In defense of the no further inquiry rule: a response to professor John Langbein.

AuthorLeslie, Melanie B.
PositionResponse to Yale Law Journal vol. 114, p. 929, 2005

TABLE OF CONTENTS INTRODUCTION I. HOW THE NO FURTHER INQUIRY RULE ADVANCES BENEFICIARY INTERESTS II. PROFESSOR LANGBEIN'S ARGUMENT III. PROFESSOR LANGBEIN OVERSTATES THE NO FURTHER INQUIRY RULE'S POTENTIAL FOR OVERDETERRENCE IV. PROFESSOR LANGBEIN'S PROPOSED RULE WOULD SIGNIFICANTLY UNDERDETER TRUSTEE SELF-DEALING A. Monitoring, Exit, and External Pressure: Comparing Trusts to Other Relationships 1. Family, Business, and Corporate Relationships 2. Trusts a. Beneficiaries Are Uniquely Poor Monitors b. Absence of External Pressures c. Beneficiaries Cannot Exit B. The Enduring Value of the No Further Inquiry Rule V. EXCEPTIONS AND EXCLUSIONS TO THE RULE ARE NOT EVIDENCE THAT THE RULE IS "NO LONGER THE BASELINE" FOR FIDUCIARY CONDUCT A. Section 802(f) B. Section 802(c): Self-Dealing as Indirect Self-Dealing VI. THE NO FURTHER INQUIRY RULE AND CONCERNS FOR FAIRNESS TO INDIVIDUAL, NONPROFESSIONAL TRUSTEES CONCLUSION INTRODUCTION

In an article recently published in the Yale Law Journal, Professor John Langbein of the Yale Law School advocates a radical change in trust law. (1) Professor Langbein targets the "no further inquiry" rule, a centuries-old rule that unequivocally prohibits a trustee from profiting from transactions with the trust without advance approval from a court or trust beneficiaries. (2) The rule also imposes harsh consequences for unauthorized trustee self-dealing. (3) Langbein argues that the rule should be replaced with a regime that allows trustees to profit from conflicts of interest as long as they can prove, if challenged in court, that the conflicted transaction was in the trust's best interests. (4) In essence, Langbein would like to see trust law mirror the duty of loyalty rules that currently apply to corporate fiduciaries.

Professor Langbein is one of the most influential trust scholars of our time. In fact, Professor Langbein is a member of the committee responsible for drafting the Uniform Trust Code (UTC) and the UTC's duty of loyalty provisions are consistent with his views. Two such provisions, taken together, effectively release institutional trustees from the constraints of the no further inquiry rule for many, if not most, of the conflicted transactions in which they might engage, (5) and allow trustees to rebut a charge of self-dealing with proof that the transaction was fair to the trust. (6) This is a radical change in trust law, (7) and one that seems to have occurred with little critical analysis or fanfare. Professor Langbein now argues that we should take this trend to its logical conclusion and eliminate the no further inquiry rule entirely. (8)

In the past few years, fourteen states and the District of Columbia have enacted the UTC. (9) Most other states are considering whether to adopt it. (10) The UTC loyalty provisions that eliminate the no further inquiry rule clearly will make life easier and more profitable for institutional trustees. But it is critical to examine whether they will generate comparable benefits for trust beneficiaries.

This Article argues that Professor Langbein fails to prove that the no further inquiry rule is problematic, or that his proposed "best-interest" defense would make trust beneficiaries better off. In fact, a best-interest defense would generate serious harm to future beneficiaries.

  1. HOW THE NO FURTHER INQUIRY RULE ADVANCES BENEFICIARY INTERESTS

    For centuries, trust law has stubbornly insisted that when a trustee profits from engaging in a conflicted transaction with the trust, the beneficiary may void the transaction unless the trustee obtained prior approval. (11) The trustee is held per se liable simply upon a beneficiary's showing that the trustee had a personal interest in the transaction (the "no further inquiry" rule), even if the self-interested transaction caused the trust no damage. (12) The trustee must disgorge all profits realized as a result of the transaction and return them to the trust. (13)

    Consider an example: X is trustee of a testamentary trust that holds as an asset a twenty-acre plot of land. X determines that the time is right to sell the land for development. In addition to being trustee, X also happens to be a developer, and she would like to purchase the land from the trust herself. After obtaining several appraisals, X purchases the land from the trust for a sum that she reasonably believes represents the land's fair market value. If the trust's beneficiaries sue the trustee for breach of the duty of loyalty, should they prevail even though the trustee seemed to have paid a fair price? The law answers "yes." (14)

