The Common Law Tort of Breach of Fiduciary Duty: The Whole | Farrell Fritz, PC

In the famous case of Meinhard versus Salmon, Judge Benjamin Cardozo wrote in lofty language that lawyers for abused business owners love to quote since the duty of loyalty between closely held business owners is extremely high:

Not honesty alone, but the punctilio of a most sensible honor is . . . the standard of behavior.

Countless published decisions since citing Meinhard. Grounded in language laden with morality (no “market morality” here), it is not surprising that the tort of breach of fiduciary duty as expressed in Meinhard became the workhorse of business divorce litigation in New York.

Over the years, the common law cause of action for breach of fiduciary duty has evolved into a remarkably versatile claim, encompassing a vast—almost limitless—range of conduct that may amount to misappropriation, insider trading , waste or disloyalty. Breach of fiduciary duty in New York also presents a number of odd legal quirks, making it a powerful weapon in a plaintiff’s/plaintiff’s arsenal when argued thoughtfully.

For example, the claim has not one, not two, but three potential limitation periods. If the claim is for damages only, the limitation period is three years. But plead the claim as a claim for equitable relief, and the statute of limitations increases from three to six years. If you plead the claim as “based on fraud”, the statute of limitations extends further and further: six years from the date of the fraud, or two years from the time the fraud could have been discovery with due diligence, whichever is longer.

A recent decision by a Rochester Court of Appeals, Howard vs. Pooler___ AD3d ___, 2020 NY Slip Op 03347 [4th Dept June 12, 2020]highlights two other extremely useful aspects of the tort of breach of fiduciary duty: firstthe possibility of “restitution” of the profits of a person who breaches a fiduciary duty even in the absence any actual damages resulting from the breach; and secondthe ability of the non-offending party to recover its attorneys’ fees to pursue the fiduciary duty claim when the claim is litigated derivatively on behalf of the entity.

Facts

Howard and Pooler formed Archer Rd. Vista LLC (the “LLC”) to develop a residential development on 300 acres of land in Chili City. They planned to develop the land into approved vacant lots for sale to builders who would then build homes on the land. The LLC had a writing operating agreement, that both members had equal voting rights although they owned a disproportionate shareholding (Pooler owned 60%; Howard 40%). The operating agreement named Pooler’s “manager”, a position that Howard allegedly abused, leading to a breakdown in the relationship and Howard’s 2013 filing of a complaint in the Monroe County Supreme Court alleging thirteen causes of action against Pooler, including Breach of Operating Agreement (Count I), Breach of Fiduciary Duty (Count VII) and Accounting (Count VIII ), all derivatively pleaded on behalf of the LLC.

The underlying commands

In 2016, former Business Division Judge Matthew A. Rosenbaum issued a decision and ordered granting Howard partial summary judgment on the issue of liability for its derivative claims for breach of contract, breach of fiduciary duty and accounting. The court ordered a lawsuit for damages for these causes of action and for liability for the other causes of action. In 2017, the parties tried the case during a week of testimony in a trial before Judge Rosenbaum, following which the Court in 2018 issued a decision and ordered which ultimately led to Pooler’s appeal.

In his post-trial ruling, Judge Rosenbaum awarded Howard damages of more than $1.2 million based on Pooler’s breaches of the operating agreement and fiduciary duties. In the first of two decisions that are the subject of this article, the court ruled that Pooler breached his fiduciary duties by entering into undocumented insider trading with a separate entity of which he was principal, Pooler Enterprises. In addition to awarding damages to Howard, the Court awarded Howard restitution of Pooler’s profits, writing:

Pooler awarded Pooler Enterprises a non-memorial contract, and the Court has already recognized the liability of the defendant in this respect. . . Pooler ultimately caused Archer Rd. Vista to pay Pooler Enterprises $692,080 on this uncommemorated contract, of which at least $103,812 is attributable to overhead and profit. Taking into account the actual value of the work, the overstatement of the invoices and the actual amount of the work performed, Archer Rd. Vista is entitled to $317,146 in damages, plus prejudgment interest. Archer Rd. Vista is also entitled to recovery of an additional $103,812, which is the overhead and profit billed by Pooler Enterprises. To see Excelsior 57th Corp. vs. Lerner, 160 AD2d 407, 408-09 (1st Dept. 1990) (“Where insider and split loyalty claims are made, a fiduciary may be required to return any ill-gotten gains even if the [Company] suffered no direct economic loss”). Pooler is not entitled to overheads and profits charged by Pooler Enterprises.

