As discussed in our articles on Trusts and Wills and Fiduciary Duty, the Trustee and Executor owes to the beneficiaries of a Trust or Will a fiduciary duty, the highest duty known to law. This duty imposes personal liability on the Trustee to act in accord with the best interests of the beneficiary.
However, many Trusts have different categories of beneficiaries. For instance, a typical Trust can have income paid to the spouse during his or her life with the right to invade for need…and upon that spouse’s death, what is left over is paid out to the next generation. In Trust parlance, the person receiving the immediate benefit is the “beneficiary” or “income beneficiary” while the people who are to receive the largess only after the beneficiary has died are the “remainder beneficiaries.”
How is the Trustee to coordinate and balance the interests of the two classes…or indeed with more classes if they exist. For example, assume an income beneficiary has a need for a great deal of income…thus wants high risk investments that generate high income. But the remainder beneficiaries, worried about drops in the market, and not receiving any income in any event, want very conservative investments and claim the Trustee is in violation of his duty if he invests in risky investments. How is the Trustee to decide? Are there rules and guidelines?
Yes there are and this article shall outline them.
THE BASICS: THE DUTY TO DEAL IMPARTIALLY WITH ALL BENEFICIARIES
Under California Probate Code 16003, if a trust has two or more beneficiaries, the Trustee has a duty to deal impartially with them and shall act impartially in investing and managing the trust property, taking into account any differing interests of the beneficiaries.
Trustees are saddled with a duty of impartiality and must treat future and income beneficiaries fairly and equitably. Restatement (Second) of Trusts 183 (1995).
According to comment (c) to Restatement (Third) of Trusts 227, the interests of a life income beneficiary are “almost inherently in competition with those of the remainder beneficiaries…these conflicting fiduciary obligations result in necessarily flexible and somewhat indefinite duty of impartiality. The duty requires the Trustee to balance the competing interests of differently situated beneficiaries in a fair and reasonable manner.”
A Trustee must struggle to structure the trust’s investments to balance the investment desires of the current and future beneficiaries.
Bowles v. Superior Court (1955) 44 C2d 574. The court held that no Trustee can properly act for only some of the beneficiaries-he must represent them all or he cannot properly represent any of them.
The Trustee must balance the interests of remainder and income beneficiaries
Restatement Second of Trusts 232- Because of the duty of impartiality to balance competing interests, a Trustee cannot invest solely or primarily in assets that have no potential for capital appreciation but produce a high stream of income unless the trust agreement specifically provides. Nor can the Trustee invest solely or primarily in aggressive growth stocks that produce little or no income. Restatement 232, comment b.
In Estate of Bissinger (1963) 212 CA2d 831 an income beneficiary objected that not enough stocks were sold to produce adequate income, but the remainder beneficiary objected to the sale of low income producing stocks made in order to buy bonds producing higher and more regular income for the income beneficiary. The court concluded that the Trustee acted prudently by selling part of the stock rather than all or none, stating that neither the income beneficiary nor remainder man “advocated a course that would not have ignored the claims of the other.”
In Bissinger the court held that where the Trustee is directed to pay income to a beneficiary for a designated period and on the expiration of that period to pay the principal to another beneficiary, the Trustee is under a duty to the former beneficiary to take care not merely to preserve the trust property but to make it productive so that a reasonable income will be available for him, and he is also under a duty to the latter beneficiary to take care to preserve the trust property for him. Although the Trustee is not under a duty to the beneficiary entitled to income to endanger the safety of the principal in order to produce a large income, he is under a duty to him not sacrifice income for the purpose of increasing the value of the principal. Thus the Trustee is under a duty to the life beneficiary not to retain unproductive property or low income property although it is probable that the property will appreciate in value. On the other hand the Trustee is under a duty to the beneficiary who is ultimately entitled to the principal not to purchase or retain property which is certain or likely to depreciate in value, even though the property yields a large income, unless he makes adequate provision for amortizing the depreciation. Therefore, he has to balance the interests of all beneficiaries.
Many states provide methods for a Trustee to attempt to balance the interests of current and future beneficiaries. These methods include: the power to adjust under the Uniform Principal and Income Act, unitrust statutes and the Uniform Management of Institutional Funds Act. See also the Prudent Investor Rule discussed elsewhere on this web site.
TERMS OF THE TRUST
But a Trustee’s duty of impartiality may be modified by specific language in the instrument by the Settlor. Such language may be mandatory, directing the Trustee to favor specific beneficiaries or classes, or may be precatory, merely asking the Trustee to consider the needs of one beneficiary first.
Although the Trustee has a duty to treat all beneficiaries equally, the terms of the trust instrument need to be taken into consideration. The trust instrument may excuse the Trustee from “rigid adherence” to the duty of impartiality. See 2-96 California Wills & Trusts 96.03, Probate Code 16000. The trust may specify that the rights of remainder men are subordinate to the rights of income beneficiaries or may authorize the Trustee to take certain actions (such as making certain tax elections) that will have the clear effect of favoring one class of beneficiaries.
For example a trust can state that his spouse’s welfare is paramount, etc. In Estate of Colyear (1970) 20 CA3d 670, 677, the court held that they should look to the provisions of the will to see if there was specific direction or a general pattern indicating that preference should given to the income beneficiary or to the remainder men. Absent some indication it is presumed that the testator did not intend to give preferential benefits to the remainder men or to the income beneficiary and the Trustee is then required to use his discretion so as not to favor one class of beneficiaries over another. If the testators intends otherwise, a clause is often inserted stating that in the case of doubt the rights of one group shall be paramount to the rights of another.
Thus, the duty to deal impartially applies to remainder men as well as to current beneficiaries except where the trust instrument indicates differently.
TRUSTEE’S BEST JUDGMENT
If the clauses of the trust directing preference are too subjective for the Trustee to follow confidently, he or she must use his or her best judgment in carrying out the terms of the trust and following the intent of the Settlor. Estate of Colyear (1970) 20 CA3d 670, 677, See California Trust Administration (Depper & Bernstein) §3.41.
But if there is anyway the Court can determine what the Settlor wished, the Courts are firm that the Trustee is to follow those directions.
Wells Fargo Bank v. Eda Sherman Huse (1976) 57 Cal. App. 3d 927 (The trust is to be interpreted according to the intention of the Settlor.); Lillian Stanton v. Wells Fargo (1957) 150 Cal. App. 2d 763 (It is the general duty of the court to enforce the provisions of the trust instrument. In Stanton the court also noted that almost all interested parties in the trust sought a certain action, and the fact that almost all of the parties sought the same thing was “a factor to be considered.” Therefore, the amount of interested parties who desire a particular act does matter.)
Conclusion:
A well written clear instrument is by far the preferable method to instruct the Trustee. It was (or is) after all the Settlor’s property and up to him or her to determine how it is to be held. The Settlor, when drafting the trust language, is well advised to attempt to find the right mix of flexibility for the Trustee so that he or she can adjust to an unknown investing climate, and clear directions so that the Trustee has a good idea of the goals of the Settlor. Time spent drafting careful language can save a great deal of anguish and, perhaps, years in expensive wrangling in court.