By Jeffrey C. Blumenthal with Dan Felix © Reprinted by permission of 
                                             the Chicago Trustee Collaboratory

Introduction:

Attorneys Marshall Eisenberg and Earl Melamed of the large Chicago law firm Neal, Gerber and Eisenberg are/were tax and corporate attorneys for some of Chicago’s wealthiest families, such as the Pritzkers and their corporate entities, including the Hyatt Hotel System. As an apparent accommodation for their clients, and as a source of business for themselves and their law firm, Eisenberg and Melamed, began a Trust Company, known as General Trust Company, to act as a trustee for trusts, some or all of which were set up by their clients for themselves and their children. The case of Scanlon v. Eisenberg (caselaw.findlaw.com/us-7th-circuit/1592006.html ) discussed below indicates the legal pitfalls that a Corporate Trustee can face when the owners and officers of the Trustee play other, arguably conflicting, roles at the same time they are acting on behalf of the Trustee.

Summary of Scanlan v. Eisenberg, 669 F. 3d 838 (7^th Cir. 2012).

I.                   Facts

THE FAMILY, THE FAMILY BUSINESS & THE TRUSTS: Mary Bucksbaum Scanlan  (“Scanlan”) is the 44 year old daughter of Martin Bucksbaum, who, along with his brother, started General Growth Properties, Inc. (“GGP”), which develops shopping centers and became one of the largest Real Estate Investment Trusts (“REITS”) in the United States. GGP is traded on the New York Stock Exchange. Mary lives in Denver, Colorado and is not involved in the business.

When Scanlan was a child, her father and uncle established 6 trusts (the “Trusts”) naming her as the primary beneficiary. The trusts authorized the corporate trustee, General Trust Company (the “Trustee”) to distribute “all or as much of the net income or principal” or “both” of the trusts to Scanlan “as the Trustee deems to be necessary for her support” or “in her best interests”. Mary is the only one eligible to receive distributions from the Trusts her lifetime. Scanlan’s children are contingent remaindermen.

THE LAWYER/TRUSTEE/OFFICER/STOCK HOLDER/BOARD MEMBER: Neal Gerber & Eisenberg, LLP (the “Law Firm”) through two of its partners, Marshall Eisenberg (“Eisenberg”) and Earl Melamed (“Melamed”) generally represented Scanlan throughout her adult life. At the same time Eisenberg and Melamed also represented both GGP and the Trustee. Eisenberg was also an officer (secretary) of GGP from April, 1993 through October, 2008. Both Eisenberg and Melamed owned GGP stock. Eisenberg and Melamed controlled General Trust Company, the Trustee of Scanlan’s Trusts. Eisenberg is the majority owner, its president, a member of its board of directors, and one of three members of its Trust Committee. Melamed serves on General Trust Company’s Board of Directors, serves as its’ corporate secretary and is the second member of its Trust Committee.

THE SET UP FOR THE LOSS:  In 2007 and 2008, the Trusts purchased hundreds of millions of dollars of additional GGP stock. These purchases were financed with loans secured by the pledge of the Trusts’ assets. At the time of these purchases, the Trusts were already heavily invested in GGP stock, which constituted over 65% of the assets of Scanlan’s Trusts. Eiseberg and Melamed approved the Trusts’ additional GGP stock purchases as officers and directors of the Trustees, and the Law Firm, together with Eisenberg and Melamed, provided legal advice with respect to the stock purchase transactions.

In, 2009, GGP declared, what was then the largest real estate bankruptcy ever filed.  Scanlan’s Trusts lost more than $200 million due to a drop in value of the GGP stock purchases in 2007 and 2008.

THE ALLEGATIONS OF WRONG-DOING: Scanlan brought suit against the Trustee, the Law Firm and the Lawyers, Eisenberg and Melamed, on behalf of herself and on behalf of her children as contingent beneficiaries. The suit alleged that the 2007 and 2008 stock purchases were not in her best interests or her children’s best interests, but instead were to further

  (1) her lawyers own interests in retaining GGP as a client;

(2) the interests of other Bucksbaum family members who managed GGP and who were also clients of the lawyers;

(3) Eisenberg and Melamed’s interests as GGP shareholders; and

(4) Eisenberg’s interest as Secretary of GGP.

