Beyond the Delaware Statutory Trust Act: Is Willful Misconduct the Floor for Liability?

February 2, 2012

Publication| Corporate Trust & Agency Services

Freedom of contract, including the ability to alter the fiduciary duties and liabilities of trustees, is the hallmark of Delaware trust law and may be the foremost reason for the preeminent position of the Delaware statutory trust in structured finance and investment fund transactions.1  However, practitioners in this area should be aware that there are substantive rules contained in Delaware’s general trust law, set forth in Chapters 33 and 35 of Title 12 of the Delaware Code (the “General Trust Law”), that may apply to statutory trusts formed under the Delaware Statutory Trust Act (the “Act”). An example of such rules can be found in Section 3303 of Title 12, which states, “Notwithstanding any other provision of [the Delaware Code] or other law, the terms of a governing instrument may expand, restrict, eliminate, or otherwise vary … a fiduciary’s powers, duties, standard of care, rights of indemnification and liability to persons whose interests arise from that instrument; provided, however, that nothing contained in this section shall be construed to permit the exculpation or indemnification of a fiduciary for the fiduciary’s own willful misconduct or preclude a court of competent jurisdiction from removing a fiduciary on account of the fiduciary’s willful misconduct.” The broad prohibition set forth in Section 3303 may be a further limitation of the contractual flexibility with respect to liability under the Act.

In addition, practitioners should be aware that the Delaware legislature has shed further light on the meaning of the terms “willful misconduct” and “wrongdoing.” Section 3301(g) of the General Trust Law provides that “willful misconduct” means “intentional wrongdoing, not mere negligence, gross negligence or recklessness” and “wrongdoing” means “malicious conduct or conduct designed to defraud or seek an unconscionable advantage.”

Many trust agreements take advantage of the contractual flexibility set forth in Section 3806 of the Act, which permits the governing instrument to eliminate liability of a trustee or other person except for any act or omission that constitutes a bad faith violation of the implied contractual covenant of good faith and fair dealing. However, reliance on the Act alone may not be sufficient. Given the broad language in Section 3303 of the General Trust Law, the limitation regarding willful misconduct may be a further mandate below which liability for breach of a trustee’s or other person’s standard of care cannot be eliminated. Whether the Act’s limit on the elimination of liability or Section 3303’s limit is the ultimate floor for the elimination of liability is unclear, given that to date the Delaware courts have not provided any guidance.

Section 3809 of the Act contains an express default rule which states, “Except to the extent otherwise provided in the governing instrument of a statutory trust or in [the Act], the laws of [Delaware] pertaining to trusts are hereby made applicable to statutory trusts.” This is a reference to the General Trust Law as well as the constantly evolving body of case law relating to trusts in Delaware. In addition to the provisions discussed above, other significant provisions of the General Trust Law can be found in Chapters 33 and 35. Insofar as these provisions are mandatory unless altered by the governing instrument, practitioners must carefully consider their effect on a particular transaction or structure and either accept their application or expressly override them in the governing instrument.

1Section 3825 of the Act expressly states, “It is the policy of [the Act] to give maximum effect to the principle of freedom of contract and to the enforceability of governing instruments.”  Thus, the Act is primarily a default rule statute with few mandatory rules.
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