Where a fiduciary serves as trustee and simultaneously manages a business entity owned by the trust, the fiduciary serves in dual fiduciary capacities. This “trustee-manager” owes fiduciary obligations to the trust beneficiaries both in his capacity as trustee and in his capacity as business manager (whether as an officer, director, or other manager of the business). This dual fiduciary status raises a question—what law governs the trustee-manager’s conduct? If claims are asserted by the beneficiaries of the trust regarding management of the business entity, what fiduciary standard should govern his actions? Is the trustee-manager’s conduct governed by the law of trust and estate administration, the law of business management, or some combination of the two?
These questions surface more often now that ownership of closely-held family business entities by trusts has become more common. Such arrangements are not limited to operating businesses owned by a decedent. In today’s tax-planning world, tax savings often are one of the many reasons testators create business entities—they place assets in family limited partnerships and other entities that benefit from valuation discounts or other advantages in order to pass assets to family members in a tax-efficient manner. Regardless of why the entity was created, where a trust beneficiary asserts claims against a fiduciary holding such assets, the dichotomy of the trust-level and business-level fiduciary duties must be considered by the courts.
It is well settled that trustees and personal representatives of estates are held to the very highest fiduciary duties in their fiduciary-beneficiary relationship:
Many forms of conduct permissible in a workaday world for those acting at an arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the marketplace. Not honesty alone, but the punctilio of an honor the most sensitive, is the standard of behavior.
Meinhard v. Salmon, 294 N.Y. 458, 465 (1928). “A trustee is a fiduciary of the highest order in whom the hope and confidence of the settlor are placed with the expectation that the trustee will exercise the obligations of the office for the exclusive benefit of those holding beneficial interests.” Smith v. Baptist Found. of Okla., 50 P.3d 1132, 1144 (Okla. 2002).
Most courts apply these fiduciary standards with “uncompromising rigidity.” Taylor v. Errion, 137 N.J. Eq. 221 (Ch. Div. 1945), aff’d, 140 N.J. Eq. 495 (E. & A. 1947) (quoting Wendt v. Fischer, 243 N.Y. 439, 444 (1926)). The trustee must act “at a level higher than those trodden by the crowd.” Carter’s Estate, 6 N.J. at 436 (quoting Meinhard, 294 N.Y. at 465). Among the trustee’s many fiduciary obligations are the proverbial triad of primary duties—the duties of good faith, loyalty, and due care.
Directors, officers, and managers of business entities, such as corporations, limited liability companies, and limited partnerships, likewise owe fiduciary duties to the entities’ owners. Those directors, officers, and managers, however, might claim their actions should be subject to a lower level of scrutiny. They may cite concepts like the “business judgment rule” as the standard governing their actions. “The business judgment rule vests the directors and shareholders with wide latitude in making judgments that affect the running of the corporation.” Herbik v. Rand, 732 S.W.2d 232, 235 (Mo. App. 1987).
That rule, as it exists in most jurisdictions, protects those individuals “from being questioned or second-guessed on conduct of corporate affairs except in instances of fraud, self-dealing, or unconscionable conduct.” In re PSE&G Shareholder Litigation, 173 N.J. 258, 277 (2002) (quoting Maul v. Kirkman, 270 N.J. Super. 596, 614 (App. Div. 1994)) (internal quotations omitted). The “business judgment rule” establishes a “rebuttable presumption” and places the initial burden on the person challenging the action to show that a director or officer engaged in self-dealing or other misconduct.
If the business judgment rule applies, the business manager may claim that more deference should be granted to the decision-making and actions taken in a director or officer capacity than would apply to the conduct of a trustee or personal representative of an estate. The difference in these two fiduciary standards creates a quandary for courts, which must evaluate the conduct of an individual who serves in both capacities—as trustee and as director or officer of the entity owned by the trust he or she administers.
Where a fiduciary acts in the dual role as trustee and manager, the Uniform Trust Code may be interpreted to promote the imposition of the higher trust-level fiduciary duties to govern the conduct of trustee-managers. For example, it provides that “(i)n voting shares of stock or in exercising powers of control over similar interests in other forms of enterprise, the trustee shall act in the best interests of the beneficiaries.” Unif. Trust Code § 802(g). This obligation to act in the best interests of the trust’s beneficiaries extends to the election or appointment of directors or managers of business entities where the trust is the sole owner of the entity.
The Restatement (Second) of Trusts likewise can be viewed as promoting higher trustee-level duties. For example, it provides the duty of a trustee in voting shares of stock is “to use proper care to promote the interest of the beneficiary.” § 193, Comment a. If the trustee votes in a manner that would “violate his duty to the beneficiary,” the Restatement provides the trustee “may be restrained by injunction or otherwise from casting a vote.” While the Uniform Trust Code and the Restatement might be interpreted to impose higher trust-level fiduciary obligations on a trustee who exercises his voting power over an entity owned by the trust, different courts in different states have taken varied approaches when evaluating the trustee-manager’s conduct.
