What Are Fiduciary Duties?
A fiduciary relationships consists of two individuals: the beneficiary and the fiduciary. The fiduciary is entrusted to manage and protect the assets of the beneficiary. In doing so, the fiduciary must fulfill certain duties and act in good faith for the profit of the beneficiary.
Examples of fiduciary relationships include, but are not limited to:
- Attorney and client
- Broker and principal
- Trustee and beneficiary
- Executors of an estate and the estate’s heirs
In the corporate world, the Board of Directors of a public company are considered fiduciaries. Since their decisions effect the investments of public shareholders, board members are required to fulfill various fiduciary duties.
If a board member fails to fulfill their duties, they can be sued for damages.
Fiduciary Duties of Directors and Officers
It is important to note that each state has its own specific laws regarding corporate law. While fiduciary duties are fairly standard, there may be unique exceptions or additions in your particular state.
Duty of Care
Duty of care is a legal principle that states that directors and officers must act in a reasonably prudent manner. Reasonably prudent is clearly inexact, and courts have come up with the Business Judgment Rule to help in legal cases.
The Business Judgment Rule is the presumption that the courts should not second-guess the decisions of directors and officers as long as the fiduciaries were reasonably well-informed, acted in good faith and rational judgment, and conducted business without any conflict of interest.
Violating the duty of care generally requires gross negligence. A merely careless business decision that results in a loss of profits, for example, is not a violation of fiduciary duty.
Duty of Loyalty
The duty of loyalty requires that directors and officers act on behalf of the corporation without personal economic conflicts. In other words, the directors and officers cannot personally benefit from their decisions made as fiduciaries of the corporation.
A classic violation of the duty of loyalty is insider trading. A director or officer is often privy to information that will affect the company stock long before a public investor is made aware. Selling or buying shares based on this information is a violation of the duty of loyalty.
Another example: a director is made aware of a cheap piece of property which will be ideal for the corporation. But instead of informing the corporation, the director purchases the property himself and then sells it to the company for a significant profit.
The duty of loyalty requires fiduciaries to always place the corporation above personal interests, and in situations where a conflict of interest may arise, to step down or recuse themselves.
Duty of Good Faith
The principle of good faith refers to idea that directors and officers act in conscious regard to their fiduciary responsibilities. It includes advancing the interests of the corporation and its shareholders, not violating the law, conducting business honestly, and fulfilling all their duties.
In addressing lack of good faith, courts have noted conscious and intentional disregard of responsibilities, don’t-care-about-the-risk attitudes, and even intent to do actual harm.
A director or officer found to have acted in bad faith can be held liable and denied indemnification from the corporation for judgments and expenses.
Breach of Duty
When a director or officer violates their fiduciary duty, this is known as a breach. There are numerous ways in which a breach of fiduciary duty can occur.
Common Fiduciary Breaches:
- Insider trader
- Failure to disclose
- Misappropriation of funds
- Misuse of superior knowledge
There are two significant categories of corporate breach of duty: nonfeasance and malfeasance.
Corporate nonfeasance is the failure to act when under the obligation to do so. In this case, directors and officers can be held liable for not acting in situations where they should have.
A common example of nonfeasance is when a director lacks fundamental and rudimentary knowledge of their industry and the corporation itself. This lack of knowledge can be sited as evidence that the director is incapable of fulfilling their fiduciary duties.
Corporate malfeasance is a broad category including both minor and major crimes committed by directors and officers of a corporation. Malfeasance occurs when a director or officer engages in a wrongful or illegal act.
One of the most well-known examples is the case of Enron, whose corporate executives knowingly deceived and defrauded employees and the public investment marketplace. Aware of an impending financial collapse, executives sold off their stock in the company just before the corporation tanked, netting millions in profits. These individuals were later prosecuted for securities fraud.