What Is Fiduciary Duty?

In everyday life and professional settings, we often rely on others to make important decisions for us, such as managing our money, handling legal matters, or guiding business decisions. When another person performs tasks on your behalf, they have a legal responsibility to act in your best interests—this is known as fiduciary duty.

This legal obligation is the cornerstone of many critical relationships, and understanding its implications is essential to navigating potential legal or financial challenges. In this article, we will break down the concept of fiduciary duty, explore its various types, and provide real-world examples of breaches that can lead to significant legal consequences.

Definition of Fiduciary Duty

Fiduciary duty is the ethical and legal responsibility of one party (the “fiduciary”) to act in the best interests of another party (the “beneficiary”). This relationship is based on trust, and the fiduciary is legally required to prioritize the beneficiary’s needs and interests over their own.

Fiduciary duty typically arises in situations involving:

Financial management: For instance, a financial advisor manages a client’s investments.
Legal representation: For instance, a lawyer acts on behalf of a client in legal matters.
Corporate governance: For example, board members make decisions in the best interest of shareholders.

Fiduciaries must fulfill their responsibilities with care, loyalty, and honesty, ensuring they act with integrity and avoid conflicts of interest that could harm the beneficiary.

What Are the Fiduciary Duties?

Fiduciaries are entrusted with significant responsibilities that require them to act in the best interests of those they serve. These duties go beyond simple obligations and are rooted in legal and ethical standards that demand a high level of care, loyalty, and integrity. Below, you can review the key fiduciary duties that every fiduciary must fulfill:

Duty of Care

Fiduciaries must act with the same level of care a reasonable person would implement in a similar scenario. They should make well-informed decisions and ensure their actions meet the principal’s best interest.

Example: A corporate board member must conduct thorough research before deciding on matters that affect the company and its shareholders.

Duty of Loyalty

Fiduciaries are obligated to put the principal’s interests above their own. They should actively avoid conflicts of interest and not benefit personally at the expense of the party they’re acting for.

Example: A financial advisor must not simultaneously make investments that benefit them and put their client’s assets at risk.

Duty of Obedience

Fiduciaries must adhere to all relevant regulations and laws. Furthermore, they must follow the instructions in governing documents such as trust agreements, wills, and contracts. The duty of obedience ensures that fiduciaries act within their authority and respect the principal’s wishes.

Example: A trustee managing a trust must distribute the funds to the beneficiaries only after the beneficiaries reach the stated age in the trust document.

Duty of Disclosure

Fiduciaries must fully disclose relevant information to the principal, informing them of potential conflicts of interest and material facts that could impact decisions.

Example: A financial advisor must inform their client that they will receive a commission if the client chooses to invest in that option.

Duty of Prudence

The duty of prudence requires fiduciaries to manage the principal’s affairs and assets with caution and sound judgment. They must take precautions to avoid unnecessary risks.

Example: A trust fund manager must invest in a diversified portfolio of stocks and bonds rather than placing all funds into a single high-risk stock.

Duty of Good Faith

This duty requires fiduciaries to act ethically, honestly, and with integrity. Every decision the fiduciary makes must be without deception or bad intent. The duty of good faith helps maintain the trust within a fiduciary relationship.

Example: A financial advisor must recommend investing options that align with the client’s best interests and financial goals, even if other investment options offer higher commissions.

Duty of Accountability

Fiduciaries must keep accurate records of their decisions and actions and be accountable to the principal. They should provide thorough, honest reports about how they manage the principal’s affairs or assets.

Example: A property manager must maintain detailed financial records of all income and expenses related to a rental property.

Duty of Confidentiality

Fiduciaries must protect sensitive information relating to the principal or their assets. This duty prevents the fiduciary from disclosing confidential information or using it for personal gain.

Example: An attorney must keep client information private and only use it to benefit the client.

