Opinion ID: 1441469
Heading Depth: 1
Heading Rank: 5

Heading: The Correct Standard to be Applied to a Claim of Breach of Fiduciary Duty

Text: The trial court incorrectly equated the standard of fiduciary duty of a corporate director with that of a trustee of a trust. [17] The absolute prohibition under common law against self-dealing by a trustee has been modified in the corporate setting to offer a safe harbor for the directors of a corporation if the transaction is approved by a majority of disinterested directors. [18] Transactions approved by the directors are therefore not voidable because there are interested directors, if a committee of disinterested directors approves the transaction. [19] In such a case the directors are protected by the business judgment rule. [20] If, however, the transaction is not approved by the requisite number of disinterested directors, the directors must prove that the transaction was entirely fair. [21] Defendants argue that there is no distinction between the law of self-dealing whether corporate law or trust law is involved because the type of the transaction does not change the nature of the act. That argument is not persuasive. In Oberly v. Kirby , this Court made it clear that in conducting a review of allegations of self-dealing, the standards of trust law and corporation law are different. [22] In that decision, this Court refused to apply the stricter standards of trust law to the decision of the directors of a nonstock, charitable corporation to engage in a transaction where the directors had a personal interest. [23] Because the grantor chose the form of a charitable corporation over a charitable trust, this Court applied the less stringent restrictions of corporate law. [24] Which standard will apply, therefore, is governed by the legal format the grantor chose to accomplish his purposes. [25] Because A. Gray Magness chose a trust to carry out his testamentary intent, the stricter principles of trust law must apply to the challenged transaction. Unlike corporate law, [u]nder trust law, self-dealing on the part of a trustee is virtually prohibited. [26] Originally under Delaware law a trustee [was] prohibited absolutely from purchasing the property entrusted to his care. [27] Under current Delaware law: [a]n interested transaction is not void but is voidable, and a court will uphold such a transaction against a beneficiary challenge only if the trustee can show that the transaction was fair and that the beneficiaries consented to the transaction after receiving full disclosure of its terms. However, a court of equity has the power to approve a transaction on behalf of the trust's beneficiaries if they are not sui juris and if it finds the transaction to be in their best interest. [28] Although a sale by an interested trustee is no longer automatically void, even under the more relaxed rule, a court will carefully scrutinize all the attendant circumstances before it can find that the sale is not detrimental to the trust. [29] Courts have recognized that a sale by a trustee with a personal interest is not voidable, if there is a before-the-fact approval by the grantor, the court, or the beneficiaries. [30] None of these exceptions is present here, however, and the transaction would be voidable at the instance of the beneficiaries, if the land had not been sold to bona fide purchasers. Some authorities have held that good faith and the payment of full consideration is irrelevant as a trustee's defense. [31] Under those authorities, the evidence of a fair price is not even admissible on the issue of whether the transaction is voidable. [32] In any case, the burden of persuasion to justify the upholding of a transaction by an interested trustee rests on the fiduciary, not the beneficiary. [33] All the cases relied upon by the Court of Chancery in finding against Stegemeier and Mulrooney involved corporate fiduciaries. [34] In Sinclair Oil Corp. v. Levien , this Court held that, although a breach of fiduciary duty by the directors was claimed, the burden of proof will shift to a parent to prove intrinsic fairness in dealing with its subsidiary: only when the fiduciary duty is accompanied by self-dealing  the situation when a parent is on both sides of a transaction with its subsidiary. Self-dealing occurs when the parent, by virtue of its domination of the subsidiary, causes the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to, the minority stockholder of the subsidiary. [35] Defendants assert that because Donald Magness did not stand on both sides of the challenged transaction he did not engage in self-dealing and under the rule applied in Sinclair, he therefore did not breach his fiduciary duty to the beneficiaries. The principles of trust law, however, impose a higher standard. Under trust law, self-dealing occurs when the fiduciary has a personal interest in the subject transaction of such a substantial nature that it might have affected his judgment in material connection. [36] Under trust law, it is irrelevant that Donald and Anne did not have the exclusive power to sell the land. Even if a sale of trust property is conducted by someone else, a trustee can not purchase the trust property. [37] Defendants assert that because Donald Magness never had the power to sell, he had no obligation to refrain from purchasing trust property. The non-existence of a power of sale is not the test, however. The rule is well established that a person acting in a fiduciary capacity cannot also act for himself where he has duties to perform for another, [s]pecifically [that] one who is acting in such a position of trust cannot be a purchaser from the estate for which he is trustee, however fair the terms of sale or however honest the circumstances of an individual transaction may be. [38] The Restatement (Second) of Trusts also supports this principle, even where a trustee does not control the sale: A trustee with power to sell trust property is under a duty not to sell to himself either by private sale or at auction, whether the property has a market price or not, and whether or not the trustee makes a profit thereby. It is immaterial that the trustee acts in good faith in purchasing trust property for himself, and that he pays a fair consideration. The trustee cannot properly purchase trust property for himself even though he does not make the sale. [39] This principle was established not only to prevent fraud in the management of the sale, but to the broader object of relieving trustees from any possible conflict between duty and self interest. [40] There are considerations other than unfairness of the actual sale, such as the trustee may have obtained important information regarding the value of the property that he has kept to himself. [41] Although Donald may not have been both the buyer and the seller of the property, he, as the trustee of the residuary trust, had a fiduciary duty not to purchase trust property regardless of whether he executed the deed to the property. [42] Defendants assert that because Charles Almond was disinterested in the sale, his executing the deed cured any breach of fiduciary duty. This premise is without merit because it is again predicated on fiduciary principles of corporate law, not trust law. [43] Defendants also rely on Bernhardt v. Luke. [44] While Bernhardt holds that a trustee does not have the power to act without the other trustees it does not address self-dealing. [45] Bernhardt, therefore, does not support the argument that existence of a disinterested co-fiduciary excuses a breach of the fiduciary duty of loyalty. [46] Under trust law, [w]here there are several trustees, one of them cannot properly purchase trust property for himself, although his co-trustees are not personally interested in the purchase and consent to the sale. [47] Therefore, execution of the deed by Mr. Allmond did not cure the breach of fiduciary duty. [48] A trustee is under a duty to `participate in the administration of the trust and to use reasonable care to prevent a co-trustee from committing a breach of trust.' [49] Although Mr. Allmond was disinterested in the transaction, he knew of Anne and Donald's interest in the corporation that purchased the property and he should have refused to enter into the sale without prior notice to the beneficiaries or court approval. While the absolute prohibition of a trustee purchasing trust property has been modified, the purpose of the rule remains  to relieve the trustee of any claim of a conflict of interest, and to prevent fraud through imposing strict prohibitions of self-dealing on the basis that the fraud involved in such transaction is difficult to discern. [50] The few recognized exceptions do not detract from this purpose. We, therefore, decline to extend the less strict corporate fiduciary principles to the law of trusts. Defendants also assert that this sale was necessary to save trust assets because of the decline in the real estate market and the heavy financial debt of Magness Construction Company. While this reasoning may offer an explanation for the need to sell the land and may affect any remedy, it does not excuse a breach of fiduciary duty. The co-administrators should have resigned, requested court approval, or sought the beneficiaries' consent.