Application of the Sales Projection Method Reviewed by Momizat on . In Measuring Trustee Breach of Fiduciary Duty Damages (Part I of II) The prudent investment of trust assets can minimize the potential for trustee fiduciary lit In Measuring Trustee Breach of Fiduciary Duty Damages (Part I of II) The prudent investment of trust assets can minimize the potential for trustee fiduciary lit Rating: 0
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Application of the Sales Projection Method

In Measuring Trustee Breach of Fiduciary Duty Damages (Part I of II)

The prudent investment of trust assets can minimize the potential for trustee fiduciary litigation risk, in addition to maximizing the trust beneficiaries’ economic interest in the trust. However, trust beneficiaries may initiate a breach of fiduciary duty tort claim when they feel that the trustee has breached any investment management fiduciary duties to the trust. For trust beneficiaries, and their legal counsel, who have brought breach of fiduciary duty tort claims against a trustee, one of the issues is how to measure the “damage” to the beneficiaries because of the breach. This discussion addresses the role of the investment management trustee as a fiduciary to the trust beneficiaries. This discussion then presents an analysis that legal counsel, in collaboration with a damages analyst, can use in attempting to quantify the “damage” to the trust beneficiary because of the investment management trustee breach of fiduciary duty.

Introduction

When investing trust assets, a trustee has a fiduciary relationship to the beneficiaries of that trust.  As presented in Paul v. North:

A fiduciary relation exists between two persons when one of them is under a duty to act or to give advice for the benefit of another upon matters within the scope of the relation.1

Most business relationships/partnerships are not fiduciary relationships/partnerships.  While most business relationships/partnerships have a degree of trust and confidence, a fiduciary relationship exists when:

  1. one party is accustomed to being guided by the judgment and advice of another party or
  2. one party otherwise believes that another party is acting in his or her best interest.

Potential fiduciary liabilities (i.e., breach of fiduciary duty tort claims) are possible when an investment management trustee does not adequately perform the required fiduciary duties.

These fiduciary liabilities generally arise from a breach of the “standard of care,” as defined by the “prudent investor rule” (PIR).  This means that the trustee standard of care and investment management fiduciary duties require a prudent investment of the trust assets.  This duty typically includes both (1) competent initial investment and (2) continued monitoring of the performance of the trust assets.

It is common in breach of trustee fiduciary duty tort matters for the court to award economic damages in an amount necessary to make the beneficiary whole.  However, quantifying the damages caused by the trustee breach of fiduciary duty can prove problematic.  While there are several generally accepted methods available to measure economic damages, the sales projection method is one method to measure economic damages in a trustee breach of fiduciary duty tort matter.

While the sales projection method is commonly used to quantify lost profits economic damages for business operations, it can also be tailored to effectively analyze and quantify investment management economic damages as a result of a trustee breach of fiduciary duty.

This discussion:

  1. provides a summary of investment management trustee fiduciary duties to beneficiaries, as well as some examples of a breach of those fiduciary duty;
  2. discusses and addresses how the damages analyst can assist legal counsel in estimating the tort “damages” attributable to a breach of fiduciary duty by the trustee; and
  3. includes an illustrative example of the sales projection method, which we simply call the “projection” method.

Trustee Fiduciary Duties

Common-law trusts separate legal and beneficial ownership, with the trustees holding legal title to trust property, which they in turn manage on behalf of the beneficiaries.  The person who establishes a trust is referred to as the “trust settlor,” “grantor,” or “trustor.”

Trustee fiduciary duties originate from the responsibility of having fiduciary powers—that is, the investment management fiduciary power to select the investments of a particular trust on behalf of the trust settlor, grantor, or trustor.2

As presented in the American Bar Association article, Trustee Bank’s Breach of Investment Management Fiduciary Duties:

The investment management fiduciary power, in conjunction with the duty of undivided loyalty, creates the standard of care and scope of the investment management fiduciary duties.3

Because of these fiduciary powers, trustees are held to a high standard of care.  As presented in the judicial decision Meinhard v. Salmon:

[A fiduciary] is held to something stricter than the morals of the marketplace.  Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.  As to this there has developed a tradition that is unbending and inveterate.4

In selecting the investments of a particular trust and considering the requirement of the trustee to continually monitor the performance of the selected trust investment assets, trustees should choose the extent to which the trust returns (and ultimately the beneficiaries’ trust distributions) are subject to market risks and volatility.  This is because trustees are required to provide a standard of care and act prudently in selecting and monitoring trust investments for the beneficiaries.

