Mcle Self-study Article Trustee's Obligation to Maintain Impartiality in Trust Litigation: Zahnleuter v. Mueller (2023) 88 Cal.app.5th 1294

• Publication year: 2023
• Citation: Vol. 29 No. 4
• Author: Written by Denise E. Chambliss, Esq. and Clare Capaccioli Velasquez, Esq.[sup *]

MCLE SELF-STUDY ARTICLE TRUSTEE'S OBLIGATION TO MAINTAIN IMPARTIALITY IN TRUST LITIGATION: ZAHNLEUTER v. MUELLER (2023) 88 CAL.APP.5TH 1294

Written by Denise E. Chambliss, Esq.^* and Clare Capaccioli Velasquez, Esq.^*

I. SYNOPSIS

In trust litigation, navigating the boundary between a trustee's right and duty to defend the trust, and the contrasting duty to remain impartial in disputes as to who is the rightful trust beneficiary, can prove to be complex and complicated.

This tension was at issue in the case of Zahnleuter v. Mueller (2023) 88 Cal.App.5th 1294 ("Zahnleuter"). In Zahnleuter, the trustee was surcharged in the amount of attorney's fees he paid from the trust in connection with a dispute over the validity of a trust amendment.⁰¹ The court held that Thomas Mueller ("the Trustee") incurred attorney fees to benefit the interests of his two children, Julie and Amy, not the interests of the trust estate.⁰² In Zahnleuter, the court reaffirmed that, for a trustee to avoid personal liability and a surcharge, the attorney's fee expenditures from the trust must benefit the trust rather than fund the trustee's engagement in a dispute over the identity of the proper beneficiaries.⁰³

Analyzing the holding in the Zahnleuter case starts with the general fiduciary duties set forth in the California Probate Code and continues with a survey of the developing case law addressing a trustee's ability or inability to use trust assets in trust litigation. Historically, trustees were provided a proverbial "blank check," at the trust's expense, to litigate nearly any issue subject only to a "reasonable" under the circumstances test.⁰⁴ The analysis in Zahnleuter is the latest in a string of cases addressing the circumstances under which trustees are precluded from using trust assets to pay for their attorney's fees in litigation where one beneficiary is challenging the operative trust or amendment.⁰⁵

As addressed in greater detail in this article, the general rule applied in Zahnleuter is that a trustee is not entitled to reimbursement of litigation expenses from the trust estate when the trust instrument does not direct the trustee to defend the instrument in dispute and "[t]he dispute was, and continues to be, over who will enjoy the benefits and who will control the trust."⁰⁶ However, certain circumstances still exist where a trustee's attorney's fees can be paid from the trust or later reimbursed from the trust after the resolution of the dispute.⁰⁷

II. TRIAL COURT PROCEEDINGS: ZAHNLEUTER V. MUELLER

A. Establishment of the Trust

Richard Mueller ("Richard") and Joan Mueller ("Joan," collectively, "Settlors") had two children: Petitioner Katherine Zahnleuter ("Katherine") and Amy Mueller ("Amy").⁰⁸ Richard also had a daughter from a previous marriage, Julie Van Patter ("Julie").

In 2004, Settlors created a revocable living trust ("Trust").⁰⁹ Under the terms of the Trust, Katherine and Amy were equal remainder beneficiaries after payment of certain

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expenses, including a $10,000 gift to Julie.¹⁰ Amy and then Katherine were named as successor trustees.¹¹

The terms of the Trust authorized the Trustee in his discretion to initiate or defend, at the expense of the Trust estate, any litigation related to the Trust or any property of the Trust.¹² Of note, the Trust also included a no contest clause that read:

The Trustee is authorized to defend, at the expense of the Trust Estate any contest or other attack of any nature on this trust or any of its provisions. This paragraph shall not apply to any amendment of this document executed after the date of this document.¹³

B. Disputed Third Amendment

The Trust was purportedly amended three times.¹⁴ The First Amendment, which made no substantive changes to the Trust, was executed by Settlors in November 2005.¹⁵ The Second Amendment, executed by Richard after Joan's death in October 2017, named Amy and Katherine as successor co-trustees, but did not modify the distributive terms of the Trust.¹⁶ The Second Amendment included a no contest clause which stated that it applied to beneficiaries who sought to contest the validity of the amendment, but did not expressly authorize the trustee to defend any contest to the amendment at the expense of the Trust estate.¹⁷

The Third Amendment to the Trust, executed in April 2018, made significant changes.¹⁸ Amy, who by this time was living with Richard, emailed a handwritten letter to a local attorney, Gabriel Lenhart, that purported to express Richard's "final wishes" and outlined several changes to be made to the Trust.¹⁹

