Trustee Liability

Trustees owe duties both to the settlor (the person who created the trust) and to the beneficiaries (those intended to benefit from the trust). Regardless of to whom duties are owed, liability will result if those duties are not carried out.

The potential liabilities are numerous. If the trustee commits a breach of trust obligations (or even prior if there is reason to believe a breach might occur), there are options. First, the court might enforce specific performance, essentially requiring that the trustee perform as the trustee agreed to perform. The court might enjoin the trustee from committing a breach of trust and/or compel the trustee to pay monetary damages. Lastly, the court might suspend or remove the trustee.

If damages are the chosen remedy, it'll be important to understand how to measure them. For breach of trust, the trustee is liable to the beneficiaries for the greater of (1) the amount necessary to restore the trust property to what it would have been had the trustee not breached or (2) the trustee's profit from the breach. Stated otherwise, if the profit exceeds the value necessary to restore, then damages will be measured by profit; if the amount needed to restore exceeds profits, then damages will be measured by the amount needed to restore. Should be noted that in an action for breach of trust, minor beneficiaries may be represented by another beneficiary with substantially identical interests.

Just as it's important to understand the consequences when a trustee breaches, it's also important to distinguish when a trustee will not be liable for breach of trust. A trustee is not liable if the trustee acted in reasonable reliance on the terms of the trust or if a beneficiary consented to the conduct claimed to have been a breach. Likewise, there is no liability if prior to the claimed breach there has been a release of liability or if the transaction claimed as a breach has been later ratified. 

Exculpatory clauses in a trust are intended to shield a trustee from liability. But, as you've likely learned elsewhere, these clauses are not always valid. In this context, exculpatory clauses are void if they relieve the trustee of liability for breach of trust committed in bad faith or with reckless indifference. They are also void if they appear in the trust instrument because of the trustee's abuse of a confidential relationship with the settlor, unless the trustee can prove that the clause is fair and not influenced by that confidential relationship.

Questions might arise where there is more than one trustee. A trustee will generally not be liable for the acts of co-trustees if the trustee did not join in the action and exercised reasonable care in preventing the breach of trust by co-trustees.

The liability above all relates to liability that a trustee might have towards beneficiaries of the trust. Worth noting that a trustee may be sued on a contract or a tort by third parties as well. A trustee may be sued on a contract by a third party only if in entering the contract, the trustee failed to reveal the trustee's representative capacity. (This might bring to mind concepts learned when studying agency law.) A trustee may be sued personally in tort only if the trustee is personally at fault. Respondent superior (suing the trustee for the tortious acts of another) is not available here.  

Secret Trusts vs. Semi Secret Trusts

Both secret trusts and semi-secret trusts fall under the larger category of testamentary trusts. You'll know you're dealing with a testamentary trust if there's a will involved. Unlike with an inter vivos ("among the living") trust, a testamentary trust is one in which the intent of the trust and the essential terms of the trust must be ascertained from the will itself, from a writing incorporated by a reference to the will, or from the exercise of a power of appointment created by the will. Simply, look out for a will in which property is not left outright to a beneficiary of the will as might normally be the case, but is instead left to a trustee to do all the things that a trustee does with the property for the benefit of the beneficiaries.

Secret Trust: A will might make a gift which appears to be an absolute gift but was in fact made in reliance on the will beneficiary's promise to hold the property in trust for another. The way this might show up on an exam is that someone might contest the will by presenting extrinsic evidence that the will beneficiary promised to hold the property in trust for another. If the promise is proven by clear and convincing evidence, a constructive trust will be imposed on the property such that the will beneficiary will be deemed a trustee so that the only power granted to the will beneficiary over that property will be to hold the property in trust for the intended beneficiary. Note that it's irrelevant whether the promise was made before or after the will was created; in either case, a constructive trust may be imposed.

Semi-Secret Trust: A semi-secret trust is even a bit more straight forward than a secret trust. In a semi-secret trust, the will makes a gift in trust to a named trustee but fails to name any beneficiary. Without any named beneficiary there can be no trust and so the gift fails. Here, unlike in the above, a constructive trust will not be imposed. Rather, the named trustee holds the property on a resulting trust with the only obligation to ensure that the gift is transferred to the testator's heirs.

I should add that it's tough to really figure out why this second type is called a "semi-secret" trust. But that's not important; just know how it differs from a secret trust, and how each might apply to a given set of facts.

