Breach of Fiduciary Duty.
New York Supreme Court.

Who Owes Fiduciary Duties Under New York Law

A fiduciary duty arises wherever the law recognizes a relationship of trust and control: one person entrusts his interests to another, and the other is expected to act on behalf of the first rather than for herself. In the business context, New York law imposes fiduciary duties on a defined set of actors.

• Directors and officers of a New York corporation owe fiduciary duties to the corporation and, in many contexts, derivatively to its shareholders. BCL 717 codifies the duty of directors to perform their functions in good faith and with the care an ordinarily prudent person in a like position would use under similar circumstances.
• Controlling shareholders of a closely held corporation owe heightened fiduciary duties to minority shareholders, especially where the controller uses the levers of control to extract value at the expense of the minority. See Alpert v. 28 Williams St. Corp., 63 N.Y.2d 557 (1984).
• General partners owe each other fiduciary duties of loyalty and care under Partnership Law 43 and the common law synthesized in Meinhard v. Salmon, 249 N.Y. 458 (1928). Cardozo’s “not honesty alone, but the punctilio of an honor the most sensitive” remains the governing formulation in New York.
• LLC managers and members of a member managed LLC owe duties under LLC Law 409 and the operating agreement. Operating agreements can narrow common law duties; they cannot eliminate the obligation of good faith and fair dealing.
• Attorneys, trustees, executors, agents, and joint venturers are the classic fiduciaries. Duties in these relationships run on the same principles but with their own statutory and common law overlays.

The first question in any fiduciary duty matter is identifying the source of the duty and the person to whom it is owed. The answer controls who can sue, what posture the claim takes, and which statute of limitations applies.

The Three Core Duties: Loyalty, Care, Good Faith

New York recognizes three core fiduciary duties. Most fiduciary duty litigation collapses into one of them.

Duty of loyalty

The duty of loyalty requires the fiduciary to place the interests of the principal ahead of her own. It prohibits self dealing without informed consent, usurpation of business opportunities that belong to the entity, and competition adverse to the entity. The duty of loyalty is the most jealously enforced of the fiduciary duties. Violations are not excused by the business judgment rule and are typically addressed with disgorgement remedies designed to strip the fiduciary of the benefit of the breach, not merely to compensate the principal.

Duty of care

The duty of care requires reasonable diligence in decision making. A director who approves a transaction without informing herself of the material facts reasonably available breaches the duty of care. New York protects good faith, informed business judgments under Auerbach v. Bennett, 47 N.Y.2d 619 (1979). Gross negligence, conscious disregard of known risks, or a process so deficient that no reasonable director could have relied on it, takes the decision outside the business judgment rule.

Duty of good faith and fair dealing

The duty of good faith is implied in every fiduciary relationship and in every contract governed by New York law. It prohibits conduct undertaken with a purpose other than advancing the best interests of the entity, and it prohibits the exercise of discretion in a way that deprives the other party of the fruits of the relationship. The Chancery Court’s Stone v. Ritter formulation, widely cited in New York trial courts, treats knowing bad faith as a predicate for loss of exculpation and indemnification.

Self Dealing and Entire Fairness

A self dealing transaction is one in which a fiduciary stands on both sides, or has a material financial interest not shared with the principal. Classic examples: the director who causes the corporation to lease space from a building he owns, the majority shareholder who sells his personal asset to the corporation at a premium, the managing member who contracts with an entity in which his spouse holds a substantial interest.

Self dealing transactions are not automatically void in New York. Under BCL 713, an interested director transaction is voidable unless one of three safe harbors is established: (1) disclosure to the board and approval by a majority of disinterested directors, (2) disclosure to shareholders and approval by a majority of shareholders entitled to vote, or (3) affirmative proof that the transaction was fair and reasonable to the corporation at the time of approval.

When a safe harbor is not established, the fiduciary bears the burden of proving entire fairness: fair dealing (how the transaction was timed, initiated, structured, negotiated, and disclosed) and fair price (the economic and financial considerations). This is a substantive standard, not a pleading test. Once a conflict is shown, the burden shifts. This is where most self dealing cases are actually won and lost.

Corporate Opportunity Doctrine

A fiduciary may not divert for personal benefit a business opportunity that belongs to the entity. New York applies a multi factor test drawn from Alexander & Alexander v. Fritzen and subsequent cases. The opportunity is corporate if:

• The corporation has an interest or expectancy in it (e.g., an active negotiation or a line of business in which the corporation operates);
• The opportunity was presented to the fiduciary in her corporate capacity rather than personally;
• The corporation is financially able to take advantage of it; and
• Taking the opportunity would not place the fiduciary in a position inherently inconsistent with her duties to the corporation.

A fiduciary who takes a corporate opportunity without informed consent is liable for disgorgement of profits, imposition of a constructive trust on assets acquired with the opportunity, and injunctive relief. The full disclosure and consent safe harbor is available but only on the record. Oral consent after the fact is not a defense.

