Fiduciary roles: should you serve as a trustee?

Your father asks you to serve as trustee for the trust he’s creating to hold the shares of the family business. Most of us are honored to be invited to serve in a fiduciary role, to be asked to take on an important position of responsibility. But particularly in a family situation, consider the potential downsides of a fiduciary role. Before you sign the documents, think about the responsibilities you’re taking on, and whether you’ve got the time, energy and expertise necessary to do the job right.

Serving as a trustee is a fiduciary role, which requires you to act in the best interests of another – in the case of the trust, in the best interests of the beneficiaries. At great risk of oversimplification, the core notion of fiduciary duty is: never can you put your own interests first, or act for your own personal gain.

Under the common law, a fiduciary owes three primary duties to the beneficiaries: the duty of care, the duty of loyalty, and the duty of impartiality. The trustee must carry out the express terms of the trust, must act prudently, must treat the current and future beneficiaries impartially. The trustee must protect and secure the trust property, ensuring that it is not commingled with other assets. He or she must invest the trust property to produce a reasonable income. Fiduciary duty is the highest legal standard under US law, a particularly daunting hurdle if you are someday sued for negligence.

If you’re asked to serve as trustee of a family trust, find out who the beneficiaries will be. Will you be asked to exercise discretion over distributions? What will it do to your relationship with your siblings if you turn down a request for a distribution? Your fiduciary duty to act in the best interests of the beneficiaries may conflict with the desires of your father, the grantor of the trust – for example, your father may envision that all profits will be reinvested in the company, while a sibling beneficiary may have a compelling need for distribution, and your fiduciary duty obligates you to invest the trust property to achieve a reasonable income. How will you resolve those conflicts within the scope of the law and the scope of the family relationship? Are you also in the senior management team of the company? You may agree that the company desperately needs to retain cash – but remember, your duty as trustee is to the beneficiaries, not to the business.

Adding further fuel to the fire, what about the duty to diversify trust property, a fiduciary obligation recognized under the law of some states? Are you at risk for being sued by a beneficiary who believes that the capital would be more productive if invested in a diversified portfolio rather than a single, privately-held stock? Does the trust instrument direct you to retain the company stock? Permit you to retain it? Does your state law permit the grantor’s intent to trump the duty to diversify?

If these questions make you feel a bit queasy, good. Serving as a trustee can be a tough job, at times requiring you to resolve layers of familial and legal conflicts. Don't undertake the role without giving it considerable thought. Talk with experienced legal counsel and at least one other person who has taken on a similar role.

Next post, we’ll talk about strategies for reducing trustee liability.

More on structuring business-owning trusts

How can business-owning families use trusts to transfer ownership between generations, without demotivating and disengaging the next generation?

Last week I attended the annual conference of Attorneys for Family Held Enterprises (“AFHE”). Friday morning brought an excellent presentation by Marion McCollom Hampton and Andrew Hier of OMBI Consulting on “The Impact on Beneficiaries When Family Business Ownership is Held in Trust”. The speakers pointed out that trusts can undermine effective and healthy ownership of family businesses by removing the decision-making authority of family members and weakening initiatives for shareholder education, and by reducing or eliminating the incentive for the family to create governance structures and decision-making processes.

At Fisher Renkert LLC, we recognize that transferring ownership of a family business in trust rather than outright can have a substantial negative impact on the business. Improperly drafted trusts can demotivate and disenfranchise next generation family members, who find themselves passive beneficiaries rather than active shareholders. Inserting a third party – the trustee – into the system can disrupt both the family and the business. However, given the potential upside to be gained from transferring ownership in trust – significant tax savings over generations, protection from creditors (including divorcing spouses), ensuring stable ownership even when the beneficiary is legally incompetent – our goal is to design trust structures for business-owning families that engage the family, promote effective family and business governance, and support business continuity.

As the OMBI team pointed out, and as I’ve emphasized in prior posts, choosing the right trustee for a family business trust is critical. But even more important than choosing the right trustee in the first instance is ensuring ongoing oversight of the trustee by granting a trusted individual the power to remove the trustee, and to replace a trustee who has resigned or been removed. The holder of this “remove/replace” power has substantial indirect power over the trustee, and through that power, the ability to influence trustee decision-making. While a family member often can’t serve as trustee for tax reasons, a family member can hold and exercise the remove/replace power without running the risk of estate or gift tax inclusion so long as the successor trustee is not “related or subordinate to” the grantor or the beneficiaries (as that phrase is defined in Section 672(c) of the Internal Revenue Code). By granting the remove/replace power to a beneficiary or other family member, power can be shifted from the trustee back to the family.

Typically, the holder of the remove/replace power is called the Protector. Traditionally, the Protector of a trust has been an individual. At Fisher Renkert LLC, we suggest that families consider appointing a committee, or sometimes better yet, an entity, to serve as Protector, particularly for dynasty trusts or trusts holding substantial interests in an operating business. With either a committee or an entity, the remove/replace power will be exercised by a group of individuals. The group can be made up entirely of beneficiaries or other family members, but just as the quality of the decision-making of a board of directors will be strengthened by including independent directors, it can be helpful to include non-family members on the protector group, selected for their knowledge of the family, skills and experience. While the primary charge of the Protector group is oversight of the trustee, ongoing education of family members regarding the purposes, structure and investments of the trust can be an important secondary charge.

The group should meet regularly – at least quarterly – with the trustee and the family, and should receive copies of all information provided to the trustee, as well as the trust’s accountings, tax filings and other formal records of trustee decision-making. The group may also liaise with the family council and the board of directors of the operating business. The issue of protector succession is also simplified by use of a group – when a member of the group ceases to act for any reason, the group itself can be charged with the task of appointing a successor in accordance with specified criteria.