Proving a Breach of Fiduciary Duty Claim

• Posted on: Jan 31 2018

Like many things in life, operating a business with another person, or many persons, is a risk. There is always the possibility that your business associates may act for their own benefit, rather than for the benefit of the business. The law recognizes this risk and assigns special obligations of fidelity to business partners. These obligations are commonly known as fiduciary duties, which require business partners (including officers, directors and managing shareholders of corporations) to act in a trustworthy manner, with honesty, and with the best interests of the company in mind. Unfortunately, these obligations do not always encourage good behavior. Countless claims of breach of fiduciary duty have been brought in commercial litigation over the years.

What is a Fiduciary Duty?

There are two types of fiduciary relationships: 1) those created by law (e.g., statute) or contract; and 2) those that arise from the circumstances underlying the relationship between the parties and the nature of the transactions at issue.

While courts generally look to a statute or contractual arrangement to determine the nature of the parties’ relationship (e.g., the first type of fiduciary relationship), the existence of a fiduciary relationship is not dependent solely upon a statute or contractual relation. See EBC I, Inc. v. Goldman, Sachs & Co., 5 N.Y.3d 11, 20 (2005). Rather, the actual relationship between the parties determines the existence of a fiduciary duty (e.g., the second type of fiduciary relationship). Id.

In Meinhard v. Salmon, 164 N.E. 545, 546 (N.Y. 1928), Justice Cardozo provided the “classic formulation” of a fiduciary duty:

Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty. Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this, there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the ‘disintegrating erosion’ of particular exceptions. Only thus has the level of conduct for fiduciaries been kept at a higher level than that trodden by the crowd.

In more modern times, the New York Court of Appeals has described the duty as arising from a relationship “‘between two persons when one of them is under a duty to act for or to give advice for the benefit of another upon matters within the scope of the relation.’” See EBC I, 5 N.Y.3d at 19, quoting Restatement (Second) of Torts § 874, Comment a.

The circumstances under which a fiduciary relationship can arise have no limit. Nevertheless, there are certain persons who are often found to be fiduciaries:

• lawyers;
• bankers;
• business partners;
• corporate directors;
• corporate officers;
• managing shareholders;
• personal representatives (executors and administrators);
• trustees; and
• investment advisors.

There are three forms of fiduciary duties (often referred to as the “triad” duties):

• due care;
• loyalty; and
• candor

Any disinterested and independent decision that is made by a fiduciary, especially a corporate fiduciary, is analyzed under the business judgment rule. The business judgment rule is based on the premise that a court should not be entitled to Monday-morning quarterback decisions made by fully informed individuals who are free from conflicts of interest. Auerbach v. Bennett, 47 N.Y.2d 619 (1979). Thus, the courts will not second-guess the decisions made by fiduciaries and will not hold them personally liable even if the decision turns out to be the wrong one.

Duty of Care

The duty of care, quite simply, is the duty to act as a reasonable and prudent person in a similar circumstance would act.

Duty of Candor

A fiduciary must act, not only with honesty, they must fully disclose information that may harm the business or individual that is owed the duty.

Duty of Loyalty

The duty of loyalty requires that fiduciaries act in good faith and with the best interests of the business or corporation in mind, putting the interests of the business or corporation above their own personal interests. As one court observed:

The reasons for the loyalty rule are evident. A man cannot serve two masters. He cannot fairly act for his interest and the interest of others in the same transaction. Consciously or unconsciously, he will favor one side or the other, and where placed in this position of temptation, there is always the danger that he will yield to the call of self-interest.

Wachovia Bank & Trust Co. v. Johnston, 269 N.C. 701, 715, 153 S.E.2d 449, 459-60 (1967). See also Birnbaum v. Birnbaum, 73 N.Y.2d 461, 466 (1989) (“it is elemental that a fiduciary owes a duty of undivided and undiluted loyalty to those whose interests the fiduciary is to protect. This is a sensitive and ‘inflexible’ rule of fidelity, barring not only blatant self-dealing, but also requiring avoidance of situations in which a fiduciary’s personal interest possibly conflicts with the interest of those owed a fiduciary duty.”) (citations omitted).

Included under the umbrella of loyalty is the duty of good faith and fair dealing, which obligates fiduciaries to act with honesty and in the best interests of the corporation. Examples of a breach of the duty of loyalty include:

• usurping a corporate opportunity;
• acting with a conflict of interest;
• competing with the corporation; and
• misappropriating assets of the corporation.

If a fiduciary has the consent of other disinterested fiduciaries, such as a corporate director, that person may undertake the first three bullet points.

If a fiduciary breaches the duty of loyalty, the business judgment rule does not apply, and the fiduciary may be held personally liable for their actions.

Burden of Proof

A plaintiff making a claim against another for breach of fiduciary duty must prove certain factors, depending upon whom the fiduciary is.

1. Fiduciary is a partner, agent, trustee or non-statutory fiduciary – a plaintiff must prove: (a) the existence of a fiduciary duty, (b) the defendant breached that fiduciary duty, and (b) the plaintiff was damaged directly by the breach. Baldeo v. Majeed, 150 A.D.3d 942 (2d Dep’t 2017).
2. Fiduciary is a director or officer – the plaintiff must first overcome the business judgment rule – that is, the presumption that the defendant acted on an informed basis, in good faith, and with the best interests of the company taken into account. In some cases, the court will apply an enhanced scrutiny standard, which shifts the burden to the defendants to show that: (a) the decision-making process was adequate (the reasonableness test), and (2) reasonable in light of the existing circumstances (the proportionality test).

Takeaway

A breach of fiduciary duty claim is generally no different from other tort claims. Therefore, a breach of fiduciary duty claim should be approached in much the same way as any other tort claim.

In this regard, plaintiffs should be mindful of their burden of proof. In New York, a breach of fiduciary duty claim must be pleaded with particularity. Litvinoff v. Wright, 150 AD 3d 714, 715 (2d Dep’t 2017). And, if the plaintiff asserts a contract claim, s/he should be mindful that the claims do not overlap. Under New York law, a breach of fiduciary duty claim that is premised on the same facts and seeks the same relief as a breach of contract claim is duplicative of the contract claim and subject to dismissal. Gawrych v. Astoria Federal Savings & Loan, 148 A.D.3d 681, 684 (2d Dep’t 2017).

Finally, where the claim arises in the corporate context, attention should be given to the business judgment rule and the presumption that attaches to it.

Tagged with: Breach of Fiduciary Duty, Business Litigation, Commercial Litigation, Fiduciary Duty