Fiduciary duty of participants in corporate relations: concept and examples

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

Fiduciary rights and obligations are very confusing. The courts impose appropriate obligations on participants in various relationships: between an employee and an employer, a doctor and a patient, a manager and a beneficiary, a lawyer and a client, and so on. At the same time, fiduciaries are required to follow a general obligation, which at the same time differs in many variations in each specific case. In addition, the courts impose ad hoc obligations in those legal relations where one person trusts another, as a result of which he is exposed to damage. In the article we will consider the concept of fiduciary responsibility, the formation of this institution in the United States and the Russian experience.

Concept

A fiduciary duty is a duty to refrain from acting for one's own benefit with respect to a beneficiary's asset in the exercise of authority. Care and diligencemanifested in this case is not inherently fiduciary, as it may appear in other legal relations.

A fiduciary duty is a mechanism that provides protection in those situations in which the exercise of discretionary action by one person must be controlled due to a specific legal relationship with another person. Many lawyers believe that these relationships are characterized by the unlimited powers of the fiduciary and the inability to control his actions by the beneficiary.

The reason for this lies in the fact that the beneficiary has neither the knowledge nor the proper qualifications to understand the situation. Therefore, there is a mechanism for compensation through judicial control.

Fiduciary Relations in the US

Let's look at how fiduciary relations have developed in the US. Initially, they were based on the fact that the fiduciary waives his own interests and performs activities only in the interests of the beneficiary. The standard of excellence in the performance of fiduciary duties was used in the Meinhard Salmon case, where the judge interpreted the relevant relationship as a moral imperative. The case concerned a joint venture. It strongly influenced the subsequent development of duties also within closed corporations.

Meinhard-Salmon case

The judge used the fiduciary principle in the broadest sense, saying that the partners of a joint venture are comrades and, by implementing business together, are obliged to each otherbefore a friend by displaying the highest devotion. Much that is normally allowed in contractual relationships is prohibited for persons who have fiduciary duties. Along with honesty, their behavior should be characterized by respect for each other.

Donack Case

Ethical norms of conduct also played a more important role in later cases of closed corporations than declared legal standards and rules. For example, in the Donak case, the court recognized that the participants have in fact the same fiduciary duties as partners in a joint venture (partnership). They are expressed in devotion and conscientiousness in the highest manifestation of these qualities. That is, shareholders are not en titled to act solely for their own benefit. This violates the principles of loy alty towards other shareholders, as well as corporations. The court noted that due to the inability of minority shareholders to sell shares, majority shareholders can easily use this provision. Thus, in a closed corporation, this situation encourages majority shareholders to abuse their rights and obligations.

Vykes Springside Nursing Home Inc. Case

The way in which the fiduciary duties of participants in corporate relations were violated is stated in the case of Vikes Springside Nursing Home, Inc., where, in fact, the second degree of development of the relevant legal relations is expressed.

In this case, hadplace of conflict of interest. As determined by the court, the obligations of fiduciaries depend on the ability of the controlling participant to demonstrate the purpose of their actions as to whether they are in the interests of the company or not. Where possible, there is a presumption that the contested act does not violate the assigned obligations. The exception is cases in which minority shareholders manage to prove that the goal could be achieved in a different way, less infringing on their interests. Since the majority shareholders failed to demonstrate a business purpose in the Vikes case, the court found a breach of their duties, which was followed by fiduciary liability.

Case "Smith v. Atlantic Properties Inc."

Another significant case was called Smith v. Atlantic Properties, Inc.. In it, the court considered that the behavior of the controlling shareholder was justified as long as he had a more compelling reason for the relevant behavior compared to the non-controlling shareholder. In this case, the provision was finally approved that fiduciary duties will not be considered violated if reasonable and justified grounds for violating the rights of minority shareholders are presented.

Pragmatic approach

Further there was a departure from the standard of loy alty and good faith that was voiced in the Donak case, and the adoption of a more pragmatic approach, which allowed for the interested behavior of the controlling shareholder. He was forbidden only to causeharm to minority shareholders intentionally.

At the same time, the courts ruled that controlling shareholders violated their obligations only if they abused their powers, and also excluded minority shareholders from participating in profits in an intentional way. Although the courts also called the actions of the controlling shareholders a violation of their obligations, in reality this was a deliberate tort, the purpose of which was to oust minority shareholders. As a result of this practice, the original essence of the concept was lost.

Case "Zidel v. Zidel"

Relevant rhetoric was especially evident in the Zidel v. Zidel case. The court pointed out that the duty is to restore the violated right, and not to reconcile the respective business interests. Therefore, if fraud, bad faith, violation of fiduciary duties and other illegal acts are not recorded, then this means that there are no reasons to go to court.

After that, the courts began to demand evidence from the shareholder - a minority shareholder, that the majority shareholder violated the rights not once, but several times. As a result, the tort of displacement began to develop.

Displacement

This theory is detailed in the Sugerman v. Sugerman case. The court concluded that the minority shareholder had to prove the fact that the majority shareholders used several mechanisms, as a result of which the minority shareholder was excluded from the distribution of profits in the form of dividends or salaries. Thus, it had to be shown that the offer to sell the block of shares at a reduced cost wasculminating in the ousting of a minority shareholder. The corresponding actions should have been unprofitable for the minority shareholder, the violation of the majority shareholder should have been intentional, and the deprivation of income should have been intentional.

It turns out that if earlier the courts were indifferent to the categories of guilt and violation of the law, then at this stage they began to allow the possibility of actions of a fiduciary manager in their own interests. Moreover, such actions were no longer illegal.

Fiduciary duties in Russia

In our country, this institution was formed recently. It is expressed in the obligation of the participants to act conscientiously and reasonably. There are fiduciary duties of the board of directors under Russian law, as well as persons who can actually direct corporate actions.

For example, in the case of UralSnabKomplekt, controlling persons were held liable due to the fact that they exercised control over the actions of a legal entity. At the same time, the duties of the director were only to make such decisions that are beneficial to the beneficiaries.

The fact that the expression “in good faith and reasonable” is not indivisible phraseological units (as was previously supposed in the courts), the Presidium of the Supreme Arbitration Court of the Russian Federation explained only in 2012 in the case of the Kirov Plant. The court ruling says that these terms have their own separate meaning.

Based on the existing judicial practice today, we can say that Russian law has only begun to turn to fiduciary duties. And thereforejurisprudence has not yet fully developed. However, general trends are still outlined.

Conclusion

Despite the small judicial practice in our country, it is possible to single out certain features inherent in fiduciary duties, namely:

• They can be used by participants in the turnover in order to determine the standard of behavior for a participant in corporate legal relations in the event that the law does not provide for a specific rule.
• The basic principle is that the corporate interest takes precedence over the interests of individual participants. Therefore, the corresponding duties are to take active actions in the corporate interests and not harm the company.
• Unlike the fiduciary duties of the director of an LLC or a company of a different organizational and legal form, the duties of a minority shareholder do not include the performance of active actions. But he can block the corporation's decision. If it is contrary to corporate interests, there is a breach of fiduciary duty.
• Relevant duties can be directed to a third party if it can influence the decision-making of the corporation, thereby abusing them. The third party must put corporate interests ahead of their own.

As you can see, the understanding of fiduciary duties by the courts in Russia differs significantly from what has developed in the United States, although this practice has existed recently.