Fiduciary Laws – The Fiduciary Duty in a Long-Term Management Agreement

Introduction

On September 5, 2022, judgment was passed down by the District Court in Tel Aviv on mutual claims that had been prosecuted for years, including dozens of interim motions, between Fatal Hotels Ltd. (the “Manager”) and N.Y. Ashkelon Ltd. (the “Owners”) regarding a management agreement signed between the parties in 2013 for a term of 10 years, according to which a hotel owned by the Owner was placed under the management of the Manager. The Manager made a claim for the enforcement of the management agreement, while the Owner of the hotel demanded the cancellation of the agreement.

Background

The management agreement entrusted almost all management powers of the hotel to the Manager – “Exclusive control and absolute discretion in the operation… and management of the hotel”, while the Owner of the hotel warranted to refrain from interfering in the management of the hotel.

From the outset of the management term, the relationship between the parties was problematic; the Owner breached his warranty not to interfere in the management of the hotel and often tried to give management instructions and intervened and interfered with many decisions of the Manager.

The Owner, on his part, claimed an extreme lack of transparency by the Manager and a lack of full disclosure of the operating data, as well as the improper exercising of the management’s authority in imposing network expenses of the Fatal chain onto the hotel that it manages for the Owner.

The relations between the parties were characterized by frequent petitions to the court to obtain temporary relief in a variety of issues related to the management of the hotel and the provision of information pertaining to the management.

Summary of the claims

The Manager claimed that an agreement to manage a hotel is not an agreement to provide personal service, with respect of which the courts allowed cancellation due to a lack of trust that arose between the parties. This is a business contract and when the Manager exercised its discretion according to the provisions of the agreement, there was no reason to cancel it. The Manager, despite its claims of a breach of the agreement by the Owner, urged the court to uphold the priority given by law and by the courts for keeping an agreement and enforcing it instead of cancelling it.

The Owner countered with his claim of a breach of the agency relationship between the parties, and also claimed that a complete lack of trust has developed between the Owner and the Manager, which in itself justifies the cancellation of the agreement due a breach of the fiduciary duty arising from the fiduciary relationship between the parties.

In other words, the court had to decide between the continuation of the agreement by granting the relief of enforcement or the termination of the agreement by granting the relief of cancellation (in the claims brought before the court, no monetary relief was claimed).

Fiduciary relations in a long-term relationship

The court determined on the factual level that there were mutual breaches of the agreement – the Manager did indeed breach its duty to provide data and information about the management of the hotel to the Owner and also imposed chain management expenses on the hotel in a manner that was discriminatory in comparison to other hotels managed by the Manager. On the other hand, the Owner had blatantly breached its commitment to refrain from any interference in the management of the hotel.

Together with this, the court emphasized the fiduciary duty that applies to the parties even when the agreement is a commercial agreement and not an agreement to provide a personal service, and especially when taking into consideration that the agreement is long-term and requires a great deal of cooperation between the parties.

Likewise, when the agreement entrusted the Manager with broad management powers and left the Owner with negligible influence, then naturally such an agreement imposes high fiduciary duties on the Manager to perform its obligations honestly and fairly, even when the Owner is an experienced businessman who understands the terms of the agreement that he signed. With the granting of broad discretion comes a greater responsibility that is placed on the shoulders of the Manager.

According to the District Court, this conclusion emerges not only from the agency relationship between the parties but also from the fiduciary relationship (fiduciary duty) that is required in a long-term relationship:

“We are dealing in a special category of relationship, in which one person gives another power over his property without that person having the option of protecting its own interests. The starting point is that the issue cannot be based on the free contractual exclusion of the relationship. There is, therefore, justification for social intervention in the establishment of a special law”.

It also explains the two components that make up the fiduciary duty in a commercial agreement between corporations:

“The general structure of the fiduciary duty stands, therefore, on two legs: the prohibition of a conflict of interest and the duty of full disclosure. The prohibition of a conflict of interest deals, as mentioned, with the fiduciary’s self-preference, and the duty of full disclosure deals with the problem of partial information”.

Summary

The court ruled that in a long-term management agreement in which one party receives broad powers, but cooperation is still required in the relations between the parties to the agreement, there is – inter alia – a heightened fiduciary duty in matters pertaining to the provision of information from the managing party to the owner of the property as well as in refraining from exploiting the position for self-preference.

In the present case, the breaches of the fiduciary duty on the part of the hotel manager, even if they were made within the provisions of the agreement, and the lack of the required fiduciary relationship between the parties, justified the cancellation of the agreement by the Owner and not its enforcement by the Manager.

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