Know Your Fiduciary Duties

by Patrick B. Hughes

Business people often assume that as long as they don’t do an act the law prohibits they are free to act out of self-interest.   They may assume that if they are honest and keep their word, and if they don’t mislead, trespass upon, or cause physical injury to someone else, they can do what benefits themselves to the detriment of someone else.  In short, they may assume that each person is responsible for, and looks out for, his or her own interests.  That view is generally correct but like all generalities, it is the exceptions that are important and demand attention.

In some circumstances, the law imposes a duty to act in the best interest of someone else.  That occurs when either a contract or the nature of the relationship between two parties requires it.  The obligations are called fiduciary duties and they arise in a wide range of settings.  A person entrusted with property belonging to someone else has fiduciary duties as to that property.  Whenever a person or entity has the power to act on someone else’s behalf, whether as an agent, executor, trustee, corporate officer, or member of a board of directors, that person has a fiduciary duty to use that power for the benefit of the other person, not the fiduciary’s own benefit.  These circumstances are easy to deal with because trustees, agents, officers and directors know they are in such a role and it should be clear to them that they must act accordingly.

However, fiduciary obligations do not arise only in relationships where a person has a contract to be a fiduciary or position that is inherently one in which there are fiduciary duties.  Instead, fiduciary duties arise whenever there is a relationship of special trust.  This does not mean one may abandon all caution and responsibility for his own protection and unilaterally impose a fiduciary relationship on someone else. Yet the parties may, without explicitly recognizing it, develop a relationship where fiduciary duties arise.  As a result while we can say as a general rule that a creditor does not owe a duty to a debtor, there are times when, because of the special trust that has developed between the two, fiduciary obligations can arise.  There is no list of types of relationships in which fiduciary duties arise.  Instead there is a broad principle that a fiduciary relationship exists  “where there has been a special confidence reposed in one who, in equity and good conscience, is bound to act in good faith and with due regard to the interests of the one reposing the confidence.” Such a relationship is “characterized by a unique degree of trust and confidence between the parties, one of whom has superior knowledge, skill or expertise and is under a duty to represent the interests of the other.”

Fiduciary duties fall into two basic categories: duties of loyalty and duties of care.  The duty of loyalty is the duty to pursue the interests of the other person. For example, the duty of loyalty requires that the best interests of the corporation and shareholders take precedence over a director, officer, or controlling shareholder’s self-interest that is not shared by the stockholders generally.  It prohibits fiduciaries from engaging in self-dealing and requires that the other person receive the full benefit of transactions in which the fiduciary engages, without thought to personal gain. In short, it is the duty of the person in whom confidence was placed to act with the utmost good faith and loyalty for the furtherance and advancement of the interests of his or her principal. Kansas sets a higher standard or stricter fiduciary duty for directors and officers of corporations than some other jurisdictions.  Any unfair transaction induced by a fiduciary relationship gives rise to a liability with respect to unjust enrichment of the fiduciary and it is the fiduciary who must prove the transaction is fair. 

The duty of care is an obligation to exercise the skill, care and diligence that would be exercised by a reasonably prudent and competent person in the place of the fiduciary.  What it means to owe such a duty to someone else is that a failure to perform gives the other person a claim to recover whatever damage the failure causes.  Therefore fiduciaries, whether trustees or homeowners’ association officers, are liable for losses resulting from their malfeasance, misfeasance or their failure or neglect to discharge their duties.  The risk of failing to adequately perform fiduciary duties is not limited to having to pay the damages the failure causes.  In some circumstances the fiduciary may have to forfeit benefits the fiduciary received, or even the compensation paid to the fiduciary.  In other cases a fiduciary may have to pay a multiple of the damages or may be liable for punitive damages.  The potential liability for breaching fiduciary duties can persist much longer than for some other types of legal claims.  Sometimes the statute of limitations will not start running until the fiduciary relationship ends.  For example, a trustee who has served for 10 years may remain liable for acts done at the beginning of that period, even if that statute of limitations for the conduct is otherwise two years.

The best way to control exposure to claims for breach of fiduciary duty is to be sure to understand in what relationships you owe such duties and how they apply.  Often the best way to recover for an economic injury is through a claim that a person who contributed to it was a fiduciary and breached fiduciary duties.

(Article appeared in Adams Jones November 2010 Newsletter)