Remedies for Breach of Fiduciary Duties: an Economic Analysis of Trusts

Daniel B. Kelly (University of Notre Dame)

Abstract: The conventional view is to characterize fiduciary relationships, including trusts, as contractual and fiduciary duties as implicit contract terms. One might suppose, then, the optimal remedy for fiduciary breach would be the same as the remedy for contract breach: compensatory damages. Applying optimal deterrence theory, this Article analyzes private trusts and concludes the optimal remedy for fiduciary breach is a plaintiff’s election of either damages (a legal remedy) or disgorgement (an equitable remedy). This election eliminates a trustee’s incentive to breach: if the harm to beneficiaries exceeds a trustee’s gain, damages deter; conversely, if a trustee’s gain exceeds the harm to beneficiaries, disgorgement deters. Thus, while contract law, by relying on damages, allows efficient breach (at least if non-opportunistic), trust law, by allowing disgorgement, presumes efficient fiduciary breach is undesirable. Yet damages or disgorgement deter fiduciary breach only if detection and enforcement is perfect. In trust law, given asymmetric information, it can be difficult for beneficiaries to detect a trustee’s breach and courts to enforce fiduciary duties. This low probability of detection suggests the need for punitive damages. A punitive multiplier, set equal to the inverse of the probability of detection, forces a fiduciary to internalize the expected harm (Polinsky & Shavell 1998). Punitive damages may be necessary to deter fiduciary breach if detection is imperfect, especially if non-legal sanctions, via market competition, reputation, and social norms, are ineffective. Similarly, if an election is optimal, there is a justification for punitive disgorgement. Under this novel remedy, a court not only would strip a fiduciary’s ill-gotten gains but also use a punitive multiplier to ensure full disgorgement of the expected benefit.