Fiduciarity

What are the dangers and can you avoid them?

Keith Wallace looks at the increasing attempts to claim that a fiduciarity relationship exists and to use this to seek more substantial redress
(taken from Isssue No 13 –  October 2000)

What terrifies the businessman, and his lawyers, is being accused of a breach of fiduciary duty for a lapse in the conduct of some part of the group’s activity. Carelessness or mistakes (in lay terms), or negligence or contract breach (to lawyers) are part and parcel of the daily grind, but an asserted `breach of fiduciary duty` carries much more sinister overtones.

This article explores whether this nightmare of `fiduciarity` is justified, who may be troubled by these ghouls, and how they may arrange their business to procure a less troubled night’s rest. I have tried to angle this towards financial sector and corporate trust related activities. Obviously pure trust work has its own issues. But before assessing the scope of fiduciarity, it seems sense to start with the risks.

Why be scared of fiduciarity?
There are nine reasons why it may be advantageous for claimants to assert a breach of fiduciary duty in connection with some lapse, and why the party against whom fiduciarity, and its breach, is asserted should have nightmares.

1 Liability
It may simply be the case that there is no independent cause of action at all under other or parallel heads – such as breach of contract, negligence, breach of trust or equitable compensation for breach of skill and duty.

2 Measure
The measure of compensation to the claimant may be much higher than the claimant’s pecuniary loss because the redress for breach of fiduciary duty requires `restitution` rather than damages. Damages puts the claimant in the position he would have been but for the lapse. The higher possibility accords him `restitution of property unconsciously withheld` where `unconsciously` equals `against conscience`.

3 Constructive trust – increases damages/recovery further
The remedy for breach of fiduciary duty is intended to counteract the unconscionable behaviour of the supposed fiduciary and, as mentioned under `measure` this may entail a recovery to the claimant of higher than any loss he may have suffered. Indeed he may have suffered no loss at all. In this case, which should be familiar to trust officers, Boardman was a trustee with others of a minority shareholding in an unquoted company. Identifying possibilities for gingering up the activities and profitability of this company he acquired further shares in a personal capacity and, using the influence derived from the combined shareholdings achieved substantial profits for the trust (and himself). Phipps, a beneficiary under the trust, who had benefited handsomely from Boardman’s assumption of personal exposure and energy nevertheless claimed – successfully that Boardman’s personal profits should become the property of the trust.

4 Limitation
All businesses acknowledge they may make mistakes, with a concomitant need for redress. They would wish, in exchange, for the process to be predictable, and to be free from the prosecution of stale claims for actions taken or omitted many years before. The general limitation period for a straightforward breach of trust is six years. The same period applies to a simple breach of contract and also to equitable compensation for breach of a skill and care duty. Where property is still in the possession of a trustee, there is no time limit to its recovery, only a potential bar through `laches` (excessive delay) applies. Similarly for property in possession of a bare trustee, though here laches cannot operate to defeat assertion of the claim.

All this is good sense, comprehensible and cohesive, but what is the position for equitable compensation for breach of fiduciary duty. The answer is that there isno limitation at all, though the possibility of a bar on the ground of laches is present.

An illustration of the effect of the main limitation principles as regards breach of fiduciary duty is given in a recent judgement of Harman J. In this case Gwembe’s director caused it to pay money to another company controlled by him over a number of years before the actions were discovered. On the issue of limitation it was held that the action to recover the money was not a claim to recover trust property, nor straightforward breach of trust (in which case the six year principle noted above would have applied). Instead, it was held that the claim was for breach of fiduciary duty as a director and not therefore barred under theLimitation Act 1980 at all. Laches, in this case, was not arguable. From this it followed that the limitation case against the company controlled by the errant director was that the latter was a constructive trustee still in possession of trust property. Accordingly no limitation bar precluded any claim against the company as well.

