The Hershey School Trust recently tried to sell a controlling interest in Hershey Foods, the largest chocolate maker in the United States. The initiative ignited very vocal public protest and rapid-fire state court litigation that attracted a huge amount of national publicity. That furor finally died down in September, when the trustee backed down by deciding against the sale. But still unresolved is the case’s troubling impact on charitable trusts and fiduciary duties. The Hershey imbroglio—and the proposed state legislation it seems to have inspired—may broaden the state attorney general’s scope of review of charitable trusts, burden trustees of charitable trusts with significant new duties, and cause donors to doubt whether their charitable purposes will be served.
At the core of the debate is the irrevocable deed of trust that Milton S. Hershey, founder of the Hershey Chocolate Company, and his wife Catherine executed in 1909 to establish a trust that would support the Hershey Industrial School to educate poor, white, male orphans.1 The school, later renamed the Milton Hershey School, would be residential, and was intended to adopt a holistic approach to the education of its students. The deed of trust named the Hershey Trust Company as trustee and nine individuals as managers. These managers were empowered to exercise substantial decision-making authority over the trust, and to govern the school. Initially Hershey contributed land to the trust, but a few years later he transferred shares of common stock constituting a controlling interest in Hershey Chocolate, now known as Hershey Foods.
Hershey’s philanthropy was not limited to the establishment of the school and what has become known as the school trust. He and his wife also built churches, schools, libraries, swimming pools, and a palatial public garden modeled on Versailles. The company that he founded was and remains the dominant employer in the town of Hershey. Today, it has a work force of 6,200 people. Hershey, with a population of 13,000 in south central Pennsylvania, is the quintessential company town.
Today the school is set on a campus of 2,700 acres just southeast of downtown Hershey. It has about 1,200 students (racially and ethnically diverse, male and female) who receive free tuition, room, board and healthcare and live in clusters of brick homes with full-time caregivers.
The school trust has assets with a principal value in excess of $5 billion. About 56 percent of the fair market value of trust assets consists of Hershey Foods stock. That stock represents a 77 percent voting interest in the company.
In Dec. 2001, the 17 individuals who constitute both the board of directors of the Hershey Trust Company and the managers of the school, held a meeting with a Pennsylvania deputy attorney general, who had been investigating some alleged conflicts of interest and mismanagement. The deputy reportedly encouraged them to diversify the trust assets. In March the directors and managers voted 15-2 to explore a sale. Shortly thereafter they engaged an investment banker. By mid-July the exploratory efforts became public knowledge, sparking a huge outcry in Hershey and its environs.2 The public feared that any sale of a controlling interest in the company would lead to job reductions and possible plant closings in the Hershey area.
Michael Fisher, attorney general for Pennsylvania and Republication candidate for governor of the state, publicly opposed the sale.3 On Aug. 12, he filed with the Orphans’ Court Division of the Court of Common Pleas of Dauphin County a Petition for Rule to Show Cause Why a Proposed Sale of Trust Assets Constituting the Controlling Interest in Hershey Foods Should Not Be Conditioned Upon Court Approval.4 This petition began a whirlwind tour through the Pennsylvania court system. On Aug. 23, Fisher petitioned for an ex parte injunction against the school trust and the company to prohibit them from entering into any agreement of sale before his petition had been heard. On Sept. 3, Senior Judge Warren G. Morgan of the Orphans’ Court held a hearing on the injunction request, at which a number of witnesses testified, including a former chief executive officer of the company and an investment banker. The following day, Morgan entered an order granting the injunction. The trustee and the managers immediately appealed.5 On Sept. 10, the Commonwealth Court heard oral argument on the appeal.
