1 N O R T H E RN T RU S TP R O F ES I O NA L AD V I S O R F O RU M Beware the Fine Print: Effectively Advising the Individual Trustee in Today's Changing Times 1 January 31, 2012 Stacy E. Singer Senior Vice President Midwest Fiduciary Practice Leader (312) 444-3826 [email protected]The Northern Trust Company 50 S. La Salle Street Chicago, IL 60603 1 The author wishes to express her deep gratitude to Laura G. Mandel , Senior Trust Administrator, for her assistance in the creation of these materials, which are based in part on materials previously developed by her.
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NORTHERN TRUST PROFESSIONAL ADVISOR FORUM
Beware the Fine Print: Effectively Advising the Individual Trustee in Today's Changing Times1
The Northern Trust Company 50 S. La Salle Street Chicago, IL 60603
1 The author wishes to express her deep gratitude to Laura G. Mandel , Senior Trust Administrator, for her assistance in the creation of these materials, which are based in part on materials previously developed by her.
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1. Introduction
The vast majority of trusts are handled by individual trustees, named to the
position because of the grantor’s confidence in their decision making skills. While
this may well reflect the best approach for managing the family situation, naming
an individual as the fiduciary presents its own unique challenges. Individuals are
oftentimes inexperienced and unaware of the proper processes and procedures
that should be followed in carrying out their fiduciary duties. As a result, the
advisors to such individuals face an additional burden of advising the fiduciary on
these issues to ensure that the trust is managed properly.
2. Fiduciary Duties of a Trustee
A. One of the most significant challenges for the individual fiduciary is
clarifying and understanding the role the individual trustee must play, and
how it differs from his or her role as an individual. Many individual
trustees believe that they can act as they think appropriate, without any
consideration of whether that is the proper fiduciary decision, or whether
there are other consideration that are required.
B. Key to advising an individual fiduciary is a thorough explanation of the
Trustee’s fiduciary duties, including:
1. Duty of Loyalty
2. Duty of Impartiality
3. Duty to Furnish Information
4. Duty to Exercise Reasonable Care and Skill
5. Duty to Keep Accounts
6. Duty to Take and Keep Control
7. Duty to Preserve Trust Property
C. Trustee’s Duty of Loyalty: “The trustee is under a duty to the beneficiaries
to administer the trust solely in the interests of the beneficiaries.” See
Restatement of Trusts (Third)2, Section 78 (2011). This duty is considered
2 In most situations, the terms of the trust document will control. If the document is silent or its provisions are contrary to applicable state law (and state law does not allow the instrument to override it), state law will apply. In general, the Restatement may be used as authority only where both the document and state law are silent.
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to be the most fundamental duty of a trustee. A trustee must not place
itself in a position where it would benefit at the expense of the
beneficiaries. Even if the transaction is fair to all parties, the transaction
may be set aside. See Scott, The Law of Trusts, Section 170 (1987). An
example of self-dealing would be a trustee’s purchase of assets from a
trust..
1. Actual economic loss to the beneficiary may not be required for a
lawsuit.
2. The transaction may be voidable by the beneficiary. The
beneficiary also may be entitled to disgorge the trustee’s profit on
the transaction.
3. The trustee may have a defense if the beneficiary has failed to
raise objections in a timely manner (“laches”), or if court approval
has been obtained.
4. The document may contain express language which waives the
duty of loyalty.
D. Trustee’s Duty of Impartiality: “A trustee has a duty to administer the trust
in a manner that is impartial with respect to the various beneficiaries of the
trust.” See Restatement of Trusts (Third), Section 79 (2011). The duty
applies to simultaneous (where several beneficiaries are entitled to share
in the income and principal) as well as successive interests. The typical
trust provides for successive enjoyment by different beneficiaries. The
trustee has a duty of fairness to all of the beneficiaries and of impartiality
among them. This duty requires a trustee to balance the competing
interests of differently situated beneficiaries in a fair and reasonable
manner. Ordinarily, the question of the duty of impartiality of the trustee
arises where there are successive beneficiaries, some being entitled to
income, others being ultimately entitled to the principal. A trustee’s duty to
deal impartially with beneficiaries is often challenged when the income
beneficiaries want the portfolio skewed towards income producing
investments as opposed to growth type investments. Absent contrary
provisions in the instrument, a trustee is under a duty to make investment
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decisions which produce income as well as increase the value of the
principal (including inflation). The Third Restatement adopts a “total
portfolio” approach to investing. Some commentators are encouraging
attorneys to counsel their clients on the “unitrust” or “total return trust”
alternative; legislation authorizing the conversion of an existing trust to a
unitrust or total return trust has now been passed in the majority of states.
