May 7, 1999
JUDGE KEVIN S.C. CHANG
IN THE CIRCUIT COURT OF THE FIRST CIRCUIT
STATE OF HAWAII
In the Matter of the Estate
of
BERNICE P. BISHOP,
Deceased.)
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)EQUITY NO.2048
ORDER REGARDING ORDER TO SHOW CAUSE REGARDING SPECIAL PURPOSE TRUSTEES' REPORT AND ORDER TO SHOW CAUSE REGARDING NEW CEO BASED MANAGEMENT SYSTEM
Date: May 7, 1999
Time: 9:00 a.m.
Judge: Kevin S. C. Chang
ORDER REGARDING ORDER TO SHOW CAUSE
REGARDING SPECIAL PURPOSE TRUSTEES' REPORT
AND ORDER TO SHOW CAUSE REGARDING
NEW CEO BASED MANAGEMENT SYSTEM
The Internal Revenue Service ('IRS') has been conducting an examination or audit of Kamehameha Schools Bernice Pauahi Bishop Estate ("Trust Estate') for several years ('IRS Audit').
On January 4, 1999, the Trust Estate and its subsidiaries received Notices of Proposed Adjustment or Forms 5701 from the IRS which identified various issues related to the IRS Audit (the 'IRS Forms 5701'). The Master appointed by this Court, Colbert M. Matsumoto, filed a Report on January 21, 1999, which made certain recommendations to the Court relating to the IRS Forms 5701 and the IRS Audit.
After a hearing and the Court having completed an in camera review of the IRS Forms 5701 and other related documents produced by the Trust Estate, the Court agreed with the Master's recommendations. In pertinent part, the Court found, concluded and declared that actual, apparent, adverse and material conflicts of interest exist between the individual interests of Henry Haalilio Peters, Oswald Kofoad Stender, Richard Sung Hung Wong, Marion Mae Lokelani Lindsey, and Gerard Aulama Jervis, Trustees of the Trust Estate (the Incumbent Trustees) and the interests of the Trust Estate with respect to issues raised in the IRS Audit and by the IRS Forms 5701.
The Court also found and concluded that the receipt and, more specifically, the content of the IRS Forms 5701 received by the Trust Estate and its subsidiaries, constituted extraordinary and unprecedented circumstances not anticipated by the settlor of the Trust Estate.
As a result, the Court prohibited the Incumbent Trustees from exercising any trust power in connection with the IRS Audit and the IRS Forms 5701, and appointed a panel of five Special Purpose Trustees ("Special Panel") to exercise the trust power and to address the issues raised in the IRS Audit and by the IRS Forms 5701. See Order Granting Trustees Stender and Jervis' Petition far Approval of Voluntary Recusal With Respect to Pending Tax Audit and for Appointment of a Panel of Special Administrators With Respect to Pending Tax Audit Filed January 21,1999, filed an February26, 1999.
On April 27,1999, the Special Panel filed the Special Purpose Trustees' Report with the Court ("Special Panel Report"). On April 29, 1999, the Master filed the Master's Report Regarding Special Purpose Trustees' Report Filed On April 27,1999 ("Master's Report"). After reviewing the Special Panel Report and the Master's Report, on April 29,1999, the Court issued an Order to Show Cause related to the recommendations made in the Master's Report ("OSC I").
Subsequent to a hearing held on April 30, 1999, the Court issued an May 3, 1999, an Order to Show Cause Regarding New CEO Based Management System which was served upon the Incumbent Trustees ("OSC Il").
The Special Panel filed a Supplemental Report on May 4,1999 The Incumbent Trustees each filed written responses to OSC I and OSC II.
