Goldman v. Rubin

Rodowsky, J., delivered the opinion of the Court. ⁶⁹⁵ This case arises out of a liquidity problem in the administration of the testamentary estate of the founder of a family corporation. In exchange for a note, the personal representatives sold stock from the estate to the issuing corporation, which was controlled by the persons serving as personal representatives, in a transaction designed to qualify under § 303 of the Internal Revenue Code. Because of a conflict of interests the chancellor surcharged the personal representatives on complaint of the petitioner. The Court of Special Appeals reversed.

Rubin v. Goldman, 48 Md. App. 59 , 426 A.2d 961 (1981). Under the facts involved here, where divided loyalty in the transaction necessarily resulted from the provisions of the will, we shall hold that the conflict does not per se constitute a breach of trust. However, for other reasons hereinafter set forth, we shall vacate both judgments below and remand for further proceedings. The testator, Max Rubin (Max), died September 18, 1973 at age 79, leaving five adult children.

His wife had predeceased him. Max had been engaged in the manufacturing of men’s clothing. The principal corporation of his enterprise is Max Rubin Industries, Inc. (MRI). There are a number of subsidiary and affiliated corporations.

His oldest child is the petitioner, Edythe R. Goldman (Goldman), born April 30,1920. She has not engaged in the family business. A son, Bernard Rubin (Bernard), was president of MRI before and following his father’s death. A daughter, Pearl, has not engaged in the business but is married to Lee Morrow (Morrow), the vice president of MRI before and following Max’s death.

Another daughter, Mildred, is married to Mannes Greenberg (Greenberg), an attorney, whose ongoing services as secretary of, and counsel for, the family business antedate the testator’s death. A son, Seymour Rubin (Seymour), is a practicing physician. The chancellor found that "[f]or many years, there had been great antagonism, acrimony, and hostility between [Goldman] on the one hand, and virtually all other members of the Rubin family on the other.” Business could have been better. As acknowledged by the petitioner, MRI has had cash problems since 1966.

Foreign ⁶⁹⁶ imports have undercut domestic clothing manufacturers and in periods of recession men’s clothing sales decline. The uncertified consolidated financial statements of MRI, including its wholly owned subsidiaries, for the year ending June 30, 1979 reflected a net loss from operations of $3,157.64 on gross sales of $5,149,821.58. There were retained earnings of $262,214.90. At the time of trial in December 1979 the company had temporarily laid off 250 employees, leaving a skeletal office staff.

From a time prior to Max’s death the board of directors of MRI has consisted of Bernard, Morrow, Seymour, Greenberg and Samuel L. Silber (Silber). Silber is a member of the bar, a practicing CPA, and has been the accountant for MRI since 1948. In 1973, 6,800 shares of common stock of MRI were outstanding, of which 5,900 were held by Max (86.77%), 400 by Bernard (5.88%), 400 by Morrow (5.88%) and 100 by Greenberg (1.47%). 1 The persons who comprised the board of directors of MRI, with the exception of Morrow, were named by Max to be the personal representatives of his estate and served as such. Max’s last will and testament, prepared after consultation with Greenberg, was dated March 23, 1971.

Of relevance here is the interplay between the disposition of the estate’s common stock in MRI and the residuary clause. Item VIII of the will creates trusts out of all of the testator’s common stock in MRI, 2 60% for the benefit of Bernard and 40% for the benefit of Pearl Morrow. The will designates as trustees the five persons who also comprise the board of MRI. This common stock bequest was expressly subject to the charge made in Item I of the will, which provides: ⁶⁹⁷ (a) I direct my personal representatives to pay out of the principal of the Trust created under ITEM VIII...

(1) any and all estate and inheritance taxes, Federal and State, which may be assessed against ... any devises and bequests made in this Will . .. it being my intention that such gifts, devises and bequests .. . shall pass in full to the persons entitled thereto, free and clear of such taxes, and that my personal representatives . .. shall not demand contribution toward such taxes from such persons, (2) all of my burial expenses . .. and (3) all administration expenses allowable as deductions to my Estate under Section 2053 of the Internal Revenue Code of 1954. (b) Except as provided in ITEM I (a) above, I direct that my personal representatives shall pay out of my residuary estate passing under ITEM X ... all of my just debts ... and all other expenses not payable pursuant to the directions in paragraph (a) of this ITEM I. Item X bequeathed one-ninth of the residue to Seymour and two-ninths respectively to each of the remaining children, i.e., Goldman, Pearl Morrow, Mildred Greenberg and Bernard. There was also a codicil, written in longhand by the testator without consulting counsel. It is in the form of a letter dated December 24, 1969 "[t]o all concerned” which was republished and witnessed July 8, 1971.