Common Fiduciary Relationships

Fiduciary relationships arise in various professional and personal contexts, where one party is legally obligated to act in the best interest of another. Below are some of the most common types of fiduciary relationships:

Agents and principals: An agent acts on behalf of the principal in legal or financial matters, often in real estate transactions or business deals. Agents must follow the principal’s instructions and make decisions that align with the principal’s interests, such as handling financial affairs or making medical decisions through a power of attorney.
Corporate board of directors and shareholders: A corporate board of directors must act in the best interest of the shareholders. They must prioritize shareholder value while considering the company’s long-term viability. They must also avoid self-dealing and ensure that any decisions benefit the corporation and its shareholders as a whole.
Employees and small businesses: Employees who hold positions of authority within the company, including managers and employees with access to confidential information, typically owe fiduciary duty to their employer.
Trustees and beneficiaries: A trustee must manage and preserve assets within a trust for the beneficiary’s benefit. A trust agreement governs the terms of this relationship, ensuring that the trustee manages the assets without conflicts of interest.
Financial advisors and clients: Under fiduciary law, financial advisors must provide advice that aligns with the client’s risk tolerance, financial goals, and personal circumstances. Their obligations involve the duty of care, ensuring recommendations are well-researched, and the duty of loyalty, avoiding any actions that prioritize the advisor over the client.
Attorneys and clients: Attorneys must represent their client’s best interests, provide competent legal counsel, and ensure that sensitive information remains confidential. They must also avoid conflicts of interest, ensuring that their personal interests don’t interfere with their ability to provide impartial legal advice.

What Happens If a Breach of Fiduciary Duty Occurs?

A breach of fiduciary duty can lead to severe and far-reaching legal consequences. Parties may start with mediation or arbitration to resolve conflicts, but the affected party may pursue a civil lawsuit when the parties can’t agree.

If a civil court proves a breach occurred, the fiduciary may face various penalties. Some common consequences include the removal or suspension from their position, payment of court costs and attorney fees, and the return of misappropriated assets. In more severe cases, the fiduciary may have to pay compensatory damages to reimburse the estate, trust, or beneficiary for losses incurred due to the breach.

The fiduciary may also be required to pay punitive damages to punish them and discourage similar behavior in the future. In extreme cases involving theft, fraud, or embezzlement, the affected party may file criminal charges.

A duty existed: The plaintiff must show that a duty existed, whether inherent due to the nature of the parties’ relationship or present in a written agreement.
A breach occurred: The plaintiff must show that the fiduciary failed to fulfill their duties, such as by being negligent or acting in their own self-interest.
The plaintiff sustained damages: The plaintiff must prove that they suffered actual harm, whether emotional, financial, or otherwise, due to the breach of fiduciary duty.
Causation was proved: The plaintiff must show that the breach directly caused the plaintiff’s damages.

Common Breaches of Fiduciary Duty

Breaches of fiduciary duty occur when fiduciaries fail to uphold their responsibilities, either through negligence, misconduct, or self-serving actions. Below are some of the most common ways fiduciaries can breach their duties, putting their principals at risk.

Misappropriating assets: The misappropriation of assets occurs when the fiduciary uses the beneficiary’s assets for their own gain.
- For example, misappropriation could occur when a will executor pays themselves a higher service fee than the will states.
Failing to distribute assets: This breach occurs when the fiduciary unreasonably delays or neglects to distribute assets.
- For example, suppose a trust instructs a trustee to distribute funds to a beneficiary when they turn 30. If the trustee waits until the beneficiary is 25, this action is a breach of their fiduciary duty.
Improperly delegating duties: Fiduciaries often have certain qualifications that make them the right person for the job, so they often can’t delegate duties.
- For example, consider a financial advisor who delegates the management of a client’s investment portfolio to an unqualified third party. This action is a breach of fiduciary duty, as it puts the client’s assets at risk.
Not disclosing a conflict of interest: A fiduciary must not have any conflict of interest, as it can interfere with acting in the beneficiary’s best interest.
- For example, consider a fiduciary who must manage a trust for a beneficiary and also happens to own a construction company. The trustee may have to perform repairs on a house as part of their trust duties. If the trustee hires their company to perform the work and uses substandard materials to prioritize their company’s profit, this could be an example of self-dealing, which is a type of conflict of interest.
Making reckless financial decisions: A fiduciary shouldn’t make decisions without careful and attentive research.
- For example, consider a corporate officer who invests company funds in a high-risk venture. If they don’t conduct proper research first, they create a breach of fiduciary duty.
Failing to disclose certain information: Fiduciaries must provide all the facts and information they have relating to a beneficiary’s affairs or assets and the circumstances that can affect the beneficiary’s situation.
- For example, a business partner who doesn’t reveal their personal financial difficulties to other partners when making a decision about a significant investment could pose risks to the business’s future.
Failing to document their activities: Diligent record-keeping is an important aspect of being a reliable and ethical fiduciary.
- For example, consider a trustee who doesn’t keep accurate records of communications and transactions regarding the trust. This oversight makes it difficult for beneficiaries to understand the management of their assets.

