A disturbing trend is afoot regarding fiduciary liability: States are passing laws that exculpate fiduciaries from virtually all liability other than outright fraud or criminal acts. This approach, together with the option of totally exculpating the trust advisor, is seriously undermining our centuries-old respect of the trust relationship. The logical and, unfortunately, likely outcome of this trend is the death of the trust as we know it.
Dan, a New York resident, establishes an asset protection trust in Delaware and funds it with $2 million. He names a Delaware trust company as the trustee and a “hot shot” local (New York) individual as the trust investment advisor to manage the trust funds. In light of the investment advisor’s authority to manage the investments, the trustee requests that Dan’s trust contain a provision exculpating the trustee for following the advisor’s instructions.1 Dan’s attorney, who’s drafted many such “directed trusts,” includes two provisions in the trust: 1) his firm’s standard language for such trusts, permitting the trustee unconditionally to follow the investment instructions of the advisor and exculpating the trustee for anything except “willful misconduct;” and 2) a declaration that the advisor shall not be considered a fiduciary. Both provisions are permissible under Delaware law.2
Dan’s advisor has adequate experience in managing funds and recently had made substantial gains for some of his clients by aggressive investing in young companies in the computer field. He recommends two such companies for Dan’s trust, Banana Technology and Gargle Worldwide, which he believes will be the next Apple and Google, respectively. Accordingly, he instructs the trustee to invest $900,000 in each company (representing over 30 percent equity in each), leaving some cash in case Dan requires a distribution.3
The trustee follows the advisor’s instructions and shortly after the investments are made, the trustee receives notice of a private takeover bid for Banana stock, which the shareholder must act on quickly. The trust administrator asks his secretary to send the notice to the advisor, but by accident she sends it to a local elementary school where she does volunteer work. The takeover bid is unsuccessful, and Banana shares slide to near zero. And, for reasons beyond anyone’s control, Gargle shares also head for the drain. Dan, who discovers this on his return from a vacation, is understandably upset and sues the trustee and the advisor.
Both the trustee and the advisor simply point to Delaware law and the provisions of Dan’s trust, which exculpate them from virtually all liability other than outright fraud or criminal acts. In fact, the trustee could only be liable for “willful misconduct,” which, under Delaware law, means intentional wrongdoing, not mere negligence, gross negligence or recklessness,4 and “wrongdoing” means malicious conduct or conduct designed to defraud or seek an unconscionable advantage.5 The trustee in this case is considered to be an “excluded fiduciary.” As such, and in the absence of willful misconduct, the trustee is totally exculpated from any loss, expenses or damage caused by the advisor.6 Further, the trustee has no duty to keep track of (monitor) the acts or conduct of the advisor.7 And, the advisor responds, “Look, I took my best shot, but I’m not even a fiduciary here, so short of stealing your funds, I can’t be liable under the law.8 Furthermore, you can blame the trustee for failure to send me the takeover notice.”9
To this comment, the trustee responds: “First, Delaware law requires us to keep co-fiduciaries reasonably informed on matters that bear upon their duties,10 and we did make the effort. The fact that the information was sent to the wrong address may have been negligent, but it was most certainly not willful misconduct. Second, and more importantly, the relevant law requiring us to keep co-fiduciaries informed specifically applies only to the fiduciaries. The trust expressly provides that the advisor is not a fiduciary, so we have no duty to him at all, other than to provide him with information that he specifically requests and which bears directly on his powers. He made no such request for the information he says he never received.”11
Dan, who had done some reading on trusts, is stunned, as he believes that the very term “trust” suggested an arrangement in which he could rely on the integrity, diligence and careful attention the trustee and advisor would apply to his trust and investments. He took this to mean that they had a serious responsibility to him and to the trust beneficiaries, and if they breached that responsibility, they would be liable for any resulting loss. He remembers reading phrases like:
. . . a trustee is held to something stricter than the morals of the marketplace. Not honesty alone, but the punctilio of an honor most sensitive, is then the standard of behavior. Only thus has the level of conduct for fiduciaries been kept at a level higher then that trodden by the crowd. It will not consciously be lowered by any judgment of the court.12
“In light of the long history of trusts and the court’s high degree of respect and adherence to trust relationships, how,” Dan asks, “could the law hold that neither the trustee nor the advisor is liable for this huge loss?” Incredibly, it looks like that actually might be the case, unless some thoughtful Delaware court decides there’s something terribly wrong with this picture and that it must be changed if the very concept of the trust is to survive.13
A Disconcerting Trend
Although the foregoing hypothetical may be exaggerated, the applicable law and likely results are not. Not all states allow such arbitrary and near absolute protection of fiduciaries or the total abandonment of fiduciary duty by declaring that an advisor with critical powers over a trust has no duty to the trust or the beneficiaries. But, what’s most disconcerting is that it’s becoming a trend, and what’s worse, too many lawyers are ready to follow the trend. Why would we do that? Whom do we represent when we include provisions that strip beneficiaries of their basic rights under a trust without calling the settlor’s attention to them? To claim that we represent the interests of the settlor or the settlor’s beneficiaries in such cases is gratuitous, to say the least. How many of our settlors would proceed with their trusts if they really understood that their beneficiaries had no enforceable rights in the event of gross negligence or even reckless misconduct of the trustee, or of any misconduct, incompetence or negligence of the non-fiduciary advisor, short of outright fraud?
