Corporate trustee did not breach its duties by exchanging insurance policies for new policies obtained through its affiliate.
In 1991, Jim French created two irrevocable trusts, creatively called Trust 1 and Trust 2. Trust 2 paid its income annually into Trust 1 and distributed all remaining assets into Trust 1 at Jim’s death. Trust 1 provided for no distributions during Jim’s lifetime. At his death, the assets of Trust 1 were to be distributed equally among Jim’s four children. Northern Trust was the initial trustee of the trusts.
Among other assets, Trust 1 held two life insurance policies: (1) a Pacific Life Insurance Company policy with a $5 million face value and annual premium of $160,000; and (2) a Prudential Life Insurance Company second-to-die whole life policy with a $5 million death benefit and a premium scheduled to increase by more than $40,000. Together, the policies had a combined cash value of approximately $2.2 million dollars.
By the end of 2004, Wachovia Bank, N.A., took over as successor trustee of the trusts. Jim asked Wachovia to investigate options for the insurance policies held in Trust 1. After eight months of discussions between Jim, his attorneys, and Wachovia personnel, Jim agreed to a section 1035 exchange whereby Wachovia, through its affiliate Wachovia Insurance Services, Inc., would exchange the policies for two John Hancock policies containing no-lapse guarantees, but poor cash values. Because the new policies were obtained through an affiliate, Wachovia requested a conflict of interest waiver. Jim was angered by the request for a waiver and refused to sign it.
Near the end of the process and about one year after Jim’s initial meeting with Wachovia, Jim requested information about the commissions charged by Wachovia Insurance for its role in procuring the John Hancock policies. The total commissions were approximately $548,000 and had not been disclosed prior to the completion of the 1035 exchange.
Jim’s children, as the trust beneficiaries, sued Wachovia for breach of trust for exchanging the insurance policies and sought to recover the lost cash value of the surrendered policies as well as the fees paid to Wachovia and its affiliate. The children alleged that the exchange was a self-dealing transaction done in bad faith. The court held that Wachovia was authorized to engage in self-dealing because the trust agreement contained language specifically authorizing Wachovia to invest assets “without regard to conflicts of interest.” The court also held that Wachovia did not act in bad faith and acted in the best interests of the trust on the grounds that the transaction took an entire year and during that time the family was well aware of the conflict of interest between Wachovia and its affiliate, and Wachovia engaged in a lengthy analysis of the transaction. The court also approved the transaction under the prudent investor rule on the grounds that: (1) the trust already held $30 million in other assets, so the loss of cash value in the policies was likely a minor concern; and (2) the family’s attorneys recognized the value of the no-lapse policies in written memoranda, despite the inflexibility of the policies and the loss of the cash value.