For parties involved in trustee negligence cases or cases involving trust losses, there is a Tennessee statute, the Tennessee Uniform Prudent Investor Act (which was adopted in Tennessee in 2002), which may well take center stage in the lawsuit. The purpose of the Uniform Prudent Investor Act was to codify, alter, and update the common law “prudent man” or “prudent investor” rule, which rule is at the heart of a significant amount of trust litigation.
The Act applies to trustees, guardians and other fiduciaries (all of whom are referred to in the Act, and in this article, as “trustees”). The Act does not apply to every fiduciary relationship, but only to those where the trustee, fiduciary or guardian relationship was created by a will, deed, agency agreement, or trust agreement. For trusts created after July 1, 2002, the Act applies with no restrictions. For trusts already existing as of July 1, 2002, the Act applies only to “decisions or actions” occurring after that date.
It is helpful to understand the fundamental objectives which the drafters of the Act intended to achieve. Those objectives are: (1) To ensure that the prudent investor standard is applied in the context of the entire portfolio instead of to individual investments within a portfolio; (2) to promote the ability of a trustee to focus on the tradeoff between risk and return as a primary consideration; (3) to eliminate the rules categorically prohibiting trustees from making certain types of investments; (4) to integrate into the definition of prudent investing the requirement of diversifying; and (5) to allow the trustee to delegate investment and management functions.
In trust litigation involving the prudent investor rule, now codified in the Act, one of the first questions that should be asked is whether the Act applies. If the requirements already discussed above are met, the Act may still not apply. The prudent investor rule set forth in the Act is a default rule. Thus, if the terms of the trust alter, expand, restrict, or eliminate the prudent investor rule as set forth in the Act, then, in that event, a trustee cannot be held liable under the provisions of the Act if he or she followed the provisions of the trust.
The Act sets forth the standard used to determine whether a trustee should be held responsible for trusts losses, while, at the same time, it shields from liability trustees who have made investments or followed strategies authorized under the Act. Under the Act, “a trustee shall invest and manage trust assets as a prudent investor would, by considering the purposes, terms, distribution requirements and other circumstances of the trust.” The Act requires a trustee to “exercise reasonable care, skill, and caution.”
The Act sets forth a number of factors for a judge or jury to consider in evaluating whether the trustee’s conduct fell below that of a “prudent investor”:
• The “general economic conditions”
• What effects inflation and deflation might have
• Tax consequences
• How each investment or strategy suits the overall portfolio of the trust
• The amount of total return to expect from income and also from appreciation
• The resources of the beneficiary other than the trust
• The necessity of liquidity, regular income, preservation of capital, and appreciation of capital
The Act requires a trustee to diversify the investments of the trust unless there are special circumstances. For trusts with two or more beneficiaries, a trustee is required to act impartially in investing and managing trust funds, which requires that the trustee consider the different interests of the beneficiaries.
A trustee is allowed to delegate investment and management decisions, but is required to exercise reasonable care, skill and caution in: (1) Selecting the agent; (2) establishing the scope and terms of the responsibilities delegated to the agent; and (3) monitoring the agent. A trustee cannot be held liable for the negligence of an agent selected by the trustee so long as that trustee has used reasonable care in (1)-(3) above.
The Tennessee Uniform Prudent Investor Act is expressly incorporated into the Tennessee Uniform Trust Code (enacted in 2004). Keep in mind that the Uniform Prudent Investor Act applies not only to trust instruments, but also to wills.