In the codicil Max explained the reasons underlying his testamentary gifts. As to Mildred Greenberg and Seymour he in substance stated that they did not need financial help. As to his other children he said: (1) I left the bulk of my estate to my son Bernie Rubin. He worked hard and helped me build up my business. ⁶⁹⁸ He knows no other trade nor profession has a family and this is the only way he can make a living.

He worked hard, conscientious, devoted. Should the property be divided I fear he would be left at the mercy of others, perhaps the property divided and business destroyed. He would then be the greatest sufferer. My conscience would suffer.

This [is] his livelihood. This is the only business he knows. (3) My daughter, Pearl, will get the next biggest share. Pearl and Lee will have a goodly share, a business Lee can devote his time diligently and make the business grow.

Pearl thought the business should be divided equal between Lee and Bernie. According to Jewish law a son (Bernie) is entitled to receive the biggest share. Bernie has been with me longer and I believe he worked harder and understands the business better. So Pearl should consider herself lucky and adjust her thinking and be grateful to me.

She will get the lions share of a business I worked hard to build. (5) Next is my dearly beloved daughter, Edith. My pride and joy. I am worried.

At the present time her income is perhaps the smallest. For a long time she thought my estate should be divided between all five children alike. If I would do that the business would sooner or later be sold or destroyed. Sooner or later there would be nothing left.

And Bernie and Lee (Pearl) would be the greatest sufferers because the clothing business is all they know and once a business is destroyed at this age it would be hard to get started. And so to help out my beloved daughter, Edith, this decision should be carried out faithfully as my will and as a part of my last will. [Emphasis added.] ⁶⁹⁹ The codicil then directed that Goldman receive $100 per week for ten years in addition to the other bequests to her. This codicil was not admitted to probate until May 14,1974, after a written agreement had been reached between Goldman, Max’s other children and his personal representatives. The federal estate tax return reported a gross estate of $648,106.81, based on values at the alternate valuation date of March 18,1974. 3 Max’s 5,900 shares of MRI common were reported at $22.91 per share ($135,169) at March 18, 1974, and at $25.72 per share ($151,748) on the date of death.

These valuations represented one-third of book value. The personal representatives’ valuation was accepted by the Internal Revenue Service. In the course of administration cash and certain liquid assets of the estate, which were not specifically bequeathed, were utilized in the payment of the federal estate tax ($137,433.53), 4 the Maryland estate tax and other expenses of administration. In an effort to exonerate the residuary estate from the taxes and expenses described in Item 1(a) of the will, and to carry out against the Item VIII common stock the charge of Item 1(a) taxes and expenses, the personal representatives effected a stock redemption under I.R.C. § 303, 26 U.S.C. § 303 (1970).

Section 303 provided in part: Distributions in redemption of stock to pay death taxes. (a) In general. A distribution of property to a shareholder by a corporation in redemption of part or all of the stock of such corporation which (for Federal estate tax ⁷⁰⁰ purposes) is included in determining the gross estate of a decedent, to the extent that the amount of such distribution does not exceed the sum of — (1) the estate, inheritance, legacy, and succession taxes (including any interest collected as a part of such taxes) imposed because of such decedent’s death, and (2) the amount of funeral and administration expenses allowable as deductions to the estate under section 2053 ... shall be treated as a distribution in full payment in exchange for the stock so redeemed. The effect of a redemption that qualifies under § 303 is to treat the property received by the shareholder on a capital gains basis and not as a dividend. 5 Most of the details of the redemption were established at a meeting of the personal representatives, other than Seymour, on August 31, 1977 in Silber’s office.

Taxes, funeral expenses and administration expenses which would fix the ceiling on a distribution under § 303 by MRI were computed to be $203,000. Because MRI was "without adequate funds or resources to fund a redemption of stock,” 6 the personal representatives-directors determined that MRI would have to issue a note to the estate for $203,000 in exchange for stock, and that the note would thereafter be distributed to the residuary legatees. The $203,000 figure was used for the note in order to give the residuary legatees the possibility of obtaining from MRI the maximum amount subject to § 303 treatment. Determination of the number of shares to be redeemed reflected a number of factors.

