Breach of Fiduciary Duty in California
Certain types of business relationships can create fiduciary duties between parties – that is, an obligation that one person act in the best interests of another person or entity. 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?
According to the Judicial Council of California Civil Jury Instructions, a fiduciary duty is “any relation existing between parties to a transaction wherein one of the parties is in duty bound to act with the utmost good faith for the benefit of the other party.” 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 that exist in California: 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 an 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 California Revised Uniform Partnership Act of 1994 (RUPA) 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 entirely, a partnership agreement can determine standards for measuring the performance of the duties, provided such standards are not manifestly unreasonable.
A partner’s duty of loyalty applies to an accounting to the partnership for any property, profit or benefit derived by the partner, including the appropriation of a partnership opportunity. The partner must refrain from having an interest adverse to the partnership. They must also refrain from 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 closely held corporations are subject to more stringent fiduciary duties than other corporations. In jurisdictions like California, the duties between controlling 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 to compete against their own corporations. A minority shareholder is also owed a fiduciary duty by the majority shareholders.
Limited Liability Companies (LLCs)
In California, an LLC will either be structured as a manager-managed LLC or a member-managed LLC. In a manager-managed LLC, fiduciary duties are not owed to the LLC or any other members unless an operating agreement provides otherwise. In a member-managed LLC, members owe duties of loyalty and care. This distinction makes it clear that fiduciary duties are only imposed on those in control of the LLC.
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.
California law expressly states that while directors of corporations can limit their personal liability for breaches of duty to the corporation or its shareholders, duties of loyalty and good faith may not be limited or waived. California Corporations Code s.204(a) states that a corporation’s Articles of Incorporation may not “eliminate or limit the liability of directors” for acts or omissions that are in violation of the director’s (or officer’s) fiduciary duties to the corporation or its shareholders. According to the California Revised Uniform Limited Liability Company Act (RULLCA), LLC members similarly can modify (but not eliminate) the duty of loyalty, subject to a “not manifestly unreasonable standard.”
What are some examples 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, but are not limited to, the following:
- Acting on behalf of a competitor
- Sharing an employer’s secrets
What Are the Requirements for Bringing a Claim for Breach of Fiduciary Duty?
To bring a legal claim for breach of fiduciary duty in California, 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.
No fraudulent intent is required to prove breach of fiduciary duty in California.
Aiding and Abetting a Fiduciary Breach
Notably, someone who aided and abetted a fiduciary breach can also be liable for damages. The elements for a claim of aiding and abetting a breach of fiduciary duty are: (1) a third party’s breach of fiduciary duties owed to plaintiff; (2) defendant’s actual knowledge of that breach of fiduciary duties; (3) substantial assistance or encouragement by defendant to the third party’s breach; and (4) defendant’s conduct was a substantial factor in causing harm to plaintiff. See CACI No. 3610.
The Business Judgment Rule
Where a fiduciary is a director or officer of a company, the plaintiff must overcome the Business Judgment Rule (BJR), which provides a presumption that the defendant acted in good faith and with the degree of care 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 for every bad decision made. However, the BJR does not apply if the plaintiff can show fraud, bad faith or gross dereliction of responsibilities. In addition, the rule does not protect the fiduciary from personal liability for decisions made without business justification or rationale, uninformed decisions or for their failure to make a decision when they 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 is 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. Contact a member of our team for next steps.
Photo by Colin Lloyd on Unsplash
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