Course 8—Abuse Involving the Following of Trust Terms

This course addresses a trustee’s failure to follow the trust terms, especially when they are required to create sub-trusts after the death of a settlor. Let’s start with a basic understanding of the trust law we will apply to this problem.

The Basics of Following California Trust Terms

Under Probate Code section 16000, every trustee must administer the trust according to the trust instrument. That means the trustee must take all actions required of them by the trust document and by trust law.

Following Trust Terms Hypothetical: Danielle and Jaime 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 follow the trust terms. After the hypothetical, we will discuss trust terms in more detail.

In 2001, Rene and Phil created a joint trust. At the time, their estate was worth $3 million, and they were worried about the surviving spouse having to pay federal estate tax upon the other spouse’s death. As a result, the joint trust Rene and Phil created had a provision that required the creation and funding of two sub-trusts after the first spouse died.

Under the trust, once the first of Rene and Phil passes away, the trust assets are divided into two equal shares. One share is to be funded into a survivor’s trust, which remains a revocable trust and is held for the benefit of the surviving spouse. The other share is to be funded into a bypass trust, which is an irrevocable trust. The bypass trust is held to benefit the surviving spouse during their lifetime, and then the remaining assets pass to the children equally. Rene has no children, but Phil has two children from a prior marriage, Danielle and Jaime. Under the trust terms Jaime’s share is held in a separate trust for his benefit.

In 2015, Phil dies, and Rene takes over as the sole successor trustee of their joint trust. Unfortunately, Rene does not seek the advice of an attorney, and she is not aware that the survivor’s trust and the bypass trust have to be created after Phil’s death. Instead, Rene keeps administering the trust assets for her own benefit as if nothing has changed.

Over the next year, Danielle and Jaime begin to wonder what has become of their father’s share of the estate, so they make multiple inquires with Rene about it. Rene takes offense to these inquires and tells both kids to mind their own business. Rene refuses to provide copies of the trust to the children and stops returning their calls.

In February 2016, Rene decides to leave the entire estate to her two sisters, Betty and Linda, instead of the children. Rene meets a lawyer who drafts a simple trust amendment changing the beneficiaries of the trust from the children to Betty and Linda. The lawyer does not discuss the survivor’s trust or bypass trust with Rene because he did not carefully review Phil and Rene’s trust, so he did not notice the sub-trust requirements. The lawyer simply prepares the trust amendment.

In August 2016, Rene dies and Betty takes over as successor trustee of the trust. Betty reads the trust amendment and believes that she and her sister, Linda, are the sole beneficiaries. When Danielle and Jaime ask for a copy of the trust document, Betty provides them with a copy of the trust and the trust amendment.

Danielle and Jaime consult a lawyer. The lawyer notices that Rene was supposed to create a bypass trust after Phil’s death, but she failed to do so. Since the bypass trust was supposed to be irrevocable, Rene had no power to amend that part of the trust. The lawyer believes that Danielle and Jaime have a claim to force Betty to hand over at least one-half of the trust estate in spite of the trust amendment Rene created.

 

The Options

It now appears that Rene has ignored her duties as trustee and failed to create and fund the bypass trust. What can Danielle and Jaime do to obtain their fair share of the trust estate? Here are the options:

  1. Contest amendment. File a trust contest petition challenging the validity of the trust amendment.
  2. Petition for instructions. File a petition for instructions to enforce the terms of the bypass trust.
  3. Financial elder abuse lawsuit. File for financial elder abuse against Betty (Rene’s sister).
  4. Creditor’s claim. File a creditor’s claim with Rene’s estate for one-half the value of the trust.
  5. Letter writing. Hire a lawyer to write a letter to Betty asking that she distribute one-half of the trust estate to Danielle and Jaime.

Our Expert Recommendation

Here, Rene failed to follow the trust terms. The trust required that one-half of the estate be transferred into the bypass trust after Phil died. The bypass trust would have supported Rene during her lifetime, but Rene couldn’t amend the bypass trust to disinherit Jaime and Danielle. That means the trust amendment Rene signed could only affect the survivor’s trust, not the bypass trust.