MRI common stock as at June 30,1977 had a book value of $34.07 ⁷⁰¹ a share. 7 A redemption at book value (assuming the note of MRI really equaled $203,000) would require 5,958 shares. This exceeded the amount of estate-held common stock (5,900 shares). Under a redemption of all of the estate-held common stock "control of the corporation would pass from the Trust to the individuals which would effectively thwart the intentions of the testator.” 8 It was decided to allocate the effect of a redemption of 5,958 shares pro-rata over all the outstanding common stock. As a result 5,170 shares of estate common were to be redeemed, leaving it 730 shares (86.70%), and the $203,000 note was to be given exclusively in exchange for the estate stock.

Without direct consideration, Bernard, Morrow and Greenberg contributed to MRI 350, 350 and 88 shares respectively, leaving Bernard 50 shares (5.94%), Morrow 50 shares (5.94%) and Greenberg 12 shares (1.42%) in their individual capacities. By a written agreement dated September 1,1977 between MRI and the personal representatives, to which the trustees of the Item VIII trusts affixed their consent, the estate sold 5,170 shares to MRI in exchange for a promissory note of MRI in the principal amount of $203,000. The note provides for interest at the rate of 6% per annum, payable annually, on the unpaid balance. No payment on principal is required until the tenth year, by the expiration of which 10% of the original indebtedness is to be paid, and 15% of the original indebtedness is to be paid each year thereafter until payment in full.

The obligation represented by the note is "subordinate to any and all liens, debts and obligations now or hereafter owing to any creditor of’ MRI. MRI, as maker, agreed to substitute separate notes aggregating the total indebtedness, on the same terms, so as to facilitate distribution by the estate, as holder. A meeting of the shareholders of MRI, which seems to have been much in the nature of a family meeting, was held ⁷⁰² on April 26, 1978 at which the redemption, and the reasons for the promissory note, rather than any cash payment, were explained. All interested parties approved the transaction with the exception of Goldman who was not present but whose son, an attorney, attended the meeting as an observer on her behalf.

When the personal representatives filed their fifth and final administration account in the summer of 1978, it proposed distributing the $203,000 note among the residuary legatees. Goldman’s two-ninths interest in the note was reflected in the account at $29,549.33. 9 The final administration account also proposed distributing $13,363.45 in personal representatives’ commissions, after tax on commissions. The orphans’ court had previously authorized the distribution of $7,199.05 in after-tax commissions, pursuant to interim accounts. Gross commissions proposed in all accounts aggregated $22,847.23, 10% of which represented tax on commissions, so that total after-tax commissions from all accounts aggregated $20,562.50.

A counsel fee to Greenberg and Silber of $27,200 was also included in the account. In the orphans’ court Goldman excepted to the account and to the petitions for commissions and counsel fee. She alleged that the stock redemption was upon terms so unfavorable as to substantially prejudice the residuary legatees, that it was inconsistent with the fiduciary duty owed by the personal representatives, and that it amounted to a frustration of the intention of the testator. She requested that the personal representatives "be directed to reduce the Note to cash in the amount of $203,000' and distribute cash to the residuary legatees.” The personal representatives thereupon petitioned the Circuit Court for Baltimore County to assume jurisdiction over the administration of the estate and to grant declaratory relief.

They requested a declaration, inter alia, that the § 303 redemption resulted from a proper exer ⁷⁰³ cise of discretion and that the administration account be approved. 10 The "serious and substantial conflict of interest” of Bernard was a focus of attention by the chancellor. He held that the fiduciaries "were obligated to do their utmost to prevent any detriment to [Goldman],” but that "they did absolutely nothing to attempt to secure the cash for” her and that "[n]othing was done to upset the corporate apple cart.” He observed that if the fiduciaries "could not resolve the dilemma by raising the cash, only one alternative remained and that was to resign their fiduciary positions and let the ultimate decision be made by someone who could be completely impartial and without any possible conflicting interest.” His decree included a direction that the personal representatives pay $45,111.10 (two-ninths of $203,000) to Goldman, in cash. The commissions and counsel fee were approved and were allowed to the extent there would be cash available in the estate after payment to Goldman. 11 In reversing, the Court of Special Appeals concluded that there was an implied exemption from the duty of loyalty insofar as the stock redemption transaction was concerned, that there was no allegation or evidence of fraud or bad faith, and that there was no evidence to support a finding of abuse of discretion by the personal representatives. We granted Goldman’s petition for certiorari, which asks that we reject any implied exemption and, alternatively, that we hold the evidence sufficient to support the relief granted by the chancellor.

