Corporate Trustees Beware Disappointed heirs lose their case against a bank -- but look at how much convincing the court needed By Samantha Weissbluth, senior counsel and Erika Alley, associate, Foley & Lardner, LLP, Chicago A recent Minnesota state court decision on a claim for breach of fiduciary duty should give corporate trustees pause.
The facts and final decision in In the Matter of the Janice Galloway Trust, No. C5-04-200042 (Minn. Dist. Ct. 2007) went resoundingly in favor of the corporate trustee. But it's surprising the amount of attention the trial court paid to what seems like a cut-and-dry breach of fiduciary duty claim. And, given the court's emphasis on the facts in this case, it seems possible that a different set of facts and different experts testifying for the beneficiaries would have meant a decision against the fiduciary.
In Galloway, the court held that a corporate trustee does not have a duty to contribute assets of a qualified terminable interest property (QTIP) marital trust to a family limited partnership (FLP). It gives corporate trustees some assurance that, at least in certain circumstances, they need not implement aggressive planning techniques to reduce estate taxes.
The QTIP marital trust at the center of the case was created under the revocable trust of Herbert Galloway for the benefit of his surviving spouse, Janice. Herbert's wealth had originated in an inheritance received by his mother from her brother, Herbert Huse Bigelow, co-founder of the Brown & Bigelow Company of St. Paul, Minn. Bigelow was a calendar salesman who with Hiram D. Brown, a printer, founded Brown & Bigelow, which became the largest calendar house of its kind in the world. For 37 years, the firm published The Boy Scout Calendar, illustrated by Norman Rockwell. In 1933, Bigelow drowned in a northern Minnesota lake when a storm overturned his canoe.
Only a very few financial professionals who target the affluent are bringing in 10 or more new affluent relationships each year. This book shares the Mindset, Activities and Skills of the Rainmakers who consistently achieve this level of success.
Herbert was a successful businessman who built upon his inheritance by founding Minnesota Plastics, a company he eventually sold to Standard Oil. Herbert and Janice had two children, Richard and Victoria. Herbert died in 1994, at which time his revocable trust became irrevocable and split into three separate trusts, including an exempt QTIP marital trust, a non-exempt QTIP marital trust and a credit shelter trust.
U.S. Bank, based in Minneapolis, had served as corporate trustee of almost all of the various Galloway family trusts for years, and was trustee of the non-exempt QTIP marital trust (the NEMT), which was the trust at issue in the case. The trust required all of the NEMT income to be paid to Janice during her lifetime, with principal distributable to her at the trustee's discretion for her health, maintenance and support.
When Janice died in 2001, she had a gross estate of about $26.4 million, which included the assets of her own revocable trust, the two marital trusts created under Herbert's revocable trust and another trust Herbert had created during his lifetime. The estate paid taxes of more than $12 million; about $10.2 million of that amount came from the NEMT.
Although the children had been informed that after Herbert's death that there would be substantial estate taxes due upon Janice's death, they were surprised at the extent of the estate tax liability. They objected to the payment of trustee's fees to U.S. Bank on various grounds, including that the bank had breached its fiduciary duty to the children by failing to contribute the NEMT's assets to an FLP (which, they argued, would have resulted in a substantial valuation discount for estate-tax purposes.)
The trial court dismissed all of the children's objections -- except for one breach of fiduciary duty claim.
In a very lengthy opinion (177 pages, double-spaced), the court ultimately found that U.S. Bank had no duty to contribute the NEMT's assets to an FLP for several reasons. All of the experts (even those testifying on behalf of the children) agreed that QTIP trusts do not typically invest in FLPs, and the experts were not aware of corporate trustees taking the initiative to invest QTIP trust assets in FLPs. There was no evidence that U.S. Bank or other corporate trustees commonly engaged in aggressive estate-planning techniques, such as the creation of FLPs. The court concluded that the children did not establish a community standard of care requiring trustee initiation of QTIP trust investments in FLPs.
Indeed, the court said, not only isn't it common practice, but also it's probably not a very good idea. The court spent a portion of its opinion discussing the inherent problems with investing QTIP trust assets in an FLP: First, the trustee's duty to keep control over the QTIP assets for the benefit of the income beneficiary directly conflicts with the need to relinquish control over the assets in an FLP to obtain estate tax discounts.
Also, specific requirements of a QTIP trust would make investing trust assets in an FLP difficult. The surviving spouse must receive all income from the QTIP trust, and a trustee must ensure that the QTIP assets are generating reasonable income for the spouse. Contributing QTIP assets to an FLP could interfere with the flow of income to the surviving spouse.
Furthemore, an FLP could interfere with the surviving spouse's right to convert non-income producing assets to income-producing assets. If an FLP were drafted to comply with these QTIP rules, the availability of discounts for estate tax purposes would be negatively affected. Furthermore, the court noted that if U.S. Bank had created an FLP, the assets of the NEMT would have decreased in value by more than the amount of any estate tax savings. (So long as the marginal estate tax rate is less than 100 percent, the value of the trust assets contributed to an FLP will always decrease more than the amount of any estate tax savings.) If the bank had created an FLP and invested NEMT assets in it, it could have been subject to a claim of breach of fiduciary duty for reducing the value of the NEMT.
In addition to the experts' testimony, the facts about the family situation and Janice's attitude toward her family and estate planning all weighed against an FLP being an appropriate strategy for this family: It was clear that Janice wanted to keep her financial affairs private and did not want to involve her children in her estate planning. She was not particularly close with either of her children and did not always approve of how they handled money. Also, Janice had rejected even simple estate-planning techniques recommended by her estate-planning attorney. Clearly, she was not interested in engaging in planning as complicated as a partnership.
The evidence also made clear that Janice was primarily concerned with ensuring the income was available for her use; she was not overly worried about saving on estate taxes to increase her children's inheritance. After Herbert's death, Janice became very concerned about whether she would have sufficient income. She wanted and needed the income from the NEMT to maintain her standard of living. Moreover, the court noted, there did not appear to be any non-tax purpose to form an FLP, so the FLP would likely not pass muster with the Internal Revenue Service.
As for U.S. Bank's actions as trustee: the court noted the record was clear that the bank had actively participated in many estate-planning meetings with Janice and her estate-planning attorney. Bank representatives had independent discussions with Janice on estate tax rates and ways to reduce them when she died. Janice not only took no steps to reduce the estate taxes. She also failed to implement other tax-planning techniques, like maximizing annual exclusion gifts and creating a qualified personal residence trust.
Unsurprisingly, then, the court found sufficient support for the bank's position that it had no basis to believe Janice wanted to engage in such an aggressive technique as forming an FLP. (The bank never discussed an FLP with Janice, although there was evidence that her attorney separately discussed this strategy with her.)
The court also briefly discussed U.S. Bank's marketing materials, which were introduced into evidence by the children, and found that although they discussed estate planning, the materials made it clear that clients should depend on their outside advisors (rather than the bank) to implement estate-planning strategies. Although the bank was ultimately found not liable, based on the Galloway court's decision, corporate trustees would be well-advised to carefully document meetings with clients regarding estate planning and ensure that their marketing materials are clear in directing clients to rely on outside advisors when implementing estate-planning techniques.
