Richard Lyon Articles

TRUST WARS:
LIMITING CLASHES BETWEEN TRUSTEES AND BENEFICIARIES

The use of trusts in estate plans has grown exponentially in recent decades. Trusts are often used as will substitutes, transferring assets outside of probate. With this rising popularity of trusts has come an increase in trust disputes and litigation. We will focus here on one category of such trust disputes, those arising between beneficiaries and trustees, and primarily those which are related to trust administration. The question posed is this: Are there reasonable ways for the settlor of a trust to effectively reduce the likelihood of clashes between disgruntled or litigious beneficiaries and the trustee(s)? We believe the answer is a qualified yes.

Trusts and the Role of the Trustee

The trustee’s job, particularly in a testamentary scenario, is not an easy one. The trustee has fiduciary duties to the beneficiaries and must seek to implement what the trustee believes was the settlor’s intent. Mercantile-Safe Deposit & Trust Co. v. Purifoy 280 Md. 46 (1977). But, because trust settlors cannot anticipate all future circumstances, and cannot always predict how various beneficiaries will react, trustees are often exposed to conflicts. Beneficiaries who are frustrated or disappointed (justifiably or not) have ample opportunities to object to the action or inaction of a trustee. And, where the beneficiary is angry and determined, that beneficiary can cause significant distress for the trustee, as well as costs, fees and harm to the trust and other beneficiaries.

But, trustees are not without remedies. Maryland statutes and rules address, in a patchwork fashion, the nature of trusts and the role of the trustee, in Titles 14 and 15 of the Estates & Trusts Article and elsewhere. When there is conflict or uncertainty, a trustee can file a Petition in a Circuit Court, asking the Court to assume jurisdiction of the trust, for all or only limited purposes, including interpretation of trust provisions and approval of planned distributions and accounts. See Maryland Rules 10-501 and 10-706 through 10-710. And, Maryland courts have developed a body of law applicable to trust disputes that, although not comprehensive, provides guidance and certain general principles. The following sections of this article discuss some specific trust provisions that may help avoid or limit disputes between trustees and disgruntled beneficiaries, the current state of Maryland law in such situations, and some ideas on where the law may further develop.

Exculpatory Clauses

One effective tool that is sometimes used by settlors to protect their designated trustees from potential claims is the exculpatory clause, i.e. a clause that relieves the trustee of liability under certain conditions. In Maryland, a trust instrument may expressly limit the liability of the trustee to circumstances like gross negligence or intentional misconduct. See Jacob v. Davis, 128 Md. App. 433 (1999). Such limiting language in a trust is generally found to be enforceable, unless (a) the limits are so broad as to be considered against public policy (e.g. excusing intentional misconduct, which is fundamentally at odds with the trustees fiduciary duties), or (b) the liability limitation language was inserted into the trust as a result of the trustees abuse of a confidential relationship with the settlor. Sullivan v. Mosner, 266 Md. 479 (1972). While limiting the trustees potential liability will certainly not eliminate many forms of trust litigation, it can go a long way toward reducing the leverage that disgruntled beneficiaries may seek to exercise over a trustee. On the other hand, the settlor must carefully consider whether he or she wishes to give the trustee such broad protection, as it could potentially be abused by a trustee. In most cases, settlors do understand the importance of careful selection of the person(s) who will serve as trustee, and most often the selection is well made. But, when a family member is selected as trustee and given broad discretion, especially when that person is also a beneficiary, the opportunity for abuse of the position arises, as well as the perception (rightly or wrongly) of other family members that the trustee role is being abused. So, the exculpatory clause is not right for all trusts, but is certainly worthy of consideration.

Forfeiture or Fee Shifting Provisions

Maryland law provides that a testator may include a provision in a will, known as an In Terrorem provision, that penalizes a legatee if he or she challenges unsuccessfully the will or institutes other proceedings in an estate. However, in Estates and Trusts Article §4-413, the General Assembly determined that when a beneficiary challenges a will that includes such a provision, with probable cause to do so, the provision is void. By its terms, §4-413 does not mention or expressly apply to use of an In Terrorem provision in a trust. But, because no Maryland case has construed §4-413, the scope of the statute may be open to some debate.

