FIDUCIARY RELATIONSHIPS IN CONTRACTUAL DEALINGS

Ivan Hoffman, B.A., J.D.


        Here is one situation that, as an entertainment and intellectual property law attorney, I deal with fairly regularly:  Party One enters into an agreement granting to Party Two the exclusive rights to certain intellectual property in exchange for Party Two’s agreement to use and exploit the intellectual property and pay Party One a royalty or other sums derived from such use and exploitation.  The intellectual property can be rights to recordings, musical compositions, books, software, trademarks and other IP.

        Party Two fails to either use and exploit the same or fails to properly pay Party One for such use and exploitation.  For the sake of simplicity of this article, we shall assume that Party Two is in breach of the agreement entitling Party One to compensatory damages (i.e. damages for unpaid royalties and other sums).  The issue is, also for the sake of this article, whether or not there is a fiduciary relationship created by the agreement.   The difference is significant since if such a fiduciary relationship was created, then Party One would possibly be entitled to punitive damages in addition to the compensatory damages.  Punitive damages are not awardable in breach of contract claims.

        Among other cases, I would like to discuss 2 cases decided in California that deal with this issue.

        The issue that the California Supreme Court had to decide in City of Hope National Medical Center vs. Genentech, Inc.  was whether, within the context of the contractual relationship, a fiduciary relationship was also created.  In the Genentech case, a trial court jury awarded City of Hope $200,000,000.00 in such punitive damages, so we are talking about potentially significant money.

        In the other case, Wolf vs. Superior Court, the plaintiff was the author of the novel “Who Censored Roger Rabbit?” who had entered into an agreement with Walt Disney Pictures and Television to exploit the novel which later became the motion picture “Who Framed Roger Rabbit?” The plaintiff claimed, among other claims, “that Disney is a fiduciary because Disney enjoyed ‘exclusive control over the books, records and information concerning the exploitation [of the Roger Rabbit characters] and the revenue and Gross Receipts Royalties derived therefrom.’”

Definition

        In Wolf,  this is the California Court of Appeals definition:

 A fiduciary relationship is “‘any relation existing between parties to a transaction wherein one of the parties is in duty bound to act with the utmost good faith for the benefit of the other party.  Such a relation ordinarily arises where a confidence is reposed by one person in the integrity of another, and in such a relation the party in whom the confidence is reposed, if he voluntarily accepts or assumes to accept the confidence, can take no advantage from his acts relating to the interest of the other party without the latter’s knowledge or consent. . . .’”  (Herbert v. Lankershim (1937) 9 Cal.2d 409, 483; In re Marriage of Varner (1997) 55 Cal.App.4th 128, 141; see also Rickel v. Schwinn Bicycle Co. (1983) 144 Cal.App.3d 648, 654 [“‘A “fiduciary relation” in law is ordinarily synonymous with a “confidential relation.”  It is . . .  founded upon the trust or confidence reposed by one person in the integrity and fidelity of another, and likewise precludes the idea of profit or advantage resulting from the dealings of the parties and the person in whom the confidence is reposed.’”].)
...

Inherent in each of these relationships is the duty of undivided loyalty the fiduciary owes to its beneficiary, imposing on the fiduciary obligations far more stringent than that required of ordinary contractors.  As Justice Cardozo observed, “Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties.  A trustee is held to something stricter than the morals of the market place.  Not honesty alone, but the punctilio of an honor the most sensitive is then the standard of behavior.”  (Meinhard v. Salmon (N.Y. 1928) 164 N.E. 545, 546.)

