| Breach of Fiduciary Duty Litigation |
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Recent Cases and Practice Pointers Mark S. Werbner Sayles|Werbner, P.C. October 2008 Read Original Footnoted Version This paper approaches the subject of fiduciary duty litigation from a litigator’s perspective applying Texas law. Its focus is to examine the basic parameters of this cause of action, to explore some of the distinct and important procedural and substantive aspects of asserting and defending this claim, and to note, where applicable, significant or instructive recent opinions involving breach of fiduciary duty claims under Texas law. A. The Basics “A fiduciary duty is a formal, technical relationship of confidence and trust imposing greater duties upon a fiduciary as a matter of law.” “Generally speaking, it applies to any person who occupies a position of peculiar confidence towards another. It refers to integrity and fidelity. It contemplates fair dealing and good faith, rather than legal obligation, as the basis of the transaction.” In Texas, the elements of a breach of fiduciary duty claim are (1) the existence of a fiduciary relationship (either as a matter of law or as a matter of fact) between the plaintiff and the defendant; (2) defendant’s breach of the fiduciary duties accompanying the relationship; and (3) the breach of the duty that either injured the plaintiff or benefited the defendant. A fiduciary duty may arise formally, as a matter of law, or informally, through moral, social, domestic, or purely personal relationships of trust and confidence. Texas law recognizes certain relationships that give rise to fiduciary duties as a matter of law. These include: (a) attorney – client; (b) partners; (c) spouses; (d) agent/principal; (e) officers and directors to a corporation; (f) trustee of a trust; (g) employee to employer (in certain cases); and (h) executor of an estate to a beneficiary, among certain select others. In contrast, certain relationships have been deemed not to be fiduciary as a matter of law. These include insurer and third party claimant, lender and borrower, general contractor and subcontractor, and mortgagor-mortgagee, among others. The Texas Supreme Court has also embraced the concept that certain informal relationships may provide a basis for the imposition of fiduciary duties. Such “confidential relationships” may arise “where one person trusts in and relies upon another, whether the relation is a moral, social, domestic, or merely personal one.” However, it is axiomatic that not all relationships that involve a high level of trust and confidence can be characterized as fiduciary; instead, the law examines whether “influence has been acquired and abused . . . [and] confidence has been reposed and betrayed.” “Due to its extraordinary nature, the law does not recognize a fiduciary relationship lightly. Whether such a duty exists depends on the circumstances.” The Texas Supreme Court has announced repeatedly that, as a general rule, “while a fiduciary relationship or confidential relationship may arise from the circumstances of a particular case, to impose such a relationship in a business transaction, the relationship must exist prior to, and apart from the agreement made the basis of the suit.” Simply because one person trusts another and relies upon his promise to perform under a contract does not create a confidential or fiduciary relationship. Finally, the existence of an informal fiduciary relationship or confidential relationship is ordinarily a question of fact for the jury. However, when there is no evidence of a confidential relationship, the existence of a fiduciary duty is a question of law. The question of whether certain acts by the alleged fiduciary fall within the scope of the fiduciary duty may also be a question of fact for the jury. A fiduciary relationship may also be created and/or limited by contract. Moreover, the nature and scope of the particular duties owed can vary according to the facts of the case and the specific relationship at issue and must be specifically analyzed in every case. Texas law also recognizes a claim for aiding and abetting a breach of fiduciary duty, so that a third party who knowingly participates in the breach of duty of a fiduciary becomes a joint tortfeasor with the fiduciary and is liable as such, unless the third party had a legal right to do so.” B. Recent Texas Case Law Finding The Existence of A Confidential Relationship or “Informal” Fiduciary Duties More often than not, a party who asserts a claim for breach of fiduciary duty arising from an alleged informal or confidential relationship fails to overcome the high threshold required to assert such a claim. However, in at least three recent cases, Texas courts of appeals have found confidential relationships that supported the existence of fiduciary duties on specific case facts. These cases demonstrate the often extreme and case-specific facts that must exist in order to justify the imposition of an informal fiduciary relationship. In Gordon v. Gordon, 2006 WL 5961831 (Tex. App.