A trustee or fiduciary is exposed to an action for an `account`. The ambit of this is likely to be broader than that to which, for example, a contractual counterparty might be exposed Even though such an action for an account may not be brought after the expiration of any limitation period, which governed the relationship forming the basis of the duty to account, it has been suggested that the mechanism could be still be used for a potentially time barred account against a fiduciary, with a view to ascertaining whether any component of claim might not, in fact, be free from any limitation bar. While this possibility may not increase a fiduciary’s theoretical legal exposure, it is, again, likely to increase, in practice the likelihood of such an exposure being substantiated.

5 Remoteness; and
6 Causation
In contract and negligence litigation there are twin hurdles; oversimplifying, did the particular act of the defendant cause the particular loss to the claimant, and were the causes of the loss too `remotely connected` such as to justify exonerating the defendant from what would otherwise be legal consequences for his over-remote act? The theme underlying fiduciary cases suggests that, if these hurdles to recovery by a claimant exist at all, they are set at a much lower height.

Thus some fairly tangential lapse by the supposed fiduciary may have been followed by domino consequences, acts of other parties, and so forth, while still leaving the fiduciary on the hook for the total consequence and loss.

7 `Contribution`
This article is written for trust officers and those involved the financial field generally. It is a characteristic of this field, when things go wrong, that there is a lattice of parties all of whom have involvement in or knowledge of some facet of the lapse.

The party against whom the finger is pointed for breach of fiduciary duty may legitimately say `the brokers (or investment managers or administrators) and systems house (or regulators, auditors, directors or employees) of these or others knew about or facilitated these events. Therefore if we should be found responsible for the lapse there should be mechanisms by which these other parties are made to bear or share the redress`.

Doubts have been expressed whether a fiduciary is entitled to seek `contribution`. These doubts may have been allayed by a 1995 Court of Appeal case but the position is still unsatisfactory.

8 Contributory negligence
Where the claimant himself has been careless and has partly contributed to his own loss (traffic accidents being regular examples) the claimant’s recovery is reduced by the assessed component of his own contributory negligence. Even though there has been considerable assimilation of the consequences of a breach of the equitable duty of care to the tort of negligence (which it closely resembles) contributory negligence is not available to reduce the claimant’s recovery should breach of fiduciary duty be asserted, even though it may itself have been careless.

9 No relief
A disadvantage which a fiduciary suffers relative to an expressly appointed trustee is that, unlike a trustee, a fiduciary is not entitled to discretionary relief from the court where it has acted honestly and reasonably. This protection, frail as it is (since the courts appear consistently reluctant to grant relief) is unavailable to a fiduciary in a principal and agent context.

What this boils down to, therefore, is that fiduciarity exposes the fiduciary to four main areas of risk; a fresh stand-alone liability different from contract breach, negligence or trust breach; higher levels of redress to claimant; fewer defences; and fewer opportunities for sharing the blame/redress with the third parties and the claimant.

Who are fiduciaries?
It is accurate if unhelpful to say that a person is a fiduciary if the law characterises him as such, and the fiduciary obligations he owes are those which the law, in varying cases, imposes on persons categorised as fiduciary. Case law suggests the following are fiduciaries:-

Fiduciary Obligations owed to
Trustee Beneficiary
Guardian Ward
Solicitor Client
Principal Agent
Director Company
Promoter Company
Partner Partner
Doctor Patient
Priest Penitent

These are not fiduciaries:-

Manufacturer Distributor
Intending Joint Venturer Intending Joint Venturer

The underlying theme of fiduciarity is predicated on the loyalty expected of the fiduciary, and the vulnerability of the party to whom the duties are owed, this main theme is important since it should inform judicial thinking when faced with novel situations and the more extreme or creative assertions of claimants and the advisors.

Implications for corporate trustees and financial service sector
One needs to be very, very careful with over facile categorisation. Corporate trustee departments fulfil all sorts of functions which are broader than the trusteeship of conventional trusts. Businesses described as banks conduct an immensely broad range of activities, differing from each other immensely – and other players in the financial services field have a correspondingly broad, and diverse, range of activities, any of which might, despite the terminology applied, be categorised as fiduciary.

