Being a successor trustee is an important responsibility. On one hand, a successor trustee will try to carry out the grantor's intentions, as expressed by the terms of the trust agreement. On the other, a successor trustee will try to maintain and hopefully enhance the value of assets for beneficiaries of the trust. A key issue to address is minimizing the successor trustee's personal liability in managing trust assets when these objectives conflict.
Living trusts have become key vehicles in estate planning to avoid the adverse effects of guardianship and probate proceedings. While the grantor is typically the initial trustee of his or her living trust, upon the death or disability of the grantor, a successor trustee is designated under the living trust to thereafter manage trust assets.
A successor trustee can be liable for breach of fiduciary duty in a host of situations when the successor trustee actually mismanages trust assets, including fraud, misappropriation, negligence or self-dealing. It certainly seems reasonable for a successor trustee to bear liability in each of these cases when the successor trustee has committed some “bad action.”
However, in other cases, the liability of a successor trustee may seem less reasonable. Specifically, what if the trust agreement requires a successor trustee to act in a certain manner, but acting in such manner would be imprudent from a fiduciary perspective? If the successor trustee does not follow the terms of the trust agreement, the successor trustee may be liable for breach of the trust agreement. If the successor trustee follows the terms of the trust agreement, the successor trustee may be liable for breach of fiduciary duty.
This article examines how a successor trustee can minimize personal liability when confronted with this situation by examining its applicability in two sample cases involving successor trustees – “Brian” and “Michelle.”
Brian as successor trustee
Brian is one of three children. On their father's death, pursuant to the terms of the trust agreement for their father's living trust, Brian has been designated as the sole successor trustee. The trust agreement for Brian's father also provides as follows:
- “Because it has been in the family for generations, the Trustee shall not sell my home after my death, even if it is unoccupied and otherwise could be sold at or above its fair market value to realize cash for my beneficiaries.”
- “Because I believe that they are profitable and growth industries, the Trustee shall continue to maintain my stock portfolio 50% in airline company stocks and 50% in cruise line company stocks.”
- “Because I believe that they will eventually replace the personal computer, the Trustee shall use all of the income from my assets to purchase as many abacuses as possible.”`
It is assumed that owning an unoccupied house that otherwise could be sold at or above its fair market value to realize cash for beneficiaries, owning airline company stocks and cruise line company stocks in the midst of the COVID-19 pandemic as well as owning abacuses would each be considered imprudent investment decisions.
Michelle as successor trustee
Michelle is one of three children. On their father's death, pursuant to the terms of the trust agreement for their father's trust, Michelle has been designated as the sole successor trustee. The trust agreement also provides as follows:
- “Because it has been in the family for generations, it is my precatory intention that the Trustee may not sell my home after my death, even if it is unoccupied and otherwise could be sold at or above its fair market value to realize cash for my beneficiaries.”
- “Because I believe that they are profitable and growth industries, the Trustee shall continue to maintain my stock portfolio 50% in airline company stocks and 50% in cruise line company stocks, except if my beneficiaries unanimously agree to declare this provision null and void.”
- “I appoint Frank Financial as trust protector and grant him the right to amend or revoke any of the investment provisions of the living trust to be consistent with prudent investing and to reflect current economic conditions.”
- “Because I believe that they will eventually replace the personal computer, the Trustee shall use all of the income from my assets to purchase as many abacuses as possible. The Trustee shall be released from, and indemnified and held harmless by the assets of the living trust against, any and all liability based on the Trustee using all of the income from my assets to purchase as many abacuses as possible”.
Michelle's personal liability as successor trustee is minimized by the trust agreement
Michelle's case prevents an example when the successor trustee's liability is minimized by the terms of the trust agreement.
First, the ownership of the family home is not a requirement. Unlike in Brian's case, where the mandatory word, “shall,” is used, in Michelle's case, the suggestive phrase, “precatory intention” and the related suggestive word, “may” are used. By using non-binding language, Michelle's father's trust gives Michelle more flexibility as successor trustee and reduces her risk of personal liability.
Second, the ownership of airline company stocks and cruise line company stocks is not required if the beneficiaries unanimously agree to declare this provision null and void.