In the court’s second decision, it held:

Howard is seeking reimbursement of attorneys’ fees related to the derivative claims. The Court agrees and damages in this regard are awarded. Similarly, Howard is seeking fees as a derivative plaintiff acting on Archer Rd. on Vista’s behalf. The Court agrees and fees in this regard are also awarded. See, for example, Tzolis vs. Wolff, 10 NY3d 100 (2008); Seinfeld vs. Robinson, 246 AD2d 291, 294 (1st Dept. 1998). . . .

To the extent that Howard seeks honoraria on an individual basis, no honorarium is awarded.

In the resulting order, the Court ruled: “Pooler shall be liable to pay damages to Howard in connection with attorneys’ fees incurred by Howard as derivative plaintiff. . .”

The call

Pooler appealed Judge Rosenbaum’s post-trial rulings. You can consult the main appeal briefs of the parties here, hereand here. Pooler hid his arguments about the Court’s alleged errors regarding reimbursement and attorney’s fees in the last two points of his brief. In its Factum and Order, the Appeal Division upheld in part and reversed in part these two decisions.

First, the Court held:

Defendant further contends that the court erred in the amount of damages awarded in connection with the cause of action’s derivative breach of fiduciary duty, upon which liability had already been imposed, because nothing proved that the LLC was harmed by his misconduct. We reject this assertion. Disgorgement of profits is an appropriate remedy for breach of fiduciary duty, even when the company has not been directly harmed by the misconduct (to see Diamond vs Oreamuno24 NY2d 494, 498, 301 NYS2d 78, 248 NE2d 910 [1969]; Excelsior 57th Corp. against Lerner160 AD2d 407, 408-409, 553 NYS2d 763 [1st Dept. 1990]).

Second, the Court held:

[W]We agree with Defendant that the Court erred in determining that Plaintiff is entitled to attorneys’ fees and disbursements in its status as a derivative plaintiff acting on behalf of the LLC and in awarding those fees and disbursements, . . . “The basis for an award of attorney’s fees in a derivative shareholder lawsuit is to reimburse the plaintiff for expenses incurred on behalf of the company.” . . These costs should be paid by the companywho benefited from the plaintiff’s efforts and who would have borne the costs if she had sued herself” (Glenn vs. Hoteltron Sys.74 NY2d 386, 393, 547 NYS2d 816, 547 NE2d 71 [1989] [emphasis added]). Thus, plaintiff’s success as a derivative plaintiff is not an acceptable basis for awarding attorney’s fees and disbursements against the individual defendant.

Return of ill-gotten gains

The principle that courts may award restitution of compensation or benefits for breach of fiduciary duty is an old one. Most often, restitution is seen in connection with the “unfaithful servant doctrine”, according to which an agent who is disloyal to his principal is subject to equitable forfeiture of any compensation from the date of the first disloyal act of the agent. As noted by the Court of Appeal in Howardthe most succinct expression of the doctrine comes from Excellency, which held that “where allegations of insider and divided loyalty are presented, a fiduciary may be liable to disgorge any ill-gotten gains even where the claimant has suffered no direct economic loss”. In the realm of business divorce, where allegations or disloyalty and personal dealings are the norm, the potential for restitution can be a powerful weapon indeed.

Attorneys’ Fees Pursuing Derivative Fiduciary Duty Claims

Section 626 (e) of the Commercial Companies Act, a law that has been followed in cases involving LLCs, allows courts to award attorneys’ fees to litigants who “succeed, in whole or in part” in pursuing derivative claims. But the law does not specify WHO pay the fees. A strong argument could be made that the tortfeasor — the one who caused all the harm — should be responsible for paying the costs. But in Howardthe Court pointed to a significant limit to the ability to recover costs: the entity itself — not the wrongdoer — is liable for those costs payable on recovery.

So when you’re preparing to start a corporate divorce lawsuit, think about ways to maximize the potential of your cause of action for breach of fiduciary duty. Breach of fiduciary duty offers a wonderful panoply of remedies: legal remedies, equitable remedies, right to an accounting, award of damages, restitution of self-treasured profits, and finally, if pleaded in a manner derived, the possibility of recovering attorney’s fees.

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