Directed or Administrative Trustees: Coming Soon to Michigan

Take-Away: Michigan’s legislature is currently looking at the adoption of the Uniform Directed Trustee Act. If that Act is adopted, a directed trustee will only be held liable when the trustee follows the adviser’s directions if the trustee’s misconduct is willful. The directed trustee will not be held liable for negligence when it follows the directions of another as required by the trust instrument.

Background: A directed trust is a trust that removes one or more powers or discretions that are traditionally held by the trustee, and vests that power or that discretion in a person who is either a special trustee, a trust protector, or not a trustee at all. The power or discretion can relate to investment decisions, management decisions, distribution decisions and any other decision that affects the administration of the trust. Usually specific trust adviser language is included in a trust instrument either for a narrow purpose for which the trust is created, e.g. to hold closely held stock, or unique reasons why the adviser or trust protector is appointed, e.g. to permit a person who is more familiar with the trust beneficiaries to direct discretionary distributions to meet those trust beneficiaries’ special needs. Trustees faced with the fiduciary duty to diversify trust assets and deal impartially with income beneficiaries and remainder beneficiaries often welcome the ability to limit their liability through the use of a directed trust.

• Current Law: While a trustee can be directed by a trust protector under the Michigan Trust Code, the directed trustee can still be held liable if the trustee acts knowing that the exercise of the power pursuant to that direction is either contrary to the terms of the trust, or the exercise of that power would constitute a breach of any fiduciary duty that the trust protector owes to the beneficiaries of the trust. [MCL 700.7809(4).] Example: A trust protector directs the trustee to sell a trust asset to the trust protector’s sister- an act of self-dealing by the trust protector who has a fiduciary duty to the trust beneficiaries. How does the trustee, following that direction from the trust protector, learn that the directed sale is an act of self-dealing, and thus a breach of the trust protector’s fiduciary duties to the trust beneficiaries? The upshot is that the directed trustee faces residual liability if it does not independently confirm that the trust protector who gives the directions to the trustee is not violating a fiduciary duty to the trust beneficiaries. The Reporter’s Comments to this Section notes: “This seemingly simple language may present difficult questions in the administration of trusts with trust protectors. In close cases the trustee may wish to seek instruction from the court.” This residual liability from which the directed trustee cannot escape is also reiterated the Uniform Trust Code [Section 808(b)] and it also exists in the Restatement (Third) of Trusts, Section 75, common law summary with regard to a trustee’s liability. This residual liability faced by a directed trustee, which must constantly look over the shoulder of the trust protector who gives the directions that the trustee is required to follow, would be dramatically curtailed by the adoption of the Uniform Directed Trustee Act.
• Uniform Directed Trustee Act: When a trustee acts in accordance with the directions of a trust direction adviser [the term used in the Uniform Act, while Michigan’s current Trust Code uses the term trust protector who holds advisory or veto powers] the trustee will only be liable for willful misconduct.
• Willful Misconduct: Delaware’s directed trustee statute, upon which much of the Uniform Directed Trustee Act was based, defines the term willful misconduct as intentional wrongdoing and not mere negligence, gross negligence or recklessness. [Del. Code Ann. Tit.12, Section 3301(g) and (h)(4).] Wrongdoing is defined to mean malicious conduct or conduct designed to defraud or seek an unconscionable advantage. [Del. Code Ann. Tit. 12, Section 3301(g).]
• Consent Adviser: It is important to note, however, that Delaware’s directed trustee statute also recognizes another role-player in a trust’s administration called a consent adviser, who does not necessarily direct the trustee, but whose consent is required as a condition to when a trustee exercises fiduciary discretion in the administration of the trust. In this instance, when a trust instrument uses a consent adviser to act in conjunction with the trustee, there is a broader scope of trustee liability, where the trustee can be held liable for either its willful misconduct or gross negligence.
• No Duty to Monitor: The Delaware directed trustee statute also addresses a directed trustee’s obligation to monitor, communicate and inform. That statute provides: “Whenever a governing instrument provides that a fiduciary is to follow the direction of an adviser with respect to investment decisions, distribution decisions, or other decisions of the fiduciary or shall not take specified actions except at the direction of an adviser, then, except to the extent that the governing instrument provides otherwise, the fiduciary shall have no duty to: (i) monitor the conduct of the adviser; (ii) provide advice to the adviser or consult with the adviser; or (iii) communicate with or warn or apprise any beneficiary or third party concerning instances in which the fiduciary would or might have exercised the fiduciary’s own discretion in a manner different from the manner directed by the adviser.”

