Explaining fiduciary duties

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The term fiduciary duties are often used in terms of the management and governance of companies. It is also generally wrongly assumed that the term fiduciary duties is only applicable on the board of directors and officers of public companies. This misconception stems from the age old argument from the owner-managers of private companies and close corporations that they, as both the owners and managers of the entity, technically has the right to the assets and all the resources of the entity and can do with these as they deem fit. Owner-managers of entities therefore often finds it difficult to distinguish between their own individual rights and needs and the needs and rights of the entity they serve as managers.

Perhaps explaining the concept of fiduciary duties will help owner-managers to realize the importance of their fiduciary duties. Fiduciary duties consist of basically three principles namely acting in the best interest of the beneficiaries of the entity, being extremely loyal and avoiding conflict of interests. This can be put into context for private companies and close corporations as follows:

  • Acting in the best interest of beneficiaries;

Before we can talk about what acting in the best interest of beneficiaries are, we need to define the beneficiaries of private companies and close corporations. Beneficiaries of private companies and close corporations are often seen as only the shareholders or members. Most people often do not realize that there are other beneficiaries as well such as employees who are dependent on the entity for their salaries, the government who is dependent on the entity for income taxes and VAT, customers who deal with the entity suppliers and lastly, even the society in which the entity is conducting business. It is therefore the managers’ (directors’ or members’) responsibility to act in the best interest of all of these beneficiaries and not only in the best interest of the company and its shareholders or the close corporation and its’ members.

Acting in the best interest of beneficiaries further implies that the management of the entity need to be aware of laws and regulations that the entity needs to comply with. Most owner-managers for example are not nearly as knowledgeable about their statutory duties in terms of the Companies Act or the Close Corporations Act as they should be. An easy example of this is their personal liability in terms of providing interest free financial assistance or loans to shareholders or members without considering, applying and documenting the solvency and liquidity of the entity.

  • Being extremely loyal; and

Extreme loyalty in the case of private companies and close corporations entails that the managers of the entity keep the entity’s information confidential. The disclosure of information to third parties, regardless of how innocent it may seem, needs to be avoided at all cost. Unless legislation require disclosure or when specific permission are granted, information should remain confidential.

  • Avoiding conflict of interest.

Avoiding conflict of interest is not always as easy as it seems. The management of private companies and close corporations need to ensure that they put their individual needs last when dealing with business of the entity. Let us look at an easy example to demonstrate the concept:

Let us assume that in the close corporation XYZ CC, the members have decided to host a year end function for all the staff of the entity. They realized that they will need to involve a caterer for occasion and one of the members, Mr X, indicated that his wife is a great cook and that the catering contract should be given to her and that she will only charge the company for costs without any profit. At first glance this seems like a good idea as the entity can now host the year-end function at low cost and they keep the business “in the family”.

This scenario creates a clear conflict of interest. Mr and Mrs X clearly has a financial interest in this contract, even if they only charge cost. Mr X should have realized this conflict between his personal interest on one hand and the interest of the beneficiaries and the entity on the other hand, were in conflict.

The rest of the members of the entity also did not comply with their fiduciary duties in terms of this contract. It may save the entity some money in catering costs, but what will happen if the staff gets ill from the food? Who will the staff and the members hold responsible? What if Mrs X cannot deliver the food due to unforeseen circumstance? Who will be held liable for the cost and finding a new caterer? Do Mrs X have experience in catering for this many people? Does she ensure that she complies with the health regulations in terms of the preparation of the food? These are only a few questions that the members should have asked before awarding the contract to Mrs X.

The fiduciary duties of owner-managers of private companies and close corporations therefore reaches a lot further than the traditional believe of acting in the best interest of the owner-managers.

Cornelie Crous CA(SA) is a senior lecturer in auditing at the Centre for Accounting, University of the Free State