We’ll lead off this morning with a piece on the developing Schwan Foundation litigation.  In the Nonnprofit Quarterly, Michael Wyland reports on oral arguments before the South Dakota Supreme Court over the issue of whether two of the founder’s sons who serve on the Trustee Succession Committee have legal standing to gain access to documents detailing foundation investment losses of $600 million.  It is interesting to note that while the South Dakota Attorney General found no criminal wrongdoing in the investment losses, the AG did not investigate whether there was a breach of fiduciary duty.  It would certainly seem that the sons’ access to the documents would be essential in order to determine if there has been a breach of the Trustees’ fiduciary duties.  There is a link in the story to the oral argument.

In JDSupra, Jeana Goosman writes about a common asset protection tool, the Domestic Asset Protection Trust.

And in celebrity news, Natalie Robehmed reports in Forbes that Prince passed away without a Will.

cncartoons019472-549The controversy continues at the Schwan Foundation, a charitable foundation focused on Lutheran causes.    In the Argus Leader, Jonathan Ellis details the latest developments.  The Schwan Charitable Foundation’s IRS 990 for 2011 reported an investment loss of $218,265,025 related to certain real estate investments and total assets plunged from $750 million to $470 million.  It will be interesting to see how this matter plays out.

In a piece in the New Yorker about the continuing Panama Papers story, John Cassidy provides an answer to Why Aren’t There More American Names?

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In a fascinating case involving a trust established by President John Adams, a recent opinion of the Massachusetts Supreme Judicial Court follows a long line of cases holding that it is not prudent for a trustee to put all trust assets in one type of investment.

THE TRUSTEE’S DUTY TO PRUDENTLY INVEST TRUST ASSETS

In almost every state and the District of Columbia, the Uniform Prudent Investor Act (“UPIA”) governs the actions of a trustee with respect to investment of trust assets.  Section 2 of the UPIA requires a trustee to “invest and manage trust assets as a prudent investor would, by considering the purposes, terms, distribution requirements, and other circumstances of the trust. In satisfying this standard, the trustee shall exercise reasonable care, skill, and caution.”  Among the “other circumstances” that a trustee must consider in investing and managing trust assets are (1) general economic conditions; (2) the possible effect of inflation or deflation; (3) the expected tax consequences of investment decisions or strategies; (4) the role that each investment or course of action plays within the overall trust portfolio; (5) the expected total return from income and the appreciation of capital; (6) other resources of the beneficiaries; and (7) needs for liquidity, regularity of income, and preservation or appreciation of capital.  [As an aside, it is critical that a trustee DOCUMENT the factors that it considers when investing trust assets.  As one trust scholar and professional has noted, “If an action or decision is not documented, it didn’t happen.”]

But, what about professional trustees, like banks or other corporate trustees?  The general standard stated in Section 2 of the UPIA does apply to professional trustees, but the UPIA makes clear that “A trustee who has special skills or expertise, or is named trustee in reliance upon the trustee’s representation that the trustee has special skills or expertise, has a duty to use those special skills or expertise.”

One of the bedrock principles of the UPIA is the principle of diversification which is based on modern portfolio theory.  Section 3 of the UPIA provides that “A trustee shall diversify the investments of the trust unless the trustee reasonably determines that, because of special circumstances, the purposes of the trust are better served without diversifying.”  As the Prefatory Notes and Comments to the UPIA instruct, “the long familiar requirement that fiduciaries diversify their investments has been integrated into the very definition of prudent investing” and “case law overwhelmingly supports the duty to diversify.”

Another bedrock principal of investing trust assets is the duty of impartiality.  Where a trust names one individual as the beneficiary of income and another individual as the beneficiary of principle, the interest of the income beneficiary and the principle beneficiary may conflict.  The income beneficiary typically wants more income; the principle beneficiary wants growth.  The duty of impartiality requires a trustee to balance the interests of income beneficiaries to generate income with the interests of principle beneficiaries and remaindermen for growth.  Section 6 of the UPIA states that “If a trust has two or more beneficiaries, the trustee shall act impartially in investing and managing the trust assets, taking into account any differing interests of the beneficiaries.”

