Table of Contents
The Fiduciary Duties Every Entrepreneur Should Know
Why Fiduciary Duties Matter to Your Business
In the complex landscape of business law, the concept of fiduciary duties often goes unnoticed by many business owners and entrepreneurs. Understanding fiduciary duties is crucial for business owners, as it defines the very core of your legal obligations within the corporate sphere. However, the implications of these duties are significant and essential to understand for anyone in a leadership role within an organization, be it non-profit or for-profit. This article aims to shed light on what fiduciary duties are, why they are essential, and how they shape the foundation of trust in business.
What Is a Fiduciary Duty?
Fiduciary duty is a legal obligation that isn’t necessarily outlined in state or federal statutes but rather is grounded in Common Law. These duties have been shaped by court decisions over the years. Simply put, anyone in a position of power—be it a leader in a non-profit or for-profit organization, a manager, or even an employee—owes fiduciary duties. Ignorance of these duties is not an excuse and can lead to personal liability.
Why Knowing Fiduciary Duties Matters
It’s vital to be aware of these responsibilities because not knowing them doesn’t absolve you of liability. If you breach fiduciary duties and cause harm as a result, you are personally liable, regardless of your company’s structure—LLC or corporation. This makes understanding fiduciary duties crucial to mitigating both personal and organizational risk. Judges will not excuse you for a lack of awareness; the law only concerns itself with compliance.
The Fiduciary Duty of Loyalty
One of the most critical fiduciary duties is the duty of loyalty. This duty applies universally—from the boardroom to entry-level positions. Essentially, the duty of loyalty mandates that employees must act in the best interests of their employer. It extends to protecting the company’s financial assets and proprietary information.
Case Scenario: Breaching the Duty of Loyalty
For instance, if an employee in the finance department approves a non-business-related expense, like a family vacation for a fellow employee, it constitutes a breach of the fiduciary duty of loyalty. The financial loss suffered by the employer will be considered the personal liability of the employee who authorized the expense.
The Importance of Sharing Material Information
Another dimension of the fiduciary duty of loyalty is the obligation to share material, or important, information with the employer. Failure to disclose information that could significantly impact the company’s interests can also lead to personal liability.
Case Scenario: The Million-Dollar Information Gap
If you come across information about a competitor launching a similar product as your employer and choose not to disclose it—perhaps because you’re considering jumping ship—you are in breach of your fiduciary duty. Should your employer lose a significant sum due to this non-disclosure, you would be held personally accountable.
Corporate Opportunity Doctrine
When you’re working within an organization, opportunities that come your way through the course of your employment belong to the company. Known as the Corporate Opportunity Doctrine, this rule stipulates that you must present such opportunities to the company before seizing them for personal gain.
The Duty of Honesty and Full Candor
Honesty goes beyond merely answering questions; it includes a duty of full candor. You’re obliged to share any information that you know would be vital for your employer to be aware of, even if you’re not directly questioned about it.
Professional Fiduciary Duties: Beyond Employees
The fiduciary duty of loyalty isn’t limited to employees. It extends to various professionals like lawyers and financial advisors, and even business partners and shareholders. Each of these roles also encompasses the obligation to share corporate or investment opportunities, maintain honesty, and exercise full candor in their interactions.
The Duty of Care: The Reasonably Prudent Person Standard
Every person owes a duty of care, which means acting as a reasonably prudent person would under similar circumstances. While hindsight can often point out better courses of action, the law recognizes that errors in judgment can occur. What matters is whether the decision-making process was rational and undertaken with due care at the time.
The Business Judgment Rule: A Shield, Not a Sword
While fiduciary duties seem to set a high bar for conduct, the law also offers protections to decision-makers through the Business Judgment Rule. This rule asserts that as long as you acted prudently and in good faith at the time of your decision, you won’t be held liable for negative outcomes. This protection, however, is void if you stand to personally benefit from the transaction in question.
Duty of Good Faith
When entering into contracts or any business dealings, you are expected to operate in good faith. Operating in ‘bad faith’ can open you up to liability, even if what you’re doing isn’t technically illegal.
