HELP FLEDGLING FIDUCIARIES LEARN TO FLY
Attorneys’ advice can keep parties from falling prey to lawsuits
Fiduciary litigation is on the rise, as evidenced by the U.S. Supreme Court’s ruling in LaRue v. DeWolff, Boberg & Assoc. Inc., last month, which opened the door to previously disallowed claims by individual ERISA plan participants for breaches of fiduciary duty. Researchers estimate that by 2052, up to $136 trillion dollars will have been transferred from the retiring baby boomer generation to the next. Countless fiduciaries, including trustees, executors, financial professionals, or attorneys, will be involved in transferring and managing this wealth. Their actions will be subject to increasing legal challenges by beneficiaries and others.
Claims should not be unexpected as even “sophisticated” individuals will usually have little experience with such matters. Fiduciaries are often treated like nestlings. Ready or not, they are named fiduciaries and are suddenly pushed out of the nest, forced to learn to fly on their own. The fiduciaries assume their positions without knowing what their duties are, how best to perform them, and the risks for failing to do so. With preparation and advance planning, you can help these fiduciaries take flight and soar over the potential litigation traps beneath them.
Who is A Fiduciary?
A fiduciary is a person or entity that, by virtue of a “fiduciary relationship” between two or more parties, owes the other party certain legal duties involving good faith, trust, confidence, and candor. Fiduciary relationships involve much more than just the typical situations involving trustees and executors. Courts have tended to broaden the situations in which parties are deemed to be in a fiduciary relationship. Fiduciary relationships can arise in myriad situations. For example:
- Trust advisers with powers of direction, or persons holding trust powers, owe fiduciary duties.
- Agents owe fiduciary duties to their principals with respect to the subject matter of the agency.
- Joint venturers owe fiduciary duties to each other with respect to the subject matter of their venture.
- Partners owe each other fiduciary duties with respect to the affairs of the partnership.
- Directors of a corporation owe fiduciary duties to the corporation.
- Officers of a corporation owe fiduciary duties to the corporation and to its board of directors.
- Controlling shareholders owe fiduciary duties to the minority shareholders. Even non-controlling shareholders of a closely held corporation may owe fiduciary duties to the other shareholders.
- Professionals may owe fiduciary duties to their clients.
- In some states, homeowners associations may owe fiduciary duties to their members.
- In some states, even spouses owe fiduciary duties to each other with respect to community property.
Generally speaking, a fiduciary owes a duty of care and a duty of loyalty to the other parties in the fiduciary relationship. The duty of care describes the level of competence that is expected of a fiduciary, and is often described as the duty of care that an ordinarily prudent person would exercise under similar circumstances. The duty of loyalty is one of the most fundamental duties owed by a fiduciary. The fiduciary must act at all times in the best interests of the principal or beneficiary.
Fiduciaries face personal financial, regulatory, litigation, and, sometimes reputational risks for violating these duties. Typically, the burden of proof in a lawsuit alleging a breach of fiduciary duty falls on the plaintiff to prove its case by a preponderance of the evidence. When a fiduciary’s actions are challenged and a fiduciary relationship is found to exist, however, the burden of proof can shift to the defendant fiduciary to prove, by clear and convincing evidence, that it acted fairly and equitably. Burden shifting occurs in cases involving claims of fraud, self-dealing or conflict of interest, and can have a dramatic impact on the litigation and settlement positions of the parties.
Minimizing Litigation Risks
Fiduciaries often get sued because they don’t understand their fiduciary duties and the laws and regulations that affect them. As the attorney for the fiduciary, take the time to ensure that your client is aware of and familiar with all applicable documents, whether they are trust documents, wills, memoranda of wishes by the testator/settlor, articles of organization, by-laws, rules, or statutory regulations.
The fiduciary’s primary duty is to protect and preserve that with which it is entrusted. This duty is not a passive duty and can often mandate taking affirmative action to protect assets or the interests of the beneficiaries or principals. Such actions can include obtaining insurance to protect against loss of the assets; establishing additional trusts, such as educational or medical trusts; filing tax appeals; consulting with appropriate professionals to reduce tax liability; attending and voting at shareholder meetings; obtaining competent advice regarding investment of assets; and commencing lawsuits when necessary.
