Introduction:
Living trusts have become part of most estate plans in California since that structure allows families to pass assets to the next generation without the expense and delay of formal probate that having only a will entails. As discussed in detail in our articles on estate planning and trusts, the use of a trust has significant benefits for the average family and for those with substantial wealth can save a great deal of money in administrative costs and taxes.
But the increasing use of trusts has led to increasing levels of litigation involving the trusts. Most people do not have any experience acting either as trustees or beneficiaries and errors are often made which can result in rancorous litigation. Since a trust, if engaged in business or owing significant property, can last decades or longer with the trustee(s) managing or operating businesses for the benefit of the beneficiaries, such litigation can arise in the business context as trustees are alleged to be operating the business or investments poorly or with a conflict of interest.
And unlike most litigation which has statute of limitations that bar action after one or two years, or, at most, four years, trust litigation often tolls the date for the statute of limitations for many more years, often for decades. A minor beneficiary may bring action when he or she attains maturity and that can be twenty years after the alleged wrongful act. Further, if the act is only discovered after decades, the beneficiaries can bring that action even after the trustee has died. This office has brought action against trustees for acts occurring forty years prior to filing the action.
And note that the trustee has personal liability to the beneficiaries in many cases. Unlike the protection that may exist for actions alleged against limited liability entities such as corporations and limited liability companies, the Trustee must personally defend and, at times, personally pay out damages to the Beneficiaries who prove their case.
This article shall discuss the basic law and strategy of trust litigation.
The Role of the Trustee, Trustor, and Beneficiary:
Ultimately, a Trust is an agreement involving three parties. The “Trustor” is the person or persons creating the trust. The “Trustee” is the person or persons (or entity) agreeing with the Trustor to hold assets placed into the trust for the benefit of third persons. The third persons receiving the ultimate benefit of the trust are the “Beneficiaries.” A person can occupy multiple positions, e.g. a Trustor can also be a Trustee and/or Beneficiary.
Often the Trustor is also acting as the Trustee and the beneficiary until the death of the Trustor at which time the Beneficiaries become the children or other family members of the Trustor and a successor Trustee named in the Trust assumes the role of Trustee.
EXAMPLE: Husband and wife create a trust in which each serves as Trustor, Trustee and Beneficiary. They have the right to revoke the trust and receive all income. Upon the death of one, the remaining spouse then serves as sole Trustee and Beneficiary, receives all the income and can only revoke one half of the trust. Upon the death of the surviving spouse, one or more of the children assume the role of Trustee while they and other siblings are the Beneficiaries. This allows the assets to go to the children without probate and depending on the wording of the Trust, the Trust may last many more years or be immediately distributed outright to the children or grandchildren. See our article on Revocable Intervivos Trusts for a more detailed explanation.
For the purposes of this article, the key aspect is that the Trustee owes a fiduciary duty to the Beneficiaries. That duty is to act in all respects so that the interests of the Beneficiaries are protected by the Trustee. It is the same duty a parent has to a child, a spouse has to another spouse and a lawyer has to a client. It is the highest duty known to law and violation of that duty imposes personal liability upon the
Trustee.
EXAMPLES: A typical claim brought by a Beneficiary is that the Trustee paid himself or herself too much money for running the Trust or stole money from the Trust. Another example: an uncle becomes the Trustee for a minor child of the now deceased parent and until the child reaches the age of eighteen, handles the various investments in the Trust. When the child becomes eighteen, she is entitled to distribution of the remaining assets in the Trust. She discovers at that time that the Trustee has borrowed money from the Trust for his own business, did not charge interest and was not credit worthy himself. Even if the inappropriate borrowing occurred ten years before, she could sue him for breach of fiduciary duty.
The Terms of the Trust:
Since the Trust is a document created by the Trustor and agreed to by the Trustee, it can alter the requirements that apply to actions of the Trustee. Often, the Trust limits to some extent the liability of the Trustee, often providing that errors in judgment do not result in liability being imposed upon the Trustee and those limitations are binding upon the Beneficiaries. Many Trustees would refuse to serve if such protective language was not inserted into the Trust.
However, no wording can protect the Trustee who engages in dishonest action or is in a conflict of interest.
