Probate & Property Magazine: January/February 2009, Vol. 23, No. 1

Real Property|Trust & Estate

PDF DownloadNavigating the Trustee’s Duty to Disclose
I don’t want those kids knowing they have a trust!

By Dana G. Fitzsimons Jr.

Dana G. Fitzsimons Jr. is a lawyer in the Richmond, Virginia, office of McGuire Woods LLP and a vice-chair of the Ethics and Malpractice Committee of the Trust & Estate Division Ethics and Malpractice Group.

" I don't want those kids knowing they have a trust! They'll never learn the value of a dollar! Why, when I was young, I knew I had to work hard to get ahead!"

Such well-intended secrecy is the demand by many parents to the trustees of trusts that will ultimately pass to their children. If you are tempted to reduce these cries to their cartoon version—and place them alongside such other "when I was a kid" nuggets as " We walked uphill to school in the snow " and " Girls didn't dress like that "—don't. Parents are rightfully concerned about the possible negative effects of inherited wealth on the lives of their children. Those concerns are frequently brought into the trust arena when trustees attempt to comply with their duty to disclose information about trusts to members of younger generations. The resulting tension is well-known to many trust officers—and they don't like it.

Surcharge litigation against trustees is on the rise. The causes are many—the increasing transfers of larger amounts of wealth from older generations to younger generations and into trusts (and the corresponding rise of entities with freshly minted trust powers), changing tax laws, escalating beneficiary expectations, the dramatically increasing complexity and volatility of investments, and growing aggressiveness by lawyers. Regardless of the causes, the reality of fiduciary risk is aggravated when the trustee fails to fully understand its duties. Those duties include the trustee's duty to disclose information to beneficiaries, which, in turn, is shaped primarily by a combination of the terms of the governing instrument and state law.

Trust law is in a state of rapid development, in large part through the expanding enactment of the Uniform Trust Code. Although the UTC has been largely successful in making the law uniform across the enacting jurisdictions, divergent policy views and other interests have prevented uniformity on the issue of trustee disclosure. This article will look at the relationship between disclosure and fiduciary risk, the difficulty in defining the scope of the disclosure obligation, and the strategic use of disclosure to manage fiduciary risk under the Uniform Trust Code.

Assessing Fiduciary Risk

Prudent trustees are mindful of their fiduciary risk. Risk assessment is not a one-time event—ideally it is an ongoing process that happens before a fiduciary appointment is accepted, at regular intervals throughout the administration, and in connection with significant transactions or discretionary actions. Common sense and well-established practices for managing risk are important in this process—and traditionally have included communicating with beneficiaries.

This is not accidental. Although trustees owe many duties and their actions may be challenged on a myriad of legal theories, trustees have always had access to a certain near-universally applicable (although not always successful) defense—that actions were taken in good faith and under a prudent process. Open disclosure of information is a clear indication of acting in good faith, and envisioning a prudent process that does not include communication is hard, if not impossible. Courts frequently and often correctly view trustees that conceal information from beneficiaries and act in secret with suspicion. In this regard, trustee disclosure has always been an essential component of risk management and a primary defense against risk.

Trusts that restrict a trustee from disclosing information (so-called "silent trusts") necessarily increase fiduciary risk by preventing the running of statutes of limitations, frustrating defenses based on good faith, and precluding use of risk management tools such as those available under the Uniform Trust Code. Careful pre-appointment screening by trustees—which must include review of the trust instrument—is important. Certainly trustees can and frequently do accept appointments that involve risk. Accepting risk is a business decision and is best done knowingly and deliberately and with full understanding of those risks. Trustees may want to carefully consider whether to accept an appointment under a silent trust and whether to charge a larger fee for the additional risk of such trusts.

