Coykendall, S. A., Jr.

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TRUSTEE'S INSURANCE PROTECTION AGAINSTSURCHARGE FOR INVESTMENT LOSSESS. A. COYKENDALL, JR.*It must be apparent to all that the conduct of a fiduciary business involves thenecessity of accepting the dictates of business and economic trends, not to mentionthe changing status of the law. It was at one time generally felt that waivers anddisclaimers of liability would relieve fiduciaries of all liability except for grossnegligence and bad faith. This, however, is no longer the rule of conduct. The trendis for both the statutes and the cases to ignore the existence of exculpatory clauses andto hold corporate fiduciaries strictly accountable for errors both of fact and of lawand to impose upon them as a class a stricter rule of responsibility than upon indi-viduals acting in the same capacities. The very fact that different standards of con-duct may be expected of fiduciaries in different circumstances and under varyingrules of law makes the nature and the extent of their liabilities at all times very un-certain. Indeed, these may be said to be impossible of ascertainment until their actshave been judicially reviewed in the light of circumstances existing at the time theacts were committed. Even though upheld in their conduct fiduciaries may notalways be able to charge their legal expenses to the estate but may have to absorbthem in their own expense accounts.Where modern business is confronted with serious contingent liabilities, such asthose with which the corporate fiduciary business is confronted in an ever increasiigdegree, the natural impulse is to look to insurance as a means of protection. Accord-ingly, it is pertinent at this time to raise the question whether corporate fiduciariesin their capacities as administrators, executors, trustees under wills or personal trustagreements, committees for incompetents, guardians and in their various agencycapacities, should seek to protect themselves by way of insurance against surchargeor other claims. 'This is one of the questions for individual banks and trust com-panies to decide for themselves, and if their decision is in the affirmative to directtheir efforts toward making such protection more generally available than at present.Before discussing the present status of such insurance for trustees and its avail-ability to corporate fiduciaries in particular, perhaps it would be well to endeavor tooutline some of the problems to be met by insurance.THE BASES OF SURCHARGE LIABILiTYCorporate fiduciaries throughout the country have had in recent years the un-pleasant experience of having to deal with surcharge claims and will as time goes on*B.S., 1gs1, New York University; special studies, New York University School of Commerce andFordham University Law School. Vice-President, S. A. Coykendall & Co., New York. Contributor tovarious business publications.TRUSTEE'S INSUANCE PROTECTION AGAINST SURCHARGE 471find themselves faced with more claims for alleged breach of trust in the performanceof their obligations as fiduciaries. They may also have to answer charges ofnegligence in the performance of mere agency functions as variously conducted.Claims made against fiduciaries in their various fiduciary capacities constitute whatare generally known as surcharge claims and indicate that the trustee has been orwill be charged in an accounting before a surrogate's court or in an orphan's courtfor failure to perform its duties with the skill, prudence and diligence required bythe statutes or the common law in the jurisdiction in which the fiduciary conductsits business. The claimant or claimants may charge breach of trust(I) in retaining non-legals, unproductive investments, or speculative property in anexecutor's or trustee's account; or in failing to sell securities in time to avoid taxpenalties;(2) in purchasing for a trustee's account, with or without the consent and approvalof beneficiaries, investments of a class not permitted by the will or trust deed orby the statutes and cases;(3) in failing to properly diversify investments;(4) in failing to correctly apportion or to make any apportionment at all of stockdividends or of arrears of dividends or interest unpaid at the time of sale;(5) in failing to correctly apportion the profit or loss resulting from the sale of fore-closed real estate, or overpaying life-tenants any income in excess of carryingcharges while the property is in foreclosure;(6) in making overpayments to beneficiaries in any manner;(7) in loaning money on mortgages in excess of the legal limits or on securitywhich turns out to be other than a first mortgage on improved property;(8) in overlooking the existence of statutes affecting the conduct of fiduciaries inparticular circumstances;-(9) in failing to seek instructions from the courts when, although veto power mayactually rest in the hands of a co-trustee or other