March 2019 Update
The elements of a cause of action for breach of fiduciary duty are (1) the existence of a fiduciary duty, (2) breach of the fiduciary duty, and (3) damage proximately caused by the breach. Broadway Victoria, LLC v Norminton, Wiita & Fuster (2017) 10 CA5th 1185, 1192. See also Knutson v Foster (2018) 25 CA5th 1075, 1094; see §8.4. A breach of fiduciary duty may involve either negligence or fraud, depending on the circumstances. Tribeca Cos., LLC v First Am. Title Ins. Co. (2015) 239 CA4th 1088, 1114. The issue of causation will be treated differently in cases involving a negligent breach of fiduciary duty as distinct from cases involving an intentional breach of fiduciary duty. Knutson v Foster, 25 CA5th at 1094. See §1.5.
Shareholders in a duly formed corporation operating in accordance with legal requirements do not become de facto partners simply because they earn the same salary and refer to each other for convenience as partners. Eng v Brown (2018) 21 CA5th 675, 697. If partners properly change their form of business from a partnership to another type of legal entity, the partner’s fiduciary duties as partner generally terminate. Thus, in Eng v Brown, supra, the court held that, in the absence of a preincorporation agreement or evidence that the corporate form was disregarded after a partnership was incorporated, the rights and obligations that partners can enforce against each other no longer existed. See §2.7.
In Colaco v Cavotec SA (2018) 25 CA5th 1172, the court considered a conflict between the internal affairs doctrine and a California choice-of-law provision. The case presented a conflict concerning the remedies for breach of fiduciary duty, but not the extent of the duty. In that context, the court held that applying Delaware law based on the internal affairs doctrine would undermine the certainty and predictability the parties sought by including a California choice-of-law provision in their agreement. See §§3.53, 4.4.
In Bushansky v Soon-Shiong (2018) 23 CA5th 1000, the California Court of Appeal affirmed the dismissal of a shareholder derivative action based on forum non conveniens because the Delaware certificate of incorporation contained an exclusive forum selection clause. The action alleged breaches of fiduciary duty by the corporation’s directors. See §4.4.
In Baier v Upper N.Y. Inv. Co. (Del Ch, Apr. 16, 2018, No. 6896-VCS) 2018 Del Ch Lexis 122, at *19, the Delaware Court of Chancery held that “mere formation of a Delaware entity, without more, is insufficient for this Court to exercise jurisdiction.” See §4.6.
As the Delaware Chancery Court explained in In re PLX Tech. Stockholders Litig. (Del Ch, Oct. 16, 2018, No. 9880–VCL) 2018 Del Ch Lexis 336, at *65, directors’ fiduciary duties have “context-specific manifestations.” For example, in a sale of the corporation, the directors have a duty to seek a transaction offering the best value reasonably available for the shareholders. See §4.50. And any time the directors are seeking shareholder approval of an action, the directors have a duty to disclose all facts that are material to the shareholders’ decision. See §4.7.
At common law, directors and officers owed a duty of loyalty to their corporation to act in good faith, with fair dealing, and in the best interests of the corporation. This standard has been codified in California in Corp C §309(a). See §4.8. Delaware has no comparable provision in its statute, but, as discussed in §4.32, its case law creates a duty of loyalty similar to California’s duty of loyalty. See, e.g., CertiSign Holding, Inc. v Kulikovsky (Del Ch, June 7, 2018, No. 12055-VCS) 2018 Del Ch Lexis 185, at *37. See §4.9.
In Delaware, a director’s obligation to act in good faith “does not establish an independent fiduciary duty that stands on the same footing as the duties of care and loyalty,” although a failure to act in good faith may indirectly result in liability. Stone v Ritter (Del 2006) 911 A2d 362, 370; In re PLX Tech. Stockholders Litig. ( Del Ch, Oct. 16, 2018, No. 9880-VCL) 2018 Del Ch Lexis 336, at *64 (“good faith … is ‘a subsidiary element, i.e., a condition, of the fundamental duty of loyalty.’”). See §4.10.
