The Fiduciary Duty

The odds are good you already have a fiduciary duty to someone. Probably you have many fiduciary duties to many people. And the odds are good you may not fully understand the scope and the risks inherent in having such a fiduciary duty.

The fiduciary duty is an obligation of loyalty and good faith to someone or some entity that is the highest duty known to the law. It requires a degree of loyalty and care that does not allow any violation without exposing the violator to personal liability. Often, it can apply without you even expressly agreeing to undertake it. It does not allow for any conflict of interest whatsoever and requires full disclosure of any potential conflict of interest. It requires complete honesty and disclosure of any relevant information from the fiduciary to the person to whom it is owed. As one great jurist wrote, it does not allow for, “…a scintilla” of disloyalty to exist.

Before one marries, before one becomes a director of a company, a partner in a company, a parent, the executor of a will, the trustee of a trust, an employee to a company, a contractor to a company, a lawyer to a client, a real estate broker or agent, a doctor, a therapist, etc, etc, one should have a good understanding of the nature of fiduciary duty and how it affects your exposure to liability since all those relationships can create a fiduciary duty on your part.

 

Definition:

To owe a duty to someone or something means that one has a set of obligations owed to that person. The fiduciary duty is the highest set of obligations that one can owe to another. In its simplest terms, it means that the “fiduciary” (the one who has the duty) owes to the “beneficiary” (the one to whom the duty is owed) the highest degree of care and devotion. It means that the fiduciary must act in the best interests of the beneficiary at all times and can never take any action which harms the beneficiary intentionally and must avoid negligently harming the interests of the beneficiary as well. It means that the fiduciary can not place him or herself in a position in which the interests of the fiduciary are in conflict with the duty to the beneficiary. It means that full disclosure of any potential conflicts of interest must be revealed to the beneficiary if they arise. In some cases, it requires the fiduciary to make proactive investigation to determine what is in the best interests of the beneficiary and act accordingly.

Perhaps some examples will best illustrate. A lawyer owes a fiduciary duty to a client. The lawyer must at all times act in the best interest of the client and must make full disclosure of any economic or other interest that the lawyer has that might conflict with the interest of the client. The lawyer is obligated to take all actions and give all advice that will benefit the client and to use professional skill and energy to protect the client’s interests. Should a conflict of interest arise (for example, the lawyer discovers that one client wishes to hire him to sue another one of his clients) the lawyer must immediately make full disclosure of such conflict and take steps to immediately end the conflict regardless of the personal cost to the lawyer.

And that duty requires the lawyer to affirmatively determine if there is a conflict of interest. In California, the lawyer is required to investigate to determine if he or she represents any client that is in conflict with another or has any economic interest that may not be to the benefit of the clients. (Law firms are required to perform a “conflicts” search to check each client they have ever represented to make sure a new client is not adverse to that previous client’s interests.) Implicit in this concept is that one can not act as a fiduciary and be in even a potentialconflict of interest. The very fact that one may be placed in the future in a conflict requires one to make full disclosure and withdraw unless both clients, after full disclosure, waive the potential conflict.

Another example is a parent to a child. Each parent owes to each child, as a legal matter, a fiduciary duty. The parent is required by law to act in the best interest of the child and failure to do so can impose both civil and criminal liability (child neglect.) And, since the child is a minor, there can be no waiver of such fiduciary duty by the child. That fiduciary duty applies also to any guardian of the child.

Spouses owe to one another fiduciary duties as well. Each spouse is required to act in the interests of the other in all economic and other dealings, being required to make full disclosure. Contracts between spouses thus require a degree of disclosure of information and warning of possible conflicts that one does not find in a typical contract and if these disclosures are not made a spouse can often void a contract. Such fiduciary duties have been found to apply even to fiancées about to be married.

The list of such duties is extensive: A few examples:

 

· Lawyer to Client

· Director of Corporation to Corporation and its shareholders.

· Officer of Company to the Owners of the corporation.

· Broker to client (both stock and real property brokers have the duty.)

