The Dumont decision is a shocker, especially to those working under
English law. But advisors across the globe must absorb its lessonsjust
in case a trust they manage comes to be governed by New York law
A New York judge’s recent decision in
Estate of Dumont’ should give
trustees reason to pause and re-evaluate
the investment policies and procedures of
any trust for which they act, that is governed
by or may come to be governed by New York
law The judge held a trustee liable-to the
tune of $21 million-for failing to diversify
Eastman Kodak stock when its share prices fell
in the 1970s, even though the trust’s settlor
specifically instructed that the Kodak stock not
be sold solely for diversification reasons.
The July 13, 2004, decision by Monroe
County, N.Y. Surrogate Judge Edmund A
Calvaruso in Dumont makes fascinating reading,
particularly for anybody brought up in the
English common law tradition. The decision
highlights some significant distinctions
between the law in New York (which many
English practitioners view as typical of that of
the United States) and that in England (which,
of course, underpins the law in most “offshore
jurisdictions”).
Dumont involved the settlement of Lincoln
First Bank’s second intermediate account as
trustee of a testamentary trust with a high concentration
of Eastman Kodak stock. In his will,
the decedent indicated his “desire and hope”
that his executors and trustees would hold the
Kodak stock for the ultimate benefit of the trust
beneficiaries and not “dispose of such stock for
the purpose of diversification of investment
[nor shall the trustees be] held liable for any
diminution in the value of such stock” but that
they may sell the stock ” in case there shall be
some compelling reason other than diversification
of investment for doing so.”‘
The trust beneficiaries sought a surcharge
of $39 million against the trustee for failing to
diversify the trust portfolio in light of a precipitous
drop in the value of Kodak stock in
the early 1970s.
In levying a surcharge of nearly $21 million
against the trustee, Judge Calvaruso provides a
thorough overview for trustees in the areas of
trust portfolio diversification and adhering to
the testator’s intent. But the decision also serves
to alert offshore attorneys and fiduciaries to
important differences between fiduciary obligations
in U.S. jurisdictions such as New York, and
those grounded in the English common law
SETTLOR’S AUTHORITY
New York’s Estates Powers and Trusts Law
(EPTL) often permits its default provisions
to be overridden by a trust settlor.
However, EPTL Section n-q provides that,
for reasons of public policy, a settlor cannot
exonerate a fiduciary for, among other
things, failure to exercise prudence, reasonable
care and diligence. Beyond this limitation,
one would think that the settlor’s
intent as evidenced in the trust instrument
should govern a fiduciary’s duties. Yet
Dumont teaches that, at least under New
York law, there are three voices to which the
fiduciary must listen: the settlor (his intent
and strength of wording); the beneficiaries
(regarding their economic situation and
expressed desires); and the market (the
realities of the financial world and composition
of the trust corpus).
This stands in sharp contrast to the
“Anglo”3 view that, to form a trust, a governing
instrument must not only create certain
minimum duties and responsibilities that are
enforceable in a court of equity 4 but also
(unless the settlor provides otherwise)
requires, at a minimum, that the trustee
behave honestly and in good faith toward his
beneficiaries. 5 It is therefore shocking to
Anglo lawyers and fiduciaries to see a state
impose higher duties of prudence, reasonable
care and diligence.
TRUSTS & ESTATES / trustsandestates.com APRIL 2005
Most Anglo trust practitioners already
think the trust law of states such as New York
confer many more rights on settlors than
6 English law does. English law; in the broadest
sense, sees trust property as belonging to the
beneficiaries: A settlor has only those rights
that he has reserved in the trust instrument
once the ink dries.
The one power a settlor clearly retains is the
power to dictate the terms of his trust. Neither
the state nor the trust beneficiaries should second
guess what a settlor wants. Nor should a
state or beneficiaries vary the trust terms
based on market conditions or expressed
desires of the beneficiaries. So most trustees
whose duties are governed by English law
would find suprising Judge Calvaruso’s conclusion
in Dumontthat “a retention clause cannot
trump the application of prudence in the
management of an estate” even where the settlor
has provided otherwise.
MEASURING DAMAGES
Also shocking is how Judge Calvaruso measured
damages for the trustee’s failure to prudently
manage the trust investments. In
Dumont, he calculated damages by projecting
what would have been the sale proceeds had the
trustee sold the Kodak stock in 1974 (the time it
would have been prudent to do so), then subtracted
capital gains that would have been paid
and applied statutory interest to the net amount.
The judge then subtracted from the total dividends
received by the trust beneficiaries and the
actual sale proceeds received. Finally;t he judge
ordered that all of the commission paid to the
trustee over the period in question be returned
to the trust.
By contrast, under English law the standards
for measuring damages differ depending on
whether the damages are for a breach of fiduciary
duty or for a breach of executorial or managerial
responsibilities. For breaches of fiduciary
duty; damages arise from a failure to act in good
faith (at a minimum) or a failure to adhere to a
higher standard if one was imposed by the settlor.
