Abuse Involving the Fair Treatment of Beneficiaries

In this course we will discuss a trustee’s failure to treat beneficiaries fairly, especially where the trustee is also a trust beneficiary. We start with a basic understanding of the trust law that applies to this problem.

The Basics of Treating Beneficiaries Fairly under California Law

The trustee has a duty to administer the trust solely in the interest of the beneficiaries. Under California Probate Code section 16003, if a trust has two or more beneficiaries, the trustee has a duty to deal impartially with them.

Treating Beneficiaries Fairly Hypothetical: Lupe as Abused Beneficiary

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 treat you fairly as a trust beneficiary. After the hypothetical, we will discuss trust diversification in terms of fair treatment of beneficiaries in more detail.

In 1995, Juanita and Rodolfo created a revocable living trust and transferred their home, a rental property, and their financial accounts into the trust. Juanita and Rodolfo have four children who are named as equal beneficiaries under the trust.

In 2001, Rodolfo had a severe stroke. Juanita could not care for Rodolfo alone, so their daughter, Lupe, moved into their home to help care for her father. Rodolfo died in 2004. Lupe continued to live in the family home rent-free with Juanita until Juanita’s death in 2012. Lupe took care of her mother during the last several years of Juanita’s life as Juanita’s health slowly failed.

Upon Juanita’s death, the total estate was worth $1.25 million. The family home was worth $250,000, the rental property was worth $200,000, and the financial accounts had $800,000 worth of cash, stocks, and bonds.

After Juanita died, her son Miguel took over as sole trustee of the trust. The four equal beneficiaries of the trust are Miguel and Lupe, along with their two brothers, Carlos and Damian.

Miguel was not happy that Lupe was allowed to live in the family home for so long without paying rent. He believed that Lupe should have to pay back rent to the trust. Lupe, however, has no job because she has been a full-time caregiver to her parents for many years. Lupe would like to keep the family home and continue living there.

Lupe argues that her share of the trust estate, after all trust expenses are paid, is worth at least $300,000 (one-fourth of $1.2 million), so she should be able to keep the family home worth $250,000 as part of her trust distribution. While the trustee could distribute the home to Lupe, Miguel refuses to do so because he also would like to keep the home and live in it himself.

Carlos and Damian do not care about the family home and are happy to allow either Miguel or Lupe to receive the home so long as Carlos and Damien receive their share of the trust estate in cash.

Miguel immediately starts eviction proceedings against Lupe to force her to move from the home. Lupe tells Miguel that she would need a cash distribution from the trust to at least rent a new place to move out. Miguel refuses to distribute any cash to Lupe until Lupe agrees to let Miguel have the house.

Lupe then offers to move into the rental property if Miguel will distribute that house to her as part of her trust share. Miguel refuses to do so because the rental home is under a long-term lease with the existing tenant and Miguel wants to keep the rental to produce income for the indefinite future.

Currently, there is enough cash on hand to pay Carlos and Damian their shares of the trust estate in cash. Carlos and Damian demand a cash distribution immediately. They believe that the fight over the real properties is none of their concern and they should not have to wait to get paid just because Lupe and Miguel cannot get along.

Lupe’s Options

It appears that Miguel is not treating the trust beneficiaries impartially. Miguel is refusing to separate his fiduciary duties as trustee from his personal desire to retain the trust’s real estate. What can Lupe do to obtain her fair share of the trust estate and prevent Miguel from demanding back rent from her? Here are the options:

1. Petition for instructions. File a petition for instructions asking the court to order a distribution of the home to Lupe.
2. Petition for accounting. File a petition asking the court to order Miguel to prepare and file a trust accounting.
3. Petition for removal. File a petition to remove Miguel as trustee.
4. Petition for damages. File a petition for breach of trust seeking damages against Miguel.
5. Petition to sell real estate. File a petition for instructions asking the court to order the trustee to sell all trust assets and distribute the cash to the beneficiaries equally.

Our Expert Recommendation

A sibling acting as trustee, especially a disgruntled sibling, is the typical starting point for beneficiary abuse. Here, Miguel is not being reasonable. He refuses to negotiate distribution of the home to Lupe, and he refuses to discuss the rental property. Instead, Miguel seems bent on revenge.

