Tips From the Pros: Directed Trusts—Who’s Responsible?

Tips From the Pros: Directed Trusts—Who’s Responsible?

The development and use of directed trusts have increased in recent years. Although the concept of a directed trust isn’t new, states have only recently begun setting the statutory framework for the powers, duties and potential liability of directed trustees.

Directed Versus Delegated Trusts

In a directed trust, the trust instrument provides that a non-trustee party (a director) has the power to direct the trustee in carrying out one or more identified responsibilities. Usually, the trustee has no discretion over the segment(s) of administration with respect to which the director has authority. This arrangement is quite different from a delegated trust, in which the trustee contracts with a third party to perform certain administrative services on the trustee’s behalf. In this latter arrangement, the third party acts as an agent of the trustee, subject to the terms of the contractual relationship.

Restatement Third

Section 75 of the Restatement of the Law (Third) of Trusts (Restatement Third) provides: 

Except in cases covered by § 74 (involving powers of revocation and other ownership-equivalent powers), if the terms of a trust reserve to the settlor or confer upon another a power to direct or otherwise control certain conduct of the trustee, the trustee has a duty to act in accordance with the requirements of the trust provision reserving or conferring the power and to comply with any exercise of that power, unless the attempted exercise is contrary to the terms of the trust or power or the trustee knows or has reason to believe that the attempted exercise violates a fiduciary duty that the power holder owes to the beneficiaries.

The comments that follow Section 75 of the Restatement Third discuss the difference between a director who holds a power exercisable for his own benefit (for example, the settlor of a revocable trust or a beneficiary with the power to veto the sale of a trust-owned residence) and one who’s acting in a fiduciary capacity for the trust beneficiaries (for example, an investment advisor with special expertise). If the director holds the power for his own benefit, the trustee only needs to determine whether the exercise of the power is properly within the scope set forth in the trust. Conversely, if the director holds the power in a fiduciary capacity, then the director essentially becomes a co-fiduciary with the trustee, and the trustee must verify that the director’s actions don’t violate a fiduciary duty. Indiana is one state whose law follows, to some extent, the Restatement Third approach.1 

Uniform Trust Code

Section 808 of the Uniform Trust Code (UTC) provides:

POWERS TO DIRECT.

(a) While a trust is revocable, the trustee may follow a direction of the settlor that is contrary to the terms of the trust.

(b) If the terms of a trust confer upon a person other than the settlor of a revocable trust power to direct certain actions of the trustee, the trustee shall act in accordance with an exercise of the power unless the attempted exercise is manifestly contrary to the terms of the trust or the trustee knows the attempted exercise would constitute a serious breach of a fiduciary duty that the person holding the power owes to the beneficiaries of the trust.

(c) The terms of a trust may confer upon a trustee or other person a power to direct the modification or termination of the trust.

(d) A person, other than a beneficiary, who holds a power to direct is presumptively a fiduciary who, as such, is required to act in good faith with regard to the purposes of the trust and the interests of the beneficiaries. The holder of a power to direct is liable for any loss that results from breach of a fiduciary duty.

Most states with directed trust statutes generally follow the UTC approach.2 As stated in the comments that follow UTC Section 808, the provisions of that section may be altered in the terms of the trust.3 A settlor could provide that the trustee must accept the decision of the power holder without question or that the holder of the power isn’t to be held to the standards of a fiduciary.

Other Statutory Approaches

Some state statutes limit the liability of a directed trustee much more comprehensively than UTC Section 808.4 Delaware law, for instance, imposes liability on a directed trustee only if the trustee’s action or inaction results from willful misconduct.5 Illinois’ directed trust statute, on the other hand, provides for three categories of “directing party” (distribution trust advisor, investment trust advisor and trust protector), affirmatively imposes fiduciary duties on these directing parties and generally absolves the directed trustee from liability for carrying out a director’s instructions.6 In Ohio, a directed trustee (an “excluded fiduciary”) isn’t liable for loss resulting from compliance with an authorized direction of the directing party, and, to the extent the power of direction relates to any investment, the directed trustee generally has no obligation to perform investment reviews or make investment recommendations.7 The law of Virginia generally absolves an excluded fiduciary from liability (except, possibly, as a ministerial agent) for investment losses resulting from following an authorized direction.8 In Missouri, a directed trustee isn’t liable for any loss resulting from acts or omissions validly directed by the trust protector (or as a result of the trust protector’s failure to provide consent) except in cases of the trustee’s bad faith or reckless indifference or as otherwise provided in the trust instrument.9

Directed Trustee Liability Cases

Trustee liability in the context of directed trusts is based on the extent to which a directed trustee is permitted or required, under the governing instrument and applicable state law, to follow directions from another party. Liability may also arise from the inaction of a directed trustee if that trustee is under a legal obligation to monitor the director’s actions. Given the relative novelty of state statutes specifically dealing with liability of directed trustees, this area of law remains largely unresolved in the courts.

