The Dangers of Relying on Trust Language
| Publication year | 2016 |
| Pages | 55 |
| Citation | Vol. 45 No. 3 Pg. 55 |
Articles
Trust and Estate Law
The Dangers of Relying on Trust Language
By Rebecca Klock Schroer.
Trust and Estate Law articles are sponsored by the CBA Trust and Estate Section. Topics include trust and estate planning and administration, probate litigation, guardianships and conservatorships, and tax planning.
Coordinating Editors
David W. Kirch, Aurora, of David W. Kirch, P.C.—(303) 671-7726, dkirch@dwkpc.net; Constance D. Smith, Denver, of Fairfield and Woods P.C.—(303) 894-4474, csmith@fwlaw.com
This article provides guidance and caution to trustees and estate planners regarding trust language that purports to alter fiduciary duties and liability. Specifically, this article covers language regarding the Prudent Investor Rule, the Uniform Principal and Income Act, duties of loyalty and impartiality, the duty to inform and report, and exculpatory provisions.
Trustees are often surprised to learn that they can have exposure to liability even if their actions comply with the terms of the trust. While the language of the trust is certainly important, trustees must be cautious and make sure they do not rely on it to the exclusion of their fiduciary duties.
This article examines the effect of trust language on several fiduciary duties, but is not intended to be a comprehensive overview of all fiduciary duties. It identifies several duties that can be affected by the specific language of a trust and a few that cannot be eliminated no matter how strong the trust language.
Duties That Can Be Altered by the Terms of the Trust
Some of the fiduciary duties that can be altered by the terms of the trust include the duty to prudently invest, the duty to allocate between income and principal, the duty of loyalty, the duty of impartiality, and the duty of prudence. Each of these duties is discussed below.
Duty to Prudently Invest
The duty to prudently invest can be impacted by the terms of the trust.[1] As a general rule, a trustee must use reasonable care, skill, and caution to prudently invest and manage trust assets, while considering the purposes, terms, distribution requirements, and other circumstances of the trust.[2] When adhering to the Prudent Investor Rule, trustees often invest the trust assets in a diversified portfolio.[3] For example, a diversified portfolio might contain cash equivalents, bonds, asset-backed securities, real estate, and corporate stocks, diversified further by the more specific c haracteristics of each investment.[4]
Pursuant to the Colorado Uniform Prudent Investor Act, the language of the trust can expand, restrict, eliminate, or otherwise alter the duty to prudently invest.[5] The Act further provides that a trustee is not liable if she relies on the terms of the trust.[6]
While language abrogating the duty is helpful, it will not automatically dispose of a breach of fiduciary duty claim. A beneficiary may argue that the language of the trust is ambiguous and that the trustee's interpretation was not accurate. Furthermore, the beneficiary might argue that the trustee's reliance on the trust language was not reasonable, perhaps because of changed circumstances or otherwise.
The Colorado Uniform Prudent Investor Act was modeled after the Restatement (Third) of Trusts (Restatement (Third)).[7] The Restatement (Third) provides some insight into the effect of certain types of trust language that impact this duty.
First, the trustee may be given discretion as to the investments of the trust. A simple grant of discretion without more elaboration does not alter the duty to prudently invest.[8] However, the grant of extended discretion, including "sole and absolute" or "uncontrolled" discretion, does allow the trustee greater latitude in taking risks.[9] There is no way to determine how much additional latitude this language grants to the trustee, but such language would be helpful to a trustee defending a breach of fiduciary duty claim.
Second, the trust could include language stating explicitly that the trustee is not subject to the duty of diversification. This language is somewhat effective, but the trustee is still subject to the duty of prudence, which would include consideration of the role diversification may play in the overall investment of the trust.[10] The trustee should consider the settlor's objectives and have a justification for deciding not to implement a diversified portfolio other than relying only on language in the trust permitting it.[11]
Next, the trustee may be directed to retain or make a certain investment. The trustee has a duty to follow the settlor's directions, which may allow the trustee to vary from the normal duty to prudently invest.[12] Even when following a specific direction, however, the trustee can be exposed to liability for breach of fiduciary duty. There are at least three circumstances in which this could happen: (1) when compliance with the terms of the trust is unlawful, (2) when compliance is impossible, or (3) if circumstances have changed such that it is not prudent to follow the direction in the trust.
