Remedies for Breach of Fiduciary Duty: Disgorgement, Fee Forfeiture and More

Two kinds of remedy

Remedies for breach of fiduciary duty fall into two groups, and the distinction explains most of what follows. Legal remedies compensate the plaintiff for a loss: actual damages, measured by what the breach cost. Equitable remedies protect the relationship of trust by taking away what the fiduciary gained: disgorgement, forfeiture, constructive trust, rescission. The Texas Supreme Court has said repeatedly that the equitable remedies exist to deter disloyalty, not to compensate, which is why they are available even when the plaintiff cannot prove a loss.

This article covers the remedies. What the duty is and who owes it are covered in what is a breach of fiduciary duty in Texas.

Actual damages

A plaintiff who lost money because of the breach recovers it. The measures are the ordinary ones: the amount diverted, the overpayment to the fiduciary's affiliate, the value of the opportunity taken, lost profits proven with reasonable certainty. Where the fiduciary's conduct also amounts to fraud, the fraud damages measures (out-of-pocket or benefit-of-the-bargain) are available on that claim.

Actual damages are the only remedy that depends on proof of the plaintiff's loss. Everything below can be awarded without it.

Disgorgement of profits and benefits

A fiduciary who profits from the breach must give up the profit. The principle is old in Texas law. In Kinzbach Tool Co. v. Corbett-Wallace Corp. (Tex. 1942) an employee secretly took a commission from the other side of a transaction he negotiated for his employer; the court held the employer could recover the commission even though the deal was otherwise fair and the employer could show no loss. The rule is that a fiduciary must account to the principal for everything received through the relationship, and the principal, not the disloyal agent, is entitled to it.

In ERI Consulting Engineers, Inc. v. Swinnea (Tex. 2010) the Texas Supreme Court extended the remedy to the consideration paid under a contract procured by a fiduciary's fraud: a partner who fraudulently induced a buyout while owing fiduciary duties could be made to disgorge what he was paid for his interest, as an equitable remedy distinct from exemplary damages. The court held that disgorgement of contractual consideration is available for breach of fiduciary duty and left the trial court discretion over the amount, guided by the gravity of the breach.

Disgorgement reaches: secret commissions and kickbacks; profits of a competing business built on the fiduciary's position; markups taken by an affiliate; compensation received for the disloyal transaction; and, where the fiduciary bought what they should have acquired for the principal, the profit on resale.

Fee forfeiture

A fiduciary who was paid for services during a period of disloyalty may be ordered to forfeit the fees. In Burrow v. Arce (Tex. 1999) the Texas Supreme Court held that clients could obtain forfeiture of their lawyers' fees for breach of fiduciary duty without proving that the breach caused them any actual damages. The court explained that the remedy protects the relationship by removing the incentive for disloyalty, and it set out the approach: the court, not the jury, decides whether forfeiture is appropriate and how much, considering the gravity and timing of the breach, its effect on the value of the services, and whether the fiduciary acted willfully. Forfeiture may be total or partial.

Although Burrow involved attorneys, Texas courts apply the remedy to other fiduciaries who are compensated for their services: managers, agents, trustees and officers. A managing partner who paid himself a management fee while diverting company business is a candidate for forfeiture of that fee, independent of the damages the diversion caused.

Example

Suppose the manager of a Dallas real estate fund, paid a 2 percent annual management fee by the investors, directs the fund's brokerage business to a firm in which he holds an undisclosed interest and receives a share of the commissions. The investors can seek three things at once: actual damages equal to any excess commission the fund paid; disgorgement of the manager's share of the commissions, whether or not the fund overpaid; and forfeiture of some or all of the management fee for the years in which he was disloyal. Only the first requires proof that the fund lost money. The judge decides the forfeiture; the jury decides the damages.

Constructive trust and tracing

When a fiduciary acquires property with the plaintiff's money or through the breach, a court may impose a constructive trust on the property, declaring that the fiduciary holds it for the plaintiff. The remedy follows the asset: into real estate bought with diverted funds, into the shares of a company the fiduciary built on a usurped opportunity, into accounts where the money landed. It matters most when the fiduciary is insolvent, because a constructive trust gives the plaintiff the specific property rather than an unsecured claim. The mechanics are covered in recovering stolen business assets through constructive trusts.

Rescission and setting aside transactions

A self-dealing transaction between a fiduciary and the person they serve is voidable at the election of the person served, unless the fiduciary proves it was fair and fully disclosed. The court can set the transaction aside, return the parties to their prior positions, and order an accounting. Where the fiduciary sold the plaintiff an asset, the plaintiff may rescind and recover the price; where the fiduciary bought the plaintiff's interest cheaply, the plaintiff may recover the interest or its true value.

Injunctions, receivers and accountings

Because fiduciary breaches are often continuing, a court may enjoin the conduct, order the fiduciary to account for all dealings with the plaintiff's property, remove the fiduciary from a management position where the governing documents or statute allow, or appoint a receiver over an entity whose management has been disloyal. These remedies are usually sought early, before the money is gone; the process is described in receivership and judicial dissolution in Texas.

Exemplary damages

Exemplary damages are available, but on different terms than the equitable remedies. Under section 41.003 of the Civil Practice and Remedies Code the plaintiff must prove by clear and convincing evidence that the harm resulted from fraud, malice or gross negligence, and the jury must be unanimous. Section 41.001 defines fraud for this purpose as fraud other than constructive fraud, so a breach of fiduciary duty that involved no actual deceit or ill intent, however disloyal, does not by itself support an exemplary award. A breach accomplished through lies, concealment or an intent to injure does.

The cap in section 41.008 applies: the greater of two times economic damages plus noneconomic damages up to $750,000, or $200,000. The cap is lifted where the conduct amounts to certain felonies committed knowingly or intentionally, and the list includes misapplication of fiduciary property, theft at the third-degree felony level or higher, forgery and commercial bribery, which describes a good deal of fiduciary misconduct. The details are in punitive damages for fraud in Texas. Disgorgement and forfeiture are equitable, not punitive, and are not subject to the cap.

Attorney's fees

Texas has no general statute awarding attorney's fees on a breach of fiduciary duty claim, and the American rule applies: each side pays its own. Fees become recoverable through other routes: a fee-shifting clause in the partnership or company agreement, a companion breach of contract claim, a statutory claim such as the Texas Theft Liability Act where its elements are met, or a derivative action in which the entity's recovery supports a fee award. Fee forfeiture, discussed above, is a different concept: it returns fees the fiduciary was paid, rather than paying the plaintiff's lawyers.

Choosing among the remedies

Remedies are chosen, not stacked without limit. A plaintiff cannot recover the same dollar twice, and some remedies exclude others: rescinding a transaction and keeping its benefits are inconsistent. The sequence also matters. Equitable remedies are decided by the judge after the jury's findings, and the evidence that supports them, especially tracing and the fiduciary's gain, must be developed during discovery. A litigator will usually plead every available remedy and narrow the election after the facts are known. Tina Wysk represents plaintiffs and defendants in fiduciary duty litigation in Dallas state and federal courts.