Holding Closely Held Business Assets in Trust, 0320 COBJ, Vol. 49, No. 3 Pg. 49
| Author | BY REBECCA KLOCK SCHROER AND MORGAN WIENER |
| Position | Vol. 49, 3 [Page 49] |
TRUST AND ESTATE LAW
BY REBECCA KLOCK SCHROER AND MORGAN WIENER
Trustees face challenges when administering trusts that own closely held business assets. This article discusses the standard of care that applies to trustees when making business decisions, the duty to inform and report, and the duty to diversify a concentrated position in a closely held business asset.
A trustee or personal representative is often confronted with the possibility or necessity of holding and/or controlling a closely held business as part of the administration of an estate or trust.1 When a trust holds an interest in a closely held business asset such as a partnership, limited liability company (LLC), or corporation, the trustee may end up acting in multiple roles, for example, as both the trustee of the trust holding the business and an officer or partner in the business. This article discusses a few of the many considerations for trustees in this situation, including (1) the standard of care that generally applies (fiduciary standard versus business judgment rule), (2) the duty to inform and report about the business, and (3) the duty to diversify a large holding in a business. Because Colorado law frequently does not address these issues directly (or at all), this article also discusses instructive case law from other states.
The Power to Hold Business Interests
Colorado law specifically allows a trustee to hold interests in a business or enterprise.2 Te trustee is allowed to continue the business, create a successor business, and take any action that may be taken by shareholders, partners, or members.3 Furthermore, the trustee can vote or give proxies to vote with respect to stock and other securities.4 Finally, Colorado statutes specifically permit a trustee to become a general or limited partner pursuant to the terms of the will or trust and partnership agreement.5 Colorado law, however, does not address many of the issues that may arise as a result of a trust holding interests in a business.
Trustee’s Duty of Loyalty
One of a trustee’s fundamental duties is the duty of loyalty, which requires a trustee to act solely in the interests of the beneficiaries and t o properly manage or avoid any conflicts of interest.6 When a trust holds an interest in a closely held business, a conflict of interest could arise for a trustee, particularly if the trustee also holds a separate individual interest in the same company. In such case, the trustee must be careful not to favor his or her individual interests over the interests of the trust.
Colorado law addresses these conflicts of interest; a conflict is presumed when a trustee enters into a transaction with a corporation or other enterprise in which the trustee, or a person who owns a significant interest in the trustee, has an interest that might affect the trustee’s best judgment.7 As with other conflicts, the conflict can be overcome if the trust document authorizes the transaction, the beneficiaries consent after full disclosure, the court approves the transaction, the transaction involves a contract entered into before the trustee became a trustee, or the statute of limitations for challenging the transaction expires.8
Standard of Care: Fiduciary Standard or Business Judgment Rule?
When a trustee holds an interest in a business that includes voting rights, a directorship, a managerial role, or other interests that require the trustee to make business decisions, the question arises whether the trustee’s conduct with respect to the business is governed by the higher fiduciary standard of care applicable to a trustee or the business judgment rule.
The standard of care applicable to fiduciaries under Colorado law is generally set forth in the Colorado Uniform Trust Code (CUTC), CRS §§ 15-5-101 et seq.9 In broad terms, a trustee must “administer the trust in good faith, in accordance with its terms and purposes and the interests of the beneficiaries, and in accordance with” the provisions of the CUTC.10 In adhering to the proper standard of care, a trustee must act in accordance with a variety of fiduciary duties, including, among others, the duties to act prudently,11 loyally,12 impartially,13 and in the best interests of the beneficiaries.14 Te standard of care for a fiduciary is among the highest standard under the law and is perhaps stated best in the oft-quoted case Meinhardt v. Salmon:
Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. . . .15
Tis higher duty of care for a trustee exists because of the imbalance of power between trustees and beneficiaries, which does not exist in an arm’s length business relationship.
In addition to being held to a high standard of care, and despite the reality that trustees frequently work with a variety of professional advisors in administering a trust and discharging their duties, a trustee typically may not invoke a good faith reliance on the advice of counsel as a defense to a breach of fiduciary duty claim.16 This is because a trustee always has the option to seek instructions from the court about a course of action, rather than relying on the advice of counsel, in determining how to proceed.17
Te business judgment rule, in contrast, is relatively more lenient and provides some measure of protection to corporate officers and directors acting on behalf of the business. Under Colorado law, “officers, directors, and controlling shareholders of a corporation have a fiduciary duty to act in good faith and in a manner they reasonably believe to be in the best interests of the corporation and all of its shareholders.”18 In addition, officers and directors must act with care and are entitled to rely on certain information provided by advisors and experts.19 In particular, officers and directors may rely on information, opinions, reports, and statements, including financial information, provided by officers or employees reasonably believed to be competent with respect to the information; or legal counsel, accountants, or other persons retained by the business as to matters involving expertise or skills reasonably believed to be within that person’s competence.[20]
Te business judgment rule shields officers and directors who have adhered to this standard from liability and “bars judicial inquiry into actions of corporate directors taken in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes.”21 Te rule “reflects the reality that courts are ill equipped and infrequently called on to evaluate what are and must be essentially business judgments.”22 Te standard for liability under Colorado’s business judgment rule is codified in CRS § 7-108-402, which provides that there is no liability unless the plaintiff establishes that an act, omission, or decision was, among other things,
■ not in good faith;
■ not rationally believed to be in the best interests of the business;
■ at least grossly negligent, unless the governing documents change the standard of liability to something less than gross negligence; or
■ one to which the director failed to make an appropriate inquiry in light of particular facts or circumstances that would have alerted a reasonably attentive director of the need for an inquiry.23
Te business judgment rule does not apply, however, to transactions in which the director has an interest.24 In this respect, the rule is similar to the fiduciary standard of care, which also imposes a higher level of scrutiny on self-interested transactions.25
While Colorado law on the different standards of care is relatively well developed, there is no Colorado law directly addressing which standard of care applies to the trustee’s conduct when a trust owns closely held business assets and the trustee is serving in dual roles. The limited statutory authority touching on this issue is potentially conflicting.
On the one hand, the CUTC provides some guidance as to the applicable standard of care and states that the corporate form cannot shield a trustee from the duty to act in the best interests of the beneficiaries:
In voting shares of stock or in exercising powers of control over similar interests in other forms of enterprise, the trustee shall act in the best interests of the beneficiaries. If the trust is the sole owner of a corporation or other form of enterprise, the trustee shall elect or appoint directors or other managers who will manage the corporation or enterprise in the best interests of the beneficiaries.26
Te comments to the Uniform Trust Code § 802 state that “[t]he trustee may not use the corporate form to escape the fiduciary duties of trust law.” For example, the trustee cannot hide behind corporate discretion to avoid the duty of impartiality.27 Te trustee’s responsibility is heavier if the trustee holds a large proportion of shares in a corporation or is in control or substantially in control of the corporation.28 Tis position follows from the position taken in the Uniform Trust Code that if the trust holds the entire corporation, the “corporate assets are in effect trust assets.”29
On the other hand, Colorado law also provides that the business judgment rule applies when a fiduciary forms a successor entity for a family business:
A fiduciary may vote and otherwise deal with respect to interests in the family business as the fiduciary believes in the good...
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