Courthouse Columns with The Statue of Justice

This is the first in a series of posts that will examine recent litigation against bank trustees in Mississippi.

After five years of litigation, last week a Chancery Court in Mississippi found that Regions breached numerous fiduciary duties with respect to the administration of the Patricia Hall Sheppard Trust and ordered Regions to pay in excess of $4M.  (for full text of Court Orders, see Order and Opinion on liability and Order and Opinion on damages)

Facts

J. E. (“Buddy”) Sheppard, Sr. departed this life in 1997 leaving behind his wife, Patricia, and two children, Victoria and Bud. Buddy’s Last Will and Testament established a trust for the benefit of Patricia, and he appointed Deposit Guaranty National Bank, which through mergers and acquisitions became Regions, as the Trustee. The terms of the Last Will and Testament require that the Trustee distribute all of the net income, at least annually, to Patricia.  In addition, the Trustee may distribute trust principal only if one of three conditions were met: (1) the net income is insufficient to enable Patricia to maintain her standard of living, (2) an emergency arises, or (3) Patricia has any health care needs.  Upon Patricia’s death, 80% of the remaining trust property would be held in trust for the benefit of the children, Victoria and Bud.

The trust established for Patricia’s benefit was funded in 1998 with approximately $2.5M in liquid assets and 33 residential rental properties, which the court characterized as “the largest rental property portfolio in Mississippi.”  Regions served as trustee from 1998 to 2011 when Patricia removed the bank as trustee and brought suit against Regions.

While the Court found many breaches of fiduciary duty, two are particularly concerning; those concerning distributions of principal and management of the real estate.

Distributions of Principal

The regular operating procedure was to give Patricia anything she asked for and he had no idea how Patricia spent the money that was disbursed.

During the time that Regions administered the trust, Patricia thought that she was receiving only distributions of income from the trust.  In fact, Regions began distributing principal from the very outset of the trust, in 1998.  In 2009, a trust officer informed Patricia that the trust principal had been severely eroded and that the liquid assets were worth less than a million dollars at the time.  In fact, in the 13 years that Regions administered the trust, the trustee distributed trust principal 765 times in a total amount of $3,617,250.  What makes matters worse is that while Regions was distributing trust principal, it was not even distributing all trust income, as mandated by the Last Will and Testament, in a number of years.

None of the distributions of trust principal were for emergency needs and only $10,898 were for health care related expenses.  Presumably, the other distributions were to enable Patricia to maintain her standard of living.  However, as the Court notes in its Opinion, “Regions never ascertained what [Patricia’s] standard of living consisted of”; that is, Regions never performed a needs analysis or determined what expenses Patricia had.  As the trust officer testified, the regular operating procedure was to give Patricia anything she asked for and he had no idea how Patricia spent the money that was disbursed.  The investment officer assigned to the trust testified that “we’d make distributions whenever she asked.”  As the Court observed, Regions could never determine if the principal disbursements were maintaining Patricia’s standard of living because Regions never knew what her standard of living actually was.

Management of the Real Estate

The words reasonable and prudent are not synonymous with loosey-goosey.

Shortly after Regions began administering the trust, the bank delegated management of the real estate to Orville Hall, Mrs. Sheppard’s brother.  As such, Orville was responsible for collecting rent, making repairs, and documenting vacancy rates.  In delegating one of its functions as the trustee, Regions had a duty to exercise reasonable care in delegating management of the real estate and had a duty to review and monitor the agent’s actions.  Regions’ failure in this regard is alarming.  The Bank’s own in house trust real property manager testified that he:

  • Did not know if anyone at the Bank was checking to ensure all rental payments were accounted for;
  • Did not review Orville’s invoices;
  • Did not know if Orville’s invoices for services and repairs were reasonable;
  • Never monitored the net income of the rental property;

When asked if Regions’ management of the real property could be described as “loosey-goosey”, the Bank’s in house trust real property manager replied, “some of the procedures seemed to be a little on the lax side.”  The court found that “the words reasonable and prudent are not synonymous with loosey-goosey.”  Regions own expert witness testified that Regions did not have definitive rules, but testified that that was not necessarily a bad thing and that only the bottom line counts.  As the court noted, “that sentiment is not correct in the terms of the duties that a trustee has with its beneficiary.”