CASE STUDY

In 1822, President John Adams established a trust and transferred a portion of his real estate holdings to the trust.  The City of Quincy was named as the trustee. As a result of a cy pres petition, the Woodward School for Girls became the beneficiary of the trust and was entitled to receive all the net income from the trust.

By 1973, all of the real estate President Adams contributed to the trust had been sold, and the assets were invested in a portfolio consisting of 90% fixed income and 10% equity securities.  In April of 1973, the trustee, the City of Quincy, received investment advice about how the assets of the trust should be invested.  The City was advised by South Shore National Bank that the assets should be diversified and invested in a portfolio consisting of 60% equities, 35% fixed income, and 5% cash.  The trustee voted to adopt the bank’s recommendation but the trustee never implemented the recommendation.  By 1990, nearly 100% of the trust assets were invested in fixed income.  As a result, the value of the trust assets in 2008 were exactly the same as the value of the assets in 1973; $321,932.43.  So, in a 35 year period which saw the S & P 500 grow approximately 1,200%, the value of the trust assets did not increase since the assets were invested almost exclusively in fixed income.

In 2005, the school requested an accounting from the trustee.  After a year and a half, the trustee had not produced a complete accounting, so the school petitioned a court for an accounting.  Ultimately, the school filed a complaint against the trustee for breach of fiduciary duty, and the trial court held that the trustee breached its fiduciary duties by failing to keep adequate records, failing to obtain appraisals for real estate and sell it at fair market value, failing to prudently invest the assets of the trust, and failing to diversify the investments of the trust.  [It is interesting to note that during the trial, the judge said “It is inconceivable to me that the value of the portfolio has not doubled, tripled, quadrupled over 60 years.”  The Court hit the trustee with a $3 million judgment, $1.1 million of which was for unrealized gains that should be in the trust had the trustee prudently invested the trust assets.

On appeal, the Massachusetts Supreme Judicial Court applied Massachusetts’ version of the Uniform Prudent Investor Act and held that the trustee failed to prudently invest the trust assets by investing the assets almost exclusively in fixed income.  Specifically, the Court held that the trustee failed to properly diversify the trust assets between fixed income and equity and failed to protect the trust assets from the effects of inflation.

Throughout the 50 page opinion, the Court reflected the central tenets of the Uniform Prudent Investor Act:

On the trustee’s duty to diversify:

“Diversification is a central component of prudent investment” and “trustees are discouraged from investing a disproportionately large part of the trust estate in a particular security or type of security.”

On the trustee’s duty of impartiality:

“A trustee must necessarily consider both the generation of income and the growth and maintenance of the principal.”

On protecting the trust from inflation:

“At a minimum, a trustee must consider how best to guard the principal against inflation, if not how to grow the principal while simultaneously generating income to support the beneficiary.”

“A trustee must accordingly invest with a view both to safety, seeking to avoid or reduce loss of the trust estate’s purchasing power as a result of inflation, and to securing a reasonable return.”

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In the New York Times, Paul Sullivan offers a compelling look at the discord that can be caused by failing to properly plan for the distribution of personal property.

William Sleeth discusses a growing trend in trust litigation involving Trust Protectors.

Sticking to growing trends, in the Wall Street Journal, Sara Randazzo writes about the rise of competency litigation through the lens of the Sumner Redstone dispute.

In the wake of the release of the Panama Papers, Huffington Post looks at Five Legitimate Reasons to Have an Offshore Company.

Finally, Peter Lazaroff in Forbes explains the difference between a fiduciary standard and a suitability standard after the Department of Labor released new rules regulating retirement savings/investment advice.

cncartoons032852-549Stephen Gardener looks at the unique challenges of planning for families with special needs children in the New York Daily News.

In Lexology, John Lueken and Eric Metzger explain the use of a Grantor Retained Annuity Trust (GRAT) to transfer, tax-free, a significant amount of wealth to beneficiaries while maintaining control over and enjoyment of the property transferred.

Jonathan Guyton describes how baby boomers will change philanthropy in the Wall Street Journal.

In The Art of Saying No as a Philanthropist, Paul Sullivan provides a compelling argument in the New York Times.

