How to Identify and Address Breaches of Fiduciary Duty in California Partnerships

Business partnerships can be powerful vehicles for growth and success when partners work together harmoniously toward common goals. However, when partners fail to uphold their legal obligations to one another, the consequences can be devastating both personally and professionally.

At the core of these obligations lies the concept of fiduciary duty—the highest standard of care that partners owe to one another and to the partnership itself.

In this guide, our business attorneys at TONG LAW explain what constitutes the fiduciary duty of partners under California law, how to identify potential breaches, and what steps you can take to address them effectively.

Fiduciary Duties in California Partnerships

California law imposes specific fiduciary responsibilities on business partners through the Uniform Partnership Act, codified in California Corporations Code Section 16404. These duties exist regardless of whether they’re explicitly outlined in your partnership agreement, though well-drafted agreements often clarify and sometimes extend these obligations.

Under California Corporations Code Section 16404, partners owe two primary fiduciary duties:

1. The Duty of Loyalty

The duty of loyalty requires partners to act in the best interest of the partnership rather than in their own self-interest when conducting partnership business. According to Section 16404(b), this duty specifically includes:

• Accounting for Partnership Opportunities: Partners must hold as trustee any property, profit, or benefit derived through partnership business or from using partnership property or information.
• Avoiding Adverse Interests: Partners must refrain from dealing with the partnership as or on behalf of a party with interests adverse to the partnership.
• Non-Competition: Partners must refrain from competing with the partnership in the conduct of partnership business before dissolution.

2. The Duty of Care

California’s standard for the duty of care is notably limited in scope. Under Section 16404(c), a partner’s duty of care requires them to refrain from:

• Grossly negligent conduct
• Reckless conduct
• Intentional misconduct
• Knowing violations of law

This standard is significantly lower than the “ordinary negligence” standard applied in many other legal contexts, effectively protecting partners from liability for honest mistakes or poor business judgment that doesn’t rise to the level of gross negligence.

3. Good Faith and Fair Dealing

Beyond the specific duties of loyalty and care, Section 16404(d) requires partners to discharge all their duties and exercise their rights consistently with an obligation of good faith and fair dealing. This serves as a catch-all requirement for partners to act honestly and fairly in their dealings with the partnership and other partners.

Common Breaches of Fiduciary Duty in Partnerships

Recognizing potential breaches of fiduciary duty early can help protect both your interests and the partnership’s viability. Here are common scenarios that may constitute breaches:

1. Misappropriation of Partnership Assets or Opportunities

When a partner diverts business opportunities that should belong to the partnership or uses partnership assets for personal gain, this constitutes a clear breach of the duty of loyalty. Examples include:

• A partner secretly contracts with partnership clients on the side
• Using partnership funds for personal expenses
• Taking client lists or proprietary information for personal use
• Directing lucrative business opportunities to themselves rather than the partnership

2. Self-Dealing Transactions

Self-dealing occurs when a partner enters into a transaction with the partnership where their personal interests conflict with the partnership’s interests. While California Corporations Code Section 16404(f) allows partners to transact business with the partnership, such transactions must be conducted as if the partner were not a partner, with full disclosure and fair terms.

Examples of problematic self-dealing include:

• A partner selling property to the partnership at above-market rates
• Leasing space to the partnership at excessive rent
• Providing services to the partnership through another business they own without disclosing the relationship

3. Competing Against the Partnership

Under Section 16404(b)(3), partners must refrain from competing with the partnership before its dissolution. Examples of competitive breaches include:

• Starting a similar business that targets the same customer base
• Poaching employees or contractors from the partnership
• Redirecting potential clients to a competing business

4. Withholding Information or Excluding Partners

Partners have an obligation to share material information with each other. Purposefully withholding information that would affect partnership decisions or systematically excluding a partner from management can constitute a breach of fiduciary duty, particularly the obligation of good faith and fair dealing.

5. Gross Negligence in Management

While simple mistakes or bad business judgment typically won’t violate a partner’s duty of care, truly reckless or grossly negligent conduct will. Examples might include:

• Stealing from the business
• Making major partnership decisions while impaired
• Consistently failing to perform essential functions despite repeated warnings
• Signing contracts or taking actions far outside the partner’s authority
• Ignoring obvious risks that any reasonable person would address

Warning Signs of Potential Fiduciary Breaches

Breaches of fiduciary duty often begin subtly before escalating to more obvious misconduct. Watch for these early warning signs:

• Unexplained financial discrepancies or resistance to financial transparency
• Sudden changes in partner behavior, such as reduced communication or participation
• Unusual transactions that lack clear business justification
• Reluctance to share information about business activities or opportunities
• Formation of new business entities without disclosure to other partners
• Exclusion from important meetings or decision-making processes
• Incomplete or evasive answers to direct questions about business matters

Steps to Address Potential Breaches of Fiduciary Duty

If you suspect a partner has breached their fiduciary obligations, consider taking these strategic steps:

1. Document Everything

Begin by gathering and preserving evidence of the suspected breach. This may include:

• Financial records and bank statements
• Email communications and text messages
• Meeting minutes and notes
• Witness statements or accounts
• Evidence of competing businesses or diverted opportunities
• Partnership agreements and amendments

Under California law, particularly in litigation contexts, contemporaneous documentation of concerning behavior will significantly strengthen your position.