Courts That Have Applied the Heightened Trust-Level Fiduciary Standards
The New York Court of Appeals, New York’s highest court, seems to have determined that the higher trustee-level fiduciary duty prevails. It has held that “where a trustee holds a working control of the stock in an estate [owned] corporation he is accountable in the probate court for the administration of the corporate affairs.” In re Hubbell’s Will, 302 N.Y. 246, 254-55 (1950). That court recognized that the executor or trustee
may not use the corporate charter as a shield to protect himself from censure – for . . . where as here the fiduciaries control a corporation by the help of the estate stock interest added to the stock interest held personally by one of them they are not disabled to make such accounts and are, therefore, under no obligation to do so. There is nothing sacrosanct about a corporation. It is not an impenetrable screen behind which facts may be successfully hidden.
Thus New York’s highest court has held that the duty of trustees and personal representatives of estates to maintain a “punctilio of an honor the most sensitive,” as it previously described in Meinhard v. Salmon, “extends not only to the trust estate . . . but also to the operations of the corporation.”
New Jersey has likewise applied the heightened trust-level fiduciary standards over the more deferential corporate-level standards. Like New York, the New Jersey Supreme Court recognized that where a loss occurs to a beneficiary as the result of the trustee-manager’s actions, the fiduciary is held liable as trustee “even where the loss is occasioned by his violation of his duty as a director or officer of the corporation in which the trust owns shares.” In re Koretzky, 8 N.J. 506, 528 (1951).
In Koretzky, the testator left his controlling interest in his business in trust for his children, naming members of the corporation’s board of directors as two of his four trustees. The children challenged those fiduciaries’ actions on the grounds that they allowed salaries to substantially increase, permitted the corporation’s rent to increase, authorized increased compensation to themselves, and engaged in other transgressions. The court applied the trust-level standard to evaluate the fiduciaries’ conduct. Noting that “the most fundamental duty owed by the trustee to the beneficiaries of the trust is the duty of loyalty” and that a trustee “is not permitted to place himself in a position where it would be for his own benefit to violate that duty,” the court removed the fiduciaries from their positions as trustees.
Missouri has likewise determined that a trustee-manager owes the trust’s beneficiaries the highest level of fiduciary duty. See Betty G. Weldon Revocable Trust ex rel. Vivion v. Weldon ex rel. Weldon, 231 S.W.3d 158 (Mo. Ct. App. W.D. 2007). In Weldon, the court evaluated the actions of trustees who also served as members of the board of directors of a corporation owned by the trust. In particular, the court considered those trustees’ decision to sell property owned by the corporation.
The Weldon court recognized that “(w)here a corporate director or officer’s decision falls within the business judgment rule, the court will not interfere with that decision.” Rather than apply the business judgment rule, however, to evaluate the actions of the trustee-directors, the Weldon court applied the stricter standards under Missouri’s version of the Uniform Trust Code. Id. Determining that the “trustee’s duty of loyalty to administer the trust solely in the interests of the beneficiaries” governed, rather than the business judgment rule, the court enjoined the trustee-directors from selling certain property owned by the corporation.
Other states have likewise applied the heightened trust-level fiduciary obligations to evaluate the conduct of a trustee who serves as director of a trust-owned corporation. See, e.g., Jones v. Ellis, 551 So.2d 396, 403 (Ala. Sup. Ct. 1989).
Courts That Have Applied the Lower Business-Level Fiduciary Standards
While many courts have applied the heightened trust-level fiduciary standards to evaluate the actions of trustee-managers, others have applied the more deferential business-level standards.
In Massachusetts, a trust beneficiary challenged the actions of his uncles as trustees and directors of the company owned by the trust, claiming those trustee-managers engaged in various transactions that amounted to self-dealing. Perry v. Perry, 160 N.E.2d 97, 99-100 (Mass. 1959). The Massachusetts court noted there was no evidence of actual fraud or bad faith and held there was “no basis on the findings for disregarding the corporate entity in determining the obligations of the officers of the corporation who were also trustees.” Accordingly, the Massachusetts court refused to set aside the transactions, even though they amounted to self-dealing. This is in contrast to the trust law adopted in other states that makes transactions that amount to self-dealing either void or voidable. See, e.g., In re Fulton, 253 A.D. 494, 495-96, 2 N.Y.S.2d 917 (3d Dep’t 1938).
In Wood Prince v. Lynch, the Rhode Island Superior Court also applied the more deferential business judgment rule to evaluate the conduct of a trustee-manager. Wood Prince v. Lynch, 2005 WL 373805 at *5 (R.I. Super. Feb. 8, 2005). In making its determination, however, the Wood Prince court concluded that the fiduciary duties of trustees and directors are substantially similar. The court recognized that trustees owe their beneficiaries the “highest” fiduciary duties. Nonetheless, the court concluded it was appropriate to apply the business judgment rule because it found commonality between the duties of trustees and directors; it noted both trustees and business managers owe the “triad” of duties to exercise good faith, due care, and loyalty.
