Being a trustee entails risk of personal liability. Being one of a number of trustees can increase the risk. In the legendary Matter of Rothko,1 a fiduciary that failed to try to prevent his co-fiduciaries from breaching their duties was surcharged $6 million.
This cautionary tale sends a clear message: Know the state law that governs when a group or pair of fiduciaries disagree or even deadlock.
JOINT OR SEVERAL POWERS
Trustees sometimes disagree on how to exercise their joint powers. What to do? First, determine whether the power to be exercised is joint or several. Powers that are ministerial in nature, such as collecting assets and discharging debts are generally regarded as several.2
Joint powers are those that are not ministerial, require an exercise of prudent care and are substantive. Unless the governing instrument provides otherwise, one of multiple trustees cannot individually exercise a joint power. In Stuart v. Continental Illinois National Bank and Trust,3 the defendant bank trustee was surcharged $250,000 for making a distribution without the consent of its co-trustees.
Many states have enacted legislation concerning the exercise by multiple trustees of joint powers. While these statutes generally authorize a majority to exercise joint powers, they are not uniform. Texas Property Code Section 113.085 is typical.4 It states, “Except as otherwise provided by the trust instrument or by court order: (1) a power vested in three or more trustees may be exercised by a majority of the trustees.” The Texas statute is a codification of the Uniform Trust Code Section 703(a).
In Illinois, a majority of multiple trustees can exercise a joint power, unless the instrument provides otherwise, after giving prior written notice to the minority trustee(s), or having a waiver of such notice from the minority trustee(s).5 In contrast, California Probate Code Section 15620 requires multiple trustees to act unanimously unless the instrument provides otherwise.
The primary concern for a minority dissenting trustee is to avoid liability for the consequences of the majority's decision. The statutes that empower a majority to act typically contain a safe harbor provision for the dissenting trustee. But these safe harbors can be illusory.
Florida statute Section 737.404 (2005) is the most common version of these safe harbors, and it offers little comfort. It relieves a minority trustee from liability for the acts of the majority — if the dissenting trustee delivers his written objection to the majority at, or before the act. Note, however, that it does not relieve the dissenting trustee from an obligation to attempt to prevent a breach of trust by the majority. The operative word is “attempt.” Based on the Uniform Trustees Powers Act, a statute identical or very similar to the Florida statute has been enacted in at least 12 other states.6
Other states make life harder for trustees. Delaware imposes the same obligation of requiring a dissenting trustee to attempt to prevent a breach of trust — but adds the second obligation of going to court in a “recurring situation.”7
California narrows the passage into a safe harbor by adding an additional duty for the dissenting fiduciary. California Probate Code Section 16013, modeled on UTC Section 703(g), provides: “If a trust has more than one trustee, each trustee has a duty to do the following: (a) To participate in the administration of the trust; (b) To take reasonable steps to prevent a co-trustee from committing a breach of trust or to compel a co-trustee to redress a breach of trust.”
California Probate Code Section 16402 relieves a co-trustee for liability for breach of trust by a co-trustee, unless the non-breaching trustee negligently enabled the breach or negligently failed to compel redress if the breach is known or should be known.
New York may have the toughest law. It seems to impose upon the dissenting trustee the heavier duty of actually preventing a breach of trust. New York's Estates Powers and Trusts Law Section 10-10.7 states that “a dissenting fiduciary who joins in carrying out the decision of a majority of the fiduciaries if his dissent is expressed promptly in writing to his co-fiduciaries, shall not be liable for the consequences of any majority decision, provided that liability for failure to join in administering the estate or trust or to prevent a breach of the trust may not thus be avoided.”
The obligation of every trustee to attempt to prevent a breach of trust by its co-trustee(s) was established in a famous 1973 case involving the estate of the renowned post-war painter Mark Rothko. In Rothko, the beneficiaries sued the three executors for having sold or consigned most of the deceased artist's master works to a gallery that employed one of the executors, Bernard Reis, and marketed the paintings of a second executor, the “not-too-successful artist” Theodoros Stamos. The third executor, anthropology professor Morton Levine, joined Reis and Stamos in their divided loyalty sale/consignment of Rothko's paintings. Following the trial, the Surrogate Judge Millard L. Midonick surcharged Reis and Stamos each some $9 million, which included lost appreciation damages. Levine was surcharged $6 million, the value of the unrecovered paintings, for failing to attempt to prevent his co-executors from their self-interested action.