In short, an income beneficiary receives a fixed percentage of the value of
the trust assets rather than the “net income.” The instrument also may
permit the trustee to favor one beneficiary over another. For example: “It
is my intention that the needs of my spouse shall take priority over the
needs of my children.
E. Trustee’s Duty to Furnish Information: The trustee has a duty “promptly to
respond to the request of any beneficiary for information concerning the
trust and its administration, and to permit beneficiaries on a reasonable
basis to inspect trust documents, records and property holdings.” See
Restatement of Trusts (Third), Section 173 (2011). (State law governs
what information beneficiaries are entitled to receive.) Where there are
several beneficiaries, each of them is entitled to information. Whether a
contingent remainderman is entitled to information varies from state to
state (see discussion on page 4, F). This duty is closely related to the
duty to keep accounts. Co-trustees are entitled to enough information
about the trust to fully participate in the administration of the trust, to carry
out the purposes and terms of the trust, and to prevent or redress a
breach of trust by a co-trustee. See Bogert, The Law of Trusts and
Trustees, Section 961 (1983). This duty may also include providing a
beneficiary with a copy of the trust instrument. See e.g. Fletcher v.
1. The historical rule governing investment of trust property was
known as the “Prudent Man Rule.”
a. The Rule mandated that a trustee preserve the trust property
and make it productive.
b. Ultimately, the Prudent Man Rule was replaced by the more
flexible “Prudent Investor Rule,” which allows a trustee
greater flexibility in investments.
2. In essence, the Prudent Investor Rule requires a trustee to
preserve the trust property and to make it productive while acting
with reasonable care, skill, caution and undivided loyalty to the
beneficiaries.
B. Legislatures in many states have formally adopted the Prudent Investor
Rule, while courts in other jurisdictions have referred to the Rule as
articulated in the Restatement of Trusts in their decisions.
1. Those trustees in jurisdictions that have adopted the Restatement’s
version of the Prudent Investor Rule are given the benefit of
consideration of the performance of the investment portfolio as a
whole.
2. The Restatement approach also judges a trustee’s investment
choices at the time the choices are made, not later in time based
purely on the result of an investment portfolio3
3. Section 227 of the Restatement (Third) of Trusts suggests a list of
characteristics a trustee should consider in examining a
contemplated investment, and a trustee may wish to consider
incorporating the suggested elements into an investment review
checklist as part of the trustee’s risk management plan.
3 RESTATEMENT (THIRD) OF TRUSTS § 227 cmt. b. (“The trustee is not a guarantor of the trust’s investment performance.”). However, inevitably, performance may be a key factor persuasive to the decision-maker in a court proceeding.
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Characteristics A Trustee Should Consider
In Examining A Contemplated Investment4
1. Expectations concerning the investment’s total return, and also the
amount and regularity of the income element of that return whenever the
beneficial interests or purposes supported by the trust are affected by
distinctions between trust accounting income and principal.
2. The degree and nature of risks associated with the investment and the
relationship of its volatility and characteristics to the diversification need of
the portfolio as a whole.
3. The marketability of the investment, and the relation between its
liquidity and volatility characteristics and the amount, timing, and certainty
of the trust’s cash flow or distribution requirements.
4. Transaction costs (including tax costs) and special skills associated
with the acquisition, holding, management, and later disposition of the
particular investment.
5. Any special characteristics of the investment that affect its risk-reward
tradeoffs and effective return, such as exposure to unlimited tort liability,
the presence and utility of tax advantages, and the maturity dates and
possible redemption provisions of debt instruments.
C. In the absence of binding authority, some courts have looked to the rules
set forth in the Uniform Prudent Investor Act (UPIA) as persuasive
authority to offer guidance in a case involving allegations of breach of the
duty to invest prudently.
1. Like the Restatement, the UPIA establishes that fiduciaries be
evaluated on the basis of the portfolio as a whole, rather than on
their individual investments.
2. The UPIA also varies the investment standard depending on the
particular skill level of the trustee with respect to investments, which
is a concept often expressed in case law.
4 The list of considerations is taken verbatim from the RESTATEMENT (THIRD) OF TRUSTS § 227.
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3. The UPIA, like the Restatement, sets forth a checklist of
considerations that a trustee must take into account when
determining a proper investment portfolio for the trust.