    If X had sold the land on the open market, she would have used her best efforts to obtain the highest possible price for the land, which might have resulted in a higher sale price. If so, the beneficiaries were harmed by the trustee's purchase of the trust assets, even if the trustee paid a price within the range of the property's fair market value, because the trustee did not, and could not expect to, advocate for the trust beneficiaries seeking to obtain the highest price. (15) Instead, the trustee, not the trust, captured some of the value generated by the deal. Moreover, beneficiaries and a court would have difficulty determining after the fact whether X in fact paid top dollar for the property; the market is a better indicator of fair market value than is an ex post judgment by the court. (16) The no further inquiry rule supports trust settlors' objectives. The trustee earns compensation for acting as the beneficiaries' advocate. The trustee's duty is to subordinate its own interest to the beneficiaries' interests. The trustee's role is to advocate zealously for trust beneficiaries at all times, without regard for the trustee's personal interests. The trustee's promise to subordinate its interests to those of the beneficiaries reassures the settlor that her loved ones will be well cared for after her death.

    The rule sends a clear message to trustees: absent unusual circumstances, you may not profit from your position (aside from trustee commissions). If you want to transact business with the trust, you must obtain advance authorization from a court or the trust beneficiaries. (17)

  2. PROFESSOR LANGBEIN'S ARGUMENT

    Professor Langbein observes that our lives consist of a web of conflicted relationships. (18) Both in our personal lives and in business, we consistently surrender power to those who are in a position to abuse our trust by furthering their own self-interest at our expense. (19) The mother is conflicted about how much time to spend with her son, how much on herself. (20) The surgeon examines the patient, and then recommends costly surgery from which the surgeon will profit. (21) The adult child holds her parent's durable power of attorney, which allows her to determine how much money to spend on her incapacitated parent and how much to save to receive as an inheritance. (22) Yet the law allows the participants in such relationships to manage the conflict themselves. (23) Most of the time, people handle conflicts fairly. Only in trust law is there a rule that flatly prohibits one with a conflict from profiting from the relationship, even if a trustee could handle the conflict fairly. (24)

    Why, then, did trust law develop the no further inquiry rule as a response to trustee conflicts of interest? Professor Langbein argues that the rule is a relic, left over from a time when beneficiaries were unable to prove a trustee's misappropriation. (25) The rule was developed in the late eighteenth and early nineteenth centuries, when the English Court of Chancery lacked the mechanisms to discover and adjudicate facts, (26) and before regulatory and business pressures created a norm of stringent record-keeping practices. (27) Because beneficiaries were unable to prove self-dealing, a rule developed that imposed liability upon a showing that the trustee engaged in a conflicted transaction. (28) In today's environment, Professor Langbein argues, the rule is no longer necessary. (29)

    To justify abolishing a rule as entrenched as the no further inquiry rule, Professor Langbein must establish that the rule causes actual harm. The principal harm he identifies is that the rule overdeters: the rule sometimes prevents trustees from engaging in transactions that will benefit both the beneficiary and the trustee. (30) Although he acknowledges that the rule allows trustees to profit from a transaction with the trust as long as they seek advance approval from the court or the beneficiaries, he argues that the expense and delay of the advance approval process discourages trustees from engaging in the transaction. (31) He also fears that trustee concerns for settlor's privacy prevent trustees from seeking advance approval and, therefore, from completing beneficial transactions. (32)

    Finally, Professor Langbein offers an explanation for the judiciary's failure to abandon the no further inquiry rule. He argues that it survives only because exceptions and exclusions have developed to mitigate the rule's dire effects. (33) He cites the advance approval doctrine and courts' willingness to uphold trust provisions authorizing particularly described conflicted transactions as examples of judicially crafted exceptions. (34) He cites particular state statutes and Uniform Trust Code provisions that categorically exempt a broad swath of transactions from the reach of the no further inquiry rule as further evidence that the no further inquiry rule retains no persuasive modern-day justification. (35) These statutes (and proposed statutes) direct that certain types of self-dealing transactions shall be valid if the trustee can show that the transaction was fair and in the beneficiaries' best interests. (36)

    Professor Langbein argues that this approach should be extended to all transactions between the trustee and the trust. (37) He contends that the corporate law standard, which shields a corporate fiduciary from...

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