Option 3: as experienced trust and will attorneys, we would advise Lupe to petition for trustee removal. Miguel should be removed from office as trustee because he cannot treat the beneficiaries fairly. He seems to think that he is “in charge” and can do whatever he likes. But his duties as trustee are much different than that. As a trustee, Miguel must treat each of the beneficiaries fairly, which means that Miguel cannot benefit himself to the detriment of the other beneficiaries. As such, Miguel should be removed as trustee.

Option 1: removal takes time because the court must have a trial to determine the evidence for removal. In the meantime, we would advise Lupe to include option 1 and ask the court to order the trustee, either Miguel or his successor, to distribute the trust assets. We would ask the court to order a distribution of the home to Lupe. If Lupe wants the home, she might as well ask for it. The court may deny that request, but it is worth a try.

Option 5: it is also worth pursuing a petition asking that all the real estate be sold and the cash distributed equally. This would mean that Lupe does not get the home or the rental property, but it also means that Miguel won’t get those assets either. In other words, we may be able to put pressure on Miguel by asking the court to force him to sell all the real estate. If Miguel truly wants to keep the rental property, then he will not like this request, and he may be more open to negotiating a distribution of the home to Lupe.

Keep in mind that sometimes you must take certain actions to help build leverage against the trustee. Lupe may not want all the real estate sold, but neither does Miguel. And if Lupe is willing to live with this result, but Miguel is not, then Lupe can gain some much-needed bargaining leverage by asking the court to sell everything.

Option 2: it may be premature to pursue a petition for accounting. If you know all the finances of the trust, there may be no need for an accounting. And since the accounting will likely cost the trust several tens of thousands of dollars to prepare, we would probably skip that for now. If we discover further facts that suggest some trust assets were misappropriated, then we may request an accounting at that time. For now, we would focus on getting the home distributed to Lupe.

Option 4: a petition for damages, the final option, is also premature. At this point, Miguel is causing a lot of problems, but he has not caused any damages yet. Unfortunately, a trustee is not liable for damages simply because they breached their duty as trustee. Instead, there must be some economic loss to the trust that was caused by the breach of trust. If a trustee is refusing to make a distribution, but the court then orders the trustee to distribute, there likely are no damages from a financial-loss perspective. Yes, you suffered mental anguish (or pain and suffering) due to the trustee’s actions, but you cannot obtain damages from a trustee or trust for pain and suffering.

The Law of Diversifying Trust Assets Regarding Fair Treatment of Beneficiaries

Under California Probate Code section 16002, every California trustee has a duty to administer the trust solely in the interest of the beneficiaries. Further, Probate Code section 16003 states that if a trust has two or more beneficiaries, the trustee has a duty to (1) deal impartially with them, (2) treat them fairly in investing and managing trust property, and (3) consider any differing interests of the beneficiaries.

In other words, the trustee cannot play favorites. The trustee must act in a way that benefits ALL the beneficiaries as equally as possible. There are times when differing beneficial interests must be weighed. For example, investing trust assets to maximize income, but minimize growth, is a great strategy for the current income beneficiaries but could harm the future principal beneficiaries of the trust. To properly balance these differing beneficial interests, a trustee must invest for both income and growth.

Problems often arise where one beneficiary resides in a trust home rent-free. This is unfair to the other beneficiaries who have an interest in the same home. The trustee must collect rent, evict the beneficiary, or sell the home (or maybe do all three). Some action must be taken by the trustee to equalize the situation so that one beneficiary does not gain an unfair advantage over trust assets.

The guiding light for every trustee should be fairness. Whatever action best equalizes the beneficiaries so they all are benefitted, and no one is harmed, is the action the trustee must take. This is not optional; the trustee has an affirmative duty to treat each beneficiary fairly.

These duties sound simple, but many private trustees violate them because the trustees mistakenly assume that they are “in charge” and can do whatever they like. That is false. While a trustee is the manager of the trust estate, the job includes a host of legal duties and responsibilities. And the trustee duties are vastly different from what a person can do with their own assets. If the trustee has their own money and they want to benefit their children unequally, that’s fine. But when a trustee is managing a trust estate, they do not have the freedom to play favorites. In accepting the job of trustee, the trustee is also agreeing to abide by the duties and responsibilities of a trustee.

Investment Decisions

The California Prudent Investor Act provides the rules a trustee must follow when investing trust assets. In part, the trustee must consider the differing interests of the beneficiaries when investing trust assets.