The Wolf Case

        In response to the Plaintiff’s arguments mentioned above, the Court said that in that agreement:

Disney was not “under any obligation to exercise any of the rights” granted to it and could assign or license any and all rights granted under the 1983 Agreement as Disney “s[aw] fit.”
        The Court went on to say that merely because there is contingent compensation and a “trust and confidence” factor, these are not sufficient, standing alone, to create a fiduciary relationship.
Every contract requires one party to repose an element of trust and confidence in the other to perform.  For this reason, every contract contains an implied covenant of good faith and fair dealing, obligating the contracting parties to refrain from “‘doing anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract . . . .’”  (Nelson v. Abraham (1947) 29 Cal.2d 745, 751 (Nelson); New v. New, supra, 148 Cal.App.2d at pp. 382-383.)  “Being of universal prevalence, [the implied covenant] cannot create a fiduciary relationship; it affords basis for redress for breach of contract and that is all.”
        The Court also rejected the Plaintiff’s claims that a fiduciary relationship was created because of the sharing of profits or because he had a right to an accounting.
To the contrary, the agreement created a debtor/creditor relationship, expressly providing that in exchange for compensation, both certain and contingent, Disney, as the new owner of the rights, could exploit those rights or not exploit them as it saw fit.  Disney was under no obligation to maximize profits from the enterprise or obtain Wolf’s approval for its contracts.
        Finally, the Court also rejected the Plaintiff’s claim that because Disney had total control over the financial books and records that therefore a fiduciary relationship was created.
In cases where the financial records essential to proving the contingent compensation owed are in the exclusive control of the defendant, fundamental fairness, the “lodestar” for analysis under Evidence Code section 500 (Adams v. Murakami (1991) 54 Cal.3d 105, 119), requires shifting the burden of proof to the defendant.  In such cases, the essential facts as to the contingency and the amount owed lie in the exclusive knowledge and control of the defendant, placing the defendant in a far better position to prove satisfaction of its payment obligation.  (See, e.g., Thomas v. Lusk (1994) 27 Cal.App.4th 1709, 1717 [“the burden of proving an element of a case is more appropriately borne by the party with greater access to information”].)  Imposing the burden of proof on a defendant to prove it has fulfilled its payment obligations to plaintiff in these types of contract cases, moreover, is consistent with the long-standing rule that a debtor defending a lawsuit to recover money under a promissory note bears the burden of proving that its payment obligation has been satisfied.  (See, e.g., Roesch v. DeMota (1944) 24 Cal.2d 563, 569; Pacific States Sav. & L. Co. v. Painter (1940) 37 Cal.App.2d 645, 647.)

Although we therefore agree that the burden of proving a plaintiff has been paid contingent compensation in accord with the parties’ agreement is properly placed on a defendant in exclusive control of essential financial records (thereby imposing on the defendant the risk of any incompleteness in such records), this determination regarding evidentiary burdens does not alter the contractual nature of the parties’ relationship.  Considerations of fairness and practicality, while relevant to an analysis under Evidence Code section 500, cannot serve to create a fiduciary relationship where one does not otherwise exist.

        It is worthwhile pointing out the concurring/dissenting opinion in this case.  The dissent part of that opinion disagreed with the ruling that there was no fiduciary relationship as a matter of law.  “As a matter of law” means that, given the contractual language of this case, there is simply no way that a court sitting as a trier of fact or jury could find such a relationship.  It means that the law compels a given result.  The dissent pointed out that often factors are involved that show evidence contrary to what the contract language states and that therefore, this issue should have been allowed to go to the jury to decide.
Certainly, Disney’s contractual duty to maintain the books required to accurately record the moneys it receives from exploitation of Wolf’s characters possesses many of the attributes that have led the courts to characterize other relationships as fiduciary in nature.  As one leading commentator wrote in describing what justifies the imposition of fiduciary duties:  “Because fiduciaries manage or have some control over very substantial property interests of others, they have the potential to inflict great losses on those property owners.  [The] economic interests of fiduciaries are frequently substantially affected by the discretionary decisions they make on behalf of others . . .  As a result . . . fiduciaries have unusually great opportunities to cheat without detection and they have unusually great incentives to do so.  Moreover, the relative costs which their cheating may impose on those whose property they manage are frequently much greater than the relative costs that can be imposed without detection or remedy in simpler contractual exchanges. . . .
The City of Hope Case

        City of Hope entered into an agreement with Genentech for Genentech to “develop, patent and commercially exploit” a “secret scientific discovery” developed by City of Hope.  The Court analyzed the essential terms of the agreement between the parties and then stated:

“[B]efore a person can be charged with a fiduciary obligation, he must either knowingly undertake to act on behalf and for the benefit of another, or must enter into a relationship which imposes that undertaking as a matter of law.”  (Committee on Children’s Television, Inc. v. General Foods Corp. (1983) 35 Cal.3d 197, 221 (Children’s Television).)