The idea of exculpating a trustee or other fiduciary isn’t new, and in some cases, it’s not necessarily a bad arrangement. Because of the highly important, critical and responsible nature of the position of the trustee, even the slightest breach of fiduciary duty could cause the fiduciary concern about a claim and exposure to liability. And, as trusts became more commonplace, it didn’t take long for trustees to begin requesting a little “slack” when circumstances called for it and when it seemed more appropriate to give certain powers to someone other than the trustee. For instance, the duty to diversify sometimes clashed with a settlor’s direction to retain disproportionately large holdings of shares of a family business or parcels of unproductive real estate or situations in which the settlor wished to give business management authority to an outside advisor or committee. Without exculpation language, and sometimes even with it, the trustee faced a dilemma and even litigation.14
Today, few trustees would accept the trusteeship of a trust, the assets of which by their nature prevented the trustee from fully monitoring and controlling the investment, such as shares of closely held business. In such cases, it’s understandable that they wish to be treated as an excluded fiduciary as to the management of such assets.
But, even these situations don’t justify a total exculpation from liability merely because the trustee is expressly authorized to retain concentrated investment positions or because administrative or investment decisions are left to an advisor or protector other than the trustee. This is the case especially when applicable law allows the advisor to be totally exculpated, without applying even the lowest standard, that of willful misconduct, by declaring that the advisor isn’t a fiduciary.15 Some argue that such an arrangement is reasonable when investment decisions are the issue, but states that are heading down the no-liability trust road don’t necessarily restrict the exculpation to investments. Relevant Delaware law, for example, doesn’t limit exculpation to investment decisions and allows the exculpation to apply to any authority or direction given to or by the advisor.16 Thus, in the case of a non-fiduciary protector with broad powers over the trust, the trustee is bound to follow any direction from the protector without exposure to liability, even though the direction may be contrary to the material purpose of the trust,17 and since the protector may be declared a non-fiduciary, the protector also has no exposure to liability. In other words, unless the trustee is guilty of willful misconduct, no one has liability, even if the trustee and the advisor are found guilty of gross negligence or even reckless misconduct.18
For instance, as noted above, Delaware law allows the terms of the trust to give an advisor the authority to direct virtually any decisions of the fiduciary, with no apparent limitation. Suppose we draft a trust that gives the advisor authority over investments and all distributions of the trust: What’s left for the trustee to do? Balance the books and prepare accounts based on information fed to it? Can we delegate that authority as well? Even those who argue that the advisor then becomes the de facto trustee can gain no satisfaction (in light of the exculpation of both), unless a court was to hold that such an arrangement is clearly against public policy and the exculpating provisions may be ignored (which I feel would be the proper result). Meanwhile, think about the prospect of the beneficiaries and their attorneys wading through this legal quagmire trying to ascertain who might be liable.