Practical Examples: As noted earlier, Delaware has used a directed trustee statute for 20+ years, so it has some history in recognizing when a trustee acts with willful misconduct in a directed trustee setting. Two examples follow, one from Delaware, and one from Virginia which also has adopted a comparable directed trustee statute.

• Duemler vs. Wilmington Trust Co., C.A. No. 20033 N.C. (Del. Chancery 2004): The corporate trustee was sued by an individual co-trustee who was the sole investment direction adviser of the trust. The investment direction adviser chose to not tender a bond owned by the trust when he had an option to do so. The issuer of the bond later defaulted. The investment direction adviser then sued the corporate trustee for breach of fiduciary duty and claimed that the corporate trustee failed to provide the investment direction adviser with appropriate financial information to allow the investment direction adviser to make an informed decision with regard to holding the bond.
• The chancery judge found that this case was ‘an apt instance for [the Delaware statute’s] application because there was absolutely no evidence of willful misconduct on the part of Wilmington Trust Company…And you [Duemler] don’t get to come in and hang your fellow fiduciary on that unless they engaged in willful misconduct. There is none there. And if I were to rule that ‘oh, no. What the problem is here is the failure to provide information or to make sure that the fiduciary making the decision knew what they were doing’ I think that would gut the statute…. The trust held a non-diversified portfolio with extremely risky assets. I think in terms of the division of trust responsibilities, it was absolutely clear that this was on Mr. Duemler’s side of the ledger.” In sum, the judge found that the proximate cause of the investment loss experienced by the trust was the breach of fiduciary duty by Mr. Duemler, who had the primary responsibility as the trust’s investment adviser to the exclusion of Wilmington Trust Company.
• Rollins vs. Branch Banking and Trust Company of Virginia, 2001 WL 34037931 (Va. Cir. Ct): The plaintiffs were children and grandchildren of the trust settlor. They sued the corporate trustee for the trustee’s failure to diversify the trust’s investments. Specifically, the trusts were initially funded with shares of stock in two textile corporations. The trust instrument expressly provided: “Investment decisions as to the retention, sale or purchase of any asset of the Trust Fund shall likewise be decided by such living children or beneficiaries as the case may be.“ At that time of its acceptance, the trustee obtained written authority from the trust beneficiaries to over-concentrate the trust with these textile stocks. These stocks were held for over 20 years in the trust when the textile stock was finally sold by the trustee. The beneficiaries then sued the corporate trustee for $25 million. The beneficiaries claimed that they lost that amount due to the trustee’s failure to diversify the trust’s investments.
• Virginia’s directed trustee statute provides, in part: “Whenever the instrument under which a fiduciary or fiduciaries are acting reserves unto the settlor or creator or vests in an advisory or investment committee or any other person or persons, including a co-fiduciary, to the exclusion of one or more of the fiduciaries, authority to direct the making or retention of investments, or any investment, the excluded fiduciary or co-fiduciary shall be liable, if at all, only as a ministerial agent and shall not be liable as fiduciary or co-fiduciary for any loss resulting from the making or retention of any investment pursuant to such authorized direction.” [Va. Code, Section 26-5.2.]
• The court dismissed the beneficiaries’ claim against the corporate trustee. The judge first noted that the trustee’s power to diversify investments was limited by the express language of the trust. The judge then went on to find: “The plain language of the instrument, however, clearly contradicts the beneficiaries’ argument. The beneficiaries, alone, had the power to make investment decisions. The statute enacted by the General Assembly recognizes the basic principle that the court cannot hold a trustee, or anyone else, liable for decisions that it did not and could not have made. The statute clearly applies in this instance and the beneficiaries have not stated a cause of action against the trustee for failing to diversify the trust assets. The demurrer is granted as it relates to all claims for failure to diversify.”

Conclusion: Hopefully in next year’s legislative session Michigan will adopt either the Uniform Directed Trust Act, or some variation of that Act, to relieve a directed trustee from residual liability for a failure to adequately monitor the trust protector or confirm that the directions provided are not a breach of the trust protector’s fiduciary duties to the trust beneficiaries.