Examples of Fiduciary Breach Cases

Here are two well-known cases that demonstrate how fiduciary duty can be breached, leading to significant legal consequences:

Example 1 – The Enron Scandal (2001)

Enron was a Texas-based energy company that went bankrupt in 2001. Its CEO and CFO used fraudulent accounting practices to hide Enron’s financial losses. [1] This deception led to inflated stock prices, greatly misleading investors. The scandal led to Enron’s bankruptcy, significant financial losses for shareholders, and criminal charges against several executives.

This case was also one driving factor for the passage of the Sarbanes-Oxley Act [2] to improve corporate accountability.

Key Lesson: Transparency and honesty are paramount in fiduciary relationships. Misleading stakeholders can have long-lasting legal and reputational consequences, not just for the parties involved but for entire industries.

Example 2 – Smith v. Van Gorkom (1985)

In 1985, the board of directors of Trans Union Corporation breached their fiduciary duty when they hastily approved the sale of the company and didn’t conduct a formal valuation to determine if the proposed $55 per share price was the best price for the shareholders. [3] The board acted recklessly and without due diligence.

The Delaware Supreme Court ruled that the directors were personally liable for the resulting damages.

Key Lesson: Directors must exercise due diligence, gather necessary information, and act with careful consideration when making decisions that affect the financial interests of shareholders. Failure to do so can result in personal liability.

How to Uphold Fiduciary Duty

Upholding fiduciary duty is essential for maintaining trust and integrity in relationships where one party relies on another for guidance and decision-making.

Whether you’re a financial advisor managing investments or an attorney representing a client, it’s crucial to adhere to the highest ethical and legal standards. Follow these best practices to ensure that you fulfill your responsibilities and protect the interests of those you serve:

Educate yourself. Solidify your understanding of your fiduciary duties. If you’re a board director, you may seek guidance from your company’s legal team or attend regular trainings.
Obtain fiduciary liability insurance. Fiduciary liability insurance protects against claims of breaches of fiduciary duties.
Review supporting documents. Review the documents you must abide by to ensure you know all of the intricacies of the instructions provided by the beneficiary.
Document all actions. Keep careful records of all your actions when performing your main fiduciary duties.
Facilitate open communication. Be transparent with your beneficiary, ensuring you share all the available information. Reveal any conflicts of interest and exclude them from actions when necessary.

Empower Yourself Through the Knowledge of Fiduciary Duty

Understanding fiduciary duty lets you protect your rights in relationships where a party has an obligation to act in your best interest. If a fiduciary fails to uphold their duties and acts solely for their own interests, you can seek various forms of legal recourse, from monetary penalties to the fiduciary’s suspension from their position.

Discuss your situation with a lawyer if you believe the fiduciary has breached their obligation, as they can help you assess your situation and weigh your options for recourse.

Frequently Asked Questions

Not usually. Fiduciary duty is inherent in certain relationships, so waiving it could undermine the trust and ethical standards expected in such relationships. It may be possible to waive some fiduciary duties if both parties provide informed consent and the waiver appears in a written agreement.

A waiver of fiduciary duty may be more enforceable in some relationships, like a business partnership, than other stricter relationships, like an attorney-client relationship.

Fiduciary duty requires a party to act in the best interests of another, while a contractual obligation requires parties to perform certain actions regardless of the parties’ interest.

A fiduciary can be anyone who accepts the responsibility of acting in the best interest of another person. They may be corporate officers, financial advisors, executors, guardians, and trustees.