And finally, in a story that provides plenty of international intrigue, after a year long investigation into the Panama Papers, a report has been released which details the movement of money through offshore companies and trusts and connections to leaders from around the world.  NPR aired a segment  about the Panama Papers on yesterday’s All Things Considered:

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No fault removal statutes begin a power shift. Trust beneficiaries who are faced with lack of personal service, high fees, and unsatisfactory trust administration now have a powerful tool to tip the scale.

Traditionally, it has been difficult to remove a trustee unless the trust agreement provides that the beneficiaries have the power to remove the trustee.  In the past, where the trust agreement does not provide the power to remove a trustee, beneficiaries would have to prove that the trustee was at fault or breached a fiduciary duty.

The “No Fault” removal provision of the Uniform Trust Code, now enacted in 31 states and the District of Columbia, provides beneficiaries with a powerful tool to remove a trustee where the trust agreement does not provide the power to remove and where the trustee is not at fault.  Under Section 706 of the Uniform Trust Code, a court may remove a trustee if “removal is requested by all of the qualified beneficiaries, the court finds that removal of the trustee best serves the interests of all of the beneficiaries and [removal] is not inconsistent with a material purpose of the trust, and a suitable cotrustee or successor trustee is available.”

CASE STUDY

In a recent case, In Re McKinney, a Pennsylvania appellate court used the no fault removal provision in Pennsylvania’s version of the Uniform Trust Code to remove a trustee.  Donald McKinney and his wife, Katherine, residents of Pennsylvania, created two trusts for the benefit of their daughter, Jane, and Jane’s four children.  Donald appointed the Pennsylvania Bank and Trust Company as trustee of one trust, and Katherine appointed Pennbank as trustee of the other trust.  Through various bank mergers, Pennsylvania Bank and Trust Company and Pennbank became PNC Bank.

Jane and her children wanted to remove PNC Bank as the trustee of both trusts and appoint SunTrust Delaware Trust Company, which is based in Virginia where Jane and her four children live, as the trustee.  Neither trust gave Jane or her children the power to remove the trustee and PNC was not at fault; that is, PNC Bank had not breached a fiduciary duty.  Jane and her children asked PNC Bank to voluntarily resign, but PNC Bank refused.  So Jane and her children went court to remove PNC.  PNC filed an objection and requested that PNC remain the trustee of both trusts and that the court award PNC all of its attorney fees incurred in responding to the petition to remove.

Trial Court Decision

The trial court denied Jane’s petition to remove PNC Bank as the trustee and awarded attorney fees to PNC Bank.  The trial court held that in order to remove PNC Bank, Jane was required to show that PNC Bank administered the trust in a way that “undermined” or “harmed” the beneficiaries’ interests; in essence, the trial court required that Jane prove that PNC was at fault.

Appellate Court Weighs In

Jane appealed and a Pennsylvania appellate court reversed the ruling of the trial court, including the award of attorney fees, and removed PNC as the trustee.  The appellate court held that requiring a showing of fault would undermine the intent of the no fault trustee removal provision, and that the trial court erred in requiring a showing of fault before removing PNC Bank.

So, if a beneficiary does not have to prove fault in order to remove a trustee, what is the standard a court should use when applying the no fault removal provision?  Based on the language of Uniform Trust Code section 706, there is a four-part test:

  1. Removal must be requested by all of the qualified beneficiaries;
  2. Removal best serves the interests of all beneficiaries;
  3. Removal is not inconsistent with a material purpose of the trust; and
  4. A suitable successor trustee is available

Parts (1) and (4) are relatively straightforward.  In McKinney, the Pennsylvania appellate court invested most of its analysis on parts (2) and (3).

(2) Does removal best serve the interests of all beneficiaries?

In analyzing part (2) of the test, the Superior Court listed a number of factors that should be considered in order to determine whether a trustee best serves the interests of the beneficiaries: personalization of service, cost of administration, convenience to the beneficiaries, efficiency of service, personal knowledge of the beneficiaries’ financial situations, location of the trustee as it affects trust income tax, experience and qualifications of the trustee, personal relationships between the trustee and the beneficiaries; the settlor’s intent as expressed in the trust document; and any other material circumstances.

