10 Steps Fiduciaries Can Take to Avoid Litigation
Litigation between trust beneficiaries and trustees is on the rise. Whether you perceive this growth as resulting from the ignorance or greed of the beneficiaries or that of the fiduciaries may well depend on your own orientation. This article details 10 steps that trustees can take to avoid litigation with their beneficiaries. At first blush, these actions may seem like little more than common sense, but experienced trust and estate litigators have nonetheless found them to be at the root of many intense and costly legal battles.
1. Read the trust instrument. Fiduciaries are often first contacted by a long-time lawyer or financial planner for the trustors’ family regarding the fiduciary’s role as trustee. These individuals often have intimate knowledge of the trustors’ intentions and can explain how the trust is intended to operate. This is wonderful information, but it may not be accurate. For example, a drafting error could have been made and the actual language of the trust may not provide for its administration as intended, or an overzealous representative could overstate the terms to benefit his or her client, such as a representative of a surviving spouse with respect to a trustor’s child from a previous marriage. It is imperative that a fiduciary read and understand the terms of the trust, including all of the boilerplate provisions that most trust instruments contain. Reliance on another’s summary, or on the belief that the document is a “plain vanilla” trust, is often times disastrous.
2. Understand the estate plan as a whole. As a trustee, it is very important to understand the estate plan as whole and the intentions of the trustors in formulating the estate plan. For example, you might find that the trustor, by including common language allowing a surviving spouse to invade principal even if it depletes the trust in its entirety, truly meant that he desired his spouse to be able to deplete the trust. But perhaps the opposite was true, and the deceased trustor really intended his wife to only get the income because she has sufficient other resources, so that invading principal would not likely be needed. The trustor’s intentions can be gleaned from at least four sources – a review of the trust instrument, a review of accompanying estate planning documents, historical estate planning documents, as well as interviewing the trustor’s last estate planner for background information. These sources will provide insight into and an opportunity to inquire as to whether the fiduciary might end up in the middle of a trust contest by omitted heirs (or heirs with a more limited bequest than from prior instruments) as well as assist the fiduciary in interpreting trust provisions and may lead the fiduciary to seek court instruction regarding certain provisions that otherwise had seemed clear.
3. Obtain financial information. Financial planning documents, such as beneficiary designations for insurance policies, retirement plans and title documents, will also assist the fiduciary in learning the lay of the land. These documents provide insight into the distribution of assets other than trust assets. Again, this is useful to determine the trustor’s intent in creating the trust and will provide further information to the fiduciary to determine if there could later be a trust contest. It might also assist the fiduciary in diffusing a situation with any unhappy heir, inasmuch as he or she may have received substantial assets outside of the trust. This documentation may also provide the fiduciary with information regarding the interpretation of a trust provision leading the fiduciary to seek court instruction regarding interpretation of provisions that had previously seemed clear.
4. Determine family dynamics. Family dynamics are a key factor in determining whether a beneficiary or omitted heir will be litigious whether by bringing a trust contest or suing the fiduciary for each and every action. The relationship between the beneficiaries, although it does not give rise to a claim, is often the deciding factor in a beneficiary’s determination to bring a claim or not bring a claim. Strained relations lead not only to contests, but also to actions against fiduciaries for perceived favoritism.
5. Obtain approval of actions. It seems rather obvious, but the best way for fiduciaries to avoid litigation is to obtain approval for their actions. This can be done by obtaining a consent for a future action from all beneficiaries, a ratification of a past action by all beneficiaries or by bringing, in many jurisdictions, a petition for instructions regarding a proposed action. It is astounding how often trust litigators see fiduciaries facing breach of fiduciary claims which could have easily been avoided by simply filing a petition for instructions. Obtaining approval is useful in a multitude of situations. A few examples include selling a stock that the trustor held onto for many years, but creates an undiversified portfolio, disposing of a family heirloom, selling assets to a family member, interpreting a trust provision that would impact one or more of the beneficiaries, or taking action to settle or enforce trust claims.
