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REV: NOVEMBER 18, 2015

LYNN SHARP PAINE

The Fiduciary Relationship: A Legal Perspective

I venture to assert that when the history of the financial era which has just drawn to a close comes to be
written, most of its mistakes and its major faults will be ascribed to the failure to observe the fiduciary principle .
. . . No thinking [person] can believe that an economy . . . can permanently endure without some loyalty to that
principle.1

— U.S. Supreme Court Justice Harlan Fiske Stone, 1934, commenting on the events
leading to the Securities Acts of 1933 and 1934

Throughout the ages, individuals have faced the need to entrust others with the care and custody
of their property, information, or other valuable assets. Frequently, this entrustment puts the trusting
party in a position of vulnerability or dependence. For example, an individual foreseeing death may
turn over to a friend property to be used for the benefit of a spouse and minor children when neither
the spouse nor the children have the knowledge or experience to manage the property themselves.
Alternatively, an individual may disclose highly personal and potentially damaging or valuable
information to a cleric, doctor, or lawyer. While such arrangements serve many useful purposes,
experience teaches that individuals on the dominant side of a relationship will sometimes use the
entrusted asset or knowledge to advance their own interests at the expense of the dependent party or
will be less diligent and dedicated than the trusting party would wish.

In Anglo-American law, such relationships of trust and dependency are termed “fiduciary 2
relationships.” To address the risks of negligence and abuse of power inherent in these relationships,
the law has evolved a set of concepts and principles governing the behavior of “fiduciaries”—those
who serve as the trusted or dominant party. This note discusses the most important of these principles
and their application in the corporate context. Its purpose is to provide a broad overview of key ideas,
and it is not a substitute for specific advice on the law of particular jurisdictions.

The Definition of a Fiduciary

Legal scholars have long debated the circumstances under which fiduciary principles apply. In
general, however, a fiduciary relation arises when a party is entrusted with property, information, or
power to make decisions that involve discretionary judgment for the benefit of someone other than
himself. In this relationship, the trusted party is the “fiduciary.” A fiduciary, then, is someone in

1 Stone, “The Public Influence of the Bar,” 48 Harvard L. Rev. (1934), pp. 1, 8.
2 The word fiduciary comes from the Latin fiduciaries, whose root, fiducia, means “trust” or “thing held in trust.” Webster’s New
World College Dictionary, 3rd ed. (New York, N.Y: MacMillan, 1996), p. 1437.

Professor Lynn Sharp Paine prepared this note as the basis for class discussion. Professor Henry B. Reiling and Professor Constance E. Bagley also
contributed to its preparation.

Copyright © 2003, 2004, 2006, 2009, 2015 President and Fellows of Harvard College. To order copies or request permission to reproduce materials,
call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu. This publication may not be
digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

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 304-064 The Fiduciary Relationship: A Legal Perspective

whom trust and confidence have been reposed and who is under a duty to act for the benefit of another.
In the absence of the requisite trust and confidence, a fiduciary relationship generally does not arise. 3

Over time, the law has come to categorize certain types of relationships as inherently fiduciary.
Classic examples include the relationships between trustee and beneficiary, guardian and ward, agent
and principal, attorney and client, doctor and patient, executor and legatee (a person to whom a legacy
is bequeathed). In business, an investment advisor is a fiduciary for the client; members of a
partnership are fiduciaries for one another; and corporate officers, directors, and executives are
fiduciaries for the corporation and its shareholders. Courts have also said that a corporation’s
controlling shareholders are in some circumstances fiduciaries for minority investors.

These categories, however, are not exhaustive. Other parties—individual and corporate—may be
deemed fiduciaries in appropriate circumstances, and through the normal evolution of the law, new
classes of fiduciaries arise from time to time. Trustees, for instance, are ancient in origin, whereas the
fiduciary status of agents dates only to the late eighteenth century. 4 The fiduciary obligations of
corporate officials arose only with the emergence of corporate enterprise, but controlling shareholders
were not subjected to fiduciary principles until the twentieth century. Pointing to the fairly recent
addition of union leaders, physicians, and psychiatrists to the fiduciary class, one legal scholar has
noted that “[t]he twentieth century is witnessing an unprecedented expansion and development of
fiduciary law.”5 Indeed, in recent decades some courts have applied fiduciary concepts to landlords,
franchisors, and others not traditionally categorized as fiduciaries.

