Trustee's Failure to Account
California statutory law requires a trustee to account annually to current trust beneficiaries, i.e., those who are currently entitled to receive distributions of income and principal during the accounting period. Any trustee, other than the settlor(s) who established the trust, has a duty to account.
Abuse Involving the Provision of Accountings to Beneficiaries
In this course we will discuss a trustee’s failure to account and provide information to trust beneficiaries. We start with a basic understanding of the trust law we will apply to this problem.
The Basics of California Trust Accountings
The trustee of a California trust has a duty to keep beneficiaries reasonably informed of the trust and its administration. The trustee must also account to all current income or principal beneficiaries (1) at least annually, (2) upon the termination of a trust, or (3) upon a change in trustee.
A trust, by its terms, can waive the right to an accounting, but a court can still order an accounting to be created where a beneficiary shows that a breach of trust is likely to have occurred.
Trust Accountings Hypothetical: Neil and Leonard as Abused Beneficiaries
Let’s consider a hypothetical situation to demonstrate the problems that arise and the options you have when confronted with a California trustee who fails to account. After the hypothetical, we will discuss trust accountings in more detail.
For the last eight years, Burt has been the trustee of a trust created to benefit Neil and Leonard, two brothers. The trust terms do not mention anything about providing trust accountings to the beneficiaries. The trust terms also require the trust to continue for ten years and then distribute the assets outright to Neil and Leonard equally. The trust has two more years to go before distribution is required.
The trust assets originally consisted of a six-unit apartment building and an investment portfolio with conservative investments. Eight years ago when Burt began acting as trustee, the apartment building was valued at $2 million and the investment portfolio was worth $500,000.
Neil and Leonard have never received an accounting from Burt and do not have any recent financial information. Neil thinks that the apartment building had a small mortgage against it of $50,000 when Burt took over as trustee.
At first, Neil and Leonard were each receiving $3,000 per month from the trust. But two years ago that stopped. The distributions dropped to $1,000 per month for a while and then stopped altogether. Neil and Leonard asked for more trust distributions, but they never received a straight answer from Burt on why the distributions had stopped.
In response, Neil and Leonard demanded a trust accounting. First, Burt claimed that an accounting was not required of him because the trust was silent as to accountings. Then Burt said he would provide them with an accounting.
Last month Burt sent Neil and Leonard a one-page spreadsheet that Burt claims is the trust “accounting.” The spreadsheet has the apartment building on it with an estimated value of $2 million, but it also lists a mortgage against the apartment building for $1.5 million. All the rent from the apartment building is being used to pay the mortgage payments, which explains why the distributions have stopped.
The spreadsheet also lists $50,000 in cash, and five separate so-called investments, each with a listed value of $400,000. On paper, the trust appears to have a gross value of $4,050,000.
Neil and Leonard are surprised to see the mortgage on the apartment building because they were never told about it. They are also surprised to see the five investments, so they ask the trustee to provide more explanation on the investments. Burt tells them that the investments are “private placements,” which allow individuals with a high net worth to invest in securities that are not regulated by the government. Unfortunately, Burt believes that all five of the investments have failed and may not be recouped by the trust. On the other hand, some of the investments may pay off if the trust retains them for twenty years or more.
Neil and Leonard are alarmed at this news. The trust is supposed to distribute all assets to them outright in two years. They also wonder if they have been given all the information about the trust finances. Even though they do not know what a proper trust accounting looks like, the one-page spreadsheet does not look correct to them.
Neil and Leonard’s Options
It appears that Burt has taken a substantial loan against the apartment building to invest in highly risky investments. And the original $500,000 investment portfolio seems to be gone. What can Neil and Leonard do to find out the full extent of the trust’s financial dealings?
Here are the options:
- Petition for accounting. Petition the court to order Burt to prepare and file a formal trust accounting;
- Petition for information. Petition the court to order Burt to provide all financial statements for the last eight years;
- Subpoena information. Subpoena all bank and financial records from the financial institutions for the trust for the past eight years;
- Trustee removal. Petition to remove Burt as trustee; or
- Petition for damages. Petition to seek damages against Burt for breach of trust.