Option 2: the first action we would recommend Danielle and Jaime take is to file a petition for instructions. A petition for instructions is simply a request that the court take a certain action. Here, the action would be to force Betty to create and fund assets into the bypass trust as required by the trust terms. Or it could be setting aside assets equal to the amount that should have been placed in the bypass trust and distributing those assets to Jaime and Danielle. As a judge once told us, it is never too late to do the right thing. So long as there are assets still in the trust, the court can order the trustee to follow the trust terms and, thereby, give Jaime and Danielle the assets that should have been held in the bypass trust.

Option 1: filing to contest the amendment should not be necessary if you follow option 2 instead. Option 1 is problematic for Jaime and Danielle because it could trigger the trust’s no-contest clause. Let’s discuss the no-contest clause a bit further.

Rene created a trust amendment that purports to change the entire distribution of the trust to Betty and Linda. That amendment was not possible as to half of the trust estate because half of the estate was supposed to be transferred into the irrevocable bypass trust. The bypass trust could not be revoked or amended by Rene. However, that does not mean the trust amendment is an invalid document. The amendment could still be valid and apply to the portion of the trust that remained revocable—the survivor’s trust.

If Jaime and Danielle challenge the validity of the trust amendment in court, they would have to base that challenge on a legal claim, such as lack of capacity and/or undue influence. Under Probate Code section 21310, if you challenge the validity of a trust or trust amendment based on lack of capacity or undue influence, then you may be disinherited under the trust’s no-contest clause.

If Jaime and Danielle challenge the trust amendment and win, then they would likely receive the entire trust estate. If Jaime and Danielle challenge the trust amendment and lose, they would likely lose everything—even their share of the bypass trust.

Jaime and Danielle can protect themselves by simply not challenging the validity of the trust amendment. For these reasons, we would probably go with option 2, petition for instructions, rather than option 1. This would allow Jaime and Danielle to receive their share of the bypass trust without risking disinheritance by challenging the trust amendment directly.

Options 3: a financial elder abuse lawsuit can be brought against a party who obtains a gift under a trust by exercising undue influence against the trust settlor—in this case Rene. Such a lawsuit made against Betty would not work because Betty did not participate in the creation of the trust amendment. It seems that Betty came in after the amendment was complete and started to administer the trust as successor trustee. There are no facts to support that Betty exercised undue influence against Rene to create the trust amendment.

Option 5: a letter writing campaign rarely works. Many people think that if a lawyer writes a letter to Betty, she will do the right thing and return half of the estate to Jamie and Danielle. In our experience that occurs about 10% of the time. More often, the letter is just ignored and nothing happens. Filing in court is the only way to seek a court order and force Betty to comply with the correct terms of the trust.

Option 4: filing a creditor’s claim typically is done with trusts when one party claims to be owed money by a person who has died. For the two children, this is an interesting option if the trust assets had been transferred out of the trust before Rene’s death (I’ll explain this point shortly). Rene, as trustee, had the duty while she was alive to properly administer the trust and follow the trust terms. When Rene failed to follow the trust terms, she breached her duties as trustee. If Rene were still alive, Jaime and Danielle could sue Rene for breach of duty. After death, however, the only way to file suit is by filing a creditor’s claim in Rene’s probate estate—meaning a separate legal case filed in probate court in addition to the trust case.

The problem with a creditor’s claim is that it could trigger the trust’s no-contest clause. Under Probate Code section 21311(a)(3), the filing of a creditor’s claim, or the prosecution of an action based on it, could trigger a no-contest clause. The trust must have a no-contest clause that specifically includes this provision for this to apply. But assuming Rene and Phil’s trust has this provision, then the creditor’s claim could disinherit Jaime and Danielle.

A creditor’s claim may be the only route to take if the assets were moved out of the trust prior to Rene’s death. For example, if Rene created an entirely new trust and transferred all her assets to this new trust (rather than doing a trust amendment), then a petition for instructions (option 2) would not work. Remember that the petition for instructions was going to force Betty to follow the trust terms, but if the assets are in a new trust that does not have the same terms as the old trust, then a petition for instructions is not helpful.