In an oft-cited English case in which the responsibility of an exculpated trustee was in question, the court said:
. . . there is an irreducible core of obligations owed by the trustees to the beneficiaries and enforceable by them which is fundamental to the concept of a trust. If the beneficiaries have no rights enforceable against the trustee, there are no trusts (emphasis added).19
Undermining of the Trust
Are we not undermining the very concept of the trust by eliminating all liability? At first glance, it appears some help is offered by the Restatement of Trusts, Second and Restatement of Trusts, Third (Restatement Third), Sections 185 and 75, respectively, and the Uniform Trust Code (UTC) Section 1008(a). Both sections of the Restatements provide that the trustee must follow the directions of the party who has the power to direct, unless the exercise is contrary to the terms of the trust or the trustee believes the party is breaching a fiduciary duty. Unfortunately, the Reporter’s notes to Section 64 of the Restatement Third suggest that if the advisor’s power is a personal one (and presumably it will be, if we declare that the advisor isn’t a fiduciary), the trustee’s only duty is to ascertain that the advisor is acting within the terms of the power. Accordingly, neither of these provisions offers any help to a beneficiary who suffers a loss resulting from the gross negligence of an advisor who’s declared under the trust to be a non-fiduciary. And, although the UTC contains a mandatory provision that prohibits a trust from dispensing with a trustee’s duty of good faith,20 the fact remains that it’s highly unlikely for a beneficiary to prove bad faith or reckless indifference on the part of a trustee, especially when it has complied with the instructions of an authorized power holder. Despite the Restatements’ and the UTC’s strongly inferred intent to offer help, states, like Delaware, which allow virtual abrogation of fiduciary duties altogether, totally disregard that a fiduciary relationship should exist under a directed trust. Lastly, it must be remembered that the Restatements are merely treatises on relevant common law developed and reported by a committee assigned to the task. They’re not binding on a court. And, the UTC is a code that individual states can adopt and modify. Thus, the situation can differ from state to state and present a potential trap for drafters and beneficiaries. Therefore, the one-two punch of the directed trust scheme in which the trustee isn’t liable for following the advisor’s direction and the advisor isn’t liable for giving it, knocks the beneficiary right out of the ring.
Why are states creating this trend? And, as drafting attorneys, why are we following it? Could anyone honestly argue that it benefits the beneficiaries of a trust? Actually, there are many who support it. Their argument is, at least with respect to investments, that a trustee whose authority to manage investments is given to another shouldn’t be held liable if the other makes bad investments. Makes sense, but only up to a point. The trustee is still the trustee and has the ultimate responsibility for the integrity of the trust and the realization of its purposes. Absolute or near absolute (read “willful misconduct”) exculpation for watching trust investments (without which there will be no trust) disappear, flat out contradicts this role, especially when the liability isn’t merely re-applied, it’s repealed.
For those of us who add such provisions to clients’ trusts, are we expressly advising clients of the total exculpation of their trustee and advisor? If, as in the case of our hypothetical client Dan at the onset of this discussion, the client had no idea of this potentially disastrous result, is he, nevertheless, bound by it? Why couldn’t he argue that it was never explained to him, and there was a duty on the part of his attorney to do so?21 Most of us learned in law school that, short of fraud, individuals are presumed to have read and understood a document they sign and are bound by it.22 Therefore, whether we tell our clients of the loss of any recourse for gross negligence or reckless misconduct in the management of their trust, if they sign a trust with such provisions, there’s no recourse.
It doesn’t appear that there are many (if any) cases dealing with a client’s total exculpation of the two fiduciaries (the trustee and the advisor, and yes, I believe the advisor is generally a fiduciary, despite a provision in the trust to the contrary),23 when there’s a breach of duty. There are, however, numerous cases dealing with a trustee’s reliance on an exculpatory provision in the face of a claim for damages or loss on account of an alleged breach of fiduciary duty. In all such cases, the courts begin their consideration with the position that the trust provisions or concomitant agreements exculpating the trustee will be strictly enforced24 and in some cases, may even be against public policy.25 The standard becomes even more acute if the exculpating provision applies to the drafter of the trust.26 The point is that the relationship is so dependent on the beneficiaries’ entitlement to rely on the integrity, care, watchfulness and absolute loyalty of the trustee, that the default position is to deny exculpation if called for under the circumstances, despite the exculpatory provision. One commentary suggests that exculpatory clauses should be held contrary to public policy if they allow the liability to fall somewhere between the trustee and the holder of the power (that is, the advisor), and leave the beneficiary without any remedy for mismanagement of the estate27 (emphasis added).
When one considers that most of the laws exculpating trustees, including those in the old Uniform Trusts Act adopted in 1937, were originally proposed, supported and provided with official comments by the American Banker’s Association, and that they continue to be so, it’s not surprising that they strongly support broad exculpation of trustees. And, although a number of cases have held that a corporate trustee should be held to a higher standard,28 none of the exculpatory laws reflect that position. But that, by itself, isn’t the heart of the problem here. The issue is that we appear to be headed towards practical abandonment of liability for losses caused by the negligence of the parties to whom our clients have entrusted their assets. Should we not take it upon ourselves to reject this trend, reject blanket exculpation provisions for trustees and trust advisors, give our clients’ interests the higher priority and let those with the responsibility bear the responsibility?
