Who Is a Fiduciary and What Are Fiduciary Responsibilities?
The term “fiduciary,” derived from Roman law, is “a person holding the character of a trustee . . . in respect to the trust and confidence involved in it and the scrupulous good fair and candor which it requires.” Black’s Law Dictionary (2d ed.). A trustee “shall administer the trust in good faith, in accordance with its terms and purposes and the interests of the beneficiaries. . . .” Unif. Trust Code § 801 (2000). As of December 31, 2020, 35 states have enacted some form of the Uniform Trust Code, and legislation has been introduced in Hawaii. See Unif. Law Comm’n, Trust Code.
In addition, a trustee has the duties of loyalty to the trust beneficiaries (Unif. Trust Code § 802 (2000)), of impartiality (id. § 803), of prudent administration (id. § 804), of incurring only costs reasonable in relation to trust property (id. § 805), to use its own special skills and expertise (id. § 806), of control and protection of trust property (id. § 809), of recordkeeping (id. § 810), of enforcement and defense of claims (id. § 811), of collecting trust property (id. § 812), of informing and reporting to beneficiaries (id. § 813), and of prudent investing (id. art. 9).
The consequences of breaching one of these fiduciary duties can be severe.
A trustee who commits a breach of trust is liable to the beneficiaries affected for the greater of: (1) the amount required to restore the value of the trust property and trust distributions to what they would have been had the breach not occurred; or (2) the profit the trustee made by reason of the breach.
Id. § 1002(a).
Does Fiduciary Litigation Differ from General Business Litigation?
Unlike many business litigation cases, fiduciary litigation usually involves multiple areas of the law: contract, equity, property, tort, tax. Also, trust beneficiaries may represent many generations of complicated and intense relationships. Emotions run high and reason low. Often beneficiaries are funding litigation themselves, while the fiduciary uses trust assets to cover its defense, although courts often retain discretion to award attorney fees and costs as justice and equity may require. Id. § 1004. Settling old scores overshadows the issues at hand, and the cost of winning becomes irrelevant.
Even if the beneficiaries are civil with one another, the trustee, be it an individual or a corporation, is always a target. The litany of duties trustees owe to the beneficiaries creates a trust minefield. One misstep and the trustee is open to multiple claims. Beyond the fiduciary’s common-law and statutory obligations—if the trust is not a tight, unambiguous contract on its face, the possibilities for attack are endless.
Common Problems and How to Solve Them
Oops, we ran out of money.
John executes a trust agreement that provides for the funding of three separate trusts: a marital trust funded with a specific amount; a children’s trust funded with closely held, family business stock and a specific amount of cash; and a grandchildren’s trust funded with the maximum generation-skipping transfer (GST) exemption remaining at John’s death. (Generally, a tax is imposed on every transfer to a person two or more generations below the transferor, the GST tax. 26 U.S.C. §§ 2601, 2612, 2613 (2006). Every individual is allowed an exemption that may be allocated to property to shelter it from the GST tax. Id. § 2631(a).) All remaining assets are to be distributed to children. When John dies, there are not enough assets to fully fund the separate trusts, and there is no order of funding priority in the trust.
It seems equitable to some if the trusts are funded proportionately. John’s surviving spouse believes the marital trust should be funded first because it is listed first. The grandchildren believe their trust should be funded first because the trust directs the trustee to fund the grandchildren’s trust to a maximum amount. If the children’s trust receives only family business stock and no cash, the family business cannot operate.
What would John have wanted? Does the trustee have the discretion to make the determination or should it seek direction from a court through a complaint for declaratory judgment? Although the former option might seem appealing in order to avoid litigation, it could very well result in the trustee being sued by a disgruntled beneficiary, not only for declaratory judgment but also potentially for breach of fiduciary duty. Regardless of what the trustee decides, what, if any, obligation does the executor (also a fiduciary) have to allocate all of John’s remaining GST exemption to the grandchildren’s trust? A decedent’s remaining GST tax exemption may be allocated by the representative of the decedent’s estate on a timely filed return. Id. § 2632(a). It is the executor, not the trustee, who has the ability to allocate the maximum GST exemption to the grandchildren’s trust. Id.