In Duemler v. Wilmington Trust Company,10 the investment director, R. Leigh Duemler, sued Wilmington Trust Company, the directed trustee, claiming that it had breached its fiduciary duty by not providing him with timely financial information that would have allowed him to make a recommendation and avoid investment loss. The trust company defended itself relying on the Delaware directed trust statute, which provides, in pertinent part:

If a governing instrument provides that a fiduciary is to follow the direction of an adviser, and the fiduciary acts in accordance with such a direction, then except in cases of willful misconduct on the part of the fiduciary so directed, the fiduciary shall not be liable for any loss resulting directly or indirectly from any such act.11

The Court of Chancery of Delaware issued an unpublished order exonerating the directed trustee. The court found no willful misconduct on the part of the trust company, saying that:

Wilmington Trust acted in accordance with Plaintiff’s instructions, . . . and had no duty to provide information or ascertain whether Plaintiff was fully informed. . .12

Rollins v. Branch Banking & Trust Co. of Virginia13 also involved the duties of a directed trustee. The trust instrument conferred the power to retain, sell or purchase investments exclusively on the beneficiaries. The trusts were funded with shares of stock in two textile companies. On funding, the beneficiaries directed the trustee to hold an over-concentrated position in textiles securities. The trustee sold the stock 20 years later at the direction of the beneficiaries for a fraction of its original value.

The beneficiaries sued, claiming that the trustee failed to diversify and warn the beneficiaries of the declining condition of the trust investments. In addressing the first claim, the court examined Code of Virginia Section 26-5.2 (predecessor to Code of Virginia Section 64.2-1416), which provided that, when a trust instrument reserves investment authority in an advisor or similar party to the exclusion of the trustee, “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.” Observing that “the statute clearly prohibits the law from imposing liability on the trustee for failing to do what he had no ability to do,”14 the court concluded the trustee couldn’t be liable for failure to diversify trust investments when the beneficiaries held investment authority under the terms of the trust.

As to the second claim, however, the court stated that the trustee had a duty to keep the beneficiaries informed of the condition of the trust investments and stated that the statute, “does not excuse a trustee from liability for failing to participate in the administration of the trust or for failing to attempt to prevent a breach of trust.”15 Prior to a final resolution on the merits of the latter claim, the beneficiaries settled with the trustee.

Ultimate Responsibility

When a traditional, non-directed trust experiences a loss as a result of negligence, recklessness or willful misconduct, the culpable, ultimately responsible party is the trustee. In a directed trust context, however, identifying such party may not be simple. It must initially be determined whether the loss occurred in connection with an aspect of trust administration for which the director had authority under the governing instrument. If the director had authority for that aspect, it would then need to be determined whether the director was, under the governing instrument and applicable state law, solely responsible for the loss or whether the trustee should properly share such responsibility.

Many directed trust statutes sanction the use of trust provisions specifying that the director isn’t a fiduciary.16 Moreover, in some states (for example, Delaware, Missouri, Ohio and South Dakota), a directed trustee has little if any liability for following the directions of the director. It would, therefore, seem that the practical ability to recover damages for the trust or the beneficiary may be elusive.

Directed trustees shouldn’t conclude, however, that they’re off the hook in all states and in all circumstances. As demonstrated above, directed trust statutes vary considerably in the protection from liability they confer on trustees. Furthermore, in egregious cases, such as when a directed trustee turns a blind eye to a director’s blatant malfeasance, courts will likely find a way to give victimized beneficiaries a meaningful remedy.                          

Endnotes

1. See Ind. Code Section 30-4-3-9(b).

2. See, e.g., Fla. Stat. Section 736.0808.

3. See Uniform Trust Code Section 105.

4. See, e.g., Ind. Code Section 30-4-3-9(a); S.D.C.L. Sections 55-1B-2, -5.  

5. See, e.g., 12 Del. C. Section 3313(b).  

6. 760 ILCS 5/16.3.  

7. Ohio Rev. Code Section 5815.25.

8. Code of Virginia Section 64.2-1416(D).

9. Mo. Rev. Stat. Section 456.8-808.

10. Duemler v. Wilmington Trust Company, C.A. 20033 V.C. Strine (Del. Ch. 2004).

11. 12 Del. C. Section 3313(b).

12. Duemler, supra note 10. 

13. Rollins v. Branch Banking & Trust Co. of Virginia, 56 Va. Cir. 147 (2001).

14. Ibid., at p. 150. 

15. Ibid.  

16. See, e.g., Mo. Rev. Stat. Section 456.8-808.6.

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