Litigation has now commenced over whether the Maddox Foundation’s assets have been diverted from their charitable purposes. The State of Tennessee (represented by the Davidson County, Tennessee District Attorney) is asserting that there has been a breach of duties, that the Foundation’s assets should have never left the state of Tennessee, and that those assets have been mismanaged. One of the two trustee/directors has given an Affidavit dated August 30, 2004 (the “Affidavit”) in the lawsuit commenced by the State of Tennessee against the other trustee/director. Our copy of the Affidavit is unsigned. We also have an unsigned copy of the Complaint, which is based on the same factual allegations set out in the Affidavit. As is often the case in these disputes, the facts and allegations could serve as the basis for a soap opera....
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It is impossible to discuss the larger lessons from this dispute without first focusing on the “juicy” factual aspects of the litigation. But when all is said and done, this case has important lessons that go well beyond the allegations of mismanagement and breach of duties.
BACKGROUND
The Maddox Foundation Trust (the “Trust”) was established in 1968 to sustain, in perpetuity, the charitable legacy of Dan W. and Margaret Maddox, longtime residents of Middle Tennessee who died in a tragic accident in January, 1998. At that time, Robin G. Costa (“Costa”) and Tommye Maddox Working (“Working”), the step-granddaughter of Dan and Margaret Maddox, became the two trustees of the Trust. The terms of the Trust provide that the number of trustees is never be less than three. Not surprisingly, the trust instrument required Working and Costa to jointly select a third trustee. [Affidavit, Paragraphs 1-15]
In June of 1999, Working and Costa, in their capacities as trustees of the Trust purportedly transferred the situs of the Trust to Mississippi because Mississippi law was viewed as more favorable. Costa argued that the transfer would better insulate the trust from litigation by other Maddox family members located in Tennessee. Neither the Tennessee Attorney General, nor the District Attorney General of the State of Tennessee were given notice of the transfer despite the presence of charitable assets. Nor did the two trustees apply for court approval for the transfer of the assets out of Tennessee. We assume that some sort of notice or approval was required. [Affidavit, Paragraphs 27-33]
The trustees were authorized under the terms of the trust instrument to form a non-profit corporation to hold the Trust’s assets and carry on its charitable activities. On September 13, 1999, the Maddox Foundation Corporation (the “Maddox Foundation”) was incorporated as a Mississippi nonprofit corporation. The articles of incorporation and by-laws of the Maddox Foundation provided Costa with extraordinary powers, appearing to permit her to make decisions without regard to the other members of the board of directors (Working). According to the Affidavit, Costa is the administrator of certain trusts and the executor of the Maddoxs’ estates. These trusts and the estates hold assets that are to eventually be transferred to the Foundation. [Affidavit, Paragraphs 16-26, and Paragraphs 34-46]
THE ALLEGATIONS
As you have already probably guessed, the trouble began shortly following the transfer of assets from the Tennessee entity to the Mississippi entity. According to newspaper accounts and allegations in the Affidavit:
A. The Foundation purchased the Memphis RiverKings, a professional hockey team, and the Memphis Xplorers, a professional arena football team. The total expenditures for these purchases were at least $1,760,000. This information comes from the Affidavit, but these transactions have been widely reported in the local press. See, September 1, 2004 Tennessean article by Jay Hamburg entitled “D.A. Files Suit to Force Charity's Return."
B. The Maddox Foundation apparently had a beneficial interest in stock of American Retirement Corporation—it appears that the stock was held by an estate or a trust that would eventually transfer the assets to the Foundation, but this is not clear. Costa allegedly served as a director of ARC and member of the ARC board’s audit committee. The Affidavit alleges that Costa failed to sell the Foundation’s ARC holdings (even though she was advised to) because of conflicts of interest. Working then alleges that the value of the Foundation’s assets has been depleted because of this failure to sell. ARC was apparently formed by Dan Maddox and several other individuals. The complaint alleges that the Foundation’s interest in ARC has a basis of $29 million, and that the stock has lost more than 85% of its value since December 31, 2003. [Affidavit, Paragraphs 51-56]
C. The Affidavit makes allegations regarding excessive compensation and mismanagement of the Foundation’s assets. There are other allegations involving computer-training seminars in Cancun, Mexico, a chartered jet to attend President Bush’s inauguration and Tennessee football games, a seminar in California that was really a shopping trip, payments to a housekeeper and baby sitter by the Foundation, payments for home office equipment and cell phones, a trip to the Virgin Islands, a trip to a gambling casino, and a trip to a spa. [Affidavit, Paragraphs 76-85]
D. The Affidavit describes a sexual harassment and wrongful termination suit against the Foundation brought by an ex-assistant general manager of the hockey team who allegedly had a physical relationship with Costa. [Affidavit 86-95]
Anybody can make allegations, and Working and the State of Tennessee will have to prove these as part of the lawsuit. In fact, Costa has denied the allegations through an attorney. The attorney referred to the District Attorney General's complaint/Affidavit as containing ''scurrilous'' charges and allegations that have ''no basis in fact.'' See, September 7, 2004 Tennessean article by Jay Hamburg entitled "Former Friends Clash in Lawsuit Over Charity."
