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September 16, 2014 Articles

The Risks of Lurking Fiduciary Duties in Business Transactions

In joint ventures, crafting provisions addressing fiduciary duties in all agreements is imperative.

By William R. Taylor and Joshua L. Fuchs

Many companies that pool resources, share expertise, or apportion the risks and costs associated with new business endeavors enter into a wide variety of formal and informal business relationships in which they agree that they do not intend to create a partnership or joint venture. But can companies effectively disclaim the existence of a joint venture or partnership, and the fiduciary obligations that these relationships entail, or will courts disregard these contractual disclaimers and look to the parties’ course of conduct when determining whether a partnership or joint venture exists?

While the answer to this question varies depending on the jurisdiction, companies relying on disclaimers need to be aware that their subsequent conduct, particularly with respect to how they hold themselves out to third parties, may support allegations that a joint venture or partnership did exist and that the attendant fiduciary duties between the parties were violated.

These scenarios often occur when two companies discuss forming a joint venture or partnership but never enter into a formal agreement. The parties may sign preliminary agreements, such as confidentiality agreements or letters of intent, but set out in those documents that they have no binding or enforceable obligations to each other. Others may agree to jointly undertake some limited activity but include provisions in documents stating that they do not intend to create a partnership or joint venture.

The problem often arises when, perhaps believing that the relationship has run its course and seeing no prohibitive contractual provisions, one party decides to pursue related projects with new entities. The other party, upset that it was cut out of the additional opportunities, then claims that the parties’ relationship rises to the level of a joint venture or partnership and that  fiduciary duties are owed. In these situations, the complaining party alleges that the parties are not free to engage in so-called side dealing with a third party and that any such activity constitutes a breach of fiduciary duty.

In many cases, contractual provisions eliminating or limiting fiduciary duties may preclude claims like these. However, some courts have looked beyond contractual disclaimers when determining whether fiduciary duties exist. Accordingly, companies should be aware of potential fiduciary duties, not just at the contract drafting phase but also throughout the course of the relationship. This is particularly true when the parties have not clearly defined the scope of their relationship in their agreements. Lack of awareness of these lurking fiduciary duties can lead to costly and protracted litigation.

Fiduciary Duties and Business Tort Liability In general, a fiduciary is bound to act for the benefit of the other and owes duties of good faith, trust, confidence, and candor. A breach of fiduciary duty claim may be asserted where the relationship of trust and confidence has been violated and the plaintiff can show that the breach proximately caused him or her damages. This claim, however, is not without limits. For example, many jurisdictions require the plaintiff to prove that the nature and scope of the fiduciary duty extended to the subject matter of the claim. Courts have also noted that a fiduciary duty must come from a preexisting relationship beyond mere business transactions. See Meyer v. Cathey, 167 S.W.3d 327, 331 (Tex. 2005). In addition, many courts employ some form of the economic loss doctrine, which typically provides that a party that suffers only economic harm—as opposed to personal injury or property damage—may not recover damages for that harm based on a tort theory but may only recover under a contract claim. See, e.g.Town of Alma v. AZCO Constr., Inc., 10 P.3d 1256, 1262 (Colo. 2000). Although the application of this doctrine varies depending on the jurisdiction, the economic loss doctrine may prevent a plaintiff from asserting additional business tort theories, including a breach of fiduciary duty claim, when recovery under a contract is possible.

Notably, when a plaintiff claims that it is owed a fiduciary duty, the plaintiff will likely seek damages based on a multitude of business tort theories in addition to any breach of contract claims it may have, which dramatically expands the scope of liability for a defendant. The potential business tort theories that can be associated with a breach of fiduciary duty claim come in multiple forms.  For example, when a fiduciary fails to disclose certain types of information, a plaintiff may assert constructive fraud. This claim is common in this context because a fiduciary has a positive duty to disclose material facts.

Many jurisdictions have also recognized the tort of aiding and abetting, or tortious inducement of, a breach of fiduciary duty. This tort may be asserted against a party who knowingly participated in a breach of fiduciary duty. The jurisdictions that recognize this tort typically require a party to have actual knowledge that a breach of fiduciary duty is occurring and often require the participation in the breach to be substantial or akin to proximate causation. See Sender v. Mann, 423 F. Supp. 2d 1155, 1176 (D. Colo. 2006).

