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George F. Bearup, J.D. Senior Legal Trust Advisor

14-Jul-20

Trustees and Self-Dealing

Take-Away: Like all fiduciaries, a trustee is subject to the prohibition on self-dealing. There are some statutory exceptions, such as being reimbursed from the trust estate, but in general a transaction where the trustee is interested is voidable by a trust beneficiary. Individual trustees are far more likely to run afoul of the self-dealing prohibitions than a corporate fiduciary.

Background: Several provisions of the Estates and Protected Individuals Code (EPIC) address the topic of a fiduciary’s self-dealing.

  • Fiduciary: The Estates and Protected Individuals Code (EPIC) defines fiduciary to include, but is not limited to, a personal representative, funeral representative, guardian, conservator, trustee, plenary guardian, partial guardian, and successor fiduciary. [MCL 700.1104(e).]
  • Self-Dealing: A fiduciary is prohibited from self-dealing. Specifically, EPIC provides:

“Unless the governing instrument expressly authorizes such a transaction or investment, unless authorized by the court, except as provided in section 3713 [personal representatives], 5421 [conservators] or 7802 [trustees], or except as provided in section 4405 of the banking code of 1999 [MCL 487.14405], a fiduciary in the fiduciary’s personal capacity shall not engage in a transaction with the estate that the fiduciary represents and shall not invest estate money in a company, corporation, or association with which the fiduciary is affiliated other than as a bondholder, or minority stockholder. A fiduciary in the fiduciary’s personal capacity shall not personally derive a profit from the purchase, sale or transfer of the estate’s property. A fiduciary’s deposit of money in a bank or trust company, in which the fiduciary is interested as an officer, director or stockholder, does not constitute a violation of this section.” [MCL 700.1214.]

  • Agent: While the statutory definition of fiduciary does not include an agent who acts under a durable power of attorney, an agent owes fiduciary obligations to the principal under Michigan common law. Several reported court cases have directly held that the agent acting under a durable power of attorney owes fiduciary obligations to his or her principal. [MCL 700.1214.] In re Estate of Susser, 254 Mich App 232 (2002.)
  • Trustees: A trustee’s duty of loyalty implicates this prohibition against self-dealing.
  • Voidable Transaction: A sale or other transaction that involves the investment or management of trust property entered into by the trustee for the ‘trustee’s own personal account, or which is otherwise affected by a substantial conflict between the trustee’s fiduciary and personal interests’ is voidable by a trust beneficiary. [MCL 700.7801(2).] This remedy is addressed in more detail below.
  • Presumption of Conflict of Interest: A sale or transaction that involves the investment or management of trust property is presumed to be affected by a conflict between personal and fiduciary interests if it is entered into by the trustee with any of the following: (i) the trustee’s spouse; (ii) the trustee’s descendant, sibling, parent, or the spouse of a descendant, sibling or parent; (iii) an agent or attorney of the trustee; and (iv) a corporation, person, or enterprise in which the trustee or a person that owns a significant interest in has an interest that might affect the trustee’s best judgment. [MCL 700,7802(3).]
  • Usurped Opportunities: A transaction that does not concern trust property in which the trustee engages in the trustee’s individual capacity will involve a conflict between personal and fiduciary interests if the transaction concerns an opportunity that properly belongs to the trust. [MCL 700.7802(4).]
  • Advancements, Reimbursements and Liens: A statutory exception from a trustee’s self-dealing prohibition is where advancements and reimbursements are made between a trustee and the trust estate. A trustee is entitled to be reimbursed out of trust property, with interest when appropriate, for expenses that were properly incurred in the administration of the trust and, to the extent necessary to prevent unjust enrichment of the trust, expenses that were not properly incurred in the administration of the trust. An advance by the trustee of money for the protection of the trust will give rise to a lien against trust property to secure reimbursement with reasonable interest charged. “Advances and reimbursement under this section are not considered self-dealing by the trustee and are not breach of the trustee’s fiduciary duty.” [MCL 700.7709.]
  • Statutory Exceptions: Some transactions entered into by the trustee will not be considered to be a breach of the trustee’s duty of loyalty if they are “fair to the trust beneficiaries.” Those transactions include: (i) an agreement between the trustee and trust beneficiary that relates to the appointment or compensation of the trustee; (ii) payments of reasonable compensation to the trustee; (iii) a transaction between a trust and another trust, the decedent’s estate, or conservatorship, of which the trustee is a fiduciary or in which a trust beneficiary has an interest; and (iv) an advance by the trustee of money for the protection of the trust. [MCL 700.7802(7).]

Voidable Transactions: The Michigan Trust Code identifies two types of transactions that involve investments or management of trust property that is voidable by a trust beneficiary. Transactions that violate the trustee’s duty of loyalty are voidable by any trust beneficiary, not just the beneficiary who may have been directly impacted by the trustee’s conflict of interest.

