Blocking &. Tackling: Strategies to Avoid Fiduciary Litigation

Published on: 6/13/2009

Ever wonder why people rob banks? "Because that's where the money is." At least, that's what bank robber Willie Sutton said in the 1930s, and his simple observation remains true today. Financial institutions hold substantial assets and, consequently, are prominent targets for litigation. That is why we invest so much time coaching bank and trust officers, fiduciaries, trustees and risk managers how to avoid fiduciary litigation.

Frankly, litigation avoidance is less expensive and removes the obvious risk factor.

This Alert offers some practical tips to do just that. By way of disclaimer, the tips are not profound in any respect. Actually, the tips are quite elementary. That is not a commentary on either the topic or the audience. Rather, what we have observed over many years of defending fiduciaries in all sorts of claims is the simple fact that most fiduciary litigation can be avoided  by adhering to certain basic principles.

1. Read the Instrument

We see so many claims that could have been avoided if the fiduciary had carefully read the relevant instrument. After all, it is the controlling document. We start with this simple rule to illustrate how easy litigation avoidance can be.

Unfortunately, it is too late when a trust officer testifies, "Well, I read the important parts," or worse yet, "I didn't read the whole thing." We are not making this up. It really happened. Fact truly would be funnier than fiction if it did not expose an institution to significant liability.

2. Do Not Rely on a Predecessor's Course of Dealing

This is a kissing-cousin of the first rule. Following by rote the practice of one's predecessor seems to be a systemic problem within institutions. The larger the institution, the worse the problem seems to be. Add in some turnover and you have a recipe for claims. The pattern goes like this: A new trust officer receives a cursory overview of general practice and procedures, or the new person inherits an account without any background information. When decisions need to be made, the new trust officer haplessly picks up right where his or her predecessor left off without ever reading the instrument or the entire file.

The problem can come to light when the new hire happens to be an aspiring bank president who starts doing everything by the book, not by prior practice. He denies requests for payments, puts beneficiaries on a budget and so forth, not because he is callous, but because he has read the instrument. The defense in that suit goes something like this: "Well, Your Honor, we may have been mismanaging the trust before this ace trust officer came along, but now we are doing everything just right!" Admittedly, this is not an enviable position to defend.

3. Faithfully Follow the Terms of the Instrument

Most decisions involving the administration of a trust could and should be made by referring to the terms of the instrument. Granted, there will be unusual situations where a call to counsel or even a suit for aid and guidance may be necessary, but they are few and far between. More often than not, the instrument will dictate the proper course of conduct. Horror stories are born when fiduciaries fail to follow this simple tenet.

One case will illustrate the point. The bank entered into individual custodial agreements with an investment company and hundreds of investors. The agreements authorized the bank to transfer funds to the investment company, but also required the bank to deliver to the investors quarterly reports showing deposits and withdrawals. The investment company, however, was required to provide detailed statements showing the actual investments and returns. Over many years, millions of dollars were invested and millions of dollars in interest were paid to the investors. The investors' only complaint was that the bank statements were not helpful and a waste of paper, considering that the investment company was providing detailed reports. Then one day the investment company, on behalf of the investors, asked the bank to stop sending statements to the investors. The bank cheerfully complied but without sending a notice to the investors or documenting the event in any fashion. Eighteen months later, the investment company was insolvent and the investors were unsecured creditors in bankruptcy claiming they were victims of a huge Ponzi scheme. A bankruptcy lawyer happened to read the agreements and discovered what the bank had done. While the bank's failure to mail quarterly statements or otherwise document the file had no causal connection to the Ponzi scheme, the bank was sued in a multi-million dollar class action. A simple letter to the investors would have prevented a major piece of litigation and saved the bank hundreds of thousands of dollars in legal fees.

4. Document All Significant Changes, Complaints or Events

Assuming the fiduciary reads the instrument and faithfully follows its terms, documenting the file is probably the next most important practical tip for avoiding claims of breach of fiduciary duty. Trust officers need to think defensively. Any problems, unusual requests and complaints of any nature should be documented, including the action taken by the fiduciary. The press of time or the feeling that it is not terribly important are the two most frequently cited excuses for not documenting the file. Whatever the excuse, if the file does not contain a written reply to the beneficiary or a note describing the action taken, the fiduciary opens himself to a claim of breach of fiduciary duty, as well as an argument that the breach was arbitrary and capricious. Always take the time to document the file.

5. Do NOT Document Random Thoughts or Rank Speculation

There are limits to the last rule. Fiduciaries can get themselves into trouble when they make subjective notes in the file that were never intended to see the light of day, speculate about some aspect of the administration of the trust, or make an arguably disparaging remark about a beneficiary. Be careful about handwritten notes, emails and entries into an electronic database. Here, we recommend two pieces of time-honored advice. As Joe Friday always said, "Just the facts, Ma'am." Next, do not write down anything you would not say directly to the beneficiary. You do not want your random thoughts or rank speculation to become the lynchpin of a modern day Willie Sutton's theory of liability.

6. Make Regular Audits, Inspections or Visits

The administration of some trusts necessarily requires the trustee to take affirmative steps to protect the trust assets or a beneficiary's interests. For example, if the trust operates or has an interest in an ongoing business operation, regular audits would be in order. If the trust possesses special assets such as unimproved real estate, buildings or a coal mine, regular inspections of the premises would be prudent to the administration of the trust. Also, if the beneficiary has special needs, is incapacitated or institutionalized, regular visits may be necessary to confirm that current expenditures are appropriate. While audits, inspections and visits take time and resources, we regularly see the tremendous value of the trustee's firsthand knowledge of the situation or inclusion in the file of periodic reports about the condition in question. Conversely, the absence of such information can evince not only a breach of duty, but a callous disregard for the interests of the trust or the beneficiaries.

7. Deal With the Difficult Account

Despite the best precautionary measures, from time to time the trustee will be confronted with the difficult beneficiary or challenging composition of assets. Rarely do these situations get better with time. In fact, they usually get progressively worse. At the first hint of a relationship going sour or a problem with the administration of the trust, take some remedial action. This may involve consulting the trust committee or bank management, seeking advice from in-house counsel, contacting outside counsel, or in some situations filing suit for aid and guidance. Perhaps resignation may be in the best interest of all concerned. Whatever the case, do not wait for the Apocalypse. Be proactive and act promptly.

To be sure, there is no prescription to avoid all fiduciary litigation. It simply comes with the territory. However; following these basic rules will enable the fiduciary to avoid many claims or achieve a happy outcome when and if a claim is made. Remember what Ben Franklin said, "For the want of a nail ... the kingdom was lost .... " Do not let a missing nail cause the loss of your kingdom.




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