Disclosure and Recent Surcharge Litigation

Trustee disclosure, or the lack of it, has played a role in several recent fiduciary cases. In McNeil v. McNeil , 798 A.2d 503 (Del. 2002), the Delaware Supreme Court made it clear that the failure to disclose information about a trust can be the basis for surcharge in its own right, rather than solely as an appendage to a claim for breach of another fiduciary duty. The Delaware Supreme Court found that the trustees breached their fiduciary duty by withholding information about the existence of a trust from one of the beneficiaries entitled to discretionary distributions who was a family "outsider," while providing information to the other beneficiaries. The Delaware Supreme Court rejected the trustees' claim that larger distributions from another trust cured any damage to the beneficiary and ordered a 7.5% makeup distribution to the beneficiary and his family, removed one of the trustees, and surcharged each of the trustees one-fifth of their commissions for a nine-year period.

In some recent cases, the trustee's disclosures have helped the trustee avoid liability. In Americans for the Arts v. National City Bank , 855 N.E.2d 592 (Ind. Ct. App. 2006), the Indiana Court of Appeals upheld the protections of an exculpatory clause against a claim of failure to diversify in part because the clause was part of a trust agreement that was ratified by the court in conservatorship proceedings conducted with full disclosure to and participation by the beneficiaries. In In re Ronsenfeld Foundation Trust , O.C. No. 1664 IV of 2002, Contr. No. 040671, 2006 WL 3040020 (Pa. Com. Pl. July 31, 2006), the trial court granted summary judgment in favor of the corporate co-trustee against a claim for failure to diversify a stock concentration and awarded the payment of its attorney's fees of over $400,000, in part because the corporate co-trustee actively communicated the risks of the stock concentration to the other trustees (who were ultimately surcharged for the loss in stock value).

In other recent cases the failure to disclose has contributed to decisions against the trustees. The Kentucky Court of Appeals decision in Hale v. Moore , Nos. 2005-CA-001895-MR & No. 2006-CA-000662-DG, 2008 WL 53871 (Ky. Ct. App. Jan. 4, 2008), involved the interpretation of the tax payment provisions under the Kentucky will and the Pennsylvania trust created by the widow of Colonel Sanders of Kentucky Fried Chicken fame. The corporate trustee sought to resolve any uncertainty about the tax clause and eliminate its own liability by having all of the beneficiaries enter into an agreement. On appeal from the trial court's decision on a later suit brought by the beneficiaries, the court of appeals disregarded the release signed by the beneficiaries in part because the beneficiaries were not fully apprised of the consequences of signing the releases, and therefore the court found the releases suspect. In In re Alice Shotwell Gustafson Revocable Living Trust , No. 268552, 2007 WL 4248561 ( Mich. Ct. App. Dec. 4, 2007), the Michigan Court ordered the trial court on remand (with a new probate judge) to remove a trustee for failing to disclose information to a beneficiary.

Defining the Duty

As important as disclosure may be, the duty to disclose is not precisely defined at common law and far from uniform. This creates fiduciary and administrative problems for trustees that operate in multiple jurisdictions. There are, however, certain consistent themes and basic principles.

A trustee must, on request, provide a beneficiary with information about the trust property and allow the beneficiary or his or her agent to inspect the trust records. The beneficiary is entitled to that information reasonably necessary to enable the beneficiary to enforce the beneficiary's rights or to prevent or redress a breach of trust. When necessary to protect the beneficiary from a third party, the trustee may have an obligation to provide the information even without a request by the beneficiary.

The duty runs not only to current beneficiaries but also to future beneficiaries regardless of whether their interests are vested or contingent. Courtesy of the Virginia Supreme Court's decision in Fletcher v. Fletcher , 480 S.E.2d 488 (Va. 1997), the trustee is generally required to provide a full copy of the trust instrument and not merely those portions that directly relate (or in the trustee's belief, directly relate) to the beneficiary's interests.

The rules are refined for revocable trusts. Although a trust is revocable by the settlor and the settlor has the capacity to revoke the trust, the trustee generally owes a duty only to report to the settlor and should generally not report to any other beneficiaries without the settlor's consent.