EXAMPLE: Assume a Trustee is operating a business but negligently fails to supervise some of the employees and because of that the business loses money. If the Trust bars actions for negligence against the Trustee, no action would lie. However, if the Trustee received a bribe from one of the employees to look the other way, then regardless of the wording of the Trust, the Trustee would be liable for intentional breach of trust.
Trust Accountings: Protection of the Beneficiaries and Trustee:
In probate, executors of estate and Trustees of trusts subject to court supervision must file regular accountings of all their actions with the court, copy to all beneficiaries, who have a right to object to any irregularities and ask the court to step in to control the errant executor or Trustee.
Most Trusts limit the accountings that a Trustee must file by their own terms or the Trustee may ask for a waiver of accountings from the Beneficiaries. The idea is that accountings are time consuming and can be expensive when accountants are required. Note, however, that taxes have to be paid either by the Trust or the Beneficiaries on income derived, so an accounting is required in any event though not often as detailed as that filed with the court.
We normally advise our fiduciary clients to err on the side of giving too much, not too little, information to the Beneficiaries. Beneficiaries are always curious as to what is happening to assets that may eventually to go them and letting them know what the Trustee is doing to protect and improve the assets is a good idea almost always. Indeed, we have found that most trust litigation arises when Beneficiaries feel deprived of accurate information or receive inaccurate or incomplete information from the fiduciary.
Court accountings are not only far more detailed, but most courts have their own rules as to precisely how they must be prepared, down to the penny. The accounting voluntarily provided to Beneficiaries need not conform to those precise methods but must be accurate and complete and an accountant should be part of the team.
Note that if an accounting is received by the Beneficiaries without objection, that is a powerful defense to be available to the Trustee should later complaints be made…so long as it is accurate. And if the court approves an accounting, that can act as a full bar against later action.
This also means that any Beneficiary receiving such an accounting should carefully review it, with professional assistance if necessary, to determine if any objection is warranted.
The Fiduciary Duty:
Note that the fiduciary duty is one way: only the Trustee has it and has it both in terms of the relationship with the Trustors and the Beneficiaries. And that is true when the Trustee operates a business for the trust, sells assets of the trust, or interacts with the trust. This high duty is not only personal but is extremely dangerous for a Trustee to ignore.
The most common error of a Trustee is to engage in a conflict of interest. Put simply, that means the Trustee engages in a transaction in which the Trustee or someone in the Trustee’s family benefits to the detriment of the Trust. Commonly, this is some type of business transaction or sale of asset or access to Trust assets.
It can be far from black and white. Assume a Trustee hires his wife to do the bookkeeping for a business run by the trust. If she performs adequately and is paid fair market value, the odds are good that no court would find that a conflict of interest. However, if she is not qualified, creates erroneous books and/or is paid above the going rate, that could be a conflict of interest with the Trustee and a violation of the fiduciary duty.
The best method is for the Trustee to make sure all beneficiaries are aware of that type of transaction and to address any concerns they may have. All too often, the Trustee becomes irate at the suggestion of wrongdoing, cuts off communication, and anger builds on the part of the Beneficiaries. That is when lawyers are likely to come into the picture.
One Trustee put it to the writer well. “If objections are heard, no matter how subtly put, I take time to truly decide if there is cause. If there is any chance there is, I change my method, even if I am convinced I am right. I’m the only one really at risk-I’m the fiduciary. If I am found to be wrong, I face liability. If the Beneficiary is found to be wrong…they face no liability. No brainer…”
The Mechanics of Trust Litigation:
Depending on the terms of the Trust, most disputes end up in a court of law, often the probate court, with one or more beneficiaries filing suit to have the Trustee removed, account for all sums spent, and to repay the Trust for damages. Some Trusts provide for arbitration of all disputes.
The Trustee responds in the court, discovery ensues, and a court trial can occur. The process can take years, cost many tens of thousands, and during the case the Beneficiaries can attempt to have the Trust taken over by a temporary fiduciary until the court determines if the fiduciary duty was violated.
More often than not, the Trustee wants the trust to pay the costs of defense and while the Beneficiaries can object, most courts will allow that, but will insist the Trustee pay the Trust back if the fiduciary duty was found to be violated.
The standard rules of evidence apply, and the trial is similar to any one encounters in any other case. Usually there is no right to a jury in most probate cases, but there are exceptions.