The PIR provides guidance to trustees with regard to fiduciary duties that are required by a trustee in managing trust investment assets.  As presented in the Restatement (Third) of Trusts (1992) and the Uniform Prudent Investor Act (1994), the PIR requires a trustee to utilize an overall investment strategy.  Such a strategy should have risk and return objectives that are “reasonably suited” to the trust.

Further, the PIR requires that a fiduciary (i.e., trustee) invest trust assets as if they were his or her own assets.  The fiduciary (i.e., trustee) should consider the needs of the trust’s beneficiaries, the provision of regular trust income or distributions to the beneficiaries, and the preservation of trust assets.

The PIR also requires the trustee to:

  1. diversify the investments of the trust,
  2. avoid investments that are excessively risky, and
  3. monitor investments and make portfolio adjustments on an ongoing basis.5

Fiduciary liabilities, that is, breach of fiduciary duty tort claims, are typically initiated as a result of the trustee not adequately performing his or her fiduciary duties.  However, it is important to note that fiduciary liabilities, or breach of fiduciary duty tort claims, are not always dependent on the relative change in value of the trust assets.  Rather, breach of fiduciary duty tort claims may be brought against a trustee as a result of a failure to prudently represent the beneficiaries of a particular trust.

For example, let’s assume there is a two million dollar trust that had been set up for two 20-year-old beneficiaries.  The 20-year-old beneficiaries are:

  1. unable to work,
  2. expected to live approximately 50 years, and
  3. anticipating the receipt of annual distributions from the trust of $100,000 (in aggregate) over the next 50 years based on the initial goal of the trust.

Further, let’s assume that it is also the goal of the trust to ensure that the two million dollar initial principal balance is available for the beneficiaries at the end of the 50-year term.

Next, let’s assume that the initial trust assets were comprised of dividend-paying common stocks.  However, shortly after engaging the trustee to manage the trust, the trustee sold all the dividend-paying common stocks and invested the entire proceeds in non-dividend-paying, growth-oriented common stocks.

If over the next three years there is insufficient income from the trust investment assets to meet the $100,000 annual distribution to the 20-year-old beneficiaries, then it may be inferred that the trustee has not prudently represented the beneficiaries of the trust.

Should legal counsel determine that the trustee has breached his or her fiduciary duty to the beneficiaries, the next step is to utilize a damages analyst to quantify any potential damages associated with the breach.  It is important to note that the damages analyst should be consulted early in the process.

This is because it may be advantageous to legal counsel for the damages analyst to:

  1. assist with assessing the merits of the case (including providing some initial analysis to determine the scale of the potential economic damages associated with a breach of fiduciary duty),
  2. assist with weighing the merits and risks of going to trial, and
  3. assist with reviewing and critiquing other damages analyst’s work that may be transmitted during the engagement.

This article was previously published in Willamette Insights Spring 2018.

Notes:

  1. Paul v. North, 191 Kan. 163, 380 P.2d 421, 426 (1963).
  2. The trustee fiduciary duties are based on the rights conferred by (1) the purpose of the subject trust, (2) the subject trust terms, and (3) relevant state laws.
  3. A. Ishmael, “Trustee Bank’s Breach of Investment Management Fiduciary Duties,” Commercial and Business Litigation Articles, americanbar.org.
  4. Meinhard v. Salmon, 164 N.E. 545, 546 (N.Y. 1928).
  5. Ultimately, investment management trustees are expected to continually analyze investments that differ in their risk and return characteristics, with the optimal risk selection reflecting the financial resources, life situations, and risk tolerance of the beneficiaries who will ultimately receive the trust income and distributions.

Justin Nielsen is a vice president in our Portland, Oregon, practice office. Mr. Nielsen holds an MBA, with a concentration in finance, and is a certified valuation analyst (through the National Association of Certified Valuators and Analysts). He specializes in providing valuation and consulting services related to divorce and shareholder dissent/oppression matters, gift and estate tax, employee stock ownership plans (ESOP’s), lost profits and economic damages, and intangible assets.
Mr. Nielsen can be contacted at (503) 243-7515 or by e-mail to jmnielsen@willamette.com.

The National Association of Certified Valuators and Analysts (NACVA) supports the users of business and intangible asset valuation services and financial forensic services, including damages determinations of all kinds and fraud detection and prevention, by training and certifying financial professionals in these disciplines.

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