—Beaumont, July 31, 2008, no pet.) (not designated for publication), the Beaumont court of appeals reversed the trial court’s take-nothing judgment on their breach of fiduciary claim on the ground that the trial court’s finding that no confidential or informal fiduciary relationship existed was “so against the great weight and preponderance of the evidence as to be wrong and manifestly unjust.” Specifically, husband and wife plaintiffs, Greg and Lisa Gordon, sued Greg’s brother, David Gordon, a corporate law attorney who had advised plaintiffs in connection with taking their jewelry business public, although the attorney-client relationship was never formalized. The evidence did not establish an arms-length business transaction; rather, it demonstrated that the brothers were close and had been business partners, that David Gordon had previously provided legal representation to plaintiffs and held a power of attorney on Greg Gordon’s behalf with regard to other legal representation, and was known and respected by plaintiffs as an attorney who successfully specialized in mergers and acquisitions. David Gordon had initiated the discussions with plaintiffs about taking plaintiffs’ company public, identified the opportunity, and represented that he would act as their attorney and prepare the documents needed for the transaction. Defendant also advised plaintiffs that they were only required to continue selling jewelry but, after the stock purchase agreement was signed and a public entity created by a reverse acquisition, defendant substituted plaintiff Greg Gordon as president and sole director of the public company and offered him no instruction regarding how to perform that position. Instead, the evidence showed that defendant was the de facto person running the public company. There was also evidence that David Gordon had given repeated assurances that he would protect plaintiffs’ interests and act as their attorney. After the reverse acquisition, defendant continued to advise plaintiffs regarding the SEC restrictions on the ability of insiders to sell stock in a public corporation on the open market and repeatedly counseled them against such sales to the point that plaintiffs never sold any stock before the corporation filed for bankruptcy. In Western Reserve Life Assurance Co. v. Graben, 233 S.W.3d 360, 373-74 (Tex. App.—Fort Worth 2007, no pet.), the Fort Worth Court of Appeals concluded that an informal fiduciary relationship existed where an individual (Hutton) began performing as a financial advisor to two clients who were not sophisticated investors and represented to them that he would monitor and manage their investments and make appropriate financial plans. The clients had specifically told Hutton that they depended upon him for his counsel, experience, and advice. Also, Hutton testified that the relationship he had with the clients was “a very sacred trust” and that he treated them “better than I would treat myself.” Also, an expert witness for certain brokers who also were sued testified that “someone who represents themselves as an investor advisor [like Hutton did] has a heightened responsibility to review the account and act as a fiduciary.” Importantly, on the specific facts of this case, the court of appeals rejected the broker-defendants’ argument that a fiduciary relationship must have existed prior to, and apart from, the agreement made the basis of the suit. Finally, in Lee v. Hasson, 2007 WL 236899 (Tex. App.—Houston [14th Dist.] January 30, 2007, pet. denied), the Fourteenth Court of Appeals in Houston found sufficient evidence of a confidential relationship to support the imposition of fiduciary duties. There, a financial advisor had a long-standing personal relationship with the client, they had vacationed together, and the client had relied upon him for support and advice during the client’s divorce. C. Procedural Aspects of Fiduciary Duty Claims Parties litigating breach of fiduciary duty claims must develop their cases with the awareness of the special presumptions that may apply in certain instances to this claim. Specifically, Texas courts apply a rebuttable presumption of unfairness to transactions between a fiduciary and a party to whom he owes a duty of disclosure. Therefore, the profiting fiduciary bears the burden of rebutting the presumption and of showing the fairness of the transactions. Also, a claim that a fiduciary has breached its duty against self-dealing likewise raises a presumption of unfairness. To rebut the presumption, the fiduciary must show that the transaction at issue was made (a) in good faith, (b) for fair consideration, and (c) after a full and complete disclosure of all material information to the principal.” Breach of fiduciary duty claims also are distinguished from certain other tort claims because they are governed by a four-year statute of limitations. The discovery rule frequently applies to breach of fiduciary