  • At-Will- The Trustee’s Personal Account: One category deals with transactions that are directly for the trustee’s personal account between a trustee and the trust. These transactions are voidable by the affected trust beneficiary without regard to the materiality of the transaction. A transaction is voidable at will without further proof by the affected trust beneficiary, and regardless of whether the transaction was entered into in good faith or whether fair consideration was paid to the trust by the trustee.
  • Substantial Conflict: The other category deals with a transaction that is otherwise affected (directly or indirectly) by a substantial conflict between the trustee’s personal and fiduciary interests. Note that in this instance, the conflict must be
  • Exceptions: The ‘conflicted’ transaction may not be voidable if one or more of the following factors apply:
    • (i) the transaction was authorized by the terms of the trust;
    • (ii) the transaction was approved by a court after notice to all interested persons;
    • (iii) the trust beneficiary did not commence a judicial proceeding within the time prescribed by statute, i.e. one year per MCL 700.7905(1)(a) or five years after the removal or resignation of the trustee, the termination of the beneficiary’s interest, or the termination of the trust, per MCL 700,7905(3);
    • (iv) the trust beneficiary consented to the trustee’s conduct, or gave release to the trustee;
    • (v) the transaction involves a contract entered into or claim acquired by the trustee before that person became, or contemplated becoming ,a trustee; or
    • (vi) the transaction is expressly permitted by statute.

Examples: Some fairly recent examples of where EPIC’s rules against a trustee’s self-dealing came into play follow:

  • LLC Membership Transfer: A probate court ordered the co-trustees to terminate the trust and distribute its assets pro rata among the trust beneficiaries. The trust held membership interests in an LLC. A co-trustee was also personally the manager of the LLC. The co-trustee-manager distributed to trust beneficiaries only ‘distributable interests’, i.e. assignee interests only entitling the holder to distributions from the LLC but without any voting rights or other rights associated with a full membership interest. The co-trustee-manager’s efforts were rejected as self-dealing. The appellate court felt that the probate court order to distribute the interests to the trust beneficiaries bound the co-trustee-manager in his capacity as manager to ensure that the beneficiaries each received full LLC membership interests, not assignee non-voting interests. The co-trustee-manager claimed that the probate court did not have the authority to require him, acting  as  LLC manager, to carry out the probate court’s order. The appellate court found the manager’s claim to be ‘disingenuous.’ The Court noted that a co-trustee has duties of honesty, loyalty, restraint from self-interest, and good faith. In re Soble Family Trust, No.334411 (Michigan Court of Appeals, December 19, 2017.)
  • Jointly Owned Condominium: The trustee of a revocable trust transferred title to a condominium from the trust into the name of the settlor and the individual name of the trustee, as ‘joint tenants with full rights of survivorship.’ The Court found that the transfer of title was a ‘sale’ of trust property in which the trustee had a personal interest. Consequently, the ‘sale’ to the joint tenants was voidable. In re Beverly J. LaForest Living Trust and Beverly J. LaForest Family Trust, No. 323296 (Michigan Court of Appeals, January 5, 2016.)
  • Sale of LLC Membership Interest: The settlor’s widow served as successor trustee of his ‘credit-shelter’ trust. The widow entered into a transaction with the trust to purchase an interest in LLC membership interests held in the ‘credit shelter’ trust in exchange for her 20 year promissory note (when she was 83 years old.) The Court of Appeals refused to find the purchase of the membership interests voidable because the terms of the trust authorized the sale of trust assets by the trustee, and the probate court found that the transaction was ‘fair to the remainder trust beneficiaries.’ In re Estate of Gerald R. Mahoney Trust and Nancy W. Mahoney Trust, No. 320074 (Michigan Court of Appeals, August 20, 2015.)
  • Usurp Trust Opportunity: The trust owned agricultural real estate that was leased to a third party to grow hay. During the trust’s administration the individual trustee (the settlor’s son) leased the farm acreage in his own name and he used trust farm equipment to grow the hay. The proceeds from the lease were never included in the trust estate. The trustee was removed  by the probate court and an independent non-family member trustee was appointed to replace the son. The reason given by the probate judge, and accepted by the appellate court, was that the trustee had personally benefited from an opportunity that the court felt had belonged to the trust and its beneficiaries. In re Vogel, No. 288837 (Michigan Court of Appeals, May 27, 2010.) See also, In re Estate of Harrington, no. 216708 (Michigan Court of Appeals, May 9, 2000, which extended the so-called ‘corporate opportunity doctrine’ to transactions within the scope of EPIC.)

Conclusion: Trustees always need to be aware of potential conflicts of interest and the dangers of self-dealing transactions. The reported court decisions all dealt with an individual who served as trustee who was either incapable, or oblivious to, the self-dealing that they engaged in with the trust. It is fair to say that the risk of a trustee violating his or her duty of loyalty to the trust beneficiaries is at its greatest when an individual, often a family member who is also a trust beneficiary, serves as trustee. If an individual, or family member, is to serve as trustee, it will be important when the trust is drafted to anticipate their potential transactions with the trust, or the trust’s assets, that might otherwise constitute a violation of the trustee’s duty of loyalty.