Tapping the Trust to Fund the Battle: When Trustees Can Use Trust Funds to Litigate With Beneficiaries

• Jurisdiction: California,United States
• Author: By Adam F. Streisand, Esq. and Miguel Sanqui, Esq.*
• Publication year: 2003
• Citation: Vol. 9 No. 1

TAPPING THE TRUST TO FUND THE BATTLE: When Trustees Can Use Trust Funds To Litigate With Beneficiaries

By Adam F. Streisand, Esq.^* and Miguel Sanqui, Esq.*

In litigation with a beneficiary, the trustee's ability to access the trust as a war chest is a major strategy consideration for both sides. By cutting off the trustee's money supply, a beneficiary can gain enormous leverage. Even if the beneficiary fails to cut the money supply short, the threat of removal and surcharge against a trustee for improperly tapping the trust to fund the battle can be distracting (if not debilitating). Thus, it was with great consternation to trustees (and their attorneys) that on December 27, 2002, the Third District of the Court of Appeal, in dictum, made this remarkable statement:

[L]itigation seeking to remove or surcharge a trustee for mismanagement of trust assets would not warrant the trustee to hire counsel at the expense of the trust. Such litigation would be for the benefit of the trustee, not the trust.¹

Not surprisingly, petitions to remove and surcharge trustees are already quoting this language from Estate of McAdams with emphasis and fanfare. But the statement, which is nothing more than dictum (the opinion had nothing to do with removal and surcharge petitions), also contradicts long established California law. On the frontline of these battles, lawyers for trustees should be armed to respond and, in a broader sense, to advise their clients when they can use trust funds to litigate with beneficiaries. The following discussion is intended to help arm our fellow frontline lawyers.

I. A TRUSTEE ACTING IN GOOD FAITH CAN AND SHOULD USE TRUST ASSETS TO DEFEND AGAINST REMOVAL AND/OR SURCHARGE

When the settlor names a trustee to manage his or her trust, the trustee is a central part of the settlor's estate plan, which status can and should be defended using the assets of the trust. As long as the trustee is acting in objective and subjective good faith, the trustee is entitled to pay lawyers from trust assets to defend against a removal and/or surcharge action. The source of the trustee's right to a defense from trust assets is Probate Code § 15684, which provides that a trustee is entitled to recoup from the trust estate:

(a) Expenditures that were properly incurred in the administration of the trust; or

(b) To the extent that they benefited the trust, expenditures that were not properly incurred in the administration of the trust.²

Whether a trustee is entitled to a defense in a removal and surcharge proceeding depends on the latter principle, i.e., whether the litigation confers a benefit to the trust.³ As a practical matter, of course, the courts uphold the trustee's right to pay for his defense from the trust when the trustee is successful in defending against a removal petition. As will be seen below, the cases provide that a trustee who is unsuccessful is not entitled to a defense unless he was acting with objective and subjective good faith in opposing the removal petition. However, the courts leave us with little guidance as to circumstances where it would be appropriate to mount an eventually unsuccessful defense against a removal and/or surcharge petition. Indeed, it seems improbable that the courts will ever find the right case to award attorneys' fees to a trustee who has been removed and/or surcharged.

A. A Trustee May Use Trust Assets To Defend Himself Against An Unmeritorious Removal Action

A trustee who successfully defends against a removal petition confers a benefit to the trust, because when "a trustee has been appointed by the trustor, the identity of the trustee is part of the trustor's plan to benefit the beneficiaries. In that event, the trustee has a duty to oppose any unmeritorious effort to have the selected trustee removed."⁴ If the trustee prevails against a claim that he be surcharged or removed for misconduct, the attorneys' fees he incurred may be recoverable from the trust despite the fact that the trustee also benefited from the defense.⁵

Thus, despite the broad, categorical dictum in Estate of McAdams, a trustee who successfully defends against charges that he is guilty of mismanagement and/or breach of trust confers a benefit on the trust by dispelling such charges, allowing him to continue to serve as trustee as the trustor intended. Under such circumstances, the trustee may be reimbursed for the attorneys' fees he incurred.