Scanlan claimed the Trustee breached its fiduciary duties of loyalty, prudence and disclosure, when it purchased the GGP stock in 2007 and 2008. Scanlan sued the lawyers for breach of fiduciary duty, malpractice, aiding and abetting the Trustee’s breach of fiduciary duty. Scanlan sought equitable relief, including (1) restoration of the Trust Corpus; (2) the removal of the Trustee; (3) an accounting and books and records request; (4) modification of the trusts to provide her with the power to remove the Trustee; (5) the disgorgement of attorneys’ fees; and (6) punitive damages.

The district court dismissed Scanlon’s suit on the basis that Scanlan lacked standing to sue because she was a discretionary trustee. Scanlan appealed. The Appellate Court reversed the dismissal holding that Scanlan had an interest that had been damaged by conduct alleged in the Complaint.

II. THE APPELLATE COURT’S REVERSAL OF THE
     TRIAL COURT’ S DISMISSAL ORDER AND HOLDING
     THAT SCANLAN STATED A CLAIM THAT COULD BE PURSUED.

THE LEGAL ISSUE OF STANDING: The Trial Court dismissed the case because Scanlan was a “discretionary” beneficiary, who could show no “injury in fact” because the Trusts were still worth 800 million dollars even after the losses incurred in the 2008 recession. Accordingly, Scanlan could not show that the trust monies would ever be insufficient to fund either any potential “support” need or “best interests” payments that she might need. The trial court reasoned that Scanlan’s legally protected interest arose solely out of her status as a discretionary beneficiary. Since Scanlan could not show that the Trusts would ever have insufficient funds to make any discretionary payments due her, Scanlan could no show injury in fact and had no standing.

THE APPELLATE COURT FOUND STANDING: The Seventh Circuit disagreed and held that Scanlan had standing to bring suit. The Appellate Court held that the issue of whether Scanlan had standing to bring suit as the beneficiary of discretionary trusts depended on the law that defined the rights of a discretionary beneficiary. In the Scanlan case, was Illinois law governed the trusts and Scanlan’s rights thereunder. The Seventh Circuit noted that, pursuant to the Restatement (Third) of Trusts, a beneficiary had standing to enjoin a breach of trust and contingent beneficiaries and persons eligible to receive discretionary payments as beneficiaries were also deemed to have standing to sue.

    The Court further reasoned that a fiduciary relationship existed between the Trustee and Scanlon as a result of Scanlon’s status as a beneficiary. Accordingly, the Trustee owed Scanlon a duty of loyalty and the Trustee was charged to act with the highest degree of fidelity and good faith. The Court further held at 669 F. 3d 844, that  as a matter of Illinois law, “a contingent beneficiary can bring an action against the Trustee—even though his interest is remote and contingent—to protect his possible eventual interest, i.e., to protect and preserve the trust res.” The Court held that, in Illinois, “a trustee owes the same fiduciary duty to a contingent beneficiary as one with a vested interest insofar as necessary for the protection of the contingent beneficiary’s rights to the trust property.” Id.

   At 669 F. 3d 845, the Appellate court reasoned: “[N]o authority requires a discretionary beneficiary to first allege that the trust corpus is insufficient to fund a distribution when bringing a claim for breach of trust.”

As the Court stated at 669 F. 3d 846: “Here, Scanlan is the beneficiary of several discretionary Trusts, and under those Trusts, she is currently eligible to receive all of the Trusts’ corpus. We established that Scanlan, as a beneficiary, is owed a fiduciary duty and that she has an interest in ensuring that the Trustee discharge its duties with fidelity and a certain degree of care. The Trustee and her lawyers, Scanlan claims, breached those fiduciary duties, causing the Trust corpus to lose approximately 200 million dollars. Under these circumstances, the Trustee’s and Lawyer’s dereliction of their fiduciary duties is a direct invasion of Scanlan’s protected interest in the prudent and loyal administration of the Trusts. Scanlan has therefore suffered an injury sufficient to satisfy Article III’s case and controversy requirement.”

III.           Postscript:

According to a March 27, 2014 Chicago Tribune Article, Scanlan has just reached a Settlement with the defendants in the suit.  While General Growth has survived its bankruptcy, the Bucksbaum family no longer has any interest in the company. Another recent Tribune Article of March 30, 2014 indicates that Mary’s brother or cousin, John Bucksbaum, who was the former CEO of GGP, has started a new real estate company and is developing urban residential real estate. Both Articles and the full opinion summarized above are provided as supplements to this memo.