The reason that the parties and courts moved so quickly was that Sept. 14, was the deadline for prospective buyers to submit bids. Two bids were received, one from William Wrigley Jr. Co.; the other, a joint bid from Nestle and Cadbury-Schweppes. Shortly before midnight on Sept. 17, the trustee and managers announced that, by a vote of 10 to seven, they had rejected both bids, and terminated their efforts to sell the company. On the following day the Commonwealth Court entered an order upholding the grant of injunctive reliem, and directed the Orphans’ Court to rule on the merits of the first petition “expeditiously.”
A week later the directors of the trust company raised the white flag. The board chair confirmed in writing to the attorney general that the school trust would not sell its controlling interest without advance notice to his office and approval of the Orphans Court. At their Oct. 2, meeting the directors ratified this action, and petitioned Judge Morgan to dismiss Fisher’s petition as moot. In an adjudication and decree dated Oct. 16, the judge agreed—but not without pointedly criticizing the boards of the trust company and school.
“We view the resolution adopted by the Directors/Managers on October 2, 2002 as a proper gesture toward that reconciliation [of community, company and school],” said the judge, “but it will not be enough...Reconstituting the Boards in number and composition closer to the model utilized by Milton S. Hershey during his lifetime, and until recently by all succeeding Boards, will hasten the reconciliation.”
Morgan is urging the directors and managers to reduce their number from the 17 to the original nine, and increase the number, now just four, who live in Hershey. It seems that, “however well-intentioned,” the board members have become “detached” from Hershey’s vision, Judge Morgan said. “Not the least significant reasons for this being that the membership of each Board is unusually large and the residences and daily lives of too many members are distant and disconnected from the charitable interests they serve.”
Two Views of Trust Law
Whatever reconciliation between the Hershey Trust and the Hershey community is possible, it will be a lot harder to reconcile the opposing views of the attorney general’s power over trusts, a trustee’s duty and a donor’s right.
The attorney general never contended that the trustee lacked the power to sell trust assets. After all, Section 7141 of the Pennsylvania Probate Estates and Fiduciaries Code provides: “Except as otherwise provided by the trust instrument, the trustee, for any purpose of administration or distribution, may sell, at public or private sale, any real or personal property of the trust.” And, unlike many founders of companies or controlling shareholders, Hershey had not mandated or even expressed any preference that the school trust retain the company’s stock. The only limitation Hershey placed was that the trustee had to obtain the managers’ approval. In fact, the company’s name was never mentioned in the deed of trust. According to the school trust’s answer to the first petition, the company had, during Hershey’s tenure as chairman of the board, executed an agreement for the merger of the company with Kraft-Phenix Cheese Corporation and Colgate-Palmolive Peet Company.6
But Fisher did take the position that seems to be a startling enlargement of a state attorney general’s traditional parens patriae role for charitable interests. Fisher argued that this role authorized him to review not only whether the sale would protect the interests of the intended beneficiaries of the school trust (that is to say, the present and future students of the school), but also whether it would adversely impact the interests of the public at large, that is to say the community of Hershey.
The trustee and managers presented a more traditional view of trust law. Their position was that, subject to the approval of the managers, the trustee had a clear power to sell under the governing instrument and Pennsylvania statutory law. The trustee’s objective of diversifying the portfolio was, they claimed, advocated earlier by the deputy attorney general. It certainly represented an investment approach that is almost universally accepted under modern portfolio theory.7 The trustee and managers also argued that the statutory power of the Orphans’ Court to restrain the sale of a trust asset does not apply when the trustee has a power to sell.8
A Sympathetic Judge
How did the courts react to these two stances?
It is important to keep in mind that the hearing in the lower court was held to entertain the request for a preliminary injunction; the merits of Fisher’s argument were not being decided. Nevertheless, to justify the injunctive relief, the attorney general had to convince Judge Morgan of the following: that there would be immediate and irreparable harm; greater injury would result from refusing the injunction than granting it; the injunction would restore the parties to the status quo before the “alleged wrong;” the wrong is manifest and would be abated by the injunction; and the right to relief is clear.9
Judge Morgan’s adjudication indicates some of the factors that resonated with him in making his decision:
Consistent with the provisions of the deed of trust, the board of directors of the trust company and the managers of the school were the same individuals. This identity of personnel governing the trustee and the trust beneficiary made it unlikely that the beneficiary would question the actions of the trustee and warranted an active role by the attorney general.
