Fiduciaries (and Others) Beware—an Over-reaching Release May Be Voidable

• Publication year: 2015
• Author: By Christopher D. Carico, Esq. and Golnaz Yazdchi, Esq.

FIDUCIARIES (AND OTHERS) BEWARE—AN OVER-REACHING RELEASE MAY BE VOIDABLE

By Christopher D. Carico, Esq.^* and Golnaz Yazdchi, Esq.^**

I. INTRODUCTION

The majority of contested trust proceedings are resolved before trial, frequently as a result of a successful mediation between the parties. The settlement is often memorialized in a written agreement signed by all fiduciaries, beneficiaries, heirs, and other litigants. With the goal of bringing finality to present disputes and avoiding future ones, the settlement agreement often includes a broadly drafted general release. Usually, the general release in the settlement agreement purports to absolve the trustee (and the other parties) from past errors, omissions, breaches, and other wrongdoings. The general releases typically include language waiving the protections of Civil Code section 1542, intending to release all of the parties from existing claims that are not yet known or discovered by the parties at the time of signing the settlement agreement.

Despite the all-encompassing language, broadly drafted general releases may still have limited effectiveness for fiduciaries in light of Probate Code section 16464, subdivision (b). To enforce the release, the trustee will bear the burden of proving that the beneficiary was on "equal footing" with the trustee.¹ In the event of a future dispute concerning the scope of the release, the trustee will have the burden of establishing that the beneficiary was aware of all material facts, the beneficiary had a full understanding of his or her legal rights and the settlement/release was fair and reasonable to the beneficiary.² Where the trustee has failed to disclose material facts, or the release is economically unfair to a beneficiary not represented by counsel, the release may be voidable by the beneficiary through an action for rescission.³

Regardless of the recitals set forth in the settlement agreement containing the release, the enforceability of a release in favor of a trustee is always a fact-specific inquiry. The courts will look beyond the language of the agreement into the circumstances surrounding the beneficiary's execution of the settlement agreement containing the release.⁴ Whether the beneficiary was represented by legal counsel in executing the agreement containing the release may be the most pivotal factor. In the absence of independent counsel, it will be very difficult for the trustee to establish that the beneficiary fully understood his or her legal rights. A thorough understanding of the limitations imposed by law on releases favoring trustees is needed to avoid a future finding by a court of over-reaching. Until a court order approving the release becomes final, the over-reaching release may jeopardize the entire settlement.⁵

California decisional law interpreting subdivision (b) of section 16464 and its predecessor statute in the context of general releases is sparse. By virtue of Probate Code section 15002, the decisional law of sister states is relevant and applicable in California except as otherwise modified by statute.⁶ Subdivision (b) of section 16464 is taken almost verbatim from section 217 of the Restatement of Trusts,⁷ which was derived in substance from even earlier versions of the Restatement of Trusts and Contracts.⁸ Section 217 has remained largely unchanged for nearly a century. California courts generally recognize the Restatement of Trusts (second and third editions) as embodying the common law of trusts.⁹ Where California cases or statutes are not on point, the common law interpreting section 217 of the Restatement of Trusts can be determinative.

This article begins by summarizing the current California law restricting the enforceability of releases protecting fiduciaries, as embodied in subdivision (b) of section 16464 of the Probate Code. This summary is followed by an analysis concerning the burden of proof when such releases are disputed. This article then separately discusses each of the four subparts of subdivision (b) of section 16464. To explain each subpart, the authors draw upon California statutory law, California decisional law, current and prior versions of the Restatement of Trusts and the Restatement of Contracts and the decisional law of other states. With the discussion of each subpart of section 16464, the authors provide their own practical suggestions on how to structure settlements so that releases are protected against future challenges. The authors conclude with recommendations of model language for release provisions in settlement agreements for practitioners who are concerned a release might be challenged in the future.

