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Today’s class

Today’s class. Complete discussion of the duty of prudence Waiving the duty to diversify Duty of impartiality. Opting out of the prudent investor rule. As we’ve seen with many statutory rules, they are default rules that can be waived

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Today’s class

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  1. Today’s class • Complete discussion of the duty of prudence • Waiving the duty to diversify • Duty of impartiality

  2. Opting out of the prudent investor rule • As we’ve seen with many statutory rules, they are default rules that can be waived • “The prudent investor rule, a default rule, may be expanded, restricted, eliminated, or otherwise altered by the provisions of a trust. A trustee is not liable to a beneficiary to the extent that the trustee acted in reasonable reliance on the provisions of the trust.” • UPIA §1, page 711 • But courts are reluctant to recognize waivers, so careful drafting is important • Janes, as a former state senator, might have wanted his trust to favor Kodak, an important local company

  3. Wood v. U.S. Bank Wood v. U.S. Bank, N.A. 828 N.E.2d 1072 (Ohio App. 2005), p. 712 What were the facts in this case? John Wood II creates revocable trust with assets of over $8 million, 80% in Firstar stock, with Firstar as successor trustee. Trust instrument says trustee may “retain any securities in the same form as when received, including shares of a corporate Trustee.” Dana (a trust beneficiary) and her advisor request diversification. 1999 mid-2000 1998 Apr. 1999 After John’s death, Firstar sells other stock to pay debts of estate. Retains Firstar stock because of “strong earnings momentum.” No sales of any stock for sake of diversification. Firstar makes final distribution to beneficiaries. Firstar stock plunged in the meantime from $35/share to $16/share.

  4. Wood and opting out of the prudent investor rule • Ohio had adopted the UPIA, so the court applied the UPIA’s opt out provision • Did John Wood waive the duty to diversify when he authorized the retention of the Firstar stock? • No. He waived the duty of loyalty, which otherwise would have prevented the bank from investing the trust’s assets in the bank’s stock • Special circumstances may justify the failure to diversify, but there were none present in this case (any tax concerns would have disappeared at John’s death, and there was no family business or homestead)

  5. Modifying the duty to diversify • No modification • The trustee may “retain any securities in the same form as when received” (page 712) • Modification may be found • The trustee is directed or authorized to “retain all of the securities bequeathed to the trustee” (end of page 715) • The trustee may “retain any or all of the securities, as the trustee deems proper, without regard to the ordinary requirement of diversification” (end of page 715)

  6. Modifying the duty to diversify:Third Restatement, § 229 • “It is a question of interpretation whether . . . an authorization to retain property . . . modifies the trustee's normal duty with respect to diversification. • “Among the factors that may be of importance in this matter are: • whether, in effect, the settlor has intended to encourage or merely to authorize retention of the investments; • whether an authorization to retain applies to specific investments, to particular types of investments, or to all property received as a part of the trust estate; • the character of the original trust property in question; and the purpose of the trust generally, and • especially any identifiable purposes underlying the particular grant of authority.

  7. Another area for clear drafting • Inadequate language: • The trustee may make investment decisions “as to it may seem suitable, and to change investments and to make new investments from time to time as it may seem necessary or desirable, regardless of any lack of diversification, risk, or nonproductivity.“ • The case involved a bank as trustee and a heavy concentration of trust assets in the bank’s stock, with a settlor who had been president and chair of the board of the bank • Spragins, page 717

  8. Limits to the ability to eliminate the duty to diversify • UPIA § 1 allows the settlor to expand, restrict or eliminate the duty to diversify, BUT • Trustees are subject to a duty to seek judicial modification of an administrative provision of a trust when adhering to the provision could “cause substantial harm to the trust or its beneficiaries” (Restatement (Third) of Trusts § 66, page 645) • Courts in Pulitzer and Mayo ordered modification, but court in Toledo Hospital did not

  9. Beneficiary waiver of duty to diversify • A trustee is not liable to a beneficiary for breach of trust if the beneficiary • consented to the conduct constituting the breach, • released the trustee from liability for the breach, • or ratified the transaction constituting the breach, unless . . . • at the time of the consent, release, or ratification, the beneficiary did not know of the beneficiary’s rights or of the material facts relating to the breach. • Uniform Trust Code § 1009

  10. UPIA §9: Delegation (a) A trustee may delegate investment and management functions….The trustee shall exercise reasonable care, skill, and caution in: (1) selecting an agent; (2) establishing the scope and terms of the delegation…; and (3) periodically reviewing the agent’s actions…. (b) In performing a delegated function, an agent owes a duty to the trust to exercise reasonable care to comply with the terms of the delegation. (c) A trustee who complies with the requirements of subsection (a) is not liable to the beneficiaries or to the trust for the decisions or actions of the agent ….

