TRUST LITIGATION: WHO PAYS THE TRUSTEE’S FEES TO DEFEND CLAIMED BREACH OF DUTY?
Litigation between the beneficiaries of a trust and the trustees appointed in the trust instrument are not common but do occur. The reader should first review the articles on trusts, fiduciary duty and duties of trustees elsewhere on this website. The beneficiary can if necessary, bring legal action to ensure that the trustee comply with the fiduciary duty in all dealings with the trust.
A beneficiary has the right to petition the court to remove a trustee and may seek civil remedies against a trustee who the beneficiary proves breached his or her fiduciary duty. Note that the beneficiary has no such duty to the trust; only the trustee has a fiduciary duty to the beneficiaries and the trust. Personal liability attaches to the trustee who has violated the duty to the trust.
By far the most common claim is that the trustee was engaged in a conflict of interest, either enriching him or herself at the expense of the trust or failing to protect trust assets to his or her personal benefit. At times, the claim is more basic: the trustee simply ignored the trust duties and did nothing, putting trust assets at risk.
The typical steps in such litigation is for the beneficiary to retain his or her own counsel, make demand for a full accounting from the trustee, and if no such accounting is provided or is inaccurate or shows breach of duty, demand immediate resignation and compensation to the trust. If the trustee refuses, legal action can follow, and such action often includes both a petition to remove the trustee and to obtain compensation to the trust for all damages.
The trustee is normally defended by his or her own legal counsel and such litigation can last years and can costs tens or even hundreds of thousands of dollars. Note that during the litigation, the trustee can still insist that he or she receive trustee fees as allowed in the trust, though the beneficiary can insist that the trustee still needs to comply with full fiduciary duties to the beneficiary.
One thus has the seemingly odd situation that the trust continues to pay fees to a trustee currently being accused of wrongdoing and that trustee must continue to make trust payments to the beneficiary in conformity with the terms of the trust. As one trustee complained to the writer, “I’m making payments to her which she is using to pay her lawyer to sue me!”
Litigation in the United States normally lasts years and discovery and auditing of the trust records is an expensive and time-consuming process. A beneficiary fighting the trust will not want the trust to pay for legal counsel to defend the trustee. The question is, can the beneficiary insist that the trust not pay for the legal fees incurred in defending the trustee?
The Basic Law:
Duties Imposed by the Trust:
The trust instrument itself is the most important source for instruction on rights and remedies. While civil law does apply to all aspects of the trust (and even criminal law if intentional wrongdoing was involved) the judge will first look at the instructions to the trustee contained in the trust instrument to determine if the trustee is behaving in conformity with the trust.
The rationale is simple: the assets in the trust originally belonged to the person who created the trust and he or she should be the one to determine appropriate safeguards and actions for and against the trustee. Only if the trust instructions violate public policy significantly will the judge be likely to ignore clear instructions to the trustee in the instrument.
It is the power of the wording of the trust instrument that is often overlooked by the people creating a trust. They simply use a standard form and do not take the time to carefully consider precise wording for instructions that could not only avoid later confusion and dispute but will likely be binding on the judge.
As a typical example, if I leave my residence to the trustee, it is vital for me to indicate if the property is to be sold or, if retained, who gets to use, who pays for upkeep and maintenance, if rent is charged, etc. etc. All too often a dispute arises when one beneficiary wants to use property for free while another beneficiary wants to sell the property and divide the proceeds. The trustee is caught in the middle or, worse, the trustees are the two children and deadlocked. All that could have been avoided if the trust instrument is precise in its instructions.
But no instructions from the trust can allow a trustee to loot the trust or ignore the rights of a beneficiary. Those rights can be limited by the trust but cannot be ignored entirely. Again, as an example, I can instruct my trustee to withhold payments to a beneficiary if he or she becomes a drug addict or fails to earn their own way by becoming gainfully employed. The trust can withhold payments until the beneficiary achieves those criteria. But once those criteria are achieved, the trustee can not continue to withhold payments due the beneficiary without violating his or her duties to the trust.
And if the trustee is involved in a conflict of interest in which his or her interests are directly contrary to those of the beneficiary, that can only be allowed via very specific wording in the trust. As an example, I can put in my trust that the trustee can be employed to operate the business owned by the trust and pay him or herself a salary and bonus commensurate with others in the field. Even though the salary must be paid from the income of the business, thus reduce what the beneficiary gets, that is perfectly fine. But if the trustee begins to declare massive bonuses to him or herself even while the business is losing money, it is likely that the beneficiary could claim conflict of interest and bring legal action. Again, precise wording and reasonable actions by the trustee are vital to avoid conflict.
