Challenging The Account of a Fiduciary
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Trustees are entitled to compensation for serving in their fiduciary capacity. The trust may provide a fee schedule or may provide for a waiver of fiduciary fees. If the will is silent or provides for statutory commission, then reference should be made to Section 2309 of the Surrogates Court and Procedure Act (SCPA). Trustees are entitled to annual commissions as well as commissions based upon amounts paid out. SCPA §2309(2) provides that trustees are entitled to annual commissions at the following rates:
(a) $10.50 per $1,000 or major fraction thereof on the first $400,000 of principal.
(b) $4.50 per $1,000 or major fraction thereon on the next $600,000 of principal.
(c) $3.00 per $1,000 or major fraction thereof on all additional principal.
Annual commissions may be computed either at the end of the year or, at the option of the trustee, at the beginning of the year; provided, that the option selected be used throughout the period of the trust. The computation is made on the basis of a 12-month period but is adjusted upward or downward for any payments made in partial distribution of the trust or the receipt of any new property into the trust within that period. SCPA §2309(3) further provides that annual commissions shall be paid one-third from the income of the trust and two-thirds from the principal, unless the will or trust otherwise directs.
Commissions Based Upon Sums of Money Paid Out
In addition to annual commissions, SCPA §2309(1) provides for trustee commissions to be paid on the settlement of the account:
On the settlement of the account of any trustee under the will of a person dying after August 31, 1956, or under a[n] [inter vivos] trust . . .the court must allow to him his reasonable and necessary expenses actually paid by him . . . and in addition it must allow the trustee for his services as trustee a commission from principal for paying out all sums of money constituting principal at the rate of 1 per cent. Therefore, the trustee is entitled to a commission of 1 percent.
Annual Accounting to Beneficiaries
Trustees are required to furnish annually as of a date no more than 30 days prior to the end of the trust year to each beneficiary currently receiving income, and to any other beneficiary interested in the income and to any person interested in the principal of the trust who shall have made a demand therefor, a statement showing the principal assets on hand on that date and, at least annually, a statement showing all receipts of income and principal during the period including the amount of any commissions retained by the trustee. SCPA §2309(4) provides that a trustee shall not be deemed to have waived any commissions by reason of his failure to retain them when he becomes entitled thereto; provided however that commissions payable from income for any given trust year shall be allowed and retained only from income derived from the trust during that year and shall not be supplied from income on hand in respect to any other trust year.
II. Accountings
SCPA §§ 2201 through 2227 govern trust accountings. Often, an account may be settled informally by agreement among the trustee and all beneficiaries. If an informal settlement cannot be agreed upon, then a formal accounting will be required. An accounting proceeding begins with a Petition, accompanied by the trustee’’s final account, which is filed with the Surrogate and served upon all beneficiaries. Beneficiaries may examine the fiduciary under oath, either before or after filing objections to the account.
III. Burden of Proof
In establishing fiduciary liability, the party on whom the burden of proof is imposed is a crucial factor. In an accounting proceeding
[t]he accounting party has the burden of proving that she has fully accounted for all assets of the estate, and this burden does not change in the event the account is contested. While the party submitting the objections bears the burden of coming forward with evidence to establish that the account is inaccurate or incomplete, upon satisfaction of that showing the accounting party must prove by a fair preponderance of the evidence that his or her account is complete. (Matter of Schnare, 191 AD2d 859, 861 [3d Dept 1993], lv denied 82 NY2d 653 [1993] [internal citations omitted]).
IV. The Prudent Investor Standard
The common law standard required a trustee ““to employ such diligence and such prudence in the care and management [of the trust], as in general, prudent men of discretion and intelligence in such matters, employ in their own like affairs” (King v. Talbot, 40 N.Y. 76, 85-86 [1869]). This common law rule was later codified in EPTL 11-2.2(a)(1). Under this standard, risk was discouraged (see Bank of New York, 35 NY2d 512 [1974]), and diversification was encouraged though not mandated (see Matter of Newhoff, 107 AD2d 417 [1985], appeal denied 66 NY2d 605 [1985]). The standard was somewhat less strict vis à vis investments which the grantor transferred to a trust (see Matter of Hahn, 93 AD2d 583 [1983], affirmed 62 NY2d 821 [1984]). On January 1, 1995, the Prudent Investor Act [EPTL 11-2.3] became the governing standard for fiduciaries. It imposes an affirmative duty on a fiduciary “to invest and manage property held in a fiduciary capacity in accordance with the prudent investor standard defined by this section” (EPTL 11-2.3[a]).