Executors, administrators, trustees and other fiduciaries should be aware that they are also charged with non-delegable duties. While they may employ attorneys, accountants, and others to assist and provide advice, fiduciaries have a personal duty to perform their responsibilities and may only delegate responsibilities in situations where a prudent person might do the same. As the attorney for the fiduciary, guide your client with respect to what is and is not delegable and be aware of additional duties, such as a duty to supervise, that delegation can create.
Conflicts Of Interest
As the Bible says, “No one can serve two masters,” and the same holds true for fiduciaries. A fiduciary is under a duty to act for the benefit of all beneficiaries or principals. This includes a duty not to favor one beneficiary or principal over another, not to profit at the expense of the beneficiary or principal, and not to enter into competition with the beneficiary or principal without its consent. Whether corporate or individual, the fiduciary cannot use trust property for its own financial gain. For example:
- A bank or trust company serving as trustee cannot invest trust assets by purchasing its own stock unless expressly or impliedly authorized by the terms of the trust.
- A fiduciary cannot accept for itself any bonus or commission paid by a third party for any act done by the fiduciary in connection with the performance of fiduciary duties.
- A majority shareholder cannot procure its own election as an officer of the corporation at a salary greater than that which is warranted under the circumstances.
Conflict of issue interests can often be avoided by full disclosure of the potential conflict, employment of prophylactic action (such as abstaining from a vote) or the appointment of a co-fiduciary. A fiduciary’s failure to avoid actual conflicts of interest may result in the fiduciary being removed from its position; being held liable by a beneficiary or principal for breach of fiduciary duty; and having transactions to which the fiduciary was a party rescinded or cancelled.
Duty To Account
A fiduciary must manage, protect, and preserve the property for which it is responsible. First and foremost, the fiduciary must always keep all property within its charge segregated from its own property or the property of others. Fiduciaries can further reduce their risk of being sued for an accounting or for mismanagement of trust funds by keeping proper documentation and retaining appropriate records throughout the term of the fiduciary relationship. Proper record keeping will also assist the fiduciary in rendering timely accountings, whether annual, interim or final. Fiduciaries would be well served to prepare accountings at least twice a year.
The fiduciary should always consider whether sufficient documentation exists to support its actions. If an investment performs poorly and is sold by a fiduciary, the fiduciary may have potential liability for claims by the beneficiary or principal for breach of fiduciary duty for selling the asset well under fair market value. If advice is received from an investment professional, have the advice put in writing in advance of taking any action. Obtaining other documentation, such as a simple appraisal of the asset before the sale, could substantially reduce or virtually eliminate the litigation risk.
Duty To Disclose
A fiduciary is required to communicate to the beneficiary or principal (or, as applicable, other shareholders, partners, etc.) all material facts known, or that the beneficiary or principal should know, in connection with the fiduciary relationship. Even, or perhaps especially, when the fiduciary acts improperly, this conduct must be disclosed by the fiduciary. Officers, directors, and majority shareholders can be held personally liable for breach of fiduciary duty when there is a misappropriation of corporate funds for personal benefit and subsequent fraudulent concealment.
Because they owe both a duty to disclose and a duty of loyalty, fiduciaries should also disclose situations in which they will make an otherwise secret profit or commission from the performance of duties. It is a breach of fiduciary duty to earn a secret profit or commission and a breach of fiduciary duty to fail to disclose it.
Disclosure also reduces litigation risk. Regular communication with beneficiaries or principals can eliminate a sense of distrust that sometimes festers and that can create otherwise avoidable conflicts. Moreover, a beneficiary or principal who consents to or ratifies with full knowledge an act of a fiduciary may be precluded from later objecting to the impropriety of the act on the ground of waiver or estoppel and from holding the fiduciary liable for any resulting loss.
While it is impossible to counsel a fiduciary to all the possible issues that may arise, you can reduce your client’s litigation risk by giving him or her working knowledge of his or her fiduciary duties. With this working knowledge, your client may recognize the minefield before crossing it and will be more likely to seek your assistance in avoiding potentially risky situations.