Corporate trustees have wrestled with investing trust assets in their own stock, their own proprietary mutual funds, or through their affiliates. State trust laws take varied approaches to these practices as have the corporate trustees themselves. Some options – where permitted by law – include refunding the entire commissions, reducing the commissions, offsetting the commissions by reducing the trustee fees, or taking the full commissions. Needless to say, any approach may be met with hostility from the beneficiaries and claims of improper self-dealing. In French v. Wachovia Bank, N.A., a federal appellate court has given us a watershed opinion on one of these approaches taken by a corporate trustee.
Jim French established two irrevocable trusts for the benefit of his four children. He decided that the current trustee wasn’t meeting his investment goals, so he changed trustees. The assets that were the center of this case were two whole life insurance policies. After the new trustee took over, it spent months evaluating and consulting with French and his lawyers about what to do with these life insurance policies. The trustee eventually replaced the old policies with new ones that provided the same death benefit albeit at much lower premiums. The transaction through which this was accomplished earned the trustee’s insurance brokerage affiliate a handsome commission. French’s children were allegedly shocked at the size of the commission and sued the trustee for breach of fiduciary duty claiming that the trustee impermissibly engaged in self-dealing.
Where do we always start? The trust instrument. The trust instrument expressly allowed the type of transaction with a fairly standard conflict-of-interest waiver provision:
without limiting powers incidental to the purposes of the trust or otherwise existing by law, the trustee and all successors shall have, without approval of any court, the power: to retain, invest and reinvest in any property without regard to whether the same may be authorized by law, regardless of any risk, lack of diversification or unproductivity involved; . . . to continue as trustee and to deal with any trust hereunder without regard to conflicts of interest; . . . and in general, without limitation by reason of the foregoing, to do any and every act and thing that the trustee would have the right to do as trustee under applicable common and statutory law or as the absolute owner of property provided that all powers shall be exercised exclusively in a fiduciary capacity.
The court found that, while general language granting broad powers to a trustee is not sufficient to waive the prohibition on self-dealing, the authorization here was express and clear enough to be effective. This language “overrides” the common-law prohibition against self-dealing. Also of importance to trustees, this language also overrode French’s refusal to sign a proposed conflicts waiver identifying the connection between the trustee and its affiliate and disclosing that the affiliate would earn a commission on the transaction. In other words, the trustee didn’t need French’s authorization or waiver of conflicts to proceed with the transaction because it was authorized under the trust instrument to complete the transaction.
The applicability of the prudent investor rule also had to be dealt with by the court. The district court assumed that Wisconsin’s statutory prudent investor rule applied and found that the trustee had not violated it. The appellate court, however, addressed the more fundamental question: can a trust instrument override the duty of prudence? The Wisconsin prudent investor rule is a “default rule” that “may be expanded, restricted, eliminated, or otherwise altered by the provisions of a will, trust, or court order.” The following language displaced the prudent investor rule: “[T]he trustee . . . shall have . . . the power . . . to retain, invest and reinvest in any property without regard to whether the same may be authorized by law, regardless of any risk, lack of diversification or unproductivity involved . . . .” So, not only did the above-quoted provision in the trust “override” the prohibition against self-dealing, it also ”displaces” the prudent-investor rule.
Even if the trust instrument permits self-dealing and overrides the prudent investor rule, at least under Wisconsin law, our inquiry doesn’t end. We next need to look at whether the transaction was in bad faith because no matter how broad the discretion granted to a trustee, the duty to administer the trust in good faith remains. Remember French’s refusal to sign the conflicts waiver and the trustee going ahead with the transaction anyway? Well, to the court, that was a “nonstarter” because, unless the trust instrument specifically requires it, a trustee doesn’t need the settlor’s or beneficiaries’ consent to make investment decisions. Looking at the remaining specific facts of the case, the court determined that the insurance exchange was undertaken in good faith.
This federal appellate court made clear that, at least in Wisconsin, the trust instrument is still king and careful drafting can override fiduciary duties other than the duty to administer the trust in good faith.