The specific information that must or should be disclosed to beneficiaries may vary depending on the terms of the governing instrument and state law and also on other factors such as the nature of the beneficiary's interest, age, capacity, and sophistication, the nature of the trust assets and transactions, and the identity of the trustee.

Depending on consideration of these and other factors, disclosure to beneficiaries may include the trust instrument, information about the trustees, trustee compensation and expenses, trust assets and investment policies and performance, liabilities, receipts, and disbursements, distributions, and other discretionary actions taken by the trustee, tax matters, and other items.

The timing of disclosure may be imposed by state law or may be driven by the trustee's desire to take advantage of risk management tools. Absent these, prudence suggests that the trustee send disclosure to the beneficiaries no less frequently than annually and also at the termination of the trust and the end of the trusteeship. More frequent disclosures may be preferable for various reasons, including relations among the beneficiaries. In addition, the trustee should monitor the trust and the beneficiaries for events that may modify the trustee's duties or give rise to new duties or new notice recipients, such as the death of the grantor or the grantor's spouse, the birth, birthday, or death of beneficiaries, changes in institutional rates for fiduciary compensation, and significant law changes.

Disclosure Under the Uniform Trust Code

The Uniform Trust Code is a codification of the law of trusts prepared by The National Conference of Commissioners on Uniform State Laws. The goal of the UTC is uniformity of trust law across the country. The UTC, with state variations, has been enacted in 21 jurisdictions: Alabama, Arkansas, Arizona, the District of Columbia, Florida, Kansas, Maine, Missouri, Nebraska, New Hampshire, New Mexico, North Carolina, North Dakota, Ohio, Oregon, Pennsylvania, South Carolina, Tennessee, Utah, Virginia, and Wyoming. The UTC has been introduced as a bill for enactment in Oklahoma, Massachusetts, and Connecticut.

The UTC imposes several distinct duties to provide information to beneficiaries, which are located in section 813 (titled "Duty to Inform and Report"). The UTC's disclosure requirements do not apply uniformly to all classes of beneficiaries. Some apply only to "qualified beneficiaries," which generally means current distributees or permissible distributees of trust income or principal, successor distributees or permissible distributees, and presumptive remaindermen, and does not generally include contingent remaindermen.

The seven categories of disclosure under the UTC are

1. the duty to keep the qualified beneficiaries of the trust reasonably informed about the administration of the trust and of the material facts necessary for them to protect their interests;

2. the duty, unless unreasonable under the circumstances, to respond promptly to a beneficiary's request for information related to the administration of the trust;

3. the duty on request of a beneficiary to furnish promptly to the beneficiary a copy of the trust instrument;

4. the duty within 60 days after accepting a trusteeship to notify the qualified beneficiaries of the acceptance and of the trustee's name, address, and telephone number;

5. the duty within 60 days after the date the trustee acquires knowledge of the creation of an irrevocable trust, or the date the trustee acquires knowledge that a formerly revocable trust has become irrevocable, whether by the death of the settlor or otherwise, to notify the qualified beneficiaries of the trust's existence, of the identity of the settlor or settlors, of the right to request a copy of the trust instrument, and of the right to a trustee's report;

6. the duty to notify the qualified beneficiaries in advance of any change in the method or rate of the trustee's compensation; and

7. the most controversial of the UTC's disclosure provisions, the duty to send to the distributees or permissible distributees of trust income or principal, and to other qualified or nonqualified beneficiaries who request it, at least annually and at the termination of the trust, a report of the trust property, liabilities, receipts, and disbursements, including the source and amount of the trustee's compensation, a listing of the trust assets, and, if feasible, their respective market values.

The UTC provides that beneficiaries may waive their right to reports and may later withdraw their waivers. Also, like the common law, while a trust is revocable by the settlor and the settlor has capacity, the trustee's disclosure obligation is owed only to the settlor.