Our Recommendations on Enforcing Trust Accountings
Options 1 and 2: our firm would recommend that Neil and Leonard start with options 1 (accounting) and 2 (information). A proper trust accounting is desperately needed in this case because Neil and Leonard have no idea what has occurred in their trust assets. It seems that their $500,000 investment portfolio is gone. And the $1.5 million in loans against the apartment buildings appear to have been invested in risky private placements that are now worthless. The best way to begin to understand what has occurred is with a proper trust accounting.
Option 3: subpoenaing financial information is also important, but you cannot issue a subpoena until you first file a lawsuit in court. Once you file a petition demanding a proper trust accounting, then you have the power to issue subpoenas. You would want to issue subpoenas to every bank, financial institution, and investment institution you can. This process will allow you to obtain information from the source so you can begin to figure out what happened in this trust administration.
Option 4: trustee removal could be brought at the beginning of the case, but removal is not easy to obtain. It is much easier to obtain trustee removal after you uncover the financial problems and mistakes. As such, we recommend forcing an accounting and subpoenaing financial information before filing to remove the trustee in most cases. But that is not always the case, so evaluate your removal options and include that in your petition if you think it necessary to do so upfront.
Option 5: the final option, petition for damages, will come later. Again, once you have an accounting, then you can file objections to the accounting asking the court to surcharge the trustee. You can also file a separate petition for breach of trust after you uncover the financial information that supports your claims. You could bring a petition for damages upfront, but that depends on your particular case. In Neil and Leonard’s case, we would wait until more financial information comes to light before filing a petition for damages.
The Law of Probate Accounting in California
The right to a trust accounting, also known as probate accounting, in California is provided under the terms of the Probate Code and under the terms of the trust document (subject to any overriding provisions of the Probate Code). For starters, California Probate Code section 16060 provides that the trustee has a duty to keep the beneficiaries of the trust reasonably informed of the trust and its administration by providing an accounting at least once a year.
Right to information: further, under California Probate Code section 16061, except as provided in Section 16069, on reasonable request by a beneficiary, the trustee must provide information to the trust beneficiary relating to the administration of the trust relevant to the beneficiary’s interest. This means that a beneficiary has the right to all information, including financial information, relating to the beneficiary’s share of the trust.
The right to information under section 16061 is separate from the right to an accounting, but the two requirements complement each other. An accounting, discussed below, is a formal report of information given in a format specified by the California Probate Code. Whereas the right to information under section 16061 goes beyond the mere accounting requirements and includes things like copies of bank statements, escrow closing statements, property management statements—any documents the trustee has that are relevant to the beneficiary’s share. The right to information also includes information such as a description from the trustee of actions they have taken.
Many people overlook the right to information and focus solely on the right to an accounting. At times, the underlying information is more valuable and more helpful, than a formal accounting. Of course, it never hurts to ask for both, but don’t underestimate the right to information—it can be a powerful tool to uncover trustee misdeeds.
Right to formal accounting: generally speaking, a trustee is required to provide a trust accounting at least annually, at the termination of the trust, and upon a change of trustees. Accountings are also required at the termination of a trust and upon a change of trustee. (See California Probate Code section 16062(a).)
The trustee is not required to account, however, to the beneficiary of a revocable trust for the period of time that the trust remains revocable, or where the trustee and the beneficiary are the same people.
The trustee is also not required to account where the trust document has a specific provision that waives the accounting requirement (California Probate Code section 16062). This is a fairly common provision in many trusts. It is unfortunate because beneficiaries should always be given the right to accounting if the trust settlor wants to ensure their trustee is being kept accountable.
Luckily, even where a trust document waives the accounting requirement, the court can still order the trustee to account where the beneficiary is able to show a reasonable likelihood that a material breach of trust has occurred.
Finally, the trustee is not required to account where a beneficiary has waived the right to accounting in writing. However, the beneficiary has the right to withdraw the waiver, in which case all transactions that take place after the withdrawal has been made are subject to accounting. Further, the court can compel an accounting where a waiver of account has been made with a showing that it is reasonably likely that a material breach of trust has occurred.