· Employee to Employer

· Executor of Will to Beneficiaries.

· Trustee of Trust to Beneficiaries.

· Spouses to each other. Parent to child.

· Partner to all other partners.

· Doctor to patient.

· Psychiatrist to patient.

· Financial advisor to client.

· Insurance broker to client.

· Agent to Principle.

· Accountant to client

· Guardian to beneficiary

· Conservator to beneficiary (conservatee)

And many, many others. To determine if a fiduciary duty applies, one should seek legal advice. It is vital to know if your relationship to another person or entity is a fiduciary one.

Certain relationships that may be close are not held to amount to a fiduciary duty. Thus friends do not have such a duty to each other, nor do shareholders to other shareholders (unless one is a majority shareholder in which case some jurisdictions impose such a duty) nor advertising executives to clients nor negotiation parties to each other. Sales people do not normally have any fiduciary duty to the customers, and most employers do not have a fiduciary duty to most employees though duties to keep a location secure and safe and free from illegal harassment have been imposed on some employers in some jurisdictions.

 

Contrasting Other Types of Duties:

The law does impose other, lesser, duties. For instance, one has a “duty of due care” in operating an automobile so that one does not injure another. One has a duty to act to reasonably mitigate damages if one has suffered a breach of contract and is planning to sue. There are dozens of other duties that the law imposes, but none reach the high standard of fiduciary duty which is, literally, the highest obligation that the law can impose on a person.

 

Personal liability and the Statute of Limitations:

Inherent in the concept of fiduciary duty is that one is personally liable if one violates it. Thus, if you are a trustee or a real estate broker, the law imposes personal liability upon you for the breach of that duty. While corporations or other limited liability entities may at times act to limit the extent of personal liability in some instances, and while insurance is often available that can cover one for negligent breach of fiduciary duty, in most instances the law will impose liability directly on the fiduciary who is found to have breached that duty and if the breach was willful, insurance will normally not cover the liability.

Thus, a director to a company, an executor to a will, a trustee to a trust, etc, etc, undertake a personal obligation that can have far reaching risks should they breach that duty. Further, the statute of limitations (the time in which an injured party must commence action for alleged breach of duty) is normally extremely long for a fiduciary. First, if the beneficiary is a minor, the statute is normally tolled until the minor reaches the legal age to sue. Further, if the fiduciary does not fully disclose to the beneficiary the facts that give rise to the liability, the statute may be tolled until the beneficiary knew or should have known that the wrongful act occurred.

This office filed an action against a trustee who had breached her duty to her beneficiaries in 1963. The embezzlement was discovered twenty years after the theft and five years after she died. During the discovery, additional wrongful acts were discovered going all the way back to the 1940’s and since those had been kept hidden they were allowed by the Court as additional causes of action…including action against co trustees, in this case the bank. Thus almost fifty years after the wrongful act occurred the Court granted a judgment based on breach of fiduciary duty! Since by the time of the judgment the fiduciary was deceased, the verdict was enforced against her spouse who had received (perhaps unknowingly) some of the proceeds of her wrongdoing.

 

Joint Fiduciary Duties:

One aspect of fiduciary duty not understood fully by many fiduciaries is that if they are co fiduciaries (joint trustees, joint executors, directors, etc.) the duty and the liability may be “joint and several.” This essentially means that if two fiduciaries breach their obligations resulting in harm to the beneficiary, each is individually liable for the entire damage rendered to the beneficiary. While each fiduciary may be able to claim contribution from the other for payments therefore due the beneficiary, the beneficiary need not collect equally from both. Commonly, one fiduciary disappears or is insolvent and the remaining fiduciary must therefore bear the entire brunt of the payments.

The duty of inquiry on the part of a fiduciary also means that if you know or should know that another fiduciary is breaching his or her duty, you must both make reasonable inquiry to determine if that is the case and take proactive steps to protect the beneficiary. If your own negligence allows the other fiduciary to harm the beneficiary, you may find yourself liable, at least in part, even if the other fiduciary acted intentionally wrongfully. (Typical example is that you allow a co fiduciary to sign all the checks and do not audit or oversee the action. If that co fiduciary steals some money and disappears, it is likely your negligence would allow the beneficiary to seek relief against you.)

