FIDUCIARY JUDGMENT RULES.

• Author: Velasco, Julian

TABLE OF CONTENTS INTRODUCTION 1399 I. THE PROBLEM 1402 A. A Primer on Fiduciary Law 1402 B. The Attraction 1405 C The Drawbacks 1408 D. The Desired Solution 1410 II. PRIMER ON CORPORATE LAW 1411 A. Fiduciary Law Principles 1412 B. Idiosyncrasy and the Business Judgment Rule 1414 C. Conflicts of Interest in Corporate Law 1421 III. FIDUCIARY WANNABES 1422 A. Corporate Law Model Does Not Work 1422 B. Examples 1426 1. Friends 1426 2. Parents 1431 3. Politicians 1436 CONCLUSION 1444 INTRODUCTION

Fiduciary law is not so much a separate area of law, like contracts and torts, as it is a set of legal principles that is incorporated in other substantive areas of law, such as trusts, agency, and corporate law. (1) Fiduciary law principles are distinctive in many ways. First, fiduciary law employs strong moral rhetoric that is uncharacteristic outside of criminal law. (2) Thus, for example, it tends to demand the "utmost good faith" and "undivided and unselfish loyalty" of fiduciaries. (3) Second, fiduciary law principles impose demanding and pervasive duties upon fiduciaries, (4) often utilizing prophylactic rules to secure their objective. (5) Finally, fiduciary law opens up strong equitable remedies that are generally unavailable to plaintiffs in other areas of law. (6)

Characteristics such as these make fiduciary law attractive to jurists in other areas of law. It is not surprising to find lawyers and legal scholars seeking to expand the reach of fiduciary law principles into new relationships and new areas of law. Three particularly interesting examples will be considered in this Article (7)--friends, (8) parents, (9) and politicians (10)--but there are many others. (11)

The problem with expanding the reach of fiduciary law into new areas of law is that it often does not quite work. Fiduciary law is very demanding. While it works well in traditional fiduciary relationships, it would be much more difficult to apply in other relationships. Nevertheless, many remain interested in extending fiduciary law principles into new areas of law and seek solutions to these difficulties.

One technique that is often employed is a resort to the corporate law model. One of the widest-known doctrines of corporate law is the business judgment rule, which applies a deferential standard of review to director actions that are undertaken in good faith. (12) It is, essentially, a policy of underenforcement of fiduciary duties. (13) Advocates of expanding the reach of fiduciary law tend to point to the business judgment rule as a solution. Although a strict trust law model of fiduciary law could not be adopted in other areas of law, they argue that the more flexible corporate law model could. Thus, they often call for a "fiduciary judgment rule"--a "friendship judgment rule," (14) a "parental judgment rule," (15) or a "political judgment rule" (16)--that would subject the new fiduciaries to deferential judicial review, thus overcoming the difficulties posed by demanding fiduciary duties.

Unfortunately, these arguments are based on a deficient understanding of the business judgment rule. The business judgment rule may be an abstention doctrine, (17) but it is not an arbitrary one. Rather, it represents a prudential policy decision that balances competing interests in a special context. It is a practical response to the idiosyncratic needs of the business setting.

In this Article, I argue that the business judgment rule cannot serve as a model for indiscriminate expansion of fiduciary law principles into new areas of law because its theoretical underpinnings tend to be absent from other relationships. Thus, if fiduciary law principles are to be expanded into new areas of law, other solutions must be found for the difficulties that will be encountered in doing so. My argument proceeds as follows. In Part I, I explain the difficulty of extending fiduciary law principles into new areas of law. I start with a short primer on fiduciary law. I then elaborate on the attraction of fiduciary law principles. Finally, I explain the difficulty of extending them to new relationships and new areas of law. In Part II, I provide a short primer on corporate law. I show how corporate law presents a typical fiduciary situation, as well as how it is idiosyncratic. I explain how the business judgment rule responds to its circumstances, as well as the limits of the business judgment rule--in particular, how it does not apply to conflict of interest situations and how the corporate law model deals with conflicts. In Part III, I argue that the corporate law model does not work in most other contexts. I do so first in general principle, and then with respect to the examples of friends, parents, and politicians. I conclude by addressing the limits of this Article. I am not arguing that fiduciary law cannot be expanded or that a rule of deference is always inappropriate. My argument is only that the business judgment rule, properly understood, cannot be the basis for overcoming the difficulties entailed in expanding fiduciary law indiscriminately into new areas.