The Court held that Jane and her children proved by clear and convincing evidence that removal would best serve the interests of the beneficiaries and focused on a few key facts: (1) because of successive mergers, Jane and her children were no longer receiving the personal service that they once enjoyed when the initial trustees were appointed; (2) because none of the beneficiaries still lived in Pennsylvania and because they had an existing relationship with SunTrust which was knowledgeable of the family’s financial situation and was close in proximity to the beneficiaries, the beneficiaries would have a stronger connection with SunTrust as the trustee than PNC Bank.

(3) Is removal inconsistent with a material purpose of the trust?

In analyzing part (3) of the test, the Superior Court considered whether the appointment of a particular trustee is a material purpose of a trust.  The Court determined that appointment of a particular trustee certainly can be a material purpose of a trust and that some deference should be given to the Settlor’s choice of trustee.  However, in McKinney, Donald and Katherine’s choices of trustees had long ago been merged and ceased to exist; through various mergers, acquisitions and name changes, the Pennsylvania Bank and Trust Company became Pennbank which became Integra National Bank North which became Integra Bank which became National City Bank of Pennsylvania which became National City Bank which ultimately became PNC Bank, the current trustee of both trusts.  As a result, the court ruled that the designation of a corporate trustee was not a material purpose and held that “There is no evidence that the settlors ever even contemplated [PNC Bank] serving as trustee. When the chosen trustee no longer exists, the only material purpose that can be served through designating a trustee is that the trustee effectively administers the trusts. Where both the trustee and the proposed successor trustee are qualified to serve that purpose, we will not find that removal violates a material purpose of the trust.”

LESSONS LEARNED?

So, what lessons might be learned from the application of the no fault removal provision in McKinney?  Traditionally, the difficulty of removing a trustee tipped the balance of power between trustees and beneficiaries in favor of the trustee.  No fault removal statutes begin a power shift.  Trust beneficiaries who are faced with lack of personal service, high fees, and unsatisfactory trust administration now have a powerful tool to tip the scale.  When confronted with a no fault removal statute, many trustees may be more willing to resign rather than contest its removal in court and potentially, as in McKinney, be on the hook for attorney fees and expenses incurred in the process.  A no fault removal statute may also begin a period of increased market competition between corporate trustees who are interested in increasing assets under management.  Ultimately, by shifting the balance of power back towards beneficiaries and increasing market competition, a no fault removal statute may lead to more prudent trust administration and a higher standard of service, both of which are good news to beneficiaries.

Ticking-ClockA statute of limitations is a straightforward concept: if a beneficiary has a claim against a trustee, the beneficiary must file a lawsuit before a certain period of time passes or the claim is forever barred.  Section 1005 of the Uniform Trust Code provides two statutes of limitations: a 5 year statute of limitations when a beneficiary has no notice of a claim and a 1 year statute of limitations when a beneficiary has notice of a claim.  (Be aware that states that have adopted the Uniform Trust Code vary widely in the number of years that have to pass before a claim is barred; for example, Tennessee has a 3 year statute when a beneficiary has no notice of a claim and a 1 year statute when a beneficiary has notice of a claim).

What Starts the Clock?

When a beneficiary has no notice of a claim, the UTC provides that a claim must be brought within 5 years of the first to occur of (1) the removal, resignation, or death of the trustee; (2) the termination of the beneficiary’s interest in the trust; or (3) the termination of the trust.  Typically, the termination of the trust starts the 5 year clock ticking.

When a beneficiary has notice of a claim, the UTC provides that a claim must be brought within 1 year from the date that the beneficiary was sent a report which “adequately disclosed the existence of a potential claim for breach of trust and informed the beneficiary of the time allowed for commencing a proceeding.”  [This is why beneficiaries may see certain language in the fine print of trust statements such as “You should immediately review this statement and consult with your legal advisor about this account on a regular basis.  If a potential claim is disclosed by this statement, you have one year to bring a claim.”]