In an inter vivos trust, an In Terrorem provision may be enforceable, without the probable cause escape hatch applicable to wills under §4-413. If so, then any unsuccessful challenge to the trust by a beneficiary may void that beneficiary’s distributive share. That may pass muster if the In Terrorem provision is limited to challenges to the creation or the terms of the trust (e.g. suits arguing that the settlor lacked the mental capacity to validly create the trust, or that undue influence was practiced upon the settlor which invalidates the trust). However, if the In Terrorem clause in either an inter vivos or testamentary trust is so broad as to arguably cause forfeiture of a beneficiary’s share for in any way challenging the trustees administration of the trust, that may well run afoul of the basic principle behind a trust that: [a] settlor who attempts to create a trust without any accountability in the trustee is contradicting himself. . . . If the court finds that the settlor really intended a trust, it would seem that accountability in chancery or other court must inevitably follow as an incident. G. Bogert, Trusts and Trustees §974, at 467 (2nd ed. Rev. 1983). See also 23 ALR 4th 369, Validity And Enforceability Of Provision Of Will Or Trust Instrument For Forfeiture Or Reduction Of Share Of Contesting Beneficiary, for an excellent survey of these issues.

Given the competing interests of trying to limit disputes between trustees and beneficiaries, yet maintaining the integrity of the trustees fiduciary duties, how can the settlor properly try to avoid suits against the trustee? Of special concern are beneficiaries who are to receive lesser shares, and who therefore may seek to pursue disruptive claims, despite an In Terrorem clause, based on the theory that I have nothing to lose and everything to gain.

To this end, trust draftsmen may consider a provision in a Trust which is broader than, and perhaps combined with, an In Terrorem provision. Consider the following example:

I hereby instruct, direct and authorize my trustee to deduct from the distributive share due any beneficiary, the costs and expenses, including attorneys fees, expert witness fees and court costs, incurred by or for the trust, because of the following actions or behavior of such beneficiary: (insert list of actions that will cause fee and cost deductions, e.g. pursuit of court proceedings to interpret the trust terms, remove the trustee, or challenge distributions or partial distributions from the trust, if the beneficiary is unsuccessful in making such claims in court). I so instruct my trustee because I do not wish for innocent and cooperative beneficiaries to suffer or bear the costs and expenses which are caused by a non-cooperating beneficiary who is challenging, obstructing or thwarting the effective administration of the Trust.

The idea is to shift the burden of fees and expenses to a beneficiary who is unreasonable or obstructionist, while preserving the beneficiary’s rights to receive relevant information about the status of the trust and any planned distributions. In order to fully retain the basic rights of a beneficiary, especially the right to receive information, the settlor should probably add language that says the fee and cost shifting provision would not apply to actions to force a trustee to provide an annual accounting or to take some other act that is mandated by specific statute, rule or other trust instrument. While provisions like the example above grant considerable power to a trustee that could be abused, there are other options for protecting against abuse by the trustee. For example, the clause could include a final sentence that reads:

Notwithstanding the above provisions of this clause, any beneficiary may petition to remove a trustee without invocation by the trustee of the above stated cost and fee deduction provisions, but I direct that if the petitioning beneficiary does not establish a breach of trust or fiduciary duty by the trustee in that proceeding, then the trustee shall at that time apply the cost and fee deduction provisions to the distributive share of the challenging beneficiary as described above.

In the absence of such fee and cost shifting provisions in the trust, the trustee may seek an award of fees and costs under Maryland Rule 1-341, for bad faith or meritless litigation attacks by a disgruntled beneficiary. Courts have been more receptive to this argument in the trust context because of the harm to the innocent, non-objecting beneficiaries. If such fees and costs are awarded under Rule 1-341, the trustee can then file an accounting and seek judicial approval for the trustee to charge those awarded fees against the troublesome beneficiary’s distributive share, to the extent the award has not been otherwise paid to the trust by the beneficiary.

Non Judicial Resolution of Accounts

    Frequently, a trustee will request or insist upon a Release and/or Refunding Agreement from a beneficiary prior to a partial or final distribution of trust assets and the stating of an account.   Such an agreement protects the trustee in the event the disgruntled beneficiary files suit or claims against the trustee after receiving a distribution. It also protects the trustee in the event of the need to require return of funds from the beneficiary for an unanticipated and unpaid expense (e.g. a tax obligation) which occurs after the distribution or partial distribution.

    There is no provision in the Maryland Code or Rules that either expressly authorizes or prohibits a trustee from seeking such a Release and/or Refunding Agreement. As a matter of practice, trustees typically request them. If one or more beneficiaries will not agree to a Release and/or Refunding Agreement, then a trustee can seek a judicial settlement of accounts and distribution, to include a judicial discharge from liability. Section 10-501 of the Maryland Rules of Procedure permits a trustee (or other interested person) to file a Petition for a Circuit Court to assume jurisdiction of the Trust Estate and to grant related relief. Maryland Rules 10-706, 10-708, 10-709 and 10-710 permit a trustee to file a Final Accounting and to seek Court approval of an account and other relief. A judicial order approving an account should operate as res judicata and subsequent claim and issue preclusion. See, e.g., Berlage v. Boyd, 206 Md. 521 (1955).

