§ 54  Introduction  [319-320]

 

The jobs of administering estates or of administering trusts involve different considerations.  Personal representatives of estates face a shorter time span, with limited goals.  Estate administration has the feel of holding things together.  See Estate of Beach, 542 P.2d 994 (Cal. 1975); but see In re Estate of Janes, 681 N.E.2d 332 (N.Y. 1997).  Trust administration, on the other hand, usually has a longer time horizon.  Trustees must be attuned to the changing personal needs of the beneficiaries and the changing markets affecting the management of the trust assets.  Trust administration has more of a pro-active feel. 

 

Despite these differences, fiduciaries engaged in either type of administration face very similar problems, and the legal principles governing them tend to cut across the particulars of individual situations.  See UPC §§ 7-302 and 3-703(a); UTC § 804.  The legal doctrine itself also tends to flow together.  For example, a single investment decision may involve the duty of loyalty, a question of adequate care, and the interpretation of a will clause seeking to exonerate a trustee from liability.  See In re Estate of Collins, 139 Cal. Rptr. 644 (Cal. App. 1977).

 

§ 55  Relationships with Beneficiaries  [321-331]

 

         A.  The Duty of Loyalty

 

The duty of loyalty distinguishes fiduciary duties from other obligations the law imposes.  Fiduciaries must place the beneficiaries’ interests above their own.  

 

               1.   Fiduciary-Beneficiary Conflicts

 

Because some kinds of conflicts are virtually inevitable, the law recognizes degrees of conflict of interest between fiduciaries and beneficiaries.  In addition, the settlor or the beneficiaries can consent to the conflict.  See UPC § 3-713; Restatement (Second) of Trusts § 216.

 

                     a.   Self-Dealing

 

Suppose Martin, as executor, owns land that Martin, as real estate developer, would love to purchase.  Because of the temptation for the executor to give the developer a really good price, the law follows a “no-further-inquiry” rule in self-dealing situations.  Any beneficiary can undo the deal, regardless of its underlying fairness.  By making transactions voidable at a beneficiary’s option, the rule hopes to prevent self-dealing in the first place.

 

Self-dealing often arises when family members are fiduciaries.   See In re Estate of Allison, 488 N.E.2d 1035 (Ill. App. 1986); UTC § 802(c).  

 

                     b.   Other Conflicts of Interest

 

The duty of loyalty extends well beyond self-dealing, to any situation in which the interests of a fiduciary and those of the beneficiaries are in conflict.  When such conflicts arise, courts will examine the underlying fairness of the situation.  See In re Estate of Rothko, 372 N.E.2d 291 (N.Y. 1977). 

 

               2.   Impartiality

 

Conflicts are particularly common among income beneficiaries, and between them and those who expect to take the remainder. A fiduciary must treat each individual beneficiary impartially.  See UTC § 803. 

 

                     a.   Investment Strategy

 

Income beneficiaries may want high income to live on, or they may prefer low current income and capital growth.  Persons who hope to take the remainder will be concerned primarily with being sure the value of their interest has not eroded over time because of inflation.  Compare Commercial Trust Co. of New Jersey v. Barnard, 142 A.2d 865 (N.J. 1958), with In re Dwight’s Trust, 128 N.Y.S.2d 23 (N.Y. Sup. Ct. 1952).

 

                     b.   Taxes

 

Tax rules also pose a conflict when they allow the fiduciary to allocate tax benefits or burdens among beneficiaries.  For example, the tax code gives the executor the choice of claiming the expenses of estate administration against the income taxes due from the estate or against estate taxes.  I.R.C. § 642(g).   Claiming against income taxes might make income beneficiaries happy while incurring the wrath of remainder beneficiaries.  See In re Estate of Bixby, 295 P.2d 68 (Cal. App. 1956). 

 

                     c.   Principal-Income Allocation

 

A common question is whether particular receipts and disbursements should be credited or charged to the income beneficiaries or to the trust principal.  The basic vehicle for addressing these problems is the Uniform Principal and Income Act.  The Act was promulgated in 1931, revised in1962, and revised again in 1997.  See 7B Unif. Law Ann. 1 (2000).  Among the most important innovations of the 1997 version is Section 104, which gives the trustee the authority to adjust between principal and income instead of applying traditional rules that would be inappropriate for the trust in question.

 

For a decision highlighting a few of the more notorious trouble spots, see First Wyoming Bank v. First National Bank & Trust Co. of Wyoming, 628 P.2d 1355 (Wyo. 1981). 