person, it constitutes grossnegligence for the trustee not to act; or(xo) in exceeding the authority given to the fiduciary through improper interpretationof the will or trust deed.The foregoing are only some of the likely allegations to be brought by the claim-ants and do not by any means exhaust the list of possible allegations involving sur-charge claims. As a matter of fact, the claimants may even allege "fraud" under thetheory of tort liability for failure to fulfill the representations which the fiduciary inits advertising may have held out with respect to any particular skill or specialknowledge it may have claimed to possess.PRESENT STATUS OF INSURANCE AGAINST SURCHARGE LIABILITIESInsurance policies as such against surcharge liabilities have not heretofore beenmade available to corporate fiduciaries. Aside from the lack of any previous actuarialor statistical experience, which alone constitutes an almost insurmountable difficultyfrom the standpoint of any third party liability insurance business as now conductedLAw AND CONTEMPOMRY PROBLEMSin this country, there is at present no specific authority under which domestic insur-ance companies can if they are so disposed undertake this new form of insurance.It is a strange inconsistency but it is nevertheless a fact that, even though the willing-ness to undertake the business may somewhere exist, yet the specific authority islacking to permit insurance companies to underwrite the insurance of surchargeliabilities even with the safeguards of the most careful selection of business and theuse of "deductibles" as a discouragement to careless practices based upon the exist-ence of insurance. The defect in existing laws may sooner or later be cured by arevision of the insurance laws'in the various states whereby casualty and bondingcompanies may be permitted to underwrite third party liability insurance not onlyagainst injuries to persons and damage to property as at present but against civildamage claims of all kinds, including of course claims of the kind under discussion.Until such time, however, as specified powers are given, no domestic companies canundertake the insurance of surcharge liability claims without at least raising seriousquestions of ultra vires. Nevertheless the trend continues in the direction of holdingcorporate fiduciaries to a stricter rule of responsibility and liability than heretofore,and the means should be made available at least to experienced and well-managedcorporate fiduciaries by which they can, if they wish, protect their stockholders anddepositors against loss by the purchase of insurance analogous in form to the insur-ance now generally carried by accountants and for many years carried by Englishfirms of solicitors. Until insurance of this sort is made available generally, the onlyprotection obtainable is in the form of service and indemnity contracts which areavailable only to a very limited number of corporate fiduciaries.ScoPE OF PRoPosm INSURANCE CONTRACTSThe underwriting of surcharge liability insurance must of necessity be surroundedwith adequate safeguards not only to prevent the abuse of the fiduciary relationshipthrough undue reliance upon the existence of the insurance but also to avoid cuttingoff the insurance market altogether through the occurrence of the abnormally highlosses which would otherwise inevitably result.Insurance should in any case take the form of errors and omissions insurance-not the form of an ordinary third party liability insurance policy in which the in-surers agree to take over the defense and pay the judgment or settle the claim regard-less of any wanton or reckless conduct. on the part of the insured. In this casethe insurance must of necessity exclude reckless conduct or at least make it impos-sible for .any fiduciary carrying the insurance to proceed without thought of theconsequences merely because protected by insurance. Nevertheless, it must protectthe fiduciary who in good faith unwittingly incurs a claim involving a breach oftrust. The test of the fiduciary's ability to recover should be: Does the act cqmplainedof by, the claimants or self-discovered by the fiduciary constitute a breach of trustcommitted through the failure of the human equation, or through mistake of fact orlaw, or does it result from a conscious and deliberate act or omission to act known inadvance to constitute a breach of trust according to the will or trust deed and theTRUSTEE'S INSURANCE PRomCTI'oN AGAiNsT SURCHARGE 473statutes and the finally adjudicated cases pertaining thereto? There should be noquestion of the right to recover should the act or omission to act constitute anunconscious or inadvertent act as distinguished from a conscious or deliberate act asaforesaid.While there may be some border line cases in which it may be difficult to distin-guish between the two, there should not be much difficulty on this score providedgood faith is shown in the