Application of Fiduciary Duty

A fiduciary duty arises when an ethical and/or legal relationship based on trust and regarding management of money or money’s worth exists between two or more parties. Such a relationship is solely founded on confidence and trust. The one who acts on behalf of the other is referred to as a fiduciary. The party to whom the fiduciary is answerable to is called the principal. An example of a fiduciary relationship is where shareholders of a company give the power of office to directors to run a company on their behalf. In such a case the shareholders are the fiduciary while the shareholders are the principals. The essence of a fiduciary relationship is that one party, often in a vulnerable position, reposes in good faith, trust and confidence in another whose expertise, aid, protection and advice is needed in some matter. It is therefore conscientious for a fiduciary to act for the sole benefit of the principal (Rahaim, 2005).

In law, a fiduciary should observe the highest standard of care in executing what he is engaged to do. He is supposed to put the interest of the principal first, well above his personal interests. He must not seek to profit from his position without express consent from the principal. Fiduciary duty carries more weight and requires higher and stricter behavioral code than duty of care under the law of tort. Above all, a fiduciary must observe undivided loyalty to the principal and never place himself in a situation where his personal interest conflict with those of the principal.

To prove that a party is a fiduciary doesn’t necessarily expose him/her to fiduciary liability in court of law. Before liability is presumed under a fiduciary relationship, certain facts have to be proved. In SEC Vs Chenery Corporation 318 U.S. 80 (1943), the judge ruled that saying a man is a fiduciary is not enough to presume liability in case of fault. Rather, one has to prove his obligations as a fiduciary, to whom he is obligated, to what extent he failed and the consequences for the alleged failure. Only after providing such proof can a party be presumed liable.

Not all relationships give rise to fiduciary duty. One of the most familiar fiduciary relationship is the one between a beneficially and a trustee. In their case, the trustee has legal ownership of property entrusted to a beneficiary. On the other hand, a beneficiary has no legal title to the property entrusted to him by the trustee. Despite that, the trustee is obligated under equity to subordinate his interests to those of the trustee and to administer the entrusted estate to the sole benefit of the beneficiary. This ensures that the beneficially gets returns for his/her property despite not having day-to-day control over it. In this same way, directors of a company have a fiduciary obligation to its shareholders. So do directors of a bank who have fiduciary to protect the deposits of their clients. Other relationships that can give rise to fiduciary duty include lawyer/client, estate administrators/heirs, liquidators/company, and so on.

Partners in a partnership business often owe fiduciary duty to one another. This is as opposed to joint ventures where presumption of fiduciary duty doesn’t arise. However, if the joint venture is executed like a partnership, the courts have grounds to establish fiduciary obligations amongst the joint venture partners. In, the case of Arklow vs. MacLean Privy Council (1999), the judge ruled that a joint venture partner has fiduciary duty to withhold private information and not to use it to his/her advantage.

A fiduciary is held liable if it is proven that he gained or profited from the relationship in one or all of the following;

If there is conflict of the fiduciary duty and his personal interests

If there is conflict of the fiduciary duty owed to two persons

abusing the relationship/taking advantage of it

On the basis of these three provisions, the fiduciary is obligated to avoid situations of conflicts between his fiduciary duties and personal interests. Also, he is also obligated not to be in a situation where two fiduciary duties conflict and not to unfairly profit from his position as a fiduciary.

Conflict of duties occurs when two contracts entered into by a fiduciary have conflicting interests. For instance a lawyer can’t represent two clients who are a defender and a plaintiff in a case. This is because he cannot make his principals’ interests a top priority if they have competing interests. Additionally, a fiduciary mustn’t profit from a position if such profit arises out of his position as a fiduciary. If he indeed makes profit, he is bound by law and equity to report all such profit to the principal.

Breaches of fiduciary duty

Any conduct by a fiduciary based on omissions, acts or concealments that gives him undue advantage calls for redress on grounds of public policy. Such breach may occur if a fiduciary or a related party uses material and confidential information obtained by virtue of his position. If the principal can prove that a fiduciary duty was owed to him and was for that purpose breached through the violation of the aforementioned rules, the court offers redress by returning the unconscionable gain to its rightful owner-the principal. This is unless the fiduciary proves that s/he made full disclosure of gain and the principal consented to such course of action. The remedies for such breach of fiduciary duty include personal and proprietary remedies as follows;

Constructive trusts

This is applied where an unconscionable gain is easily identifiable. In this case, the court creates and imposes a duty upon the fiduciary to hold the gains in safekeeping for eventual transfer to the principal.

Account of profit

This is usually applied where the breach is either ongoing or hard to identify. In such a case, all the gains realized must be taken to the principal as they are in effect, due to him. This needs to be differentiated from constructive trust in that it is very hard to isolate the gains made by the fiduciary by virtue of his own effort from those unfairly acquired by virtue of his position. For instance, an employee who runs his own company besides employment makes profits that would not have been made were s/he not in such a position. It is difficult to split the profits amicably between those legitimately earned and those that unfairly accrued out of his breach of fiduciary position.