The Fiduciary’s Special Responsibilities

Determining whether an individual has fiduciary status is not just an exercise in semantics.
A party’s status—as fiduciary or ordinary contractor—bears directly on the legal standard applied to
the party’s conduct. The fiduciary designation carries with it a distinctive set of legal responsibilities
that go beyond those of parties to an ordinary arm’s-length contract. These special responsibilities fall
into three broad categories6—candor and disclosure, diligence and care, and loyalty and self-restraint.
The following description of these special responsibilities in part paraphrases the analysis offered by
Harvard Law School Professor Robert C. Clark in the work cited in note 7:

Candor and disclosure. Compared to independent contractors, fiduciaries have more extensive duties
of candor and disclosure. Although parties to an arm’s-length contract may not lie to one another and
may sometimes expressly warrant the truth of certain information, they are often free to remain silent
about information the other party would find relevant to the exchange. For example, a party about to
sign a requirements contract with a supplier of raw materials probably has no duty to disclose facts
indicating a likely increase or decrease in its future requirements unless the contract expressly calls for
such disclosures. By contrast, a fiduciary in a similar situation would be obliged to disclose. 8

3 See, e.g., Northeast General Corp. v. Wellington Advertising, Inc., 624 N.E.2d 129 (N.Y. 1993).
4 Tamar Frankl, “Fiduciary Law,” California Law Review, vol. 71 (May 1983), pp. 795–796.
5 Frankl, op. cit., at p. 796.
6 Legal scholars have traditionally classified fiduciary duties into two main categories—the duty of care and the duty of loyalty—
with the duty of disclosure as a corollary of both. For purposes of this note’s comparison between the responsibilities of
fiduciaries and ordinary contracting parties, however, the three-part categorization is more revealing.
7 This section relies heavily on the analysis of fiduciary responsibilities offered by Professor Robert C. Clark, Dean of the Harvard
Law School from 1989 until 2002, in his article “Agency Costs versus Fiduciary Duties,” in Principals and Agents: The Structure of
Business, ed. John W. Pratt and Richard J. Zeckhauser (Boston: Harvard Business School Press, 1985), pp. 55–79.
8 This example is from Clark, op. cit.

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 The Fiduciary Relationship: A Legal Perspective 304-064

Consider the non-executive director of a utility company who was simultaneously the president,
director, and chief stockholder of a woolen company that entered into a requirements contract with the
utility. The contract put a ceiling on the amount the woolen company would have to pay during the
term of the contract. The director presided at the utility company board meeting at which the contract
was approved, though he did not vote and said nothing about the substance of the contract nor about
anticipated changes in the woolen company’s production processes. When the woolen company later
modified its processes in a way that greatly increased its need for electricity, the utility company began
losing substantial sums of money. Stressing that “[a] beneficiary . . . may be betrayed by silence as well
as by the spoken word,” the court held that the director violated his duty as a fiduciary to apprise the
other directors of all the relevant facts and possibilities. 9

Diligence and care. Unlike ordinary agents or arm’s-length contractors who usually have relatively
well-defined obligations spelled out by the terms of their contract, fiduciaries are subject to open-ended
duties to exercise their best efforts on the beneficiary’s behalf. To be sure, the law requires contracting
parties to act “reasonably” and to carry out their obligations “in good faith,” and all contracts are by
their very nature somewhat incomplete. Nonetheless, fiduciaries have far more discretion to choose
how to exercise the authority entrusted to them, and the law imposes a correspondingly strict “duty of
care” in making those decisions.

For example, the law gives directors broad authority to manage the corporation’s “business and
affairs,” but it also requires them to exercise this authority with the degree of care and diligence that
ordinarily prudent individuals in a like position would exercise under similar circumstances. Directors,
moreover, are expected to act in a manner reasonably believed to be in the best interests of the
corporation,10 and to consider reasonably available and relevant information in making decisions. 11
Although money judgments against directors for breaching their duty of care are infrequent, the
standard of conduct expected of directors is a demanding one, and failure to meet it may give rise to
legal action.12

Loyalty and self-restraint. Parties to an arm’s-length contract generally have no legal obligation to
protect one another’s interests—apart from a good faith and reasonable effort to fulfill the terms of the
contract. Fiduciaries, on the other hand, are required not only to protect and promote the interests of
the beneficiary but also to avoid putting their own interests ahead of the beneficiary’s. This duty of
“undivided loyalty” has been translated into specific legal doctrines that limit fiduciaries’ ability to
secure personal advantage from their position and expressly prohibit them from benefiting at the
expense of their beneficiaries.

