Challenges to holding closely held business interests in trust Alexander J. Lyden-Horn, J.D., LL.M Theresa L. Hughes Todd M. Skobinsky

Goals for this session Review the specific challenges presented by: Assess and offer solutions to the challenges facing directed trustees holding closely held entities Review the specific challenges presented by: Onboarding Ongoing Administration Closing

Onboarding: Pre-acceptance due diligence What is the appropriate amount of due diligence to perform prior to accepting a closely held entity? The best time to ask for information is BEFORE you accept your role as trustee Once trusteeship has been accepted, the trustee may have limited power to request information or reject a proposed transfer. Requesting information before acceptance is less likely to create an implied duty of oversight over the entity. Request Governing Agreements Understand your role vis-à-vis the investment Are there any rights or privileges associated with the investment? Any ongoing responsibilities a corporate fiduciary might have in respect of the investment? Ensure you don’t execute a direction that is contrary to the governing document Proof of Ownership: Signed LLC Operating Agreements, Assignments, Stock Certificates, etc.

onboarding: pre-acceptance due diligence Sample Due Diligence List: Copies of all governing documents (e.g., operating agreement, certification of formation) Names and contact information for all managers/directors A list of assets and liabilities of the entity A description of the business of the entity and its activities A description of the tax status of the entity and, if applicable, contact information for the paid preparer/CPA who will be preparing the entity’s returns If possible, the identity of all other beneficial owners If there are multiple entity layers, an organizational chart Should the above information also be requested for all subsidiary entities?

Onboarding: risk Assessment What does the company do? Does the business or industry in which the company operates pose a risk to the corporate fiduciary’s franchise? What is the tax status of the corporate entity? Are all required returns filed and current? Does the corporate trustee have an obligation to monitor? History of litigation, fines, sanctions or other issues of concern? Any contingent liabilities?

Bridge the terms of the trust to the operating entity Do the terms of the corporate governing instrument confer certain rights and privileges to the shareholder? Under the terms of the trust and if directed, is it clear that the corporate trustee should not exercise discretion (i.e., vote a proxy) as it relates to the company? What happens if the Manager (who is your client) is no longer able or willing to serve? Ensure the terms of the trust outlines the mechanism to appoint a successor manager to that the trustee is not thrust into a position of management/control

onboarding: Entity document review The trustee should be certain of its rights and responsibilities as an owner under the governing documents of the entity. If management responsibility is not desired, the entity governing documents must clearly provide for the appointment of a successor manager/director in the event of a vacancy. The assignment/transfer documents must meet any requirements or limitations set forth in the governing documents (e.g., consent requirements, rights of first refusal) The trust must meet any restrictions on permissible owners

onboarding: trust instrument review If the trustee knows that a proposed trust will hold a closely held entity, then the trust instrument can be tailored specifically for this purpose The trust instrument should define clearly the trustee’s and investment advisor’s respective responsibilities with respect to closely held entities, including with respect to: Management Valuation Ongoing administrative functions (e.g., voting proxies, responding to capital calls) The trust instrument should make it clear that the directed trustee has no duty to: Monitor or account for activity that takes place within the entity Verify independently any valuation provided by the investment advisor Vote proxies or take any other actions with respect to the entity absent an express direction

Ongoing administration: Directed actions What is a directed trustee’s responsibility with respect to review of documents presented for execution? Does a trustee have the authority to refuse to carry out a directed action? Once the entity has been transferred by the trust, does the trustee have any ongoing responsibilities absent further direction (e.g., voting proxies)? The trustee should make it clear that any review or inquiry constitute “administrative actions taken by the fiduciary solely to allow the fiduciary to perform those duties assigned to the fiduciary under the governing instrument” and do not “constitute an undertaking by the fiduciary to monitor the adviser or otherwise participate in actions within the scope of the adviser's authority” as set forth in 12 Del. C. 3313(e)

Ongoing administration: valuation What responsibility does a directed trustee have with respect to the valuation of closely held entities? Delaware Code Under 12 Del. C. 3313(d), the term “investment decision” includes “with respect to nonpublicly traded investments, the valuation thereof.” Under 12 Del. C. 3317, each co-fiduciary has a duty to “keep all of the other fiduciaries for the trust reasonably informed about the administration of the trust with respect to any specific duty or function being performed by such fiduciary to the extent that providing such information to the other fiduciaries is reasonably necessary for the other fiduciaries to perform their duties.”

Ongoing administration: valuation The Trust Instrument should: Specifically define the investment advisor’s responsibility to provide values (and other relevant information) for trust-owned entities Provide that the trustee may rely without liability upon such information Release the trustee from liability for any failure to fulfill its duties if the investment advisor fails to provide it with any necessary information. State explicitly that trustee shall have no obligation to independently value any non- marketable assets held by the trust.

Ongoing administration: Financial Statements If the trust is the sole owner of the entity, then the trust can be set up to receive all statements issued to the entity pertaining to its underlying investments. If the trustee is to use financial statements to periodically update the entity value, there should be a standing order direction in place to do so. The trustee should avoid any implied duty of oversight over the underlying activity of the entity Again, the trustee should make it clear that any review or inquiry constitutes “administrative actions taken by the fiduciary solely to allow the fiduciary to perform those duties assigned to the fiduciary under the governing instrument” and do not “constitute an undertaking by the fiduciary to monitor the adviser or otherwise participate in actions within the scope of the adviser's authority” as set forth in 12 Del. C. 3313(e)

Ongoing Administration: entity transactions Some families may not always respect the trust or the trustee’s role Dividends and other distributions may by-pass the trust Contributions from the grantor may be made directly to the entity Trust power-holders may exercise authority and the trust might be “the last to know” For the trust and entity structures to be respected (e.g., for tax and creditor protection purposes), legal formalities must be observed. All payments to and from the entity must pass through the trust account. Any transaction that creates a deemed transfer to or from the trust (e.g., constructive gift by direct payment of premiums) must be (i) properly documented and (ii) include the trust as a party on all such documentation.

Closing: transferring the entity If the trustee is being replaced, is a formal assignment document necessary for the entity interest? Whose responsibility is it to ensure that the change in ownership/control is reflected on the records of the entity? If the assignment is to a beneficiary as an exercise of the trustee’s distribution discretion, is a direction from the investment advisor required? What should a trustee do if it is told the entity is “worthless” and/or the registration with the state has lapsed? Can it be simply taken off the books?

Questions Alexander J. Lyden-Horn, J.D., LL.M Theresa L. Hughes Todd M. Skobinsky