Worse yet, if Rene emptied the trust and put the assets into her individual name, then the petition for instructions has no usefulness because there are no assets in the original trust. Forcing the trustee of a trust to distribute assets to Jaime and Danielle only works if the trust has assets to distribute. No assets in a trust equals no assets to Jaime and Danielle.

If there are no assets left in the original trust created by Phil and Rene, then a creditor’s claim would be required—indeed, it would be the only viable option to enforce the trust terms. The claim would be made against Rene’s estate for breach of trust, and the damages would equal one-half of the trust assets. Once that claim is asserted in Rene’s estate, and if it is granted by the court, then Jaime and Danielle can enforce that claim against all assets in the probate estate and all assets transferred to any other trust created by Rene during her lifetime.

As you can see, the option Jaime and Danielle pursue is dependent not just on the trust terms they want to enforce, but also on the location of assets at the time of Rene’s death. Assets still held in the original trust created by Phil and Rene are much easier to attack and gain distribution from than assets that were transferred out of the original trust. There are ways to force a distribution, but the beneficiaries must choose options based on how the assets are titled at the time of Rene’s death.

The Law of Following Trust Terms

Probate Code section 16000 sets out the standard every trustee must follow in administering a trust estate—namely, follow the trust terms. Seems like an easy mandate, and yet many private trustees violate this simple directive.

Many people do not understand that trusts typically require different actions at different times throughout the life cycle of the trust. There are provisions that apply while the trust settlor(s) is still living, provisions that apply after a settlor dies, and even provisions that apply long after the settlor is gone, such as sub-trusts created for children and grandchildren.

You can think of the initial trust estate created by the settlor as the main trust. This is the part of the trust that controls the assets of the trust estate for the benefit of the settlor(s). When a settlor dies, there is a period of administration (sometimes referred to as the administrative trust—it is the same trust as before, just in an administrative phase). During trust administration, the trustee is supposed to take all actions required by the trust document, including creating sub-trusts.

Commonly created sub-trusts include survivor’s trusts (for the surviving spouse), bypass trusts (to hold the assets of the deceased spouse), marital trusts (also to hold assets of the deceased spouse), disclaimer trusts (to hold any property a beneficiary decides to disclaim or turn down), children’s trusts (held for the benefit of kids), and grandchildren’s trust (held for the benefit of grandchildren). Each of these sub-trusts has a different set of rules and a different set of beneficiaries.

Each sub-trust must be created by opening new financial accounts in the name of the sub-trust and transferring assets into those accounts. Or in the case of real estate, the deed is transferred into the name of the appropriate sub-trust. Each trust will require its own tax identification number from the IRS for tax-reporting purposes.

Creating sub-trusts is not hard to do, but it does take deliberate action—the sub-trusts don’t create themselves. And if a trust mandates the creation of sub-trusts, then it is the trustee’s duty to follow the trust terms and create the sub-trusts. Failure to do so is a breach of trust by the trustee.

 

Creation of Sub-Trusts—Mandatory vs. Discretionary

Typically, when a trust provides for the creation of sub-trusts, it is a mandatory requirement. You will know if it is mandatory by use of the word “shall,” as opposed to using the word “may.” If a trust says a trustee shall create a sub-trust, then it must be done. If a trust says a trustee may create a sub-trust, then it is up to the trustee’s discretion to do so.

In the case of survivor’s trusts, bypass trusts, and marital trusts, their creation is almost always mandatory. Once the first spouse of a married couple dies, the sub-trusts must be created to protect the surviving spouse from the imposition of estate taxes and to ensure that assets pass to the deceased spouse’s children.

There are some sub-trusts, however, that are discretionary. For example, disclaimer trusts are created when a surviving spouse decides they do not want to take possession of assets. Usually this is done for estate tax purposes, but it could also be done to give assets to the deceased spouse’s children. In any event, once a spouse disclaims an asset, then the disclaimer trust is created, and it acts pretty much the same as a bypass trust.

There are also various generation-skipping transfer trusts that can be created at the discretion of the trustee if it would be advantageous to do so from a tax perspective.