Court Approval:
It is possible in most trusts to have the Trustee petition the court for instructions as to how to handle a particular transaction or matter. The Beneficiaries are given notice and can voice their concerns, but the decision of the court will normally be binding upon the parties and the Trustee nervous about possible litigation may find protection in that relatively inexpensive solution.
Trustee Fees:
Most trusts provide for what fees can be paid for the Trustee services and when those fees are paid. Most courts have schedules as to appropriate fees. It is vital for the Trustee to comply with the trust terms and, if necessary, get court approval before pulling fees out and, as always, keep all Beneficiaries fully advised as to that aspect of trust administration.
Practicalities:
The legal process is expensive both in terms of fees and costs and emotional effort. Most trust fights are essentially family fights and the emotions can become deeply involved. One should not enter into such litigation lightly.
The problem often stems from lack of understanding on the part of Trustees as to their actual fiduciary role. Few train to be Trustees, few realize the personal obligations such a role places upon a person, and when one suddenly is operating a business or managing millions of dollars of property, the lack of expertise is often ignored. Some Trustees become self-important, seeming to think that their role grants them uninhibited discretion to operate the trust assets as they wish. Others are ignorant of the restrictions placed upon them and quickly hire family members or friends to operate the business or assets, not bothering to utilize the cost benefit analysis that any business must undertake. Many Trustees are shocked at the time and effort required to perform their tasks and feel that the family or other beneficiaries do not understand the tremendous effort required to be Trustee.
Conversely, most Beneficiaries do not grasp the extent of work required to be a good Trustee and themselves are ignorant of the appropriate role and responsibility of a Trustee. They see the Trustee defending his or her fees or role as simply grousing and failing to take the Beneficiaries’ objections seriously.
In reality, courts are loathe to second guess a Trustee on business decisions made or the day to day administration of a Trust. It is only when conflicts of interests seem to arise that the courts become determined to investigate and right the situations. Self-dealing is the core aspect of most successful actions against Trustee. Even if negligent rather than intentional, some courts have found such negligence so inappropriate as to justify both removing the Trustee and charging the Trustee to repay the sums wrongfully spent…and perhaps even the Trustee fees previously paid.
Courts will follow the wording of the trust closely, so a good first step for any potential party in trust litigation is to closely read the document, determine rights and remedies and only act with a thorough knowledge of that instrument.
If information is sought to determine what acts have occurred, the Beneficiaries are wise to make formal written demand for such information, setting a reasonable time span for response. Failure to provide accurate and full information may expose the Trustee to an angry court, so the Trustee receiving such a formal demand should take it seriously and either respond completely in writing or have a good legal reason why it is not necessary.
Mediation of differences may be useful since we have found that much of trust litigation stems from lack of communication and suspicion rather than hard evidence of wrongdoing. Again, the wise Trustee makes sure the Beneficiaries are fully informed as to all important matters and realizes that there should be no problem with communicating events. After all, the assets are held in trust for the Beneficiaries and they have every right to know what is happening with property they own, do they not?
Conclusion:
To become a Trustee is a serious undertaking, one that is greater than most of us have ever assumed. Few who have not occupied that role grasp the effort required and most Beneficiaries are both impatient to receive the monies due them under the Trust and to minimize the cost of getting it. Trustees must understand that state of mind of the average Beneficiary and take all steps necessary to achieve an efficient, appropriate and effective trust administration in which information is regularly and fully given to the Beneficiaries.
But Beneficiaries have to be reasonable in their demands as well, especially when the Trustee is not sophisticated in business or property matters. A Trustee is entitled to obtain professional advice, at Trust expense, and is wise to do so, but the Beneficiary should make sure that emotions are not coloring expectations.
That said, there are many instances in which Trustees have violated their duty to the Beneficiaries and the wise Beneficiary should make sure all the information required is received or take immediate steps to obtain the information and review it carefully. Any Beneficiary has a right to be informed as to trust activities and to have a copy of the trust instrument and should information be withheld, or actions not be justified, prompt action be taken.
There is relief available both for wronged Beneficiaries and for wronged Trustees but before embarking on the road to litigation, efforts should be made to investigate the situation and to resolve the differences as amicably as possible. Only if those efforts are not successful should the parties turn to the courts for remedy.