Duties of a Trustee

If you run through old bar exam essays testing the subject of Trusts, it's unlikely you'll see an issue repeat more often than the issue testing the duties of a trustee. It's a topic that shows up often and isn't especially difficult. There are two main duties to understand well: the duty of care and the duty of loyalty.  There are also duties tested less often but are still worth knowing. In total, there are 6 duties to keep in mind.

Duty of Care:

Simply stated, a trustee has a duty to administer the trust in good faith and in a prudent manner, in accordance with the terms and purposes of the trust instrument and the interests of the beneficiaries. A trustee should remain impartial and if a given trustee has special skills then that trustee might be held to an even higher standard of care than the one stated here in the general rule.

Duty of Loyalty:

This one has a bit more complexity as there are multiple ways that a trustee might breach the duty of loyalty. A trustee must not do any of the following:

--buy or sell trust assets for the trustee's own benefit (as opposed to for the benefit of the trust)

--sell property of one trust to another trust if the trustee is the trustee of that other trust

--borrow trust funds or loan personal funds to the trust

--use trust assets to secure a personal loan

--personally gain through the position of trustee (though this would not include reasonable compensation)

--invest in a corporation's stock if the trustee is a trustee of the corporation that owns the stock.

More generally, absent court approval or express waiver, a trustee cannot enter into a transaction in which the trustee is dealing with the trust in the trustee's individual capacity (ie, self dealing). And self dealing will be presumed if the trustee enters into a transaction as trustee with the trustee's spouse, close relatives, attorney, or a corporation in which the trustee owns a significant interest. 

Importantly, a transaction that involves self dealing is voidable (rather than void) by the beneficiary affected by the transaction unless a court approves the terms of the transaction, the beneficiary fails to bring suit within a prescribed time period, the beneficiary consents or otherwise ratifies the transaction, or the transaction arose before the trustee became the trustee. 

Duty to Report:

A trustee must provide all qualified beneficiaries with the trustee's name, address, and telephone number. A trustee also must respond to beneficiary requests for information about the trust's administration and provide a copy of the trust instrument if requested. Lastly, a trustee must furnish an annual accounting of the trust.

Duty to Separate Trust Property and Keep Records:

This is the classic "no commingling." The trustee must earmark trust property by labeling it as trust property. If the trustee commingles trust property with the trustee's own property, losses are charged to the trustee and gains are credited to the trust. Not great for the trustee.

Duty to Enforce Claims and Defend Trust from Attack:

The trustee has a duty to enforce claims and to defend the trust. That's about it for that one.

Duty to Preserve Trust Property and to Make it Productive:

This is essentially the duty to invest the trust property as a prudent investor. The trustee is expected to lease land owned by the trust, invest money earned by the trust, etc. The measure of damages if the trustee breaches this duty is the amount of income that normally would accrue from such investments.

Charitable & Honorary Trusts

If either charitable trusts or honorary trusts show up on the essay portion of the bar exam, you'll need to know how they differ from a private trust. There are three key differences to keep in mind specifically for charitable trusts: they must have indefinite beneficiaries, they may be perpetual, and the cy pres doctrine applies. 

Charitable Trusts: To determine if a trust is a charitable trust, focus on the purpose as stated by the settlor of the trust. A charitable trust must have a purpose considered to benefit the public. For example, charitable trusts might include a purpose for advancing education or promoting public health. The class to be benefited may be limited but cannot be so limited that only a select few individuals will be benefited. If only a select few individuals will be benefited, it begins to look more like a private trust and the rules related to charitable trusts may not apply. As stated above, the beneficiaries of a charitable trust must be indefinite; the court can select the beneficiaries if none are specified by the settlor but in all cases the intent of the settlor must be ascertained so that the court can choose a purpose or beneficiary that is in accord with that intent. Those who may enforce a charitable trust include the settlor, a qualified beneficiary, or the state's attorney general.

A charitable trust may be perpetual (so that no time limit applies) and the Rule Against Perpetuities (😱) does not apply to the shifting of the beneficial interest in a trust from one charity to another charity on the happening of a condition. The Rule does apply, however, if the shift is from a private trust to a charitable trust. There might be instances in which the charitable purpose chosen by the settlor is now impracticable, unlawful, or impossible to achieve. The cy pres doctrine will allow the court to select an alternative provided that the alternative is as near as possible to effectuating the settlor's intent. 

Honorary Trusts: Honorary trust are commonly established for the benefit of pets or for the maintenance of burial places. There's no human being (as a beneficiary) to enforce these trusts so the trustee is "on his/her honor" to carry out the terms. These trusts, may, however, be enforceable by someone named in the trust instrument or by someone appointed by the court. 