A consolidated hearing on OSC I and OSC II was held on May 7,1999. At the hearing, attorneys Ronald H. Malone, Glenn K. Sato, Wayne M. Sakai, and Kenneth M. Nakasone appeared for trustee Richard Sung Hong Wong, attorneys Renee M. L. Yuen and Harry Yee appeared for trustee Henry Haalilio Peters, attorneys Crystal K. Rose, J. Douglas Ing, and Bruce D. Voss appeared for trustee Oswald Kofoad Stender, attorneys Michael Jay Green and David J. Gierlach appeared for trustee Marion Mae Lokelani Lindsey, attorneys Ronald R. Sakamoto and Carolyn E. Hayashi appeared for trustee Gerard Aulama Jervis. Also present were the following: attorney Carroll S. Taylor appeared for the Special Panel, Deputy Attorney Generals Dorothy Sellers and Hugh Jones appeared far the Attorney General as parens patriae, attorneys R. Bruce Graham, Jr. appeared for the Trustees of the Estate of Bernice Pauahi Bishop, and the Master, attorney Colbert M.Matsumoto. During the hearing, the Court ordered and directed that the IRS Forms 5701 previously reviewed by the Court be filed under seal by the Special Panel and made a part of the record of the proceeding.
The Court having considered the memorandums, affidavits, exhibits, IRS Forms 5701, and other evidence presented as well as the written submissions and arguments of counsel, the Court finds and concludes as follows with regard to OSC I and OSC II: NEGOTIATIONS WITH THE IRS
Initially, the Court accepts and approves the Special Panel Report filed on April 27, 1999, and the Supplemental Report filed by the Special Panel on May 4,1999. The Court further accepts, approves, and adopts the findings of the Master as set forth in the Master's Report filed on April 29, 1999.
The Order Granting Trustees Stender and Jervis' Petition for Approval of Voluntary Recusal With Respect to Pending Tax Audit and for Appointment of a Panel of Special Administrators With Respect to Pending Tax Audit Filed January 21, 1999, filed on February 26,1999, and the findings and conclusions stated therein are incorporated herein by reference.
The Court finds and concludes that the Special Panel Report and Supplemental Report of the Special Panel establish additional extraordinary and unprecedented circumstances not anticipated by the settlor of the Trust Estate as described herein.
First, on April 19, 1999, the Special Panel, along with tax counsel and two Trust Estate employees met with representatives of the IRS regarding issues raised in the IRS Forms 5701 and the IRS Audit.
Second, the IRS is willing to meet further with the Special Panel on an expedited basis, employ a special consolidated procedure, and attempt to resolve all of the issues raised in the IRS Forms 5701 and the IRS Audit. Importantly, the representatives of the IRS who would participate in negotiations with the Special Panel pursuant to such a special consolidated procedure would possess the authority to enter into a settlement or "Closing Agreement" with the Trust Estate an behalf of the IRS in an expeditious manner.
However, the IRS has advised the Special Panel that before entering into negotiations with the Special Panel regarding settlement administrative resolution of issues raised in the IRS Forms 5701 and the IRS Audit, the Trust Estate would have to comply with certain "nonnegotiable" conditions.
One of the nonnegotiable conditions far settlement stated by the IRS involves the status of the Incumbent Trustees. Specifically, the IRS has stated that the five Incumbent Trustees must resign or be removed, to resolve IRS concerns. This statement has been confirmed in writing to the Special Panel by the IRS.
Third, the IRS has informed the Special Panel that if it did not receive a "clear signal" that appropriate action was being taken to satisfy this condition, the IRS would discontinue negotiations with the Special Panel and proceed with steps to revoke the tax-exempt status of the Trust Estate.
Fourth, revocation of the Trust Estate's tax-exempt status will have a major financial impact an the Trust Estate and will result in litigation with the IRS regarding the tax-exempt status of the Trust Estate. The litigation will be extremely costly and could take considerable time to complete without any assurance of a successful outcome for the Trust Estate.
Fifth, it appears likely that the IRS will initiate a process to revoke the Trust Estate's status absent a negotiated settlement.
Sixth, an appropriate global settlement of all issues raised in the IRS Forms 5701 and the IRS Audit, which includes preservation of the Trust Estate's tax-exempt status, would benefit the Trust Estate, its subsidiaries and affiliated organizations, the beneficiaries of the Trust Estate, and the Hawaiian community.