Finally, there are times when the trust will state that no physical separation of assets is necessary in creating sub-trusts. This may occur when the entire trust estate is going to be held in a sub-trust for a child. Even though the trust is technically a child’s trust, the trust document may state that a trustee need not retitle all the assets if it would be inconvenient to do so. But even though the assets are not retitled in the name of the child’s trust, the trust estate is still held and administered under the trust terms for the benefit of the child.

Obviously, where several sub-trusts are required to be created, then physical segregation of the assets is a must. In that case, each sub-trust should receive its share of assets retitled in the name of each respective sub-trust.

How Do You Know If the Terms Are Being Followed?

The only way to ensure the trust document is being properly administered is to ask for confirmation. First, you need a copy of the trust document, so you know what actions are supposed to take place. Second, you need copies of all financial accounts and deeds to ensure that each sub-trust has a newly created account funded with the appropriate amount of assets. Third, you need a trust accounting. The trustee must be able to account for how the assets were valued and how they were distributed to the various sub-trusts.

If you do not have the trust documents and the financial information confirming proper sub-trust creation, then you do not know if the trustee has acted properly. It is critically important for you to obtain confirming information. Until you have confirmation, you have no idea what has occurred. And it is much easier to fix a problem earlier rather than later. Take the time and put in the effort to obtain the financial information you need to confirm the trustee has acted appropriately.

If a Trustee Refuses to Follow the Trust Terms . . .

-Petition for instructions. If you are a beneficiary of the trust, then you have a right to file a petition for instructions asking the court to order the trustee to comply with the trust terms. To bring a petition, you need to prepare a written brief to the court outlining your problem. You need to discuss what the trust terms require, where the trustee has failed to follow the terms, and then request a court order.

After you file your petition, you will need to mail notice of your hearing and a copy of your petition to the trustee and all other interested parties (that is, everyone named as a beneficiary of the trust). The court will give you a hearing date, usually forty-five to sixty days after you file the petition. You must appear in person at your hearing and make your argument to the court.

After your hearing, the court can order the trustee to comply with the trust terms. You can even ask the court to order the trustee to value the assets, or you can value them yourself and ask the court to use your values. Once the asset values are determined, then the sub-trusts can be funded with the appropriate assets. Again, be sure you receive confirming financial information from the trustee to ensure proper sub-trust funding has occurred.

-Removal and suspension. You can also file a petition with the court seeking to remove the trustee and asking that the trustee be suspended pending removal. Since the trustee has a duty to follow the trust terms, a failure to do so subjects them to possible removal. The court has discretion on whether to remove the trustee or not, but it never hurts to ask for removal if you believe it is necessary to protect the trust estate.

Damages

Can you receive damages from the trustee for their refusal to follow the trust terms? No, not really. The court can order the trustee to take all actions necessary to create and fund the sub-trusts. And the court can order that assets be placed in the proper sub-trusts. Finally, if any of the trust assets were lost or suffered damage, then the trustee can be held liable for the losses to the trust. But there are no compensatory damages (such as for pain and suffering) or punitive damages recoverable against the trustee for failing to follow the trust terms.

That may seem surprising that trustees can breach their duties, fail to follow the trust terms, and all the court can do is order them to follow the trust terms. If there is no loss or damage to the trust assets, then the trustee is not personally liable for damages. And in most cases, the trustee will not be required to pay for your attorneys’ fees and costs in forcing them to take the proper actions. However, you may seek reimbursement from the trust fund, and that is often granted where your actions benefit the trust estate.

In the case of Danielle and Jaime, they have the right to force Betty to follow the trust terms. Even though Rene failed to create two sub-trusts—the survivor’s trust and bypass trust—it’s not too late to do the right thing. But Betty is not likely to give half the trust estate to Jaime and Danielle voluntarily. That’s where the court can help resolve these issues. Jaime and Danielle can stand up and fight for their rightful share of the trust estate, provided they choose to take action in court.

In addition to following the trust terms, a California trustee is also required to follow the terms of California trust law. The next topic of beneficiary abuse: a trustee’s duty to diversify trust assets as required by California trust law.