Risk Management For Trustees: Becoming Ill-Suited For Litigation

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Risk Management For Trustees: Becoming Ill-Suited For Litigation John T. Brooks and Samantha E. Weissbluth A member of the American College of Trust and Estate Counsel, John T.

1 Risk Management For Trustees: Becoming Ill-Suited For Litigation John T. Brooks and Samantha E. Weissbluth A member of the American College of Trust and Estate Counsel, John T. Brooks is a partner with Foley & Lardner LLP focusing his practice in the area of fiduciary litigation. Samantha E. Weissbluth is senior counsel with Foley, concentrating her practice on estate and trust litigation with a particular interest in risk management by John T. Brooks and Samantha E. Weissbluth. The authors gratefully acknowledge the able assistance of Erika A. Alley, Associate, and Aubrey Refuerzo, Summer Associate, in preparing this outline. A. The Need For Risk Management 1. Increased Risk Environment a. The fiduciary litigation explosion: Litigation against fiduciaries has grown from fairly rare to commonplace and continues to increase each year. Disputes frequently arise due to the unique relationship and power imbalance between a fiduciary and beneficiaries. In 2005, [t]he Center for Fiduciary Analysis report[ed] a twenty-two percent compounded annual increase in fiduciary litigation cases. See Susan W. Drewke and Richard A. Naski II, Representing Fiduciaries in Trust and Estate Litigation, Illinois Institute for Continuing Legal Education Handbook: Litigating Disputed Estates, Trusts, Guardianships, and Charitable Bequests, at 7-5 (2009). b. The rise of specialization in law firms: Most, if not all, large law firms and even some smaller boutique firms now have attorneys who specialize in estate and trust litigation. ALI-ABA Estate Planning Course Materials Journal 7

2 8 ALI-ABA Estate Planning Course Materials Journal February 2010 c. Changing fiduciary law and ensuing high-profile cases: The increasing codification and modernization of fiduciary law have provided fuel for new causes of action, and high-profile cases have drawn attention to these potential new claims to an increasingly litigious populace. See Drewke, supra. d. Demographics and transfer tax reductions: The members of the baby boomer generation are now coming into their inheritances. This generation is more litigious than previous generations and with the reduction in transfer tax, more of their inheritance is left for them to fight over. e. Changing attitudes toward trustees: People used to be hesitant to question or sue an experienced individual or a corporate fiduciary serving as trustee. Today, however, that is no longer the case, as the litigious baby boomers and their children are not afraid to sue trustees. See 2. Effective Risk Management a. Effective risk management requires trustees to carry out their fiduciary duties with great diligence and integrity and to adopt a best practices approach to serving as trustee. The result of these efforts will be that the trustee will more effectively serve the beneficiaries. The bottom line: Proper risk management should make for happier beneficiaries and, as a result, minimize fiduciary litigation. b. This outline looks at several facets of trustee service and suggests steps that can be taken to reduce the trustee s risk. Although this discussion will focus on risk management for trustees, many of the principles discussed can be applied to other fiduciaries, such as executors and guardians. B. Pre-Acceptance Of Trusts: The Screening Process 1. Risk Profile And Profitability Standards a. Perhaps the greatest risk management tool is to avoid trusts with high risk profiles and those that, regardless of risk, do not meet with the trustee s profitability standards. b. If possible, a potential trustee should be given an opportunity to evaluate the trusteeship at the drafting stage or before the initial funding of the trust. 2. Analyze The Trust Instrument a. Look for ambiguities, inconsistencies, potential tax problems, and potential conflicts of interest. b. Carefully analyze the trustee provisions, including exculpatory clauses, if any. Note that exculpatory clauses in the trust document may not adequately protect the trustee. An exculpatory clause is generally not effective to relieve the trustee of liability for breach of a trust committed in bad faith or intentionally or with reckless indifference to the interest of the beneficiary, or of liability for any profits that the trustee has derived from a breach of trust. 3. Nature Of Trust Assets a. The potential trustee must be capable of handling the specific trust assets. For example, being trustee of a trust that controls a closely held business is very different from being trustee of a trust that is made up solely of marketable securities.

3 Risk Management For Trustees 9 b. The Uniform Trust Code ( UTC ) provides that a person designated as trustee, without accepting the trusteeship, may inspect or investigate trust property to determine potential liability under environmental or other law or for any other purpose. See UTC 701(c)(2). The UTC, which was approved in August 2000 by the National Conference of Commissioners on Uniform State Laws, has been enacted in 22 states (Alabama, Arizona, Arkansas, Florida, Kansas, Maine, Michigan, Missouri, Nebraska, New Hampshire, New Mexico, North Carolina, North Dakota, Ohio, Oregon, Pennsylvania, South Carolina, Tennessee, Utah, Vermont, Virginia, and Wyoming) and the District of Columbia. Amendments to the UTC were approved by the Uniform Law Commissioners in 2001, 2003, and 2004, and by the Commissioners Executive Committee in January Uniform Trust Code Legislative Fact Sheet, National Conference of Commissioners on Uniform State Laws, 4. Beneficiary And Co-Trustee Information a. The potential trustee should learn as much as possible about the beneficiaries of the trust, including their family history and familial relationships. b. If co-trustees are involved, it is extremely important for the potential trustee to become familiar with the other trustees and learn as much as possible about the other trustees respective reputations. 5. Is This A Successor Trusteeship? a. Scope Of Liability Of Predecessor Trustee i. Unless a co-trustee remains in office or the court otherwise orders, and until the trust property is delivered to a successor trustee or other person entitled to it, a trustee who has resigned or been removed has the duties of a trustee and the powers necessary to protect the trust property. UTC 707(a). ii. A resigning or removed trustee remains liable for any breaches of duty committed during the trustee s administration of the trust. iii. The exiting trustee should seek discharge immediately as of the termination of the trusteeship so that the time period for any liability is limited and the period during which a party may bring suit is clearly defined. b. Scope Of Liability Of Successor Trustee i. Under common law, a successor trustee is not liable for a predecessor trustee s breaches of trust. However, both the successor trustee and the predecessor trustee are liable when the successor knows of the predecessor s breach and allows it to continue or does not try to compel the predecessor to remedy the breach. See also UTC 812, which limits the successor s obligation to known breaches. This means that the successor trustee effectively may have a duty to review the predecessor s administration of the trust to avoid liability for continuation of breaches committed by the predecessor. Restatement (Second) of Trusts 223 (ALI 1959) states that a successor is liable if the successor knows or should know of a breach and improperly permits it to continue. In Illinois,

