- Trustees have certain powers.
- Trustees owe a fiduciary duty to the beneficiaries of a trust.
- Trustees owe certain duties to third persons.
1. Powers of a trustee
A trustee has all enumerated power. A trustee also has implied power (helpful to carry out the trust purpose). A trustee has the implicit power to sell trust property, to incur expenses, the power to lease, and to borrow (modern power).
Another view is that a trustee doesn’t have power other than those granted by the trust document. Selling a trust asset is never an implied power; it must be given expressly. Even with an overproductive asset that you need to sell to avoid being in breach of fiduciary duty, you still have to go to court and get permission to sell.
The modern way to give power to trustee in California is through a statutory list that is automatically read into the trust document. These powers are automatically granted unless the trust doc excludes them or the trust doc says something to the contrary.
2. Trustee Duties Owed to the Beneficiaries
Duty of Loyalty
There are 2 prongs to this duty. First, the trustee can’t engage in self-dealing. Second, the trustee can’t act under a conflict of interest.
No self-dealing allowed
The trustee can't engage in self dealing. What this means is that the trustee cannot buy/sell to/from the trust. He cannot profit personally from trust or engage in transactions with the trust. It is a per-se breach if the trustee engages in self dealing. It does not matter if the dealing is fair. There is no further inquiry.
However, there are 2 narrow exceptions. The first exception is if the settlor authorized the self-dealing transaction. If the instrument says the trustee can sell the property to himself, then this gives rise to further inquiry: (1) was it done in good faith AND (2) was it fair and reasonable?
The second exception is: if there was full disclosure to the beneficiaries and the beneficiaries consent, this will give rise to further inquiry: (1) was the transaction done in good faith AND (2) was it fair and reasonable?
If there is a breach of the duty of loyalty, the remedy is to undo the transaction. If you bought something, you must give it back to the trust and get the money you paid back OR if you sold something, you must take the item back from the trust and purchase price is refunded. If you can’t undo the transaction because you sold the trust asset to a third party, then you must disgorge profits and give the profits to the beneficiaries.
Measure of damage is "appreciation damages." This is the value of assets at the time of judgment minus what the trustee sold the assets for.
No conflict of interest allowed A conflict of interest is not a per se breach like a self-dealing transaction is. If there is a conflict of interest, you inquire further: (1) was the trustee was acting in good faith AND (2) was it fair and reasonable to the beneficiaries?
The remedy, if there was a conflict of interest, is recovery of trust assets that were not sold to bona fide purchasers.
If it was sold to a third party, assets are unrecoverable, but you can get money damages for unrecoverable assets. How much beneficiaries gets depends on whether the trustee has the “power of sale.” If trustee did NOT have "power of sale" then the recovery is equal to the value of assets at the time of judgment minus what the trustee sold the assets for. These are "appreciated damages." But if trustee did have "power of sale," then the recovery is only the market price at the time of sale minus what the trustee sold the assets for.
Duty of care
In addition to the duty of loyalty, trustees owe the beneficiaries a duty of due care. The trustee must act as a reasonably prudent person as if he is dealing with his own affairs. Remedies: damages, constructive trust, tracing, ratify if good for the beneficiary, removing the trustee.
Reasonable care and skill in managing the investment
3 standards for investing:
- Some states have an exhaustive "state lists." Typically, they allow only for (i) federal government bonds, (ii) federally insured certificates of deposits, (iii) first deeds of trust in real estate, and (iv) sometimes stock of publicly traded corporation.
- Common law "prudent person" standard: Under common law, the trustee must act as an ordinary prudent person who is investing his own property. There is even a higher standard if the trustee is a professional investor. Good investments under common law: (i) federal government bonds, (ii) first deeds of trust in real estate, (iii) federally insured certificates of deposit, (iv) blue chip stock, and (v) sometimes mutual funds, but (v) never a new business or second deeds of trust. Each individual investment is scrutinized.
- Uniform "prudent investor" standard: the trustee must act as a prudent investor. Under a "portfolio theory" the trustee must look at each investment in light of the whole portfolio and in light of the purpose of the trust/investment strategy. She must look at the total return, rather than seeing whether each individual investment was prudent. Sometimes a trust may invest certain assets in types that traditionally would have been overly risky. If something turns out to be not prudent, those losses cannot be offset with gains made in other parts of the portfolio. Any particular investment is not invalid per se.
Duty not to delegate
Traditionally, the trustee alone must select investments of the trust and decide how to distribute.
The modern approach will allow delegation of picking investments, but deciding how to distribute must still be done by the trustee. The trustee must pick investors carefully and must supervise those she hires to help pick investments. The trustee may delegate minor ministerial tasks, but not tasks that require judgment. Although she can ask investors for advice, she must maintain discretion and make ultimate decisions.