The standard of conduct under this role is not defined by “outcome.” Rather, compliance “is determined in light of facts and circumstances prevailing at the time of the decision or action of the trustee” (EPTL 11-2.3[b][1]. Matter of HSBC Bank USA, N.Y., 2010 WL 5186667 at *9 (Sur. Ct. Erie Co. 2010), 30 Misc.3d 1201(A), 2010 N.Y. Slip Op. 52234(U). Notably, an entity holding itself out with special investment skills, such as a bank, will be held to the standard of a prudent investor of discretion and intelligence having special investment skills. EPTL 11-2.3[b][6].
Cases Interpreting the Prudent Investor Standard
Matter of Korn, 36 Misc.3d 1224A (Sur. Ct. 2012) involved an objection to an accounting by a trust beneficiary, the brother of the trustee, who was also a trust beneficiary. The alleged breach of fiduciary duty related to whether the trustee had failed to act prudently in not exercising a right of first refusal to acquire certain real estate. The Surrogate held that the prudent person standard of investing governed the trustee, and required that the trustee employ prudence in the care of trust assets equivalent to that of a prudent person of discretion and intelligence in managing his or her own affairs. Applying that standard, the Surrogate found that the trustee had invested prudently in that the trust had insufficient liquid assets available to purchase the real estate, and also was already heavily invested in real estate.
EPTL 11-2.3[b] (the NY Prudent Investor Act) provides that a trustee shall exercise reasonable care, skill and caution to make and implement investment and management decisions as a prudent investor would for the entire portfolio, taking into account the purposes, terms and provisions of the governing instrument. In Matter of Knox, 2012 N.Y. App. Div, LEXIS 4880 (4th Dept. 2012), trust beneficiaries objected to a trust accounting alleging a failure to properly diversify stock investments. The beneficiaries alleged that the trustee had breached his fiduciary duty by imprudently retaining a high concentration of stock in two companies. The beneficiaries further alleged that the trustee had improperly relied upon the advice of a family member who was not a trustee. The Surrogate held that the trustee had negligently managed the trust by failing to maintain proper documentation and failing to develop an investment plan. The Appellate Division reversed primarily on the ground that the trust instrument itself expressly granted the trustee the power to invest without regard to diversification. The Court also noted that even though assets were held in “overweight” positions, the objectant had failed to demonstrate that it was imprudent to do so, and the objectant had failed to show a financial loss from the holdings.
In contrast, in Matter of Hunter, 2010 NY Slip Op 50548U, the Surrogate of Westchester County imposed a surcharge of $4.322 million against JP Morgan Chase, a trustee that had failed to diversify a stock portfolio which consisted entirely of Eastman Kodak stock. The Surrogate held that a prudent trustee would have sold 95 percent of the Kodak stock, noting that JP Morgan Chase had no written investment plan for the trust, other than to eventually sell some of the Kodak Stock. The Surrogate imposed a surcharge based upon the lost capital to the trust. On appeal, the Second Department found “no reason” to disturb the Surrogate’s finding that JP Morgan Chase had violated both the prudent-person standard of investing and the Prudent Investor Act, noting that the high concentration of Kodak stock had been held for twenty years. The Appellate Division also remarked that JP Morgan Chase had “acted contrary to its own internal policies, which restrict the retention of any one stock unless certain circumstances existed, none of which were present. Matter of Hunter, NY Slip Op 08124, 11/28/12.
V. Delays in Distribution
When a trust terminates, trustees who delay in distributing assets to the beneficiaries do so at their own peril. In Matter of McCluskey, 951 N.Y.S.2d 852 (Nassau Cty Surr. 2012), the trustee failed to distribute trust assets for over a year after the trust terminated, by which time trust assets had declined in value. The trustee argued that damages should be mitigated if (i) the beneficiaries would have made the same mistake as the trustee or if (ii) the value of the trust assets appreciated subsequent to the distribution such that any theoretical loss was negated. Finding the arguments without merit, the Surrogate denied the motion made by the Trustee to compel production of the beneficiaries’ personal investment portfolios for the period during which it was alleged that the Trustee had been neglectful in distributing trust assets.
Matter of Lasdone, 2011 NY Slip Op 51710U (NY Cty Surr. Court, 2011) also presented a situation where the trustee had delayed distribution of trust assets, during which time the value of trust assets declined. The trustee had refused to timely distribute trust assets to two beneficiaries who had been entitled to receive trust assets upon attaining the of age thirty-five. The Surrogate granted summary judgment to the beneficiaries on their surcharge claim. With respect to the issue of damages, the Surrogate ruled that the surcharge award should not be reduced by the capital gains tax that would have been incurred by the beneficiaries, since the beneficiaries could have held the stock until their respective deaths, thus benefitting from a stepped up basis. The Surrogate held that reasonable attorneys’ fees should be chargeable to the estate, and not to the trustee, since the cost of preparing the accountings and other work done by the attorneys was necessary to the administration of the estate.
