We get asked a lot about two categories of cases: (1) cases about discretionary distributions; and (2) cases about concentrations and diversification. And, it’s easy to understand why – fiduciaries are often given a great amount of discretion in exercising their duties, but then may get sued over it. While there seems to be a growing number of decisions dealing with matters like undue influence and lack of capacity, the numbers of authorities regarding the exercise of discretionary powers and diversification/concentrations are still limited.
That’s why when an opinion like that of the Illinois Court of Appeals in Carter v. Carter comes along, we have to take notice. In this case, the court considered a breach of fiduciary duty claim arising from the trustee’s alleged strategy of investing only in tax-free municipal bonds. The appellate court determined that this strategy did not violate the prudent investor rule or any fiduciary duty owed by the trustee. Let’s see why. . .
Luther Reynolds Carter, Jr. created a living trust that then created a marital trust that went in effect upon Luther’s death. Audrey E. Dressen Carter was Luther’s wife. Audrey was the trustee and sole income beneficiary of the marital trust. Audrey also happened to be the stepmother of Tiffany L. Carter, the sole remainder beneficiary of the trust. Tiffany sued Audrey on the grounds that Audrey’s investment strategy benefited Audrey while damaging Tiffany’s interest in the trust’s principal.
There’s a lot of great stuff going on in the case that warrants giving the opinion a full read, but since it’s a lengthy opinion, let’s just jump right ahead to the diversification/concentration portion. Audrey invested 100% of the trust funds in tax-free municipal bonds, which, of course, pay interest over time but do not increase the value of the principal. Why wasn’t this a violation of Audrey’s fiduciary duties?
1. Pursuant to the plain language of the trust, when viewed in the context of Luther’s entire estate plan, Luther intended for the trust to provide income to Audrey during her lifetime by means of whatever investments she deemed appropriate. Specifically, the trust contained a provision that provided mandatory payment of income to Audrey without any discretionary payments of corpus to either Tiffany or Audrey. Furthermore, the ‘investment’ section of the trust instrument permitted Audrey to invest in any property “regardless of diversification and regardless of whether the property would be considered a proper trust investment.” This provision made it clear that Luther intended for Audrey to generate unlimited income for herself from virtually any investment.
2. Tiffany claimed that even if a trustee is granted authority to make investment decisions regardless of diversification, the trustee is still required under the prudent investor rule to diversify her investments. In other words, Tiffany argued that a grantor cannot absolve a trustee from an independent duty imposed by the prudent investor rule. This is a pretty common argument made by remainder beneficiaries and has had some limited success in some jurisdictions. This argument, however, didn’t work for Tiffany under Illinois law.
First, several of the authorities relied upon by Tiffany involved a trustee’s investing a concentration of trust assets in the trustee’s own stock. Audrey’s investments in municipal bonds were not similarly self-serving. Here’s the important warning for trustees: The Illinois court of appeals stated in dicta that where a trustee invests a concentration of trust assets in its own stock, a case may exist for finding that a trustee’s duty of prudence trumps trust language excusing diversification. However, that was not the case here.
Second, the trust agreement expressly permitted Audrey to make investment elections “regardless of diversification.” That’s important language and is not merely “boilerplate.” Where a trust instrument does not contain similar diversification language, the prudent investor rule may more easily come into play. It’s worth noting that Illinois’s prudent investor rule provides that the provisions of the rule “may be expanded, restricted, eliminated, or otherwise altered by express provisions of the trust instrument.”
Regardless of the trust’s language, as a trustee, Audrey was required to be mindful of Tiffany’s interests as the remainder beneficiary and was prohibited from acting inconsistently with those interests, regardless of whether she was acting in bad faith or good faith. There was no evidence that Audrey’s decision to invest in municipal bonds was arbitrary or unreasonable, and, therefore, Tiffany’s breach of fiduciary duty claims against Audrey were dismissed.