We turn to the issues for decision. Goldman’s exceptions to ⁷⁰⁴ the account are filed solely in her capacity as one of the residuary legatees. 12 She does not complain that liquid assets were used to pay estate taxes, funeral expenses and certain expenses of administration. All of the estate expenditures included in the $203,000 were for claims which fall within the four highest priorities of payment under Md. Code (1974), § 8-105 (a) (1) through (4) of the Estates and Trusts Article and were proper. Nor does Goldman claim that a redemption of estate-held common stock of MRI was unauthorized or improper, as such.

Her complaint goes to any deferred payment for the redemption, reinforced by this particular note’s terms which permit deferral of any payment on principal until she is age 67, and which subordinate payment of principal to present and future corporate debt. She claims entitlement to $45,111.10 in cash, now. To reach that goal her argument essentially consists of four steps: (1) the redemption involved a conflict of interests by the personal representatives; (2) in such cases the burden of proving that there is no breach of duty is on the fiduciary; (3) the personal representatives did not satisfy the chancellor that there was no breach of duty; and (4) the remedy which she has elected, to surcharge the fiduciaries, is appropriate in this case. The fiduciaries’ position is that, although they sold as personal representatives and the stock was bought by the corporation of which they are directors, any conflict of interests was of the testator’s creation, and that in such cases the burden of proof is on the beneficiary to show fraud, bad faith or an abuse of discretion, which they say Goldman has failed to do.

I The personal representatives, in that capacity, held the controlling stock of MRI. Consequently their fiduciary ⁷⁰⁵ duties to the legatees, as legatees, apply not only to the administration of the testamentary estate, but also to their action as directors of the buyer in the redemption transaction. See In re Hubbell’s Will, 302 N.Y. 246, 254-55 , 97 N.E.2d 888, 891 (1951); Cahn, Estate Corporations, 86 U. Pa. L. Rev. 136 , 138 (1937).

This is not a case of self-dealing in the strict sense. MRI was the purchaser. The fiduciaries did not buy for their personal accounts. See Niles, The Divided-Loyalty Rule, 91 Tr. & Est. 734 (1952).

But it is a case of conflict of interests, at least as to Bernard. In the redemption, the personal interest of Bernard was to keep the price down, so as not to jeopardize MRI and his position as its president, while duty to the legatees made obtaining the best possible price the objective of the fiduciaries. In step two of her argument, Goldman seeks to have rigidly applied, based on the conflict of interests, the rules applicable to fiduciary loyalty. These are: [A] trustee is prohibited from placing himself in any position where his self-interest will or may conflict with his duties as trustee, or from using the advantage of his position to gain any benefit for himself at the expense of the beneficiary of the trust.

It is accordingly an accepted rule in equity that the presumption is against the validity of any purchase by a trustee from the beneficiary or any other transaction with the beneficiary which might result in a benefit to the trustee. [Hughes v. McDaniel, 202 Md. 626, 632 , 98 A.2d 1, 4 (1953) (will made pursuant to contract between settlor of inter vivos trust and trustee left testamentary remainder to trustee individually, and was voided).] As explained in dicta in Harlan v. Lee, 174 Md. 579, 592 , 199 A. 862, 869 (1938), the rule has been adopted because "[c]onfidence in the loyalty and impartiality of a fiduciary is not maintained by one who is at once the seller and the buyer of the subject of sale,” and because "the danger of ⁷⁰⁶ fraud or collusion is so great, and there is such advantage in concealment, and such difficulty of detection, exposure and establishment by evidence . ...” If self-dealing is involved, "the law does not denounce the sale as fraudulent in fact or make it absolutely void, but voidable on objection by a party in interest.” Id. But "[notwithstanding the importance of the rule and the salutary effect of its rigid enforcement, it is not of universal application.” Id. The rule does not apply if the purchase is made to protect the interests of the beneficiaries, or if the beneficiaries validly consent, or if they are guilty of laches, "or if the fiduciary be authorized by statute, by the instrument creating the trust, or by the court having jurisdiction of the subject matter, provided the sale be fairly made.” Id. at 593 , 199 A. at 869 . And see McDaniel v. Hughes, 206 Md. 206, 221-22 , 111 A.2d 204, 211 (1955); Turk v. Grossman, 176 Md. 644, 665-66 , 6 A.2d 639, 650 (1939).

