Understanding the Role of a Trustee(s) in a Family Trust That Owns a Family Corporation

HNWShareholder Rights Litigation, Understanding When a Trust Should Be Used in NJ

shareholder rights

  • I read an interesting trust litigation case which was decided in the Federal District Court of New Jersey. The case involves the New Jersey Trust Code and the NJ Corporation Act.  Of course, the participants were family members (siblings) fighting over a deceased parent’s trust and several family corporations founded by their parent during his life.

Factual Background and Procedural History

  1. The History of the Family Trust and Family Corporations Founded by the Trust Creator

The controversy involved four (4) siblings and several of the trustee(s) of a Family Trust.  The trust was formed by their father who was its initial trustee.  The four siblings are the beneficiaries of the trust and have equal interests in the Trust’s assets.  The Trust Agreement is governed by New Jersey law.  The trust sets forth the rights of the trustees including the ability to vote and sell shares of stock in several family corporations owned by the Trust.  Pursuant to the Trust, the four siblings became co-trustees of the Trust upon their father’s death.  The Trust’s primary asset is the majority of the voting shares of the family company founded by the grandfather.

  1. The Board of Directors of the Corporations Owned by the Trust

In this litigation, plaintiff (a beneficiary and one (1) Director of the Family Corporation) challenged three distinct corporate actions; they are 1) The issuance, and subsequent forgiveness, of two $500,000 loans; 2) Payment of the commissions to several brothers in connection with the sale of one family company to a third-party; and 3) the sale of a subsidiary company to another company owned by a trust beneficiary and member of the Board of Directors.
Plaintiff asserted that “[t]here was no Trust meeting held, no vote of the co-trustees, no prior notice to the beneficiaries, and no effort to obtain approval from co-trustees in advance of the board’s decision to approve both the loans and their forgiveness.”  However, it was clear plaintiff was provided with the Notices of the Annual Meeting in advance of each meeting.  After receiving an offer, plaintiff was asked to consent to the sale, but he refused.
Despite plaintiff’s objection, the sale of the company to an unrelated company for $130 million was an increase over the initial offer of 127.5 million, and was approved by Unanimous Written Consent of the Shareholders.
Each shareholder received a distribution of the sale proceeds.

  1. The Sale of a Second Company Owned by the Trust to a Trust Beneficiary

At another board meeting, a trust beneficiary and brother expressed an interest in purchasing a second family corporation owned by the Family Trust (remember, he is a Director and Trustee and Shareholder and Trust beneficiary).  Ultimately, it was sold for $17.6 million to the family members.  The sale was approved by a Unanimous Written Consent of the Board of Directors, with the exception of the dissident brother who recused himself from the vote.  A sales commission was waived by the purchasing brother because the Board indicated that a commission for him would be inappropriate, given the nature of the sale.  The rest of the board members similarly agreed to waive their commissions as well. Plaintiff claims that the company was sold for over $30,000,000 (million) below its market value.

Following the sale, plaintiff filed a lawsuit against his family members, co-trustees and shareholders asserting claims for breach of fiduciary duty, and unjust enrichment, and self-dealing willful misconduct as trustees of the Family Trust; Conflict of interest and duty – loyalty and self-dealing.

Analysis of the Case by the Court

  1. Breaches of Fiduciary Duty as Directors

Plaintiff argued that defendants breached their duties both as trustees of the Family Trust, and as Directors as a result of their actions in connection with 1) the forgiveness of the loans; and 2) the sale of the family company.

Under New Jersey law, directors of a corporation are expected to “discharge their duties in good faith and with a degree of diligence, care and skill which ordinarily prudent people would exercise under similar circumstances in like positions.” N.J.S.A. § 14A:6-14.

However, New Jersey courts have long recognized that

[a] decision made by a board of directors pertaining to the manner in which corporate affairs are to be conducted should not be tampered with by the judiciary so long as the decision is one within the power delegated to the directors and there is no showing of bad faith.

This doctrine, known as the “business judgment rule,” has been “fashioned as a means of protecting a board of directors from being questioned or second-guessed about the conduct of corporate affairs except in instances of fraud, self-dealing, or unconscionable conduct.”  The initial burden to show unconscionable conduct is “on the person who challenges a corporate decision to demonstrate the decision-maker’s ‘self-dealing or other disabling factor(s).’ If a challenger sustains that initial burden, then the ‘presumption of the rule is … rebutted, and the burden of proof shifts to the … defendants to show that the transaction was, in fact, fair to the company.'”  “In defining whether the business judgment rule applies to protect the actions of [the] board of directors . . . [one] ‘generally asks (1) whether the actions were authorized by statute or by charter, and if so, (2) whether the action is fraudulent, self-dealing or unconscionable.'”

As to the issue of the family loans, New Jersey law permits a corporation to “lend money to…any director or officer…whenever in the judgment of the directors, such loan…may reasonably be expected to benefit the corporation.” (N.J.S.A. 14A:6-11).

