Trustees are probably tired of learning hundreds of tips to avoid breach of fiduciary duty lawsuits fashioned by beneficiaries and of states adopting uniform acts piecemeal. This combination of perpetually unsatisfied beneficiaries and independently oriented states, however, mandates that trustees remain vigilant. Whether a corporate trustee may administer a trust that holds stock, bonds, or other financial products of the corporate trustee without violating the prudent investor rule is a persistently sticky area that varies based on state statutes, state case law, and the facts and circumstances of a particular matter.
In Adams v. Regions Bank, No. 3:14cv615-DPJ-FKB, 2016 BL 2497 (S.D. Miss. Jan. 6, 2016), the plaintiff (Adams) borrowed $3,000,000 (Loan) from Regions and secured the loan with Regions stock held by a limited partnership (LP) owned by Adams’ family. Adams’ father, Warren Hood, Sr. (former chairman of Deposit Guaranty National Bank, which eventually became Regions), created an estate plan under which Adams would receive one-quarter of the residue of Hood’s estate, consisting primarily of the LP, which would be held in a spendthrift trust (Trust).
Hood’s will provided that the trustee had the power “[t]o retain, with no obligation to sell, any property coming into their hands as Trustees under the terms of this instrument, including stock of AmSouth Bancorp [now Regions Bank]…regardless of any lack of diversification risk, without being liable to any person for such retention unless otherwise provided herein.” Additionally, the will provided that Adams had the power to direct the trustees to dispose of non-income producing assets held in trust.
Upon the death of Hood, the Trust became 99% owner of the LP. The trustees of the Trust resigned, and Regions was appointed as replacement trustee. Due to certain regulatory restrictions and bank policies, Regions had Adams sign a retention agreement allowing it to retain the Regions stock held in the Trust, unless Adams provided written notice directing it to dispose of the Regions stock. A couple of years later, the value of the Regions stock began to decline significantly, and Adams discussed the possibility of diversifying the Trust holdings to obtain assets that would yield earnings sufficient to cover the interest payments on the Loan. Regions did not diversify, and the stock continued to decline in value. When Adams defaulted on the Loan, Regions seized the Regions stock held in the Trust. Adams brought an action against Regions alleging breach of various fiduciary duties.
The U.S. District Court for the Southern District of Mississippi dismissed the claims that Regions breached the duty to diversify because special circumstances existed that allowed Regions to retain the Regions stock without diversifying. First, the court noted that Hood’s professional background and the language in Hood’s will strongly suggested that Hood intended to give Regions the power to retain the Regions stock without regard to diversification or risk and without liability. Second, the court found that the retention agreement permitted Regions to retain the Regions stock and granted Adams the right to cease retention, which Adams never exercised. Finally, the court emphasized that Adams had the right to force Regions to dispose of non-income producing assets at any time under the language in Hood’s will.
Counterintuitively, the educational value of this case arises from the brevity of the court’s discussion regarding whether Regions violated the prudent investor rule. The court’s brevity suggested that the evidence set forth by Regions created a very strong presumption in favor of retaining the Regions stock. In fact, the very instruments that gave Regions the power to retain the Regions stock without regard to diversification provided Adams the right to cause Regions to dispose of the Regions stock. Without any sort of written notice from Adams requesting that Regions diversify the Trust assets or dispose of the Regions stock, Regions’ right to retain its own stock remained a valid exercise of trustee authority.
A corporate trustee should take as many precautionary measures as necessary to protect itself when it administers a trust that holds stock, bonds, or other financial products of the corporate trustee so that when the beneficiaries sue, the court grants the trustee’s motion for summary judgment. Some precautionary measures include:
Carefully review state case law to determine if your state has established whether, and under what circumstances, a corporate trustee may retain its own stock held in a trust. Christopher P. Cline’s Portfolio 861 T.M., Trustee Investments, provides an excellent discussion comparing conclusions reached by different state courts regarding a variety of issues surrounding the duty to diversify, including whether a trustee may retain its own stock held in trust. For example, when determining whether a trustee breached the duty to diversify by holding its own stock in trust, a court may apply a more lenient standard if the trustee acquired the stock from the grantor, rather than if the trustee acquired other property and subsequently purchased the stock.
Carefully review the trust instrument to determine whether it permits a trustee to retain or purchase its own stock. This is where the facts and circumstances become important. In Adams, the court emphasized the grantor’s affiliation with the predecessor bank and concluded that the language allowing retention of the Regions stock included by the grantor was specific and intentional, not merely boilerplate. Additionally, consider whether the instrument requires or merely allows a trustee to retain its own stock.
Request that the beneficiaries sign retention agreements. The court in Adams emphasized that the only action required to cease retention or to require diversification was to provide Regions with written notice. Because Adams was not diligent enough to exercise her right, she could not subsequently “cry foul.” Consider whether to give the beneficiaries the same right to cease retention upon providing written notice, thereby placing the burden on the beneficiaries to perform an action before retention must cease.
If the beneficiaries want the trustee to retain the trust assets but the trust instrument does not address retention (especially in the context of family businesses), consider whether to require that all beneficiaries, whether vested or contingent, sign retention agreements that absolutely protect the trustee from liability for such retention, specifically identify the retained assets, and heavily document the diligence performed in reaching the investment decision to retain the trust assets. Undertake careful analysis of the state’s virtual representation statutes and case law if a trustee needs to have the representative for a minor or incapacitated individual sign a retention agreement.
As an alternative to the retention agreement, consider requesting that the beneficiaries consent to a trust modification or reformation to incorporate language permitting retention of the trust assets and, subsequently, having a court approve such modification or reformation.
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