Leveraging Fiduciary Duties for Business Success
Understanding fiduciary duties empowers you to act in ways that are legally sound and ethically robust. Moreover, it provides a lens through which you can evaluate the actions of those you engage with in your business dealings. If someone violates their fiduciary duty and it results in harm to you or your organization, this understanding can be a vital tool in legal recourse.
Fiduciary duties are the building blocks of trust in business. While the concept may seem vague and intangible, its consequences are very real. Business owners and entrepreneurs should make an earnest attempt to understand these duties to safeguard their companies, protect themselves from legal consequences, and most importantly, cultivate an atmosphere of trust and mutual respect within their organizations. Failure to understand and uphold these duties not only undermines the foundations of business relationships but can also lead to severe personal and corporate liabilities. Familiarize yourself with your fiduciary responsibilities today and make it your business to know your fiduciary duties and ensure that your team does too.
What Is a Fiduciary Duty?
Let’s talk about this concept today because it is huge for business owners. Why does it matter? Because, as a business owner, it defines what your legal obligations are. It is this whole body of law that says, “Even though there is no state statute that has been passed by the legislature, and even though there is no federal law passed by Congress, you still have legal duties.”
These duties are not written necessarily, in any statute, code, or regulation. You might say, “Where are they?” They are in what is called the Common Law. In other words, they are written in cases, cases that you have never read. And yet you are liable to comply with them. That is why it is so important for you to understand what are fiduciary duties, because any person who is in leadership in a nonprofit organization or a for-profit company, any person who is a manager, a supervisor managing projects, even every employee, owes fiduciary duties. And again, these duties are not written in statutes, regulations, or codes. They are in what is called the Common Law. In other words, they have been identified by courts over the years, and you are responsible for complying with them.
Why Knowing Fiduciary Duties is Essential
Let’s face it. Most people don’t even know what they are. I am not going to get into whether that is right or wrong. It is what it is. You are responsible for knowing these laws. And if you don’t know them and you violate them, you are still liable for the consequences. You can’t say, “Hey, judge, I didn’t know about fiduciary duties. I didn’t know about this area of law. So can you cut me a break?” Judges will say, “The law doesn’t care whether you know about it. The law only cares whether you complied with it or not.” If you violate fiduciary duties and then you cause harm to somebody through that violation, you will be liable personally for that harm, not your corporation, not your LLC. They might have liability too, but you have personal liability if you violate fiduciary duties.
Duty of Loyalty
What are these fiduciary duties? First, the fiduciary duty of loyalty is a big one. This is the one that applies to every employee. Every employee owes a duty of loyalty to their employer. So that means if an employee learns of important information that is relevant to the employer’s business, the employee has a duty of loyalty to share that information with the employer.
Understanding Fiduciary Duty of Loyalty
If the employee is handling money for the employer, the employee has a duty to be loyal to the employer and make sure that money is protected for the employer. Not misappropriated for some other purpose. Now, obviously, we know if the employee steals money, that is wrong. That is going to violate criminal laws. But what we are talking about here is not necessarily the employee benefits themselves. But let’s say, for example, the employee knows that when expense reports come in, some of the expenses are not approved by the employer or not for the benefit of the employer. Let’s say hypothetically, there is no policy regarding what expenses should be covered by the employer. And one of the other employees turns in a family Disney World trip. All the expenses associated with that. And you work in the finance department and you process these expense reports, and you call up the employee and say, “Hey, did you do any business here? Is there any business purpose to this?” and the person says, “No, we just had a great time as a family.” And I figured, hey, the worst that happens is the employer rejects it. If you, as the person approving expense reports, use the employer’s money to approve to be reimbursed for that Disney World trip, you have just violated the fiduciary duty of loyalty.
What does that mean? It means you have personal liability for the amount of the expense or the money that was transferred from the company to another employee for a wrongful purpose. That is why the fiduciary duty of loyalty is so important. It is important to preserve the resources of the employer and to allocate the resources appropriately. Not just money, but information. So if you learn important information that would affect the company, you have a duty to pass that along to the employer.
What Employees and Employers Need to Know
Say, for example, that the employer is preparing to launch a product that will revolutionize your industry. And, while you are at a trade show talking with somebody, you find out a competitor is going to be launching a very similar product. And you say to yourself, “You know what? This is really interesting. I bet I know my employer would love to know that information, but I think I am not going to share it because I am not sure how much longer I am going to work with this employer. In fact, I think I might go apply to the competitor.”