duty claims, so that the four-year limitations period begins to run when the claimant knew or should have known of facts that in the exercise of reasonable diligence would have discovered the wrongful act. In the recent case of Kerlin v. Sauceda, ___, S.W.3d ___, 2008 WL 3991036, at * 7 (Tex. Aug. 29, 2008), a case involving a breach of fiduciary claim (among others) arising out of the sale of oil and gas royalties and other interests, the Texas Supreme Court reversed the court of appeals decision in plaintiffs’ favor and rendered judgment for defendant Kerlin on the ground that plaintiffs’ claims were barred by the four-year statute of limitations. In so doing, the Court rejected plaintiffs’ claim that the jury’s fraudulent concealment findings precluded the applicability of the limitation statute because plaintiffs could have discovered Kerlin’s wrongful conduct through the exercise of reasonable diligence. Attorneys should remain mindful of the generous four-year limitations defense that attaches to breach of fiduciary duty claims and that establishing fraudulent concealment can operate as a basis for tolling the statute. D. Damages Issues Texas law affords a broad range of remedies to plaintiffs who successfully establish a breach of fiduciary duty. A plaintiff can recover actual damages, including out-of-pocket damages and lost profits. However, it is significant that a party need not show actual damages in order to prevail on its breach of fiduciary duty claim. Instead, a party can prevail on its breach of fiduciary duty claims either by showing that it was damaged by the breach or that the fiduciary benefited therefrom. In addition, exemplary damages are available for a breach of fiduciary claim if the factfinder concludes that breach was intentional. Some courts have observed that “[t]he ‘intent’ issue concerning exemplary damages for breach of fiduciary duty is whether the one with a fiduciary duty intended to gain an additional unintended benefit.” This standard differs from the more stringent and commonly-applied rule that punitive damages are not warranted unless the defendant acted willfully, maliciously, or fraudulently. The Texarkana court of appeals has explained: A defendant’s intentional breach of fiduciary duty is a tort for which a plaintiff may recover punitive damages. While it is a general rule that Texas courts allow the recovery of punitive damages where the defendant, in committing a tort, acted willfully, maliciously, or fraudulently, where punitive damages are awarded for breach of fiduciary duty the actual motives of the defendant and whether the defendant acted with malice are immaterial. But something more than a simple breach is required for the recovery of punitive damages; the acts constituting the breach must have been fraudulent, or at least intentional. An intentional breach may be found where the fiduciary intends to gain an additional benefit for himself. Exemplary damages are warranted if the fiduciary engaged in self-dealing. Moreover, in certain cases, the recovery of actual damages may not be required to support an award of punitive damages. Recently, the Fifth Circuit Court of Appeals explored the applicability of the “one satisfaction rule” to punitive damages awarded for a breach of fiduciary duty claim. In Advocare International, LP v. Horizon Laboratories, Inc., the jury awarded plaintiff $3 million on his breach of fiduciary claim (less $320,799 awarded to defendants for indemnity), $6,312,132 from one defendant for profits wrongly obtained, $2 million in exemplary damages, plus prejudgment and postjudgment interest. The jury entered two punitive damage awards – one for fraud and one for breach of fiduciary duty. The Fifth Circuit, applying Texas law, reversed the award of punitive damages on the fraud claim on the ground that Texas’s “one satisfaction rule” applied. In so doing, the Court clarified that, despite its prior statement in Ratner v. Sioux Natural Gas Corp., 719 F.2d 801, 804 (5th Cir. 1983) “‘the rationale of the ‘one satisfaction’ rule is usually inapposite to punitive damages’, the rule does not stand for the proposition that one theory of liability can support several punitive damages awards.” Texas law also embraces an array of equitable remedies that may be awarded for breaches of fiduciary duties. For example, the imposition of a constructive trust is one significant remedy that is available. A constructive trust is an equitable remedy employed against a fiduciary who, in breach of the fiduciary relationship, obtained legal title to the property of the person to whom the fiduciary duty was owed. “A party seeking to impose a constructive trust has the initial burden of tracing funds to the specific property sought to be recovered.” “Once that burden is met ‘the entire . . . property will be treated as subject to the [constructive] trust, except insofar as the trustee may be able to distinguish and separate that which is his own.’” The remedy of fee forfeiture also is