Meghan Day

Principal Solution Designer

Fiduciary duty: Definitions, breaches, and prevention tips

Board members hold a position of significant trust and responsibility. They’re tasked with overseeing the strategic direction of the company, ensuring its financial health and safeguarding the interests of its shareholders.

Fulfilling these obligations requires a firm understanding of a board member's fiduciary duties.

What is a fiduciary duty?

So, what are fiduciary duties? For businesses, fiduciary duty is the legal and ethical responsibility of board members (known as the fiduciary) to act in the best interests of the business and its shareholders. It’s the most important and basic obligation required to ensure a strong legal and professional relationship between every board member and the organization.

There are many reasons why upholding fiduciary duties is important:

• Ensures legal and moral integrity are maintained
• Builds trust and confidence
• Protects the interests of both parties
• Ensures accountability
• Maintains fairness for all parties
  

The 3 core fiduciary duties

What are the three main fiduciary duties? The three core fiduciary duties of a board member are the duty of care, the duty of loyalty and the duty of obedience. These duties form the foundation of good corporate governance and guide board members in making decisions that are in the best interests of the corporation.

1. Duty of care: This duty requires board members to act with reasonable diligence and prudence. This translates to attending meetings, actively participating in discussions, reviewing relevant materials, and making informed decisions based on all available information. Board members should possess the necessary skills and qualifications to understand the complexities of the business and exercise sound judgment.
2. Duty of loyalty: This duty demands undivided loyalty to the corporation and its shareholders. Board members must avoid conflicts of interest and prioritize the company's well-being above personal gain or the interests of any other entity. This includes refraining from using their position for personal advantage, taking corporate opportunities for themselves or engaging in self-dealing transactions.
3. Duty of obedience: This duty compels board members to act in accordance with the law and the company's governing documents, such as the articles of incorporation and bylaws. This ensures the corporation operates within legal boundaries and adheres to established procedures.
   

While these are the three core duties, they’re certainly not where it ends. There are many more important fiduciary duties that ensure fairness, integrity, transparency and trust:

• Duty of good faith: All actions must be honest, and decisions must be made based on integrity. The success of the business is always the priority. These decisions must also align with the organization’s beliefs, goals and values.
• Duty of confidence: All board members must adhere to confidentiality and privacy agreements to protect the organization’s operations, finances and strategies.
• Duty of oversight: Board members must take an active role in overseeing every aspect of the business to ensure they can make informed and effective decisions.
• Duty of prudence: Decisions must be made carefully and cautiously, using information and data to ensure strong decision-making. Risks must be considered at all times to protect the business’ assets, resources and reputation.
• Duty of accountability: Board members must take ownership over their actions and decisions, ensuring complete transparency to stakeholders and members of the public.
  

Types of fiduciary relationships

There are many types of fiduciary relationships. A relationship can be classed as fiduciary if one party is acting on behalf of or advising another. They must ensure they’re working together with the best interest of the beneficiary in mind.

Examples of fiduciary relationships include:

• Corporate board of directors and shareholders: The directors must act in the best interests of the shareholders, making decisions that enhance shareholder value. This includes duties of care, loyalty, and good faith, such as avoiding conflicts of interest, not using company information for personal gain, and acting with prudence and diligence in managing the company’s affairs.
• Lawyer and client: Lawyers are expected to prioritize their clients’ interests over their own, maintain client confidence, provide competent representation, and disclose any relevant information that can affect the client’s case or decisions.
• Financial advisor and client: Financial advisors have a fiduciary duty to prioritize their client’s best interests, provide unbiased advice and disclose any conflicts of interest. They must base investment recommendations on the client’s financial goals and risk tolerance, ensure optimal transaction execution, and diligently monitor the client’s investments and financial status.
• Trustee and beneficiary: In this fiduciary relationship, the trustee administers the assets in a trust solely for the beneficiary’s benefit. The trustee must manage the trust assets with care and skill, avoid conflicts of interest, and act solely in the beneficiary’s interests. This includes making prudent investment decisions, ensuring the trust assets are secure, and distributing the assets according to the terms of the trust. The trustee is legally accountable to the beneficiary for their actions and decisions regarding the trust.
• Agent and principal: This relationship is common in many business transactions, where the agent has the authority to act in the principal’s stead in contractual situations, negotiations, or other business dealings. The agent must also provide the principal with all relevant information that can affect the principal’s decisions.
  

