What Is a Fiduciary Duty and When Do I Know If I Owe One?
Laura and I (Amy) have helped our business clients maneuver through various aspects of their business operations: personnel issues, customer collection matters, contract revisions, and vendor disputes. Oftentimes, these issues can be resolved, and new practices can be implemented to prevent certain foreseeable issues to recur. Headaches, time, and money aside, oftentimes these issues are not overwhelmingly detrimental to the business or to the future of the company. That is why Laura and I are excited to offer general counsel services to our business clients to ensure that our clients are working with an attorney on a consistent basis to spot certain issues or weak points in their businesses and address them swiftly.
But, when it comes to counseling our business clients on the inner workings on the executive level of the business - i.e., the partnership between partners/members, the officer suite of a corporation - the issues that can arise amongst business partners and officers can be catastrophic if they are (i) not addressed promptly and/or (ii) not anticipated at an early stage in business. More often than not, though, we start tackling these issues with our clients once some damage has already been done. For example, there is a dispute amongst partners as to how the business should pivot when there is a reduction in cash flow - one partner may suggest a reduction in overhead/workforce while another partner may suggest that the business take out a loan so as to avoid letting team members go. Arguments can be made for both sides to take the suggested course of action, but what happens when partners cannot agree? What happens when the officer and daily manager of the corporation takes immediate action without the approval of the other officers? What is the recourse? What is the responsibility? What did the partnership agreement say? Was that officer acting in good faith or for personal gain? Who takes the blame? Questions abound….
The first crucial point that business owners must understand is that, when there are multiple managing partners or officers in a corporate entity, managing members of the partnership or company owe a fiduciary duty to one another.
Under New York law, a fiduciary relationship exists 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. Each relationship is fact-specific, and it is also grounded in a higher level of trust than what would normally be present in an arm’s length business transaction. Thus, a fiduciary owes a duty of undivided and undiluted loyalty to those whose interests the fiduciary is to protect. See Landes v. Provident Realty Partners II, L.P., 2017 NY Slip Op. 30196(U) (N.Y. Sup. Co., Jan 31, 2017).
A fiduciary relationship can arise (i) by function of law, statute, or contract; or (ii) by the nature of the relationship and the transactions engaged in by the parties. For the purposes of a business partnership as we are discussing here, the fiduciary relationship exists.
In a fiduciary relationship, the fiduciaries owe the duties of due care, loyalty, and candor. Due care means that the fiduciary must act reasonably in their execution of their duties to the entity and to one another. Loyalty means just like you may be assuming - that the fiduciary acts in the best interests of the entity and each other by placing these interests ahead of his/her own self interests. Lastly, candor means that each fiduciary is required to act honestly and with full transparency.
In the event of a breach of any of these three duties, litigation will likely ensue. To determine whether a breach of a fiduciary duty exists, courts will determine (i) whether a fiduciary relationship exists; (ii) the misconduct by the defendant (one of the fiduciaries); and (iii) the damages caused/suffered by reason of the misconduct. John v. Varughese, 2021 NY Slip Op. 3026 (2d Dept. 2021).
The takeaway is that members of a partnership or corporation need to understand this basic facet of their business relationship - what duties are owed to one another - and to ensure that they are acting in alignment with these duties daily. When issues arise in business, Laura and I stress the importance of communication between partners. Try to discuss the issues amongst you, and if you reach an impasse or need further guidance or clarification, seek out the advice of counsel to ensure that you are acting in accordance with the terms of the business arrangement and in accordance with the laws that guide your conduct.
Disclaimer: The information contained in this post is not, nor is it intended to be, legal advice. You should consult an attorney for advice regarding your individual situation. We invite you to contact us and welcome your calls and communications. Contacting us, however, does not create an attorney-client relationship.