2. Review Your Partnership Agreement

Carefully review your partnership agreement to understand:

• Any specific provisions regarding fiduciary duties
• Dispute resolution procedures outlined in the agreement
• Buy-sell provisions that might be triggered by breaches
• Notice requirements for addressing partner misconduct
• Voting or approval thresholds for partnership decisions

3. Consider Direct Communication

In some cases, particularly where misunderstandings might be at play, direct communication with the partner in question may resolve the issue. However, approach such conversations carefully and consider:

• Having a neutral third party present
• Documenting the conversation afterward
• Focusing on specific actions rather than accusations
• Being prepared for defensive or hostile reactions

4. Seek Internal Remedies

Before pursuing litigation, exhaust any internal remedies available through your partnership structure:

• Call a formal partnership meeting to address concerns
• Invoke dispute resolution mechanisms in your partnership agreement
• Consider engaging a neutral mediator to facilitate discussions
• Propose temporary safeguards to protect partnership interests

5. Consult with a Business Attorney

Given the complex legal and business considerations involved, consulting with an experienced business attorney who specializes in partnership disputes is crucial. An attorney can:

• Evaluate the strength of your fiduciary duty claims
• Advise on potential remedies and strategic options
• Help quantify damages from the breach
• Represent your interests in negotiations or mediation
• Prepare for potential litigation if necessary

6. Consider Legal Remedies

If internal resolution isn’t possible, legal remedies for breach of fiduciary duty may include:

• Declaratory Relief: Seeking a court determination of rights and duties under the partnership agreement
• Injunctive Relief: Obtaining court orders to prevent ongoing harm, such as:
  • Freezing partnership assets
  • Prohibiting competing activities
  • Preventing the destruction of records
  • Mandating access to information
• Monetary Damages: Seeking compensation for losses caused by the breach, including:
  • Direct financial losses to the partnership
  • Lost profits or opportunities
  • Disgorgement of profits improperly obtained by the breaching partner
• Accounting: Requesting a detailed accounting of partnership assets and activities
• Dissolution: In severe cases, seeking judicial dissolution of the partnership under California Corporations Code Section 16801
• Removal of Partner: In some cases, courts may order the removal of a partner who has breached fiduciary duties, though this remedy is typically only available if provided for in the partnership agreement

Avoiding Fiduciary Breaches in Your Partnership

The best approach to fiduciary breaches is prevention. Consider implementing these protective measures:

1. Comprehensive Partnership Agreements

Develop detailed partnership agreements that clearly outline:

• The specific fiduciary obligations of each partner
• Processes for disclosing and approving potential conflicts of interest
• Permitted outside activities and investments
• Consequences for breaches of fiduciary duty
• Buy-sell provisions triggered by breaches
• Dispute resolution procedures

2. Regular Financial Transparency

Establish systems for regular financial reporting and transparency, including:

• Monthly financial statements accessible to all partners
• Regular partnership meetings to review finances
• External accounting or auditing processes
• Clear documentation of major financial decisions
• Dual approval requirements for significant expenditures

3. Documented Operating Procedures

Create written protocols for:

• Decision-making authority and limitations
• Disclosure requirements for potential conflicts
• Processes for pursuing new business opportunities
• Documentation of partner activities related to the business
• Regular review of compliance with fiduciary obligations

How TONG LAW Can Help with Partnership Fiduciary Issues

At TONG LAW, our business attorneys have extensive experience helping California business owners navigate the complex terrain of partnership disputes and fiduciary duty issues.

Whether you’re establishing a new partnership and want to prevent future problems or facing a potential breach of fiduciary duty in an existing partnership, we provide strategic guidance tailored to your specific situation.

Our services include:

• Drafting and reviewing partnership agreements with robust fiduciary provisions
• Advising on potential fiduciary duty concerns
• Implementing protocols to prevent breaches
• Representing partners in disputes involving fiduciary obligations
• Negotiating resolutions to partnership conflicts
• Litigation of fiduciary duty claims when necessary

If you’re concerned about potential breaches of fiduciary duty in your partnership or want to establish protective measures for your business, contact TONG LAW today for a consultation with our experienced California business attorneys.

Our offices in Oakland and Sacramento serve clients throughout California, providing sophisticated legal counsel with practical business insights to protect your interests and help your business thrive.