What is the Proper Duty of a Trustee? — The Battle Brews
Earlier this year, John H. Langbein, the Sterling Professor of Law and Legal History at Yale Law School, authored an article entitled Questioning the Trust Law Duty of Loyalty: Sole Interest or Best Interest?, 114 Yale L.J. 929 (2005). Here is the abstract of this article as published on SSRN:
The duty of loyalty requires a trustee to administer the trust solely in the interest of the beneficiaries. Any transaction in which the trustee has an actual or potential interest violates the sole interest rule, no matter how beneficial the transaction to the beneficiaries. This Article develops the view that a transaction should not give rise to liability merely because the trustee also benefits. Sometimes beneficiaries are better off when a transaction also benefits the trustee. Corporation law has wholly abandoned the sole interest rule, preferring a rule that permits a conflicted transaction that satisfies disclosure and fairness standards.
Important changes have been undermining the trust law sole interest rule. The grievous procedural inadequacies of the equity courts that gave rise to the rule have now been overcome. The rise of professional trusteeship has required that the sole interest rule be abridged to permit trustee compensation. As trusteeship has increasingly become a branch of the financial services industry, major exceptions to the sole interest rule have been recognized to facilitate trustee-provided financial services. The rationale for these exceptions is that they benefit trust beneficiaries by promoting integration of functions and economies of scale.
This Article contends that the exceptions are wiser than the rule they modify. The duty of loyalty should be reformulated to prefer the best interest rather than the sole interest of the beneficiary. A conflicted transaction should continue to be presumed to violate the duty of loyalty, but rebuttably, not conclusively. The trustee should be allowed the defense that the transaction was in the best interest of the beneficiaries.
Prof. Langbein’s article triggered a strong response from Prof. Melanie B. Leslie (Cardozo Law School) who has recently released her article entitled In Defense of the No Further Inquiry Rule: A Response to Professor Langbein. Here is the abstract of her article as provided on SSRN:
In an article just published in the Yale Law Journal, Professor John Langbein argues for abolition of the “no-further-inquiry” rule. This rule has, for close to two hundred years, prohibited a trustee from engaging personally in transactions with the trust, unless the trustee obtains advance approval from a court or beneficiaries. Langbein contends that the rule deters trustee behavior that benefits trust beneficiaries, and urges substitution of a “best interest” defense that mirrors rules currently applied to corporate fiduciaries.
Langbein’s analysis, however, fails to recognize that trustees of private express trusts face fewer incentives to act in the financial interest of trust beneficiaries than do other parties who face conflicts of interest. Trust beneficiaries are typically poor monitors of trustee behavior; beneficiaries have few opportunities to exit from the trust relationship; and market forces play a much more limited role in disciplining trustee behavior than they do in the case of the corporate fiduciary.
The no-further-inquiry rule, with its bright-line prohibition and its advance approval requirement, compensates for the unique vulnerability of trust beneficiaries. The rule responds to the significant prospect of underdeterrence. This problem is inadequately addressed by a “best interest” defense, and is far more significant than the overdeterrence problem on which Langbein focuses.
Judicial and legislative recognition of limited exceptions to the no-further-inquiry rule provides no evidence that the rule has outlived its usefulness. Instead, some of the exceptions are entirely consistent with the rule’s rationale, while more recent exceptions reflect the lobbying power of the banking industry, not the inefficiency of the long-established rule.