Trust- and financial-related services may expose the provider to fiduciarity under the trustee/beneficiary or principal/agent route of course. There appears to be no case law prescribing fiduciary duties in the ordinary course of a banking relationship but my warning holds good here since it is entirely understandable that such a position applies to the traditional view of a bank. A party that accepts deposits, makes loans and clears cheques is not an immediate candidate, in common sense terms, for the loyalty/vulnerability designation required in fiduciarity.

Commentators take the view that there may be occasions where these duties may be held to arise for a traditionally viewed bank. Fiduciary may occur, it has been argued, in these contexts, banks being more vulnerable where private customers are concerned:-

  • If the customer expects advice to be given, even where the contrary to the bank’s interests;
  • If advice is expected and the bank’s interest is represented to be formal or nominal;
  • If the bank, while it is expected to act in it’s own interest, has created the expectation that it will otherwise advise in the customer’s interest (e.g. on the wisdom of the customer’s borrowing);
  • If the bank advises or acts for two customers in their transactions with each other.

As I say, the breadth of activity in the financial services sector makes any case law derived categorisation dangerous. A contemporary example is the asserted practice of banks operating TESSAs (where for tax reasons the deposit has to remain untouched for a minimum period) of according to these deposits, some time after initial placement, a substantially lower rate of interest than that credited to comparable accounts outside the TESSA net. The issue is being addressed at Ombudsman level but what if it were litigated in court? Principal/agent describes the provider’s role as TESSA manager, and there is certainly a degree of `vulnerability` on the part of the depositing customer. Hence fiduciary duties may apply.

There may be a number of areas in financial services where the customer/counterparty’s property rights are secured to him through the trust (as a matter of property). Global securities custodianship, nominee work, PEP and ISA management spring to mind. I have argued elsewhere that the involvement of the trust in a property context may not be enough to render the entire relationship that of trustee and beneficiary. The provider will, though, be a fiduciary to the customer through the principal/agent route. So while fiduciarity will apply the consequences are likely to be administered with a much lighter hand by the courts, I suggest, and as has, indeed, been borne out in recent case law.

Main themes of fiduciary breach
Fiduciary status depends on the themes of vulnerability and loyalty. The fiduciary is required to disgorge unacceptable profits from the relationship, is not to put himself in a position where his duty and self-interest may conflict, and should not act for his own benefit or for the benefit of the third party. All of these principles, though, can be ameliorated or negatived.

The recent Mothew case contained an elaboration of these principles into three fiduciary duties in Millett L J’s classification. These are the `double employment` rule, the `actual conflict` rule and a duty of good faith.

The double employment rule prohibits a fiduciary from accepting potentially conflicting engagements without the informed consent of both principals. This is exemplified by the result that in considering the validity of transactions between such a fiduciary’s different principals, if only one of them has authorised double employment and knows that the other has not, then the authorising principal will not be able to resist action by the non-authorising principal to undo the transaction.

The `actual conflict` rule operates to prevent a fiduciary with duel engagements from continuing to act where an actual conflict between the duties he owes to the two principals arises, such that he cannot fulfil duties to one without breaching or omitting duties to the other. He his thus deprived of a defence at the suit of the second principal to the effect that compliance with the duties owed to that second would have entailed a breach of an obligation to the first.

The third duty, that of good faith, may be regarded as an operational exemplification of overriding loyalty within authorised conflicting engagements to two principals.

`Even if the fiduciary is properly acting for two principals with potentially conflicting interests he must act in good faith in the interests of each and must not act with the intention of furthering the interests of one principal to the prejudice of those of the other.`

Breach of this duty requires actual and intentional disloyalty and `the court will jealously scrutinise the facts to ensure that there has been nothing more than inadvertence, but there can be no justification for treating an unconscious failure as demonstrating a want of fidelity.`

With these in mind, the nightmares should be lifting from the shoulders of the reader. While the consequences of fiduciarity may be grave, and the status relatively easily acquired, the occasions when it will bite should be relatively few and, to that extent, reasonably containable in practice.

Duty to warn?
There may be an inchoate duty to warn or enquire.