1. As in the case of a number of states that have enacted directed trust statutes, when the trustee is required to follow the instructions of an advisor or protector, the trustee becomes an “excluded fiduciary” as to the directed matters and is exculpated for following such direction. See, e.g., 12 Del.C. Section 3313(a), (b).
2. Ibid., Section 3303(a).
3. Despite the disproportionate, speculative investments and the issue of the trustee’s duty to diversify under the Prudent Investor Act, the trustee, being an excluded fiduciary, needn’t concern itself with these details.
4. Ibid. and 12 Del.C. Section 3301(g).
6. Ibid., Section 3313(b).
7. Ibid., Section 3313(e).
8. Delaware law provides, as do those of a number of other states, that an advisor may or may not be considered a fiduciary, depending on the terms of the trust. Ibid., Section 3313(a). If the trust declares the position to be a non-fiduciary one, then the powers given to the advisor are personal powers, and the advisor has virtually no duty whatsoever other than to avoid committing a fraud on the power. Re, Wright 1 Ch. 108 (1920). Some commentators suggest that one reason a trust should expressly provide that an advisor isn’t a fiduciary is to avoid exposure to a state income tax if the advisor is domiciled in a state that imposes an income tax on trusts, if a trustee is domiciled there. This would be based on the taxing state’s position that the advisor holding significant powers is the equivalent of a trustee. See State of New York TSB-A-04(.7)1, Nov. 12, 2004. To think that exposure to such a tax can be avoided simply by saying that the advisor isn’t a fiduciary is no different from thinking a duck may be transformed into a cat by declaring that it’s a cat.
9. Although Delaware law provides that co-fiduciaries have a duty to keep each other informed of information relevant to the performance of their fiduciary duties (12 Del.C. Section 3317), that duty may be excused by the terms of the trust, but in this case, the advisor was declared to be a non-fiduciary, so the provision wouldn’t apply in the first place. In addition, a Delaware court confirmed this result in a case with very similar facts. See Deumler v. Washington Trust Company C.A., 2003 Del.Ch. (Oct. 28, 2004).
10. 12 Del.C. Section 3317.
11. See Deumler supra note 9.
12. Meinhard v. Salmon, 249 N.Y. 458, 464 (1928).
13. See, e.g., N.Y.E.P.T.L. Section 1-1.7(a)(1), providing that a provision in a testamentary trust or will is void as against public policy if it purports to exculpate a fiduciary from liability for failure to exercise reasonable care, diligence and prudence.
14. See, e.g., Matter of Dumont, 791 N.Y.S.2d 862 (N.Y. Surr. 2004).
15. 12 Del.C. Section 3313(a), (b).
16. Ibid., Section 3313(a).
17. Uniform Trust Code (UTC) Section 808(b) states that the trustee shouldn’t follow the direction of an advisor if the trustee believes that the direction is “manifesting contrary to the terms of the trust.” However, Delaware hasn’t enacted the UTC, and even states that have adopted the UTC may elect to override this provision.
18. Occasionally, the settlor will name himself as the advisor. In such a case, the picture changes substantially, though not completely. Presumably, the settlor would want to limit his exposure to liability, and that intention would weigh heavily with a court. On the other hand, even a settlor in that position can have a fiduciary duty to the beneficiaries, and he could, or at least should, be held liable for a breach of his presumed fiduciary duty.
19. Armitage v. Nurse, 3 WLR 1046 (1997) England.
20. UTC Section 105 (b)(2). UTC Section 808(b) seems to acknowledge the existence of fiduciary duty, but, in the comments to that section, it allows the abandonment of the duty to protect the beneficiary.
21. Under the Model Rules of Professional Responsibility Section 1.4(a)(2), a lawyer shall “reasonably consult with the client about the means by which the client’s objectives are to be accomplished” and under Section 1.4(b), “A lawyer shall explain a matter to the extent reasonably necessary to permit the client to make informed decisions regarding the representation.” Would the beneficiaries’ inability to effectively enforce the client’s trust fall under these responsibilities? But, would the beneficiaries have standing to sue the attorney?
22. Pimpinello v. Swift & Company, 253 N.Y. 159 (1930).
23. See, e.g., Alexander A. Bove, Jr., “The Case Against the Trust Protector,” ACTEC Journal (Summer 2011).
24. Restatement Second Trusts Section 174 comment d.
25. Supra note 10.
26. UTC Section 1008(a)(2).
27. “Directory Trusts and the Exculpatory Clause,” 65 Columbia Law Review 138, 151 (1965).
28. See, e.g., Liberty Title and Trust Company v. Plews, 60 A.2d 630, 642 N.J. (1948).