Trusty trustees: what every trustee should know about California law.

• Author: Handy, Nelson J.
• Position: ESTATE PLANNING

The rules governing a trustee's duties are primarily set forth in the trust instrument, but CPAs who serve as trustees for clients also should be aware that California law plays a major role in the governance of the trustee.

California law provides default rules, which apply if a trust instrument is silent on a matter, and mandatory rules, which apply regardless of the instructions set forth in the trust instrument.

THE MORE OBVIOUS DUTIES

Probate Code Sec. 16040 provides that the trustee must administer the trust with reasonable care, skill and caution under the then-prevailing circumstances that a prudent person acting in a like capacity would use in the conduct of an enterprise of like character and with like aims to accomplish the purposes of the trust as determined from the trust instrument.

This standard is similar to the business judgment rule. A court second-guessing a trustee's reasoned decisions is not common. However, a common error for trustees is believing that they "know" what the settlor wants and proceeding to administer the trust based on this belief rather than the purposes stated in the trust.

If the trustee's understanding of the settlor's intent is inconsistent with the trust instrument, the trustee should seek the court's assistance to resolve the conflict.

Prudent Investor Act. Under this act (Probate Code Secs. 16045-16054), the trustee--unless the trust instrument provides otherwise--must invest in a manner that maximizes the investment return of the entire trust while minimizing the risk to a level reasonably suited to the trust.

The PIA applies to all actions taken by a trustee after the effective date of the act, generally Jan. 1, 1996. The date the trust was created is irrelevant.

The PIA is somewhat of a double-edged sword: It allows a trustee to invest for total return, but it increases a trustee's potential liability for an underperforming trust. To avoid liability, trustees should understand how to invest under the PIA. For an individual trustee, this can be accomplished by delegating the responsibility to a professional under Probate Code Sec. 16052.

Investing under the PIA requires:

* Developing an investment policy statement that includes appropriate objectives, policies and procedures;

* Documenting the reasons for each investment decision; and

* Acquiring the education to become well-informed in investment decisions.

Proper Exercise of Discretionary Powers. Under Probate Code Sec. 16081, the trustee must exercise any discretionary power reasonably, not arbitrarily. Even "absolute," "sole" or "uncontrolled" powers provided in the trust must be applied in accordance with fiduciary duties--that is, trustees...