Are Fiduciary Duties Different When Partners Are Involved?

• The fiduciary duties of loyalty and care may be different when a partnership is involved, rather than a corporation.

• The duties that shareholders in a corporation owe to each other are different than those owed in a partnership.  Shareholders have more discretion to consider their own interests first. 

• Understanding the duties owed by those in a business is important to avoid liability to business partners

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This fight between accountants in practice together demonstrates the different ways that courts will look at corporations on the one hand and partnerships, an entity that the what the law calls an unincorporated business association.  Limitied liability companies are also unincorporated business assocations.

The case is also another lesson in the course: Bad Things Happen to People Who Don’t Bother with Contracts When They Start a Business with Others.

Fiduciary Duties Owed Between Partners

The takeaway from this case is that the duties that shareholders owe to each other are different from the duties that partners and LLC members owe to each other. That is not to say that there are no duties between shareholders in a closely held corporation, but those duties are not presumedto exist.  They have to be proven from the circumstances.  We will discuss some of the differences as we go through the details of the case.

Why does this matter?  Because understanding the duties owed by those in a business is important to understanding the rights and liabilities of those involved, Those who have fiduciary obligations are personally liable when they ignore these duties.  And those who are owed the fiduciary duty have a right to hold the fiduciaries responsible.

Accounting Partnership Dissolves

This dispute between the accountants turned into a lawsuit. The combatants were involved in Forward LLP, a poorly documented accounting partnership. Kristina Edwards and Sean Forman were locked out of the business, but they went to court and got temporary restraining orders (TROs) by the trial court.

These allowed them to get back to using  Forward software, email, Google Drive, and client files and communications at the outset of the case. The defendants appealed that decision and lost.

The case we are looking at is from the California Court of Appeals, Edwards v. Forward, but the legal principles here will apply in most states, including New York and New Jersey, where I practice.

Former Partners Dispute Ownership of Data

The main disagreement was about a deal between the plaintiffs, who were practicing as Edwards CPA, Inc., and John Ward, who started Forward with a partner in 2015. Ward, Edwards, and Forman all agreed to have their own businesses become partners of Forward. Forward would then own all of Forward’s profits, losses, cash, and debts and distribute profits to the partners.

The dispute started in 2022.  The plaintiffs contended that Ward modified the company’s payment processes, causing Edwards and Forman to miss out on a payment that they claimed of $40,991. Ward then locked Edwards and Forman from Forward records and files, such as client files, and ProSystems tax software in January 2023.

In the lawsuit that followed, the court ultimately issued two TROs, finding that injunctive relief was required to prevent irreparable harm to the plaintiffs.

Relying on a case involving lawyers in a law firm dispute, the defendants contended that the court had improperly changed the possession of accounting client files without the consent of affected clients, incorrectly concluded plaintiffs were likely to succeed, and that the TRO was broader than the relief they should get for the alleged in their complaint.

The biggest error made by the court, according to the defendants, was to violate the legal principle that a court cannot change who possesses property as part of the emergency relief given with a TRO.

Court Distinguishes Shareholders from Partners in Partnership

On appeal, the court said that while that perhaps might be the case with a corporation, not so with a partnership. There is a difference between the relationship between shareholders and the relationship between partners. The appellate court rejected the argument in large part because of the difference between corporations and partnerships, and more particularly between shareholders and partners.

Unlike shareholders, the partners in a partnership owe each other the duties of candor and loyalty. The common law recognizes that when persons execute a contract that has the legal effect of creating a partnership, they acquire rights and subject themselves to duties growing out of their fiduciary relationship.

The defendants said that because Edwards and Forman were no longer partners and had dissociated themselves under partnership law, so they were not entitled to access to Forward’s files or email systems.  First, Forward said had no right to that property, and, second, Forward, as an accounting firm, cannot disclose client tax information without the client’s consent.  The court rejected that claim, finding that the Forward defendants did not explain how restoring an accountant’s access to information to which they previously had access was unlawful “disclosure” under these circumstances.

The presumption here was that, as partners, all of the parties to the case had fiduciary duties to each other.  That means in practical terms that they could not just consider their own interests in managing the business.

Duties of Shareholders Oftenare Different than Duties of Partners

Shareholders as a rule do not owe fiduciary duties to other shareholders or to the corporation.  The presumtpion is that they leave the management of the business to the directors and officers who have an obligation to run the business in the best interest of the shareholders.

That is just a presumption, however.  As soon as shareholders get involved in the management of the business, they take on fiduciary obligations.  Often, they are also the officers and directors.  But even when that is not the case, when shareholders exercise control over a business and have the ability to make decisions that affect the financial interests of the other shareholders, they will have duties to act not just in their own interests but in the interests of the company and the other shareholders.

You see similar circumstances in the management of limited liability companies.  Some companies are managed directly by their members.  This is often the case when there is no operating agreement in place.

Limited liability companies may also be managed by managers. The managers can be named in an operating agreement or elected by the members, and like corporate directors or officers, they control the day-to-day operations of the business.  When the limited liability company is managed by the managers, the members will typically not owe the company or each other any fiduciary duties.  It is the same principle; without control, there is no fiduciary duty.  The LLC member with no management responsibility only has to think of his or her own interests.