IV.           QUESTIONS:

1)   The case does not say whether the Trust agreements required the Trustee to diversify investments, what if the Settlor specified that diversification of investments was not required and/or the Trustee could decide on the percentage of GGP stock the trusts could hold?

2)   What if the Trust agreements excused the Trustees’ “negligence” or did not require the Trustee to act with prudence?  Are those exculpatory clauses enforceable? Should they be?

Answer:

   Exculpatory or limiting provisions of a trust will protect a Trustee from liability provided the trustee acts in good faith and/or without reckless indifference to the beneficiaries. Accordingly, if a Trust Instrument specifically provides that the trustee will not be held liable for negligence or for failure to diversify the holdings or for allowing the trust to hold a specific percentage of stock in a given company, those clauses are enforceable and  will protect the Trustee from liability. However, because exculpatory provisions are strictly construed, the clauses on which the Trustee relies must be broad enough to justify non-diversification or not adhering to an objective “prudent man” standard with respect to the trust assets.

    Section 5 of the Illinois Trust and Trustees Act, entitled “Investments” (760 ILCS 5/5) provides in relevant part in paragraph 1 that: “The trustee has a duty to invest and manage trust assets as a prudent investor would considering the purposes, terms, distribution requirements, and other circumstances of the trust”. Paragraph 3 further provides that: The trustee has a duty to diversify the investments of the trust, unless, under the circumstances, the trustee reasonably believes it is in the interest of the beneficiaries and furthers the purpose of the trust not to diversify.”

However, despite the above investment rules, paragraph 1 of Section 3 of the Trustee’s Act, entitled “Applicability” (760 ILCS 5/3) provides:

        A person establishing a trust may specify in the instrument, the rights,
      powers, duties, limitations and immunities applicable to the trustee,
      beneficiary and others and those provisions where not otherwise contrary
      to law shall control, notwithstanding this Act. The provisions of this Act
      apply to the trust to the extent that they are not inconsistent with the
     provisions of the instrument.

Through 760 ILSC 5/3 “the legislature intended that the settlor [i.e., the grantor]of a trust have the freedom to direct his bounty as he sees fit, even to the point of giving effect to a provision regarding the rights of beneficiaries that might depart from the standard provisions of the Act, unless ‘otherwise contrary to law. In re Estate of Feinberg, 235 Ill 2d 256, 267, 919 N.E. 2d 888, 335 Ill. Dec. 863 (2009. The exercise of discretion by the trustee is not subject to interference by the court absent proof of fraud, abuse of discretion or bad faith.” Carter v. Carter, 965 N.E. 2d 1146, 1153 (1st Dist. 2012) appel den’d 2012 Ill LEXIS 837(2012).

 Moreover paragraph 6(b) of Section 5 of the Trustee’s Act (760 ILCS 5/5(6)(b))specifically allows the creator of the trust (the Settlor) to provide different investment rules to govern his/her/its “gift”. Paragraph 6(b) provides that: “The provisions of this Section [relating to investments] may be expanded, restricted, eliminated, or otherwise altered by express provisions of the trust instrument. The trustee is not liable for the trustee’s reasonable and good faith reliance on those express provisions.”

In Carter v. Carter, 965 N.E. 2d at 1157-1158, the appellate court relied on this precise paragraph in holding that the Trustee, who also held a life estate in the trust, did not breach any fiduciary duties owed to her step daughter, who held the remainder interest, by investing solely in tax free municipal bonds. The Carter Court held at 965 N.E. 2d 1158, that the grantor of the Trust “gave the [Trustee] authority to invest in any property without regard to diversification and, as such, altered the requirements of the prudent investor rule.” 