New Jersey corporate law gives directors the authority, by vote of a majority of the board, to establish reasonable compensation for themselves. See N.J.S.A. 14A:6-8(3). Under the statute, a transaction is not a conflict of interest, if “[t]he board, by the affirmative vote of a majority of directors in office and irrespective of any personal interest of any of them, shall have authority to establish reasonable compensation of directors for services to the corporation as directors, officers, or otherwise.” Id. The NJBCA also permits a corporation to lend money to, or guarantee any obligation of, or otherwise assist, any director, officer or employee of the corporation or of any subsidiary, whenever, in the judgment of the directors, such loan, guarantee or assistance may reasonably be expected to benefit the corporation. The loan, guarantee or other assistance may be made with or without interest, and may be unsecured, or secured in such manner as the board shall approve, including, without limitation, a pledge of shares of the corporation, and may be made upon such other terms and conditions as the board may determine.

N.J.S.A. § 14A:6-11

Although plaintiff claimed that these transactions constituted a conflict of interest, the NJBCA clearly provides that a director approving his or her own compensation, is not a conflict of interest, and thus, does not constitute a breach of the duty of loyalty. N.J.S.A. 14A:6-8(3). Moreover, the record plainly demonstrated that the two disinterested directors both voted in favor of the commission payments to the several brothers as well as the issuance and forgiveness of the $500,000 loan to each brother, as part of their compensation as directors.  The plaintiff in this case may very well have voted differently if he had participated on the vote of the Board of Directors, but under the business judgment rule, “bad judgment, without bad faith, does not ordinarily make officers individually liable.” Plaintiff did not present any evidence that these decisions were made in bad faith.

The court also concluded plaintiff failed to establish that the Board of Directors as a group breached their duty of care by authorizing the loans and the commissions. “[D]irectors must discharge their duties in good faith and act as ordinarily prudent persons would under similar circumstances in like positions.” As part of exercising a board of director’s duty of care, “the directors are required to obtain all material information reasonably available to them when making the decision, and act with the requisite care in the discharge of their duties.”  In assessing whether a director has breached his or her duty of care, “the court’s inquiry is not into the substantive decision of the [director], but rather is into the procedures employed by the board in making its determination.  In that regard, there is no statutorily prescribed procedure that a [director] must follow.”

Here the plaintiff was found not to have established any facts that the Board of Directors was anything less than fully informed when it approved the forgiveness of the loans, as well as the commissions.  At the time the loans were initially issued, the company was indisputably on solid financial footing.

Further, the company’s controller was also involved in determining the appropriate accounting mechanisms for the loans and arranging for defendants to pay the requisite payroll taxes.

The Board performed its due diligence and considered the impact of the forgiveness of loans and the commissions on the company’s finances.  Therefore, the Board’s decision to forgive the loans was entitled to the protections of the business judgment rule.

Accordingly, the court found that defendants were entitled to judgment dismissing the breach of fiduciary duty claims.

  1. b) The Sale of the Family Corporation by the Trustees to a Related Family Buyer Trust Beneficiary

Plaintiff’s case regarding the company and Board of Directors was also dismissed.  The court admitted on its face the sale to an entity formed by family members, might seem to constitute a self-dealing transaction which would fall outside the scope of the business judgment rule.  A “director has a conflicting interest in the transaction” if he or she “either appears on both sides of a transaction or expects to derive (any) personal financial benefit from self-dealing which should otherwise be enjoyed by the corporation and all stockholders generally.”  However, the NJCBA expressly provides procedures for determining whether transactions between a corporation and one or more of its directors, directly or indirectly, constitute a conflict of interest. See N.J.S.A. 14A:6-8 (“Director Conflicts of Interest”). Under the statute, transactions which would typically be void or voidable due to a conflict of interest, are permissible if any one of the three following conditions is met:

(a)    The contract or other transaction is fair and reasonable as to the corporation at the time it is authorized, approved or ratified; or

(b)    The fact of the common directorship or interest is disclosed or known to the board or committee and the board or committee authorizes, approves, or ratifies the contract or transaction by unanimous written consent, provided at least one director so consenting is disinterested, or by affirmative vote of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; or

(c)    The fact of the common directorship or interest is disclosed or known to the shareholders, and they authorize, approve or ratify the contract or transaction.  N.J.S.A. 14A:6-8(a)-(e).

Of interest is that the vote of the common or interested directors may be counted in determining the presence of a quorum at a board or committee meeting at which a contract or transaction described in subsection 14A:6-8(1) is authorized, approved or ratified.

In this case, one family member/trustee recused himself from the Board of Director’s vote, and there is no dispute that that the other three members of the Board of Directors were aware that he was the purchaser of the family company.  They unanimously approved the transaction.

Plaintiff did not establish that defendants breached their duty of care with respect to the transaction even though plaintiff argued the company was sold for significantly less money than it was worth.  The focus of the duty of care is “not into the substantive decision of the [director], but rather is into the procedures employed by the board in making its determination.  With respect to a sale of substantially all of a company’s corporate assets, such as here, “the directors must focus on one primary objective—to secure the transaction offering the best value reasonably available for the stockholders — and they must exercise their fiduciary duties to further that end.”

