Litigation risk is an unavoidable aspect of running a business, but with thoughtful planning, exposure can be significantly reduced. From contractual disputes to employment disputes, potential legal challenges can arise at every stage of a company’s growth. Among these challenges, disputes involving fiduciary duties pose a particularly serious risk, potentially exposing both the business and its leaders to substantial liability and reputational harm. In this fifth installment of PilieroMazza’s blog series, “Managing Litigation Risk During the Business Lifecycle,” we explore fiduciary duties—what they are, how breaches occur, and how businesses can proactively limit exposure. Visit this link to access Parts 1-4 in this blog series.
What Are Fiduciary Duties?
Fiduciary duties are legal obligations that require certain individuals—typically directors, officers, and partners—to act in the best interests of another party, such as a company or its shareholders. These duties form the bedrock of corporate governance and reflect the trust placed in business leaders to make prudent and honest decisions.
Key fiduciary duties include:
- the duty of care, which requires informed and diligent decision-making;
- the duty of loyalty, which ensures that leaders avoid conflicts of interest and self-dealing;
- the duty of good faith, which emphasizes integrity and fair dealing;
- the duty of disclosure, which requires directors and officers to disclose relevant information to shareholders; and
- the duty of oversight, which requires leaders to appropriately oversee a company’s operations.
While these duties exist across corporations, LLCs, and partnerships, their scope can vary based on state law and the company’s governing documents.
Real-world examples underscore how fiduciary breaches can arise. For example, in the Tesla-SolarCity litigation, Tesla’s board faced allegations of breaching their duty of loyalty to the company and its shareholders by approving Tesla’s acquisition of SolarCity, a company closely tied to CEO Elon Musk. The court scrutinized whether conflicts of interest were properly disclosed and managed, illustrating how even prominent companies are not immune when fiduciary obligations are questioned.
Common Litigation Risks Related to Fiduciary Duties
Claims for breach of fiduciary duty are among the most frequent legal actions brought against business leaders. Stakeholders may allege that officers or directors acted in their own interests, failed to manage risks, or did not act in the company’s best interests. These claims often result in significant financial exposure and reputational damage for the company.
One notable example is the WeWork litigation, in which founder Adam Neumann was accused of using company resources for personal benefit, ultimately leading to shareholder suits and a highly publicized settlement. In another high-profile case, shareholders sued Citigroup’s directors for failing to adequately monitor and manage the company’s risk exposure during the subprime mortgage crisis. While the directors were ultimately shielded by the business judgment rule, the litigation highlights how even perceived oversight failures can lead to costly legal battles.
These examples remind companies that breaches, whether due to intentional misconduct or perceived mismanagement, can erode stakeholder trust and attract regulatory and media scrutiny.
Proactive Strategies to Mitigate Fiduciary Duty Litigation Risks
Companies can greatly reduce fiduciary duty risk by adopting robust governance practices and a culture of transparency.
Key steps include:
- Implementing clear governing documents—such as bylaws, operating agreements, and codes of ethics—that define fiduciary responsibilities, implement reporting systems, and outline procedures for addressing conflicts.
- Regularly reviewing and updating governance documents to reflect changes in law and best practices.
- Proactively disclosing conflicts of interest and documenting material business decisions to demonstrate good faith and informed judgment.
After the Tesla-SolarCity litigation, many boards have strengthened their procedures for vetting related-party transactions to avoid the appearance of conflicts. Notably, documenting key decisions and the basis for those decisions can be a company’s strongest defense in litigation.
Similarly, after facing oversight failures related to the 737 Max aircraft crash, Boeing enhanced its board-level safety oversight to better fulfill its fiduciary duty of care obligations.
Ongoing compliance programs, internal controls, and regular training also help reinforce fiduciary responsibilities across all levels of the organization. Companies that invest in clear policies, education, and accountability are better positioned to detect issues early and resolve them before they escalate into costly litigation.
Legal Remedies and Defenses in Fiduciary Duty Litigation
When fiduciary duty claims arise, leaders often have strong legal defenses. Chief among them is the business judgment rule, which shields directors and officers from liability for decisions made in good faith with reasonable care, even if the outcome is unfavorable.
Indemnification provisions and directors and officers (D&O) liability insurance offer additional safeguards by covering legal costs, settlements, and judgments, except in cases involving fraud or willful misconduct. Companies should review these protections regularly to ensure they adequately protect the company and its leaders and comply with state and federal laws.
Alternative dispute resolution (ADR) mechanisms, such as mediation or arbitration, can resolve fiduciary duty disputes more efficiently and discreetly than courtroom litigation. If a fiduciary duty claim arises, it is vital to involve experienced legal counsel immediately, preserve relevant records, and evaluate all available defenses.
Conclusion
Fiduciary duties play a critical role in responsible corporate governance and day-to-day business operations. Understanding these obligations and taking steps to meet them can help companies avoid costly disputes and maintain stakeholder trust.
While fiduciary duty claims cannot always be prevented, businesses that adopt clear governance policies, encourage transparency, and provide regular training are far better equipped to mitigate risk and demonstrate good faith if a claim arises.
A proactive approach to fiduciary responsibilities not only protects the company and its leaders, but it also supports long-term success and resilience. For questions about fiduciary duties or strategies to reduce litigation risk, please contact Todd Reinecker, Abby Baker, Kaavya Ramesh, Kirby Rousseau, or Akinyi Orinda, members of PilieroMazza’s Litigation & Dispute Resolution and Corporate & Organizational Governance practice groups.
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