Furthermore, a trustee who is partially successful may also be entitled to a defense. In Estate of Cassity, the court held that a trustee was entitled to attorneys' fees, because he successfully defended against a majority of the charges. The trial court found that the trustee "'made extensive and large purchases on margin and short sales, which resulted in extensive losses to the trust.'"⁶ According to the lower court, these transactions were "'without authority and constituted a breach of trust.'"⁷ The trustee was surcharged for some, but less than a majority, of these transactions. The trustee resigned before trial, but the lower court found that he would have been removed due to his breaches of trust. The trial court concluded that it would be inequitable to grant the trustee the attorneys' fees he incurred in his defense.⁸ On appeal, the appellate court noted that the lower court's "findings justif[ied] the surcharges made against the trustee and would support an order denying him compensation and attorney's fees attributable to defending his wrongdoings resulting in the surcharges."⁹ However, the court of appeal compared the amount of the surcharge against the amount of the claimed losses and concluded that the trustee was entitled to be reimbursed for the attorneys' fees he incurred in his defense. The court reasoned as follows:

The fact that some surcharges were assessed against the trustee is not, in itself, grounds for completely denying him compensation and expenses.... Here the trustee admittedly was guilty of some malfeasance, however, most of the charges were disproven. A considerable portion of

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the trustee's efforts and expenditures must necessarily have been for the purpose of protecting himself from unjust surcharge for conduct in administering the trust which the court's findings . . . determined were perfectly proper. Such efforts and expenditures in the trustee's successful defense are chargeable against the trust estate."¹⁰

On the other hand, at least one court refused to permit a trustee to charge his successful defense to the trust.¹¹ But the case was before the appellate court in such a strange procedural posture that it really says nothing more than a bad trustee is not entitled to use trust assets for his defense. Mrs. Hartman, a beneficiary, filed a petition to remove the trustee, Mr. Burford. The lower court found that Mr. Burford's demeanor and conduct toward Mrs. Hartman was cold, aloof and defensive, and further that Mr. Burford "'presents a general picture of unwillingness to act except upon order of the court . . . . There has been an unrelieved and inexcusable want of diligence to proceed toward assumption of responsibility in performance of the clear mandate of the trust . . . .'"¹² But oddly enough, the trial court denied the removal petition.¹³ The court also granted Mr. Burford's petition for attorneys' fees. As if that were not odd enough, Mrs. Hartman appealed the order granting attorneys' fees but not the order denying the removal petition.

The court of appeal reversed the award of attorneys' fees. The court reasoned that the findings of the lower court regarding Mr. Burford's temperament towards Mrs. Hartman, and his general unwillingness to follow the terms of the trust absent instructions from the court justified the beneficiary's efforts to remove him. Accordingly, the court found that "[t]here [was] no substantial evidence that would justify an award of attorneys' fees in connection with Mr. Burford's resistance of the justified efforts to remove him."¹⁴ In other words, the fact that the trustee was successful was not determinative of whether he would be entitled to a defense from the trust. Although the trustee successfully avoided removal, the court found that there was sufficient evidence to establish that the petition to remove Mr. Burford was justified.

B. A Trustee Who Is Unsuccessful Against Claims That He Is Guilty Of Misconduct Is Ordinarily Not Entitled To A Defense

A trustee who unsuccessfully defends against removal and surcharge claims is ordinarily not entitled to a defense from trust assets.¹⁵ Metzenbaum is often cited as the earliest case supporting the proposition that a trustee who unsuccessfully defends against a claim that he be surcharged not recover the attorneys' fees he incurred. Metzenbaum involved an appeal by the liquidating partner of two dissolved partnerships from an order denying him reimbursement for attorneys' fees allegedly incurred by him on behalf of one of the partnerships. In determining that the liquidating partner was not entitled to reimbursement, the court analogized to the trust context when it adopted the reasoning in In re Drake's Will¹⁶, when the Drake court explained as follows:

To say to a trust beneficiary that, even if he succeeds in having his trustee's account surcharged to the amount of $2,500, he must nevertheless pay the trustee's attorneys' fees and the trustee's fees for contesting the allowance of such a surcharge, is unreasonable.¹⁷

However, a trustee who unsuccessfully defends against a petition for removal may be entitled to use trust funds for his defense if it was objectively reasonable for him to defend and if the trustee had a good faith belief that the defense was for the benefit of the trust.¹⁸

That both objective reasonableness and subjective good faith are

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