Private and charitable trusts hold trillions of dollars in assets. Trustees manage, invest, and distribute these assets, subject to fiduciary duties, such as the duty of loyalty and prudence. But remedies for breach of trust, and their justifications, are convoluted. The conventional view, especially in law and economics, is to characterize most fiduciary relationships, including trusts, as contractual and most fiduciary duties as implicit contract terms. One might suppose, then, the optimal remedy for fiduciary breach would be the same as the optimal remedy for contractual breach: damages. But the traditional equitable remedies in fiduciary law, and modern remedies in trust law, allow a plaintiff to elect either damages or disgorgement. Plus, courts increasingly allow punitive damages for breach of a fiduciary duty, especially if a breach is ‘egregious’, even though punitive damages were not available as an equitable remedy. Applying insights from optimal deterrence theory and the agency costs theory of trusts, this Article provides an economic framework for analyzing trust law remedies. It argues that disgorgement and punitive damages serve distinct functional purposes and both remedies may be necessary to serve the deterrence and disclosure functions of trust law depending on how likely it is for a trustee to escape liability.
If a trustee is always found liable, the optimal remedy for a breach of loyalty is an election of damages or disgorgement. Damages deter self-dealing and conflicts of interest if the harm to the beneficiaries exceeds the gain to a trustee. Disgorgement is necessary not only to deter breach if the gain exceeds the harm but also to encourage disclosure. Specifically, rather than allowing a trustee to breach and pay damages, a trustee must disclose any potential gain from a transaction and obtain approval from the beneficiaries, whom the settlor selected as the residual claimants. Similarly, the optimal remedy for a breach of prudence is to elect damages or disgorgement. Such a breach usually entails damages (eg, harm from failing to invest trust assets in a diversified portfolio), but, to the extent it entails disgorgement, over-deterrence is unlikely because, unlike a party to a contract, a trustee may resign to pursue other opportunities. Thus, while contract law, by relying on damages, typically permits efficient breach, trust law, by disgorging a trustee’s ill-gotten gains, attempts to prevent efficient fiduciary breach.
However, if there is a significant chance of a trustee’s escaping liability, the optimal remedy also includes an election of punitive damages or punitive disgorgement. Given asymmetric information between trustees and beneficiaries, it is usually difficult for beneficiaries to detect breach. A total damages multiplier, set equal to the inverse of the probability of escaping liability, would force a trustee to internalize the harm by paying average damages equal to expected harm. Similarly, if an election of remedies is optimal, there is a justification for punitive disgorgement. Under this novel remedy, a court not only would strip ill-gotten gains but also use a punitive multiplier to ensure the trustee disgorges the gain by paying average disgorgement equal to the expected benefit. Overall, punitive remedies may be necessary to deter an ordinary breach that is difficult to detect but unnecessary to deter an egregious breach that is easy to detect. Because it is often more difficult to detect mismanagement than misappropriation, punitive damages may be needed to deter imprudence, even while disgorgement is needed to deter disloyalty.
Kelly, Daniel B, Remedies for Breach of Trust (April 14, 2017).