Seventh, the Special Panel is scheduled to meet with representatives of the IRS on May 10, 1999. Consequently, there is a need to act promptly and without delay in this matter.
Eighth, the tax counsel to the Special Panel has recommended that all steps be taken that the special consolidated procedure with the IRS described herein above is applied to of the issues raised in the IRS Forms 5701 and the IRS Audit.
Ninth, review of the IRS Forms 5701 indicates that many of the major claims asserted by the IRS in the IRS Forms 5701 implicate the actions and decisions of the Incumbent Trustees and serve as bases for the threat to the Trust Estate's tax-exempt status.
Tenth, the Special Panel having considered the contentions of the IRS as set forth in the IRS Forms 5701 and the IRS Audit, and having taken into account the risk that the tax-exempt status could be revoked if those claims are sustained, and based upon the advice and recommendations of the Special Panel's tax advisors and counsel regarding the desirability of engaging the IRS in negotiations pursuant to the special consolidated procedure, the Special Panel, in the exercise of its discretion, has reached the conclusion that the interests of the Trust Estate would be best served by immediately engaging in negotiations with the IRS pursuant to the special consolidated procedure.
The conclusion reached by the Special Panel is one which a reasonable person and a prudent trustee might be expected to arrive at and as such the Court finds that the Special Panel has not abused its discretion in concluding that negotiations with the IRS pursuant to the special consolidated procedure, for which the immediate permanent or interim removal of the Incumbent Trustees is a predicate condition, is in the best interests of the Trust Estate.
Eleventh, the Court finds that the loss of the ability of the Trust Estate through the Special Panel to negotiate with the IRS pursuant to the special consolidated procedure poses a threat of imminent harm to the Trust Estate.
Twelfth, except for trustees Stender and Jervis, the Incumbent Trustees have not expressed a willingness to resign, consider resignation or otherwise accede to any of the "nonnegotiable" conditions of the IRS stated herein.
Based on the foregoing, the Court finds and concludes that, with the exception of Trustee Stender, the failure or refusal of the other Incumbent Trustees to resign or accede to the conditions stated by the IRS, whether on a conditional or unconditional basis, creates an immediate and substantial risk of significant harm to the Trust Estate.
The immediate and substantial risk of harm to the Estate is twofold - first, the lost opportunity to engage in bona fide and meaningful settlement negotiations with the IRS in a special consolidated procedure which is advantageous to the Estate, and second, the potential loss of the Estate's tax-exempt status.
The Court further finds and concludes, with the exception of Trustee Stender, under the strict fiduciary standard applicable to the Incumbent Trustees, that the inaction and indifference of the other Incumbent Trustees to the potential loss of the opportunity to engage in bona fide and meaningful settlement negotiations with the IRS in a special consolidated procedure which is advantageous to the Trust Estate and the potential loss of the Trust Estate's tax-exempt status might thereby result because of their refusal to offer their resignations as Trustees of the Trust Estate constitutes a breach of duty. Simply put, with the exception of Trustee Stender, the other Incumbent Trustees are not acting in the interests of the welfare, protection and preservation of the Trust Estate.
As a result, the Court must exercise its inherent power as a court of equity to protect and prevent injury to the Trust Estate. Hawaiian Trust Co. v. Breault, 42 Haw. 268 (1958), In re Ikuta 64 Haw. 236, 639 P.2d 400(1981) and In re Holt, 33 Haw. 352 (1935). CEO MANAGEMENT BASED SYSTEM
Initially, the court accepts, approves, and adopts the findings of the Master as set forth in the Master's Report Regarding New CEO Management Based System filed on April 27, 1999.
The Incumbent Trustees, the Attorney General and the Master entered into Stipulations Concerning Master's Recommendations (109th, 110th, and 111th Annual Accounts) and Order filed herein on October 2, 1998 ("Stipulated Order").
The Incumbent Trustees agreed to and are required by order of the Court to comply with the following: Stipulation No. 14: A New CEO Based Management System Shall Be Instituted.