    Section 817 of the Uniform Trust Code (UTC) states that if a beneficiary fails to object within 30 days to proper notice from the trustee of proposed distribution of the trust assets, then the beneficiary’s right to object is terminated. However, Maryland has not adopted the UTC (21 states to date have adopted it). Although that mechanism is not adopted by statute or rule in Maryland, practitioners may wish to specifically include such language in trusts as a means of garnering some protection.

     Additionally, if a settlor wants more protection for the trustee against unreasonable objections by rogue beneficiaries, it might be useful to at least consider the insertion of a trust provision that authorizes the trustee to withhold distribution from a beneficiary of his distributive share if he unreasonably fails to sign a release of the trustee. To insure that the trustee does not overreach, such a provision should require that the trustee provide a proper trust accounting with the release. It should also provide that the beneficiary does have the right to file a court challenge of the proposed distributions, but the cost and fee shifting provisions discussed above could be used to charge the trustees legal fees and costs against the litigating beneficiary if he does not prevail. If such provisions were used, then one should also define what happens if a beneficiary fails to sign the release, but also does not challenge in court e.g. if neither occurs within x days, that beneficiary’s share shall be redistributed to the other beneficiaries. If the settlor wishes to include protections for the beneficiaries, perhaps a provision could also be included that a trustee who wrongfully requires a release without providing an appropriate disclosure and accounting or who has otherwise breached a fiduciary duty shall be held accountable for such wrongful demand for a release.

    Case law generally allows the settlor considerable leeway to include trust terms that will protect the trustee to a reasonable extent. However, there are limits. In an interesting recent case from Illinois, the court held invalid a trust provision that said approval of a final accounting by a majority of beneficiaries released the trustee from liability. Vena v. Vena, 387 Ill. App. 3rd 389, 899 N.E. 2d 522 (2008). The appellate court determined that this majority approval process did not provide effective oversight of the trustee, and could improperly exculpate him for breaches of trust or acts done recklessly or in bad faith, without allowing for court supervision.

     While a settlor may place some limits on the trustees potential liability, that must be balanced by allowing beneficiaries to seek relief from a court for wrongful acts of a trustee in the administration of the trust. However, the settlor who wants to discourage (but not completely prevent) court challenges by beneficiaries on the trustees administration, should be able to employ certain fee and cost shifting provisions, and other limited forms of forfeiture provisions, to achieve that effect.

Trust Protectors and Advisors

Another mechanism which may be available to trustees, beneficiaries and their counsel, and which may serve to prevent or limit some potential litigation, is the trust protector or trust advisor. A trust protector or advisor is any person, other than a trustee, who under the terms of the trust, and agreement of the qualified beneficiaries, or a court order has a power or duty with respect to a trust. UTC Section 808. The advisor or protector can be granted the power to review and approve trustee reports or accountings, the power to remove a trustee or co-trustee for specified reasons and appoint a successor, and/or the power to veto or approve a trustees action or inaction in making distributions or other related decisions.

Such a mechanism may help to avoid litigation in some situations. For example, a trust advisor may be authorized to break a deadlock among co-trustees. The trust advisor may also be authorized to remove and replace a trustee, which is often the only power given to a trust advisor. That power provides a person who can potentially intercede between a trustee and beneficiary in conflict, and in essence mediate a resolution. An independent and well-respected trust advisor may be especially effective where the trustee is a family member and/or a beneficiary of the trust. But, keep in mind that Maryland has no specific statute or case law approving the use of a trust advisor or protector. Nevertheless, the specific authorization of this in the UTC may be persuasive for a Maryland court in the right situation. While a trust protector or advisor is not a trustee, it nonetheless appears that such a protector or advisor must act in good faith and is subject to at least some fiduciary standards. See UTC §808.

Mediation/Arbitration

The idea of arbitration or mediation of disputes in the Estate and Trust context is gaining momentum. Currently, trustees and beneficiaries do mediate disputes but such efforts are generally voluntary with the exception of court orders which direct mediation. As of July 1, 2007, Florida adopted a statute which expressly authorizes mandatory arbitration clauses in wills and trusts. Florida Statute 731.401. Maryland does not have such a provision. Only time will tell if the Florida statute is a valuable initiative and worthy of adoption. But, it is food for thought in the trust drafting process.

Conclusion

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