There is no indication in the contract that Genentech entered into it with the view of acting primarily for the benefit of City of Hope.  Article 1 of the contract envisions a mutually beneficial relationship between the parties, as particularized in these provisions:  Article 1.03 expresses Genentech’s desire to acquire from City of Hope synthetic DNA for the purpose of manufacturing and selling certain polypeptides.  Article 1.04 states that City of Hope would receive funding from Genentech to conduct the DNA synthesis work and would earn royalties from Genentech’s sales.  Article 3.04 gives Genentech exclusive ownership of patents and other proprietary property stemming from City of Hope’s work under the contract.  And Article 10.01 gives Genentech the right to assign and transfer its contractual rights, including patents and patent licenses.  These contractual provisions indicate that the parties’s common goal was to achieve a mutually beneficial arrangement, not that Genentech had undertaken a fiduciary obligation “to act on behalf of and for the benefit of another.”  (Children’s Television, supra, 35 Cal.3d at p. 221.)  And nothing in the contract indicates that Genentech was to subordinate its interests to those of City of Hope (id. at p. 222), a point conceded by City of Hope. [emphases added]

Nor is there a factual basis showing that Genentech through its conduct “knowingly” undertook the obligations of a fiduciary.  (Children’s Television, supra, 35 Cal.3d at p. 221; Chodos, The Law of Fiduciary Duties (2000) § 1.19, pp. 42-44 (Chodos).)  The jury here was not instructed on, was not asked to determine, and did not decide that issue.

The remaining question then is whether an agreement to develop, patent, and commercially exploit a secret scientific discovery in exchange for the payment of royalties is the type of relationship “which imposes that undertaking [fiduciary obligation to act on behalf of and for the benefit of another] as a matter of law.”  (Children’s Television, supra, 35 Cal.3d at p. 221.)

        The Court ruled that none of these factors established such a relationship.

City of Hope argued that the following factors are among the issues that go into a determination as to whether parties are in a fiduciary relationship:

(1) one party entrusts its affairs, interests or property to another; (2) there is a grant of broad discretion to another, generally because of a disparity in expertise or knowledge; (3) the two parties have an “asymmetrical access to information,” meaning one party has little ability to monitor the other and must rely on the truth of the other party’s representations; and (4) one party is vulnerable and dependent upon the other.
        The Court said that these factors alone do not necessarily create such a relationship and cited other cases in which such factors were held not to create such a relationship.

        The Court stated:

We agree with the holding in Wolf, supra, 107 Cal.App.4th 25, that fiduciary obligations are not necessarily created when one party entrusts valuable intellectual property to another for commercial development in exchange for the payment of compensation contingent on commercial success.  The secrecy of information provided by one party to another — here the scientific discovery by City of Hope — may be considered by the trier of fact in deciding whether a fiduciary relationship exists, but it does not compel the imposition of fiduciary duties by operation of law.  (See Davies v. Krasna (1975) 14 Cal.3d 502, 511 [submission of a written story in confidence to another “may impose upon [the other] a duty to refrain from unauthorized disclosure of the idea, but [it is] insufficient to impose upon him the fiduciary-like duties”]; Chodos, supra, § 1:21, p. 55 [mere receipt of confidential information does not create fiduciary duty].)
Conclusion

        Among other issues, these cases illustrate the importance of precise contract language.  Read “Precise Contract Language” and “Precise Contract Language-Again” and “Precise Contract Language-Flashdance” on my site.

Copyright © 2008 Ivan Hoffman.  All Rights Reserved.

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This article is not legal advice and is not intended as legal advice.  This article is intended to provide only general, non-specific legal information.  This article is not intended to cover all the issues related to the topic discussed.  The specific facts that apply to your matter may make the outcome different than would be anticipated by you.  This article is based on United States law.  You should consult with an attorney familiar with the issues and the laws of your country.  This article does not create any attorney client relationship and is not a solicitation.

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