Recent events have demonstrated that Boards of Directors of companies are often found liable for failure to exercise their fiduciary duty when an officer of the company breaches his or her own fiduciary duty and they fail to exercise reasonable oversight.

The key lesson is this: just because you have other people sharing your fiduciary duty does NOT lessen your obligations to protect the beneficiary. Indeed, in light of the need to carefully oversee the actions of the other fiduciaries, it may enlarge your duties.

 

Protections:

The most important steps a fiduciary can take are to exercise due care in protecting the beneficiary and understand that duty can not be easily avoided by waiver or “excuses.” If you are a fiduciary, you are there to protect and you must take those duties seriously and continuously oversee the obligations you have undertaken.

If there is any conflict of interest, you must make full disclosure and either get a written waiver from the beneficiary AFTER full written disclosure is made or, better yet, resign from any fiduciary position in which you are in a conflict of interest. The important steps are disclosure and informed consent or resignation.

If you become ill or other factors make it impossible to perform your duties, you must immediately take those steps to assure someone else will assume the duties. If no other people are apparent, you may have to petition the court to be removed and to appoint another person to assume your duties. Most documents creating fiduciary duties, such as By-laws of a corporation or a Will or Trust provide for either alternative fiduciaries or a method to appoint one.

For those duties imposed by law, such as parent to child or spouse to spouse, the duty can not be abrogated so easily and in some cases, as with a child, not at all. In that case, you must simply perform as the law requires.

 

Self-Dealing

By far the most common cause of litigation with fiduciaries involves “self dealing,” namely acting to benefit the fiduciary to the harm of the beneficiary. Typical situations are entering into contracts between the Trust or Company and the fiduciary that are above market value to the fiduciary; borrowing money from the Trust or estate; failing to report errors made so the beneficiary can not protect him or herself, etc. etc.

In such instances, the fiduciary is often not only removed, but faces reimbursement to the beneficiary and possible punitive damages if the self dealing was known. A good basic rule is never engage in any transaction with the fiduciary in which the decision to make the transaction is not approved WITHOUT your involvement AND is in the best interests of the beneficiary who has received full written disclosure of all aspects of the transaction.

A typical method and one often seen in corporations is that any director whose business is to enter into a transaction with the company makes written disclosure to the board, removes himself from the board room when the matter is deliberated, and does not vote on the decision. (The corporations code specifically allows such self dealing if certain steps are taken. Other fiduciary obligations, as when one is a Trustee of a trust, may be much harder to overcome in self dealing situations.) Legal advice is vitally necessary before any such transaction occurs and both the fiduciary and the beneficiary should obtain separate legal counsel to advise on the transaction.

 

So, Why Become a Fiduciary?

Some duties are imposed upon you and you have no choice (parents and children, spouses, etc) but others are undertaken voluntarily by the fiduciary who understands that the obligation is either necessary to achieve business or family ends, or a moral obligation that must be undertaken.

Most fiduciaries are in the family estate and trust structure and understand that they must assume the obligation for protection of siblings, parents or children. And if you are in a corporate or limited liability structure, or a partnership structure, such duty is necessarily imposed as part of the business structure. Even as an employee you must assume that duty and the simple fact is that to get by in life and earn a living and be a member of a family or community, one necessarily finds oneself assuming such fiduciary duties and, in most cases, many fiduciary duties.

It is thus important to fully understand what that means and to make sure your actions do conform to those obligations. One friend put it well to the writer when asked if he really wanted to assume that obligation in an estate plan: “One can judge oneself by the number of people who trust you enough to ask you to undertake what amounts to the highest obligation that exists. They want me to protect them if incompetent. What greater compliment could they ever give me?”

But with that compliment comes obligation and perhaps the first duty of a fiduciary is…to know what the total duties are!