There are a number of other potential theories of liability that plaintiffs employ in cases involving alleged fiduciary duties, including unfair competition and violations of various state statutes. Notably, under aiding and abetting or tortious inducement theories, a plaintiff may attempt to sue lawyers, financial advisors, and purchasers and sellers who participated in a deal that excluded the plaintiff.

Joint Ventures A joint venture is typically defined as a business partnership formed for a limited purpose or a specific activity. When a joint venture is formed, the parties owe each other fiduciary duties. While parties often create an entity in which they share ownership to carry out a specific activity, thus formally creating a joint venture, if no such formal agreement exists, determining whether a joint venture has been created can be a fact-intensive and complex analysis.

Several jurisdictions have set forth similar factors to determine whether or not a joint venture exists, including (1) a community of interest in the venture, (2) an agreement to share profits and losses, and (3) a mutual right of control or management of the enterprise. Joint venture or partnership status will sometimes be imposed on entities holding themselves out as if they were joint venturers, even if they did not intend to create a joint venture or partnership. SeeMont. Farm Serv. Co. v. Marquart, 578 P.2d 315, 317 (Mont. 1978). Some jurisdictions require that all of the factors be present, while other jurisdictions take a more flexible approach. Compare Breckenridge Co. v. Swales Mgmt. Corp., 522 P.2d 737, 739 (Colo. 1974) (all three elements of joint venture must exist), with Ingram v. Deere, 288 S.W.3d 886, 895 (Tex. 2009) (holding that the statutory test for partnership formation, which also applies to the formation of joint ventures, contemplates a “less formalistic and more practical approach to recognizing the formation of a partnership,” as compared with the common-law test requiring proof of all five factors of the Texas Revised Partnership Act). But the analysis becomes even more difficult when the parties have entered into a series of contracts and have a relationship spanning several years.

For example, what level of “control or management” of the enterprise do courts require? The Fifth Circuit in Sparks v. Baxter, 854 F.2d 110, 113 (5th Cir. 1988), held that there was evidence to support the jury’s finding that the parties were joint venturers in their oil and gas projects where the parties “worked in tandem, with coordinated efforts,” and one party “arranged for potential investors” while another party “made the presentations.” In general, according to the Fifth Circuit, “there was a mutuality of control of the activities.” In Blocker Exploration Co. v. Frontier Exploration, Inc., 740 P.2d 983, 988 (Colo. 1987), however, the Colorado Supreme Court found that “Blocker’s role was that of an investor, not a partner; the rights to receive certain data, to have access to the site, and to be consulted do not convince us that Blocker actively controlled the exploration.” These questions are difficult, in part because the term “joint venture” is often used where the parties to a dispute had not reached any clearly defined agreement with respect to their relationship.

In general, the existence of a joint venture means that one party may not exclude other members of the joint venture from an interest in the assets that are the subject matter of the joint venture. In fact, a member of a joint venture may not acquire any interest that is antagonistic to the interest of the other participants in the joint venture. See, e.g., Patrick H. Martin & Bruce M. Kramer, Williams & Meyers, Oil and Gas Law § 437 (LexisNexis Matthew Bender 2013). Once a joint venture exists, one party cannot unilaterally terminate it, and parties may have difficulty proving that the joint venture was abandoned.

Joint Ventures and Particular Agreements, Relationships, or Industries Joint ventures have been found to exist in numerous types of contractual relationships and a wide range of industries, including, for example, between purchasers of real property where each party has agreed to pay a proportionate share of the purchase price and later sell the land and share the profits equally; between parties to an agreement for carrying on farming or manufacturing operations; and for the exploitation of intellectual property, such as between inventors and manufacturers where the parties have agreed to manufacture and market the invention. See, e.g., 46 Am. Jur. 2d Joint Ventures §§ 38–56 (2014). 

Joint venture allegations commonly arise in the oil and gas industry, where companies seek to share the risk and expense of oil and gas exploration, production, processing, or transportation. In the oil and gas exploration and production context, two common contracts are joint operating agreements (JOAs) and area of mutual interest (AMI) agreements, both of which may have implications for the existence of a fiduciary duty. As a general matter, most courts and commentators agree that the existence of a JOA should not, by itself, be construed as creating a joint venture or partnership. In Tarrant v. Capstone Oil & Gas Co., 178 P.3d 866, 871 (Okla. Civ. App. 2007), for example, the court held that an operator’s breach of a JOA gave rise to a breach of contract claim, not a breach of fiduciary duty claim. However, this may not stop a plaintiff from claiming that a JOA was executed as part of a preexisting joint venture.