BREACH OF TRUST
Whether the dissenting trustee is obliged to prevent a breach of trust (New York), or to attempt to prevent a breach of trust (Delaware, Florida and elsewhere), it's essential that the dissenting trustee recognize whether his co-fiduciaries' intended action will be a breach. The Illinois Supreme Court defined the term “breach of trust” as “sufficiently comprehensive to include every violation by a trustee of a duty which equity lays upon him, whether willful and fraudulent, or done through negligence, or arising through mere oversight or forgetfulness. Included is every omission or commission which violates in any manner the three major obligations of carrying out a trust according to its terms, of care and diligence in protecting and investing the trust property, and of using perfect good faith.”8
Most jurisdictions do not tolerate the kind of defense that Richard M. Scrushy, former CEO of HealthSouth Corp., employed in his corporate fraud trial, that is to say a defense essentially arguing, ‘I was in charge but ignorant.’ In many jurisdictions, a fiduciary cannot avoid liability by being “inactive” (Tennessee)9 or failing to participate in the administration of the trust (for example, California, Florida and New York). In other words, abdication is unacceptable.
What constitutes a failure to join in the administration of a trust is a question of fact. Matter of Farley10 is instructive, in that its contours are so common. In Farley, a bank and an individual were co-trustees. The bank trustee bought and sold assets without consulting the individual trustee or later obtaining her consent. The individual trustee testified that she had no other experience as trustee and no formal training about investments. Yet she did review the periodic reports from the bank and had periodic discussions about the trust's investments with officers of the bank. Surrogate Judge Peter N. Wells ruled that the individual trustee's conduct over 23 years of administration amounted to ratification of the bank's conduct and that she was not liable for failing to administer the trust as she administrated it to the extent that she was able. Matter of Farley could be helpful in like cases.
ADVICE AND DIRECTION
What if all the trustees know — and understand — what's going on, but simply disagree among themselves about the best course of action? In some instances, this lack of agreement may be resolved by seeking the advice and direction of the court having jurisdiction over the estate or trust. The courts in New York will give advice and direction on a variety of matters, including tax elections, complex valuation issues and sales of assets. But courts usually decline to rule when the advice or direction requested amounts to a substitution of the court's judgment for that of the fiduciary.11 So, for example, the court will say X but won't say Y. (Surrogate Court Procedure Act Section 2107; Estate of Turell, Matter of Leopold.)
A dissenting fiduciary's last resort may be an exculpatory provision in the instrument, which relieves the fiduciary from liability for its own, or its co-fiduciary's, breach of trust. An exculpatory provision would seem to license breaches of trust and thereby be antithetical to the highest degree of loyalty and responsibility imposed by the common law upon fiduciaries. An exculpatory provision operates to elevate the interest of the fiduciary over the interests of the beneficiaries who, by hypothesis, suffer loss by reason of the fiduciary's negligence or intentional breach of trust.
Nevertheless, some jurisdictions respect some variations of an exculpatory provision. In Warren v. Pazolt12 the Massachusetts Supreme Judicial Court held that the trustee was not liable for his breach of trust, which was, in essence, the investment in a concentration, because the instrument exculpated the trustee except for “willful neglect or default.”13 In contrast, New York's Estates Powers and Trusts Law Section 11-1.7 prohibits the exoneration of executors and testamentary trustees from liability for failing to exercise “reasonable care, diligence and prudence.” The public policy imperative underlying the New York statute has been articulated in the common law of numerous other jurisdictions.
OFF WITH HIS HEAD
Occasionally, fiduciaries reach an impasse, paralyzing administration of the estate or trust. These impasses are resolved, generally by the judiciary, in various ways, some of them quite creative. It is stated in New York's Carmody-Wait, Section 1505: “The Surrogate's Court is empowered to suspend, modify or revoke the letters of a fiduciary for misconduct, and it is well established that the Surrogate's Court may exercise this power to remove a fiduciary for lack of harmony and ability to work in unison with co-fiduciaries for the benefit of the estate or trust fund.”