This may be said to derive from the unsatisfactory Canadian case of Froese and was likely to have been litigated with custodians involved in the Maxwell events, but for settlement out of court. In Froese the employer established a pension scheme for employees. By separate contract it engaged Montreal Trust, the defendant, to perform functions limited to custody and administration, all other responsibilities for management and operation of the plan been reserved to the employer or devolved to an investment manager. Montreal Trust was exclusively excluded from any duty to collect contributions or police the solvency of the plan, and the plan documentation envisaged that the employer might from time to time take `contribution holidays` under which it made no contributions to the plan.

As it happened the company for some years made no, or inadequate, contributions to the plan. This was ultimately wound up in the manner directed by the plan documentation and certain, already awarded, pensions had to be reduced in view of the plan’s deficiency. The plaintiff whose pension had been thus reduced sued, not the employer, but Montreal Trust for failure to ensure the plan was fully funded, failure to warn plan members of the failure of the employer sufficiently to fund the plan, and securing reduced pensions without the consent of the plaintiff and knowing of his grievance.

It was held, Gibbs J A dissenting, that the trust company had breached the common law duty of care it owed beneficiaries within the scope of its engagement. It may possibly not be right to categorise Froese as a case of breach of fiduciary duty so much as a breach of a skill and care duty owed by a trustee or fiduciary, but nevertheless one hopes the case would be not be followed in other jurisdictions.

If a custodian or custodian trustee has to double check every executive act performed by the customer or managing trustees, the duplication and trouble caused by such a dyarchy would be chaotic. Indeed a duty to warn third parties sits thoroughly uneasily with the duties of loyalty and confidentiality required of an agent to his principal

Pointers from case law
The classes of fiduciary have not opened to include manufacturer/distributor or intending joint venturers.

Mere carelessness on the part of a solicitor (despite him being a fiduciary) is not breach of fiduciary duty when he has a single client. Southin J put it thus in 1987:-

`Counsel for the plaintiff spoke of this case in his opening as one of breach of fiduciary duty and negligence. It became clear during his opening that no breach of fiduciary duty is in issue. What is in issue is whether the defendant was negligent in advising on the settlement of a claim for injuries suffered in an accident. The word `fiduciary` is flung around now as if it applied to all breaches of duty by solicitors, directors of companies and so forth. But `fiduciary` comes from the Latin `fiducia` meaning `trust`. Thus the adjective, `fiduciary` means of or pertaining to a trustee or trusteeship. That a lawyer can commit a breach of the special duty of a trustee, e.g. by stealing his client’s money, by entering into a contract with the client without full disclosure, by sending a client a bill claiming disbursements never made and so forth is clear. But to say that simple carelessness in giving advice is such a breach is a perversion of words. The obligation of a solicitor of care and skill is the same obligation of any person who undertakes for reward to carryout a task. One would not assert of an engineer or physician who had given bad advice and from whom common law damages were sought that he was guilty of breach of fiduciary duty. Why should it be said of a solicitor? I make this point because an allegation of breach of fiduciary duty carries with it the stench of dishonesty – if not of deceit, then of constructive fraud. See Nocton v Lord Ashburton [1914] AC 932 (HL). Those who draft pleadings should be careful of words that carry such a connotation.`

These words were quoted and endorsed by Millett L J in Mothew and were also approved by L A Forrest J in LAC Minerals. The Judge added `not every claim arising out of a relationship with fiduciary incidents will give a rise to a claim for breach of fiduciary duty`. The Judge continued `it is only in relation to breaches of the specific obligations imposed because the relationship is one characterised as fiduciary that a claim for breach of fiduciary duty can be founded`.

The position of an estate agent with instructions from two different sellers, with a potential conflict was considered in 1993. The estate agent was engaged separately by two owners of adjacent properties to find buyers. The intending buyer of the first property sought to negotiate, through the estate agent, with the owner of the adjacent second property in order to buy that as well. The estate agent did not disclose that the enquirer was already treating for the adjacent property. It was held that since it was the business of estate agents to act for numerous principals, several of whom might be competing and whose interest would conflict, a term had to be implied in the contract that the agent was entitled to act for other principals selling similar properties, and to keep confidential information obtained from each principal. The extent of the agent’s fiduciary duty was determined by the contract of agency.