 

                           i.    Unitrusts

 

A relatively new way of conceptualizing trusts makes allocation arguments irrelevant.  A “unitrust” (a/k/a “total return trust”) views the trust assets as a whole.  Instead of paying out “income,” a unitrust typically distributes to the current beneficiary a pre-determined percentage of the trust’s total market value.

 

         B.  The Duty to Communicate

 

Ethics rules require lawyers to keep their clients informed.  See Model Rules of Professional Conduct, Rule 1.4 (2002).  Probate rules and trust documents regularly require that fiduciaries account to the beneficiaries.  See Jacob v. Davis, 738 A.2d 904 (Md. Ct. Spec. App. 1999).  UPC § 7-303(b) requires trustees to answer beneficiaries’ reasonable requests for information.  UTC § 813(a) requires trustees to keep beneficiaries “reasonably informed about the administration of the trust and of the material facts necessary for them to protect their interests.” 

 

Sometimes the duty may go beyond telling what has happened.  Before making a major decision, a fiduciary should check with the beneficiaries to get their input.  See Allard v. Pacific National Bank, 663 P.2d 104 (Wash. 1983).

 

§ 56  Managerial Issues  [332-340]

 

Perhaps the most important point about fiduciary management is that good intentions are not enough.  See Witmer v. Blair, 588 S.W.2d 222 (Mo. App. 1979).

 

         A.  Investments

 

Determining the propriety of any trust investment requires asking two questions.  The first is general: what types of investments can the trustee make?  Statutes, case law, or the trust document may preclude investment in common stocks or real estate, for example.  The second question is specific: assuming the type of investment is appropriate, is the particular investment proper?  Although a document may authorize a trustee to buy common stocks, obtaining shares in Widgets, Inc., a company on the verge of bankruptcy, may be imprudent. 

 

               1.   The Traditional “Prudent Man”

 

The prudent man rule got its start in Harvard College v. Amory, 26 Mass. (9 Pick.) 446 (1830), and has had differing amounts of influence throughout its history. 

 

a.      An Example

 

Visualize Stewart, the prudent man.  He is, most of all, cautious.  He dresses in blues and greys.  He drives a four-door sedan with front and side airbags.  He shuns football pools and has given up smoking.  He plays not to lose.

 

As trustee of a family trust, Stewart is concerned most about safety.  His primary goal is preservation of capital, without much regard for the corrosive effects of inflation.  He does not “speculate,” but instead relies on investments with guaranteed returns, like government bonds or, at least, stocks with established records of paying dividends.  If he makes loans, he gets plenty of security.  Diversification is perhaps his most important device for achieving safety.  He tends to think about the rate of return in absolute terms: is he generating enough income to meet the needs of the income beneficiaries?  He tends not to focus on the total return of the whole portfolio over time.  Avoiding individual losses is more important than achieving overall gains.

 

One of the dominant features of the traditional prudent man rule is its one-investment-at-a-time approach.  See First Alabama Bank of Montgomery v. Martin, 425 So. 2d 415 (Ala. 1982).

 

               2.   The Prudent Portfolio Investor

 

To modernize fiduciary investment law, the American Law Institute in 1990 approved new “prudent investor” rules.  See Restatement (Third) of Trusts §§ 227-229.  The Uniform Prudent Investor Act (UPIA) followed in 1994.  See 7B Unif. Law. Ann. 56 (1998 Supp.).  The most significant impact of the prudent investor rules is likely to be furthering the movement toward judging investments as part of a whole, rather than on a one-at-a-time basis.

 

a.      An Example

 

Imagine Jessica, a “prudent investor.”  She shares many traits with her conservative cousin, the prudent man.  She is careful, sensible.  She has her share of dark suits, but occasionally wears pinks or reds for variety.  She drives a two-door sporty car, but paid extra for airbags.  She does not smoke, but buys a lottery ticket occasionally. 

 

Like her older counterpart, Jessica cares about risk and return, but she views a larger picture, based upon her understanding of modern portfolio theory and related concepts.   She sees “return” as including both income and capital appreciation. 

 

b.      Diversification

 

Under a prudent investor approach, there is more attention to balancing the portfolio among investments that are unlikely to move in the same direction in the face of particular events.  The insight that purchase of a “risky” stock actually can lower the overall risk to the portfolio means that the traditional, one-investment-at-a-time approach is counterproductive.  Because the prudent investor must judge each investment decision in light of the overall portfolio and the needs of the trust, no investment is imprudent per se.

 

         B.  Other Managerial Duties

 

               Other principal duties that can present problems include:

 

·        to take control of the assets

·        not to commingle funds from one trust account with those of another 

·        to identify trust assets as such by “earmarking” them, though many states eliminate or soften the earmarking rule for securities

·        not to delegate to others obligations they ought to perform themselves.  (UTC § 807 allows trustees with lower skill levels to delegate more.)

