March 20, 2013

Removal of a Trustee - Breach of Fiduciary Duty

100% financing for realty can cause problems/image: Bob Ionescu
When a trustee fails to execute their fiduciary duties, a trustee may request the trustee's removal via petition. The California law which provides for this is Prob C § 17200(b)(10). The following involves a case that has been litigated for years in the California court.  This is almost expected given the amount of money involved. A reality of law is that cases which involve small sums of money, arguably less than $5,000, do not get litigated given the time and expense of litigation. This case however involves a pretty penny.

The founder of Herbalife, Mark Hughes, passed away in 2000 as the result of an accidental overdose of alcohol combined with antidepressants. During his career, Mr. Hughes amassed a huge fortune thanks to the success of Herbalife. Prior to his passing, Mr. Hughes drafted a trust which provided for a rather large inheritance to be distributed to his only son, Alexander, once he turned 35. The trust estate's current value is pegged at $350M. Yeah not too shabby of an inheritance.

This past Monday, a Los Angeles Superior Court Judge ordered the removal of the trust's 3 trustees, John Reynolds, Christopher Pair and Conrad Klein, an attorney. The 3 trustees all had a close connection to Mr. Hughes either through familial, business or professional relationships. Judge Mitchell Beckloff ruled that the 3 had breached their fiduciary duty owed to Alexander because they had failed to manage the trust estate with "prudence, skill and diligence." In particular, the ruling was based on the sale of real property the trust formerly owned in the Santa Monica mountains. The trust sold the realty to a business entity for $23.7M, yet did not require that the buyer tender any down payment. In other words, the trust sold the realty to the business entity with financing constituting 100% of the transaction. Following the purchase, the business entity sought bankruptcy protection.   

For reference, many of the real estate purchases that occurred during the great sale recession involved 100% financing. That is, the buyer did not have to tender a down payment. This is a very risky endeavor because the buyer lacks much equity in the home. Therefore, the buyer would be more willing to walk away from the home, i.e. strategic default, if issues go awry, e.g. loss of income, severe illness, since the buyer lacks money in the property so to speak. Lenders prefer to use a conventional 20/80 financing model, 20% down and 80% financed, because then the buyer has "skin in the game" (their own money). 

Personally, I can definitely understand the judge's ruling given the buyer's financing arrangement. In light of the great recession, it would have been prudent for the trustees to at least require some down payment given recent history.

Obviously, the decision may be appealed and given that the trustees' have ample resources, this is a distinct possibility.