Written by: REBECCA KLOCK SCHROER, JD, & MORGAN WIENER, JD

Trustees face a number of complexities when administering a trust that owns interests in a closely held business. This article focuses on two of those complexities:

(1)  Which standard of care applies to the trustee’s business decisions: the fiduciary or the corporate standard of care?

(2)  What is the trustee’s obligation to produce information about the business to the trust’s beneficiaries?

Because there is no national consensus on either of these issues, this article will first provide an overview of each issue and then review leading cases exemplifying the different approaches taken by courts.

STANDARD OF CARE

The standard of care that typically governs a trustee’s conduct is among the highest under the law. It is perhaps stated best in the seminal case Meinhard v. Salmon:

Many forms of conduct permissible in a workaday world for those acting at arm’s length are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the marketplace. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.

This heightened duty of care for a trustee exists because of the imbalance of power between trustees and beneficiaries, which does not exist in an arm’s length business relationship.

The fiduciary standard of care is generally set forth in the Uniform Trust Code (UTC), which has been enacted by the majority of states. In adhering to the proper standard of care, a trustee must act in accordance with a variety of fiduciary duties, including the duties to act prudently, loyally, impartially, and in the best interests of the beneficiaries.

In contrast, the business judgment rule, which guides the conduct of corporate officers and directors, is relatively more lenient and provides a measure of protection to those acting on behalf of the business. While the laws of each state may vary, corporate law generally provides that officers and directors owe a duty of care to the business to act in good faith, in a manner reasonably believed to be in the best interests of the business, and with the care that a person in a like position would reasonably believe to be appropriate under similar circumstances. Under this standard, courts will consider circumstances such as a director’s responsibilities to the corporation, the information available at the time the action was taken, and a director’s special background knowledge or expertise.

The corporate standard of care is moderated, however, by the fact that courts are hesitant to second-guess business decisions and are instead more concerned with a director’s decision-making process and whether the director used reasonable care to make an informed decision. This judicial standard of review, which is more lenient than that applied to actions taken by a trustee, is commonly known as the business judgment rule.

Under the business judgment rule, officers and directors have broad discretion in making business decisions, and courts typically defer to the officers’ and directors’ exercise of business judgment as long as they used a minimum level of care and there was some rational basis for the decision. In Delaware and many other states, the business judgment rule creates a presumption that a business decision was made in good faith, on an informed basis, and with an honest belief that it was in the best interests of the business. A party challenging a corporate decision must show one of the following to overcome the presumption of the business judgment rule: (1) no business decision was actually made (i.e., the directors are liable for an omission, not an action), (2) the decision was not made on an informed basis, (3) the directors were not disinterested (e.g., self-dealing transactions), or (4) the directors were grossly negligent.

When a trust owns an interest in a closely held business, a question arises as to which standard—fiduciary or corporate— governs the trustee’s conduct with respect to that business and the business decisions made by the trustee. The UTC provides some guidance and states that the corporate form cannot shield a trustee from the duty to act in the best interests of the beneficiaries:

In voting shares of stock or in exercising powers of control over similar interests in other forms of enterprise, the trustee shall act in the best interests of the beneficiaries. If the trust is the sole owner of a corporation or other form of enterprise, the trustee shall elect or appoint directors or other managers who will manage the corporation or enterprise in the best interests of the beneficiaries.

The comments to section 802 of the UTC state that “[t]he trustee may not use the corporate form to escape the fiduciary duties of trust law.” For example, the trustee cannot hide behind corporate discretion to avoid the duty of impartiality. The Restatement (Second) of Trusts also explains that a trustee’s responsibility is heavier if the trustee holds a large proportion of shares in a corporation or if the trustee is in control or substantially in control of the corporation. This position is consistent with the UTC in that, if the trust holds the entire corporation, the “corporate assets are in effect trust assets.”

Although an initial reading of section 802 and its comments might suggest that the fiduciary standard of care applies to all business decisions made by a trustee, it is not an open-and-shut case. For example, as the cases discussed below indicate, there has been much litigation about the applicable standard of care, and states have developed different rules and exceptions. In addition, some state statutes specifically recognize the business judgment rule as the applicable standard. For example, Colorado law provides that the business judgment rule is the standard of care for a fiduciary’s formation of a successor entity.

DUTY TO INFORM AND REPORT

In addition to questions surrounding the applicable standard of care when a trust owns an interest in a closely held business, a question also arises as to the trustee’s duty to inform and report to the beneficiaries about the business entity owned by the trust. There is no consensus on the scope of a trustee’s duty in this situation. As explained by the treatise Bogert’s The Law of Trusts and Trustees,

[m]any cases have held that beneficiaries of the trust are entitled to information about the business entity, especially when the trustee is an officer or director of the entity or, with the trust’s interests, controls the entity, while other cases have held beneficiaries are not entitled to such information or have limited their right to receive it.

Typically, the trustee of an irrevocable trust must “keep the qualified beneficiaries of the trust reasonably informed about the administration of the trust and of the material facts necessary for them to protect their interests.” This duty is fundamental, subject only to certain exceptions. As explained by Bogert’s,

[a]lthough the duty is fundamental and widely if not universally recognized, it is subject to several limitations. First, the duty extends only to information requests that are reasonable. Second, generally, while a trust is revocable, only the person who may revoke it is entitled to receive information about it from the trustee. Third, in many jurisdictions the duty may be modified by the settlor in the terms of the trust. Fourth, in limited circumstances, the trustee may properly deny certain information to beneficiaries who request it.

These standard exceptions do not, however, address whether a trustee may withhold information about a business owned by a trust:

The UTC does offer some guidance in this regard, explaining that a trustee is justified in not providing . . . advance disclosure [of a transaction involving a company owned by the trust] if disclosure is forbidden by other law, as under federal securities laws, or if disclosure would be seriously detrimental to the interests of the beneficiaries, for example, when disclosure would cause the loss of the only serious buyer.

The UTC’s guidance is limited, however, because it does not address the scope of a trustee’s duty to disclose information about the business generally.

LEADING CASE LAW AND DIFFERENT APPROACHES

The leading authority addressing these issues comes from New York and Georgia, and the two states take different approaches.

The New York case In re Shehan addresses both the applicable standard of care and the trustee’s duty to produce information to the beneficiaries. Shehan involved a fiduciary who served not only as the executor but also as an officer and director of a related corporation and as a voting trustee of voting trusts with control of the corporation. The court held that the fiduciary should be held to the higher fiduciary standard of care even when acting in a business capacity and that he had to produce the corporate books and records to the trust’s beneficiaries. . .

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