First, a trustee has a duty not to comply with the terms of the trust if the trustee knows or should know (through reasonable diligence) that the provision is unlawful or contrary to public policy.[13] In the context of investments, this can arise in situations in which the investment is in violation of securities laws, zoning laws, or any other applicable law.
Second, a trustee has a duty not to comply with the terms of the trust if it is impossible to comply or if the expense to comply is unreasonable.[14] To make the determination that compliance is impossible or the expense is unreasonable, the trustee must perform some level of investigation.[15] For example, the trustee could not reasonably comply with a trust term that instructed the trustee to invest in certain specific properties if the trust funds were not adequate to make such an investment.
Third, the trustee must be cognizant of changed circumstances. For example, if the terms of the trust direct the trustee to retain a farm, it would be prudent for the trustee to follow this direction. However, if the farm fell into an irreversible pattern of losses and low yields even in relatively good years, the trustee may want to seek court approval to deviate from the terms of the trust.[16]
The trustee has a duty to seek court approval of a modification or deviation if the trustee knows (or should know) that following the terms of the trust could result in substantial harm to the trust or its beneficiaries under particular circumstances, or if the settlor's purpose would be jeopardized.[17]
Even though there are circumstances in which a trustee must be careful to rely on the trust language and may even have a duty to deviate from the trust terms, it is certainly worth including as much language in the trust as possible to reflect the settlor's intent and try to limit the trustee's exposure to liability. Recent Colorado case law has recognized and respected the inclusion of language in a trust abrogating the trustee's duty to prudently invest. In Van Gundy v. Van Gundy, the Colorado Court of Appeals emphasized that the trust can contain language that alters the duty to prudently invest.[18] The trustee in Van Gundy had the following power:
[t]o invest and reinvest in common stocks, preferred stocks, investment trusts, bonds, securities and other property, real or personal, foreign or domestic, including any undivided i nterest in any one or more common trust funds maintained by an corporate trustee, whether or not such investments be of the character permissible for investments by fiduciaries under any applicable law, and without regard to the effect any such investment or reinvestment may have upon the diversity of the investments.[19]
The court noted that provisions such as these are strictly construed, but also found that this provision relaxed the degree of diversification required.[20] The trustee had maintained investments in seven common stocks and a mutual fund, so the investments were not drastic or particularly risky. In Van Gundy, the court ultimately reversed the trial court's ruling that the trustee had breached his fiduciary duties by failing to diversify the trust's investments.[21] While Van Gundy is helpful precedent, the outcome of a case like Van Gundy is fact-specific and dependent not only on the law, but also on the interpretation of the specific trust language at issue.
As with other fiduciary duties, while the drafting attorney can try to abrogate the duty to prudently invest, the trustee still has a duty to act prudently and in consideration of all the trustee's other fiduciary duties.[22]
Duty to Allocate Between Income and Principal
The Colorado Uniform Principal and Income Act provides default rules for the allocation of income and principal.[23] The specific provisions of the Act guide trustees on the characterization of receipts between income and principal. This is especially important when the income and principal beneficiaries are different, as it defines the assets available for distribution to each.
Like the Prudent Investor Rule, the Uniform Principal and Income Act allows the trust language to alter the rule.[24] The terms of the trust can grant the trustee discretion to allocate between income and principal or may direct the trustee to allocate receipts in a certain way.
If the trust contains language directing the trustee to allocate receipts a certain way, the trustee should comply unless one of the exceptions mentioned above applies (compliance is unlawful, impossible, or circumstances have changed such that compliance is not in the best interests of the beneficiaries). The Uniform Principal and Income Act provides an exception to fair and...
To continue reading
Request your trial