Just last year in Amarillo, Texas, there was a trustee of a charitable trust whose behavior became so intolerable that his co-trustees petitioned the court for his removal. This trustee had used his influence to get a scholarship for the son of a friend and used inordinate pressure, foul language and intimidation at meetings, creating such hostility and friction among the trustees that he impeded the proper functioning of the trust.
The court removed him, finding he had created an environment in which effective operation of the trust was impeded and therefore his removal was proper.14
In Tennessee, a provision of a trust established as part of a marital settlement directed that the principal of the trust be used for college tuition for the children, while another provision directed the trustees to use the principal for the wife, and noted that providing for her needs was the principal purpose of the trust during her life.
The wife requested use of principal for various purposes, including education and living expenses. One trustee was willing to invade the trust to comply with her request; another refused. The court, upon the petition of one trustee for instructions, ruled that the trustees were permitted to distribute principal to the wife, but they must bear in mind the need to preserve some principal for the children's education.15
Sometimes trustees disagree as to the allocation of estate taxes and mortgage payments. In a California case, one of the trustees was also a beneficiary, living in a house that was part of the trust corpus. This trustee directed payments from the trust to be made for the mortgage on the residence, as well as estate taxes allocated to the residence. The other trustee-beneficiaries said these payments should come out of her personal assets, or she should pay rent to the trust. This impasse sparked disagreement over other aspects of the administration of the trust and allocation of estate taxes. Complicating matters was a “no-contest clause” wherein the trust provided that any beneficiary who contested clauses of the trust would lose all beneficial interest in the trust. The court appointed a special trustee and ruled that raising this question to the court would not violate the trust's no-contest clause, because the petition did not seek, frustrate or thwart the testator's intentions, but rather to resolve a conflict between trustees.16
In North Dakota, two co-trustees disagreed as to how to divide farmland held by the subject trust. The relevant North Dakota statutes17 require trustees to act together unless the governing instrument permitted otherwise. (It didn't.) The law also stipulates that, if trustees disagree, the courts have the authority to supervise a trust's administration.
One trustee wanted to allocate individual tracts of farmland to each trust, while the other, citing the trustors' intent, wanted undivided interests in the farmland to be distributed rather than individual tracts. The court sided with the trustee who wanted to allocate specific tracts of farmland to each trust.18
In two New York cases, the courts have twice appointed tie-breaking trustees. In Estate of Duell,19 discord between nominated fiduciaries resulted in a hopeless deadlock in the administration of an estate. The court appointed a permanent, third fiduciary to cast a deciding vote and prevent potential loss to the estate resulting from the fiduciaries' inaction.
How did this happen? Manny Duell was a substantial real estate owner in New York City for many years. His will divided his estate into two trusts with outright distributions from one of the trusts to be made to two children when they reached certain ages. Duell's widow and his son, Andrew, were named executors and trustees. Andrew proposed to make distributions of the estate in kind by distributing fractional shares of the properties. Manny's widow suggested instead that outright ownership of individual buildings be distributed; her other child, Thea, agreed with her. After several meetings had demonstrated the acute family disharmony and impossibility of joint ownership, the executors petitioned the court for instructions and were directed by the court to submit a proposal for outright individual distributions. The executors submitted conflicting proposals, unable to reach an agreement. The court then appointed a third co-fiduciary to resolve the deadlock or make an alternative recommendation to the court.
Again in New York, two trustees could not agree on the selection of a foundation for a charitable distribution from an estate. One wanted to benefit the Whatnot Foundation in which the testatrix expressed an interest; the other favored the University of Arizona for no specific reason other than that he deemed it “the worthiest recipient.” The governing instrument directed the trustees to make the decision in their “sole discretion.”