The business judgment rule may also be used to evaluate a merger proposed by a controlling shareholder provided that, before the start of negotiations, the merger has been approved by an independent special committee and disinterested stockholders. Kahn v M & F Worldwide Corp. (Del 2014) 88 A3d 635. It is critical that the approvals be obtained “early in the process and before there has been any economic horse trading.” Flood v Synutra Int’l, Inc. (Del, Oct. 9, 2018, No. 101, 2018) 2018 Del Lexis 460, at *2. See §4.31.
The “entire fairness” test is used if the directors had actual conflicts of interest and, as a result, the challenged decision was not made by a disinterested and independent board majority. See Cede & Co. v Technicolor, Inc. (Del 1993) 634 A2d 345, 361; In re Hansen Med., Inc. Stockholders Litig. (Del Ch, June 18, 2018, No. 12316-VCMR) 2018 Del Ch Lexis 197, *14 (self-dealing by controlling stockholder). See also In re PLX Tech. Stockholders Litig. (Del Ch, Oct. 16, 2018, No. 9880–VCL) 2018 Del. Ch. Lexis 336, at *66 (detailed review of the three standards). See §4.31.
In Central Laborers’ Pension Fund v McAfee, Inc. (2017) 17 CA5th 292, applying Delaware law, the California Court of Appeal reviewed the three standards of judicial review in depth, concluding that the enhanced scrutiny standard of review, rather than the entire fairness standard, applied to a corporate board’s approval of a merger because the record did not support allegations that the president had concealed from the independent directors either an interest in continued employment with the acquiring company or information justifying a higher price. See §4.31.
Delaware courts adhere to the standard of materiality expressed in TSC Indus., Inc. v Northway, Inc. (1976) 426 US 438, 449, consistent with the federal securities laws. Morrision v Berry (Del 2018) 191 A3d 268, 282; see §4.43.
Corwin v KKR Fin. Holdings LLC (Del 2015) 125 A3d 304 involved a merger between entities that were related, although the acquirer did not control the target. The Delaware Supreme Court held that the business judgment rule was the appropriate standard of review because the transaction had been approved by a fully informed, uncoerced vote of disinterested stockholders as well as an independent board of directors. This principle, which has become known as the Corwin doctrine, holds that such a disinterested stockholder vote can operate to “cleanse” an alleged breach of fiduciary duty, provided that the vote is fully informed and uncoerced. In Morrision v Berry (Del 2018) 191 A3d 268, 272, the court emphasized that “partial and elliptical disclosures cannot facilitate the protection of the business judgment rule under the Corwin doctrine.” See §§4.44, 4.53.
Under Delaware law, controlling stockholders owe fiduciary duties to the corporation. See Hollinger Int’l, Inc. v Black (Del 2004) 844 A2d 1022, 1087, aff’d Black v Hollinger Int’l, Inc. (Del 2005) 872 A2d 559; Basho Techs. Holdco B, LLC v Georgetown Basho Investors, LLC (Del Ch, July 6, 2018, No. 11802-VCL) 2018 Del Ch Lexis 222, *59. In Delaware, there are two ways a shareholder can be considered a controller: (1) if the shareholder owns more than 50 percent of the voting power of the corporation, or (2) if the shareholder owns less than 50 percent but exercises actual control over the corporation’s business affairs. In re Hansen Med., Inc. Stockholders Litig. (Del Ch, June 18, 2018, No. 12316-VCMR) 2018 Del Ch Lexis 197, at *15. See §4.57A.
The Tax Cuts and Jobs Act (HR 1) (Pub L 115–97, 131 Stat 2054) added a new exception to the excess business holdings rules for independently operated philanthropic business holdings. IRC §4943(g). See §5.3.
A lower standard of care appears to be applicable to spousal fiduciary relationships by operation of the reference in Fam C §721 to Corp C §16404—the same standard of due care applicable to general partners (see §2.31). By reference in Fam C §721(b), Corp C §16404(c) requires spouses to avoid “grossly negligent,” “reckless,” and “intentional” misconduct. Marriage of Kamgar (2017) 18 CA5th 136, 149 (describing standard). See §6.22.
