Business Divorce

Originally published by David Fowler Johnson.

Business Divorce: Partnership Agreement Was Invalid Where It Was Entered Into Between A Fiduciary And Principal And Was Otherwise Unfair And The Principal Did Not Owe Fiduciary Duties As A Partner Where There Was No Enforceable Partnership

In Adam v. Marcos, an attorney and his client agreed to a joint venture/partnership. No. 14-18-00450-CV, 2021 Tex. App. LEXIS 2060 (Tex. App.—Houston March 18, 2021, no pet. history). The attorney sued the client for breaching the agreement. The trial court ruled for the client on the attorney’s breach of the partnership agreement claim and a breach of fiduciary duty claim. The court of appeals affirmed. The court of appeals first held that the partnership agreement was presumptively invalid because the attorney owed fiduciary duties to the client when it was entered into:

Contracts between attorneys and their clients negotiated during the existence of the attorney-client relationship are closely scrutinized. Because the relationship is fiduciary in nature, there is a presumption of unfairness or invalidity attaching to such contracts. The burden is on the attorney to prove the fairness and reasonableness of the agreement. Moreover, as a fiduciary, Marcos had the burden to establish that Adam was informed of all material facts relating to the agreement. Additional important factors in determining the fairness of a transaction involving a fiduciary include whether the consideration was adequate and whether the beneficiary obtained independent advice.

Id. The court of appeals held that the jury’s finding of breach of duty by the attorney supported invalidating the partnership agreement: “Because the jury found that Marcos failed to fulfill his fiduciary duties to Adam in regard to the alleged partnership agreement, and the evidence supports that finding, the presumption that the contract was invalid applies. Thus, the trial court did not err in holding the agreement was invalid and unenforceable.” Id.

The court of appeals then held that the client did not owe any fiduciary duties to the attorney and affirmed the trial court’s judgment for the client on that claim:

To recover on a breach of fiduciary duty claim, a plaintiff must prove that (1) a fiduciary relationship existed between the plaintiff and the defendant, (2) the defendant breached his or her fiduciary duty to the plaintiff, and (3) the defendant’s breach resulted in an injury to the plaintiff or a benefit to the defendant. The only basis Marcos alleges for a fiduciary relationship in which Adam owes fiduciary duties to him is the partnership agreement. As discussed in the previous section, the alleged partnership agreement between Marcos and Adam was invalid and unenforceable. Fiduciary relationships do not arise from unenforceable contracts. Without a fiduciary relationship between Marcos and Adam, Adam could not be liable for breaching any fiduciary duties to Marcos; thus, the trial court did not err in granting a directed verdict on Marcos’s breach of fiduciary duty claim.

Id. The court of appeals affirmed the judgment for the client.

Interesting Note: This case is an example of the risks involved with fiduciaries entering into business deals with their principals. Other examples of fiduciaries who may enter into transactions with principals are trustee/beneficiary, power of attorney agent/principal, and executor/beneficiary. Additionally, certain confidential relationships can lead to fiduciary duties. A fiduciary owes a principal a duty of loyalty and should look out for the principal’s interests above the fiduciary’s interests. Due to this, transactions between a fiduciary and principal are closely monitored by the courts, and there is a presumption that they are invalid. The fiduciary has the burden to prove that the transaction is fair. Fitz-Gerald v. Hull, 150 Tex. 39, 49, 237 S.W.2d 256, 261 (1951). See also Keck, Mahin & Cate v. Nat’l Union Fire Ins. Co., 20 S.W.3d 692, 699 (Tex. 2000) (considering whether a release agreement could bar claims arising from a fiduciary relationship and holding that the presumption of unfairness or invalidity applied). To establish the fairness of a transaction between a fiduciary and his principal, relevant factors include: (1) there was full disclosure regarding the transaction, (2) the consideration (if any) was adequate, (3) the beneficiary had the benefit of independent advice, (4) the party owing the fiduciary duty benefited at the expense of the beneficiary, and (5) the fiduciary significantly benefited from the transaction as viewed in light of the circumstances in existence at the time of the transaction. Jordan v. Lyles, 455 S.W.3d 785, 792 (Tex. App.—Tyler 2015, no pet.); Lee v. Hasson, 286 S.W.3d 1, 21 (Tex. App.—Houston [14th Dist.] 2007, pet. denied). For example, in In re Estate of Miller, the court held that the fiduciary failed to prove the fairness of a loan transaction between the principal and agent and that transaction was, therefore, a breach of fiduciary duty. 446 S.W.3d 445, 450 (Tex. App.—Tyler 2014, no pet.). So, before a fiduciary enters into a transaction with the principal, it should be very careful to: disclose all known facts about the transaction and the risks involved with same and the benefits that the fiduciary may gain from the transactions, ensure that the fiduciary pays fair consideration for the interest that it is obtaining, and make sure that the principal has independent counsel and advice. It is a good idea to enter into a written agreement between the fiduciary and principal that, in addition to other provisions, makes the required disclosures, provides that the consideration by the fiduciary is adequate and that the benefits are fair, provides that the principal has obtained independent counsel, and provides that the principal is not relying on the fiduciary’s duties to him or her regarding the transaction.

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