Unlike with the charitable trusts mentioned above, these trusts often are burdened by time limits. Many jurisdictions will void honorary trusts if they extend for too long (often measured by the Rule Against Perpetuities). The Uniform Trust Code specifically states that an honorary trust not for the care of animals may not be enforced for more than 21 years. 

As for those honorary trusts that are set up to care for animals/pets, those trusts terminate automatically when the animal/pet dies.

The Uniform Prudent Investor Act

Not the most exciting of legal topics here but if you review the trust essays that have appeared on the UBE in the past, this pops up from time to time. The idea here is that in a "prudent investor" jurisdiction, only prudent investments are permissible regardless of the trust's terms.

There are similarities between the standards here and the standards learned when studying negligence. A trustee must exercise reasonable care, skill, and caution when investing and managing trust assets. But a trustee with special skills or expertise who has represented him/her self as having such skills will have to use such skills or expertise when investing.

Further, a trustee must act exclusively for the beneficiary when investing and managing trust assets. If there are multiple beneficiaries, the trustee must act impartially never benefiting one or more than one at the expense of others.

Importantly, investment decisions must be evaluated in the context of the entire trust portfolio and as part of an overall investment strategy. In other words, risk is often inherent when investing and so the fact that certain investments might seem risky should not lead to a conclusion that the trustee has not acted with prudence, especially if those risky investments were balanced with safer investments. A trustee should always diversify investment unless it is reasonably determined that the purpose of the trust is better served absent diversification.

When analyzing this issue of compliance or non-compliance with the Prudent Investor Act, there are certain elements to address. Some of those elements are as follows: general economic conditions; the possible effect of inflation or deflation; the expected tax consequences of investment decisions or strategies; the role that any individual investment plays within the overall investment strategy; the expected total return from income and appreciation of capital; other resources for the beneficiaries; needs of the beneficiaries for liquidity and regularity of income, etc.

A trustee who acts in substantial compliance with the Prudent Investor Act will not be held liable for non-compliance. A trustee may also delegate investment decisions but in doing so the trustee must act prudently in selecting an agent, establishing the scope and terms of the delegation, and reviewing the agent's investment decisions.

Modification of Trusts

When I work on essay writing with students, they have the option to choose which subjects to focus on throughout the essays. Somewhere near the top of the list is Trusts. It's a difficult subject that is tested often. A topic that shows up with some frequency is the modification of a trust. A trust can be modified by the settlor, by the beneficiaries, by the court, or by the trustee.

The Settlor: A settlor can modify a trust unless the terms expressly state that the trust is irrevocable. Some states hold that a trust is irrevocable unless expressly stated otherwise, but this is not the rule on the Uniform Bar Exam which follows the Uniform Trust Code.

The Beneficiaries: A trust may be modified upon the consent of the settlor and all beneficiaries even if such modification or termination conflicts with a material purpose of the trust. If only the beneficiaries consent without the consent of the settlor, the trust may still be modified but only if no material purpose of the trust would be frustrated by the modification. If there is no material purpose frustrated and all beneficiaries consent to termination of the trust, the trustee must upon termination of the trust distribute the trust property to the beneficiaries.

The Court: Assume here that modification by the beneficiaries alone is not available since not all beneficiaries have consented to modify the trust. A court may still modify if the trust could have been modified had all beneficiaries consented (no material purpose would have been frustrated) and if the interests of any non-consenting beneficiaries will be adequately protected. In addition, a court may also modify a trust if unanticipated circumstances threaten the purpose of the trust, continuation of the existing trust is impracticable, or if the value of the trust is insufficient to justify the cost of administering the trust.

The Trustee: A trustee can modify (terminate) a trust if the trust purpose is less than $50,000 and the amount is insufficient to justify the cost of administering the trust as long as the trustee provides the beneficiaries with notice. A trustee can also modify a trust by combining several trusts into one trust or by dividing one trust into several trusts provided that doing so does not frustrate any purpose of the trusts or impair the rights of beneficiaries. Notice to the beneficiaries is required of such an intent to combine or divide trusts but obtaining consent from the beneficiaries is not.

Creation of a Trust

A good place to begin in the study of Trusts is with the creation of a trust. It's also a straight-forward way to score a lot of points on an essay that tests this issue.