Here, there was no indication that the Board did less than its due diligence.

“It matters not that plaintiff’s expert came to a different conclusion for purposes of this litigation. Indeed, the court’s focus in applying the business judgment rule is on the procedure utilized rather than the result.” Here, it is clear that the Board garnered all of the relevant information prior to approving the sale. Moreover, the sale price was within the scope of the various valuations.

The Claims Against the Trustee(s) of the Family Trust

Plaintiff argued that defendant trustees breached their duties as trustees because they did not act “solely in the best interests of the beneficiaries.” In Plaintiff’s view, “[t]he three transactions – the loans, the commissions, and the inside sale of the company to family members were all either entered into by the trustee for the trustee’s own personal account or [were] otherwise affected by a conflict between the trustee’s fiduciary and personal interests.”  With respect to the loans, and the commissions, plaintiff noted that there was no trustee vote to approve or disprove either transaction.  Moreover, with respect to the sale of the company, plaintiff argued that although family members voted as a majority to approve the sale, it nonetheless constituted a breach of fiduciary duty because it was a self-dealing transaction.  Accordingly, plaintiff argued that the trustees violated their duty not to engage in a transaction in which he or they had a personal interest, and that they violated a duty to prevent a breach of trust, and “also a violation of their duty . . . to act solely in the best interests of the beneficiaries and ‘to protect the beneficiaries’ interests by voting to approve the self-interested transaction.”  “As trustees of the Family Trust, each trustee owed fiduciary duties to this plaintiff, as a beneficiary of the trust, including a duty of impartiality”.

The Court’s Discussion of the Duties of Trustees

Trustees owe the trust and its beneficiaries a duty of loyalty and a duty to exercise reasonable skill and care.  (Restatement Second of Trusts §§ 170, 174).  A trustee’s duty is “to administer the trust solely in interest of the beneficiaries”.  Where a trustee fails to act in the best interest of the beneficiaries, he or she is liable for harm resulting from a breach of his or her duties.

The court granted judgment against plaintiff’s breach of fiduciary duty claim for two reasons. First, there was no dispute that the co-trustees of the trust, were permitted to vote the Trust’s shares in order to approve the Board’s decision to sell the family company, and second, plaintiff did not demonstrate that there was a genuine issue of material fact regarding whether the transaction was a self-dealing one.

As co-trustees of the Family Trust, all four of the siblings had the authority to exercise the Trust’s voting shares in favor or against the sale. In the absence of a contrary provision in the trust agreement, trustees are vested with a wide range of powers, including the power to vote corporate stock owned by the trust. See N.J.S.A. § 3B:14-23(n)(p) (providing that every fiduciary shall have the power “[t]o vote in person or by proxy, discretionary or otherwise, shares of stock or other securities held by the estate or trust” and “and to consent to corporate sales”).  Here, the Family Trust Agreement expressly granted the trustees the power to “vote in person or by proxy, or consent for any purpose, in respect to any stocks or securities constituting assets of the trust,” and to “participate in any plan . . . and any action thereunder or to any . . . sale or other action.”

Moreover, the Trust Agreement did not require the co-trustees to act unanimously. In the absence of a provision requiring unanimity, the NJ Uniform Trust Code provides, “[c]o-trustees who are unable to reach a unanimous decision may act by majority decision.” N.J.S A § 3B:31-48(a). Here, that is precisely what occurred. The trustees, with the exception of Plaintiff, acted by majority decision and chose to vote the Trust’s shares in favor of the sale of Metals.

Like directors of a corporation, trustees of a trust are subject to a duty of loyalty.  The most fundamental duty owed by a trustee to the beneficiary of a trust is the duty of loyalty. This duty is imposed on the trustee independent of any trust provision because of the fiduciary relationship which arises from the creation of the trust.  Further, in voting corporate stock held by a trust, the trustees’ fiduciary duties impose a duty to vote the stock in such a way as to promote the interests of the trust’s beneficiaries.  “In voting shares

of stock fiduciaries are under a duty to vote in such a way as to promote the interests of the beneficiaries”); N.J.S A. 3B:31-55(f).

Plaintiff’s position was (essentially) that defendants were precluded from voting, as trustees, to approve any corporate actions because they were also directors and officers of the selling corporation and the underlying corporate transaction would benefit several adversarial family members.  However, no New Jersey law or statute precludes defendants from holding their positions as directors or officers of their company, simply because they were also trustees of the Family Trust. Such a position is untenable, and inconsistent with both New Jersey trust law and the intent underlying the Trust Agreement.

If you are looking for additional details on this topic or if you require advice about your situation, please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at fniemann@hnlawfirm.com.  Please ask us about our video conferencing or telephone consultations if you are unable to come to our office.

By Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold Township, Monmouth County, NJ Shareholder Litigation Attorney

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