MEF commenced proceedings in Surrogate’s Court seeking Peters’ removal as executor of the Estate and for discovery based upon allegations Peters breached his fiduciary duties to MEF in three ways:
Peters allegedly acted in a position of “divided loyalty” serving as executor of the Estate and manager of HD simultaneously when he chose to “modify HD’s operating agreement to the disadvantage of the estate’s minority interest” in the business (unfortunately, the decision did not elaborate upon the nature of the alleged modifications);
Peters allegedly “directed distributions from HD to another LLC, generating management fees for Peters”; and
Peters allegedly “failed to provide the estate’s beneficiaries with information about HD.”
Peters challenged the proceedings on jurisdictional grounds, arguing that Surrogate’s Court “cannot compel the requested discovery regarding HD . . . because the court does not have subject matter jurisdiction to order what would in essence be an accounting for HD, an entity in which the estate has only a minority interest.”
Peters also argued that “MEF, as residuary beneficiary, lacks standing to seek information regarding HD because it is not a current member of the LLC.”
In Matter of Piccione (57 NY2d 278 ), the Court of Appeals adopted the principle that “for the Surrogate’s Court to decline jurisdiction, it should be abundantly clear that the matter in controversy in no way affects the affairs of a decedent or the administration of his estate” (quotations omitted).
And in Matter of Brandt (81 AD2d 268 [1st Dept 1981]), the Appellate Division ruled that Surrogate’s Court had subject matter jurisdiction to compel accountings from two trustees who were also the 50% general partners of a limited partnership in which the trusts had a 50% limited partnership interest.
Brandt held, “Where an estate fiduciary is a controlling stockholder in a corporation by reason of holding such stock in a fiduciary capacity, he can be compelled to disclose the details of the corporate activities” (quotations and brackets omitted).
According to Surrogate Mella:
Brandt thus stands for the proposition that an estate need not have a controlling interest in a business entity for this court to exercise jurisdiction to compel an account, particularly where there are allegations of bad faith, waste, diversion, or improper exploitation by an estate fiduciary functioning in dual capacities.
Applying these authorities, Surrogate Mella concluded that Peters “failed to establish that issues arising from a fiduciary’s administration of an estate’s minority interest in a business entity are outside this court’s subject matter jurisdiction over all matters relating to estates and the affairs of decedents” (quotations omitted).
The Standing Argument
Turning to Peter’s lack-of-standing defense, Surrogate Mella wrote:
Where, as here, the fiduciary normally charged with taking action to protect estate or trust assets cannot be expected to do so because of a conflict, beneficiaries may seek redress on the estate’s or trust’s behalf (Brandt, 81 AD2d at 279-80 [trust beneficiaries have right to sue on behalf of trusts where trustees will not act in accordance with their fiduciary obligations]). The application is one in the nature of a derivative action, brought on behalf of the business itself, where, like here, the manager or director will not take action because they are the person alleged to have engaged in waste, bad faith, or self-dealing (see id.).
In sum, Surrogate Mella concluded that she had the power to order – and MEF standing to seek – an “investigation into the executor’s handling of the estate’s interest in HD.”
Thoughts on Matter of McKelvey
McKelvey is another example among several about which we have on this blog (read here and here) where a controversy falls on the jurisdictional penumbra of matters belonging in Supreme Court, where most business divorce cases play out, and Surrogate’s Court, where most trust and estate matters are decided.
Unlike Supreme Court, Surrogate’s Court is a court of limited jurisdiction. So what are the limits on its power to hear close ownership disputes?
Somewhat inconsistently with this latter line of cases, the McKelvey Court characterized MEF’s claims against Peters as “in the nature of a derivative action, brought on behalf of the business itself . . . .” How can one explain the discrepancy?
Peters’ allegedly conflicted, dual role as both estate executor and controller of MD was absolutely essential to the Surrogate’s Court’s exercise of jurisdiction to compel disclosure of information about Peters’ management of MD.
Other cases like Matter of McKelvey hold that where an estate or trust fiduciary exercises control over a business entity in which the estate or trust has an ownership interest, the dual role has something like a prismatic effect, casting the Surrogate’s Court’s scrutiny of the estate or trust fiduciary into his management of the entity itself, at least insofar as the fiduciary’s conduct directly impacts the estate or trust over which the Court has jurisdiction (see e.g. Matter of Mooney, 263 AD2d 727 [3d Dept 1999] [“On the question of standing, we note that [petitioners] allege a breach of duty, independent of any duty owed to the corporations, namely the fiduciary duty of a trustee. The objections do not seek to vindicate a wrong to [the entities] but, rather, seek relief that would directly benefit the trusts”]).
The takeaway is that in cases where an estate or trust beneficiary asks the Surrogate’s Court to require an accounting of a business entity in which the decedent left a minority interest and of which the trust or estate fiduciary is controller, it is essential to allege some form of direct harm to that interest by the fiduciary separate and apart from any harm to the business itself. In a way, the petitioner must allege the opposite of what is required of derivative standing: harm not to the entity itself, but to the petitioner individually.