The following day, Attorney Lenhart e-mailed Amy the Third Amendment and Richard promptly signed it.²⁰ In it, Richard's older brother Thomas Mueller was named successor Trustee, replacing Amy and Katherine; Thomas' daughters would each receive a $10,000 gift; Amy's caregiving services would be reimbursed from the Trust estate without any impact on her inheritance; and Amy would receive a life estate in the family home.²¹ The Third Amendment included a no contest clause that did not authorize the trustee to defend, at the expense of the Trust estate, any contest to an amendment to the Trust.²²

For unknown reasons, the week after Richard executed the Third Amendment, Attorney Lenhart sent a second version of the Third Amendment containing materially different terms.²³ The material changes went unnoticed at the time.²⁴ The Trustee provided the beneficiaries with a copy of the second version of the Third Amendment.²⁵

C. Petitions on Execution of Third Amendment and Invalidity of Third Amendment

After Richard's death, Katherine filed a petition to invalidate the Third Amendment for lack of due execution.²⁶ A few months later, she amended her petition to assert that the Third Amendment was invalid as a product of undue influence.²⁷ The Trustee opposed this petition. After hearing cross-motions for summary adjudication on the issue of due execution, the court found that the Third Amendment was validly executed.²⁸

The undue influence claim was set for a bench trial.²⁹ At trial, Attorney Lenhart presented troubling testimony, conceding that there were two versions of the Third Amendment with materially different terms.³⁰ Attorney Lenhart acknowledged that the version signed by Richard was not consistent with the directions he was given by Amy. Evidence was presented that the Third Amendment had been modified by Lenhart after it had been signed by Richard.³¹ The following day, Amy and the Trustee requested a mistrial or suspension of the trial, which was granted at the parties' mutual request.³²

Amy then filed her own petition to invalidate both versions of the Third Amendment based on lack of due execution.³³ No party objected to this Petition, including the Trustee.³⁴ In August 2020, the court granted Amy's petition and found that the Trust, as amended by the first and second amendments, was valid and enforceable and appointed a private fiduciary as successor trustee.³⁵

D. Petition to Compel an Accounting and Surcharge the Trustee

Meanwhile, Katherine requested an accounting from the Trustee twice, to no avail.³⁶ Katherine filed a Petition to Compel an Accounting and to Surcharge the Trustee for the Trust assets he expended to defend her contest of the validity of the Third Amendment.³⁷ The Trustee's accounting indicated that he expended $201,164.15 in attorney fees from November 15, 2018 to May 11, 2020.³⁸ The accounting did not include any information regarding the specific services that were performed for the fees incurred.³⁹

E. Surcharge Award

In February 2021, the trial court granted Katherine's petition for surcharge, and ordered the Trustee to pay $201,164.15 to the Trust for the full amount of the Trust assets he expended on attorney's fees.⁴⁰

The court held that the express terms of the Trust authorized the Trustee to defend, at the expense of the Trust estate, "any contest or other attack of any nature on

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th[e] Trust or any of its provisions," but not to defend at the expense of the trust estate "any amendment" to the Trust.⁴¹ The trial court concluded that neither the original Trust document nor the First or Second Amendments to the Trust authorized the Trustee to expend Trust assets to defend against a contest to the Third Amendment.⁴² Further, the court found the Trustee breached his duty to deal impartially with all beneficiaries because he did not take a neutral position in the dispute over the validity of the Third Amendment. Instead, he represented the interests of beneficiary Amy over Katherine.⁴³

On appeal, the Trustee argued that the surcharge must be reversed because he properly expended Trust assets to defend against the contest to the Third Amendment.⁴⁴ Citing an absence of adequate supporting records before the trial court, the appellate court rejected the Trustee's arguments and affirmed the trial court surcharge award in full.⁴⁵

III. GROUNDS FOR IMPOSITION OF TRUSTEE SURCHARGE FOR BREACH OF DUTY OF IMPARTIALITY

A. California Statutory Authority on the Fiduciary Duty of Impartiality

The fundamental first step in trust administration is the trustee's duty to administer the trust according to the trust instrument and according to the expressed intent of trustor, rather than how the trustee would personally prefer to administer the trust.⁴⁶ Closely related is the fiduciary duty to administer the trust solely for the benefit of the beneficiaries.⁴⁷

In furtherance of the fiduciary duty to act in the best interests of the beneficiaries, Probate Code section 16003 states that a trustee has a duty of impartiality. When a trust has two or more beneficiaries, "the trustee has a duty to deal impartially with them and shall act impartially in investing and managing the trust property, taking into account any differing interests of the beneficiaries."⁴⁸

This duty of impartiality is especially important when the trustee is also a beneficiary, as an appearance of self-interest could arise. Trustees are...