Moreover, other  Illinois Courts have consistently held that:

"Although exculpatory provisions . . . do not enjoy special favor in the law, if they are inserted in a trust instrument they are generally held effective except as to breaches of trust committed in bad faith or intentionally or with reckless indifference to the interest of the beneficiary." Axelrod v. Giambalvo, 129 Ill App 3d 512, 517, 472 N.E. 2d 840,844 (1st Dist. 1984); Accord: MAJS Investment, Inc. v. Albany Bank & Trust Co., 175 Ill App 3d 478, 488, 529 N.E. 2d 1035, 1037 (1st. Dist. 1988); Jewish Hosp. v. Boatmen’s Nat’l Bank, 261 Ill. App. 3d 750, 767 (5th Dist., 1994) appeal den’d 157 Ill. 2d 503 (1994)(Exculpatory clause in a trust relieved Co-Trustee bank from liability for alleged negligence characterized as a breach of fiduciary duty); Metz v. Independent Trust Corp., 994 F. 2d 395, 400 (7th Cir. 1993).

As the Axelrod Court further held at 129 Ill App 3d 517:

    “In Illinois language expressly exempting or exculpating a trustee from
   personal liability, if contained in the instrument creating the trust, has
   also been recognized.”

See also: Restatement of the Law of Trusts, 3d, §96 and Restatement of the Law of Trusts 2d, §222, both of which indicate that a trust instrument may contain exculpatory provisions relieving a trustee of liability for breach of trust for instances of ordinary negligence.

However, because “exculpatory provisions are strictly construed against the person seeking [their] protection” (MAJS Investment, Inc. v. Albany Bank & Trust Co., 175 Ill App 3d 478, 488, 529 N.E. 2d 1035, 1037 (1st. Dist. 1988)), the Trustee needs to make sure that the trust provision on which the Trustee relies is broad enough to permit the conduct in question.

Furthermore, in Vena v. Vena, 387 Ill. App. 3d 389, 394,397-398 (2nd Dist. 2008)appeal denied 231 Ill. 2d 688 (2009), the Second District Appellate Court held that a trust clause providing that “an approval of the trustee’s accounts by a majority of the ‘income beneficiaries’ would have the same effect as court approval of the accounts” (387 Ill App 3d at 390) was unenforceable as contrary to public policy because of the limitations it placed on redress for serious intentional or reckless trustee misconduct. Id. at 394.

Relying on the limitation on trustee exculpation articulated in Axelrod, supra, and its progeny, the Vena Court stated at 387 Ill App 3d 397 that:

We do not think that the majority- approval provision is an effective mechanism for holding a trustee to his or her duty.Thus, the provision is an improper method for exculpating the trustee of serious misconduct—of acts done in bad faith, of intentional breaches of trust, or of breaches of trust committed with reckless indifference to the interest of the beneficiary.

    ADDITIONAL QUESTIONS

3)   Is the moral of the Scanlan story that if you are acting as Trustee of Trusts, you should not simultaneously serve in any other position visa via the Trusts you are serving?

4)   Could the Trustee have avoided liability for the many conflicting roles if the Trustee had disclosed all of the conflicts in writing and received a written waiver of the disclosures from Mary Scanlan, for herself and on behalf of her children, the contingent remaindermen?

5)   Could the Trustee have avoided liability, notwithstanding that the owners of the Trustee were attorneys, who also represented General Growth Properties, Inc., if Scanlan had been represented by independent counsel and the Trustee had disclosed all of the conflicts in a writing reviewed by Mary and her independent counsel and if the Trustee had received a written waiver of the disclosures from Scanlan, for herself and on behalf of her children, the contingent remaindermen, that had been reviewed by Mary’s independent counsel before Mary signed it?

6)   Are the conflicts presented by this case inherently not waivable?

ANSWER:

   If you are serving as Trustee or advising one, you need to be careful what other roles the Trustee plays or might play in connection with the trust. Clearly serving as attorney for the Settlor, the Settlor’s company, and the beneficiary of the trust, as well as serving as an officer and owner of the Trust company that is acting as trustee- which is the situation in the Scanlan Case-, can place you in substantially conflicting positions that in certain circumstances– at least as far as lawyers are concerned – may not be curable by disclosure and the beneficiaries’ “knowing consent” of the conflicts even after review and explanation by independent counsel[1]. 

