A round-up of significant court rulings
With litigation on the rise, fiduciaries and their advisors are striving to reduce or eliminate risk and understand how time-worn fiduciary principles may be applied in a world with volatile markets, changing trust and tax laws and a seemingly endless sea of lawyers looking for targets with deep pockets. The cases below provide recent examples of the perpetually evolving nature of fiduciary claims and guidance on how to navigate or avoid the many potential pitfalls.
Standing to Bring Surcharge Claim
In Scanlan v. Eisenberg,1 the U.S. Court of Appeals for the Seventh Circuit reversed a district court decision that a discretionary beneficiary lacked standing to bring a surcharge claim for $200 million in investment losses from investment concentration.
Martin Bucksbaum and his brother developed shopping centers and founded a very large real estate investment trust called General Growth Properties (GGP). They created six trusts for the benefit of Martin’s daughter, Mary, which provided for discretionary distributions to her during her lifetime. The same law firm represented Mary, GGP and the trustee of the trusts. The trusts were heavily concentrated in GGP stock and, after GGP declared bankruptcy in 2009, Mary’s trusts lost more than $200 million. Mary sued the attorneys and the trustee.
At the time Mary brought her lawsuit, the combined value of the trusts’ assets was $800 million. Mary brought various claims against the trustee and the attorneys, including for breach of fiduciary duties of loyalty, prudence and disclosure related to the purchase of GGP stock, and she sought various equitable remedies. The district court, sua sponte, ruled that Mary lacked standing for her claims because she was only a discretionary trust beneficiary, and she couldn’t prove that the trusts’ principal would be insufficient to satisfy discretionary distributions to her. The trial court dismissed all of Mary’s claims against the defendants with prejudice.
On appeal, the Seventh Circuit rejected the district court’s characterization of Mary’s interest in the trusts as being limited to her interest in discretionary payments from the trusts and found that a beneficiary of a discretionary trust whose rights are adversely affected has standing to enforce the trust. The appellate court concluded that Mary had a legally protected interest in the principal of the trust and its administration and that such interest in the trusts, coupled with her alleged injury in fact, gave her the requisite standing to pursue her claims in federal court.
Transaction With Affiliated Company
In French v. Wachovia Bank, N.A.,2 a Wisconsin court found that a corporate trustee didn’t breach its duties by exchanging insurance polices for new policies obtained through its affiliate.
Jim French created two irrevocable trusts called “Trust 1” and “Trust 2.” Trust 2 paid its income annually into Trust 1 and distributed all remaining assets into Trust 1 at Jim’s death. Trust 1 provided for no distributions during Jim’s lifetime. At his death, the assets of Trust 1 were to be distributed equally among Jim’s four children. Northern Trust was the initial trustee of the trusts.
Among other assets, Trust 1 held two life insurance policies: (1) a Pacific Life Insurance Company policy with a $5 million face value and annual premium of $160,000; and (2) a Prudential Life Insurance Company second-to-die whole life policy with a $5 million death benefit and a premium scheduled to increase by more than $40,000. Together, the policies had a combined cash value of approximately $2.2 million dollars.
By the end of 2004, Wachovia Bank, N.A. (Wachovia) took over as successor trustee of the trusts. Jim asked Wachovia to investigate options for the insurance policies held in Trust 1. After eight months of discussions among Jim, his attorneys and Wachovia personnel, Jim agreed to an Internal Revenue Code Section 1035 exchange, whereby Wachovia, through its affiliate Wachovia Insurance Services, Inc. (Wachovia Insurance), would exchange the policies for two John Hancock policies containing no-lapse guarantees, but poor cash values. Because the new policies were obtained through an affiliate, Wachovia requested a conflict of interest waiver. Jim was angered by this request and refused to sign the waiver. Near the end of the process, about one year after Jim’s initial meeting with Wachovia, Jim questioned the commissions charged by Wachovia Insurance for its role in procuring the John Hancock policies.