This was established in Bristol and West
Building Society v Mothew,7 where the court
held that a breach of fiduciary duty required
some degree of disloyalty or infidelity beyond
mere incompetence, and that damages in such
cases are calculated in equity; that is to say what
would be the economic position of the damaged
party had the trustee taken appropriate and
timely action and in light of succeeding market
conditions. This approach is not unlike that of
Judge Calvaruso’s, aside from the fact that the
application of statutory interest appears to be
more of a penalty than an attempt to make up
for lost appreciation. Under English law; however,
the failure of the trustee to diversify the trust
portfolio would not be treated as a breach of
fiduciary duty in the first place; rather it’d be
considered a tortious breach of executorial or
8
managerial responsibilities. Therefore, an
English court would employ an entirely different
strategy for calculating damages than was
used in Dumont.
Because English law would see the
trustee’s failure as tortious, damages would be
based on tort principles of foreseeability a~d
remoteness. The difference in legal theories
applied could have resulted in very different
damage awards.
PRUDENITN VESTOR
The Dumont decision also discusses the need
to diversify and the shift from the prudent
person standard to the prudent investor standard.’
While it’s true that a settlor can override
the prudent investor standard set forth in
EPTL Section n-2-3, at least some have taken
the position that non-diversification is per se
imprudent and violates EPTL Section n-2-3.
So, a clause inserted by a settlor authorizing
non-diversification must always fail.’° Under
this view, the prudent investor standard
seems to mandate the application to trusts of
modern portfolio theory
Neither England nor (so far as we know) the
offshore jurisdictions use the prudent investor
standard. The English Trustee Act 2000
empowers trustees to make any investments
they would make if they themselves were entitled
to the trust’s assets.” Under Section 5 of
Trustee Act 2000, trustees are required to take
proper advice concerning their investments,
and that advice must consider both the suitability
of the investments in relation to the trust and
the “need for diversification. . .in so far as is
appropriate to the circumstances of the trust.””
But that’s a long way from requiring trustees to
APRIL 2005 TRUSTS & ESTATES / trustsandestates.com
It’s
shocking
how the
judge
measured
damages for
the trustee’s
failure to
prudently
manage
trust
investments.
71
-alls of
• New
• Nonas
•
ing
provide
,isser
wices
,anies
adopt modem portfolio theory
Indeed, it’s clear from Section s’s
wording that a settlor can eliminate any
need for investment diversification. In
fact, that’s what settlors commonly do
in their offshore trusts. There is simply
no notion in the Anglo world of the
settlor’s wish in that regard being
subject to some form of statutory
override.
EXCULPATION
Dumont provides little discussion of
how trustees might be exculpated,
beyond noting that the trust instrument
attempted to absolve the trustees
from responsibility for losses arising
from non-diversification, and the
court’s view that this was trumped by
the statutory duty of prudence.
Many older English trusts leave a
trustee liable even for innocent breaches
of trust. But most modem trusts, particularlyt
hose with professionalt rustees,l imit
a trustee’sl iabilityto , for example,f raud (in
the equitable sense), wilful default and
either negligence or gross negligence.
Further, it’s dear from the English Court of
Appeal decision in Armitage v. Nurs/
that a trustee may be absolved from all
wrongdoing provided he acted honestly
and in good faith in the best interests
of the beneficiaries.
Not all of the offshore jurisdictions
go so far. Jersey and Guernsey, for
example, do not allow a settlor to
absolve trustees from liability for gross
negligence,”‘ and it may well be that
England will go the same way when
the legislative timetable permits.’5
PAPERING THE FILE
There is another line in the Dumont
decision that provides a sharp contrast
to English law. Judge Calvaruso
declared that “the complete lack of
documentation alone is itself a breach
of trust. “‘
6
There can be no doubt that
the absence of any paperwork presents
trustees with a considerable evidentiary
burden in any jurisdiction.” But while
the fact that a trustee never wrote anything
down may not be bright, it does
72
not mean that there have not been
meaningful discussions leading to the
decisions made. Indeed, English tradition
used to be that company directors
should record their thinking in full, but
trustees should do no more than record
the bare fact of their decisions. That has
changed (in no small part due to the volume
of anti-trustee litigation). Even so,
no one in the Anglo world would imagine
liability hanging on lack of paperwork
alone.
IHE MESSAGE
One of the most surprising things
about Dumontis that it happened at all.
Apparently the Dumont trust officers
found the term “compelling reason”
clear, but it’s baffling why In
England, we’d expect the trustees, soon
after Charles Dumont’s death, to have
consulted external counsel. And certainly
the advice the Dumont trustees
would have received would be: Go to
the courts to have the will construed.
Surely there is sufficient doubt in
the trust document’s wording that
the costs of such an application
would have been ordered to be paid
out of the trust fund, and a judicial
construction would have absolved the
trustees of future liability
Dumont sends a clear warning to
trustees throughout New York that
they must be sure to institute policies
and procedures to ensure that fiduciary
responsibilities are met, particularly
in the area of trust investment. But it
sends an even louder message to offshore
trustees subject to New York
laws: Don’t assume you understand
the rules of the game even if you have
extensive experience as a fiduciary in
the Anglo world. Fiduciary responsibilities
are quite different in New York.
Don’t be taken by surprise. I
Endnotes
1. Estate of Dumont, New York Law
Journal, July 13, 2004, p. 19, col. 3.
2. Ibid.
3. By “Anglo” we mean all non-U.S. jurisdictions,
in England or elsewhere, that derive