The Trustees shall cease to employ "the lead trustee" system of management in administering the Trust Estate.
The Trustees shall adopt and implement a CEO based system of management for the Trust Estate consistent with the concept recommended in the Anderson Report and hire a CEO within 180 days after the date on which the Court enters its order approving this Stipulation. The system shall incorporate a formal governance policy which more clearly defines the roles of the Board of Trustees and that of the CEO. The role of the CEO shall be consistent with the standards for delegation of authority under trust law.
The Master shall have full access to the Trustees to monitor and review the development of the CEO based management system, the formal governance policy, and the selection of the CEO, and may require such status reports and meetings as he reasonably sees fit.
The Trustees shall seek comment from the Master and the Attorney General, as parens patriae, regarding the CEO based management system and the formal governance policy and shall obtain the approval of the CEO based management system and formal governance policy from the Court, through a stipulation or order. Stipulated Order at pages 13-14.
The Stipulated Order was filed on October 2, 1998. The 180 day period specified in Stipulation No. 14 of the Stipulated Order elapsed on March 31, 1999
The Trustees' First Response to Stipulation No. 14 was filed on March 31, 1999. In pertinent part, the Incumbent Trustees requested an extension of time to "hire a CEO." The request of the Incumbent Trustees was denied by the Court on April 30, 1999.
As of May 7, 1999, the Court finds that the Incumbent Trustees have not implement[ed] a CEO based system of management for the Trust Estate and have not "hire[d] a CEO." Additionally, the Court also finds that the Incumbent Trustees have not presented a "CEO based management system and formal governance policy" to the Master for comment or to the court for approval. The deadline for the Incumbent Trustees to complete the above action was March 31, 1999.
The Incumbent Trustees have prepared a "Position Specification" and retained the services of a professional "headhunter" firm at substantial expense. They also previously represented that they were close to identifying a candidate for the CEO position.
However, the Incumbent Trustees have failed to present a "CEO based management system and formal governance policy" to the Court for approval. Thus, even assuming arguendo that the Incumbent Trustees did identify and hire a CEO, such a hiring would be premature since there would be no approved framework at the Trust Estate in which the CEO would function in and manage the Trust Estate and untimely since the deadline for a "CEO based management system and formal governance policy" has expired.
During the hearing, counsel for the Incumbent Trustees disclosed that the day before the hearing, over the sole dissenting vote of trustee Stender, the four other Incumbent Trustees approved the extension of an offer to a prospective candidate for the CEO position to serve on an "interim" basis. It was disclosed that the candidate was not selected from any list of candidates developed by the executive "headhunter" firm hired by the Trust Estate or any opportunity for all of the Trustees to participate in the screening or interview process, The extension of the job offer by the Trustees is inconsistent with the requirements of Stipulation No. 14 of the Stipulated Order since it was extended prior to the Court's approval of a CEO based management system and formal governance policy.
The Court finds that the Incumbent Trustees have failed to meet the deadline and other requirements of Stipulation No. 14 of the Stipulated Order. Importantly, these items were agreed to by all of the Incumbent Trustees and were the result of negotiations among counsel for the Incumbent Trustees, the Attorney General and the Master. The Incumbent Trustees acknowledge that they agreed to adopt and implement a CEO based management system and that this matter was not judicially imposed upon them except upon their stipulation. See Trustees' Response to Order to Show Cause Concerning Stipulation No. 14 (CEO Based Management System) filed on May 4, 1999, at page 2.
Thus, the Court finds and concludes that the Incumbent Trustees are in noncompliance with Stipulation No. 14 of the Stipulated Order. The Court notes that trustees Stender and Jervis were in favor of a CEO based management system.
The language of Stipulation No. 14 is clear and unambiguous.
It is undisputed that the Incumbent Trustees were aware of the March 31, 1999 compliance deadline. The Court further finds that with the exception of Trustee Stender the other Incumbent Trustees knowingly failed to adhere to Stipulation No. 14 of the Stipulated Order. The other Incumbent Trustees' noncompliance and failure to respect the order of the Court was not thoughtless or inadvertent.
