ESTATE AND FINANCIAL PLANNING: Shutting Down a “Fiduciary” Who Is Misusing Trust Assets

Vol. 31 No. 2

By

Daniel Ebner is an attorney with the Chicago, Illinois, firm of Prather Ebner LLP.

This article is for good lawyers representing good clients who are beneficiaries of trusts administered by bad fiduciaries represented by bad lawyers. Courts always have broad discretion to control trust funds and fiduciaries in response to purely equitable arguments—such as evidence that a trustee is misusing trust assets—but judges are often more willing to exercise their broad discretion if the equitable arguments are accompanied by more formal legal analysis.

This article gives the legal framework for why it is appropriate for a court to exercise its broad discretion over trust assets and trustees at the outset of a case and provides some ideas about three categories of relief to request: injunctions prohibiting use of funds a trustee has already stolen, injunctions limiting a trustee’s access to current trust assets, and temporary replacement of the fiduciary.

Preliminary injunctions prohibiting use of funds a trustee has already stolen. When a trustee has already stolen money that can be traced to the trustee’s possession or to the possession of an entity the trustee controls, enjoining future use of those funds would help to prevent the funds from being further misused or dissipated during the course of the litigation. If you are bringing suit to enjoin use of stolen trust funds, consider whether to do it indirectly by petitioning for the court to appoint a trustee ad litem to bring the preliminary injunction. The elements of a preliminary injunction are well-known and similar in most states, usually involving a three- or four-part test.

In states that follow traditional injunction analysis (which are most states other than California), the lawyer runs into problems with the irreparable injury and adequate remedy at law prongs when the relief the client seeks is about money. Locking down money to satisfy a claim that has not yet been reduced to judgment is an equitable attachment that is prohibited in most states.

Litigation to recover from a trustee who has misused trust funds is fundamentally about money, so a preliminary injunction to prevent a trustee from misusing funds seems as if it would violate the prohibition on equitable attachments. In many states, however, the rule against equitable attachments has an exception, the “specific funds exception,” when the property that a litigant seeks to enjoin is the specific subject of the controversy. A court should be willing to use the specific funds exception to enjoin use of money allegedly stolen by a fiduciary because the stolen money is the subject of the suit.

If your state does not follow the specific funds exception, Restatement (Second) of Trusts Section 202 may allow you to reach the same result. Under Section 202, a court can impose a constructive trust or equitable lien on stolen property, or the product of stolen trust property, held by the trustee and traceable. If the goal of the litigation is to obtain a constructive trust or equitable lien on a particular piece of property, then the remedy the client seeks is no longer strictly money damages, and traditional injunction analysis can be used to obtain a preliminary injunction on the specific property even if it is just a bank account.

Preliminary injunctions prohibiting use of current trust assets. Traditional injunction analysis can be used to argue for an order prohibiting use of current trust assets while litigation moves forward. Whenever a suit involves current trust assets, that suit necessarily involves questions about how the assets should be invested, used, or distributed. Consequently, the specific funds exception applies to any argument that enjoining use of trust funds is inappropriate before there is a final judgment because the funds and their use are the specific subject of the litigation. In addition, the prohibition on equitable attachment should not apply to a trustee’s control of trust funds because the trustee has only legal title to the funds—not equitable or beneficial title.

Because courts have broad discretion to issue orders concerning trustees and trust funds, it seems as if traditional injunction analysis should not be necessary. The more prudent course, however, is to argue both that the court has broad discretion to issue the injunction because the suit is equitable in nature and to argue that a preliminary injunction should be granted because the jurisdiction’s three- or four-part test is satisfied.

Account restrictions. An additional remedy that can provide more protection than a bare injunction is for the financial institution holding the funds to place a restriction on the account. The restriction would not allow any employee of the institution to release funds from the account without a court order. To have an account restriction put in place, ask the court to issue an order directly to the financial institution controlling the accounts. Because the account restrictions prevent the trustee from withdrawing account funds and do not restrict the financial institution’s ability to use the funds, there is no need to give the financial institution notice before the order is entered. The order simply needs to be served on the institution once it is entered.

Give notice of litigation. If the trust holds real property, filing a lis pendens will make it difficult for the trustee to liquidate the property and misappropriate the resulting funds. Consider whether any other property held by the trust can be made less fungible or otherwise harder to transfer by somehow giving notice to potential purchasers that the property is the subject of litigation.

Appointment of a temporary fiduciary. Courts always have the authority to appoint a temporary fiduciary during litigation that could result in the actual trustee’s permanent removal.

In addition, the simple existence of a conflict of interest in the outcome of the litigation is grounds for appointing a temporary fiduciary because “the purpose of removing a trustee is not to inflict a penalty for past action, but to preserve the trust assets.” Getty v. Getty, 2252 Cal. Rptr. 342 (Ct. App. 1988); see also In re Gerbing’s Estate, 37 N.E.2d 29, 32 (Ill. 1975).

Although courts always have the power to appoint a temporary fiduciary, a court may leave the existing fiduciary in place for several reasons, even when there is an allegation that the trustee misappropriated funds or has an interest in the outcome of the litigation. First, there are often rolling administrative and tax deadlines, and changing the person who has responsibility for administering the trust could jeopardize the trustee’s ability to comply with these deadlines. Second, the trustee has a legal duty to defend against attacks on a trust’s validity. Consequently, a court may find that the simple fact that the trustee has an interest in the outcome of the litigation is not a sufficient reason to remove a trustee who would be obligated to defend the trust validity anyway. One possible “compromise” to propose to a court that is disinclined to remove a trustee because of the obligation to defend the trust assets and to administer the trust in the face of running deadlines is to suggest that a temporary receiver take control of trust funds while the trustee still acts to administer and defend the trust.

When a court is unwilling temporarily to remove a trustee, but there may be a cause of action against a third party that the trustee will not bring, a trustee ad litem is a possible solution.

Conclusion. The different forms of relief to limit a bad trustee’s ability to misuse trust assets are not independent of each other. In general, injunctive relief is viewed as less intrusive (and consequently a preferable remedy) than appointment of a receiver or other temporary fiduciary. Consequently, a litigant seeking to have a temporary fiduciary appointed should demonstrate that injunctive relief is not sufficient to protect the beneficiaries’ interests. 

ABA REAL PROPERTY, TRUST & ESTATE LAW SECTION

This article is an abridged and edited version of one that originally appeared on page 35 of Probate & Property, January/February 2013 (27:1).

For more information or to obtain a copy of the periodical in which the full article appears, please call the ABA Service Center at 800/285-2221.

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BOOKS AND OTHER RECENT PUBLICATIONS: The Advisor’s Guide to Life Insurance; The Commercial Lease Formbook, 2d ed.; The Insured Stock Purchase Agreement, with Sample Forms, 2d ed.; From Handshake to Closing: The Role of the Commercial Real Estate Lawyer, 2d ed.; Education Planning: Taxes, Trusts, and Techniques; Real Estate Opinion Letter Practice.

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