And so here are the elements, all of which should be addressed should this issue show up:

Capacity: First, you'll need a settlor (the person who creates the trust) with the capacity to create it. The capacity required is the same as the capacity required to create a will.  Look out for things like undue influence, fraud, and duress. All of these will prevent a settlor from having the necessary capacity and without the capacity, no trust is created.

Intent:  The settlor with capacity must intend to create a trust. Under most circumstances a writing is not required to prove intent but always keep in mind the Statute of Frauds when real property is involved.  The settlor must intend that the trust take effect immediately and not at some future time.  And, importantly, a settlor's expression of hope (rather than a direct instruction) that the property be used in a certain way is not evidence that a trust was intended. That's known as precatory language and such language cannot be used to create a trust.

Trustee:  There's got to be a trustee. A trust, however, will not fail if the trustee dies, refuses to accept performance, or resigns. The court will appoint a successor unless it is clear the settlor intended the trust to continue only if that particular trustee served.  The trustee must have enforceable obligations and anyone who has the capacity to acquire and hold property for his/her own benefit has the capacity to act as a trustee.

Beneficiaries:  Beneficiaries enforce the trust and so without them there can be no trust (there are exceptions for both honorary and charitable trusts). Any person capable of taking or holding title to property can be a beneficiary of a private trust. Although notice to the beneficiary as to the existence of the trust is not required, acceptance is required and it may be express or implied. A beneficiary cannot be forced to accept an interest in the trust; rather, a beneficiary may disclaim the interest by filing a written instrument stating an intent to disclaim.

Trust Property:  Where there is no trust property there can be no trust since without property there would be no obligations required by the trustee. The property must be existing property that the settlor has the power to convey. A future interest will suffice, but an interest not yet in existence will not.

Trust Purpose:  There must be a valid trust purposes and a purpose will not be valid if it is illegal, contrary to public policy, impossible to achieve, or intended to defraud the settlor's creditors. If a condition attached to the trust violates public policy the trust might still be valid if the settlor has expressed an alternative desire. In such a case, the condition can be ignored.

Purchase Money Resulting Trusts

There are a few different types of resulting trusts that could show up in a trusts essay on the essay section of the UBE.  The one I'd most expect to see is a purchase money resulting trust.

You should consider a purchase money resulting trust whenever a person (call him "x") furnishes consideration for the acquisition of real or personal property, but with x's consent title is taken in the name of another person (call him "y"). No trust has actually been created in the traditional sense, but the idea here is to presume that if the facts are as stated above, then x is the beneficiary of a trust and that y is a trustee of a trust and is merely holding the property for the benefit of x.  For a purchase money resulting trust to be presumed, the consideration paid by x for the purchase of the property must be supplied at or before the time that y takes title to the property.

The burden will be on x to prove by clear and convincing evidence that he supplied the consideration.  Once x has met this burden, a resulting trust will be presumed. Y can then rebut by showing that no trust was intended. Y might, for example. present evidence that the payment from x was a gift or a loan to y to satisfy a debt that x owed to y.

An exception to keep in mind is where there is a close personal relationship between x and y. In that case it will be presumed that there was a gift from x to y and no trust will result. As with the above, this presumption is also rebuttable, this time by x. "Close personal relationship" can be be tough to define, but the notes indicate that a parent, grandparent or spouse would satisfy the definition, whereas an uncle, aunt, brother, sister, child, or grandchild would not.

Spendthrift Provisions (Trusts)

A common question I often get in the final weeks before the bar exam deals with study strategy.  As the exam approaches it becomes much harder to cover everything that might potentially show up on the exam.  I think it's important to be sure not to go into the test having not reviewed a subject hoping that subject won't show up.  But it is also important, especially when time is short, to focus your studying on the subjects that are most likely to be tested.

Trusts has shown up with some real frequency on the MEE.  A spendthrift clause in a trust precludes a beneficiary from voluntarily or involuntarily transferring his/her interest in the trust.  As such, creditors are precluded from reaching the trust to satisfy their claims. Importantly, note that once income has been distributed to the beneficiary, the creditors can then reach that income; it is only the income interest that the creditors cannot reach!

There are some exceptions to note:  A spendthrift clause cannot be used shield the beneficiary from his/her own creditors where the beneficiary is also the settlor.  In other words, a settlor cannot create a trust whereby the settlor is the beneficiary of the trust with a spendthrift clause if the purpose was merely to shield him/herself from creditors  Further, claims for support, alimony, and necessities as well as claims by the government are valid and will withstand a spendthrift provision.  Lastly, any creditor can reach a mandatory distribution of income or principal if the trustee did not make that distribution within a reasonable time.