Who should I trust? If your answer is no one, the world would be a more difficult and expensive place. Wherever someone does something on your behalf you might have to employ someone else to watch over them, and then someone else to watch over the someone else etc etc.
Over the centuries, equity law has picked out certain kinds of relationships where there is an imbalance of power or knowledge and called them fiduciary relationships. The “trust” is a prime example. A fiduciary has a duty of loyalty, of not taking an undisclosed benefit from the relationship, and of doing everything they can on the beneficiary’s behalf.
This is quite different from the normal situation in a market, where the rule is “caveat emptor”: let the buyer beware.
Fiduciary law versus contract law reflects the balance in life between being fair to others and letting others look after themselves: a balance that is forever changing in the law.
In an exciting climax to the episode, the two Steves debate how you pronounce “fiduciary”.
TRANSCRIPT
Stephen Parker
Last time we looked at Equity and how it is a separate strand of legal thinking from the common law. In this episode we look at two concepts developed by equity over the centuries; the fiduciary and the trust.
Stephen Bottomley
The common law generally assumes that we are capable of pursuing our own interests and acting on own behalf in our dealings with others. But in reality, that is not always the case. Often, we have to rely on someone else and trust them to look after our legal interests or put our wishes into effect. This might be because we don’t have the time to do it ourselves, or perhaps we don’t have sufficient knowledge or expertise in the matter.
Stephen Parker
This is where equity steps in. The law calls certain relationships of trust and reliance ‘fiduciary relationships’. You the listener have almost certainly been in a fiduciary relationship if you have money in a superannuation or pension fund, have a business partner, have inherited property under a will, own shares in a company, had legal advice on a sensitive matter or visited a doctor.
Stephen Bottomley
The word ‘fiduciary’ derives from Latin term ‘fiducia’, meaning ‘trust, confidence, reliance’ and those three words point to the core concern in this area of law. Fiduciary relationships are based on the idea that one person – called the fidicuary – is required to act exclusively in the best interests of another person- we’ll call them the ‘beneficiary’.
Stephen Parker
A lawyer is a fiduciary in relation to their client (the beneficiary). In Episode 7, when we looked at the Lawyer X scandal, the barrister breached all aspects of fiduciary duty by putting her own interests ahead of her clients, betraying their confidences and not doing her best for them.
A company director owes fiduciary duties to the company and its shareholders. And perhaps the prime example of a fiduciary is a trustee, who must act always and only in the interests of the beneficiaries. We’ll come back to trusts a bit later in this episode.
These are just examples. There is no definitive list of fiduciary relationships. The courts emphasise that the category of fiduciary relationships is ‘not closed’.
Stephen Bottomley
So how do these fiduciary relationships differ from the contract arrangements that we enter into every day? As we have said, the key thing about a fiduciary relationship is the trust and reliance that the beneficiary places in the fiduciary. This is the reason why the law imposes special and higher standards on a fiduciary than those that apply in contract law.
If you buy a car, it’s up to you to check it out. The principle of caveat emptor, or let the buyer beware, applies. This is the opposite of a fiduciary relationship. Yes, the law of contract and consumer laws may apply to put duties on the seller, but they aren’t of this standard, and they certainly don’t address the question of whether it is in your interests to buy the car in the first place.
Stephen Parker
Typically, a fiduciary is asked to exercise some discretionary judgment to make decisions on the other person’s behalf. For example, a person might go to a financial adviser and ask them to invest their money in whatever way the adviser judges best.
In exercising that discretion, the fiduciary is bound by legal duties and obligations that are unique to equity law. These duties are not written out in an Act of Parliament (although sometimes Parliament has passed laws that mimic the fiduciary duties). These are ‘judge-made’ duties – an example of how judges do make law.
Stephen Bottomley
For simplicity we can say that the two main types of fiduciary duty are the ‘no conflict’ and the ‘no profit’ duties. There are others, but we’ll keep it simple and stick with these two. Stevo, hearkening back to our episode on Justice, let’s toss a coin to decide who deals with either of these duties.
