One of the most fundamental duties of a fiduciary is the duty of loyalty. That is, every fiduciary must administer the estate or trust subject to his or her stewardship solely in the interests of the beneficiaries. That duty is breached when a fiduciary engages in self- dealing; i.e. places his/her own interests over those of the beneficiaries. Self-dealing can take several forms, not the least of which is when a fiduciary purchases an estate or trust asset, or engages in competition with the estate or trust subject to his/her charge.
Fiduciary self-dealing has been the subject of numerous decisions affecting trusts and estates practice, the most notable of which include Matter of Rothko, 43 NY2d 305 (1977) and Flaum v Birnbaum, 120 AD2d 183 (4th Dept 1986). These decisions and others of their kind have relied on the “no further inquiry” rule, established by long-standing precedent as the basis for declaring any such transaction voidable at the behest of the beneficiaries (see e.g. Flaum v Birnbaum, supra.; Matter of Bradley, 143 NYS2d 264 ).
This rule and the liability attendant to fiduciary self-dealing was recently examined by the Surrogate’s Court, Albany County, in Matter of Smith, NYLJ, May 17, 2018, at p. 28. Before the court was a motion by the petitioner, the Public Administrator, as temporary administrator of the estate, for, inter alia, summary judgment finding that the respondent engaged in unlawful self-dealing.
The decedent died, testate, on May 19, 2003. The principal asset of his estate consisted of a 90% interest in a closely held company, Quailman Investors, Inc. (“Quailman Investors”). The remaining 10% interest was owned by the respondent. Pursuant to the pertinent provisions of his Will, the decedent directed that 70% of his interest in Quailman Investors be held, in trust, together with the remainder of his estate, for the benefit of a group of individuals, some of whom were minors. The remaining 20% of the decedent’s interest in the company was bequeathed to the respondent (15%) and to another named individual (5%). Preliminary letters testamentary were issued to respondent, who served as preliminary executor of the estate until the Will was admitted to probate, at which time he received Letters Testamentary. Although respondent was also the nominated trustee of the trust created under the instrument, he never received letters of trusteeship.
Thereafter, in a proceeding instituted by the respondent to terminate the trust as uneconomical, the guardian ad litem, appointed by the court to represent the interests of the minor beneficiaries, revealed a corporate resolution of Quailman Investors, which had been adopted by the Board of Directors, and signed by the respondent, as Secretary, authorizing the respondent, without prior court approval, to pay himself the sum of $725,453, consisting of deferred compensation and salary for a number of years. In addition, the report of the guardian ad litem noted that the net value of real estate sales by the company from October 2003 through May 2004 amounted to approximately $960,184.81. Notably, at the time of each of these transactions, the respondent remained a minority shareholder of 10% of the company, and was acting as preliminary executor of the estate, through which he controlled the remaining 90% interest held by the decedent.
The respondent was subsequently removed as executor of the estate due to his failure to comply with numerous court orders directing him to account, and the Public Administrator was appointed temporary administrator cta in his place and stead. Upon his appointment, the Public Administrator requested information from the respondent pertinent to the valuation of Quailman Investors, and instituted a discovery proceeding against him seeking recovery of $960, 184, i.e. the alleged profits derived from the sale of assets by Quailman Investors, and subsequently paid by respondent to himself. After a series of motions and appeals, the Public Administrator moved for summary relief.
The court observed that one of the most sacred duties of a fiduciary is to avoid self-dealing. Once self-dealing is disclosed, the “no further inquiry rule” is triggered, which will result in the transaction being set aside regardless of its fairness. The court further noted that in cases where a fiduciary places himself in a position where his interest is in conflict with his duty of loyalty, the fiduciary may be surcharged.
Based on the foregoing, and the undisputed record reflecting the improper payments the respondent made to himself, without prior court authorization, at a time when he was serving as preliminary executor of the estate, and was in full control of Quailman Investors, the court held that his conduct was an act of self-dealing in violation of his fiduciary duty of undivided loyalty to the estate beneficiaries. As such, the court set aside the payments, and directed the respondent to restore the sum of $725,453 to the estate.
In addition, the record revealed that the respondent, also, without prior court approval, paid himself a personal claim he had against the estate (see SCPA 1805). As in the case of self-dealing, when a fiduciary pays himself a claim without leave of court, he subjects himself to a surcharge, which can include, among other things, costs, attorney’s fees, and interest. Noting that attorney’s fees may generally not be collected by a prevailing litigant in the absence of statute or agreement, or where the losing party has not acted maliciously or in bad faith, the court, nevertheless, found based on respondent’s conduct, that an award of attorney’s fees, to be paid by respondent personally, was warranted. Accordingly, the court scheduled a hearing to determine the surcharge and fees in connection with the improper payment of the claim.
The foregoing opinion provides a sharp lesson to be learned by fiduciaries who are tempted to benefit themselves at the expense of the estate or trust to which they owe undivided loyalty.