Duties Imposed by Law:
The duties of a Trustee may vary from state to state, but in general, a Trustee's duties include the following:
1. The Trustee has a duty to carry out the trust in accordance with the terms of the trust or will.
2. He or she has a duty not to delegate the Trustee's duties to another person-any duty which calls on him to exercise skill and judgment cannot be delegated, such as investment responsibilities. This duty does not prohibit him or her from hiring professional experts to evaluate the investments for their suitability to the trust.
3. He or she has the duty to exercise a reasonable degree of skill and care when managing the trust assets.
4. He or she owes the highest duty of loyalty to the beneficiaries to administer the trust solely in their best interests and put aside his or her own self-interests. No “conflicts of interest” are allowed at any time and full disclosure of any potential conflicts of interest must be made.
5. He or she has a duty to possess, protect, and preserve the trust property. He or she must also defend the trust and the beneficiaries against anyone who would challenge the validity of the trust or seek to claim trust assets.
6. He or she has a duty to separate and set aside the trust property and is required to keep the trust property separate from his or her own property. If the Trustee should co-mingle his property with the trust's property, he or she is liable for any losses that could result from the co-mingling.
7. He or she has a duty to make the trust property productive. He or she must act in a prudent, or sensible manner when it comes to investing, acquiring, selling, and managing the trust property. Appropriate tax planning for both the Trust and the beneficiaries is part of this duty.
8. Depending on the terms of the Trust instrument, the Trustee normally must file with the Court an accounting, often every year, indicating income and outgo and status of all assets.
It is important to note that the trustee is allowed to hire professionals to assist in performance of duties, from attorneys to assist with contracts and advice as to duties to accountants to assist with any financial duties. Such professionals are normally paid by the trust but report only to the trustee. The attorney is to perform in conformity with the instructions of the trustee.
And herein lies the crux: the attorney retained by the trustee is to follow the instructions of the trustee and the trust is the entity that pays for the attorney.
Paying for Breach of Fiduciary Duty?
When a beneficiary sues the trustee, it is typical for the trustee to utilize trust assets to pay the attorney to defend him or herself. This can be maddening to the beneficiary who sees finite trust assets utilized to defend a trustee who is claimed to be in violation of fiduciary duty. And, indeed, the beneficiary can petition the court to ban the trustee from having the trust pay his or her fees to defend.
Most times, the petition will not be successful. The rationale of the court is that until the trustee is proven to have breached his or her duty, he or she is entitled to payment of fees in defense. The trustee is presumed innocent until proven in violation of duty by a preponderance of the evidence.
This can be a very difficult proposition for a beneficiary who has to pay his own fees while the trustee has the trust footing the bill. Since the case can last years and cost hundreds of thousands, the burden can be insurmountable to a potential beneficiary.
But there are some bright spots for the beneficiary. If he or she wins, the court can require the trustee to repay not only the damages suffered by the trust, but the fees advanced by the trust to defend the trustee. Further, since a judgment against the trustee can be based on intentional wrongdoing, bankruptcy protection may not be available to the trustee since the discharge in bankruptcy will not apply to judgments predicted on intentional wrongdoing. If the trustee is also a beneficiary, then that trustee’s right to future income and trust assets allocated to him or her can be attached.
And if the evidence is truly overwhelming, such as e mails from the trustee apologizing for the conflict or thefts and promising to pay them back, then an immediate petition to the court may very well result in removal of the trustee and thus ending his or her access to trust assets to defend.
But minus such evidence, the beneficiary suing the trust can expect the trustee to have the fees paid until the beneficiary proves his or her case.
Relief is available for a wronged beneficiary, but the burden of proof and the expense are placed upon the beneficiary until wrongful conduct is demonstrated at which point there is a good chance the beneficiary will be made whole. Since most cases settle before trial, the ability to retrieve not only damages but the fees paid to opposing counsel is one more bargaining chip on the table for the beneficiary.
But as with all litigation, be careful before starting it. Since an accounting is the first step in any conflict with the trustee, the final decision as to whether to commence full litigation should await a close and objective review of the economic history of the trust and the reported actions of the trustee.