In 2010, Regions began an investigation into the trust to determine if someone within the trust department was stealing money.  The Bank’s internal investigator determined that Orville was reporting that rent was collected but that the rent was not accounted for in the bank’s records.  In his report, the Bank’s internal investigator determined that the real estate was not being handled properly and that there was a failure of institutional controls.  The investigator submitted his report to the Bank’s Human Resources department and assumed that Human Resources would meet with the trust department to discuss the report and make necessary changes within the trust department.  However, the Human Resources Department never forwarded the report to the trust department and the Bank’s own in house trust real property manager testified that he saw the report for the first time on the witness stand.  Not surprisingly, Orville, who in fact was not a licensed real estate broker, had little to no experience managing real estate, and spent most of his time in Tennessee while all of the real property was located in central Mississippi, disappeared while the Bank’s internal investigation was ongoing.

Damages

After entering its Order finding liability, the Court appointed two special masters to assess damages.  One of the special masters resigned, and the other special master amended his report a number of times before submitting a final report.  The Court adopted the special master’s final report and awarded damages in the amount of $3,363,026 plus prejudgment interest in the amount of 8%, for a total of over $4M.

Around the Water Cooler this morning, we look at decanting (of trusts, not wine), a fascinating story of business succession done well from Canada, the 100th anniversary of the estate tax and September interest rates.

Finally . . . September interest rates.  The current § 7520 rate for use with estate planning techniques such as GRAT’s, CRT’s, CLT’s, and QPRT’s is 1.4%. The applicable federal rate (“AFR”) for use with an intra-family loan having a duration of 3 – 9 years, a sale to a defective grantor trust,  or a self-canceling installment note (“SCIN”) is 1.22%.

The low § 7520 and applicable federal rates continue to present planning opportunities with GRAT’s, sales to defective grantor trusts, SCIN’s and intra-family loans with depressed assets that are expected to perform better in future years.

On August 2, 2016, the IRS issued proposed regulations which would eliminate a common estate tax planning technique for transfers of ownership interests in family-controlled entities, like family limited partnerships and family limited liability companies.  Holly Bastian and Lynn Pearle describe the proposed regulations and the impact on planning in Lexology.

Leah McElmoyl describes “The Top Five Responsibilities of a Trustee of a Special Needs Trust” in JDSupra.

In the Madison State Journal, Dan Caplinger writes about a common estate tax planning technique, the Irrevocable Life Insurance Trust.

The CPA Practice Advisor offers another look at the benefits of Irrevocable Life Insurance Trusts.

Forbes highlights the need for trust planning for minor children.

Shawn Gardner writes about Trust Protectors, an increasingly common tool in estate and trust planning, in the Yuma Sun.

In ThinkAdvisor, Adrienne Penta offers Top 5 Tips for Nonprofessional Trustees.

  • Wrapping up The Water Cooler this morning, two stories at the intersection of presidential politics and the world of exempt organizations:

As first reported by Richard Pollock of the Daily Caller, the IRS Commissioner has referred congressional charges against The Clinton Foundation to the IRS exempt organizations office for investigation; and

In Nonprofit Quarterly, Erin Bradrick offers her perspective on Donald Trump’s rhetoric calling for the repeal the Johnson amendment.

 

The Scream by Edvard Munch, 1893
The Scream by Edvard Munch, 1893.

A Testator cannot be allowed to hamper so fundamentally such a vital right to seek redress for grievances through due process of law.

In order to reduce the possibility of expensive and fractious litigation, many wills and trusts include “in terrorem” clauses.   Such clauses provide that anyone who contests the will or trust is disinherited, and they are intended to terrorize or frighten heirs who may be inclined to institute a will or trust contest.  An in terrorem clause may provide, for example:

“If any beneficiary hereunder (including, but not limited to, any beneficiary of a trust created herein) shall contest the probate or validity of this Will or any provision thereof, or shall institute or join in (except as a party defendant) any proceeding to contest the validity of this Will or to prevent any provision thereof from being carried out in accordance with its terms (regardless of whether or not such proceedings are instituted in good faith and with probable cause), then all benefits provided for such beneficiary are revoked and such benefits shall pass to the residuary beneficiaries of this Will.”

A few states, like California and New York, enforce no contest clauses without limitation.  Other states, such as Florida, do not enforce no contest clauses.  In recent years, we have seen more and more states follow the approach of the Uniform Probate Code, which carves out a good faith and probable cause exception to in terrorem clauses.  Under this exception, if someone brings a will or trust contest in good faith and with probable cause, the in terrorem clause will not be enforced and the individual who instituted the contest will not be disinherited.

