Recent Delaware Opinion Draws Distinction Between Legal Authority and Equitable Duties
A recent Delaware trust case held that reliance on a legal opinion does not necessarily exculpate a trustee from breach of fiduciary duty. The opinion is also notable in that it found a family member liable for breach of fiduciary duty even though she wasn’t serving as trustee at the time of the breach.
The trust involved was straightforward. Charles created an irrevocable life insurance trust (ILIT) for the benefit of his grandson, Trey. Sterling was named as trustee. The trust was funded with cash, which was used to purchase a second-to-die life insurance policy on Charles and his wife, Eleanor.
Eleanor wanted to revoke the ILIT and access the cash value of the policy. She tried to do so for several years, but each time was told that the trust couldn’t be revoked. So she consulted with an attorney and came up with a different plan. Instead of revoking the trust, she would access the cash value by having the trust loan her the equivalent of the cash value. The trustee would fund this loan by taking out an equivalent loan on the cash value of the policy.
The trustee’s attorney wrote him a letter advising him that the trust instrument did permit the trustee to make loans with adequate security under commercially reasonable circumstances. Sterling decided to make the loan, albeit without security and with favorable terms.
When Trey reached age 30, he had the right to serve as the successor trustee of the trust. But Eleanor didn’t tell him about this. Instead, she appointed herself as trustee after Sterling died. When she quit paying interest on the loan, the policy lapsed. And, in the meantime, the trust didn’t take advantage of an opportunity to acquire more shares when the policy insurer demutualized. Eleanor eventually resigned as trustee and appointed her handyman as her successor.
Trey found out about the trust and, understandably, wasn’t happy. He promptly exercised his right to become trustee and demanded payment of the trust loan. He then sued Eleanor and the handyman over their mishandling of the trust.
The Court found that Sterling breached his duty of loyalty by acting in the best interests of the Charles and Eleanor instead of acting on behalf of the Trust. The fact that Sterling obtained a letter from his attorney was not determinative. The court drew a very important distinction between what the trustee could do (as a matter of legal authority) and what the trustee should do (as a matter of fiduciary duty). While Sterling was legally permitted to make the loan, he was equitably prohibited from doing so because it wasn’t in the best interest of the beneficiary.
The Court found Eleanor was jointly liable for Sterling’s breach of fiduciary duty even though she wasn’t serving as Trustee at the time. This has far-reaching implications for parties that pressure the trustee to breach a fiduciary duty even if they themselves are not the fiduciary.
This case illustrates the need to resist attempts by the grantor and his family to sway the trustee to make questionable decisions. This admittedly puts trustees in a tight spot. On the one hand, trustees often have established relationships with clients who establish irrevocable trusts. These relationships could include other trusts (since ILITs are not often used alone) and accounts under management. In these circumstances, the trustee must place the duty to the beneficiary above these relationships.
But perhaps of more importance is the distinction between legal authority and fiduciary duty. The trustee could still be held liable for breach of fiduciary duty even if the trustee was legally authorized to engage in a transaction. The inquiry is two-fold: Does the trust instrument give the trustee legal authority to engage in this transaction? and Why is the trustee engaging in this transaction? If the trustee is acting for a reason other than the benefit of the beneficiary in accordance with the terms of the trust, the trustee could be liable for breach even though the trust instrument gives legal authority to go through the mechanics of the transaction.