The Pennsylvania Prudent Investor Rule, which generally requires trustees to diversify portfolios, does not apply to the school trust. The hearing judge seemed to take particular pleasure in the fact that the expert witness for the trustee did not know this legal point.
The hearing judge was persuaded by the testimony of Richard Zimmerman, a former chief executive officer of the company, that a sale of the controlling interest would necessitate expense reduction in the form of massive job layoffs and potential closings of plant facilities in the Hershey area. Therefore, the Hershey community might be irreparably harmed even if the school trust were enriched.
The financial needs of the school did not require a sale of the controlling interest in the company stock. Three years earlier the trustee had petitioned the same judge for permission to expend substantial funds to establish an institute to study and recommend methods for teaching needy children, documenting that the school trust was then holding in excess of $600 million of unexpended income. And in 1963, the trustee had secured court approval to expend $50 million to establish the Pennsylvania State Medical School at Hershey.
Clearly, the judge was sympathetic to the attorney general’s position. Morgan wrote, “Next, the Directors/Managers argue that the law of Pennsylvania establishes that the duty of a trustee is to administer the trust solely for the benefit of the beneficiaries of the trust, quoting in support the statement under Comment p. of §1701(1) of the Restatement Trusts which reads, ‘The trustee is under a duty to the beneficiary in administering the trust not to be guided by the interest of any third person.’ We are familiar with these rules but do not construe them to mean that as long as the act of a trustee is an exercise of a power given in the trust instrument and purports to serve the trust, the trustee can act with impunity and without regard for adverse effects on others. We know of no case that employs the rules advanced by the Directors/Managers in the context of an Attorney General asserting his duty to see that the public interest is not harmed by an act of a trustee that may otherwise be lawful and purports to be in furtherance of the trust.”
The ruling of the Orphans’ Court was appealed to the Commonwealth Court, an intermediate appellate court in Pennsylvania that hears appeals in all cases that have been commenced by the Commonwealth government or officers thereof acting in their official capacity. In Pennsylvania, most appeals involving trust and estate matters are referred instead to a different intermediate appellate court, the Superior Court. In a majority opinion the Commonwealth Court did not focus on the substantive claims in the case and limited its review to a determination “whether there were any reasonable grounds for the trial court’s action.” Noting that a consummation of a sale would terminate the entire legal proceedings prior to a resolution of the substantive issues, the President Judge wrote, “Because we cannot conclude that no reasonable grounds exist to support Judge Morgan’s order, we must affirm his grant of the preliminary injunction.”
One judge dissented on the basis that the trustee had the power to sell this trust asset and that the state attorney general was exceeding his parens patriae authority.
AG’s New Power
Indeed, for trusts and estates practitioners, Fisher’s position, and the support it garnered in the Orphans’ Court, raises the pressing question: What is the proper scope of the attorney general’s review in its capacity as parens patriae for charitable interests? Citing the decision of the Supreme Court of Pennsylvania in Pruner’s Estate, the attorney general had argued that the “ultimate beneficiary and real party in interest of all charitable trusts is the general public.” From this point Fisher extrapolated the proposition that the attorney general is authorized to consider the likely effect of a charitable trust action upon all segments of the general public. In this case, of course, that meant considering the projected consequences of the sale for the general citizenry of Hershey and its environs.