Since the property owner knew that the agent would be acting for other vendors of comparable properties and would receive confidential information from them, the contract of agency could not have included terms requiring the agent to disclose confidential information to the claimant property owner, or precluding the agent from acting for rival vendors. Nor did the agent’s financial interest in a rival sale (the commission) give rise to a breach of fiduciary duty. Even if a breach of fiduciary duty had been proved, the agent would not have lost his right to commission unless he had acted dishonestly. No bad faith had been alleged or found.

In 1994 the Supreme Court of Western Australia took up the baton in a case where the liquidator of a building society sued five of the society’s former directors in connection with a transaction in which two of those directors were financially interested in regard to the other contracting party. Ipp J, giving the judgement of the court, gave a full review of the development – and limitations – of fiduciary obligations, before finding that a company director who had merely been careless was not guilty of a breach of fiduciary duty.

Cases have arisen where a solicitor has two clients, and one of them takes proceedings on the ground of a supposed lapse, seeking redress on fiduciary grounds. In one case the headnote states:-

`that a claim for fiduciary duty could not be prayed in aid to enlarge the scope of contractual duties and since the defendants [solicitors] had not owed any contractual duty to advise the plaintiff on the wisdom of entering into the transaction, they could not owe any fiduciary duty to give such advice`.

In the late 1990s Building Societies sought to obtain increased financial redress for the consequences of their property lending decisions by taking proceeding against surveyors, whose valuations, or their contents, were asserted to have caused the lenders loss. Current UK practice tends to be that the lender insists that the property purchasing borrower engage a surveyor of the lender’s nomination or approval, who will make reports to both parties. Hence themes of double employment and conflict could be raised by the lenders against the surveyors. The lenders were are unsuccessful in this line of argument.

`Contracting out`, interrelationship of contractual and fiduciary duties
Since fiduciarity applies to many purely commercial situations it is clear that contractual and fiduciary relationships regularly co-exist.

`Indeed the existence of the basic contractual relationship has in many situations provided a foundation for the erection of a fiduciary relationship. In these situations, it is contractual foundation which is all important because it is the contract that regulates the basic rights and liabilities of the parties. The fiduciary relationship, if it is to exist at all, must accommodate itself to the terms of the contract so that it is consistent with, and conforms to them. The fiduciary relationship cannot be superimposed upon the contract in such a way as to alter the operation which the contract was intended to have according to its true construction`.

This is entirely logical and, indeed, since fiduciarity rests on loyalty/vulnerability one has some difficulty in discerning quite how vulnerable the country’s largest building society may be to small firms of surveyors, for example. Our Law Commission in 1994 took the same line:-

`…our provisional view was that, in general, no restriction operated as a matter of fiduciary law to prevent a fiduciary from contracting out of or modifying his fiduciary duties, particularly where no prior fiduciary relationship existed and the contract sought to define the duties of parties`

However, two years later an understandable and salutary caution was sounded in a later case, that while fiduciary duties must accommodate themselves to the contractual ones they are not subsumed within them since it was `the essence of a fiduciary relationship… that it creates obligations of a different character from those deriving from the contract itself`.

So, contracting out is certainly possible though regard should be had to the Unfair Contract Terms Act 1977. Financial services regulation in some cases, of course, positively requires client agreements for terms of business to be formulated, and may require disclosure of specific conflicts as they arise, or general statements of potential conflict in the relationship. It should not be assumed that disclosure, or terms, that fulfil any regulatory need fully block fiduciarity consequences, nor that the absence of imposition of a regulatory requirement exonerates the provider or frees him from the need for appropriate documentation disclosure.

Outside the mainstream financial services sector written terms of engagement may simply be absent (how many surveyors or insurance brokers issue these?) and, if available, may not be framed with an eye to negativing the consequences of fiduciarity.