This holding of the Wood Prince court is a bit of an aberration in that most courts have long recognized that a trustee owes a heightened fiduciary obligation when compared to the more deferential business judgment rule. See, e.g., Stegemeier v. Magness, 728 A.2d 557 (Del. 1999).
The Grantor’s Ability to Control the Governing Fiduciary Standard
Where the grantor exhibits, either explicitly in the trust instrument or through his conduct, an intent that the lower business-level fiduciary duty govern the trustee-manager’s conduct, some courts will honor that intent, although in many instances, that type of exculpatory language is disfavored or strictly construed. See Unif. Trust Code § 1008; N.J.S.A. § 3B: 31-77.
Georgia, for example, has recognized that a grantor may explicitly provide in the trust instrument that the trustee-manager is to be governed by the lower business-level fiduciary duties. In Rollins v. Rollins, the Georgia Supreme Court reversed a decision of the Georgia Court of Appeals that extended the higher trustee-level fiduciary standard to the conduct of trustee-managers (that decision was largely premised on New York case law). 294 Ga. 711 (2014). The Georgia Supreme Court noted the Georgia Court of Appeals’ ruling “may be appropriate as a general rule.” Based upon the Rollins facts, however, the Georgia Supreme Court found the settlor took great pains to clarify in the trust instrument his specific intention that the trustee-managers were to manage the companies owned in trust not solely for the benefit of the trusts’ beneficiaries, but also for the benefit of other shareholders. Thus, while recognizing that trustee-managers are generally subject to a trust-level fiduciary standard, under those particular facts, the court found that a corporate-level fiduciary standard was more appropriate to evaluate the trustee’s conduct as director of the corporation.
New Hampshire has recognized that a grantor’s own conduct may evidence his intent that the trustee-manager’s conduct be governed by lower business-level fiduciary duties. In Bartlett v. Dumaine, the grantor created trusts during his lifetime that were funded with stock in corporations the grantor controlled. 523 A.2d 1, 5-6 (N.H. 1986). After his death, the grantor’s children pursued claims against the trustees who also managed the company. They objected to various transactions that they claimed were affected by conflicts of interest, including the trustee-managers’ issuance of unsecured loans from the trust to the corporation, the payment of large management fees by the trust to the company, and other transactions.
The New Hampshire Supreme Court recognized that trustees owe a high fiduciary duty to their beneficiaries. The court, however, determined that “[t]hese general principles of trust law apply to a trustee unless the settlor imposes different constraints on the trustee.” In this case, conflicts of interest of the trustee-managers were “inherent in the declared scheme of the settlor.” During his lifetime (when he served as trustee-manager himself), the grantor ran both the trust and the company as an integrated entity maintaining the very conflicts of interest of which the beneficiaries later complained. The evidence demonstrated “that the settlor intended the trustees . . . , within their discretion, to take business risks with trust funds in concert with the . . . Company.” In this particular case, the New Hampshire Supreme Court therefore did not apply trust-level fiduciary duties to the conduct of the trustee-managers.
What if the Trust Holds a Minority Interest in the Business Entity?
Rather than apply a single rule governing the conduct of the trustee-manager, some jurisdictions will first consider the extent to which the trust owns the business entity. Where the trust owns less than half of the equity of the business entity, some jurisdictions may apply the lower business-level fiduciary standards.
Courts have held that where a trust owns a minority interest in the company, the heighted trustee fiduciary duties may not govern the actions of the trustee-manager. For example, in Rollins, in addition to the reasons noted above, the Georgia Supreme Court applied the lower business judgment rule because the trusts owned only a minority interest in the family business entities.
These decisions appear to be in line with the Restatement (Second) of Trusts, which distinguishes between the obligations of a trustee who holds controlling power over the shares of an entity and the obligations of a trustee who holds only a minority interest. It provides that the trustee’s “responsibility with respect to the voting of the shares is heavier” where the trustee is in control or holds substantial control over the entity than where the trustee holds a small fraction of such shares. § 193, Comment a.
This approach, however, is in contrast with the approach of other courts. For example, in In re Scuderi, the New York Appellate Division found that where a trust holds less than a majority interest in a company, the trustee-manager is still bound by trust-level fiduciary duties. 667 N.Y.S.2d 913 (2d Dep’t 1998).
Regardless of the fiduciary duty owed to the beneficiaries of the trust, the trustee-manager should likewise consider whether separate or different duties are owed to the other owners of the business entity (i.e., to the shareholders of the business entity, other than the trust). It is possible that their interests will differ from those of the trust, leading to the types of disagreement that could result in oppressed minority shareholder claims.
The law governing the fiduciary obligations of a trustee-manager is varied and often depends on the specific circumstances of a case. As the ownership of closely-held family business entities by trusts becomes more common, one can expect that this intersection of trust law with business law will probably be the subject of further litigation. Practitioners should take note of the governing law in their jurisdictions, including the nuanced circumstances that may warrant the application of a different fiduciary standard.