Corporate opportunity disputes frequently arise in tandem with departures. The director, officer, or member who sets up a competing venture while still owing duties to the existing entity creates a textbook corporate opportunity problem. Timing matters. The duty ends when the fiduciary relationship ends, but conduct undertaken while the relationship exists carries forward.

Direct Claims vs. Derivative Claims

A breach of fiduciary duty claim can be direct, derivative, or both. Pleading the claim in the wrong posture is the most common reason fiduciary duty complaints are dismissed on the papers.

New York courts apply the Tooley test, as articulated in Tooley v. Donaldson, Lufkin & Jenrette, 845 A.2d 1031 (Del. 2004), and adopted in New York through Yudell v. Gilbert, 99 A.D.3d 108 (1st Dep’t 2012). The test asks two questions:

1. Who suffered the alleged harm? The corporation, the shareholders individually, or both?
2. Who would receive the benefit of any recovery? The corporation, the shareholders individually, or both?

If both answers are “the corporation,” the claim is derivative. The shareholder sues on the corporation’s behalf under BCL 626, the recovery flows to the corporation, and the demand or demand futility rules apply.

If the shareholder suffered a distinct, individual injury (different in kind from the harm to the corporation or the harm to shareholders generally) and the recovery is properly his alone, the claim is direct. Typical direct claims in a closely held context: denial of access to books and records, denial of preemptive rights, freeze out from employment, and claims under a shareholders agreement.

The same facts can support both theories. Pleading them in the alternative, with the direct and derivative theories clearly separated, is the defensive posture. A monolithic “breach of fiduciary duty” count without that separation invites dismissal.

Demand Futility Under Marx v. Akers

Before a shareholder can bring a derivative action under BCL 626, she must either demand that the board initiate the action itself or plead demand futility with the particularity required by CPLR 3016(b). The New York standard for demand futility comes from Marx v. Akers, 88 N.Y.2d 189 (1996), and it is strict.

Demand is futile where the complaint alleges with particularity that:

• A majority of the board is interested in the challenged transaction (has a personal financial stake or lacks independence because of dominating relationships with interested directors);
• The board did not fully inform itself about the challenged transaction to the extent reasonably appropriate under the circumstances; or
• The transaction is so egregious on its face that it could not have been the product of sound business judgment.

The word that does the work is particularity. Conclusory recitals that “a majority of the board is interested” or “the board failed to investigate” do not survive a 3211 motion. The plaintiff has to plead facts. Which directors. What financial interest. What relationships. What the board did or failed to do. Compared to what.

In a closely held corporation with a three director board, two of whom are the controlling shareholders at the center of the dispute, demand futility usually pleads itself on the face of the board roster. In a larger closely held corporation, or a professional corporation with a rotating board, demand futility requires affirmative factual development before the complaint is filed.

The Business Judgment Rule and Its Limits

The business judgment rule is the procedural shield that protects good faith board decisions from judicial second guessing. In New York, Auerbach v. Bennett sets the framework. A board decision is protected if the directors acted on an informed basis, in good faith, and in the honest belief that the action was in the best interests of the corporation.

The rule does not protect:

• Self dealing transactions. Once a material conflict is shown, the burden shifts to the fiduciary to prove entire fairness.
• Bad faith conduct. Decisions undertaken for a purpose other than advancing the best interests of the entity, or in conscious disregard of a known duty, fall outside the rule.
• Gross negligence in the decision making process. A rushed vote on a bet the company transaction without review of the material documents, without a fairness opinion, without time to consult advisors, is not a protected business judgment.
• Ultra vires or illegal acts. The business judgment rule does not authorize the board to break the law.

A plaintiff challenging a board decision must plead facts sufficient to take the decision outside the rule. Once those facts are pled, the case proceeds on the merits of the fiduciary duty claim. Until then, most fiduciary duty claims against outside directors die on a 3211 motion.

Statutes of Limitations

The limitations period for a breach of fiduciary duty claim in New York depends on the relief sought and the underlying theory pled.

• Monetary damages. Three years under CPLR 214(4). Where the plaintiff seeks compensatory damages, disgorgement measured as money, or other primarily legal relief, the three year clock runs from the date of the breach.
• Equitable relief. Six years under CPLR 213(1). Claims seeking an accounting, constructive trust, rescission, or injunctive relief get the longer equitable period.
• Fiduciary duty grounded in fraud. Six years from the date of the breach, or two years from actual or imputed discovery, whichever is later. CPLR 213(8) and 203(g). Pleading the fraud elements (false representation, scienter, reasonable reliance, damages) with CPLR 3016(b) particularity is essential to claim the fraud period.
• Aiding and abetting breach of fiduciary duty. Takes the limitations period of the underlying breach. Where the aiding and abetting sounds in fraud, CPLR 213(8) applies.
• Continuing wrong. A course of fiduciary conduct that extends into the limitations period can revive earlier conduct under the continuing wrong doctrine. The doctrine is narrow. Courts distinguish between a single wrong with continuing consequences (not revived) and a series of independent wrongs (each with its own clock).