The spousal duty of disclosure does not impose a duty on the managing spouse to continuously update a nonmanaging spouse on all community property transactions. Marriage of Kamgar (2017) 18 CA5th 136, 147. Rather, spousal disclosure duties require a spouse to adequately inform the other spouse of community transactions such that both spouses are able to exercise their rights and duties in accordance with Corp C §16403(c)(1). 18 CA5th at 148 (husband’s failure to disclose his intent to invest additional $8 million of community property was breach of his fiduciary duty of disclosure when wife only consented to investment of $2.5 million in community funds). Any agreement between spouses may be relevant to whether one spouse’s acts or transactions should have been disclosed. 18 CA5th at 147. See §6.25.
There is a lack of California case law on how Fam C §1100(d) applies in the wide variety of circumstances that can arise in a business and during a marital dissolution proceeding, including the complex situation in which both spouses have played a role in management. The legislative history of Fam C §1100(d) indicates that the statute seeks to strike a balance between the rights of both spouses to have full information about a business (or business interest, such as stock ownership), while protecting the business against unwarranted interference by a nonmanager spouse and protecting the nonmanager spouse from breaches of fiduciary duty by the manager-spouse. An extensive discussion of the legislative history of §1100(d) has been added in §6.33A.
Marital infidelity discovery implicates the privacy interests of parties (who may have placed infidelity at issue in a dispute) and third parties. The discoverability of information ultimately relates to its potential admissibility. A new discussion of the discoverability of marital infidelity evidence on fiduciary claims has been added in §6.49A.
Just as it is common for a particular family member to manage family investment assets, it is often the case that one family member manages the family liabilities, or a particular liability that affects another family member or group of family members. Such liabilities may include, for example, a home mortgage or equity line, credit cards and unsecured loans, lawsuits, liens or judgments, and contractual or financial commitments. A new discussion of the management of marital and family member liabilities has been added in §6.49B.
California courts have equitable power to appoint an agent of the court, known as a monitor, to supervise the parties’ compliance with orders and judgments. Monitors are used in complex cases when the court is unable to directly oversee compliance or the risk of noncompliance is significant. A monitor is seen as less extreme than a receiver, the appointment of which can be a costly remedy and may signal to the world that the business is failing. A new discussion of monitors has been added in §6.58B.
The tolling of a breach of fiduciary claim under Fam C §1101(d)(2) may apply not only in an action between spouses, but also in an action against a third party who is not in a fiduciary relationship with the victim spouse. See Yeh v Tai (2017) 18 CA5th 953, 958. See §6.69.
The professional conduct of California attorneys is regulated by the State Bar of California under Bus & P C §§6000–6238 and Cal Rules of Prof Cond 1.0—8.5. The California Rules of Professional Conduct were amended effective November 1, 2018; the new rules are available at http://www.calbar.ca.gov/Attorneys/Conduct-Discipline/Rules/Rules-of-Professional-Conduct/New-Rules-of-Professional-Conduct. See §7.5.
Particularly in cases involving professional misconduct, it has been recognized that a breach of fiduciary duty can be based on either negligence or fraud, depending on the circumstances. Knutson v Foster (2018) 25 CA5th 1075, 1093 (attorney misconduct); Ash v North Am. Title Co. (2014) 223 CA4th 1258, 1276 (title company). Courts have applied different standards of causation depending on whether negligence or fraud is involved. See §§7.16A, 8.4.
On March 15, 2018, the U.S. Department of Labor’s fiduciary rule was vacated by the U.S. Court of Appeals for the Fifth Circuit. Chamber of Commerce of the U.S.A. v U.S. Dep’t of Labor (5th Cir 2018) 885 F3d 360. The Fifth Circuit held that ERISA’s definition of fiduciary requires a special relationship of trust and confidence and that the DOL’s fiduciary rule conflicted with ERISA. The court concluded the conflicting aspects of the rule could not be severed and thus vacated the entire rule. As a consequence, the DOL fiduciary rule is not enforceable. See §7.27A.