The bottom line: trust accounting requirements are quite liberal in order to protect the rights of the beneficiaries. And a formal accounting is usually the best way to learn what damages, if any, have been incurred by the trust.
How to Demand a Formal Accounting
The trustee is supposed to provide you, the beneficiary, with trust accountings when they are due—for example, at the end of each year in which the trustee has acted. But where a trustee fails or refuses to account, then you have to take action.
To demand an accounting, either you, or your lawyer (if you have hired a lawyer), must do so in writing. Don’t worry, there are no special words you have to use. You can start this process yourself even if you have not hired a lawyer yet (see chapter 7 for an example of a letter demanding an accounting). All you need to do is tell the trustee, “I want an accounting,” and that suffices. Of course, you can say more than that, but the point being—there is no magic language.
Once you demand the accounting in writing, the trustee has sixty days in which to provide an accounting (California Probate Code section 17200(b)(6)(C)). If the trustee fails to do so, then you have the right to file a petition with the probate court under Probate Code section 17200 and ask the court to order the trustee to account. And that’s how you obtain an accounting.
A trust accounting is unique, meaning Burt’s single-page spreadsheet that he supplied to Neil and Leonard doesn’t suffice. The formal requirements for a trust accounting can be found at Probate Code sections 16063 and 1061 (all accountings to be filed in court must comply with section 1061).
Under Probate Code section 16063(a), all accountings must contain the following information regardless of whether they will be filed with the court:
- A statement of receipts and disbursements of principal and income that have occurred during the last complete fiscal year of the trust or since the last accounting.
- A statement of the assets and liabilities of the trust as of the end of the last complete fiscal year of the trust or as of the end of the period covered by the accounting.
- The trustee’s compensation for the last complete fiscal year of the trust or since the last accounting.
- The agents hired by the trustee, their relationship to the trustee, if any, and their compensation, for the last complete fiscal year of the trust or since the last accounting.
- A statement that the recipient of the accounting may petition the court pursuant to section 17200 to obtain a court review of the accounting and of the acts of the trustee.
- A statement that claims against the trustee for breach of trust may not be made after the expiration of three years from the date the beneficiary receives an accounting or report disclosing facts giving rise to the claim.
For court-approved accountings, the specific requirements of Probate Code section 1061 must also be followed (see chapter 7 for a sample of a proper trust accounting that meets the requirements of section 1061). Section 1061 provides a format that starts with all charges, meaning trust assets that came into the trustee’s possession (the items the trustee is charged with managing). Charges include (1) trust assets (money, stocks, bonds, real estate, jewelry, etc.) held by the trustee at the start of the accounting period, (2) receipts received by the trustee during the accounting period, (3) gains on sale of assets that occurred during the accounting period, and (4) any other trust property obtained by the trustee.
Next all credits are listed. Credits are items that the trustee is credited with in managing the trust assets. The credit side includes (1) disbursements (which is the same as bills paid), (2) distributions (payments to the trust beneficiaries), (3) losses on the sale of any capital assets, and (4) trust assets held by the trustee at the end of the accounting period.
The total amount of charges must be the same as the total amount of credits—this is how you know the accounting balances. If the two numbers do not match, then the accounting does not balance.
Each of the items of charges and credits must have its own schedule that provides details. For example, if the trustee reports that they disbursed $100,000 on bills during the accounting period, then you would want to know what bills they paid. There should be a schedule of disbursements that provides the date each bill was paid, to whom it was paid, what it was for, and the amount paid. You should be able to review the disbursement schedule and determine how the trust money was spent.
The same is true for receipts, distributions, gains and losses, and property on hand. Each category must have its own detailed schedule, so you know exactly how the numbers reported on the accounting were obtained.
Beware that not every certified public accountant (CPA) knows how to create a proper trust accounting. Many CPAs know the proper format, but some do not, so inquire beforehand to determine if your CPA knows what to do. Keep in mind that trust accountings are unique—they are unlike corporate accountings. If you request a trust accounting and you receive a balance sheet and profit and loss statement, then you have the wrong documents. Balance sheets and profit and loss statements are not used for trust accountings. Instead, it must follow the requirements of the Probate Code under sections 16063 and 1061.