John’s trust agreement should have prioritized funding and clearly stated the funding order. The agreement should have also acknowledged that John understood the funding priority may result in a shortfall for those lower on the list. Alternatively, the trust could have provided that any shortfall be allocated proportionately among the separate trusts.
Grantors often want to give $x to person 1, $y to person 2, etc. Taking a snapshot of the grantor’s net worth at the time the trust is drafted and allocating percentages among beneficiaries avoids a shortfall that may cut out one or more beneficiaries. In drafting for a distribution, consider giving the lesser of $x or z percent to a beneficiary, so that all beneficiaries benefit even if the value of the trust assets decreases significantly.
This becomes very important when a grantor includes a charity or friends as beneficiaries. If the bottom drops out (e.g., the recession of 2008 or the market decline at the beginning of the 2020 pandemic), would the grantor still include those beneficiaries at the same amounts at the expense of family members?
Hats! Hats for sale! Beware the advisor who wears too many hats.
Attorney Smith represented Bill for 20 years. He prepared Bill’s premarital agreement with Bill’s second wife, Susan. He also incorporated and maintains the corporate records for Bill’s closely held business, RealCo. Bill dies, survived by Susan and four children (none of whom are Susan’s children). Bill’s son Bob is executor of Bill’s estate and engages Attorney Smith to represent the estate and to prepare the estate tax return. Attorney Smith is also the successor trustee of Bill’s trust, which is the beneficiary of Bill’s estate. Under the terms of Bill’s trust, Susan is the beneficiary of a marital trust during her lifetime, Bill’s grandchildren are the beneficiaries of a fixed amount to be distributed to them at certain ages, and Bill’s children are the beneficiaries of a trust funded with RealCo stock and all assets remaining after the payment of taxes and expenses and the funding of the marital and grandchildren’s trusts. The children are divided into two camps—two against two. None of the children gets along with Susan. Of the children’s camps, one likes Attorney Smith and one does not. Susan hates Attorney Smith for the way she was treated during negotiation of the premarital agreement.
Attorney Smith at least has an inherent conflict with Susan, who was adverse to Bill during the premarital agreement negotiations. Attorney Smith will make decisions in preparing the estate tax return and representing the estate (e.g., advising the executor as to the allocation of the GST exemption) that will affect the trust and the beneficiaries to whom he owes a fiduciary duty as trustee. When does he wear the estate attorney/tax return preparer hat and when does he wear the trustee hat?
Attorney Smith maintains all corporate records for the closely held business and exercises voting control as the trustee of the children’s trust. Attorney Smith can expect every move to be scrutinized by at least two of the children and can also expect all past acts to be scrutinized. Furthermore, if Attorney Smith thought the children would get along after Bill died, they will almost certainly dislike each other more. If Attorney Smith looks to the children to agree on proposed actions (e.g., decisions regarding the business), there will be a stalemate that will likely result in an action for a declaratory judgment.
It is possible that the children may come together as it relates to the marital trust for Susan because they all dislike her. However, their unity will cause trouble for Susan and Attorney Smith during Susan’s life. They will question all aspects of the administration of the marital trust because they are the remainder beneficiaries. The investment of the trust and any discretionary distributions will be scrutinized.
Remember the golden rule: If the family does not get along before a death, they will not come together afterward. An advisor should avoid serving as a fiduciary, if possible. Bill may have thought it was a good idea. After all, Attorney Smith knew him forever and could “hit the ground running” after Bill’s death. In reality, Attorney Smith has a number of inherent conflicts with multiple parties after Bill’s death. An independent, third-party trustee should have been appointed in lieu of Attorney Smith.
If Bill insisted that Attorney Smith remain involved because of his historical knowledge, he could have served in a nonfiduciary trust advisor role with clearly defined direction as to what issues the advisor may or must advise the trustee about and the effect of the advisor’s advice on the decisions of the trustee.
Attorney Smith should have anticipated that the children would not get along, resulting in a deadlock. A trustee has only two options in a deadlock: The beneficiaries agree or the trustee seeks guidance from the court. A third option, that is, not doing anything unless the beneficiaries agree, is not an alternative, as it can open the trustee up to liability for breach of fiduciary duty (e.g., if inaction leads to the waste of trust assets). To avoid costly litigation that will only waste time and money, consider tiebreaker provisions. If the trustee proposes an action that splits the beneficiaries, (a) appoint a third person to break the tie, (b) appoint a mediator or mediation committee to address conflicts between the beneficiaries and the trust or among beneficiaries, or (c) allow for the division of the trust assets into separate shares for each beneficiary.