Jim’s children, as the trust’s beneficiaries, sued Wachovia for breach of trust for exchanging the insurance policies and sought to recover the lost cash value of the surrendered policies, as well as the fees paid to Wachovia and its affiliate. The children alleged that the exchange was a self-dealing transaction done in bad faith. The court held that Wachovia was authorized to engage in self-dealing because the trust agreement contained language specifically authorizing Wachovia to invest assets “without regard to conflicts of interest.” The court also held that Wachovia didn’t act in bad faith and, in fact, acted in the best interests of the trust on the grounds that: (1) the transaction took an entire year; (2) during that time the family was well aware of the conflict of interest between Wachovia and its affiliate; and (3) Wachovia engaged in a lengthy analysis of the transaction.
The court also approved the transaction under the prudent investor rule on the grounds that: (1) the trust already held $30 million in other assets, so the loss of cash value in the policies was likely a minor concern; and (2) the family’s attorneys recognized the value of the no-lapse policies in written memoranda, despite the inflexibility of the policies and the loss of the cash value.
Payment of Final Illness Expenses
Wells Fargo Bank, N.A. v. Estate of Ruth Elaine Mansfield3 involved an unsuccessful claim against a trustee, alleging abuse of discretion for not paying the expenses of a beneficiary’s final illness, when the beneficiary’s estate was sufficient to pay the expenses.
Henry S. Hansen created an inter vivos trust for his lifetime benefit. Following his death, the trust was to provide net income to both his daughters for their lifetimes and provided for discretionary principal payments to his daughters, if “needed” as a result of accident or illness. After the deaths of both daughters, the trust provided for distribution to the grantor’s descendants.
One daughter died in 1986, and the surviving daughter, Ruth, died in 2005 after suffering from a medical condition that necessitated extensive healthcare costs starting in 2002. Ruth suffered from dementia for several years, and the daughter of her longtime companion, Falion, had initiated a guardianship proceeding. Falion learned about the trust during the guardianship proceeding. Although Ruth died while the guardianship lawsuit was pending, Falion (on behalf of Ruth’s estate) demanded payment from the trust to cover the expenses of Ruth’s final illness. The remainder beneficiaries objected. The trial court held that the trustee had discretion to decide whether to pay the expenses. The trustee declined to pay them and proposed to distribute the trust assets to the remainder beneficiaries. Falion objected on behalf of the estate, but the trial court granted the trustee summary judgment and dismissed the objection. Falion appealed.
On appeal, the Nebraska Supreme Court affirmed the trial court on the grounds that: (1) Nebraska adopted the Restatement (Third) of Trusts standard that a trustee is presumed to have a duty to pay last-illness expenses only if the estate or other assets are insufficient, or the trustee either agreed to make payments or unreasonably delayed in paying a claim for which it was required to make payment; (2) the estate’s assets were sufficient to pay Ruth’s last expenses; (3) the trustee never agreed to pay any of the expenses; (4) the trustee didn’t abuse its discretion in declining to pay the medical expenses because the trustee properly examined Ruth’s other assets to see if her estate “needed” an additional distribution of principal; (5) the trustee had no duty to inquire into Ruth’s health when determining whether to make discretionary principal distributions; and (6) the trustee’s communications with remainder beneficiaries weren’t improper or an abuse of discretion.
Duty to Notify Beneficiaries
In Hobbs et al. v. Legg Mason Investment Counsel & Trust Co.,4 a Mississippi federal court refused to dismiss claims that a trustee was negligent in failing to inform beneficiaries about generation-skipping transfer (GST) taxes owed on trust distributions, but dismissed claims that the trustee had a duty to modify the trust to avoid the taxes.