THE GOOD FAITH AND PROBABLE CAUSE EXCEPTION:

In Parker v. Benoist, 160 So.3d 198 (Miss. 2015), Mississippi joins the shift towards recognizing a good faith and probable cause exception to the enforcement of in terrorem clauses.  In 1998, B. D. Benoist executed a Will which, after providing for the lifetime needs of his spouse, left all of his property in equal shares to his two children, William and Bronwyn.  Shortly before he passed away, B. D. conveyed most of his real estate to William, and B. D. executed a new Will which left a significantly larger share of B. D.’s estate to William.  The 2010 Will contained the in terrorem clause quoted in the italicized language above.

After B. D. passed away, William admitted the 2010 Will to probate and shortly thereafter Bronwyn filed a will contest which alleged that William exercised undue influence over their father.  Specifically, Bronwyn alleged that William convinced B. D., who suffered from significant dementia, to give William most of his real property and to change his Will in a manner which would leave William a significantly larger share of B. D.’s estate.

At trial, the jury returned a verdict that, although there was evidence of a confidential relationship between William and B. D., there was no evidence that William exercised undue influence over B. D.  Applying the in terrorem clause in the Will, the Chancellor then ordered that Bronwyn would receive nothing under the Will and ordered her to pay all attorney fees and court costs associated with the Will contest.

Bronwyn appealed and in a case of first impression in Mississippi, the Mississippi Supreme Court reversed the Chancellor’s order which enforced the in terrorem clause.  In particularly strong language, the Court held that “[an in terrorem] provision is unconstitutional under Mississippi’s Constitution, void as against public policy, and fundamentally inequitable, and we join the large number of jurisdictions who permit a good faith and probable cause exception to [in terrorem] clauses in wills.”  There does seem to be some dissonance in the Court’s opinion, however, over the enforceability of an in terrorem clause:  while the Court held that an in terrorem provision is “unconstitutional” and “void against public policy,” in another part of the Court’s opinion, it held that “in Mississippi, in terrorem provisions in wills are enforceable unless a contest is brought in good faith and based on probable cause.”  Despite the strong language that in terrorem clauses are unconstitutional and void, it appears that the Court recognizes the validity and enforceability of in terrorem clauses but recognizes a good faith and probable cause exception.

In its opinion, the Court reasoned that “the logic for a good faith exception is simple: courts exist to determine the truth. . . .”  “A good faith and probable cause exception to the enforceability of forfeiture clauses in wills is in keeping with the guaranty of all citizens of this state to seek redress for their grievances through due process of law.”  “A Testator cannot be allowed to hamper so fundamentally such a vital right to seek redress for grievances through due process of law.”

PARTING THOUGHTS

It is clear that there is a shift in the states, as we’ve seen in Mississippi, towards carving out a good faith and probable cause exception to in terrorem clauses.  The act of filing a will or trust contest will not necessarily mean that the heirs who file suit will effectively be disinherited and take nothing.  This shift should certainly increase the number of will and trust contests since the disincentive in in terrorem clauses has been muted.  It will be interesting to see how courts interpret and apply the good faith and probable cause standards. 

Around The Water Cooler this morning, we’re diving into more statistics.  The IRS recently released its 2015 Data Book.  The following statistics are related to 2015 estate and trust income taxes and 2015 estate taxes.  There are a few tea leaves to read in the statistics; particularly the respective audit rates.

Estate and Trust Income Taxes:

Gross Collections from Estate and Trust Income Taxes:  approximately $33 Billion (a 14% increase over collections in 2014).  Gross collections from estate and trust income taxes represent 1% of total gross collections from all sources (a total of approximately $3 Trillion).

Number of Estate and Trust Income Tax Returns Filed:  3,202,706

Number of Estate and Trust Income Tax Returns Audited:  5,288 (0.17%).  The audit rate of estate and trust income tax returns is the lowest audit rate of all types of tax returns.

Estate Tax:

Gross Collections from Estate Taxes:  approximately $18 Billion.  Gross collections from estate taxes represent 0.5% of total gross collections from all sources.

Number of Estate Tax Returns Filed:  36,343

Number of Estate Tax Returns Audited:  2,770 (7.6%)

A whopping 31.6% of estate tax returns with a gross estate of greater than $10 Million were audited.  The audit rate of these estate tax returns is the second highest audit rate of all types of tax returns behind only income tax returns of corporations with total assets over $5 Billion.