Despite the UTC's goal of uniformity, among the 21 enacting jurisdictions almost no two state versions of the UTC disclosure rules are the same (see chart on pages 44-47 for a summary of state variations). Much of the variation reflects the serious policy debate about which of the disclosure obligations, if any, should be mandatory (regardless of the terms of the trust), which should be default rules that are subject to override by the settlor, and which should be "grandfathered" and apply only to trusts that become irrevocable after the date that the UTC is enacted.

Some states have gone beyond the UTC's text with creative and potentially useful variations—the ability to name a surrogate to receive notice on behalf of a beneficiary, changing obligations before and after the death of a surviving spouse, detailed statutory reporting regimes, enhanced disclosures to the state attorney general for charitable trusts, and good faith exceptions to the trustee's duties. Although there is little doubt that significant state-by-state variations in the UTC disclosure provisions are well-intentioned, often useful, and reflect legitimate policy differences over the relationship between trustees and beneficiaries, the almost total lack of uniformity creates risks, especially for institutional trustees that often operate with standardized and automated practices and procedures.

Making Effective Use of UTC Disclosures

Many commentators have bemoaned the additional disclosure obligations imposed on trustees by the UTC. In some cases, the complaints have been driven by a misconception of the full scope of the disclosure obligations imposed by existing common law, and in some cases, especially for the UTC's requirement for trustee accountings, the complaints are well-founded. Regardless, it must be recognized that although the UTC may impose some new burdens on trustees, it balances those burdens by offering trustees several useful tools for managing and in some cases eliminating their risk.

One of the signature provisions of the UTC is the ability of trustees and beneficiaries to enter into "nonjudicial settlement agreements" that relate to any matter involving a trust that does not violate a material purpose of the trust and could be approved by a court. Because the UTC's virtual representation provisions apply to nonjudicial settlement agreements, it is possible for adult beneficiaries to enter into agreements that are binding on minor and unborn beneficiaries without having to go to court—a significant improvement over the common law and one that will facilitate efficient trust administration. Because a nonjudicial settlement agreement is a contract, to ensure the validity of the contract prudence requires that the parties to the contract have the essential information relevant to the subject matter of the contract. Disclosure supports the validity of a nonjudicial settlement agreement.

Through disclosure, a trustee may shorten the statute of limitations on a contest to the validity of a trust from three years to just 120 days. Through disclosure, a trustee may reduce to 30 days a beneficiary's ability to object to a terminating distribution from a trust. Disclosure facilitates obtaining a binding consent, release, and ratification of the trustee's actions from a beneficiary.

In arguably one of its most significant provisions relating to fiduciary risk, the UTC provides that a beneficiary may not commence a proceeding against a trustee for breach of trust more than one year after the date the beneficiary or a representative of the beneficiary was sent a report that adequately disclosed the existence of a potential claim for breach of trust and informed the beneficiary of the time allowed for commencing a proceeding. A report adequately discloses the existence of a potential claim for breach of trust if it provides sufficient information so that the beneficiary or representative knows of the potential claim or should have inquired into its existence. The one-year statute of limitations does not begin to run against a beneficiary who has waived furnishing a report or who has not otherwise been sent a report.

If the one-year statute of limitations does not apply, a judicial proceeding by a beneficiary against a trustee for breach of trust must be commenced within five years after the first to occur of the removal, resignation, or death of the trustee, the termination of the affected beneficiary's interest in the trust, or the termination of the trust.

The ability through disclosure to shorten the statue of limitations on a surcharge action from five years to just one year is a powerful risk management tool, and trustees of trusts in UTC jurisdictions should consider making thorough use of this provision.

Conclusion

The evolution of the law concerning the trustee's duty to disclose information to trust beneficiaries creates new risks for trustees who are unaware of their obligations. Equally, if not more importantly, it also creates greater opportunities for trustees to use disclosure to manage their risk. Trustees should strive to use their disclosure obligations to ameliorate and lower, rather than aggravate, their fiduciary risk.

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