I didn’t understand fiduciary duties in school and during my first few years of practice. They were taught as a confusing array of cases that seemed indistinguishable from each other. I had a vague sense that Delaware and Massachusetts represented the extremes of the national discourse but I couldn’t tell you why or how.
My understanding started to change when I began working on larger M&A transactions. As words like “proxy contest” and “tender offer” grew to mean more than abstract casebook jargon, so did “fiduciary duties.” I learned to toss around references to the Delaware cases of the day when I was first invited into the boardroom and into the litigators’ conference room. But did I really understand them? No.
Then something clicked. Fiduciary duties made sense. The same core concepts applied to large and small corporations, trusts and partnerships. What once seemed like esoteric discussions turned out to be interesting, practical and vitally important. They boiled down to three main concepts:
- Fiduciary duties come in two primary flavors, a “duty of care” and a “duty of loyalty.”
- Fiduciaries have to put certain others first, even before their own interests.
- Delaware allows people to contractually limit fiduciary duties much more than Massachusetts does.
A duty of care means to act with careful attention and diligence. As the old phrase goes, don’t just phone it in. Generally, the business decisions of people in managerial roles, like boards of directors and officers, are protected by something called the “business judgment rule,” but if the managers are just going through the motions they may be liable. If they fail to act within what the outside world sees as reasonable guardrails they may be liable. There is extensive Delaware jurisprudence on the duty of care responsibilities of directors, especially in the M&A context. Litigation often involves expert witnesses who testify whether a defendant met the appropriate standard of care.
A duty of loyalty means that if you are a fiduciary, you should not take for yourself or related persons money, other assets or opportunities that belong to the entity or the other owners. It can be a simple matter of not raiding the LLC’s checking account for your family vacation or more complicated analysis of whether your new possible business venture is a a so-called “corporate opportunity” that really belongs to the LLC. In litigation, a breach of a duty of loyalty is usually easier to show than a breach of a duty of care, but it depends on the circumstances.
In duty of care cases, putting others first means not just doing what one wants to do subjectively, but looking to external standards to take reasonable steps with reasonable diligence to seek outcomes that are in the reasonable best interest of the shareholders, members, partners or beneficiaries to whom a duty is owed. In duty of loyalty cases, it means always asking, “Is this for my benefit or the benefit of the ones to whom I owe a duty?” If in doubt, get advice. It’s complicated.
The statutes authorizing the creation of entities generally allow people to redefine the default level of fiduciary duty that would otherwise apply. Many entities have language that explicitly disclaims any duty of care. Some of them, to the extent permitted in the jurisdiction in which they are organized, redefine or exclude duties of loyalty. In addressing fiduciary duties, Delaware follows a “contractarian” approach: its courts respect language in agreements that curtails the rights of minority owners, although courts sometimes find ways to work around it. Massachusetts courts tend to be more deferential to the rights of minority stakeholders, sometimes even disregarding what they see as overreaching legal terms in contracts. Weaving around fiduciary duty disclaimers can be a challenge to both drafter and litigator alike.
We sometimes wonder if other lawyers’ classes were taught by equally confusing professors. So many people are not careful when it comes to fiduciary duties. A fiduciary duty means more than doing what seems generally fair! When we are advising clients, we have to understand both the legal and business complexities of their entities as well as how the law might apply across a range of interpretations.
If you are interested in learning how Coren Lichtenstein LLP can help with fiduciary duty concerns including those arising from partner disputes or business dissolutions, please contact us at jfink@cl-lawgroup.com.