The trustees asked the court to help. The court said it “may give advice,” even though it did not have the power to break such a deadlock and the fiduciaries' consent was required to exercise a joint power. Surrogate Judge Renee Roth wrote that if the court were a trustee, it would respect the decedent's request and distribute the fund to the Whatnot Foundation. If that nudge wasn't enough, the court also said that if its advice was disregarded, it would appoint a third trustee to cast the deciding vote. Not surprisingly, both trustees decided to let the amount in question go to the Whatnot Foundation.20
Apparently such machinations are unnecessary in Delaware. There, the Delaware Court of the Chancery in In re Revocable Trust of Marta21 itself served as the tie-breaker in a time-sensitive decision between two deadlocked trustees. In Marta, the trusts held the stock of a corporation, which owned a shopping center. The trust held other assets worth several times the current value of the shopping center. One trustee argued, and the court agreed, that if a distribution of the corporation stock was not made before the end of the month, the corporation's sub-chapter S status would be lost, resulting in a potential tax liability measured in the millions of dollars if the shopping center were sold. Another trustee gave many reasons as to why the stock should not be distributed from the trust. The court found that although these reasons had some merit, they were insufficient to counterbalance the consequences likely to flow from the inevitable loss of sub-chapter S status. Vice Chancellor John W. Noble said that the trustee's inability to agree and “the looming tax deadline which drives this matter more than anything else, leaves me with no choice but to act by directing the co-trustees to distribute the stock of the corporation in accordance with the dispositive scheme established by the trust documents.”
So, we can see that courts have taken a variety of actions in breaking an impasse, especially when the trust corpus is threatened, including removing trustees or appointing new trustees where necessary. The courts can be seen balancing the equities, preventing abusive behavior from creating an impasse in the trust, advising the fiduciaries in very strong terms, and, in its most extreme case, actually issuing a tie-breaking vote and directing the trustees to act in a manner beneficial to the trust.
The authors thank Brian P. Corrigan and Ellen S. Berkowitz, associates with Holland & Knight LLP, for their help preparing this article.
- 84 Misc.2d 830 (N.Y. Sur. Ct. Dec. 18, 1975), modified on other grounds, 56 A.D.2d 499 (1st Dept. 1977), aff'd, 43 N.Y.2d 305, 372 N.E.2d 291 (1977).
- Matter of Jacobs 127 Misc.2d 1020 (N.Y. Sur. Ct. Apr. 3, 1985).
- 369 N.E.2d 1262 (Ill. 1977).
- There is legislation pending that would modify this section by deleting the words, “Except as otherwise provided by the trust instrument of Court order.” 2005 TX H.B. 1190 (May 15, 2005).
- 760 Ill. Comp. Stat. 5/10; See, Atwood v. Commercial National Bank of Peoria, 83 N.E.2d 362 (Ill. App. Ct. 1949).
- These states include Arizona, Hawaii, Idaho, Kentucky, Louisiana, Maine (repealed effective July 1, 2005), Mississippi, Nevada, Oklahoma, Oregon, South Carolina and Washington.
- Del. Code Ann. Tit. 12, Section 3323 (2005).
- Stuart, 369 N.E.2d 1262; see also, Scott on Trusts, Section 201.
- Tenn. Code Ann. Section 35-50 114 (2004).
- 186 Misc.2d 355 (N.Y. Sur. Ct. Nov. 1, 2000).
- New York Surrogate's Court Procedure Act Section 2107; Estate of Turell, N.Y.L.J. Aug. 10, 1993 (Sur. Ct. N.Y. County); Matter of Leopold, 181 N.E. 570 (N.Y. 1932).
- 89 N.E. 381 (Mass. 1909).
- Scott on Trusts, Section 222-222.4.
- See, Bergman v. Bergman-Davison-Webster Charitable Trust, No. 0702-0460-CV, 2004 WL 24968 (Tex. App. Ct. Amarillo 2004).
- See, Graber v. Graber, No. W2003-01180-COA-RS-CV, 2003 WL 23099689 (Tenn. Ct. App. 2003).
- See, Knapp v. Schwartz, No. B155287, 2003 WL 1521994 (Cal. App. 2nd Dist. 2003).
- N.D. Cent. Code. Sections 59-02-11, 59-02-12, and 59-04-02 (2003).
- In re Larson, 341 N.W.2d 627 (N.D. 1983).
- N.Y.L.J. July 23, 1996.
- Matter of Jacobs, 127 Misc.2d 1020 (N.Y. Sur. Ct. Apr. 3, 1985).
- No. Civ. A. 20210-NC. 2003 WL 21998375 (Del. Ch. Aug. 14, 2003).