available. Importantly, a plaintiff who establishes a breach of fiduciary duty by his or her attorney need not prove that the breach caused actual damages in order to obtain forfeiture of some or all of the compensation paid to the fiduciary. Practitioners should bear in mind that the Fourteenth Court of Appeals requires a party who seeks the equitable relief to expressly plead it. As such, it seems prudent to follow this practice in all Texas courts. Also, it bears mention that the availability and scope of fee forfeiture depends on the facts of each case and is available only for clear and serious violations of fiduciary duty. Profit disgorgement is another equitable remedy that may be available. E. Diligence Regarding Jury Instructions and Preservation of Error Several recent cases involving breach of fiduciary duty claims teach a cautionary tale about the importance of exercising diligence in crafting jury instructions and in preserving error. Wilz v. Flournoy, 228 S.W.3d 674 (Tex. 2007), involved a suit by a former wife on behalf of her incapacitated son to impose a constructive trust on certain property purchased by her ex-husband and his new wife, including a 110-acre farm that they had purchased. The jury found in plaintiff’s favor on all counts and imposed a constructive trust on the entire farm. The Texas Supreme Court affirmed the conclusion that the trust should encompass the whole farm because defendants failed to demonstrate the specific portion of the farm’s purchase price that came from funds independent of the son’s. Defendants’ fatal mistake on this issue was in failing to obtain a jury finding on their affirmative claim that part of the purchase money came from their personal funds. Therefore, in the absence of conclusive evidence to the contrary (which did not exist), defendants’ complaint about the scope of the constructive trust was waived on appeal. The recent case of Lundy v. Masson, decided earlier this year by the Fourteenth Court of Appeals, also teaches caution about the importance of proper jury instructions in fiduciary breach cases. In Lundy, the jury found in favor of the plaintiff on his informal fiduciary relationship claim. The defendant challenged the jury verdict on appeal and urged that the verdict in plaintiff’s favor could not stand because there was no evidence of a prior confidential relationship between the parties. The court of appeals limited its review to determine the legal sufficiency of the evidence. The jury charge asked: “Did a relationship of trust and confidence exist between [the parties]?” and provided an instruction. However, the question did not include an instruction that the relationship had to exist prior to, and separate from, the agreement made the basis of the suit. Also, Lundy did not tender to the trial court an alternative written instruction informing the jury that a prior and separate relationship is required or otherwise object to the omission of such an instruction. Therefore, Lundy failed to preserve his argument that there must be evidence of a prior and existing relationship. Lundy also offered no argument or analysis explaining why the evidence of the parties’ relationship and interactions is insufficient to give rise to an informal fiduciary relationship and, therefore, waived this issue on appeal. Finally, like the defendants in Lundy, the defendants in Western Reserve Life Assurance Co. v. Graben also failed to tender to the trial court an alternative written instruction containing an instruction to the jury that a prior and separate relationship is required and, therefore, failed to preserve this argument. F. Fiduciary Duty Issues Relating to Closely Held Corporations An issue that arises with notable frequency is whether controlling shareholders of a closely-held corporation owe fiduciary duties to minority shareholders individually. Some Texas courts have recognized that, “in certain limited circumstances, a majority shareholder who dominates control over the business may owe such a duty to a minority shareholder.” The Texas Supreme Court touched upon this issue in 2006 in Willis v. Donnelly, wherein it analyzed the lower courts’ decisions upholding the imposition of a fiduciary duty on a corporation’s controlling shareholder with respect to Donnelly, who had contracted with the corporation and who was to receive a minority stake in it. The Texas Supreme Court observed: A host of legal questions are raised by this claim, including the issues of (1) whether a majority shareholder in a closely held corporation owes a minority shareholder a general fiduciary duty under Texas law, (2) whether a distinction must be drawn between breach of a duty owed to minority shareholder qua shareholder and malfeasance by a majority shareholder, such as usurpation of a corporate opportunity, that would only give rise to a shareholder derivative action on behalf of the corporation, (3) whether on this record, assuming the existence of a fiduciary duty, any of the alleged wrongful conduct