Common breaches by board members

There are many ways a board member can breach their fiduciary duties. Here are a few common examples:

• Making decisions without adequate information: This could involve failing to attend important meetings, reviewing key financial reports, or asking questions about proposed transactions.
• Engaging in self-dealing: This occurs when a board member uses their position for personal gain, such as awarding contracts to their own businesses or approving risky transactions that benefit them financially.
• Ignoring red flags: This could involve failing to investigate potential wrongdoing within the corporation or turning a blind eye to unethical behavior by management.
• Failing to oversee management: Board members have a duty to oversee the actions of management and ensure they’re acting in the best interests of the corporation.
• Misuse of confidential information: Leaking confidential information, whether intentionally or otherwise, breaches fiduciary duty.
• Unethical and illegal conduct: Unethical conduct, such as fraud or embezzlement, is a major breach of fiduciary duties.
• Favoritism or nepotism: Offering benefits to friends and family over others can be classed as a breach of duty or loyalty.
• Failure to disclose information: Keeping important information secret means there’s a lack of transparency, which is a breach of duties of good faith and accountability.
  

Consequences of breaching fiduciary duties

There are three main consequences of breaching fiduciary duties, which can harm both individual board members and the business as a whole. These consequences can have a major legal and financial impact on both parties and risk the future of the business. If the business commits a crime, there is also the risk of prison time.

• Legal consequences: There may be major legal ramifications in the event of a breach, including lawsuits and, in some extreme instances, criminal charges. Court cases can result in fines, restitution and injunctions.
• Financial consequences: In the event of a breach of fiduciary duty, there are often significant financial repercussions for both parties. This can include higher costs, loss of revenue, fines and long-term economic losses.
• Reputational consequences: A breach of fiduciary duty can have a major impact on trust and reputation, risking the long-term success of the business. This can affect relationships, sales and public perception.

Examples of breaches

There are several high-profile fiduciary breaches that have had major impacts on all those involved. Below are two examples of well-documented historical breaches.

Enron

Enron was at the center of one of the most infamous fiduciary breaches of all time, which saw the collapse of the organization in 2001. The board was guilty of breaching two of their duties, including:

• Lack of oversight: The board allowed management to hide debts and inflate earnings.
• Conflict of interest: Board members were guilty of not disclosing personal financial ties to specific ventures.

The breaches led to major financial losses, with share prices plummeting by almost 99%, which resulted in Enron filing for bankruptcy.

A major fashion brand

In 2015, a major international fashion brand was found to be in breach of its fiduciary duties, which resulted in a lawsuit. These breaches included:

• Failure to maximize shareholder value: The board pushed for the sale of the business at a price that would financially impact shareholders.
• Conflict of interest: It was found that the board made decisions based on self-interest and not the wider business and shareholders.
• Inadequate decision-making: The board was accused of making decisions without due diligence and failed to consider other sale offers.

While the sale of the brand eventually went through, the lawsuit was tossed out by the state vice-chancellor. However, reputational damage was felt far and wide.

11 tips to uphold fiduciary duties

There are many steps board members can take to minimize their risk of personal liability. Here are 11 of our top tips to ensure your board upholds its fiduciary duties:

