Monday, August 17, 2009

Discretion and Its Many Abuses – Part I

Here’s a pleasant thought experiment: imagine you are a trust-fund baby. Very rich (and dearly departed) parents have provided for you with a generous trust fund. You are set for life!

The trust fund, however, is not just a pile of money you can play with at your whim. In fact, the whole point of a trust fund is that your parents didn’t give you the money at all, they gave it to a trustee whom they have directed to manage and distribute the funds for your benefit. The trustee’s directions are set forth in a document – the trust instrument – which tells the trustee how to go about his job.

The trust instrument might, for example, instruct the trustee to never touch the principal and to apply interest income to your educational and medical expenses, and that’s all. So, if you want some of the money to buy a fancy new car, the answer will be no, because the trustee has his marching orders, and he can’t write you that check.

Many trust instruments, though, give the trustee discretion: they direct the trustee to use his own good judgment to manage the funds for your benefit. Now, if you want that new car, the trustee will decide whether you get it based on his own judgment about what’s best, not on any explicit terms in the trust instrument. That’s the way your rich-and-dead parents wanted it to be.

Let’s say the trustee says no, and you decide to sue - you want the damn money for that car! You are going to have a difficult time winning that one.

That’s because rich-and-dead made the decision (back when they were rich-and-alive) to leave it up to the trustee – that’s the point of giving the trustee discretion in the first place. So a judge would say, I personally might not have made the same decision, but rich-and-dead wanted the trustee’s judgment, not mine, to be the one that counted.

Therefore getting a judge to merely disagree with the trustee’s decision won’t get you that car – you have to show the trustee was not just incorrect but that he somehow went beyond the bounds of reason in making his decision, so that even though he is the one with the discretion his decision can’t be upheld. In other words, sure rich-and-dead conferred upon him discretion, but here his decision was so out-of-bounds, so crazy, that we can say he abused that discretion. That’s what you have to prove to get that car.

I’ll post further on this later this week, but for now just know this: under ERISA, insurance companies are very, very often treated like trustees, not like insurance companies. As I’ll discuss further, that is what’s crazy.

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