“[B]efore a person can be charged with a fiduciary obligation, he must either knowingly undertake to act on behalf and for the benefit of another, or must enter into a relationship which imposes that understanding as a matter of law.” Mahmoud v Select Portfolio, Inc. (ND Cal, Jan. 3, 2018, No. 17-cv-00568-MEJ) 2018 US Dist Lexis 1085, *16 (quoting City of Hope Nat’l Med. Ctr. v Genentech, Inc. (2008) 43 C4th 375, 386). See §8.5.
Although a fiduciary relationship may be based on a particular relationship between the parties, one may also arise by contract. For example, in Fast Trak Inv. Co., LLC v Sax (ND Cal, May 11, 2018, No. 17-cv-00257-KAW) 2018 US Dist Lexis 81045, the defendant-attorney entered into a litigation funding agreement with the plaintiff-lender. The plaintiff’s motion for summary judgment on its breach of fiduciary duty claim was granted after the court determined that the terms of the funding agreement created a fiduciary relationship. See §8.5.
In Sustainable Ranching Partners, Inc. v Bering Pac. Ranches Ltd. (ND Cal, Apr. 6, 2018, No. 17-cv-02323-JST) 2018 US Dist Lexis 59201, *6, the court dismissed the plaintiff’s breach of fiduciary duty claim, stating that “[a] mere contractual obligation to perform … even guided by the implied duty of good faith, does not create a fiduciary duty.” See §8.24.
Federal district courts will generally allow the plaintiff leave to amend the complaint to attempt to allege a viable claim for breach of fiduciary duty. Bonner v Melo (ND Cal, July 23, 2018, No. 17-cv-04719-WHO) 2018 US Dist Lexis 122941 (acknowledging general rule allowing leave to amend, but not allowing leave to amend). However, a plaintiff will not be allowed leave to amend the complaint if leave to amend would be futile. See §8.29.
In Sheppard, Mullin, Richter & Hampton, LLP v. J-M Mfg. Co. (2018) 6 C5th 59, the court held that a contract involving an attorney and client may be declared unenforceable for violation of the Rules of Professional Conduct. Thus, a retainer agreement with a client is unenforceable if the attorney performs services for the client while the attorney has a conflict of interest that has not been waived under controlling ethical rules. In addition to the unenforceability of the retainer agreement, the attorney is subject to forfeiture of attorney’s fees based on the “general principle of equity that a fiduciary’s breach of trust undermines the value of his or her services.” 6 C5th at 89. See §8.37.
D&O policies are “claims made” policies and generally cover only claims that are made and reported in writing during what is typically a 1-year policy period. Using the “related” or “interrelated” acts language of the policy, insureds may be able to report a later-made claim under an earlier policy on the basis that it relates back or is intertwined with a previously reported claim. By contrast, carriers use this provision to avoid stacking multiple claims-made policies by contending that the new claim relates back to a previous claim and is covered under that policy (which has already been exhausted to some extent by the first claim), thus avoid implicating a second policy. See §10.15.
In In re Palmaz Scientific, Inc. (Bankr WD Tex, June 4, 2018, No. 16-50552-CAG) 2018 Bankr Lexis 488, the court held that the insured-versus-insured exclusion applied to bar coverage because the Chapter 11 debtor’s litigation trustee, as opposed to the debtor, initiated the lawsuit. See §10.40.
Recently, the Eleventh Circuit addressed the question of whether a prior-acts exclusion bars coverage for a claim “arising out of” wrongful acts committed before the inception of the policy. Zucker v U.S. Specialty Ins. Co. (11th Cir. 2017) 856 F3d 1343, 1349, distinguished on other grounds by Certain Underwriters at Lloyd’s of London v FDIC for Omni Bank (11th Cir 2018) 723 Fed.Appx. 764, 767. The court concluded that the term “arising out of” in the exclusion was unambiguous and broad, and defeated coverage under the case-specific facts. See §10.45.