Compensatory damages

In case accounts of profits are impossible to establish, the plaintiff may seek damages both under common law and under legislation. The extent of the damages will depend on the level of breach and/or the amount of profit obtained as well as the circumstances surrounding such breach.

Question 2

Case examples involving breach of fiduciary duty by directors

Directors manage and control corporations for the benefit of shareholders and thus the law imposes strict rules in the exercise of their fiduciary duties. These rules apply to each and every director in his own capacity and the powers apply to the collective board of directors jointly (Rahaim, 2005)..

Case 1: Howard Smith Limited versus Ampol Limited (1974). Directors must act in Proper Purpose.

What constitutes proper authority was determined in this case by the Privy Council. The case involved director’s power to issue common stock. In the case and as per the plaintiff, a large amount of stock was issued by the directors to erode the voting power of a particular shareholder. The shareholder in question had the voting majority at the time and the new issue was purely to eliminate his majority voting power. The defendant argued that it was within their power to raise new capital but the judge rejected the argument as too narrow. Instead, the judge said that the it would have been in the best interest of the company to issue such new shares to a bigger company to ensure its stability and enable it to undertake the mining operations that the new capital was meant to be applied. The company already had mineral rights. The fact that the shareholder was deprived of his voting majority whether through the incidental result (even if it was a desired consequence), such share sale would not be deemed as improper. However, if the intended purpose was to solely erode a voting majority of one shareholder or to block a hostile takeover bid, such share issue would constitute an improper purpose and as such a breach of fiduciary duty. The judge ruled that directors must always exercise their powers to serve a proper purpose and that they are liable for any damage that may result from such breach (Rahaim, 2005).

Case 2: Aberdeen Railway company versus v Blaikie (1854). Transactions with the company

Aberdeen Railway Company contracted Blaikie Bros to make chairs valued at £8.50 per ton. Blaikie Bros moved to court enforce the contract. In its defense, Aberdeen Railway company argued that the contract wasn’t binding as their Board chairman also served as the managing director of Blaikie Bros which was tantamount to a conflict of interest.

A conflict of interest occurs every time a director transacts with the company in which he serves as a board member. This is especially so when the transaction is intended to profit him. A conflict arises since his interests are to profit from the transaction while his duty to the company is to let it profit as much as it can from all transactions. In such a case, the director must return all gains made where a case of conflict of interest has been proven even when the such conflict is hypothetical. In the case of Aberdeen Railway versus Blaikie, the judge ruled that a body corporate acts through its agents and these agents must always act in its best interests. The agents are obligated to observe the rules of their fiduciary status with the organization to which they diligently serve and that they as a universally applicable rule, no one with such fiduciary duties and responsibilities should have conflicting interest with those he is bound to protect (Rahaim, 2005).

Case 3: Use of corporate property, opportunity, or information, Regal Limited versus Gulliver (1942)

Regal limited had a cinema located at Hastings. They created a subsidiary company through which they obtained leases of two more cinemas. This was intended to make a good sale package. The landlord wanted guarantees but they didn’t want to offer such. They instead settled for an option to raise the share capital to £5000 which was financed through Regal’s savings of £2000 and £500 loan from each of its 4 directors. The chairman asked the company lawyer to put in £500 and the rest was gotten from outside subscribers to get the total amount to £5000. Later, they sold the business and made a £3 per share. The buyer instituted legal proceedings against the directors as they had no consent from the shareholders to dispose of the property.

In his ruling, the judge ruled that directors must not use the company’s assets, information and opportunities for their own gain without the consent of shareholders. The house of Commons further ruled that the directors acted well in the course of their engagement and application of special knowledge in their capacity as directors only that they acted for their own profit. The directors ought to have surrendered the profits to the shareholders (Rahaim, 2005).

Case 4: Mills v Mills (1938) 60 CLR 150. Acting bona fide( in good faith)

Charles Mills Ltd directors raised the voting power of their managing director through a resolution. The resolution provided that the company shall distribute profits through bonus shares. The shareholders included mainly the managing director among others. An action was instituted by the minority directors on the grounds that the majority director didn’t act in the company’s best the best interest and in good faith.

Directors should always act in good faith (bona fide) when conducting the affaris of the company. Though this is subjective, it is generally taken as that which is in the company’s best interest. In the case of Mills v Mills (1938), the judge ruled that the directors should act in light of obvious facts as would be clear to an honest and intelligent person conducting the company affairs (Rahaim, 2005).

Case 5: Dorchester Finance Company Limited versus Stebbing [1989]. Duty of care.

A director should have only the skills that may be reasonably be found in such a person of knowledge and experience. In the case, Dorechester Finance instituted a case against its accountants and non-executive directors for signing blank checks and rendering the company insolvent. The suit was founded on the grounds that the signatories were non-executive directors and didn’t know the day-to- affairs of the company. The court held that there is no distinction between a director and a non-director and that the director should have taken such care as he would have done on his own behalf and was therefore liable as all other directors (Rahaim, 2005).