One set of doctrines concerns “self-dealing”—transactions in which a fiduciary stands on both sides
of the exchange. An example is a director or officer who enters into a real estate transaction with the
corporation—or who has a personal interest in an entity that enters into the transaction. If challenged
in a “derivative suit” (a lawsuit brought by shareholders on behalf of the corporation), the fiduciary
must demonstrate that the transaction was fair to the corporation. Various methodologies are used to
establish fairness, but market price or some variant is a typical benchmark. In an ordinary contractual
exchange, such a showing is not legally required, and both parties are perfectly free to strike a bargain
that beats the market. As Professor Clark notes in this regard: “If a hardware store sells me a
lawnmower at a price that is two standard deviations higher than the average retail price for that

9 Globe Woolen v. Utica Gas & Electric Co., 224 N.Y. 483 (1918). This case is discussed in Clark, op. cit.
10 American Law Institute, Principles of Corporate Governance, (1994), §4.01.
11 Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985).
12 Dennis J. Block, Nancy E. Barton, Stephen A. Radin, The Business Judgment Rule: Fiduciary Duties of Corporate Directors, vol. 1,
5th ed. (New York, N.Y: Aspen Law & Business, 1998), p. 179.

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 304-064 The Fiduciary Relationship: A Legal Perspective

lawnmower, I cannot rescind the contract or get damages simply because of that fact. But if a corporate
president sold a batch of lawnmowers to his corporation at equally inflated prices, the corporation
would have a remedy.”13

By the same token, the duty of loyalty prohibits officers and directors from taking personal
advantage of business opportunities that belong to the corporation, unless disinterested directors have
expressly considered and consented to this arrangement. Although the law of “corporate opportunity”
varies from jurisdiction to jurisdiction, the factors used to determine whether an opportunity belongs
to the company typically include whether it is in the company’s line of business, whether it came to the
officer or director in his official capacity, and whether corporate assets were used in developing the
opportunity. Thus, corporate fiduciaries are precluded from pursuing some business opportunities
that would be fair game for those unencumbered by the duty of loyalty.

Yet another example of limits on fiduciaries’ ability to benefit from their position is found in
doctrines on “insider trading.” A corporate fiduciary who learns, for example, of a research
development that will significantly enhance or diminish the company’s prospects may not buy or sell
stock on that information before it is released to the public. Whether or not the fiduciary’s trading
actually harms the company, it involves the use of corporate assets for personal advantage and puts
the fiduciary in a position to gain at the expense of the shareholders whose interests the fiduciary is
legally required to protect.

Remedies for Breach of Fiduciary Duty

As these examples show, Anglo-American law is frequently stricter on fiduciaries than on arm’s-
length contractors. This same rigor is found in the remedies imposed for violating fiduciary
obligations, particularly the obligation of loyalty. In contrast to a breach of contract, for which the
remedy is typically measured in terms of loss to the injured party, a breach of loyalty may result in a
“constructive trust” being imposed on the fiduciary’s gains. For instance, an executive who profits by
improperly exploiting a corporate opportunity may be ordered to pay over the profits of the venture
to the corporation.

Where breach of fiduciary obligation is involved, courts are generally hostile to what otherwise
might be viewed as “gain-sharing” or “win-win” solutions. In one case, an executive argued that he
should receive a proportionate share of the gains from a corporate opportunity that he had improperly
diverted. Rejecting the executive’s argument, the court explained the reason for denying “the betrayer”
any profit:

The rule, inveterate and uncompromising in its rigidity, does not rest upon the narrow
ground of injury or damage to the corporation resulting from a betrayal of confidence, but
upon a broader foundation of a wise public policy that, for the purpose of removing all
temptation, extinguishes the possibility of profit flowing from a breach of the confidence
imposed by the fiduciary relation.14

In a similar spirit, some courts and commentators have argued for an absolute prohibition on all
forms of self-dealing and conflicts of interest by management fiduciaries. Others have pointed out that
although a strict prohibition on self-dealing would reduce the potential for malfeasance, it would also

13 Clark, op. cit., at p. 74.

14 Guth v. Loft, Inc., 5 A.2d 503 (Del. 1939).

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 The Fiduciary Relationship: A Legal Perspective 304-064

deprive companies of some valuable opportunities.15 In some cases, a company’s best supplier may be
an organization in which a director or executive has a personal interest. Or a management buyout,
which involves executives as both buyers on their own behalf and sellers on behalf of investors, may
be the best way to unlock value for shareholders.16

Moreover, an absolute ban on conflicts of interest would be impossible to implement. The potential
for conflict is inherent in the fiduciary relationship, and fiduciaries frequently face low-grade tensions,
if not outright conflicts, between their own interests and the interests of those they are obliged to serve.
Only by eliminating the relationship can the potential for breach of fiduciary obligation be wholly
eliminated. These risks, however, can be managed. Some common approaches include active and
ongoing disclosure of potentially significant conflicts, fiduciaries’ recusal from decisions involving
conflicts deemed significant, and ongoing review of fiduciaries’ conduct by disinterested parties.

