Thucydides once said, “We secure our friends not by accepting favors but by doing them.” But serving as trustee for a friend's family
trust could instead potentially end a friendship, and expose the trustee to liability.
Beneficiaries of family trusts are just that — “family” — and the complexity of family relationships overlays the management of these trusts. As the scenarios below illustrate, when things go awry among family members or with the assets held in
trust, trustees can get sued, embroiling them in protracted and contentious litigation and even putting their personal assets at risk.
COMPLICATED RELATIONSHIPS
A trustee has a duty of impartiality, meaning that the trustee cannot favor one beneficiary over another, which is difficult when there are conflicting relationships among beneficiaries. For example, for a trust established to support a second spouse with the remaining trust assets at death to go to the children from a prior marriage, every dollar paid to the second spouse reduces what is left for the children. This makes the trustee a potential target for a claim by the second spouse or the children each time the trustee agrees or refuses to make a distribution from the trust.
A trustee also has a duty to administer the trust in strict conformance with the directions in the trust document. But the grantor and beneficiaries of a family trust may encourage the trustee to ignore or loosely interpret the trust document when all is happy in the family. Problems can arise when family relationships deteriorate, like when the grantor and spouse beneficiary divorce. At that point, the trustee's prior actions may be called into question, resulting in a claim against the trustee for prior lax trust administration.
Problems can also arise if a trust beneficiary has substance abuse issues. A trustee is required to act in the interests of the beneficiaries. But what are the best interests of a beneficiary who has a substance abuse problem, and how does the trustee balance his interests against those of other beneficiaries? Should the trustee honor the beneficiary's request for distributions that are needed to meet his day-to-day needs if the beneficiary is spending his other resources to buy drugs?
COMPLEX INVESTMENTS
The trustee's obligation to manage trust assets can also give rise to problems. Illiquid assets or assets that require specialized skill to manage are particularly concerning. For example, a trustee of a trust that holds shares of a closely-held company may feel pressure to avoid selling those shares, even if a sale would be in the best interests of one or more of the beneficiaries.
Even the management of more traditional trust assets carries risk. During the Great Recession, trusts with real estate holdings suffered huge losses. And litigation against trustees by discontented beneficiaries increased.
PROTECTING YOURSELF
• Make sure you understand what you are committing to: Read the trust document carefully to uncover potential conflicts.
• Request protections be added to the trust document such as: a provision raising the standard for breach of fiduciary duty by the trustee to bad faith, and a broad indemnity clause for any exposure the trustee faces.
• Delegate duties to professionals, such as accountants, attorneys and investment advisers.
• Keep detailed records of your actions, particularly investment decisions and communications with beneficiaries.
• Determine whether your homeowner's insurance covers your service as a trustee and/or consider acquiring trustee's errors and omissions insurance.
Michael J. Gill, Richard Campbell and Kathleen M. Przywara are wealth management lawyers at Mayer Brown.