Harlan’s facts did not involve self-dealing. An attorney, who was both the executor of an estate and trustee of a trust to which one-third of the estate was bequeathed, had purchased at a public sale, through an agent for himself as trustee, ground rents which he was selling as executor. It was held that the sale was not voidable simply on the election of a legatee. The fact that the attorney both bought and sold was "immaterial” to setting aside the sale because "the purchase [was] not for the private account of the fiduciary, and the reason for the rule ceases, as does its application.” 174 Md. at 594 , 199 A. at 870 .

And see Cosden v. Mercantile-Safe Deposit & Trust Co., 41 Md. App. 519, 531-32 , 398 A.2d 460, 468 , cert. denied, 285 Md. 728 , cert. denied, 444 U.S. 941 , 100 S. Ct. 295 , 62 L. Ed. 2d 308 (1979). A sale by a fiduciary to himself as an individual was approved in Schockett v. Tublin, 170 Md. 117 , 183 A. 521 (1936). There the testator had been engaged, as a sole proprietor, in the business of selling clothing, door to door, on credit to persons of slight, if any, financial responsibility. He collected the small installment payments at the customers’ homes.

His widow and a son, who had worked to some extent ⁷⁰⁷ in the business, were named executors. Records of the accounts were extremely poor. A private sale, by bids, was held of the receivables, which the co-executor-son purchased. His sister sought to set aside the sale, at which she had had an opportunity to bid, but the orphans’ court ratified.

We affirmed, stating that "[w]ithout in any manner deviating from the unbending rule controlling transactions between fiduciaries and their cestuis que trustent, it may be stated as a general principle that each transaction depends upon the peculiar circumstances connected therewith.” Id. at 127 , 183 A. at 525 . It was noted that the widow, who individually and as a guardian represented beneficial interests in five-ninths of the estate, had approved the transaction. We said that "[t]his circumstance, considered in conjunction with the character of the property sold, its value being dependent upon a continuation of the business of the testator, in our opinion justifies a variance from the general principle hereinbefore enunciated.” Id. at 127 , 183 A. at 525-26 . In the case at bar, seven-ninths of the residuary estate interests approved the sale as structured.

Similarly, the values of the stock sold and of the note received were dependent on a continuation of MRI. Also pertinent is Gianakos v. Magiros, 238 Md. 178 , 208 A.2d 718 (1965). In that case the intestate and one of his sons were partners in a restaurant business, without any written partnership agreement. The son was appointed by the orphans’ court to be personal representative of his father’s estate.

As surviving partner, the son elected, under the Uniform Partnership Act, to continue the business and to pay to the estate the value of his father’s interest in the business as of the date of death. In answer to a contention that the personal representative-surviving partner was precluded from making this election because of a conflict of interest, we said: By reason of his court appointment, in the absence of proof of wrongdoing, he is authorized to take action which might, under other circumstances, constitute a conflict between his personal position ⁷⁰⁸ and his fiduciary capacity. He is, of course, liable under his bond as administrator for any breach of his duty in that capacity .... No intentional wrongdoing by [the son] is claimed. ...

By virtue of his position as administrator, [the son] was put to an election under the [Uniform Partnership] Act. The election was necessary by reason of his position, and the position was not only under court order, but also without objection from the [widow]. The attack is made, not because that election was deleterious to [the father’s] estate, but merely because it was made. Under these circumstances, the attack must fail. [id. at 186-87, 208 A.2d at 723 (emphasis added).] Here the personal representatives are not the ones who placed themselves in a position of conflict.

They were placed in that position by Max, through the provisions of his will. He appointed as his personal representatives four of the five directors of MRI and then caused the personal representatives to deal with themselves, as directors, and with Bernard as president, as inexorably as if the will had expressly so directed. The will directs that certain types of expenditures by the estate, which in this case total $203,000, are to be paid out of the MRI common stock, without regard to the liquidity of other portions of the estate. We need not in this case speculate on the possibility of the personal representatives converting some or all of the common stock into cash by a sale to a disinterested third party.

Max foreclosed any option of selling a controlling interest in MRI. His codicil makes plain his general intent that the business was not to be sold, and that the purpose underlying the Item VIII trust of 60% of his common stock in MRI for the benefit of Bernard was to enable the business to continue under Bernard’s day-to-day management