So the first lesson is obviously that if one wishes to contract out, there ought to be written terms. Asserting that a practice is blindingly obvious or universally known commands little judicial sympathy if it cannot be substantiated or the claimant asserts with conviction that he was unaware of the practice.

Fiduciary placed in conflict by client
Three cases of the 1990s have demonstrated the principle that if trustees or executors have been placed in a position of conflict by their settlor or testator, then the normal trustee rules preventing them from profit or self-dealing necessarily do not apply.

This clearly is of additional help to fiduciaries providing services, on whom a lesser judicial burden ought in any event to be laid, and underscores the outcome already seen for fiduciary principal/agent cases. The context of appointment controls the ambit of fiduciary duties.

Duty definition, status explanation
So the key starting point for the engagement documentation of the fiduciary must be a clear description of the duties assumed and the status that the fiduciary sees himself occupying. It may be necessary in framing these to spell out precisely what duties the fiduciary does not regard himself as undertaking. This would avoid a potential Froese situation or the problem facing the estate agent selling adjacent houses.

The mere fact of describing what the fiduciary undertakes, and is not undertaking, ought to be of immense benefit. (Trust officers and practitioners are fully familiar with the current debate about the acceptability and scope of exoneration clauses for trustees in trust instruments. Much of the heat could be taken out of this debate if it was viewed as one of duty definition, rather than exculpation from wide ranging and ill-defined duties.)

It is asking for trouble to offer a checklist of items for consideration in documentation intended to contract out but the following may give food for thought.

  • Consent to offer services to other clients
  • Consent to promote other services etc. where directly or tangentially interested
  • Associated corporate finance advice to third parties
  • Soft commission, consent to brokerage/return commission etc.
  • House or proprietary trading
  • Items coming to knowledge of employee through other engagements/relationships
  • Consent to use delegates/nominees
  • Consent to engage on local market terms, or less stringent if there is diversity; all at fiduciary’s judgement.
  • Consent to profit as banker on deposit, lending, stock-lending, repos, pooled funds etc.
  • Consent to deal and profit as principal in foreign exchange transactions
  • Consent to disclosure of information on client through local, market, fiscal or regulatory requirements, all at business judgement of fiduciary (e.g. where estate agent considers there would be positive advantages to client in disclosure)
  • Consent to participate in settlement systems on their own terms, even though this carries exposure through inter-party netting, daylight exposure etc.
  • Consent to margining where derivative etc. trades
  • Consent to giving guarantees/indemnities in client’s name to facilitate client business
  • Negative expectation to advise or monitor (except as assumed)
  • Negative obligation to alert to change in tax treatment (except as assumed)
  • Underscore no duty to inquire or warn (except as assumed)

Summary

Fear stems from ignorance and I hope this article helps to shed light.

  • Many business activities undertaken in the financial services field may be characterised as fiduciary under English law.
  • This may extend to many activities conducted by a banking house even though the activity of banking, in its classical definition, does not involve a fiduciary relationship.
  • Fiduciary duties spring from the vulnerability attributed by the law to the client, and the imperative of loyalty exacted by the law on the fiduciary provider.
  • Such fiduciary duties embrace; `double employment`, `actual conflict` and duty of good faith. They may embrace no profit and confidentiality.
  • Breach of fiduciary duties entail consequences much more severe to the fiduciary than contractual or tortious breach.
  • Compensation/redress may be much greater and defences and limitation much less favourable.
  • Not every loss caused by the act or omission of a fiduciary gives rise to compensation for breach of fiduciary duty. Carelessness or inadvertence does not suffice, there has to be intention and disloyalty.
  • The contractual scope and context of the functions assumed by the fiduciary will govern, but not totally supplant fiduciary duties.
  • The rigour of each of the fiduciary duties may be neutralised or ameliorated through the contract itself, its context, informed consent, inferred or implied consent, or the position in which the customer has placed the provider/fiduciary.
  • Hence within reasonable bounds protection can be obtained through duty definition, status explanation and similar material in the contract itself.

Keith Wallace has practised trust law since 1965 and is with Richards Butler. He advises investment and pension managers, securities custodians and charities.