Circumstances A Trustee Should Consider
In Investing and Managing Trust Assets5
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, which may include financial assets, interests in
closely held enterprises, tangible and intangible personal property, and
real property
5. The expected total return from income and the appreciation of capital
6. Other resources of the beneficiaries
7. Needs for liquidity, regularity of income, and preservation or
appreciation of capital
8. An asset’s special relationship or special value, if any, to the purposes
of the trust or to one or more of the beneficiaries
D. Diversification of the Trust Portfolio
1. Subject to modification by specific directions provided in the trust
instrument, the trustee generally has a duty to the beneficiaries to
diversify the trust portfolio.
2. This duty is not absolute and varies among jurisdictions.
E. Balancing the Investment Portfolio
1. The trustee must be aware of the duty of impartiality and properly
balance growth and income where the trust creates these
distinctions.
2. Consider the ability to adjust income and principal or to convert to a
unitrust.
5 The list of considerations is taken verbatim from the UNIFORM PRUDENT INVESTOR ACT § 2(c) (1995).
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8. Communication Dos and Don’ts
A. Outline the trust administration process, including anticipated frequency of
communication
1. Consider whether to communicate the “rules of administration” in
person, with a letter, or both
a. Provide the beneficiaries with the fiduciary’s preferred
contact information
b. Give alternates to accommodate different communication
styles
c. Phone, e-mail, letter
d. Set expectations regarding response times for phone calls,
e-mails and letters
2. Remember that the duty of impartiality requires a fiduciary to be fair
in communicating with beneficiaries
3. Even the difficult beneficiaries are entitled to information
4. Before denying a request just because he or she can, the fiduciary
should consider what is achieved by saying “no”
5. Beware of the “spokesperson” beneficiary, as well as the “squeaky
wheel” beneficiary
B. Consent or Ratification
1. Generally, a beneficiary must be competent and of legal age in
order to provide valid consent or ratification.
2. The fiduciary also must fully disclose the material aspects of the
transaction for which it seeks consent or ratification.
a. To obtain the full benefits of this protection, a trustee should
insist that the beneficiaries obtain independent counsel to
advise regarding any transactions at issue.
b. If a beneficiary does not wish to retain independent counsel,
the fiduciary should be certain that the relevant facts and
circumstances surrounding the transaction are set forth in a
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written document through which the beneficiary gives its
consent or ratifies the actions of the fiduciary.
c. Documenting that a transaction is fair and reasonable also is
a recommended practice.
C. Handling the Flow of Information, Making Decisions and Implementing
Decisions
1. Communication with the beneficiaries on a regular basis can
prevent many disagreements between beneficiaries and trustees.
2. Keep personal feelings for a particular beneficiary out of the trust
administration, as emotional decision-making may lead to lawsuits
for breach of duty.
3. Use of Advisors and Agents
a. Individual Trustees are unlikely to understand when to look
to their advisors for guidance. Part of what an adviser needs
to do is explain to the trustee when an adviser is needed, as
well as when a specialized adviser may be necessary.
b. Consider the case of Vento v. Colorado National Bank, 907
P.2d 642 (1995). There, Colorado National Bank served as
Trustee of four separate trusts that owned coal mining
property. Seven years after an initial lease of the mine, the
Trustee was approached by the lessee, requesting changes
to the lease and approval to assign the lease to another coal
company that planned to purchase the lessee’s assets. The
plaintiff objected to the changes and assignment; the trustee
ultimately agreed. Plaintiff then sued alleging, among other
things, a breach of fiduciary duty because the trustee failed
to consult independent mining experts and attorneys with
experience in mining leases prior to agreeing to the changes
and assignment. On that issue, the Appellate Court affirmed
the trial court finding in favor of the plaintiff, ruling that the
trustee failed to exercise judgment and care “when it failed to
seek the advice of independent mining experts…” and also
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should have “hired outside legal counsel to assist…” Id at
646.
c. A trustee can and will be held liable for failing to hire the
appropriate advisers with the needed expertise to advise in
the administration of the trust.
9. Conclusion:
Working with an individual trustee can be both rewarding and challenging.
Understanding what information needs to be provided, how to explain and advise
someone without any technical background or framework, and ensuring that
proper processes and procedures are implemented and followed is never easy.
However, when successful, it is one of the most important ways an adviser can