by the [fiduciaries], such as the act of loaning money to the corporation rather than simply giving cash to the corporation as a capital contribution, amounted to a breach if fiduciary duty under Texas law . . .. Ultimately, the Court did not resolve these issues because the alleged breaches of fiduciary duty occurred before Donnelly became a shareholder and before he was entitled to shareholder status; that is, before any fiduciary duties arose. Therefore, on the specific case record, Donnelly’s breach of fiduciary claim failed as a matter of law. The Court considered its holding to be “consistent with the general reluctance of Texas law . . . to ignore corporate formalities and hold an individual defendant liable where the plaintiff has agreed to conduct business with a corporation . . . [and] also consistent with our . . . reluctance to recognize fiduciary relationships, especially in the corporate context.” Breach of fiduciary duty claims brought by minority shareholders individually against majority shareholders stand in contrast to the more typical scenario in which the majority’s alleged breaches of fiduciary duty are remedied through a more procedurally complex derivative suit rather than an individual action. G. The Tension Between Legal Malpractice Claims and Breach of Fiduciary Duty Claims Under Texas Law Not surprisingly, breach of fiduciary duty claims often arise in the context of legal malpractice actions. Texas courts generally apply the principle that claims arising out of poor legal advice or representation sound in negligence. The general rule is that plaintiffs cannot “fracture” legal malpractice claims into other causes of action, including breach of fiduciary duty claims. Therefore, if the fiduciary duty claim stems from the same set of facts as the legal malpractice claim, then the malpractice claim encompasses the fiduciary duty claim and the latter cannot be asserted independently. Whether a plaintiff’s allegations assert an independent claim for breach of fiduciary duty is a question of law for the Court. This issue is of great practical significance because a two-year statute of limitations applies to claims for legal malpractice, whereas a four-year statute applies to breach of fiduciary duty claims. In 2007, the Dallas Court of Appeals examined the confusion that often surrounds the relationship between legal malpractice claims and breach of fiduciary duty claims and conducted an informative analysis that should assist lawyers applying Texas law in determining whether an independent claim for breach of fiduciary duty can be asserted. In Murphy v. Gruber, certain clients sued former lawyers who represented them in the litigation and settlement of an action arising out of the sale of partnership interests and assets back to a franchisor. Plaintiffs alleged that the lawyers represented them with divided loyalties, failed to inform them of material facts as soon as conflict arose, and failed to make a full and fair disclosure of every aspect of the settlement of the underlying case. The plaintiffs sought fee forfeiture and the imposition of a constructive trust. The trial court granted summary judgment in defendants’ favor on the breach of fiduciary duty claim on the ground that it was an impermissible fracturing of a legal malpractice claim and, as such, was barred by the applicable two-year statute of limitations. On appeal, the court examined the distinctions between negligence, breach of fiduciary duty, and fraud claims against lawyers and noted that “Texas courts do not allow plaintiffs to convert what are really negligence claims into claims for fraud, breach of contract, breach of fiduciary duty, or violation of the DTPA.” The Murphy court observed, however, that “[c]ourts in this state have reached different results in deciding whether a conflict-of-interest allegation against a lawyer gives rise to a claim for professional negligence or some other cause of action.” The court opined about this lack of clarity in this area of the law, stating: Some of [the confusion] may be attributable to the fact that the relationship between the lawyer and the client is inherently a fiduciary relationship. In non-lawyer cases in which there is a fiduciary relationship, many of the claims against the fiduciary are labeled breach-of-fiduciary-duty claims. However, with lawyers, the standard of care in negligence claims is often defined by the characteristics of that inherent fiduciary relationship. As a result, courts refer to the fiduciary relationship that the lawyer has to the client and use fiduciary standards to define the standard of care required of lawyers. See, e.g., Two Thirty Nine Joint Venture v. Joe, 60 S.W.3d 896, 905 (Tex. App.