Is Your Board Carrying Out Its Fiduciary Duty?

By Bruce A. Cholst Esq.

One of the most distressing issues confronting board members is how to comply with their fiduciary duty to shareholders and unit owners. Although misconceptions abound as to the precise nature and scope of this obligation, a breach of the fiduciary duty could result in grave consequences for both the offending board member and the community which he or she represents. Perhaps the most widespread misconception is that fiduciary duty is related to the degree of competence or zeal with which board members perform their management responsibilities. For example, I have often heard it said that, The board has a fiduciary duty to operate on budget, or, As a board member, he has a fiduciary duty to regularly attend meetings. In fact, the fiduciary responsibility has nothing to do with board members' skill or fervor. Basically, a breach of the fiduciary duty to shareholders and unit owners occurs whenever a board member's abuse of such power results in harm to one or more of his constituents. 


Defining Fiduciary Duty

The essence of the fiduciary relationship is best described in a 1972 court decision which held that a franchisor owes a fiduciary duty to a franchisee:

...a fiduciary relationship is one founded on trust or confidence reposed by one person in the integrity and fidelity of another...the rule embraces both technical fiduciary relations (i.e. trustees, executors) and those informal relations which exist whenever one man trusts in and relies upon another...A fiduciary relation exists when confidence is reposed on one side and there is resulting superiority and influence on the other...

Thus, the placement of one's trust, confidence and responsibility in another person or persons is the hallmark of a fiduciary relationship. The investiture of such trust, confidence and responsibility in the fiduciary bestows upon him or her a position of influence and superiority over the person(s) with whom he deals. As such, he is charged with an extraordinary degree of moral accountability to these people. The scope of this moral accountability is most dramatically described by Judge Cardozo in the classic case of Meinhard v. Salmon:

A trustee (i.e. fiduciary) is held to something stricter than the morals of the marketplace. Not honesty alone but the punctilio of an honor the most sensitive is then the standard of behavior...

Consequences of a Breach of Duty

The consequences of a finding of breach of fiduciary duty can be severe. First, the offending board member will be held personally liable in money damages for all pecuniary losses sustained as a result of his misconduct. Such judgments (and the attendant legal fees) are rarely, if ever, covered by directors and officer's liability insurance. In addition, courts are not shy about assessing punitive damages against those board members who breach this most exacting of moral obligations. Finally, the Business Judgment Rule does not inoculate board action from judicial review when there has been a finding of breach of fiduciary duty. Thus, board action which may in fact be highly beneficial to the community is vulnerable to being struck down by a court when it is implemented in such a fashion that it breaches the fiduciary duty. These adverse consequences can readily be avoided with advance knowledge of the nature and scope of the fiduciary obligation and forethought by board members as to the implications of their conduct.

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