  11. Problems, page 723 • Should A prevail in lawsuit against X? • On one hand, X testified that “when I put somebody in charge of something, I don’t second guess them” • On the other hand, A suggested that the trustee invest the funds exclusively in technology stocks • Court found that A’s involvement in investment decisions an important factor (in actual case, A was quite involved in investment strategy with trustee) • According to Restatement, “A trustee’s discretionary authority in matters of delegation may be abused by imprudent failure to delegate as well as by making an imprudent decision to delegate.”

  12. Duty of impartiality • If a trust has two or more beneficiaries, the trustee shall act impartially in investing, managing, and distributing the trust property, giving due regard to the beneficiaries’ respective interests. • Uniform Trust Code § 803 • Thus, impartiality does not require equivalent treatment, only fair treatment • Also, the settlor may have provided for differential treatment in the trust

  13. Howard v. Howard Howard v. Howard156 P.3d 89 (Or. App. 2007), p. 726 First wife Marcene (Co-Tr) Leo Coy (Co-Tr) Trust income to Marcene for life, remainder to Leo’s children When investing the trust principal, should the trustee favor production of income or growth of principal?

  14. What was the trustees’ duty according to Coy? • Coy and Marcene should take into account the other resources of Marcene in deciding how much income the trust should generate. • If they did not consider her other resources, she would be able to save income from the trust for her own children, and that would have frustrated Leo’s intent that the remainder pass to his children. • Leo and Marcene divided their assets in a way such that 60 percent would go to Leo’s three children and 40 percent to Marcene’s two children. That way, each child would receive an equal share.

  15. Were the trustees required to take into account other resources of Marcene? • No. A provision in the trust instrument stated that “my spouse’s support, comfort, companionship, enjoyment and desires shall be preferred over the rights of the remaindermen.” • There was no provision in the trust directing the trustees to take into account the needs of, or other financial resources available to, Marcene (and recall that the trust would pay her all of the income rather than income as needed). • There were provisions in the trust instrument instructing the trustees to take into account the needs and other resources of other beneficiaries.

  16. Drafting lesson from Howard • If Leo really did want to ensure equality between his line of descent and Marcene’s line, he should have included language in the trust agreement instructing the trustee to take into account the other resources of Marcene in allocating investments between generation of income and growth of principal (note 1, page 729)

  17. Impecunious surviving spouse, note 2, page 729 • Will the more contemporary modification statutes make courts more receptive to petitions on behalf of surviving spouses to invade principal? • “The court may modify the administrative or dispositive terms of a trust if, because of circumstances not anticipated by the settlor, modification or termination will further the purposes of the trust. To the extent practicable, the modification must be made in accordance with the settlor's probable intention.” • Ind. Code 30-4-3-24.4(a)

  18. Uniform Principal and Income Act: Reallocation between income and principal • Trust 1: $100,000 in bonds with a 4 percent interest rate. Each year, $4,000 in income is generated, and principal remains at $100,000. • Trust 2: $100,000 in stock with an 8 percent appreciation but no dividends. Each year, the principal grows by $8,000 or more, but no income. If the trustee splits the increase in trust value between income and principal, both income and principal beneficiaries are better off. (Income starts at $4,000, then $4,160, etc.) • Ind. Code § 30-2-14

  19. Uniform Principal and Income Act and the unitrust provisions • The UPIA allows trustees to focus on total return without worrying whether the return takes the form of income or principal, but trustees still have to decide how much of the return to allocate to “income” and how much to “principal.” • The unitrust provisions allow for a specified percentage of the trust’s assets to be treated as “income”—it can be a fixed percentage (4%), it can be tied to inflation, or it can be based on prevailing interest rates • When the settlor chooses the unitrust, the settlor determines the percentage • When trustees convert a trust to a unitrust, as in Heller, the statute sets the percentage (usually 3-5 percent) (3-5 percent in Indiana, with a presumption in favor of 4 percent, § 30-2-15-15).

  20. In re Matter of Heller In re Matter of Heller849 N.E.2d 262 (N.Y. 2007), p. 731 First Wife Bertha Jacob First Husband Remainder Income Suzanne Faith Sandra Alan Herbert

  21. Unitrust conversion and interested trustees • In Heller, the trustees who elected the unitrust conversion also were remainder beneficiaries who would benefit from the reduced allocation of estate returns as “income” (from $190,000 to $70,000) • The court rejected a no-further-inquiry standard for this structural conflict and instead required close scrutiny to ensure good faith and fairness by trustees • NY did not prohibit unitrust conversions by conflicted trustees even though it did prohibit UPIA adjustments that would favor a trustee • The trustees were meeting their fiduciary obligations to the other remainder beneficiaries • In Indiana, trustees who are beneficiaries need court approval for a unitrust conversion (Ind. Code § 30-2-15-11)

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