—Dallas 2001), rev’d on other grounds, 145 S.W.3d 150 (Tex. 2004). And courts have most often applied those standards to conclude that the claims are really negligence, not breach-of-fiduciary-duty claims. The Murphy court examined the substance of the claims asserted in the petition to determine whether they constituted breach of fiduciary duty claims or professional negligence claims and, hence, what statute of limitations applied. The remedy sought was but one relevant factor to consider. After a lengthy analysis, the court determined that the allegations centered primarily on the quality of the attorney’s representation and, therefore, sounded only in negligence. Though the plaintiffs did allege self-dealing, they did not allege that the attorneys “deceived them, pursued their own pecuniary interests over the [clients’] interests, or obtained any improper benefit by continuing to represent both clients.” Finally, plaintiffs’ claim that the lawyers “chos[e] their own interest in obtaining a multimillion dollar fee in the Howell case,” to plaintiffs’ detriment did not, absent more, allege the type of dishonesty or intentional deception to support a breach-of-fiduciary-duty claim. The Dallas court of appeals recently followed the teachings of Murphy in West v. Hubble, 2008 WL 2941854, at *1 (Tex. App.—Dallas, August 1, 2008, no pet. h.) (not designated for publication) and affirmed summary judgment for defendants on the breach of fiduciary duty claims because the allegations supported only a claim for professional negligence. The detailed analysis in Murphy offers a valuable roadmap for the analysis of whether certain facts give rise to an independent claim for breach of fiduciary duty and whether a plaintiff’s allegations attempt to impermissibly fracture a legal malpractice claim. Importantly, in the recent case of Trousdale v. Henry, the Houston court of appeals held that the facts supported the conclusion of a fiduciary duty breach separate and apart from a legal malpractice claim. In Trousdale, a former client sued her attorneys and their law firm for breach of fiduciary duty and legal malpractice arising out of defendants’ representation of her father’s estate and her in two other lawsuits. The trial court granted summary judgment on plaintiff’s legal malpractice claim on limitations grounds and also applied a two-year statute of limitations to her breach of fiduciary duty claim because it considered the breach of fiduciary claim to violate the “non-fracturing” rule. On appeal, plaintiff urged that she successfully alleged an independent claim for breach of fiduciary duty because the attorneys misrepresented the status of the probate action and the reason her file could not be returned to her, while they (1) knew and failed to disclose that her cases had been dismissed for want of prosecution; (2) continued to bill and collect fees from her; and (3) refused to return her file. The court of appeals agreed that plaintiff’s allegations went beyond “mere negligence” but, instead, “involve[d] allegations of deception and misrepresentations committed by appellees while they represented [her] and while they still owed her duties. The court of appeals determined that plaintiff’s cause of action, properly considered as a breach of fiduciary duty claim, was not barred by limitations and reversed the summary judgment against plaintiff on this claim. However, the Trousdale defendants have indicated their intent to appeal this decision by obtaining an extension of time to file a petition for review in the Texas Supreme Court. Whether the Texas Supreme Court disturbs the court of appeals’ analysis and conclusion regarding the separate existence of a breach of fiduciary duty claim remains to be seen. H. Conclusion The unique aspects of a breach of fiduciary duty claim under Texas law create numerous important issues for attorneys to analyze and consider in litigating this cause of action. As discussed herein, the existence, nature, and scope of the fiduciary duty at issue can be a significant hurdle to overcome. And, while Texas courts are generally disinclined to impose fiduciary duties on relationships that are not deemed to be fiduciary as a matter of law, recent case law demonstrates that courts will impose such duties if warranted by the facts. The net result is that litigating a breach of fiduciary duty claim in Texas can be intensely fact-specific, thereby making it imperative that the attorneys involved develop their cases fully and completely and have a close familiarity with decided case law. Attorneys must also ensure that they exercise great diligence in crafting jury instructions and in preserving error. Breach of fiduciary duty claims are also remarkable because they can be subject to damages standards, presumptions in the burden of proof, equitable remedies, and a limitations defense not often seen with more common tort claims. Attorneys must also exercise vigilance in noting and applying these often pro-plaintiff standards. Finally, in light of the recent volatile and uncertain economic conditions and the spate of failed businesses that is likely to increase, we can expect to see breach of fiduciary duty claims asserted with greater frequency and, quite probably, against an ever-widening circle of alleged fiduciaries. |