4 10 ALI-ABA Estate Planning Course Materials Journal February 2010 however, a successor trustee is not liable for the acts of the predecessor even with knowledge of the predecessor s breach. See 760 ILCS 5/14. ii. The successor trustee should review all prior account activity and asset information and, if possible, obtain indemnification from the beneficiaries for any actions taken before the assumption of the fiduciary relationship. iii. In any case, the successor trustee should review the trust instrument and state law for protection of successor trustees from acts of the predecessor, although exculpatory provisions in the trust instrument may not provide adequate protection to the successor (or predecessor) trustee. The successor trustee should also establish a clear date from which the successor s own liability as trustee begins to run. A dated acceptance form should be executed and coincide with the date of the predecessor s termination, if possible, to avoid time gaps. iv. The successor trustee should determine why the trusteeship is being changed and attempt to assess the litigious nature of the beneficiaries and, if applicable, co-trustees. 6. Assess The Risk a. The successor trustee should consider several factors in identifying possible risks arising from the previous trust administration: i. Qualifications and experience of the predecessor trustee; ii. Changes in value of the assets during prior administration; iii. Nature and extent of the assets held in the trust; iv. Condition and completeness of the records of administration; v. Frequency and amounts of distributions to beneficiaries during prior administration; vi. Regularity and completeness of accountings to beneficiaries; vii. Regularity and nature of communications between the predecessor trustee and beneficiaries; viii. Preparation of tax returns, including timeliness and resolution of tax liabilities; ix. Terms of the trust instrument governing powers of the trustee and dispositive terms that may create conflicts among beneficiaries; x. History of litigation or dispute relating to administration of the trust; xi. History and nature of family relationships and dynamics; and xii. Reasons for resignation or removal of the prior trustee. Julie K. Kwon, Trustee Succession: Steering the Successor Tide, ALI-ABA Course of Study: Representing Estate and Trust Beneficiaries and Fiduciaries, July 17 18, 2003, at When in doubt, decline.

5 Risk Management For Trustees 11 C. Understanding The Duties Of The Trustee 1. In many cases, trustees get sued because they have failed to understand their duties as a trustee. These duties are both of a general nature (found in the common law of trusts, such as avoidance of conflicts of interest) and of a more specific nature (such as duties imposed by the trust instrument and state law that governs the trust). Article 8 of the UTC codifies the fundamental duties of a trustee, in addition to listing the trustee s powers. Article 8 was drafted when possible to conform to the 1994 Uniform Prudent Investor Act. UTC General Comment to Article 8. All of the provisions of Article 8 may be overridden by the trust document, except for certain aspects of the trustee s duty to keep the beneficiaries informed of administration and the trustee s duty to act in good faith, in accordance with the trust s purposes, and for the beneficiaries benefit. Id. In advising trustees, whether they are individual trustees or corporate trustees, a starting point in the risk management process is to ascertain whether the trustee understands the trustee s duties and whether the beneficiaries have an understanding of the trustee s duties and the beneficiaries rights under the trust. 2. Duty To Understand The Terms Of The Trust And Administer The Trust By Its Terms a. As a prelude to accepting a trusteeship, a potential trustee must study and understand the terms of the trust and the material surrounding circumstances, including the nature of the trust assets and specific familial information regarding the trust beneficiaries. i. The trustee should read every word of the trust instrument, and trust counsel should provide the trustee with a written summary of the trust terms that highlights any special duties and responsibilities imposed on the trustee. The summary should be clipped to the front or back of the trust. Topics covered in that summary should include the following: (1) The dispositive provisions of each trust under the instrument, including any withdrawal rights and powers of appointment; (2) Provisions for mandatory and discretionary distributions of income and principal, specific standards for discretionary distributions, and ages for mandatory partial and terminating distributions; (A) Specific standards include conditions on distributions. Although conditions creating restraints against marriage, religion and family relationships are often void as against public policy, the Supreme Court of Illinois reversed and remanded a case regarding a Jewish Clause (requiring beneficiaries to marry within the Jewish faith) that the appellate court held was void as against public policy. In re Estate of Feinberg, 383 Ill. App. 3d 992 (1st Dist. 2008), rev d and remanded, 2009 Ill. LEXIS 1299 (Sept. 24, 2009). (3) Any provisions regarding special needs or treatment of a specific beneficiary; (4) The trustee s investment limitations, if any; (5) Accounting requirements, whether under the trust or under state law; (6) Special tax planning objectives for each trust;

Pay Frequency and Final Pay Provisions

Pay Frequency and Final Pay Provisions State Pay Frequency Minimum Final Pay Resign Final Pay Terminated Alabama Bi-weekly or semi-monthly No Provision No Provision Alaska Semi-monthly or monthly Next