6. Know your duties to your beneficiaries. In every jurisdiction, fiduciaries owe the highest duties to their beneficiaries. In some jurisdictions, these duties, such as properly managing assets, are increased if the fiduciary is a professional. The basic duties fiduciaries owe to beneficiaries include a duty of loyalty, avoiding conflicts of interest, avoiding self-dealing, duties with respect to trust property and investment management, the duty to report and account to beneficiaries, a duty of impartiality, and enforcing and defending claims on behalf of the trust. It is critical for the trust officer to know each and every duty he or she owes to those with a beneficial interest in the trust, but it is even more important to understand how such duties function in the every day setting. Awareness of these duties should cause the fiduciary to examine each action for a potential breach and then determine if the action, under the law, is an actual breach. A fiduciary’s intimate knowledge of what actions are permissible is vital to avoiding claims by a beneficiary.
7. Communicate with your beneficiaries. Most jurisdictions require trustees to account and report, in some fashion, to their beneficiaries. However, such reporting is not required in all circumstances. Despite any obligation to report and account to your beneficiaries, it is always wise to keep your beneficiaries as informed as possible regarding your actions and communicate frequently with them. Reporting and communicating solves two problems. First, in some jurisdictions it may begin the clock running on any statute of limitations to bring a claim. Second, it enhances the relationship and limits the distrust beneficiaries sometimes feel when kept in the dark about trust management.
8. Know your duties with respect to your co-trustees. Often times trustors appoint a relative along with a corporate fiduciary to act as co-trustees and very often in those situations, the corporate trustee and the individual trustee disagree on proper trust administration and asset management. In some jurisdictions, unless the trust states otherwise, unanimous consent is required of the co-trustees before any actions can be taken. It would appear that a simple solution would be to delegate responsibility between the disagreeing trustees. However, strict rules govern the delegation of powers, including the duty to supervise and monitor the actions of the delegatee and to object and correct situations when the delegatee is taking inappropriate action. Thus, if the co-trustees have a disagreement, simply delegating away responsibility is not a viable solution. If the disagreement between co-trustees causes a stalemate so that no action can be taken, the trustee who believes that action is prudent should seek approval of the action from the court.
9. Contemplate utilizing the power of adjustment or conversion to a total return trust. It is very typical that a trust has both income beneficiaries and remainder beneficiaries. Given the duties of loyalty and impartiality and the adoption of the Prudent Investor Rule in many jurisdictions, the tension between income interests and principal interests is magnified. The income beneficiaries’ interest in maximizing income clashes with the remainder persons’ interests in maximizing preservation and growth of principal (or keeping principal growing at least to meet the rate of inflation). In response to this tension, many jurisdictions have adopted so-called “Total Return Laws” applicable to trusts following the decades-old distribution formula, namely, “net income” to the income beneficiaries, residue to the remainder beneficiaries. The new laws free the trustee to diversify and invest prudently for maximum total after-tax adjusted return (again consistent with applicable fiduciary principles of diversification, caution, and prudence) without punishing the “income” beneficiaries with a portfolio that is dramatically skewed in favor of equities over debt securities. The laws of some states enable trustees to adjust between income and principal to prudently invest for the benefit of all beneficiaries, while the laws of other states allow trustees to convert a trust to a so-called “unitrust,” providing a regular stream of payments to the income beneficiary based upon a percentage of the fair market value of the trust principal. These options, depending on your jurisdiction, are available means to eliminate the tension between income and remainder beneficiaries and hence reduce the likelihood of litigation against the fiduciary for not being impartial and investing in favor of one beneficiary over another.
10. Seek advice of counsel and/or accountants. Any fear that the advice of counsel or assistance of accountants will be too costly will quickly evaporate when faced with the costs of defending a lawsuit for breach of fiduciary duty. Using experienced lawyers and accountants from the outset not only minimizes the likelihood of litigation, but it will significantly minimize the exposure the fiduciary faces should a beneficiary institute litigation. Corporate fiduciaries often have accountants and lawyers at their disposal and thus the expense is nominal. However, all too frequently trust officers make vital decisions without consulting counsel or an accountant that prove to be disastrous for the corporate fiduciary. The failure to consult with counsel or an accountant can be the result of many factors, including the time it takes to involve another person in the situation or the fear that the trust officer will appear incompetent should he or she seek advice. Thus, corporate fiduciaries should institute policies that make seeking the advice of in-house counsel or accountants an integral part of a trust officer’s responsibilities.
Following these few simple steps will not only aid the fiduciary in performing its duties more effectively and efficiently, but also provide advance warning as to whether the trustee may be stepping into a minefield of family disharmony, alert the trustee to ambiguities which may exist in the very instrument governing the trust’s administration and enable the trustee to avoid direct claims for breach of fiduciary duty.