What Is Fiduciary Duty & The Consequences of Breaching?
A business is made of various roles that have certain duties they must follow to help the company run and grow. Some of these roles include directors and officers. Directors and officers include specific positions such as CEOs, CFOs, HR, and managers.
They have high power and responsibility to the company and the members involved. The actions can significantly impact the business, positively and negatively. Their responsibility and duty to the organisation are called fiduciary duties.
Fiduciary duties involve a range of severe duties every director and officer must follow to benefit the company, board of directors and shareholders. A breach of fiduciary duty may result in severe lawsuits for the Director, officer, or controlling shareholder.
The short article will discuss the different types of fiduciary duties. Additionally, how D&O insurance may be the best insurance solution to a breach of fiduciary duty.
What is Fiduciary Duty?
Fiduciary duties are the highest duties known to the law. A fiduciary duty is when an individual or organisation has a responsibility to another party to act in a certain way that will benefit the other party. The other party usually includes the board of directors, shareholders, and clients.
The range of duties and specific definition of duties may differ in every industry, but it is crucial to structure businesses and industries.
Types of Fiduciary Duty
In this article – these duties are between the corporation (directors and officers) to stakeholders (board of directors, clients, and shareholders).
Duty of Care
Officers and directors are expected to show the appropriate care and diligence when making decisions on behalf of their corporation. Therefore, they must care for the various parties that could be affected and ensure they benefit from decisions.
For instance, a breach of the duty of care would include the Director not attending mandatory meetings on purpose and making decisions without knowing discussed details. The breach of this fiduciary duty can result in lawsuits, financial damage, and reputation damage.
Duty of Loyalty
Directors and officers must always put the organisation’s interests above personal interests when performing any duty. They must consider how the company will benefit from an action rather than how they will.
A breach of loyalty involves a director or officer making a deal because it will increase their personal income instead of reflecting the company’s reputation and overall company benefit. The board of directors will have the right to sue the responsible director and the business for financial loss.
Duty of Obedience
Every action performed by a business should be legal and respect laws. Officers and directors must ensure that the company follows all related laws and regulations and doesn’t engage in illegal or unauthorised activities.
An example of a breach of obedience duty could include breaking employment laws and overworking an employee (unpaid hours) for their benefits. Breaching this fiduciary duty can result in serious action by the government, including lawsuits, imprisonment, and fines.
Duty of Good Faith
The duty of good faith is a fiduciary duty which is a mixture of duty of care and loyalty. The director and officer must make the right decision that is sincere and fair to the parties involved.
An example of a breach of duty of good faith would be when the responsible party intentionally supplies false material facts to the other party to ensure they do not benefit from the information. When a board of director discover such activities, the Director and officer will have to defend their actions legally and may need to pay high settlement costs.
Duty of Disclosure & Confidentiality
Directors and officers must either disclose or protect information depending on the agreed details from the other party. Hence directors and officers may need to share certain information with the board of directors. On the other hand, they may also need to hide the same information from clients and employees.
An example of a breach of duty of confidentiality will be if an HR manager shares employee wages with another employee. An example of a breach of duty of disclosure would include if a CEO does not share important financial details with investors or the board of directors. In both cases, the person involved will face legal charges and maybe more.
How Can D&O Insurance Save a Business from a Breach of Fiduciary Duty?
Every business should purchase Director and officer (D&O) insurance to protect their leading staff from breach of duty claims. D&O insurance policies offer liability cover for company directors and managers to protect them from claims due to the outcome of the decisions and actions taken by performing their duties.
At times one may not intend to breach fiduciary duty and may need to defend themselves in court and to other parties. Defending costs can be very costly due to lawyer fees and potential settlement costs. Therefore, D&O insurance is crucial to cover these costs – as the insurance will cover most defence costs, financial loss and even settlement costs (if the case is lost).
Although it is essential to understand that D&O insurance has its limits, depending on the case and seriousness of the claim. The insurance will not always be able to protect the Director or officer from imprisonment or lawsuits where the manager is evidently at fault.