To solve the conflict between income and remainder beneficiaries of the marital trust, the trustee may be given the power to adjust to provide the income beneficiary with a unitrust interest. For example, the trustee could distribute to Susan an annual distribution of 4 percent of the value of the trust assets. If Susan is satisfied with the annual distribution, it should not matter to her how the assets are invested. The trustee could focus the investments on growth to the benefit of the children as the remainder beneficiaries. In certain states, the power to adjust has been codified and the exercise of the power is binding on beneficiaries. See, e.g., Ohio Rev. Code Ann. § 5812.03 (2007).
The poorly drafted trust.
A poorly drafted trust agreement is often the primary cause of fiduciary litigation. Issues leading to conflict include (a) failure to properly define the class of potential beneficiaries; (b) failure to provide flexibility for unforeseen circumstances through powers of appointment, trust protectors, and decanting; (c) failure to keep beneficiaries informed and to provide complete, timely annual accounts; (d) appointing one or more family members to serve as trustee over other family members’ trust shares; (e) naming co-fiduciaries without tiebreaker provisions; and (f) not giving beneficiaries the right to remove the trustee and appoint a successor trustee when conflict arises. Addressing these issues, regardless of the grantor’s expectation that the trustee and the beneficiaries will coexist harmoniously, will preserve trust assets, ensure the administration that the grantor intends, and help the trustee avoid being a litigation target.
Avoiding Fiduciary Litigation
No matter how careful the drafting, unforeseen issues and disputes will sometimes arise. Fortunately, depending on the jurisdiction, an alternative to litigation may be available. Under the Uniform Trust Code, a noncharitable, irrevocable trust may be modified with the consent of the grantor and all the beneficiaries without court approval. Unif. Trust Code § 411(a) (2000). The Uniform Trust Code goes so far as to allow for modification even if it is inconsistent with a material purpose of the trust. Id. If not all the beneficiaries consent to the modification, it may be approved by a court. Id. § 411(e).
A court may modify the administrative or dispositive provisions of a trust due to circumstances not anticipated by the grantor or if the continuation of the trust under existing terms would be impractical or wasteful. Id. § 412. It may also reform a trust to correct mistakes or to achieve the grantor’s tax objectives. Id. §§ 415, 416. Proceedings to approve a modification may be commenced by the trustee, a beneficiary, or the grantor. Id. § 410.
Under the Uniform Trust Code, a nonjudicial settlement agreement is valid to the extent it does not violate a material purpose of the trust. Id. § 111(c). Matters that may be resolved by settlement agreements include interpretation of trust terms; approval of a trust account; directing a trustee to act or refrain from acting, or granting a specific power; resignation or appointment of a trustee; trustee compensation; transfer of the trust’s place of administration; and liability of the trustee. Id. § 111(d).
In states that have adopted a form of the Uniform Trust Code, it is important to review state law to determine to what extent the grantor, the trustee, the beneficiaries, or the court, or a combination of these, may revise the provisions of a trust. Even in states that have adopted a version of the Uniform Trust Code, the ability to reform or revise a trust may still be permitted under common law. Id. § 106. Regardless of the jurisdiction, the ability to resolve disputes through modification of the trust instrument is a versatile tool in the tool belt of the fiduciary litigator.
Conclusion
As families and family wealth grow more complicated, disputes relating to trust administration, the trustee’s obligations to beneficiaries, and the protection of beneficial interests will increase. While the trustee and beneficiaries may disagree, no grantor intends that trust assets be exhausted to settle disputes. Unambiguous drafting that addresses likely and unlikely issues, including the flexibility to deal with change and conflict and naming the right fiduciary who has the best chance of fulfilling its many duties to the beneficiaries, will go far in avoiding unnecessary and expensive litigation. If conflicts do arise, most states allow for nonjudicial agreements as an alternative to court intervention or agreements among interested parties that may be approved by a court in lieu of full-blown litigation.