So, what is a report which adequately discloses the existence of a potential claim for breach of trust?  A recent opinion of the Chancery Court of the State of Delaware, In the Matter of the Thomas Lawrence Reeves Irrevocable Trust, indicates that trust statements might rise to the level of a report which adequately discloses the existence of a potential claim (one of the Plaintiffs admitted that he had received statements almost a decade before filing suit) and that an accounting of the trustee’s administration of the trust might rise to the level of a report which adequately discloses the existence of a potential claim (the Plaintiffs received a complete accounting of the administration of the trust 3 years before filing suit).  The Delaware Chancery Court held that claims which had been disclosed in the statements and in the accounting were barred forever because the Plaintiffs did not file their claim before the statute of limitations ran out.

Lessons Learned

  • For Beneficiaries: trust beneficiaries should have someone review each trust statement in order to determine if, in fact, a claim is disclosed on the statement.  If a claim is disclosed and the beneficiary does not take action quickly, the claim may be forever barred by the statute of limitations.
  • For Trustees: are you adequately disclosing potential claims?

Many posts on this blog will make reference to the Uniform Trust Code (the “UTC”), so it’s appropriate to discuss what exactly is the UTC and how it will impact this blog and provide a link back in future posts.

Historical Approach

In the U.S. federal system, both the states and the federal government have the power to enact laws.  Some areas, like immigration and civil rights, are largely covered by federal laws.  Other areas, like divorce and family matters, are primarily covered by state laws.

So, what about trust law?  Trust law falls primarily to the states.  This has left us with a hodgepodge of very different state laws which apply to trusts depending on where a trust is located.  The laws that apply to the administration of a trust that is located in Oregon were very different than the laws that apply to the administration of a trust that is located in Tennessee.

The Push Towards Uniformity Among State Laws

711010main1_dnb_united_states_673Throughout the 1900’s, as American society became more mobile and interstate commerce increased, there were calls for greater uniformity of laws among the states.  In steps the National Conference of Commissioners on Uniform State Laws (NCUSL).

NCUSL promotes uniformity in state laws through the use of Uniform State Laws.  NCUSL drafts a uniform law on a particular area, for example adoption, and then promulgates the uniform law, the Uniform Adoption Act, to the states and encourages the states to adopt the uniform law.  Each state can then decide to adopt the uniform law exactly as it is drafted, adopt a modified version of the uniform law, or simply not adopt the uniform law at all.

The Uniform Trust Code

In 2000, NCUSL drafted a uniform law for trusts, the Uniform Trust Code, and encouraged the states to adopt the UTC.  As the Prefatory Notes to the UTC state, the impetus behind the Uniform Trust Code is the increased use of trusts in estate planning: “This greater use of the trust, and consequent rise in the number of day-to-day questions involving trusts, has led to a recognition that the trust law in many States is thin. It has also led to a recognition that the existing Uniform Acts relating to trusts, while numerous, are fragmentary.”

The goal of the Uniform Trust Code is to provide “precise, comprehensive, and easily accessible guidance on trust law questions. On issues on which States diverge or on which the law is unclear or unknown, the Code will for the first time provide a uniform rule.”

Adoption by the States

As of the date of this post, 31 states and the District of Columbia have enacted a version of the Uniform Trust Code.  The states that have enacted a version of the Uniform Trust Code are Alabama, Arizona, Arkansas, Florida, Kansas, Kentucky, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, New Jersey, New Hampshire, New Mexico, North Carolina, North Dakota, Ohio, Oregon, Pennsylvania, South Carolina, Tennessee, Utah, Vermont, Virginia, West Virginia, Wisconsin, and Wyoming.

When the UTC was drafted there were already comprehensive trust statutes in California, Georgia, Indiana, Texas, and Washington.   There are many similarities between the UTC and the comprehensive trust statutes in California, Georgia, Indiana, Texas, and Washington.

How Will the UTC Impact this Blog?

Since the Uniform Trust Code has been adopted in a majority of the states, most of the posts on this blog will look at the administration of trusts through the lens of the UTC.  The trend toward state uniformity in trust law will continue (legislation to adopt a version of the UTC is currently pending in Illinois) and framing the discussion on this blog with the UTC will have the broadest application to trust beneficiaries, trustees, and CPA’s and investment managers who work with trust clients.