fiduciary's dealings with its insurers. The record of thetestimony before the referee in the surrogate's court having jurisdiction may clearlyshow that the act or acts complained of, even though constituting a breech of trust'toward the one class or the other making the exceptions, were committed in theexercise of the defendant's sound judgment either without knowledge of the limita-tions imposed by the will or trust deed and the statutes and cases pertaining thereto,or through an unintentionally wrong interpretation of these documents, or perhapsthrough the doubtful status of the law as laid down by the courts. Otherwise theproofs as in any other claim for recovery under an insurance contract must be basedupon the statements or affidavits of those directly concerned with the act or acts in-volved in the claim. If, upon the submission of satisfactory statements and afterreasonable investigation, it appears that the act or acts were "negligent acts, errorsor omissions" and not deliberate and conscious acts committed with full knowledgeof the limitations imposed, then the claim should be recoverable without furthernecessity for submitting proofs of loss.In no case, however, can the insurance operate in the ordinary manner of thirdparty liability insurance policies wherein the insurers take over the defense and havecomplete control over the litigating policy to be followed. Instead, that control,subject to reasonable restrictions upon the right to incur expenses or to make settle-ments without the authority of the insurers, should be left strictly in the hands ofthe fiduciary to employ its own counsel and to determine its own course of actionin the light of circumstances as it deems best for all concerned rather than as theinsurers deem best for themselves alone. This does not mean putting the insurersin the hands of their insureds with complete power to bind them to a course ofaction without the right to be heard, but means merely that the initiative should beleft to the fiduciary to employ its own attorneys to investigate, defend or negotiatefor the settlement of any claim provided they at all times cooperate to the fullestextent with the insurers' counsel and give consideration to any opinions expressed bythem. All reasonable disbursements and fees of the fiduciary's attorneys incurred inconnection with the claim should be considered a part of the loss with reference towhich such fees or disbursements are incurred, and the total should be added to theamounts allowed the claimants in the 4djudication or settlement, if any is made,subject of course to the deductible or first loss as expressed in the contract. In otherwords, the insurer's liability should be for the claim as a whole; and the claim as awhole should include whatever sum is actually paid in settlement and the rea-sonable costs and disbursements of the fiduciary incurred with the consent of theinsurers in connection therewith. This means in the case of a "self-discovery" the474 LAW AND CONTEMPORARY PROBLEMSamount actually paid in settlement of the particular act or acts self-discovered andmade good with the consent of the insurers, and, in the case of a breach of trustfor which the fiduciary is held accountable by some court, the amount which thefiduciary is directed to make good to the claimants as a class. This may mean thelife-tenants as a class or it may mean the remaindermen as a class, depending uponwhether the accounting is an intermediate accounting or a final accounting andwhether the claimants are life-tenants or remaindermen. While it is obviously neces-sary to place a reasonable limit of time upon the discovery of losses in the event ofcancellation or non-renewal of this type of insurance, there must be sufficient timeallowed to permit the fiduciary to account to the courts and so bring about a legalreview of its acts in the light of the circumstances existing at the time the action wastaken. Three years should be ample for this purpose because within that timeexecutors' accounts will have been reviewed in an executor's accounting and trustees'accounts will be subject to at least an intermediate accounting. If the insurance isrenewed from year to year, or from one term of years to another, the protectionshould be fully continuous from the date of taking out the first contract and therebypermit recovery on claims made by remaindermen as well as by life-tenants.WHO SHOULD BE INsuRED?Insurance of this sort is obviously for the protection of the fiduciary and/or itssuccessors in business. It should only be available, however, to corporate fiduciariesof experience and reputation. This means that the personnel in direct charge of thetrust accounts must themselves be equipped by education and training not only toinspire personal confidence and to perform their individual duties with sympatheticunderstanding of the problems of cestuis que trust, but also that they must be wellinformed with