Fiduciary Beware: Contested Accounting in the Face of Exoneration Clause Results in Liability for Inter Vivos Trustee
Although exoneration clauses in a testamentary trust will not, as a matter of public policy, absolve a trustee of liability for failure to exercise reasonable care, diligence and prudence (EPTL §11-1.7(a)(1)), there is no comparable statutory provision with respect to exoneration clauses in lifetime trusts. Nevertheless, the court, in Matter of Accounting of Tydings, NYLJ, July 7, 2011, at p. 26 (Sur Ct, Bronx County), found reason, despite the exoneration clause in the inter vivos trust instrument, to hold the trustee liable.
In Tydings, the court had the opportunity to opine on the effect of the exoneration clause in the subject trust, commissions, and the legal fees incurred by the petitioner and objectant. The objectant in the proceeding was the grantor and income beneficiary of the trust, with a discretionary interest in the principal. The ultimate remainderman of the trust was the grantor’s infant son.
With regard to the issue of the exoneration clause, the trust instrument authorized, inter alia, the trustee to retain an original investment for any length of time without liability for such retention, and to act on behalf of the trust and herself or another entity with regard to any transaction in which the trustee and the trust or the other entity had an interest. The trust also provided that the trustee would not be responsible for any loss to the trust unless such loss resulted from bad faith or fraud on the part of the trustee, and that the trustee would not be disqualified from acting because the trustee held an interest in any property or entity in which the trust also held an interest. The court noted that several of the objections raised in the proceeding hinged, inter alia, on the enforceability of this exoneration clause.
To this extent, the court opined that despite the absence of a statute applicable to exoneration clauses contained in lifetime trusts (cf. EPTL 11-1.7(a)(1)), the enforceability of such clauses were nevertheless subject to certain defined limitations. For instance, the court observed that a trustee of a lifetime trust who is guilty of wrongful negligence, impermissible self-dealing, bad faith or reckless indifference to the interests of the beneficiaries will not be shielded from liability by an exoneration clause. Moreover, when an attorney, named as trustee, is the draftsperson of the instrument containing an exoneration clause, the clause limiting the trustee’s liability to bad faith acts is void as against public policy. Further, the court noted that while improper self-dealing will not come under the umbrella of an exoneration clause, the rule of undivided loyalty due from a trustee may be relaxed by appropriate language in the trust instrument which directly or indirectly recognizes the trustee may be in a position of conflict with the trust.
Within this context, the court held that the petitioner would not be liable with respect to an interest-free loan that pre-existed the creation of the trust and that had been transferred into the trust by the grantor. On the other hand, the court found the petitioner liable for interest-free loans made by the trust subsequent to the inception of her stewardship. To this extent, the court concluded that petitioner’s conduct exhibited a complete indifference to the best interests of the objectant, mandating that she be surcharged for the income lost on the loan transactions.
Additionally, the court found that the exoneration clause in the instrument did not bar the objectant from recovering lost profits from the trustee attributable to her use of trust funds, without consideration, to benefit an entity in which she was personally interested.
As to the balance of the objections, the court concluded that the objectant was either estopped from raising the issues, or did not warrant the imposition of a surcharge.
With respect to the issue of commissions, the court opined that while not every surcharge warrants a denial of commissions, when the fiduciary has engaged in conduct evidencing bad faith, a complete indifference to his/her duties and responsibilities, or some act of malfeasance or misfeasance, commissions will be denied. Based on the record, the court found that the petitioner was lax with regard to managing the financial aspects of the trust. Indeed, although the court concluded that the petitioner had not acted in bad faith, it, nevertheless, held, particularly based on the interest-free loans that had been made, that she had exhibited indifference to her duties, and, accordingly, sufficient misfeasance to warrant a denial of commissions. Further, the court denied the petitioner annual commissions on the grounds that she had failed to establish that she had furnished the objectant with an annual statement pursuant to the provisions of SCPA 2309, that the objectant had waived her right to receive the statement, or that there was sufficient income retained by the trust in any particular year from which she could pay herself income commissions.
Finally, with regard to the issue of legal fees, the court held, in the exercise of discretion, that the petitioner and the objectant should each, individually, bear responsibility for their legal fees and expenses. The court observed that while many of the objections to the petitioner’s account had not been sustained, the petitioner could not seek payment of fees from the trust for defending objections for which she was surcharged. Moreover, the court opined that a strong case could be made for holding the petitioner responsible for the expert witness fees incurred by the objectant in proving petitioner’s liability in connection with the transactions for which she was surcharged. On the other hand, the court noted that the objectant vigorously pursued, and caused the petitioner to defend, numerous objections of which she was aware and had approved prior to their occurrence. Accordingly, under all the circumstances, the court determined it would be most equitable to have the petitioner and the objectant to personally satisfy their own legal fees in connection with the proceeding.