 

Uniform Trust Code Section 706 permits the removal of a trustee under specific circumstances, such as (1) commission of a serious breach of trust or (2) where removal is requested by all of the qualified beneficiaries, but only if a court finds that removal of the trustee best serves the interests of all of the beneficiaries and is not inconsistent with a material purpose of the trust.  This last circumstance, (2), is known as “no fault removal” because it permits removal of the trustee even though the trustee has not committed a breach of trust.  However, no fault removal requires all of the qualified beneficiaries to agree to request the removal.  (We have previously looked at a case out of Pennsylvania, In Re McKinney, in which the court applied the no fault removal provision to remove a trustee.)

But, assuming that a trustee has not committed a breach of fiduciary duty, what if all of the qualified beneficiaries do not agree to request removal of the trustee.  Do trust beneficiaries have any other avenues to remove a trustee?

EDWARD WINSLOW TAYLOR, IRREVOCABLE TRUST

In an “end around” Uniform Trust Code Section 706, the beneficiaries in another case out of Pennsylvania, used the trust modification provision of Uniform Trust Code Section 411 to remove a trustee.  Uniform Trust Code Section 411 provides that a trust may be modified upon consent of the beneficiaries if a court concludes that modification is not inconsistent with a material purpose of the trust.

In Edward Winslow Taylor, Irrevocable Trust, three of the four beneficiaries of a trust established in 1928 brought suit to modify the trust agreement.  The 1928 trust agreement did not contain a clause which provided the beneficiaries with the power to remove the trustee, who at the time of suit was Wells Fargo.  In their suit, the beneficiaries sought to modify the trust to add a trustee removal provision.  In an opinion handed down on September 18, 2015, the Superior Court of Pennsylvania, an intermediate appellate court, granted the beneficiaries’ request to modify the trust agreement and a trustee removal provision was added which gave the beneficiaries the power to remove the trustee.

STAY TUNED

Wells Fargo has appealed the decision of the Superior Court.  On April 12, 2016, the Supreme Court of Pennsylvania granted Wells Fargo’s Petition to Appeal.  In a possible tip of its hat, the Supreme Court’s Order granting the Petition of Appeal states that the issue presented is “whether the Superior Court erred in holding that trust beneficiaries may circumvent the requirements for removal of a trustee in [Pennsylvania’s trustee removal statute] by amending the Trust under[Pennsylvania’s trust modification statute].”  By using the verb “circumvent,” the author of the Supreme Court’s Order granting Wells Fargo’s Petition to Appeal may have tipped his or her hat that the decision of the Superior Court is likely to be reversed.

No trust news today….just statistics.  A. M. Publishing recently released its annual Trust Performance Report, which tracks the trust industry’s asset and income data. The following are a few highlights from the 2016 Report which reflects 2015 data:

  • 4 out of every 5 trust institutions reported asset declines.
  • 2 out of every 3 trust institutions posted revenue growth.
  • A large number of trust institutions, 70, left the business in 2015.  84% of the institutions that left the trust business reported less than $500 million in total assets.
  • In 2015, 15% of trust institutions raised fees; slightly more than 20% of trust institutions plan to raise fees in 2016.
  • While trust industry assets overall shrank for the first time in 8 years, TIAA-CREF reported asset growth of 212%.

Around the water cooler this morning, there are articles on charitable remainder trusts, the net investment income tax, and a dispute brewing over the estate of Frank Zappa.

Amber Curto and Phil Jang in the National Review and Brude Udell in Kiplinger’s, examine the use of charitable remainder trusts.

In NIIT Again!, Keith Grissom offers techniques to reduce the net investment income tax.

In the LA Times, Randall Roberts takes a detailed look at the dispute brewing over the estate of Frank Zappa, the legendary musician.

Confidential

“A beneficiary is entitled to inspect opinions of counsel procured by the trustee to guide him in the administration of the trust.”

THE PRIVILEGE

The attorney-client privilege protects the confidentiality of communications between a client and its attorney when the communications are intended to be confidential and confidentiality is not waived.  If a communication, for example an e-mail sent from a client to its attorney or a memorandum prepared by the attorney and sent to the client, is privileged then a court will not compel the disclosure of that communication unless an exception applies.

But what about attorney-client communications in the context of trust litigation?  Assume that a beneficiary has initiated a lawsuit against a trustee for breach of fiduciary duties.  Are the communications between the trustee and its attorney privileged?  For whose benefit is the attorney rendering advice and counsel?  The Trustee?  The Beneficiaries?  The leading case of Riggs National Bank of Washington, D.C. v. Zimmer sheds light on these questions and on what is commonly referred to as “the fiduciary exception to the attorney-client privilege.”

