A bank trustee has been found not liable for breach of fiduciary duty or breach of contract when a $1.9 million charitable remainder annuity trust (a “CRAT”) designed to provide a 7.5% annual payout to the annuitants for life was totally exhausted in 11 years.  An appellate court in Georgia has ruled that the bank neither violated its fiduciary duty within the applicable statute of limitations period nor breached its contract with the beneficiaries.  (Wells Fargo Bank v. Cook, Ct. of Appeals, GA, No. A15A0202, 7/8/15.) 

A married couple had obtained shares of a publicly traded technology company in gifts from the wife’s uncle.  The wife, age 47, was a certified financial planner with an MBA who had owned a financial services company.  The husband, age 50, owned his own video production company.  In 2000, after consulting their estate planning attorney, they decided that they would invest in a CRAT to assure their retirement goals and obtain the tax benefits.  Wells Fargo Bank suggested an annual payout of 7.5%.

The stock was contributed to the CRAT on February 25, 2000 at a total value of $1,904,250, thereby fixing the annual payout at $142,818.  The bank sold the stock to diversify the investments on February 28, 2000, but by then its value had dropped to only $1,678,984.  Thereafter, the trust made its annual $142,000 payout, but never had an investment return over 7.5% and lost value every year.  By September 2011, it was entirely depleted.

The annuitants sued the bank, claiming breach of fiduciary duty and breach of contract.  A trial court refused to grant summary judgment to either the bank or the annuitants, and the Court of Appeals accepted an interlocutory appeal from each.  It reversed the trial court and granted judgment to the bank to dismiss the claims.

The Court of Appeals first had to determine the applicable statute of limitations for the breach of fiduciary duty claim.  Under Georgia law, there are two different limitation periods on breach of fiduciary duty, one of six years and one of two years.  The limitation period is reduced from six years to two when the beneficiary has received a written report that adequately discloses the existence of a claim.  Although the annuitants argued that there was no breach of duty until the bank failed to make a payment in 2011, the Court held that the quarterly and annual reports of the investments of the trust were sufficient to show the decline in value and the possibility of a claim.  The Court held that the annuitants could contest fiduciary duty for only two years prior to filing suit.  It then found there was no evidence of breach of duty during that period.

The annuitants also argued that the bank had guaranteed the annual payout so long as they lived.  But the Court read the language of the CRAT to find otherwise.  The trust agreement provides that the annuity “shall be paid from income and, to the extent income is not sufficient, from principal.” 

“Because the Trust states that payments can be made from principal,” the Court said, “there is a recognition that payments can deplete the corpus of the Trust, but nothing in the Trust Agreement suggests that the trustee must continue making payments from its own funds if the Trust is depleted.”  The Court said that “the plain language of the Trust Agreement precludes the plaintiffs’ argument that Wells Fargo was contractually obligated to pay them an annual distribution for their lives even after the corpus of the Trust had been exhausted.”

YOU NEED TO KNOW

This case represents the-stock-market-always-goes-up thinking that was so prevalent before the tech bubble burst in 2000 and the Great Recession started in 2008.  Probably more people invested in charitable remainder unitrusts (CRUTs) during the market heyday, expecting continually growing income payments based on the percentage of the rising value of the fund each year.  While the payouts of a CRUT can drop precipitously, they will never drop to zero.  But asking for a high payout from a CRAT or a gift annuity shows the risks of asking too much from a high fixed income payout.  In a sustained period of low investment returns, the fund can actually be exhausted.