or an entity. The duty can arise by law, contract, or by the circumstances underlying the relationship between the parties and the nature of the transaction at issue. Typically, there is a relationship between the parties involving special trust or reliance on the fiduciary to exercise his or her discretion or expertise for the benefit of the other party.
What Types of Fiduciary Duties Exist?
There are three categories of fiduciary duties: duty of care, duty of loyalty and duty of candor.
Duty of Care
A fiduciary must act as a reasonable and prudent person in a similar circumstance would act. In the corporate context, the duty of care means that the fiduciary is required to exercise informed business judgment in conducting a transaction or their oversight of the company. This duty can be limited or waived as discussed further below.
Duty of Candor
In corporate settings, this duty typically arises between management, board members and shareholders. It requires that a fiduciary fully disclose material information that may harm the business or individual that is owed the duty.
Duty of Loyalty
A fiduciary is required to act in the best interests of the party owed the duty. This has been interpreted to prohibit a fiduciary from putting his or her personal financial interests ahead of the party owed the duty.
The duty of loyalty also encompasses a duty of good faith and fair dealing, which obligates fiduciaries to act with honesty and in the best interests of the party owed the duty.
When Does a Fiduciary Duty Arise?
As noted above, a fiduciary duty can arise by law, contract or by circumstance. It creates a principal-agent relationship between the parties. Generally, the law provides that agents owe fiduciary duties to their principals, but principals do not owe fiduciary duties to their agents. However, there are nuances in different settings.
The Revised Uniform Partnership Act of 1994 (RUPA) § 404 provides that the only fiduciary duties a partner owes to the partnership and the other partners are the duties of loyalty and care. While those duties cannot be waived, the partnership agreement can determine standards for measuring the performance of the duties, provided they are not manifestly unreasonable.
A partner’s duty of loyalty applies to an accounting to the partnership for any property and profits derived by the partner, including the appropriation of a partnership opportunity. The partner also must refrain from having an interest adverse to the partnership or competing with the partnership in the conduct of the partnership business. The duty of care is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law. Furthermore, a partner must exercise his or duties consistent with the obligation of good faith and fair dealing.
Fiduciary duties are well-established under corporate law. Officers and directors owe fiduciary duties to shareholders and the corporation. Shareholders do not owe fiduciary duties to one another, except in the case of closely held corporations.
Closely Held Corporations
Officers, directors and shareholders of a closely held corporation are subject to more stringent fiduciary duties than other corporations. In jurisdictions like New York, the duties between shareholders are akin to that between partners. Corporate directors and controlling shareholders are held to a high standard of candor, loyalty and good faith. Shareholders may owe fiduciary duties to each other, including a duty to not usurp a corporate opportunity they became aware of in their corporate shareholder capacity. A minority shareholder is also owed a fiduciary duty by the majority shareholders.
Limited Liability Companies (LLCs)
Fiduciary duties within an LLC are usually tied to the company’s operating agreement. Members may provide for duties similar to a corporation or a partnership, or they can completely waive fiduciary duties, depending on the contents of the agreement.
How Can Fiduciary Duties Be Waived?
Certain entities are permitted to contract away their right to fiduciary duties. For example, many states allow corporations to insure and indemnify their directors and officers against breaches of the duty and limit or eliminate their personal liability in some instances.
In New York, corporations can limit or eliminate the personal liability of directors for breach of their duty of care but not their duties of loyalty and good faith. LLCs similarly can limit or eliminate the personal liability of managers or members within the LLC operating agreement. The exception is where a manager’s “acts or omissions were in bad faith or involved intentional misconduct or a knowing violation of law” or the manager “personally gained in fact a financial profit or other advantage to which he or she was not legally entitled.” NY Ltd. Liab. Co. Law § 417(a)(1)
What Are the Signs of a Breach of Fiduciary Duty?
Breaches arise when the fiduciary did not act in the best interests of the other party. Common examples of a breach include the following:
· Self-Dealing. This can occur when a fiduciary is on both sides of a deal, creating a conflict between the fiduciary’s personal interest and his or her fiduciary duty towards the other party. Actions which indicate self-dealing include accepting excessive payments, selling/gifting/misappropriating assets to oneself, borrowing company funds as a personal loan, competing with the party owed the duty, or using insider or non-public information in a stock market transaction.
· Improperly Taking Advantage of Corporate Opportunity. New York law provides that fiduciaries of a corporation, LLC or partnership have a fiduciary duty not only to safeguard presently owned business assets, but also “business opportunities.” As a result, fiduciaries cannot, without consent, usurp an opportunity for themselves that should be deemed an asset of the corporation. They also cannot promote any personal interests which are incompatible with the superior interests of the business. However, determining what constitutes a corporate opportunity can be difficult. Several tests may be used in New York. The “tangible expectancy test” analyzes whether the corporation has an “interest” or “tangible expectancy” in the opportunity. The “line of business test” assesses whether the opportunity is the same as or is necessary for, or essential to, the line of business of the corporation. Other factors may also be relevant.
· Deception. Actions which would likely be considered deception include failure to provide important or sufficient information that may lead to misunderstandings, failure to disclose conflicts of interest, pursuing an opportunity meant for the company and not informing the party owed the duty, and misappropriating assets of the party owed the duty.
What Are the Requirements for Bringing a Claim for Breach of Fiduciary Duty?
To bring a legal claim for breach, there are three basic elements that must be proven:
- A fiduciary relationship and duty existed,
- A breach of the duty occurred, and
- Damages were suffered as a result of the breach.
Aiding and Abetting a Fiduciary Breach
Notably, someone who aided and abetted a fiduciary breach can also be liable for damages. Typically, such claims are brought against advisors who knowingly participated in the breach. The requirements for bringing an action for aiding and abetting in New York are (1) a breach by a fiduciary of obligations to another, (2) that the defendant knowingly induced or participated in the breach, and (3) that plaintiff suffered damages as a result of the breach.
The Business Judgement Rule
Where a fiduciary is a director or officer of a company, the plaintiff must overcome the business judgment rule, which provides a presumption that the defendant acted in good faith and with that degree of care which an ordinarily prudent person in a like position would use under similar circumstances. This is a high burden and it acts to deter frivolous lawsuits against directors and officers for every bad decision. However, the Business Judgment Rule does not apply if the plaintiff can show fraud, illegal or wrongful conduct, conflict of interest, bad faith, or a conscious disregard of one’s responsibilities. In addition, the rule does not protect the fiduciary from personal liability for a decision with no business justification or rationale to support it, an uninformed decision or for failure to make any decision when it would be reasonably required to do so.
What Remedies Are Available for Breach of a Fiduciary Duty?
A party suing for breach may seek direct and indirect damages, injunctions, restitution, rescission, legal fees, and other appropriate remedies as provided under the law.
Although breach of fiduciary duty claims are fairly common in business litigation, they often involve complex factual situations. An experienced attorney can provide appropriate guidance on the strength of your claim or defense and help resolve your matter successfully.
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