1. THE PROBLEM

   This Part explores the concern that forms the basis for this Article: the difficulty of extending fiduciary law principles into new areas of law. Section A provides a short primer on fiduciary law. Section B explains why fiduciary law principles are so attractive to jurists. Section C explains why it is not so easy to extend fiduciary law principles to new relationships and new areas of law. Section D sets forth what advocates are looking for from fiduciary law: the benefits of moral rhetoric and strong remedies without the drawbacks of pervasive duties.

   1. A Primer on Fiduciary Law

      As previously mentioned, fiduciary law might better be understood as a set of legal principles than as a separate area of law. (18) These principles are implemented in other substantive areas of law. Examples of areas of law that are heavily governed by fiduciary law principles include trust law, agency law, corporate law, and professional practice. (19) Each implementation of fiduciary law is arguably unique, adapting the general principles to meet the needs of the specific context at hand. (20) As a result, it is difficult to make detailed claims about fiduciary law. (21) Thus, some scholars have expressed skepticism about whether fiduciary law can be adequately defined. (22)

      Nevertheless, the general principles that animate fiduciary law are easily discernible. At the most general level,

      [a] fiduciary relationship is a legally recognized relationship in which one is [entrusted with] power over the interests of another, who thereby becomes vulnerable to abuse. Although such relationships are risky, they can also be very beneficial. In order to encourage and police such relationships, the law imposes a duty on the first party--the fiduciary--to act in the interests of the second party--the beneficiary.... Thus, the raison d'etre of fiduciary duties... is the protection of the beneficiary from abuse at the hands of the fiduciary. (23) The biggest issue in fiduciary law is determining which relationships ought to be considered fiduciary in nature. Ideally, the law would adopt a definitional approach. There would be a legal definition, and relationships that fall within the definition would be deemed fiduciary, and those that do not would not. Unfortunately, there is no such definition in the law. (24) Legal scholars have proposed various possibilities. One leading definition comes from Professor Paul Miller's fiduciary powers theory: "A fiduciary relationship is one in which one party (the fiduciary) exercises discretionary power over the significant practical interests of another (the beneficiary)." (25) Another comes from Professor D. Gordon Smith's critical resource theory: "[F]iduciary relationships form when one party (the 'fiduciary') acts on behalf of another party (the 'beneficiary') while exercising discretion with respect to a critical resource belonging to the beneficiary." (26)

      Although a definitional approach would be ideal, the law tends to take a status-based approach. (27) Under this approach, there is a finite set of relationship types that have been deemed fiduciary in nature. (28) Other relationships generally are not considered fiduciary. (29) However, while courts tend to be reluctant to expand the official canon, it is possible for new relationships to be added to the list if they are sufficiently analogous to the established categories. (30) In addition, courts sometimes find particular relationships that do not fall within any of the recognized categories to be fiduciary on an ad hoc basis. (31) They do so when the facts indicate that a relationship ought to be protected by fiduciary law principles. (32) However, this ad hoc approach is controversial. (33)

      Once a relationship is deemed to be fiduciary, the law imposes a special obligation on the fiduciary: a duty to act in the interests of the beneficiary in all matters related to that relationship. (34) In other words, fiduciaries are obligated to behave in a self-denying manner. (30) This duty is often bifurcated into a duty of loyalty and a duty of care, although other duties could be enumerated. (36) Under the duty of loyalty, a fiduciary is prohibited from acting counter to the interests of the beneficiary. (37) The principle is so important that it is generally protected by prophylactic rules requiring the fiduciary to avoid conflicts of interest. (38) Under the duty of care, a fiduciary must act diligently, exercising an appropriate level of care and skill. (39) The duty of care is not usually enforced with the same sort of prophylactic rules as the duty of loyalty. (40)

      Remedies in fiduciary law are "comprehensive and tenacious." (41) This stems from the fact that fiduciary law is situated in equity rather than in law. (42) As a result, breaches of fiduciary duty are not limited to normal measures of damages. (43) In...