regard to the pitfalls ahead of them and their employers through fail-ure to use a proper record and check system on all of their fiduciary accounts andto maintain the degree of control of assets and of expenditures required in the per-formance of their trust. Most important of all they must know the limitations uponiheir authority with respect to the investment and reinvestment of the corpus andthe rules as laid down with regard to allocation of gain or loss between principaland income. They must have competent legal advice in the shape of their owncounsel standing either at their elbow or instantly available to support their owndecisions in advance of their action or to advise them with respect to difficult legalsituations. They must have the benefits of sound investment counsel either withintheir own organization or employed by them or by their trust estates individually.Above all else the institution itself must have length of service and sufficient resourcesto lend evidence of substantiality and to justify the confidence of the insurers in itsmanagement and personnel.WILL INSURANCE ENCOURAGE CARELESS PRAcrICES?One of the arguments against insurance of this kind is that it will encouragelaxity on the part of the fiduciary. This, however, is not sound logic. It would beextremely unwise for any fiduciary because of the existence of insurance to relax inTRusTE's INSURANCE PRoTEcoN AGjNST SURCMRGE 475any way its careful attention to the details of trust department operation. This isso not only because of the necessary existence of a deductible clause and the aggregatelimitations upon the liability assumed, but also because good faith requires the sameobservance of the rules of conduct with insurance as it does without insurance. Thistype of insurance can never cover a deliberate and conscious breach of trust, butmust be limited to the failure of the human equation to function in the mannerexpected or, more particularly, against the uncertainties of the law and the possibilitiesof adverse decisions affecting circumstances adjudicated in the light of previoushappenings which no reasonable man could possibly have anticipated.REAcTIONS FROM THE PUBLICInsurance of this kind should not be used in any advertising or publicity, norshould it be referred to in any way by bank officers in their discussions with pros-pective clients or- with beneficiaries of trusts. Its existence should not be known tothe rank and file of the fiduciary's personnel. It is obviously not admissible evidencein court and cannot be used by the plaintiffs or their attorneys. In short, it shouldmerely be used as banks customarily use their bankers' blanket bonds and forgeryinsurance, viz., as a means of recovery for losses actually sustained by way of claimsasserted or by way of self-discovered acts for which honesty alone compels thefiduciary to make good without waiting for the claim to be asserted. It should notreact adversely upon clients or upon cestuis should its existence become known be-cause in that case it should be referred to as a contract which prudently-managedbanks require for the protection of both their stockholders and depositors againstunreasonable demands and claims by dissatisfied or ill-advised cestuis. Its analogyto accountants' liability and physicians' and surgeons' liability insurance shouldinvariably be pointed out to inquirers.PUBLIC POLICYThere can be no serious question about the right to insure against civil damageclaims of any kind; least of all about the right to protect working capital againstthe unfortunate consequences of litigation, however lacking the grounds for com-plaint may be in the final analysis. It is impossible to prevent law suits in ourcountry growing out of alleged breaches of trust in the conduct of fiduciary relation-ships because there are so many conflicting elements involved in the form of life-tenants, remaindermen, and special guardians and because access can be had to thecourts with little or no expense and with absolutely no requirement with respect tothe posting of security for costs--either court costs or costs of the opposing side.Our own courts are not nearly so strict as the English courts in regard to the postingof security for defendant's costs or so liberal with allowance of costs if successful, andaccordingly insurance is needed as much to pay the costs of defense as to pay theamount allowed the claimants by way of damages for their loss. Dishonest andcriminal acts should, of course, not be insured but with these exclusions there are nopossible grounds for saying that insurance of this kind runs counter to public policy.

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Trustee’s Insurance Protection Against Surcharge for Investment Losses

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Trustee’s Insurance Protection Against Surcharge for Investment Losses

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