An AMI agreement can be defined as an agreement by which the parties attempt to describe a geographical area within which they agree to share certain additional oil and gas leases or other interests acquired by any of them in the future. Some courts have held that the existence of an AMI agreement is a relevant factor when determining whether fiduciary duties are owed. The Kansas Supreme Court, for example, found that a joint venture existed and a party breached its fiduciary duty by failing to comply with an AMI agreement that required the party to assign a one-fourth interest in any leases acquired within a defined geographic area. See First Nat’l Bank & Trust Co. v. Sidwell Corp., 234 Kan. 867, 875 (Kan. 1984). However, in Bays Exploration Inc. v. PenSa, Inc., 771 F. Supp. 2d 1289, 1299 (W.D. Okla. 2011), a case in which an AMI agreement existed and the parties executed a form JOA, the court held that an operator does not owe its nonoperating working interest owners a fiduciary duty.

As is true of AMI agreements and JOAs in the oil and gas industry, companies should be aware of how courts in various jurisdictions treat standard types of agreements in their respective industries. Companies should then be ready to add specific language in the relevant agreements and monitor their conduct to avoid allegations that a joint venture exists.

The Difficulty of Disclaiming Fiduciary Duties  Contracts will often contain disclaimers of any partnership, joint venture, and fiduciary duties between the parties. Many courts have found that a comprehensive disclaimer precludes any claim arising out of the alleged existence of a joint venture. For example, in Come Big or Stay Home, LLC v. EOG Res., Inc., 816 N.W.2d 80, 87 (N.D. 2012), the North Dakota Supreme Court explained that a joint venture was not created where a party “had knowledge that the [agreement] it executed in late 2008 specifically provided that ‘[i]t is not the intention of the parties to create . . . a . . . joint venture or agency relationship.’”

Other courts, however, have held that the analysis should extend beyond the contracts between the parties. The Eighth Circuit has held that a contractual provision that disclaims a joint venture relationship is “not dispositive” but is “strong evidence that the parties did not intend that their cooperative undertaking create a partnership or joint venture.” Ringier Am., Inc. v. Land O’Lakes, Inc., 106 F.3d 825, 829 (8th Cir. 1997). In Sidwell, the Kansas Supreme Court found that a joint venture existed and fiduciary duties were owed even though the agreement at issue stated that “[o]ur respective rights and obligations hereunder are those of independent contractors and nothing herein contained shall be deemed to create any relationship of mining or other partnership as between us.” Sidwell, 234 Kan. at 872. Likewise, in Energy Transfer Partners, L.P. v. Enterprise Products Partners, L.P., No. 11-12667 (298th Dist. Ct., Dallas Cnty., Tex. Aug. 7, 2013), the court denied Enterprise Products Partners, L.P.’s motion for summary judgment regarding the existence of a joint venture, even though the parties had various disclaimers in several of the agreements they had executed. After a five-week trial, the jury awarded the plaintiff $319 million in damages, finding that despite the express contractual disclaimers, the parties had formed a joint venture to build a crude oil pipeline from Oklahoma to Texas.

These cases demonstrate that companies seeking to disclaim all fiduciary obligations not only should include explicit, comprehensive disclaimers in every agreement but also should consider whether their employees’ conduct—and how the entities hold themselves out to third parties—might support an allegation that a partnership or joint venture existed.

Takeaways and Conclusion Avoiding litigation relating to purported breaches of fiduciary duties, given the plethora of business torts that often come along with such claims, is high on the list of most entities and their counsel. Accordingly, for entities that routinely enter into, or contemplate, joint ventures, crafting extensive and explicit provisions that eliminate or limit fiduciary duties in allagreements is imperative. Such disclaimers should expressly state that the conduct contemplated by the particular agreement will not be used as evidence of a joint venture by any party. Companies may also want to consider including contractual provisions requiring separate payment of expenses for preliminary activities, such as marketing work. Finally, companies may want to contract for the right to monitor and approve all communications regarding the relationship to third parties to ensure that the other party is not holding both parties out as a joint venture.

Although clear, specific, and comprehensive disclaimers are important, some courts are still willing to look beyond contractual disclaimers and scrutinize the conduct of the parties and the substance of the parties’ relationship. Accordingly, without careful monitoring and control of subsequent conduct, a company can be subject to costly and protracted litigation.

Keywords: litigation, business torts, fiduciary duties, joint ventures, disclaimers

William R. Taylor and Joshua L. Fuchs – September 16, 2014