II. OPERATIVE LAW GOVERNING RELEASES

Releases are contracts, subject to the same statutory and common law defenses against enforcement as any other contract. Such defenses include, mistake, fraud, undue influence, duress, lack of consideration, and unconscionability.¹⁰ Enforcement of releases in favor of trustees is further restricted by well-established common law rules specifically governing contracts between fiduciaries (i.e., trustees, attorneys, directors, agents, and brokers) and their charges.¹¹ In California, the common law rules limiting the efficacy of releases favoring fiduciaries, particularly trustees, are codified in Probate Code section 16464.¹² Subdivision (b) of Probate Code section 16464, which restricts the enforcement of releases in favor of trustees against beneficiaries, reads in pertinent part as follows:

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(b) A release or contract is not effective to discharge the trustee's liability for breach of trust in any of the following circumstances:

(1) Where the beneficiary was under an incapacity at the time of the making of the release or contract.
(2) Where the beneficiary did not know of his or her rights and of material facts (A) that the trustee knew or reasonably should have known and (B) that the trustee did not reasonably believe that the trustee knew.
(3) Where the release or contract of the beneficiary was induced by improper conduct of the trustee.
(4) Where the transaction involved a bargain with the trustee that was not fair and reasonable.¹³

III. BURDEN OF PROOF

Where a trustee gains an advantage from a transaction with a beneficiary, the trustee is presumed to have breached a fiduciary duty.¹⁴ The presumption is rebuttable by the trustee. Almost by definition, a trustee who receives a release from a beneficiary has obtained an advantage from the beneficiary. Without any prima facie showing by the beneficiary to the contrary, the burden of proving that the transaction was fair and reasonable, with adequate consideration being received by the beneficiary in exchange for granting the release, is shifted to the trustee.¹⁵ To uphold the release, the onus is on the trustee to disprove the existence of the conditions of Probate Code section 16464, subdivision (b).¹⁶

Since a release protecting the fiduciary remains voidable by a beneficiary in the absence of the trustee proving it is fair and reasonable, the safest way to protect future enforceability of a release is to obtain immediate court approval of the settlement agreement containing the release. To ensure that the court's order approving the settlement contains the necessary findings, the authors recommend that the petition for approval of the settlement agreement allege (among other things) the following, taken directly from the statute:

(1) The beneficiary was not under any incapacity at the time of the making of the release or contract.
(2) The beneficiary knew of his or her rights and of material facts that the trustee knew or reasonably should have known.
(3) The release was not induced by any improper conduct of the trustee.
(4) The consideration received by the beneficiary in exchange for executing the settlement agreement containing the release was fair and reasonable.

In the absence of immediate court approval, the trustee could face a steep uphill battle against a beneficiary seeking rescission of settlement agreement based on an after-discovered claim. Given the detriment of hindsight, the trustee's burden of proving to the court that the trustee should not have known and disclosed that claim to the beneficiary prior to obtaining the release is substantial.¹⁷

IV. UNDER INCAPACITY

A release is invalid where the beneficiary was under an incapacity at the time of the making of the release or contract.¹⁸ Individuals are presumed to have capacity to contract.¹⁹ The presumption does not apply to a minor or person subject to a general conservatorship of the estate.²⁰ Where the trustee seeks a complete release and there is a clear case of legal incapacity of a beneficiary, such as minority or a general conservatorship, the initial step is to secure the appointment of a guardian ad litem ("GAL") to participate in the settlement negotiations and/or to consent to the petition for approval of the settlement.²¹ The appointment can usually be obtained ex parte.²²

In practice, an individual's decisional capacity to understand a transaction may be unclear. Where an individual's decisional capacity is partially impaired, the complexity of the transaction, the level of impairment, and the correlation between the impairment and the inability to understand the transaction determine whether the individual lacks capacity for the particular transaction—in this case executing the settlement and release.²³

Probate Code section 812 provides that a person lacks capacity to make decisions unless, among other things, he or she is able to understand and appreciate his or her rights affected by the decision, the probable consequences to him or her, and the risks, benefits, and reasonable alternatives involved in the decision.²⁴ Practically speaking, the more complex the transaction, the lower the level of impairment needed to find lack of decisional capacity. Probate Code section 811 adds an additional requirement for a finding of lack of capacity for a particular transaction...