Duty of Loyalty

• Author: Browne C. Lewis
• Pages: 282-301

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Chapter 10 - Duty of Loyalty

The trustee must administer the trust solely in the interest of the beneficiaries.

This is similar to the exclusive benefit rule under ERISA that requires retirement funds to be

managed for the exclusive benefit of the retirees. The two main indicators of disloyalty occur

when the trustee engages in self-dealing or ignores a conflict of interest. Self-dealing occurs

when the trustee buys or benefits from the sell or purchase of trust property directly or

indirectly. If the trustee engages in self-dealing, good faith and fairness to the beneficiaries

are not enough to save the trustee from liability. In case of self-dealing, the court makes no

further inquiry. Therefore, the trustee’s good faith and the reasonableness of the transaction

are irrelevant. The beneficiaries have several remedies when the trustee engages in self-

dealing. First, the beneficiaries can hold the trustee accountable for any profit he made on

the transaction. In the alternative, if the trustee purchased the property from the trust, the

beneficiary can sue to compel the trustee to restore the property to the trust. In the event the

trustee has sold his own property to the trust, the beneficiary can sue to make the trustee

return the purchase price and take back his property. The trustee is not without defenses

when it comes to self-dealing. In order to avoid liability, the trustee must prove that the

settlor authorized the self-dealing or that the beneficiaries consented to the transaction after

he made full disclosure. Nonetheless, the transaction must be fair and reasonable.

A conflict of interest occurs when the trustee facilitates the sell or purchase of

trust property to a person or entity to which the trustee also owes a fiduciary duty. For

example, if an attorney who is acting as trustee sells trust property to one of his clients, a

conflict of interest arises. The court will evaluate the transaction to see if was fair and

reasonable to the trust. In that case, the trust pursuit rule provides a remedy for the

beneficiary. Under that rule, if the trustee wrongfully disposes of trust property and acquires

other property, the beneficiary is entitled to enforce a constructive trust on the newly

acquired property so acquired. Hence, the new property becomes a part of the trust assets.

In the event that the trust property ends up in the hands of a third party, there are two

possible results. If the third party is not a bona fide purchaser (BFP))(one who pays value

and takes without notice of the breach of trust), he does not hold the trust property free of

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the trust. If the person is a BFP-he holds the trust property free of the trust and is under no

liability to the beneficiary.

Problems

1. Karlowba established a support trust for the benefit of her son Kahn. The corpus of the

trust was a collection of antique cars valued at $200,000 and other property. After Karlowba

died, Cory assumed his roll as trustee. The trust needed cash in order to pay monthly income

to Kahn. Thus, Cory decided to purchase the antique car collection from the trust. In order

to avoid the appearance that he was taking advantage of the trust, Cory purchased the car

collection for $350,000. Later, the car collection appreciated to a value of $800,000. Kahn

sued Cory to recover the profits from the appreciation of the car collection. What result?

2. Alberto established a trust for his daughter Isabella. The corpus of the trust was an

apartment complex valued at two million dollars. Lionel was appointed as trustee over the

Isabella trust. Lionel was also trustee over a second trust that had been created by Bradford

for the benefit of his son, Carlton. For tax reasons, the Carlton trust needed to make an

investment. Lionel purchased the apartment complex from the Isabella trust for the Carlton

trust. Lionel used two million dollars from the Carlton trust to purchase the apartment

complex. Later, the apartment complex was worth three million dollars. Isabella sued Lionel

to recover the profits from the appreciation of the apartment complex. What result?

3. Please label the following situations as self-dealing or conflict of interest.

a). Elaine’s brother Chris purchased property from a trust over which she is trustee.

b) Joseph gives property from a trust over which he is trustee to his mistress, Arlene.

c) Galvin sells land owned by his medical practice to a trust over which he is trustee.

d). Melvin, a psychologist, sells property from a trust over which he is trustee to one of his

patients.

e) Zach sells property from a trust over which he is trustee to City College. Zach is on the

board of trustees of City College.

Boyce Family Trust

, 128 S.W.3d 630

WILLIAM H. CRANDALL, Jr., Judge.