But the holding in Pruner’s Estate (and the basis on which it has been regularly cited) is that the attorney general as a representative of the public interest is an indispensable party in all court proceedings involving charitable interests. The court in Pruner’s Estate did not address the scope of the attorney general’s review. Customarily the attorney general has sought to protect charitable interests only by ensuring that charitable funds are properly managed and not subjected to unnecessary fees or other expenses; and that charitable assets are not diverted from the uses intended by the grantor.10
Fisher’s expansion of this role in the Hershey case certainly goes beyond what his office seeks when reviewing the sale of non-profit health care entities. Under Pennsylvania law, fundamental changes in non-profit corporations (such as a merger, consolidation, division, sale of major assets or dissolution) are subject to review by the Orphans’ Court to confirm that property committed to charitable purposes is not being “diverted from the objects to which it was donated, granted or devised.”11 The attorney general as parens patriae is a party to such proceedings. In 1997 the Office of the Attorney General had issued a review protocol that required 90-days prior notice, and the submission of a variety of information. Most of the informational requests are designed to determine whether the consideration being paid by the for-profit hospital chain or other buyer is fair and adequate and how the sale proceeds to be received are to be applied for future charitable uses. These requests fall easily within the non-diversion rubric.
The review protocol also demands information “relative to the perspective of the non-profit’s beneficiary class or representatives thereof (for example, the community)” and “information…bearing on the effect of the proposed transaction on the availability or accessibility of health care in the affected community.” The goal seems to determine what ripple effect the proposed transaction will have on the community—and what the public’s reaction is to the proposed transaction. Yet even here the focus is still on the health care services that have been the primary charitable purpose of the non-profit corporation. In contrast, the proposed role of the attorney general in the Hershey case looks far beyond the educational implications of the sale to the overall welfare of the Hershey community.
Trustees’ New Burden
For trustees of charitable organizations, Fisher’s stance raises this nettlesome question: Do they now owe duties to the public at large? Traditionally, trustees understood that their duty was to manage prudently the assets of the trust for the benefit of the named beneficiaries or class of beneficiaries.12
But the attorney general’s position implies that the trustee of a charitable trust also must take into account the consequences of a trust action on all segments of the public at large. This duty potentially has no bounds. Should the trustee consider impact on the local community, the statewide population or the nation as a whole? If a sale of the controlling interest in the company did lead to job reductions in Hershey, would additional employment opportunities be created in some other state? Must the trustee of a charitable trust prepare a form of environmental impact statement for every major action?13
For charitable donors, Fisher’s stance throws a huge question mark over their right to designate beneficiaries and to have their charitable purposes respected. Is there now a new, undefined class of beneficiaries who in some sense will be competing for the trustee’s loyalty? What advice can the estate planning counsel give to a client who now is considering a charitable gift in trust? Can the scrivener of a charitable trust draft provisions that will give the donor greater assurances?
To codify his stance and try to make it workable, Fisher proposed new legislation. The state senate passed an amendment to the Pennsylvania Prudent Investor Rule that would require a charitable trustee to take into account “an asset’s special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries, including, in the case of a charitable trust, the special relationship of the asset and its economic impact as a principal business enterprise on the community in which the beneficiary of the trust is located and the special value of the integration of the beneficiary’s activities with the community where that asset is located.”14
The proposed legislation also would require the trustee to give 60 days advance notice to the attorney general of any action that might involve change in control if the trust holds “a controlling interest in a publicly traded business corporation received as an asset from the settlor.” On Oct. 22, the bill sailed through the state general assembly by a wide margin. Protecting jobs and businesses is a popular stance in an election year. The bill is expected to be signed by the governor.
To some extent the proposed legislation would bring the governance of charitable trustees more in line with that of non-profit corporation directors. The Pennsylvania Non-Profit Corporation Code states that directors of non-profit corporations may consider, inter alia, “the effects of any action upon any or all groups affected by such action, including members, employees, suppliers, customers and creditors of the corporation, and upon communities in which offices or other establishments of the corporation are located.”
But there is a huge difference between the Non-Profit Corporation Code’s “may consider” the public interest and the proposed standard for charitable trusts: “shall consider.”