To the extent that the beneficiaries are the persons most likely to be upset by any “airline company stock/cruise line company stock” requirement, they can take other action (declaring the provision null and void) in lieu of filing a lawsuit against Michelle. By using a “beneficiary amendment” provision to allow the beneficiaries to change the terms of the trust agreement, Michelle's father's trust again gives Michelle more flexibility (with beneficiary consent) as successor trustee and reduces her risk of personal liability.
Third, as trust protector, Frank Financial has the authority to modify or delete any of the objectionable investment provisions of Michelle's father's living trust.
Subject to Frank Financial being willing to exercise this authority as trust protector (including if convinced to do so by Michelle), by using a “trust protector” provision, Michelle's father's living trust again gives Michelle more flexibility as successor trustee and reduces her risk of personal liability.
Fourth, Michelle is expressly released from, and indemnified and held harmless by the assets of the living trust against, liability based on the ownership of abacuses. Such “release” and “indemnification and hold harmless” provisions in Michelle's father's trust most significantly reduce Michelle's risk of personal liability as successor trustee.
What can Brian do to minimize his personal liability as successor trustee?
Unlike in Michelle's case, in Brian's case, Brian's father's trust does not include any “precatory intention,” “beneficiary amendment,” “trust protector” or “release” and “indemnification and hold harmless” provisions. While his personal liability as successor trustee is not minimized by the trust agreement for his father's trust, Brian can still take certain action to minimize his liability, as follows:
- Decanting. Decanting allows the successor trustee to distribute the assets from one trust to another trust. Brian could decant his father's trust and distribute its assets to a new trust, which would be governed by a new trust agreement that would not contain the objectionable provisions. The specific requirements to decant will be determined by applicable state law. One common decanting requirement is that the trustee has the authority to make distributions from the existing trust.
- Judicial reformation. Judicial reformation allows a court to modify the terms of an otherwise irrevocable trust. Brian could file litigation to delete the objectionable provisions from his father's trust. The specific civil procedure to follow to achieve a judicial reformation of a trust will vary from state to state. It will likely be necessary for the beneficiaries of the trust and any other interested parties with respect to the trust to consent to the intended modification before a court will approve any judicial reformation.
- Release and indemnification and hold harmless agreement. Just as “release” and “indemnification and hold harmless” provisions in a trust agreement (as described above) can minimize successor trustee liability, it is also possible to cover these issues in a separate agreement. Brian and the trust beneficiaries could execute an agreement to release Brian from liability (with respect to beneficiary claims) and to indemnify and hold harmless Brian against liability (with respect to beneficiary and other claims).
- Resignation. Designation as a successor trustee is not slavery. If Brian cannot find comfort from any of the “decanting,” “judicial reformation” and “release and indemnification and hold harmless agreement” alternatives described above, he can always resign as successor trustee. A properly drafted trust agreement should include additional successor trustees (to serve after Brian) and procedures for trustee resignations.
Importance of communication to minimize personal liability for successor trustees
Whether based on provisions in the trust agreement or subsequent action, there are multiple ways for a successor trustee to minimize personal liability in managing trust assets when confronted with a conflict between the terms of the trust agreement and prudent fiduciary conduct. One common theme in many of these alternatives to reduce successor trustee personal liability is the importance of communication.
The grantor (Brian's father and Michelle's father) should communicate with a successor trustee to discuss what provisions should be included in the grantor's living trust. If the grantor wants to include investment provisions such as are included in Brian's father's living trust, a successor trustee can try to dissuade the grantor from such provisions or at least encourage the grantor to include the “precatory intention,” “beneficiary amendment,” “trust protector” and “release” and “indemnification and hold harmless” provisions described above. In addition, if the trust agreement leaves a successor trustee in an “exposed” position as to liability (such as Brian), a successor trustee should communicate with the beneficiaries of the trust and honestly express his or her concerns about liability. The successor trustee will then know if judicial reformation or a release and indemnification and hold harmless agreement (with beneficiary consent) is a viable alternative, or if decanting or resignation (without beneficiary consent) must be considered.
By communicating with the grantor and the beneficiaries of the living trust, a successor trustee can more easily achieve the available options to minimize personal liability as a successor trustee when facing a conflict between trust agreement terms and proper fiduciary investment decisions.