Perhaps the best assurance of fiduciaries’ candor, care, and loyalty, however, lie with the character
and competence of the individuals who assume the role of fiduciaries. We may speculate that this
thought lies behind so many courts’ eloquent efforts to emphasize the element of obligation in the
fiduciary role.

Conclusion
This note has discussed the core principles governing fiduciaries in relation to those on whose
behalf they are entrusted to act: the principles of candor, care, and loyalty. It has not addressed the
question of principles that should govern the conduct of fiduciaries in their relations with other parties.
For instance, it has not addressed what, if anything, corporate executives owe to customers, employees,
suppliers, or the broader community. Nor has it taken up the vexing issue of whether the fiduciary
obligations of corporate directors and executives run to the corporate entity or to the corporation’s
shareholders—and if to the shareholders, which shareholders. Although theorists and commentators
have parsed this issue in various ways, the law itself varies from jurisdiction to jurisdiction. It is also
somewhat indeterminate. Perhaps the most common formulation in U.S. legal texts asserts that
directors and officers are fiduciaries for the corporation and its shareholders.17

However, this statement is subject to several qualifications. For example, in some jurisdictions, if a
board has decided to effect a transaction, such as a sale or break up, involving a transfer of corporate
control, the obligation to shareholders takes precedence. According to the Supreme Court of Delaware,
where more than half of all U.S. publicly traded companies are incorporated, the board is obligated to
maximize the value reasonably available to shareholders in such circumstances. 18 On the other hand,
some 31 states have tempered this judge-made rule by enacting statutes that permit boards to take into
account non-shareholder constituencies in such change-of-control or takeover situations.19 To take

15 Some have argued that a categorical ban on allowing executives to pursue corporate opportunities—even with the consent of
disinterested directors—is appropriate for public companies, while a more selective approach is appropriate for closely held
companies. See Victor Brudney and Robert Charles Clark, “A New Look at Corporate Opportunities,” Harvard Law Review,
vol. 94 (1981), pp. 997–1062.
16 On fair dealing in management buyouts, see Robert F. Bruner and Lynn Sharp Paine, “Management Buyouts and Managerial
Ethics,” California Management Review, vol. 30, no. 2 (Winter 1988), pp. 89–106.
17 See, e.g., Block, Barton, and Radin, op. cit., at p.107; American Law Institute, Principles of Corporate Governance, vol. 1 (1994),
§6.02.
18 Paramount Communications, Inc., v. QVC Network, Inc., 637 A.2d 34 (Del. 1994).
19 For a list of states with statutes requiring or permitting boards to consider the interests of other constituencies, see Guhan
Subramanian, “The Influence of Antitakeover Statutes on Incorporation Choice: Evidence of the ‘Race Debate’ and Antitakeover
Overreaching,” 150 U. Pa. L. Rev. 1795 (June 2002), at p. 1828.

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 304-064 The Fiduciary Relationship: A Legal Perspective

another example, when a company approaches insolvency, the board’s responsibility to creditors
becomes fiduciary in nature.

Moreover, while management fiduciaries are expected to conduct the corporation’s activities “with
a view to enhancing corporate profit and shareholder gain,” corporations are also “obliged . . . to act
within the boundaries set by law” and “may take into account ethical considerations . . . appropriate to
the responsible conduct of business” even if corporate profit and shareholder gain are not thereby
enhanced. In addition, the law permits companies to “devote a reasonable amount of resources to
public welfare, humanitarian, educational, and philanthropic purposes.” 20 The law thus contemplates
that corporate fiduciaries will be attentive to legal and ethical obligations not only to the company and
its shareholders, but also to other parties.

Within these broad parameters, directors and executives retain wide discretion so long as they
observe their duties as fiduciaries. Under the “business judgment rule,” courts will not second-guess
directors’ business judgment provided they have made an informed decision untainted by conflicts of
interest and reasonably believed to be in the best interests of the company and its shareholders. In
other words, courts look to see whether the company’s directors have acted in a manner consistent
with the loyalty, care, and candor traditionally expected of fiduciaries. If these standards have been
met, courts will respect the directors’ business judgment—even if it turns out to have been mistaken.

The fiduciary occupies a special position within the Anglo-American common law tradition. In
contrast to ordinary contractors who are permitted to act exclusively on their own behalf (within the
terms of their contract), the law requires fiduciaries to exert their best efforts on behalf of their
beneficiaries and, most especially, not to benefit themselves at their beneficiaries’ expense. This duty
arises not from the parties’ explicit agreement, but from the fiduciary status imposed by law.

20 American Law Institute, Principles of Corporate Governance, (1994), §2.01 (b), (c).

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