So you decide not to share that information with your employer. That is public information you gained as an employee of the employer that has a material effect on the employer. It would be important for the employer to know. You have a fiduciary duty of loyalty to share that information with the employer if you fail to do that. And let’s say, hypothetically, you then leave two weeks later and you go work at the competitor. And if you had shared that information with the employer, they would have had a jump on the competitor. Let’s say, hypothetically, in this little scenario, they would have had a million dollars in sales. You would have personal liability to the extent that your breach of fiduciary duty in not sharing important information you had with your employer hurt the employer. Any harm that resulted to the employer by you not sharing that information that you had in your possession, you would be personally liable to the employer. Now there might be some statutes that modify this, but that gives you a general idea of the fiduciary duty of loyalty that all employees owe to an employer.
Duty of Loyalty Across Professions
The fiduciary duty of loyalty is even more important if you are a manager of the business, a member of the board of directors, or a board of governors if you are an officer, like a president or a supervisor. It is also important if you are in some other role where you are working on someone’s behalf like a lawyer is considered a fiduciary of the client. A financial advisor is often considered a fiduciary of the investor. There are fiduciary duties that various professions and individuals have to the person they are working for. And one of those most fundamental ones is the fiduciary duty of loyalty.
The Corporate Opportunity Doctrine
Now, a part of the fiduciary duty of loyalty is the opportunities that are coming along. For example, you work for a company that does oil mining, and they are constantly looking for oil somewhere in the ground. And let’s say you learn of a plot of land that is available for sale, and it would be incredible with oil. If you go buy that plot of land yourself, leave the company, and start your own oil company, you are violating the fiduciary duty of loyalty because the opportunity you learned about was deemed owned by the company because you were employed by the company at that time. This is called the corporate opportunity doctrine. Under the corporate opportunity doctrine, if anyone in the corporation learns about an opportunity, they need to present that opportunity to the corporation before they take advantage of it themselves. Now, if you present it to the corporation and the corporation declines, then you have every right to take advantage of it yourself before somebody else in the public. But you need to present that opportunity to the corporation first.
The Duty of Honesty Explained
Another fiduciary duty is the duty of honesty, which includes not just honesty about questions you are asked, but honesty as far as full candor. So say, for example, your boss says, “Are you aware of this particular company offering a competitive product in our niche?” And let’s say hypothetically, you are not aware of that company offering a competitive product, but you know another one that the boss would love to know about. If you say, “Oh no, I don’t know that particular company offering a competitive product.” And you fail to mention the other one that you know the boss would have wanted to know about, you have just violated the fiduciary duty of honesty or full candor.
Do You Know Your Duties?
Now, why am I using the employee scenario when this is a video for business owners? Because, at a minimum, employees owe these duties. To a much greater extent, managers, business owners, presidents, partners, and co-shareholders owe these duties. Duty of loyalty, the duty to share corporate opportunities or LLC opportunities, the duty to be honest, the duty of full candor, and the sharing of all important information. Now, obviously, you don’t have to share all the information. It is only the important stuff. Under the law, we call that material. So you have a duty to share material information with the company that you work for, other business owners you have, the board, or whoever it is that you are working for.
Decoding the Duty of Care
Business owners owe fiduciary duties to each other. The attorney owes fiduciary duties to the client. Partners owe fiduciary duties to each other. Shareholders owe fiduciary duties to each other and the corporation. So fiduciary duties are a significant area of law that we are held to, even though we may not even know about it. There is one other important fiduciary duty that applies to everyone, but there is a huge exception. It is called the duty of care. Everybody has a duty to act as a reasonably prudent person would in similar circumstances. That is the duty of care. If you are acting reasonably, and you are doing what a reasonably prudent person would, then you have fulfilled your duty of care. Even if a bad thing happens, if you did what a reasonably prudent person would, you are fine.