1. Educate themselves on their fiduciary duties: Board members should have a clear understanding of their legal obligations. This may involve attending training sessions or seeking guidance from legal counsel.
2. Ask questions and stay informed: Board members should actively participate in board meetings, ask questions about proposed transactions, and maintain a good understanding of the corporation's business and finances.
3. Maintain independence from management: Board members should avoid becoming too close to management and should be willing to challenge management decisions when necessary.
4. Document their actions: Board members should keep detailed minutes of board meetings and document their decision-making process. This can be helpful in defending against claims of breach of fiduciary responsibility.
5. Disclose conflicts of interest and recuse themselves from decisions when necessary: Board members should disclose any potential conflicts of interest to the board and recuse themselves from voting on matters where they have a conflict.
6. Obtain directors and officers (D&O) insurance: D&O insurance can help provide financial protection for board members who are sued for breach of fiduciary duty.
7. Make an effort to understand governance policies: Ignorance should never be an excuse for a breach, so every effort should be made to be familiar with governance policies and procedures.
8. Undertake regular board self-assessments: It’s good practice to undertake board self-assessments periodically so the entire board is aligned and has the best interests of the business and shareholders in mind.
9. Encourage open communication: A board is less likely to breach its fiduciary duties if all board members are open and honest and find resolutions to conflicts and issues as early as possible.
10. Perform due diligence: Every decision must be made with risk prevention and management in mind, so it’s always vital that members err on the side of caution, ask questions and seek information.
11. Encourage a culture of continuous development: Board members should make sure they have up-to-date knowledge of their fiduciary duties and legal requirements to understand the importance of their responsibilities.

Empower your board to fulfill fiduciary duties efficiently

Understanding and upholding your legal and fiduciary duty is paramount for board members. By actively participating in board activities, asking informed questions, maintaining independence and seeking guidance when necessary, board members can effectively fulfill their fiduciary responsibilities and contribute to the success of the corporation.

Remember, this blog post is intended for informational purposes only and does not constitute legal advice. It is always advisable to consult with legal counsel for specific guidance on your obligations as a board member.

Effective board management is key to upholding your board of directors' fiduciary duties. Download our board management buyers guide to find out how board management software can help your board effectively fulfill its duties.

FAQ

What resources are available to understand legal and fiduciary duties better?

Numerous resources can help board members deepen their understanding of legal and fiduciary duties. These include:

• PwC’s Governance Insights Center: Offers insights on current issues, as well as tools for more effective and informed corporate governance.
• American Bar Association (ABA) Center for Professional Responsibility: Offers guidance on corporate governance and ethics.
• Securities and Exchange Commission (SEC): Provides resources on public company governance and disclosure requirements.
• Diligent Institute’s certification programs: Offer comprehensive education and certification for board members on topics like AI ethics, climate leadership, cyber risk, and human capital management, with a flexible online curriculum.

How should a board member handle corporate opportunities to maintain duty of loyalty?

Properly handling corporate opportunities is a major aspect of maintaining fiduciary duty, and key practices should be followed:

• Disclose opportunities to the board in full to ensure transparency
• Avoid making decisions based on self-interest
• Adhere to the organization’s goals, values and mission throughout the process
• Ensure impartiality by not taking part in the final decision
• Document the process to prove the opportunity was handled properly
• Maintain confidentiality at all times
• Always have the overall impact on the organization as the priority
• Consult legal counsel

Can board members be held personally liable for breaching their fiduciary duties?

Yes, board members can be held personally liable for breaching their fiduciary duties if their actions or inactions cause harm to the corporation. This liability can take several forms, including:

• Lawsuits: Shareholders or creditors may sue board members for breach of fiduciary duty if their actions result in financial losses for the corporation.
• Regulatory action: Government agencies may impose fines or other penalties on board members who violate their fiduciary duties.
• Reputational damage: Breaches of fiduciary duty can damage the board member's reputation and make it difficult for them to serve on future boards.

What about the duty of loyalty in situations involving corporate opportunities?

A board member must not take advantage of a business opportunity that rightfully belongs to the corporation. If an opportunity arises, the board member should present it to the company and allow the board to decide whether to pursue it.

How can a board member identify and manage conflicts of interest?

A conflict of interest arises when a board member's personal or professional interests could potentially conflict with their duty to act in the best interests of the corporation. Boards typically have established procedures for identifying and disclosing potential conflicts. Here's what board members can do:

• Disclosure: If a conflict arises, promptly disclose it to the board and abstain from discussions and votes related to the matter.
• Recusal: When appropriate, recuse oneself from participating in specific decisions to avoid any appearance of impropriety.
• Seeking guidance: Consult with the corporate secretary or general counsel to determine if a conflict exists and how to best manage it.

Upholding your fiduciary duties is critical to ensure your board operates effectively from a moral and legal standpoint. Download our board management buyers guide to discover how board management software can improve fiduciary duties and help prevent breaches.