One of the first reported Surrogate’s Court decisions of 2011 comes from Monroe County. The decision is interesting in that the court addresses various legal issues in the context of what it describes as “a power-sharing arrangement that is rather unconventional, even by today's standards of Trust and Estate practice.” The decision addresses an exoneration clause, the delegation of investment responsibility, the overriding duty of loyalty of fiduciaries, the Prudent Investor Act, the construction of wills and trust instruments, and the status of an “advisor” as a de facto trustee.
The inter vivos trust at issue was created in 1945, in conjunction with the grantor’s outright gift to the University of Rochester to create a clinic under the auspices of the University’s Department of Psychiatry. The grantor directed that Trust income be used to operate and maintain the clinic. The grantor named an institutional trustee (“Trustee”) and also created an “Investment Advisory Committee” comprised of three individuals, two to be named by the University of Rochester and one by the Trustee.
By the provisions of the Trust instrument, the Advisory Committee has considerable power and control over the investment of Trust assets. The Advisory Committee was granted “sole and exclusive power and control over the investments making up this trust fund, the sale of securities, and the reinvestment of any funds at any time in the trust estate” and given the power to direct the Trustee in writing in connection with such power and control. The Trust instrument also contains an exoneration clause, and provides that “[t]he Trustee shall be charged with no responsibility or duties with respect to the investment or reinvestment of trust funds, other than to carry out the written directions or communications received by it from the Committee.”
Approximately 65 years after the Trust was created, a disagreement arose between the Advisory Committee and the Trustee that required judicial attention. Specifically, the Advisory Committee directed the Trustee to invest all of the Trust assets in the University's long-term investment pool, and the Trustee sought advice from the Court.
The Court made clear that its task was to determine whether the proposed investment in the long term investment pool would frustrate the intent of the grantor. It first addressed the intent of the grantor and the purpose of the Trust. Reading the Trust instrument as a whole, the Court found that that the Advisory Committee and Trustee were required to work in concert to promote the goals of the grantor to fund the operation of the Psychiatry Department. Although the terms of the Trust instrument quoted above confer broad authority upon the Advisory Committee, the Court held that such authority could not be used in contravention of the stated purpose of the Trust, and that the Trustee and the Advisory Committee, as a de facto co-trustee, share the fiduciary obligation to invest and manage the assets in a manner consistent with the purpose of the Trust.
In reaching this conclusion, the Court noted the limits of the Trust instrument’s allocation of investment responsibilities to the Advisory Committee and the concomitant exoneration clause. The Court found that the exoneration clause employed in the Trust instrument, an attempt to render the Trustee completely unaccountable in deference to the Advisory Committee, is inconsistent with the nature of a trust, and void as against public policy. If the Advisory Committee’s control over investment decisions was completely dispositive, there would be little sense in having a trustee. According to the Court, while the Trustee is under a duty to comply with the directions of the Advisory Committee with respect to investment decisions, the Trustee cannot ignore its fiduciary responsibility; the Trustee could be held liable for abiding by the direction of the Advisory Committee where there may be reason to believe that the Advisory Committee is not fulfilling its fiduciary duty.
The Court had several problems with the proposed investment in the long term investment pool. The investment would remove both the Trustee and the Advisory Committee from any role in administering the Trust assets. Trust funds would be transferred to the University's custodian bank, and such bank would have no fiduciary obligation to the Trust. The funds would be managed by numerous investment management firms under the oversight of a subcommittee of the University's Board of Trustees. Once the Trust’s funds were invested in the long term investment pool, neither the Advisory Committee, nor the Trustee, would have input concerning asset allocation, or the discretion to select, retain or sell off any individual assets. Such decisions would be overseen by the subcommittee of the University’s Board of Trustees.
Quoting Meinhard v. Salmon, the Court first noted that two of the three members of the Advisory Committee were employed by the University, and that the proposed investment would place the majority of the Advisory Committee, owing a duty of loyalty to both the University and the Trust, in a position of conflict if questions were to arise as to the handling of Trust funds in the long term investment pool. The Court was “hard-pressed” to allow the majority of the Advisory Committee to be allowed to direct the investment of Trust assets in the long term investment pool under these circumstances. The Court acknowledged that the third member of the Advisory Committee was also in a potential position of conflict as an employee of the Trustee, but found that this third member’s conflict was less of a concern considering the minority status.
The Court also held that while delegation of investment and management functions is permissible under the EPTL, the proposed investment constituted a delegation far afield from what is permitted by statute (EPTL § 11-2.3(c)), and would be inconsistent with the Trust instrument.
This case is certainly worth a read.