The practical point: label the relief precisely. A complaint that seeks only monetary damages gets three years. A complaint that seeks an accounting or a constructive trust on the same facts gets six. Pleading both is often the right answer.

Remedies

Fiduciary duty relief goes beyond compensatory damages. The remedies available to a New York court, properly pled and developed on the record, include:

Compensatory damages

The principal recovers the loss proximately caused by the breach. Prejudgment interest runs at 9 percent under CPLR 5001, typically from a date of breach reasonably determined by the court.

Disgorgement and equitable accounting

In a duty of loyalty case, the measure is not the principal’s loss but the fiduciary’s gain. A disloyal fiduciary disgorges the profits of the breach, whether or not the principal can prove equivalent damages. An equitable accounting compels production of the books and an order directing payment of amounts owed.

Constructive trust

A constructive trust is imposed on property, money, or opportunities acquired through the breach. The elements under Sharp v. Kosmalski are a confidential or fiduciary relationship, a promise (express or implied), a transfer in reliance, and unjust enrichment. The constructive trust follows the property into the hands of knowing recipients.

Rescission

A self dealing transaction can be rescinded where rescission is practical and the status quo can be restored. Rescission is preferred over damages where the transaction is still unwound and the fiduciary has not dissipated or altered the subject asset.

Injunctive relief

Orders restraining further self dealing, restraining the use of misappropriated corporate opportunities, and in appropriate cases removing the fiduciary from office.

Punitive damages

Available where the breach is willful, malicious, and involves high moral culpability. New York sets a high bar; most fiduciary duty awards are limited to compensatory and disgorgement measures. The availability of punitives is nevertheless a meaningful settlement lever in egregious cases.

Attorney’s fees

Fee shifting is available under BCL 626(e) where a derivative action produces a substantial benefit to the corporation. Contractual fee shifting under a shareholders agreement, operating agreement, or partnership agreement is separately enforceable.

Provisional relief

Orders of attachment under CPLR 6201 where a fiduciary is dissipating assets. Temporary restraining orders preserving the status quo during the pendency of the proceeding. Expedited discovery on a proper showing.

What I See in Practice

After more than 20 years litigating in New York Supreme Court across every borough plus Nassau, Suffolk, and Orange, breach of fiduciary duty cases share a set of recurring patterns.

• The paper trail matters more than the narrative. A loyalty breach proven by an email chain, a wire transfer history, or a set of board minutes that reflect no discussion of a conflicted transaction beats any amount of testimony about intent. The documents are where these cases are won.
• Plead both direct and derivative in the alternative. The Tooley line draws itself in most cases, but not always. A well drafted complaint pleads the claim both ways, with the direct theory anchored to a distinct individual injury, so that a misclassification ruling on one theory does not kill the case.
• The three year vs. six year question comes up on every motion to dismiss. Pleading the equitable relief that supports CPLR 213(1), and pleading the fraud elements that support CPLR 213(8) where available, is the difference between surviving the limitations defense and not.
• Demand futility is a pleading exercise, not a merits exercise. Allegations about what directors knew, when they knew it, what financial interests they had, and what the board actually did (or did not do) need to be in the complaint, with citations to documents where possible. General allegations of interestedness fail.
• Self dealing transactions are almost never disclosed as self dealing. They are disclosed as arms length transactions with related party footnotes, or not disclosed at all. The investigation happens at the deposition and on the paper. The BCL 713 safe harbor rarely closes.
• Settlement comes on the number, not on the principle. Once the direction of the case is clear after disposition of the 3211 motion and initial document production, most fiduciary duty cases settle on a disgorgement or buyout figure. The principle is rarely worth trying.

Talk to a Breach of Fiduciary Duty Lawyer in New York

The Law Office of Frederic R. Abramson represents plaintiffs and defendants in breach of fiduciary duty matters in New York Supreme Court: duty of loyalty, duty of care, self dealing, corporate opportunity, direct and derivative claims, demand futility, and fiduciary relief across closely held corporations, partnerships, LLCs, and other business relationships. Representation is available in the five boroughs, Nassau, Suffolk, and Orange counties.

Related: Business Disputes Overview  ·  Shareholder Disputes  ·  Partnership and LLC Disputes  ·  Breach of Contract  ·  Commercial Division Playbook  ·  Civil Litigation Overview

Attorney Advertising. Prior results do not guarantee a similar outcome. The information on this page is general and is not legal advice. Consult an attorney about the specific facts of your matter. Law Office of Frederic R. Abramson, 160 Broadway, Suite 500, New York, NY 10038. 212-233-0666.