Stephen Parker
I like a good hearken – I’ll call heads
Stephen Bottomley
It’s tails. I’ll take the ‘no conflict’ duty. Sometimes this is called the duty of loyalty, and some lawyers say that it is the defining characteristic of any fiduciary relationship. It means that the fiduciary must not let their own personal interests interfere with their duty to the person on whose behalf they are acting. For example, a company director cannot set up a side business that competes directly with their company. Nor can the fiduciary allow the interests of any other person to conflict with their duty to their client. In the gendered language of the past, a fiduciary cannot serve two masters at the same time. So, for example, a solicitor cannot act for both the plaintiff and the defendant in the same case, or buyer and seller in the same conveyancing transaction.
The rule is based on the rather bleak assumption that people will always tend to favour their own interests over those of others, unless the law steps in to curb those instincts. As the courts have said, a fiduciary must meet standards that are higher than ‘the morals of the market place’.
Stephen Parker
The ‘no profit’ duty says that a fiduciary must not make any financial benefit or get any remuneration from the relationship, unless the person they are acting for has given their consent. To some extent this duty overlaps with the no conflict duty.
One aspect of this duty is the fiduciary’s obligation to account to the other person for any money they do receive in performing their work. This is particularly important for the lawyer acting for a client. If the lawyer receives money from or on behalf of the client they must hold that money in a trust account, quite separate from any personal accounts the lawyer has.
Stephen Bottomley
These duties address a well-known problem; what economists call the problem of “agency costs.” As we’ve said, they typical feature of these relationships is that the beneficiary or client has much less knowledge or expertise than the fiduciary, is not in a position to look after their best interests and is not well-placed to supervise the fiduciary.
In theory the beneficiary could engage a second person, to keep an eye on the first one, but on that basis won’t they have to engage a third one to keep an eye on the second one, etc etc?
To avoid these costs, and genuinely to protect the vulnerable, the law imposes these duties, requiring the fiduciary to put the beneficiary’s interests ahead of their own.
If they breach these duties, the penalties are more severe than just compensating for the lost benefit of a contract. It’s a technical area, but the level of damages can be higher and specific orders can be made for the return of property or directing the future behaviour of the agent.
Stephen Parker
Trusts are the primary example of these fiduciary duties in action. In its simplest form, a trust involves three people. There is the person who creates (or declares) the trust (in law, called the settlor). That person owns some property – it might be land, shares, money in a bank account. They transfer the legal ownership of that property to another person, called the trustee, on the basis that the trustee will manage the property for the benefit of a third person called the beneficiary.
Stephen Bottomley
In episodes 12 and 13 we talked about the difference between common law and equity. That difference is important in a trust; the trustee holds the common law rights to the property – what lawyers call the legal title; the beneficiary’s interest in the property is governed by equity law – what lawyers call a beneficial or “equitable” title.
Stephen Parker
We’ve described the simplest case. Trusts are quite flexible arrangements, however. So, there can be multiple beneficiaries with different rights. One person can be both the settlor and the trustee, or settlor and beneficiary. A trust can be created intentionally (an express trust), or a trust can be construed by the courts when a person is dealing with property in circumstances it would be unconscionable for them to retain the benefits of that dealing (a constructive trust).
Trusts can be used for tax planning, financial management, to protect family assets, to structure a business, amongst many uses. All are governed by the fiduciary principles that we outlined earlier.
Stephen Bottomley
Like so many other aspects of our law that have their origins in earlier centuries, the law on fiduciary relationships is facing unique challenges as the context in which it operates changes dramatically. The growth of AI is an example. Investors today can go online and seek investment advice and financial management services from artificially intelligent investment advisers (or robo-advisers). Market regulators in Australia and the US treat robo-advisers as fiduciaries in relation to the online clients.
Stephen Parker
A living example of “law in context”.