 

         C.  Liability for Contracts and Torts

 

Traditionally, fiduciaries could be sure of avoiding contract liability only if the contract explicitly excludes personal liability.  In contrast, UTC § 1010(a) absolves the trustee of personal liability on a contract “properly entered into in the trustee’s fiduciary capacity . . . if the trustee in the contract disclosed the fiduciary capacity.” 

 

Traditionally, fiduciaries could they may be personally liable for torts even when they have personally done no wrong.  See Johnston v. Long, 181 P.2d 645 (Cal. 1947).  In contrast, under UPC § 7-306(b) and UTC § 1010(b) a trustee is personally liable for torts only if personally at fault.

 

§ 57  Drafting: Powers and Duties  [340-346]

 

Testators and settlors can alter virtually all of the rules described in this chapter.  Because issues of powers and duties tend to fold back onto each other, and all operate in the context of legislation, the topics are considered together.

 

 

         A.  Legislation

 

Some states give fiduciaries either a few particular powers or a longer list, and leave it to the drafter to “opt out” of those not wanted.  See UTC § 816.  Others list powers, but say they only apply if a document specifically refers to the list.  The lesson:  check your local staute before drafting a document that reads “in addition to all other powers granted by law . . . .”

 

         B.  Language in the Document

 

Documents can either help or hurt fiduciaries trying to perform their jobs.  This subsection describes a selection of common problem areas.

 

1.      Principal and Income Allocation

 

Because questions about how to allocate receipts and disbursements between income and principal can get very complex, drafters may simply give fiduciaries broad discretion to allocate items as they wish.  Courts often read these clauses narrowly.  See American Security & Trust Co. v. Frost, 117 F.2d 283 (D.C. Cir. 1940); In re Clarenbach’s Will, 126 N.W.2d 614 (Wis. 1964).

 

2.      Power to Sell

 

Even if a document has given the fiduciary a power to sell, related duties -- like the prudent investment rules or the duty to communicate -- may still restrict the power.  See Durkin v. Connell, 92 A. 906 (N.J. Ch. 1915); Allard v. Pacific National Bank, 663 P.2d 104 (Wash. 1983).

 

3.      Continuing a Decedent’s Business

 

If a document gives an executor the power to continue a business, she still must be able to exercise it competently.   See Estate of Baldwin, 442 A.2d 529 (Me. 1982).  Moreover, without more specific language a court would be unlikely to allow the executor to borrow money or to spend other estate assets to ease cash flow or conduct repairs.

 

               4.   Identifying Investment Strategy

 

Documents sometimes tell a trustee what investment strategy to follow or absolve the trustee from liability for holding onto particular stock.  Donors who authorize only some kinds of investments can hurt the beneficiaries if conditions change.  See In re Trusteeship Agreement with Mayo, 105 N.W.2d 900 (Minn. 1960).

 

 

               5.   Exculpatory Clauses

 

Language that has the effect of relieving fiduciaries of liability can come in different forms.  Sometimes a grant of authority is read to override a fiduciary duty.  See In re Heidenreich, 378 N.Y.S.2d 982 (N.Y. Sur. 1976);  Robertson v. Central N. J. Bank & Tr. Co., 47 F.3d 1268 (3d Cir. 1995).  Sometimes settlors insert very broad exculpatory clauses in their documents. In general, courts honor these clauses except in situations of gross negligence or willful default, but states range from being very restrictive to very liberal when enforcing the clauses.

 

UTC § 1008(a) bars enforcement of exculpatory clauses to the extent they (1) protect the trustee against breaches “committed in bad faith or with reckless indifference to the purpose of the trust or the interests of the beneficiaries” or (2) are “inserted as a result of” the trustee’s abuse of a fiduciary or confidential relationship to the settlor.

 

§ 58  Remedies  [346-347]

 

Beneficiaries who have suffered from breaches of duty have available a wide range of remedies against their fiduciaries.  They can invalidate deals, get specific performance, impose constructive trusts, deny fiduciary fees, remove fiduciaries, and recover damages (surcharges).  See UTC § 1001.

 

Setting damages poses special problems.  See In re Estate of Rothko, 372 N.E.2d 291 (N.Y. 1977) (assessing “appreciation damages” for loss of art).  The “anti-netting” rule says that a trustee who breaches trust duties may not offset gains against losses if the breaches were separate and distinct.  Sometimes deciding whether two breaches are separate and distinct can be difficult.  Restatement (Second) of Trusts § 213 provides a list of factors to help.