VI. Surcharges
In Matter of Janes, 643 N.Y.S.2d 972, 976, 223 A.D.2d 20, 26 (4th Dep’t. 1996), aff’d, 90 N.Y.2d 41 (1997) the trustee had invested the entire trust in Kodak stock which, over a period of years, eventually become worthless when Kodak filed for bankruptcy. The Fourth Department held that “the failure to act as a prudent person would have acted constitutes negligence for which a fiduciary may be surcharged and made to forfeit commissions.” Similarly, Restatement 3d Trusts §76 provides:
§ 76. Duty To Administer The Trust In Accordance With Its Terms And Applicable Law
(1) The trustee has a duty to administer the trust, diligently and in good faith, in accordance with the terms of the trust and applicable law.
(2) In administering the trust, the trustee’s responsibilities include performance of the following functions:
(a) ascertaining the duties and powers of the trusteeship, and the beneficiaries and purposes of the trust;
(b) collecting and protecting trust property;
(c) managing the trust estate to provide returns or other benefits from trust property; and
(d) applying or distributing trust income and principal during the administration of the trust and upon its termination.
The Appellate Division concluded that “the Surrogate properly imposed liability on the fiduciary for its initial imprudent failure to diversify as well as for its subsequent indifference, inaction, nondisclosure, and outright deception in response to the prolonged and steep decline in the worth of the estate.” The court emphasized the corporate fiduciary’s failure to formally analyze the estate’s assets, the fiduciary’s failure to consider the risks borne by the beneficiaries as a result of the concentration of assets, and the fiduciary’s failure to adequately communicate with the beneficiaries. Id. at 31-32. The Court then articulated the rule for when a fiduciary will be surcharged:
[A] fiduciary will be surcharged for losses resulting from negligent inattentiveness, inaction, or ill consideration (see, Matter of Donner, supra, at 586; Matter of Wood, 177 A.D.2d 161, 167-168. Thus, while mere erroneous judgment or poor investment performance cannot be the basis of a finding of imprudence, where the facts known at the time of the decision establish its unreasonableness, a finding of imprudence is warranted (see, Matter of Wood, supra, at 167-168). Generally, the determination of whether a fiduciary’s conduct measures up to the appropriate standards of prudence, vigilance, and care is an issue of fact for the trial Court (see, Matter of Donner, supra, at 585, citing Matter of Hubbell, supra, at 258; see also, Matter of Yarm, 119 A.D.2d 754). Id. at 27.
The proper measure of damages “is the value of the capital that was lost. . .calculated by determining the value of the securities at the time they should have been sold, minus their value when ultimately sold or, if they are still retained by the estate, their value at the time of the accounting or the Court’s decision [citations omitted].” Id. at 34. This standard for calculating damages was affirmed by the Court of Appeals. Matter of Estate of Janes, 90 N.Y.2d 41, 56, 659 N.Y.S.2d 165 (1997). In so affirming, the Court of Appeals clarified that the fiduciary was not surcharged for a failure to meet an absolute duty to diversify per se, but rather for failing to consider the continuing risk of the investment, failing to pay sufficient attention to the needs and interests of the beneficiary, and failing to exercise the due care and skill which it held itself out as possessing. Id. at 53-54. In the view of the Court, this amounted to a violation of “certain critical obligations of a fiduciary in making investment decisions under the prudent person rule,” and therefore warranted surcharge. Id.53.
Matter of Estate of Janes was cited in Williams v. J.P. Morgan & Co. Incorporated, 199 F.Supp.2d 189 (S.D.N.Y. 2002). In Williams, a trust had been created in 1958, and funded with a corpus of $500,000. J.P. Morgan was appointed as trustee. J.P. Morgan invested in tax-free bonds since a treaty between the United States and Brazil was contemplated and this would have made the investment in tax-free bonds prudent. However, as it happened, the treaty was never ratified. In spite of the treaty never having been ratified, J.P. Morgan never divested itself of the tax-free bonds. Williams claimed that J.P. Morgan continued to invest in tax-free bonds when no longer required to do so, and sought to surcharge J.P. Morgan for its “negligent and imprudent failure to invest and/or diversify trust assets.” Id at 191.
J.P. Morgan moved for summary judgment dismissing Williams’ objections. Williams cross-moved for summary judgment. Applying New York law as articulated in Matter of Janes, and affirmed by the Court of Appeals, the District Court addressed the issue of whether – assuming Williams prevailed on the merits – the proper measure of damages was, as J.P. Morgan asserted, the lost capital only, or as Williams asserted, the lost profits. Id. at 192. The District Court found that under New York law, where the trustee had mismanaged a trust, the proper measure of damages was the value of lost capital. Id. at 196.
