A recent Delaware decision highlights a trap for the unwary adviser to a business entity. The decision holds that helping a business get started may create fiduciary duties owed by the adviser, even if he or she is not acting in one of the roles that are normally thought of as creating such duties, such as serving as a lawyer or trustee. Because those fiduciary duties limit what the adviser may do for those other than his or her immediate client, it is important to recognize when those duties exist.
The background to this decision in Bennett v. Lally, C.A. No. 9545-VCN (Del. Ch. Sept. 5, 2014), helps illustrate this problem. Mark S. Lally agreed to help establish a medical marijuana facility in Delaware, at the request of A. Judson Bennett and Jeffrey Siskind. When Lally later helped another business establish such a facility, Bennett and Siskind sued Lally. They sought both to stop Lally from working for their competitor and to recover damages. Lally asked the court to dismiss their suit, arguing that he was simply an independent contractor/adviser free to pursue his own interests and without any fiduciary duty to refrain from competing with Bennett and Siskind. The Court of Chancery denied Lally's motion to dismiss.
The court focused on several key facts. First, Lally acted as more than just an adviser. He and the plaintiffs "had a shared interest in a specific objective," to jointly operate the marijuana distribution facility. Second, Lally and the plaintiffs discussed their confidential strategy to win the state license needed to open the facility. This, the court held, evidenced the "mutual trust" that is at the core of a fiduciary relationship. Third, Lally assumed some control over the license application process, making Bennett and Siskind dependent on him. Finally, and perhaps most importantly, Lally was accused of self-dealing by using information he obtained from Bennett and Siskind to establish a competing business. These factors were enough to establish, at least at the early stage of the litigation, that Lally had a fiduciary duty to Bennett and Siskind.
What, then, are the lessons of Bennett for those who advise businesses that may compete with one another? First, you should clarify the nature of your relationship with your client at the very outset of the relationship. Lally was told that acting for a competitor of Bennett and Siskind was not acceptable to them. While Lally did not sign a binding noncompete agreement, he understood what the clients expected. Had he instead told his clients, preferably in writing, that he was free to advise competitors, the court might have ruled differently.
Second, Lally assumed a role that was more than just acting as an independent adviser. He literally became part of the proposed enterprise with potential profit-sharing if it were successful. The hallmark of a partnership is an agreement to share in the profits generated by people acting together. While Bennett and Siskind did not claim Lally was actually their partner in the potential business, his actions made him look like a partner to the court. Partners are fiduciaries to one another. Thus, agreeing to share in the ongoing profits of the proposed business will push your relationship closer to that of a fiduciary.
Of course, this does not mean that a contingent fee earned upon establishment of a business will make you a fiduciary. Lally's profit-sharing was based on the enterprise's ongoing operations after it began business. Indeed, his contemplated future role appears to have included some management role. He was acting not just as a broker entitled to a one-time fee. Avoiding that sort of an ongoing compensation arrangement is best if you want to avoid fiduciary duties.
Finally, Lally was accused of using confidential information obtained from Bennett and Siskind to benefit Lally's new clients. Every business adviser must learn something about his or her client's plans in order to give sound advice in any detail. That is unavoidable. However, it is best to treat that client information as confidential and to make a record that shows the client's confidences were respected and maintained. Financial information, proposed business locations, anticipated operational plans once the business opens and similar materials should be kept separate from any new client's files and not consulted in the course of working for that client.
This is not just a matter of cosmetics trying to cover up the use of knowledge that must influence your advice to a new client. Instead, there is a real distinction between using written or computerized data and just using your experience learned on the job. What is written down or computerized is usually more useful than memory. After all, that is why that information is memorialized in the first place.
In addition, the courts recognize that everyone is entitled to make a living by using what they have learned and that policing the use of what is in someone's mind is often too difficult to do without unfairly infringing on that right to work. Hence, the courts may temporarily limit competition by a former employee who has very confidential information in his head, but that is fairly rare in the absence of a noncompete agreement. A showing of a good-faith effort to maintain a former client's confidences will go a long way to avoiding the problems Lally faces.
In short, the Bennett decision provides a warning about how business advisers should limit their exposure to claims they have fiduciary duties to their former clients. Limit your duties at the outset, avoid ongoing compensation from the business's operations and respect former client confidences.