Avoiding the Hindsight Bias
But here is the problem. A lot of times, bad things happen. And then after the fact, people say, “Well, you should have done this, or you should have done that.” It is kind of like armchair quarterbacking. That phrase comes from the people who watch television and watch a football game from the comfort of their couch or recliner. And after a play happens, they go, “What was the quarterback thinking? Or what was the coach thinking? They should have done this, they should have done that.” You are essentially sitting with your arms on the armchair. Pretending like you could quarterback better if only they would seek your advice on how to manage this NHL team. It is easy in hindsight to say, “You should have done this better. You should have done that better.” And so, because that would essentially make every person liable for every mistake out there, of course, you can find something someone should have done better afterward.
How the Business Judgment Rule Applies to You
There is a legal doctrine that has been developed. It is called the Business Judgment Rule. It basically says, “If you did what a reasonably prudent person would have done at the time of the decision, it doesn’t matter if bad things happened after that.” All that matters is at the time, “Did you gather all the information you could, or that a reasonably prudent person would? Did you ask the right questions that a reasonably prudent person would? And did you make a thoughtful decision that a reasonably prudent person would?” Now, if you benefited from the transaction, like you decided, “Hey, I am going to sell property for the company.” And the buyer is you, and so you sold it at half price, and now you benefited. You don’t have the benefit of the business judgment rule. So if you are on the other side of the transaction, in other words, you have an interest in the deal, a personal interest, the business judgment rule does not protect you. But to the extent you are disinterested, so you have no involvement in the deal, you are protected by the business judgment rule. So even if bad stuff happens, you have not violated your fiduciary duty of care as long as you did what a reasonably prudent person would with the knowledge, information, and opportunity you had at that time. That is the fiduciary duty of care.
Unpacking the Duty of Good Faith in Business
There is one other fiduciary duty. The duty of good faith, in other words, when you enter into a contract, you need to be entering into it with the intention of good faith. You are not entering a contract, for example, with bad faith, which is with the intention to harm the other side or hurt them in a way that a court later would go, “That is dirty. That is unfair. That is wrong.” It might not technically be illegal. But you had false and wrong motives, and thus you entered a contract with bad faith. The duty of good faith applies to every relationship. Basically, if a court says, “You are a bad guy. You did the wrong thing. You had an ulterior motive that was greedy, bad, or deceptive.” If you do any engagement with bad faith, courts can conclude you have violated the duty of good faith and thus you have some liability. The duty of good faith applies to all contracts and all fiduciary relationships. So business owners to companies, employees to companies, etc.
By knowing the fiduciary duties that exist in the law, you are empowered to not only make sure that your conduct complies with the fiduciary duties, but also if you deal with somebody who does something wrong, but you think, “Well, there may not be a law against it.” You can ask yourself, “Did they violate a fiduciary duty?” Because if they did harm resulted to you from that, there is a good chance they are liable for the harm that happened to you. So fiduciary duties are a hidden part of the law. They are not in statutes, codes, or regulations necessarily. They are certainly not all in there. There are references to them from time to time, but it is an important area of law that most business owners don’t know about, but now you know. So you can make sure you follow your fiduciary duties. You help your employees and your teams follow their fiduciary duties. If somebody violates their fiduciary duties, you have spotted an issue to discuss with your attorney to see what needs to be done and what rights you have when somebody else violates fiduciary duties to you.
If you are the type of person who is interested in avoiding legal problems by growing a great, healthy company, a strong team where you are managing businesses and you are managing the people in your company or companies, you are welcome to get our free resource, which equips you with what you need to know in contract law, intellectual property law, compliance with state and federal laws and all sorts of other important areas that come up in running a business as an entrepreneur and as a leader of an entrepreneurial company, you can get it at aaronhall.com/free. There is no charge, and it is a way that you can get access to exclusive resources, videos, checklists, etc. that I have put out to help guide business owners to avoid problems.
This is all part of this YouTube channel in an effort to help business owners avoid problems, save money on legal fees, to avoid the painful distractions that lawsuits can bring or government investigations. The last thing you want to be is having a target on your back for lawsuits or government audits or investigations. If you go to aaronhall.com/free you will start getting access to the resources so that you can become empowered with education to avoid these problems in your company so you can achieve business success and have a successful life.
I am Aaron Hall, an attorney for business owners and entrepreneurial companies. To learn more about me, feel free to go to aaronhall.com.