Duty of impartiality
The trustee can’t favor one class of beneficiaries over another. If it’s producing too much income, but principal is stagnant, then it’s over-productive and it’s favoring income beneficiaries over the remainder beneficiaries
What to do with an over productive asset? If the asset is producing too much income and its value is going down (unfair to remainder beneficiaries). How to remedy? Put some money into improving, take high income and allocate to principal (take income out and earmark it as principal), or sell the asset and reinvest in property that is not over productive.
Remedy if an over-productive asset should have been sold earlier? Difference in value plus interest to account for time value of money. For example, a building was worth 300K when it should have been sold (in 2005). However, today (2009) its worth 200K. How much money should you give the remainder beneficiaries? There is a difference of 100K. Add interest: if interest rate is 5% that’s 5% times 32 years = 160K. You get 100K + 160K = 260K.
and divide it by 1+What do to with underproductive assets? You must sell it and get something else. How much does the remainder beneficiary get? If you sell the asset for 200K and the interest rate is 5% and you held it for 20 years, how to allocate between income and principal? Take the net proceeds and divide it by (1+ period of years * interest rate).
Sometimes you have to distinguish between income and principal:
(a) interest payment, dividends income, and dividends payable as stock in another company → income
(b) dividends of corp. stock itself (i.e. stock split), growth in the principal such as capital gain → principal (doesn’t change underlying ownership)
(c) assets that depreciate over time: royalties/mineral rights/copyrights must be allocated between income and remainder beneficiaries
Duty to keep control of the trust property / duty to collect the trust property
Trustee has to take possession of all the assets that should be in the trust.
Duty to preserve and protect trust assets
This includes getting insurance for any real estate.
Duty to earmark
the Trustee must earmark assets as “trust assets” (to identify which are trust assets and which are trustee’s assets). If a trustee owns a share of stock and its properly earmarked, it will be registered as "John Smith as trustee for ABC Trust."
Remedy? Under common law, any loss that was suffered by assets that were not properly earmarked become the liability of the trustee (strict liability). The modern rule requires causation. A trustee is only liable for the losses that result from the failure to earmark (not any loss). This would not include any ordinary market losses.
Duty to segregate
The trustee can't co-mingle his personal funds with trust funds. And the trustee can't co-mingle funds of trust A with trust B. If he breaches, can be removed and sued for loss.
Duty to furnish information about the trust to the beneficiary
The beneficiary has right to see entire trust instrument and look at the books. Otherwise, it's impossible to know if trustees are acting properly.
Duty to keep and render accounting
A trustee has a duty to make and provide and accounting at regular and reasonable intervals (at least 1x per yr). A trustee must give the beneficiary a statement of income and expenses of the trust. If the trustee fails to do so, beneficiary can file an action for accounting.
Generally, modern living trusts don’t involve court supervision. Accounting is done directly to beneficiaries. If they don’t get an accounting, they can go to court and make the trustee account. But if it involves a testamentary trust, there is more supervision. The accounting is made with the court. When the court receives the accounting and notice is given to beneficiaries (to contest) and no beneficiaries contest, then the judge will “allow” the accounting. The “allowance” acts as a SOL: any action taken prior to that accounting period cannot be re-opened unless fraud/concealment.
Duty to enforce /defend claims on behalf of the trust
This is a "reasonableness" standard.
Other duties
- Duty to make trust productive
- Duty to pay income to beneficiary
- Duty to exercise reasonable care in preventing breach by co-trustee
- Duty to administer the trust
- Duty to respect bank deposits
Revoking accounting of a trust
Paying money to someone who is no longer a beneficiary is a breach of fiduciary duty by the trustee. Courts supervise testamentary trusts and the court will approve and close the accounting of testamentary trusts. If no one objects to accounting, the court generally allows the accounting. When the trustee gets accounting approved by the court, this operates like a SOL, and gives the trustee assurance that it won’t later be challenged. However, you may be able to challenge previous accounting when there is fraud/concealment.
3. Liability of trustee to a third party for breach of contract or torts committed by a trustee or someone hired by trustee
Contracts
Under common law, a trustee is personally liable for any torts or breach of contract. However, if the trustee wasn’t personally at fault in tort or entered into the contract in his representative capacity (not personally) then trustee can get indemnification from the trust if the trustee acted within his power. Under the modern approach, if the third person knows the trustee is entering into the contract in his representative capacity, then the trustee can only be sued in representative capacity. Judgment is entered against the trust, not the trustee personally. But if the trustee is at fault but not in his fiduciary capacity you can still go after the trustee personally.
Torts
Under common law, the trustee is sued in his personal capacity. If the trustee was without personal fault, she can get indemnification from the trust assets. Thus if the agent committed the negligent act, or if this is a case of strict liability, then the trustee can obtain indemnification.
Under the modern approach, the trustee is sued in his individual capacity and is liable personally for torts only if the trustee is personally at fault (acted negligently, or committed a tort). Thus if an agent committed the negligent act, or if this is a case of strict liability, the trustee is sued in his representative capacity.
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