Formal or Informal Accounting
In the world of trusts and wills, we trust lawyers often talk about formal vs. informal accountings. Typically, when trust lawyers refer to a “formal” accounting, we mean an accounting filed in probate court subject to court approval. Whereas an “informal” accounting is pretty much the same document that is not filed in court.
More broadly, however, an “informal” trust accounting could be just about anything. Burt’s one-page summary to Neil and Leonard could suffice as an informal trust accounting if Neil and Leonard accepted it and didn’t need any further information. The problem for Neil and Leonard, however, is that Burt’s one-page summary did not fully describe all the financial transactions that had taken place. The best accountings are always those that follow the format and information rules under the Probate Code. Even where accounting is not being filed for court approval, the format of accounting is important if you are going to rely on it to settle a trust.
The reason many people avoid formal trust accountings—meaning those filed for court approval—is the cost of doing so. It takes time and money to draft a petition asking the court to approve a formal trust accounting. But where you have discrepancies or breaches of trust, you may need the court’s help to surcharge the trustee and force them to repay for any damages incurred to the trust. Since the formal accounting requires court approval, the court has the power to surcharge the trustee as part of its process to approve the accounting.
Of course, you can also file a petition for breach of trust using the information you have from an informal accounting. But the court may require the accounting to be filed in court for court review. So a court-approved accounting is often the better way to go when you suspect the trustee has caused damage to your trust.
Where, however, there are no damage claims against the trustee, then an informal accounting may be sufficient to ensure the trust finances are sound and then close the trust administration. It all depends on the facts and circumstances surrounding your trust estate.
Timeframes for Objecting
Once you receive an accounting or any written report of trust activity, you only have three years in which to object to all transactions reported in the accounting and seek damages against the trustee. If you wait longer than three years, then you are forever barred from suing the trustee for damages.
This statute of limitations for holding trustees liable for breach of trust is an important deadline. Anytime you receive any trust information in writing from the trustee—regardless of whether it is a written trust accounting—you must think of this three-year deadline and consider whether you need to take action in court to preserve your rights.
Furthermore, some trustees have the power to shorten the statute of limitations period from three years to six months. California Probate Code section 16461 allows trust settlors to add this exception to any trust the settlor creates, but this specific exception must be stated in the trust document. If the trust document does not allow the trustee to shorten the objection period, then it does not apply.
Some settlors add the section 16461 exception to their trust because they want to protect the trustee from “unreasonable” beneficiaries by allowing the trustee to shorten the objection time period to six months. Unfortunately, this exception can backfire when a bad trustee is managing the trust estate. To further compound the problem, most settlors have no idea this provision is included in their trust, or what the potential negative consequences can be from such a provision. Most trusts are attorney-drafted, and there are many attorneys who believe it is helpful to protect the trustee from future lawsuits. But protecting all trustees comes at a cost of protecting some abusive trustees.
Next, the trustee must also include a warning about the shortened period in the accounting that is provided to the beneficiaries. If both of these requirements are met, then the trust beneficiaries only have six months in which to file a lawsuit seeking damages against their trustee for any actions reported in the trust accounting.
In summary, don’t sit on your rights. If you receive a trust accounting, be sure to review it carefully and decide quickly if court action is necessary to protect your rights. Like Neil and Leonard, there is only one way to force a trustee like Burt to answer for their bad acts: file a petition in court. Once the lawsuit is filed, Neil and Leonard’s lawyer then has the power to issue subpoenas and obtain financial information directly from the source—banks, brokerage firms, escrow companies, etc. These source documents can tell the true tale of Burt’s bad acts.
If you are in Neil and Leonard’s shoes and don’t know what actions to take next, feel free to contact us at Albertson & Davidson, LLP. We have plenty of resources to help you stand up and fight back for your rightful inheritance. You don’t need to be the victim of a bad trustee, you have legal rights, but it is up to you to enforce those legal rights.
Providing accounting to the beneficiaries is not the only duty of a trustee. Also, a trustee must follow the trust terms. The next topic of beneficiary abuse: a trustee’s duty to follow the terms of the trust.