Thankfully, the proposed legislation seems to expand the class of beneficiaries only to the community in which the charitable institution or its primary beneficiaries are located. This may help trustees better understand their new duty. On the other hand, the trustee of a private foundation could be caught in a conflict between this state law provision, which might warrant retention of the business interest, and a federal tax law that requires private foundations to divest stock if it represents more than a 20 percent voting interest in the company.15
Fisher’s solution also does little to ameliorate the concerns of charitable donors if they plan to fund their trusts with interests in a company that has a significant presence in a community. Furthermore, community groups may someday contend that other trust assets might have the sort of special value that invokes this new provision, for example, a large tract of land that is devoted to agricultural uses but has development potential as a site for a shopping mall. On the other hand, because the new law would amend the Pennsylvania Prudent Investor Act, which governs “except as otherwise provided by the governing instrument,” a savvy donor may try to stipulate in the trust instrument that the trustee is excused from compliance with this new requirement.
Round Two?,br> As this article goes to press, there is still much uncertainty. Even though the court proceedings have quieted down and the governor is expected to sign the new law, the conditions that first sparked the controversy remain. There still are business reasons for the company to seek a merger partner. The number and composition of the directors and managers have not changed. The school trust still owns its controlling interest in the company and its investment portfolio is still undiversified. A future disposition of part or all of the shares is still possible.
It all puts me in mind of the movie character Forrest Gump’s famous quip. “Life is like a box of chocolates,” he said. “You never know what you’re gonna get.”
Endnotes 1. With court approval the eligibility criteria have been revised several times, most recently in 1976. The current class of eligible students consists of poor and healthy children (male and female) who have not been receiving adequate care from their natural parents. 2. Protesters reportedly collected more than 6500 signatures on a petition calling for the removal of the Director/Managers and presented it to the Attorney General. Associated Press Newswires 9/24/02. 3. The Democratic candidate, Ed Rendell, also voiced concern about the sale. 4. In Pennsylvania the Court of Common Pleas is the trial court at the county level and the Orphans’ Court Division is a division of the court that has jurisdiction over estates, trusts and non-profit corporations. 5. The jurisdiction of the Commonwealth Court will be explained below. 6. The agreement was signed on Oct. 25, 1929, just four days prior to the great crash of the stock market. Because of the stock market turmoil the transaction was never consummated. 7. Pennsylvania adopted the Prudent Investor Rule in 1999. PEF Code §7201 et seq. Section 7204 states the general rule that “a fiduciary shall reasonably diversify investments, unless the fiduciary reasonably determines that it is in the interests of the beneficiaries not to diversify”. Section 7205 creates an exception for assets received in kind from the grantor, even though the asset constitutes a disproportionately large share of the portfolio. These provisions, however, are not applicable to pre-existing trusts such as the school trust. 8. Section 3355 of the PEF Code. 9. The Commonwealth Court cited City of Philadelphia v. District Council 33, 528 Pa. 355, 598 A.2d. 256 (1991), for the articulation of this test. 10.The briefs of both the attorney general and the trustee cite Commonwealth v. Barnes Foundation, 398 Pa. 458, 159 A.2d 500 (1960), which is an example of the traditional parens patriae role. In that case the Attorney General petitioned the court to force a charitable foundation to permit public viewing and enjoyment of the foundation’s world-famous art collection. 11. 15 Pa. C.S.A. §5547(b) 12. The brief of the trustee and managers cited several Pennsylvania Supreme Court decisions for the proposition that a trustee is required to act solely in the interest of the beneficiariesIn Re Steele’s Estate, 377 Pa. 250, 103 A.2d 409 (1954); In re Pew Memorial Trust No. 1, 5 D.&C.3d 627 (O.C. Phila. 1977). 13. This rule of law would create the sort of “stray duties” that in a different context the Supreme Court of California had warned against. Goldberg v. Frye, 266 Cal. Rptr. 483 (Cal. App. 1990) 14. H.B. 2060 Session of 2001. 15. Internal Revenue Code §4943.