Under his will, Edward H. Johnson created a marital trust for the benefit of his wife, Bernice. The marital trust assets were divided into a GST tax-exempt trust and a non-GST tax-exempt trust. At Bernice’s death in 1998, the assets of the marital trusts passed to two charitable remainder trusts, one GST tax-exempt and one non-GST tax-exempt. The charitable remainder trusts had eight income beneficiaries and three charitable remainder beneficiaries. The trust terms provided the income beneficiaries distributions for 10 years, and, thereafter, the trust assets passed outright to the charities. One of the income beneficiaries, Peggy Grow, died before the expiration of the 10-year period, and her two children, Floyd and Cynthia, became income beneficiaries of the charitable trusts. Unlike their mother, Floyd and Cynthia were skip persons for GST tax purposes and the distributions they received from 2004 to 2008 were subject to the GST tax in the non-exempt trust.
Legg Mason, the trustee, didn’t realize the distributions were subject to the GST tax. Following the termination of the charitable trusts, the trustee advised Floyd and Cynthia that the distributions were subject to payment of significant back taxes and interest. Floyd and Cynthia didn’t have assets to pay the taxes, so they each obtained a line of credit secured by assets of a separate trust, created by their mother, and Floyd, as trustee of that trust, sold stock at a loss to raise the funds to pay the taxes and interest. Thereafter, Floyd and Cynthia sued the trustee, alleging breach of fiduciary duty and negligence and seeking damages. The trustee moved for partial summary judgment as to the damages and sought to exclude the testimony of certain witnesses.
The court found that the trustee had abided by the terms of the trust, rejected the argument that the trustee had a duty to seek modification of the trust to minimize GST tax liability under Tennessee law and granted the trustee’s motion for partial summary judgment as to the GST tax liability. The court also found that the trustee wasn’t liable for losses incurred by the sale of stock to raise funds to pay the taxes, because the loss was predicated on an erroneous assumption that the price per share would be greater at some point in the future. The court also rejected Floyd and Cynthia’s claims for emotional damages and deferred their claims for punitive damages.
The plaintiffs filed a motion for reconsideration, which the court granted, finding that it had erred in assuming that modification of the trust to minimize GST tax liability was the only theory of liability the plaintiffs advanced. The court found that its prior opinion failed to consider the plaintiffs’ argument that the trustee was negligent in failing to notify the plaintiffs of issues surrounding the GST tax liability as part of a trustee’s duty to keep trust beneficiaries reasonably informed under Tennessee Code Section 35-15-813(a)(1). The court upheld the original determination that the trustee had no duty to modify the trust. The court found the previous opinion regarding stock liquidation losses and emotional damages to be sound.
Arbitration Award Unenforceable
Trust assets aren’t subject to an arbitration award if the award isn’t against co-trustees, according the court in Portico Management Group, LLC v. Harrison.5 In that case, Alan and Wei-Jen Harrison created and were the initial trustees of the Harrison Children’s Trust for the benefit of their two children, Kim and Lynn. The trust owned the majority interest in an apartment complex called the Continental. The minority interest in the Continental was owned by a limited partnership (LP) for which Wei-Jen was the general partner. After her divorce from Alan, Wei-Jen entered into a contract with Portico Management Group, LLC (Portico), for the sale of the Continental. Alan, as co-trustee of the trust, refused to sign the deed and closing documents for the sale.
Portico brought suit against the co-trustees and the general partner of the LP for breach of contract and to compel arbitration. The motion to compel arbitration was granted and, in 2007, the arbitrator issued a final award in favor of Portico based on breach of contract due to Alan’s refusal to sign the closing documents. The arbitration award specifically noted that the co-trustees weren’t personally liable and, thus, the award for damages was against the trust and the LP. Portico petitioned the Superior Court of Sacramento County to confirm the arbitration award and judgment was entered against the LP and the trust itself, without reference to the co-trustees. The court confirmed the arbitration award.
Portico sued to enforce the judgment against the trust. The co-trustees opposed the suit because no judgment was entered against the co-trustees and the trust wasn’t an entity capable of holding title to property. The court held that Portico wasn’t entitled to enforce the judgment against the trust because the arbitrator erred by naming the trust as the judgment debtor, and that decision wasn’t subject to judicial review and couldn’t be corrected. Portico appealed.
