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Implications of Breach of Fiduciary Duty Suits

Recognizing that design professionals may face breach of fiduciary duty suits, the question becomes one of what it means in terms of risk management. That is, what are the insurance, liability, and related implications of such a suit?

1. Insurance Coverage Issues

One of the problems for a design professional is that the typical errors and omissions grant of coverage will only cover its "negligent acts, errors or omissions." Also, intentional acts may be specifically excluded by the policy, and there is a possibility that some policies may also foreclose coverage for "violations of law." Of course, most errors and omissions policies are manuscript in form; so each insurer will likely have its own language and approach to the coverage issues.

The design professional, if sued for breach of fiduciary duty, will most probably also be sued on other legal theories, e.g., professional malpractice and breach of its contract, the latter theory frequently involving an allegation of a breach of the professional standard of care, i.e., the aforesaid malpractice. [29] This is extremely important because under the law of most jurisdictions, if any of the theories advanced against the policyholder is potentially covered, a complete defense will be due under the policy of insurance. [30]

The defense duty is applicable because some of the allegations are "potentially covered," but there are jurisdictions, such as California, that go so far as to preclude an insurer from indemnifying for a so-called "willful act," i.e., an intentional one, even though a defense may be due the insured for all causes of action. [31] That is, if the trier of fact determines that "intentional" misconduct on the part of the insured is the basis for its liability, the design professional can be denied any right to indemnity, [32] but its defense costs may still be the insurer's responsibility.

On a related issue, if a breach of fiduciary duty is willful, there is a chance, in more than one-half of the states, that punitive damages may be available.33 Punitive damages are often not insurable, and even if they are, some policies have specific exclusions which permit the carrier to avoid paying such awards.

A breach of fiduciary duty may involve intentional misconduct, as in the case of actively fraudulent behavior underpinning the breach, but that is not necessarily the case. One who breaches a fiduciary duty may engage in conduct that involves a conflict of interest that is not the product of willful behavior. [34] It is, of course, another matter entirely where a conflict amounts to professional malpractice; that is likely a question for an expert witness, and beyond the scope of this paper.

If the trier of fact finds a fiduciary duty which is also characterized as a negligent act, error or omission, then insurance coverage will apply. In any event, suffice it to say that in many jurisdictions whatever "label" the plaintiff may put on its suit allegations (whether breach of contract or breach of fiduciary duty or something else) such label will likely not control the question of potential insurance coverage, as coverage in most jurisdictions depends upon the substance of the facts pled. [35]

2. Litigation Considerations

The reason for a plaintiff to sue a design professional for breach of fiduciary duty may be a completely valid one, i.e., an honest and good faith belief that the design professional owed it a fiduciary duty, and breached that duty, with resulting damages. On the other hand, such a position, taking into account the numerous decided cases discussed above, would seem improbable in relation to a standard design professional services agreement and how those services are typically performed by the professional; yet, breach of fiduciary duty allegations seem to be on the rise in litigation. So what is their practical effect in an action against a design professional?

(a) Inflaming A Jury

It is entirely possible a jury, on initially hearing about a breach of fiduciary duty, could be inclined to think that a design professional who might have behaved in such an unlawful or untrustworthy fashion is a bad person/firm. When the jury pool is examined by counsel for the design professional, the fiduciary duty issue should be brought up by the design professional's lawyer, in voir dire, or when the judge asks a series of initial questions of the prospective jury to be sure they can provide a fair hearing for the parties. [36] The danger is that the more the jury learns about the breach of fiduciary duty concept, both before and during the course of the evidentiary and argument phases of the trial, the greater the likelihood it may work against a design professional charged with such misconduct. The work done depends on may factors: attorney issue emphasis, witness credibility and likeability, nature of jury instructions, nature of alleged harm to the plaintiff, just to name a few.

The possibility of undue prejudice against the design professional is a serious matter. Of course, there is never any objective way to measure the quantum of harm done by the fact that breach of fiduciary duty is alleged or argued. Who can say whether or not the jury will keep an open mind and be fair, having heard the ugly charging allegations and the plaintiff's lawyer's opening statement, not to mention what a fiduciary is by definition? Given that it may not take a large amount of evidence to permit a finding of breach of fiduciary duty (if the theory actually goes to the jury), the prejudice factor is of major concern for collnsel's trial preparation (which is a topic beyond the scope of this presentation). [37]

(b) Forcing An Excessive Settlement?

As the above discussion suggests, the very fact that a party is sued for breach of fiduciary duty carries with it potentially damning consequences. That, of course, will put substantial pressure on the insured design professional, and its counsel, to negotiate an arguably excessive settlement, but one within the policy limits.

(c) Policy Limit's Demand Situation?

An insurer may well face a demand within the policy limits that might be perceived as relating, principally, to a non-covered claim, but the insured design professional may disagree on allocation. If the insurer declines to settle, and a judgment against the insured comes in above the available policy limits, the carrier would potentially wind up having to pay the entire judgment and perhaps even the insured's economic damages resulting from the rejection of the settlement offer. [38]

The breach of fiduciary duty allegations thus carry with them a possibility that an insured, and perhaps its carrier, would be willing to pay much to settle a case, given the risk of a very substantial judgment, and the potentially negative consequences of rejecting of an offer to settle.

(d) Further Considerations

The above discussion of settlement prospects for the most part is limited to that situation where the breach of fiduciary duty and the professional malpractice allegations both involve the same set and quantity of damages sought by the plaintiff. In the alternative, it is also possible that the nature of the lawsuit against the design professional may be sufficiently complex that professional malpractice damages are distinct from those for breach of fiduciary duty, i.e., part of the suit is clearly "potentially covered," while part of it may not be, but still a defense is due the insured, in most
states, for the entirety of the action. [39]

The situation could also be one where the insurer is willing to settle the entirety of the case, including a sum for a not-potentially-covered claim, [40] but it reserves the right
to proceed back against the insured in a separate action for declaratory relief as to the allegedly non-covered portion of the settlement. [41]

(e) Cost Of Defense Issue

Another point which is possibly related to these issues is a situation where the limit of the errors and omissions policy may not be sufficient for indemnity purposes, and the policy has an "expense within limits" feature as is commonly the case with these policies. In any event, the breach of fiduciary duty theory could be so expensive to defend, over and above the malpractice defense part of the claim, that the insured is at special risk because of the expanded type of defense that is required. [42] In such a scenario like this, an early settlement may be indicated in a "high exposure" case, taking into account that the defense costs will substantially invade the indemnity limit likely available after a proper defense.

We believe that all of the above points operate equally insofar as architects and engineers are concerned; however, it would appear that engineers, by the nature of their professional undertakings, are less susceptible to suits containing fiduciary duty claims. Still, one can imagine that on a large project where the engineer is under contract to the owner and the engineer has a far reaching range of professional duties, it too could face the same types of breach of fiduciary duty allegations that architects encounter in the decided cases. Moreover, the suggestions made above on how design professionals can guard against possible suits for breach of a fiduciary duty should apply with equal force to all design professionals.