However, in many instances, if the trust instrument contemplates a specific conflict of interest, it can be waived. Illinois Courts have repeatedly held that:

         [A] trustee may occupy conflicting positions in handling the trust where the trust instrument contemplates, creates or sanctions the conflict of interest. The creator of the trust can waive the rule of undivided loyalty by expressly conferring upon the trustee the power to act in a dual capacity, or he can waive the rule by implication where he knowingly places the trustee in a position which might conflict with the interest of the beneficiaries.” Dick v. Peoples Mid-Illinois Corp., 242 Ill App 3d 297, 304 (1st Dist. 1993) citing with approval to In Re Estate of Halas, 209 Ill App. 3d 333, 344-345 (1st Dist. 1991) Accord: O’Brien v. O’Neill, 2007 U.S. Dist. LEXIS 14777*12 (N.D. Ill. 2007);  Regnery v. Meyers, 287 Ill App 3d 354, 362 (1st Dist. 1997).

      For example in Dick, the Court held that the Bank of Bloomington did not breach its duty as a successor trustee of a trust of which Plaintiff was one of the beneficiaries. In Dick, the bank, on behalf of the trust, held stock in the bank’s own holding company and supposedly “allowed” the holding company to accumulate profits instead of paying cash dividends, which payment, Plaintiff alleged, would have far more benefited the trust beneficiaries. Because the trust instrument specifically contemplated that the bank, as trustee, could own its’ own bank stock as a trust investment, the Court held that the conflict was waived. Plaintiff also alleged that the bank violated its duties as trustee by allowing Plaintiff’s brother to vote certain holding company stock that was owned by their father’s estate. The Court held, at 242 Ill App 305, that there was no breach of duty because the decedent’s will expressly provided that the bank could hold bank stock as a trust investment and that plaintiff’s brother was authorized to vote bank stock during the life of the trust.

      In In Re Estate of Halas, 209 Ill App. 3d 333 (1st Dist. 1991), the Court affirmed the ruling that George Halas Sr. had properly served as trustee of his grandchildren’s trust which owned corporate stock in the Chicago Bears[2]. The Court reasoned that Halas Sir could serve as his grandchildren’s trustee because the Settlor, Halas Sr.’s son, Mugs Halas, had expressly authorized his father to serve as trustee in the trust instrument despite the possibility of divided loyalties resulting from Halas Sr.’s own stock ownership in the Bears and stock ownership of his daughter. Based on the terms of the trust, the Court held that the duty of undivided loyalty that Halas Sr. would have otherwise had to his grandchildren had been waived. The Court further held that because Mug’s Halas executor had not shown that any actions of Halas Sr. were fraudulent or in bad faith [or grossly negligent], there was no sustainable claim for damages.

    The results in Dick and Halas  contrast with the result reached in In Re Estate of Hawley, 183 Ill. App. 3d 107 (5th Dist. 1989). In Hawley, decedent appointed his nephew, Richard Gregory (“Gregory”) as executor of his will and trustee of his testamentary trust. Certain of the Decedent’s assets or their residue, after liquidation, were distributed as will bequests and other assets or their residue poured into the testamentary trust. Decedent’s widow, Edna Hawley (“Edna”) had a life estate in the net income generated by the trust. Decedent’s assets included three parcels of farmland, one of which included a house and other farm related buildings.

   Gregory, as executor, caused the three farmland parcels to be auctioned off by an auctioneer, who employed Gregory’s son. At auction, Gregory’s son bought the parcel that had the house and other farm buildings on it. Gregory, in his dual capacity as executor and trustee, “purchased” one of the farmland parcels for the trust and then leased that farmland to his son. Edna, as holder of the life estate, then brought an action to remove Gregory as Trustee, which the Court granted.   

   In removing Gregory as Trustee, the Court recognized the rule that where trust instrument expressly allows contemplates, creates and/or sanctions a conflict of interest it may be permitted to exist; and, in that circumstance the duty of undivided loyalty which a trustee normally owes to the trust and its beneficiaries is waived. The Court did not remove Gregory either because of his dual position as executor or because he used trust assets to purchase the Estate farmland, since the decedent had sanctioned Gregory’s dual role and the purchase of the farmland for the trust was in the Trustee’s discretion under the terms of the trust instrument. However, there was nothing in the trust instrument which sanctioned the Trustee’s lease of the trust’s property to the Trustee’s son. The Court reasoned that the lease of the farmland to the trustee’s son created a non-sanctioned conflict of interest between the Trustee’s interests and those of his son, on the one hand, and the interests of the interests of the decedent’s wife, who held a life estate, on the other. Because the conflict was a continuing one, Gregory was removed.