CASE STUDY

In Riggs, the Trustee filed a petition for instruction with the Delaware Court of Chancery.  After the Trustee filed the petition, the Trustee contacted a law firm and requested a legal opinion about the matters in the petition for instruction and about potential tax litigation involving the trust.  The law firm prepared a memorandum and provided it to the Trustee.  The Trustee subsequently paid for the law firm’s services out of the assets of the trust.  The trust beneficiaries ultimately filed suit against the trustee for breach of fiduciary duties.

During the discovery phase of litigation, the trust beneficiaries requested that the Trustee produce the memorandum prepared by the law firm.  The Trustee declined based on attorney-client privilege.  The beneficiaries requested that the Court of Chancery compel production of the memorandum.  The Court of Chancery agreed with the beneficiaries and compelled the Trustee to produce the memorandum.

Court’s Rationale

The Court held that “a beneficiary is entitled to inspect opinions of counsel procured by the trustee to guide him in the administration of the trust.”  The court reasoned that the memorandum “was prepared ultimately for the benefit of the beneficiaries of the trust and not for the purpose of the trustee’s own defense in any litigation against [the Trustee],” and that “the ultimate or real clients were the beneficiaries of the trust, and the trustee . . . in his capacity as a fiduciary, was, or at least should have been, acting only on behalf of the beneficiaries in administering the trust.”

The Court found particularly compelling the fact that the Trustee paid for the legal memorandum out of assets of the Trust and not out of the Trustee’s own pocket: “[W]hen the beneficiaries desire to inspect opinions of counsel for which they have paid out of trust funds effectively belonging to them, the duty of the trustee to allow them to examine those opinions becomes even more compelling.”

Protecting the Trustee’s interest or the Beneficiaries’ interest?

The Court found that the Trustee’s assertion of attorney-client privilege was calculated to protect the Trustee’s own interests at the expense of the beneficiaries’ interests: “The Trustee here cannot subordinate the fiduciary obligations owed to the beneficiaries to their own private interests under the guise of attorney-client privilege.”

Balancing Policy Interests

The Court weighed the policy interests supporting the fiduciary exception against the policy interests supporting the privilege and found that “The policy of preserving the full disclosure necessary in the trustee-beneficiary relationship is here ultimately more important than the protection of the Trustee’s confidence in the attorney for the trust.”

FIDUCIARY EXCEPTION IN OTHER CONTEXTS

It is interesting to note that federal courts have applied the fiduciary exception to the attorney-client privilege to contexts outside the scope of trust litigation, including shareholder derivative litigation and ERISA litigation.  The United States Courts of Appeals for the 2nd Circuit, 4th Circuit, 5th Circuit, 7th Circuit, and 9th Circuit have all applied the fiduciary exception in the context of ERISA litigation and have held that an ERISA plan administrator cannot invoke the attorney-client privilege to prevent beneficiaries from receiving communications regarding the plan’s administration.  The 9th Circuit Court of Appeals has held that “[T]here is no attorney-client privilege between a pension trustee and an attorney who advises the trustee regarding the administration of the plan.”  The 5th Circuit has explained that:

“[A] plan’s administrator owes a fiduciary duty to the plan’s beneficiaries, not its sponsor.  When an attorney advises a plan administrator or other fiduciary concerning plan administration, the attorney’s clients are the plan beneficiaries for whom the fiduciary acts, not the plan administrator.  Therefore, an ERISA fiduciary cannot assert the attorney-client privilege against a plan beneficiary about legal advice dealing with plan administration.”

The application of the fiduciary exception to ERISA litigation is not surprising since the duties of an ERISA fiduciary are modeled after the duties required of trustees.  As the 5th Circuit Court of Appeals has noted, “ERISA does not expressly enumerate the particular duties of a fiduciary, but rather relies on the common law of trusts to define the general scope of a fiduciary’s responsibilities.”

LESSONS LEARNED?

FOR BENEFICIARIES: Depending on the particular facts and circumstances of each matter, Riggs and its progeny may provide very effective tools to gain access to otherwise privileged communications which may be very helpful to establish that the Trustee breached a fiduciary duty.

FOR TRUSTEES: Who is paying for the legal advice you receive?  You or the trust?  Is the legal advice sought and rendered for the benefit of the Trustee in anticipation of litigation or is the legal advice sought and rendered on behalf of and for the beneficiaries in administering the trust?