The Woodward Case: Guidance to Trustees on Their Duties Under the Massachusetts Prudent Investor Act

On July 23, 2014, the Massachusetts Supreme Judicial Court (“SJC”), sitting in the John Adams Courthouse, issued a decision in Woodward School For Girls, Inc. v. City of Quincy, Trustee (“Woodward”). The case, involving a trust established by John Adams in 1822 of which the City of Quincy (“Quincy”) is the trustee, is the first reported case in which the SJC has reviewed a trustee’s investment duties under the 1998 Massachusetts Prudent Investor Act (“MPIA”). It is also the first SJC case since Chase v. Pevear (1981), that discusses a trustee’s investment responsibilities. In Woodward, the SJC upheld the probate court’s finding that Quincy breached its fiduciary duties by investing the trust almost entirely in fixed income instruments.

Facts

In 1822, President John Adams established two trusts and conveyed a portion of his real estate holdings to the trusts, naming Quincy as trustee. In 1953, as a result of a cy pres petition, Woodward School became the sole beneficiary of the trusts and was entitled to receive all the net income.

In 1973, Quincy retained the services of a bank to provide investment advice. The bank advised Quincy to increase significantly the equity portion of the portfolio with a recommended asset allocation of 60% equities, 35% bonds and 5% cash. Despite the bank’s advice, Quincy maintained the portfolio of the trust almost exclusively invested in bonds.

After a lengthy trial, the probate court held that Quincy breached its fiduciary duties by failing:

• To keep adequate records;
• To obtain appraisals for real estate and sell it at fair market value;
• To act on professional investment advice it received; and
• To diversify the trust’s asset allocation.

The probate court surcharged Quincy $3,000,000 for breach of its fiduciary duties based on what the portfolio would have been worth if Quincy had implemented the bank’s investment advice. Quincy appealed.

SJC Opinion

The SJC upheld the probate court’s decision that Quincy breached its fiduciary duties. It reversed the probate court, however, with regard to its calculation of damages.

The SJC rejected Quincy’s argument that because the school could only receive income, Quincy’s duty was to maximize income and therefore it did not commit a breach of trust by failing to invest in growth securities. The SJC distinguished this case from cases in other jurisdictions involving private trusts in which courts have held that investing to maximize income was not a breach of the prudent investor rule.

The SJC reasoned that because the Adams Trust is a charitable trust and is designed to support an income beneficiary in perpetuity, the trustee must consider both the generation of income and the growth of the principal. Under the MPIA, the Court wrote, where an income beneficiary will exist in perpetuity, a trustee’s mandate to act with caution requires it to consider the effect of inflation. A prudent investor would have realized that a fund that has not changed in value in decades has not kept pace with inflation. The SJC held that Quincy’s failure to protect the principal against inflation in itself was sufficient to constitute a breach of trust. The Court found that Quincy’s failure to diversify the portfolio and to invest for the long term left the principal vulnerable to inflation.

The SJC did not agree with the probate court’s calculation of damages because the calculation was based on a determination that Quincy had a duty to implement the bank’s investment advice and that the failure to do so was a breach of fiduciary duty. The Court held that while Quincy could properly retain the services of an investment advisor, it was not required to implement the advice. The Court declined to require a trustee to abdicate its duty to make investment decisions. The Court sent the case back to the probate court to recalculate the damages based on how a prudent investor would have invested the trust assets. Presumably this recalculation will involve expert testimony unless the school and Quincy settle the matter.

The SJC rejected Quincy’s arguments that the school’s claims should have been barred on the basis of sovereign immunity and laches.

Sovereign Immunity

The Massachusetts Trust Claims Act is designed to limit liability for torts committed by public employers (referred to as “sovereign immunity”). The SJC rejected Quincy’s argument that it was protected by this statute, ruling that Quincy waived this protection when it accepted its appointment as trustee of President Adams’s trust. Significantly, the Court stated:

“A trustee, regardless of whether it is a municipality, a corporation, or a private individual, is accountable to courts for its conduct in fulfilling, or committing a breach of, the fiduciary duties it owes.”

Laches

Finally, Quincy argued that the school had “constructive” knowledge of Quincy’s breach of duty because there had been litigation in the 1990s over a different fund managed by Quincy for the benefit of Woodward, which was managed in the same fashion as the Adams Trust. Quincy argued this should have put the school on notice regarding the investment of the Adams Trust and that the school’s delay in in bringing an action with respect to this trust prejudiced Quincy; therefore, the equitable doctrine of laches should apply to bar the school’s claim. The SJC held that as Woodward did not have actual knowledge of Quincy’s breaches prior to requesting an accounting, laches did not apply. For laches to apply, Woodward would have had to possess actual knowledge of Quincy’s breach of duty.

Conclusion

This case is important for trustees and those advising trustees. It is also important for counsel who advise municipalities. The SJC makes it clear that a trustee, absent special circumstances, has a duty to invest with inflation in mind. While a trustee is not required to follow an investment advisor’s advice, a trustee cannot simply ignore that advice without sufficient reason for doing so. Once accepting the position of trustee, all of the duties and responsibilities that attach to the office of trustee will be applied to all trustees, whether or not they are public entities. This case is likely to be cited as precedent in other jurisdictions which have adopted the Uniform Prudent Investor Act, or a version of the Act, as the standard for a trustee’s investment duties.