The California Court of Appeals affirmed the trial court’s decision on the grounds that: (1) a trust itself can’t sue or be sued; (2) in contrast to corporations, which the law frequently treats as persons, a trust isn’t a person but, rather, a fiduciary relationship with respect to property; (3) any claim based on a contract entered into by a trustee, in the trustee’s fiduciary capacity, must by asserted against the trustee in such fiduciary capacity; (4) because the trust itself didn’t hold title to any property, the judgment confirming the arbitration award against the trust is unenforceable against trust property; and (5) the judgment should have been against the co-trustees, because they held legal title to the property.
The court emphasized that Portico should have applied to the arbitrator to correct the award or petitioned the court to correct the arbitration award. Instead, Portico sued for confirmation of the award. Having accepted and confirmed the arbitration award against the trust without attempting to have the award revised to name the trustees as the proper parties, Portico is bound by the unenforceable arbitration award.
Arbitration Clause Enforceable
In Estate of Campana v. Comerica Bank & Trust, N.A.,6 the court ruled that an arbitration clause in an agreement between an investment advisor and trustees barred the trust beneficiary’s lawsuit against the investment advisor.
In 2003, Mary Lou Campana created a trust for the benefit of her sister, Virginia Campana. Mary Lou served as the initial trustee of the trust during her lifetime. Mary Lou retained UBS Financial Services (UBS) to provide investment management services on behalf of the trust. After Mary Lou’s death, Comerica Bank & Trust, N.A. served as successor trustee, and the bank also retained UBS to provide financial services to the trust. Each of the contracts with UBS contained a broad arbitration clause. After Virginia’s death, the executors of her estate sued in the U.S. District Court for the Northern District of West Virginia, alleging that UBS improperly managed the trust assets. UBS filed a motion to compel arbitration.
The Federal Arbitration Act (FAA) governs contractual arbitration clauses. The arbitration clauses in question provided that the trustee agrees that “any and all controversies which may arise between UBS” and the trustee concerning any account, dispute or breach of the agreement or any other agreement shall be determined by arbitration. The executors argued that because Virginia didn’t sign the contracts herself, and the arbitration clause doesn’t expressly bind third-party beneficiaries, Virginia and her estate couldn’t be bound by the arbitration clause. UBS argued that the arbitration clause was broadly drafted and should include all controversies regarding the performance of UBS on the trust’s behalf.
Citing the Fourth Circuit’s liberal policy favoring arbitration clauses and the broad enforcement of arbitration clauses under the FAA, the court granted the motion to compel arbitration. In the Fourth Circuit, “ambiguities as to the scope of the arbitration clause itself are resolved in favor of arbitration.” The court held that the dispute falls under the “any and all controversies” language and that even if the application of the clause to trust beneficiaries was ambiguous, this ambiguity would be resolved in favor of arbitration.
—The author thanks his McGuireWoods colleagues Meghan Gehr, Michael Barker, Adam Damerow and Justin Trent for their assistance with this article.
1. Scanlan v. Eisenberg, et al., 2012 U.S. App. LEXIS 1112 (Jan. 20, 2012).
2. French v. Wachovia Bank, N.A., 2011 U.S. Dist. LEXIS 72808 (E.D. Wisc. 2011).
3. Wells Fargo Bank, N.A. v. Estate of Ruth Elaine Mansfield, 281 Neb. 693 (2011).
4. Hobbs et al. v. Legg Mason Investment Counsel & Trust Co., 2011 U.S. Dist. LEXIS 999 (N.D. Miss. Jan. 5, 2011); Hobbs et al. v. Legg Mason Investment Counsel & Trust Co., 2011 U.S. Dist. LEXIS 7168 (Jan. 25, 2011).
5. Portico Management Group, LLC v. Harrison, 202 Cal. App. 4th 464 (Cal. App. 3d Dist. 2011).
6. Estate of Campana v. Comerica Bank & Trust, N.A., 2012 U.S. Dist. LEXIS 1490 (N.D. W. Va. 2012).