The Arkansas Court of Appeals recently ruled in an interesting case that a trustee's encumbrance of trust property did not, under the specific circumstances involved in the dispute, constitute a violation of the trustee's fiduciary duties. Ordinarily such actions are looked down upon, but this case is an instance in which the unique facts involved apparently warranted a slight departure from the general rule.
Specifically, on September 9, 2009, the Arkansas Court of Appeals issued its decision in the case of Hanna v. Hanna, #CA08-1256, which was an appeal from Washington County Circuit Court. The ex-wife had sued her ex-husband for self-dealing, breach of fiduciary duty, and mismanagement of assets in their children's trusts. The ex-wife had received a $16 million divorce settlement, and the ex-husbanddirected his chief financial officer to form a plan to gather the money (the couple had owned a successful candle company and several other entities) .
Long story short, the ex-husband obtained loans to raise the funds and also used company assets as collateral for loans to company officers totaling $3 million. The ex-wife brought the above-described claims against the ex-husband, and he defended arguing that he had not known it was wrong and that he had done it in the best interest of the children. In doing so the ex-husband offered evidence that it was to the company's advantage that he settle, which he could only do by pledging company assets, and that the bank would not have funded the loan absent using company assets as collateral.
Ultimately the trial court declined to award damages to the trusts or set aside the loan transactions, but did order the ex-husband to remove company assets as collateral for the officers' loans totaling $3 million. The Arkansas Court of Appeals affirmed the trial court's decision, holding that this was not a situation in which a trustee was using trust assets solely to pay for his divorce settlement, nor was it an instance in which the trustee's actions failed to benefit the trusts. The Court instead ruled that the parties to the lawsuit, the companies, and the trusts were all intertwined, and that the ex-husband's actions to carry out the divorce settlement in effect protected them all. The Court did make clear, however, that its ruling was "confined to the particular circumstances of this case and should not be read to permit a trustee to encumber trust property in the absence of extraordinary circumstances."