Based on the foregoing, the Court finds that the imposition of sanctions for noncompliance of Stipulation No. 14 of the Stipulated Order against the Incumbent Trustees is appropriate and warranted. REMOVAL OF INCUMBENT TRUSTEES
In pertinent Part, trustees Wong and Peters question the wisdom of negotiating with the IRS and argue that removal of the Incumbent Trustees would not be in the best interests of the Trust Estate and that their removal would cause harm to the Trust Estate. Trustees Wong and Peters allege that it will take at least one year for a new trustee to understand the organization of the Trust
Estate and that the Incumbent Trustees have built extensive goodwill in the business and investment community. The arguments of trustees Wong and Peters are neither compelling nor persuasive.
The Court acknowledges that a change in governance of the Trust Estate will probably result in some disruption at the Trust Estate. Such disruption is inevitable, but also temporary.
The staff of the Trust Estate is comprised of dedicated, experienced and skilled individuals who are committed to meeting the important work of the Trust Estate. Any disruption to the operations of the Trust Estate will be minimized by the presence of and continued good work of the staff of the Trust Estate. Further, the Court believes that, if given the challenge, individual members of the staff of the Trust Estate may blossom, provide additional input and assistance, assume new responsibilities and develop personally and professionally with a change of governance.
The Court having determined, in pertinent part, that the failure or refusal of the Incumbent Trustees to resign or accede to the conditions stated by the IRS, whether on a conditional or unconditional basis, creates an immediate and substantial risk of significant harm to the Trust Estate, that the Incumbent Trustees are not acting in the interests of the welfare, protection and preservation of the Trust Estate, and that the Incumbent Trustees knowingly failed to comply with Stipulation No. 14 of the Stipulated Order, the Court further finds and concludes that it is necessary to temporarily remove the Incumbent Trustees and prohibit them from exercising the trust power. In reaching the foregoing conclusion, the Court balanced the alleged harm to the Trust Estate which may result from a change in governance against the significant injury and harm which would result from the potential or actual loss of the Trust Estate's tax-exempt status.
The Court, noting the scheduled May 10, 1999 meeting with representatives of the IRS, also finds and concludes that immediate removal of the Incumbent Trustees is warranted and in the best interests of the Trust Estate.
Therefore, the Court in the exercise of its inherent power as a court of equity, hereby ORDERS:1. Trustee Oswald Kofoad Stender has tendered his resignation on an interim basis and the court accepts his resignation effective immediately upon the filing of this Order.
2. Immediately upon the filing of this Order, Henry Haalilio Peters, Richard Sung Hong Wong, Marion Mae Lokelani Lindsey and Gerard Aulama Jervis are removed as Trustees of the Estate of Bernice P. Bishop.
3. The Incumbent Trustees are relieved of all power and authority to exercise any trust power related to the Trust Estate and its subsidiaries and affiliated organizations Hawaiian Trust Co. v. Breault, supra., In re Ikuta, supra, and In re Holt, supra.
4. To the extent that the Incumbent Trustees hold offices, directorships, memberships, or ex-officio status by virtue of their status as trustees of the Trust Estate or by virtue of the Trust Estate's ownership, investment, control, or voting power with respect to any entity or organization, the Incumbent Trustees shall file with this Court proof of their immediate resignation from such offices, directorships, memberships, or ex-officio status within 10 days from the date of filing of this Order.
5. The resignation of Trustee Stender and the removal of the other Incumbent Trustees as trustees of the Trust Estate is of a temporary nature and shall be without prejudice to the rights of the Incumbent Trustees to an evidentiary hearing on whether the resignation of Trustee Stender and the removal of the other Incumbent Trustees shall result in permanent removal.
6. An evidentiary hearing on the question of whether the resignation of Trustee Stender and the removal of the other Incumbent Trustees shall result in permanent removal shall be scheduled for a date within 90 days after the date on which the Attorney General, the Special Panel, or the Interim Trustees should hereafter file a petition for permanent removal of the Incumbent Trustees ("Permanent Removal Hearing").