There are two facts worth keeping in mind. First, the complaint does refer to credit card receipts as support for the allegations. At this point it bears repeating, anybody can make allegations. However, somebody has some explaining to do if there are gambling casino and spa charges on Foundation credit cards. Second, we assume the District Attorney General did some due diligence before taking sides in this dispute.
Under Tennessee law, the District Attorney General's office is responsible for protecting the public's interest in charitable trusts. It is the District Attorney General’s position that by moving the Foundation to Mississippi, Costa harmed countless charitable organizations in Nashville that would have received donations from the Foundation. As a consequence of the allegations set out in the Affidavit and a Complaint filed the District Attorney General, the District Attorney General is seeking the removal of Costa from any position of authority with the Maddox Foundation and its related entities and is calling for an accounting of the Foundation assets during the time Costa had management responsibility.
LESSONS
The truth will come out as the legal proceedings grind their way through the legal system. But there are already a couple of lessons for those who are interested in setting up a family foundation.
A. The legal documents creating the Trust and the Foundation required a minimum of three trustees and three directors. However, only two were named in the trust instrument. From the outset, the documentation required the two named trustees (Costa and Working) to select the person who would effectively break any deadlocks. This was a prescription for the disaster which is currently unfolding.
Too often, family patriarchs believe that subsequent decision makes will get along, but the patriarchs fail to take into the account the effect that money and power can have on people. The potential for disputes can be exacerbated when the second and third generation trustees or directors are siblings or cousins—not the case in the Maddox Foundation case. Now there are family dynamics involved.
Consider the following two examples: The family patriarch may believe that he or she always treated his or her two children equally, but Mary may have always felt that dad treated Suzie better, particularly after Suzie married a football player while Mary had a lesbian relationship. Or Rick may believe that Uncle Fred took advantage of Rick’s father, Joe, when Uncle Fred and Joe ran the family business. Now that both Uncle Fred and Joe are deceased, Rick has a score to settle with his cousin Steve.
Family patriarchs must put in place a system for decision-making that anticipates these sorts of sentiments while providing for the flexibility that is necessary to deal with a future that is not knowable when the initial legal structure is erected. While family patriarchs cannot entirely eliminate the potential for conflict, they certainly can do a better than Mr. and Mrs. Maddox did. While the Maddox case doesn't involve siblings, both Costa and Working assisted Maddox and apparently viewed him as a mentor.
B. The newspaper accounts and legal proceedings paint Working as a naïve person who lacked business acumen. While the senior Maddoxs died in a boating accident, both were getting on in years. If Mr. and Mrs. Maddox wanted Working to be involved in the operation and management of the Foundation, they should have provided her with the necessary training and experience long before she was thrust into Foundation’s management and affairs
Too often, family patriarchs believe they will live forever. Unfortunately, this belief often serves as an impediment when it comes to acclimating the next generation to the responsibilities that it will eventually assume.
Family patriarchs must involve their children and grandchildren in the stewardship of family money and charitable foundations long before the patriarchs leave the scene. This may mean making them officers of a family foundation, having them attend meetings and meet with foundation advisors, or even giving them control over limited number of charitable assets so that any mistakes can serve as valuable, but less costly, learning experiences.
C. The Affidavit alleges that a number of professionals have offered advice to the parties over time, with allegations that Costa received advice regarding conflicts of interest, tax issues, and investment strategies that may not have been followed. Only time will tell what the actual facts are in this situation. However, there is a lesson in the allegations for others.
If you do set up a family foundation, your contributions to the foundation are no longer legally yours to do with as you like. If you read the District Attorney General’s complaint in the case, you will see that Tennessee law gives the State of Tennessee jurisdiction over these assets, or at least that is the view of the District Attorney General.
This is not to say that you and your family cannot be involved in the selection of charitable beneficiaries. But an entire set of corporate, charitable, and tax rules come into play. That means that you need qualified advisors and that you should heed their advice. By qualified, we do not mean the attorney for the family business, but people who actually counsel foundations. The legal rules applicable to private foundations, particularly the Federal tax rules, are incredibly complex. Mistakes are easy to make and can be very costly to fix. If the Maddox allegations turn out to be true, we may see the IRS assess taxes on excess business holdings and self dealing. And there well could be criminal charges. See our post on the King Foundation case.
D. On a more technical note, the lawsuit raises issues as to the rights of directors and trustees to see foundation documents. When Working went to Mississippi and demanded copies of the documents, she was apparently permitted to look at them, but was told she could not make copies and would have to sign a confidentiality agreement. Her counsel advised against signing the the agreement. Hopefully the lawsuit will clarify the rights of directors/trustees to information.
Foundations can be devices for good. However, those that run Foundations must understand that they are fiduciaries with respect to the Foundation’s assets rather than owners of the assets. This can be a difficult distinction to make when the Foundation’s assets came from members of one family and those or other members of the family are now charged with running the foundation. The patriarch who sets up the family foundation should provide those that will follow in his or her footsteps with a well though out plan for governance, early training, and a group of reliable and competent advisors. This is particularly important when family dynamics or prior relationships are likely to influence behavior.
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