7. The Permanent Removal Hearing shall be retained on the probate calendar and either Judge Colleen K. Hirai or Judge Kevin S. C. Chang shall preside over the Permanent Removal Hearing and shall schedule a status conference at a future date for the purpose of setting a date for the Permanent Removal Hearing.
8. Should the Attorney General, the Special Panel, or the Interim Trustees fail to file a petition for the permanent removal of the Incumbent Trustees within 90 days from the date of filing of this Order, then the Incumbent Trustees may thereafter petition the Court for a review of this Order and seek such relief as may be appropriate at that time.
9. This Order regarding the resignation of Trustee Stender and the removal of the other Incumbent Trustees as trustees of the Trust Estate, shall not be deemed to be or construed as a discharge of the Incumbent Trustees or any of their fiduciary obligations related to the performance of their duties or their exercise of power and authority as trustees of the Trust Estate until this Court enters such further Orders specifically addressing such matters.
10. All bonds filed by the Incumbent Trustees with the Court covering the performance of their duties as trustees of the Trust Estate are not released by this Order and shall be maintained and paid for by the Trust Estate until such time that the Court enters such further Orders specifically releasing such bonds.
11. David Paul Coon, Francis Ahloy Keala, Ronald Dale Libkuman, Constance Hee Lau and Robert Kalani Uichi Kihune are appointed trustees of the Trust Estate ("Interim Trustees") vested with full and complete discretion, power, and authority to exercise all trust powers with respect to the Trust Estate and its subsidiaries and affiliated organizations in a manner consistent with the Will of Bernice Pauahi Bishop and the Codicils thereto and subject to such duties, responsibilities, and fiduciary obligation as are imposed by law and under the Will of Bernice Pauahi Bishop and the Codicils thereto.
12. A vesting order shall be issued by the Court consistent with the provisions hereof.
13. The appointment of the Interim Trustees as trustees of the Trust Estate shall be effective immediately upon the filing of this Order and such appointment shall be of a limited duration subject to further order of the Court and subject to such terms and conditions provided herein and as may be further ordered by the Court.
14. The Incumbent Trustees shall immediately surrender their offices at the Trust Estate and all Trust Estate property in their custody or control to the Interim Trustees or such persons as designated by the Interim Trustees and, subject to the supervision and oversight of the Interim Trustees or their designee, the Incumbent Trustees shall remove their personal property from their offices at the Trust Estate within a reasonable time not to exceed 20 days from the date of filing of this Order.
15. The Incumbent Trustees are hereby ordered to cooperate fully and completely with the Interim Trustees to ensure that the transfer of authority shall be completed in a nondisruptive, orderly, and expeditious manner, including but not limited to the execution all documents required to effectuate such transfer of authority and title to assets of the Trust Estate and its subsidiaries or affiliated organizations.
16. The Incumbent Trustees shall not communicate with the employees, attorneys, agents and representatives of the Trust Estate and its subsidiaries and affiliated organizations regarding matters related to the Trust Estate and its subsidiaries and affiliated organizations and shall not have access to the records and resources of the Trust Estate and its subsidiaries and affiliated organizations except with the prior approval of the Interim Trustees, and only to the extent specifically permitted by the Interim Trustees.
17. The employees, attorneys, agents and representatives of the Trust Estate and its subsidiaries and affiliated organizations regarding matters related to the Trust Estate and subsidiaries and affiliated organizations shall not communicate with the Incumbent Trustees regarding matters related to the Trust Estate and its subsidiaries and affiliated organizations except with the prior approval of the Interim Trustees, and only to the extent specifically permitted by the Interim Trustees.
18. Modifications and/or enforcement of the terms and conditions of this Order may be permitted by the Court upon an expedited basis upon petition of an interested party.
DATED: Honolulu, Hawaii, May 7,1999.
______________________________
KEVIN S.C. CHANG
JUDGE OF THE ABOVE ENTITLED COURT
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