The most obvious differences come with the type of beneficial interests a trust can create. For example, one beneficiary may be entitled to receive all trust income monthly while a different beneficiary may be entitled to the principal of the trust once the income beneficiary dies. If the trustee invests with a view to only maximize income, then the principal assets may not grow in value, which would hurt the principal beneficiary. If the trustee invests with a view to only maximize the growth of the assets, then there may be no income generated to the detriment of the income beneficiary. Either of these investment strategies would be a violation of the trustee’s duty to treat the beneficiaries impartially.

What action should the trustee take when dealing with differing beneficial interests? The trustee must have a well-thought-out and a well-documented investment plan. The trustee can consult with a financial advisor and create a written investor policy statement (referred to as an IPS). The IPS would outline the differing beneficial interests and then discuss an investment strategy that would balance both income and growth. The trustee can then implement the investment plan contained in the IPS and, more importantly, check on the plan every quarter with the financial advisor. By regularly checking up on the investment plan, any changes can be made due to changed circumstances in the investment portfolio.

The duty to treat beneficiaries impartially when investing trust assets is not hard to satisfy, but it does take some forethought, planning, and adjusting along the way. The trustee can hire professional advisors, which is where a good financial advisor should be used. There is no reason to leave trust investments to chance or guess work. A trustee should devise a good investment plan, write the plan down in an IPS, and then implement the plan. This protects the trustee from being sued, and it protects the beneficiaries from being treated unfairly.

Fights among Beneficiaries

Sometimes trust beneficiaries don’t get along (imagine that), especially where the beneficiaries are siblings with a long history of family discord. There are many issues that beneficiaries may fight over. It could be a disagreement over the interpretation of a trust provision or arguing over who receives the family home. Sometimes beneficiaries argue over seemingly mundane issues, such as who will receive the original family photographs or who will receive the heirloom teapot. These “mundane” issues can be the biggest fights of all because even though the monetary value is low, the sentimental value can be priceless.

Whatever the issue may be, the trustee has a duty NOT to take sides in disputes among beneficiaries. This is true even in disputes concerning trust amendments. So long as the validity of the trust itself is not being attacked, any dispute between beneficiaries requires impartiality on the part of the trustee.

What if the trustee is also a beneficiary? That gets complicated because the trustee is essentially wearing two hats—one as trustee (requiring impartiality) and one as beneficiary. The best practice in this scenario is for the trustee/beneficiary to hire two different lawyers. One lawyer would represent the trustee/beneficiary as trustee and help the trustee remain impartial. This lawyer can be paid from the trust estate because they are providing services to the trust. The trustee can provide any helpful information to the parties and to the court, but cannot take an adversarial role in the fight.

The other lawyer would represent the trustee/beneficiary as a beneficiary. This lawyer must be paid by the beneficiary individually, and they could advocate on behalf of the beneficiary. In other words, the trustee/beneficiary can take sides in a fight, provided that they do so as an individual beneficiary only. That means no trust assets or resources can be used to fund the beneficiary’s fight.

This may all sound complicated, but it is crucially important if the trustee/beneficiary wishes to abide by their legal duties and remain impartial as a trustee. Where a trustee/beneficiary fails to take the actions described above, they risk being found in breach of trust, which could cause them to be removed and surcharged for damages.

Remaining impartial is not always easy. Many trustees, even those who are not beneficiaries, want to take sides with the beneficiaries with whom they agree, but that is strictly forbidden. The trustee has an affirmative duty to rise above the fray and remain impartial in all beneficiary fights.

Current vs. Remainder Beneficiaries

Most trusts have different layers of beneficiaries to consider. Current vs. remainder beneficiaries are the most common. For example, when a bypass trust is created, the surviving spouse is the current beneficiary. Income and principal of the trust are typically distributed to the surviving spouse for their health, education, maintenance, or support. Once the surviving spouse dies, the remainder beneficiaries (usually the children) receive whatever is left in the bypass trust estate.

In managing the bypass trust assets, the trustee has a duty to consider both the current and remainder beneficiaries. That means all management and investment decisions must balance these competing interests. Naturally, the remainder beneficiaries would prefer that the assets are invested for growth and that NO distributions are made from the trust. Whereas the surviving spouse would prefer investments geared toward income with liberal distributions of income and principal being made.

The trustee must balance these competing interests and decide how best to treat all the beneficiaries fairly. Bypass trusts are just one example of a trust with different layers of beneficiaries. The same is true for marital trusts, children’s trusts, any trust that holds assets for one person or group of people currently but then distributes the assets to a different person or group of people later.

As with investing, the best course to ensure a trustee satisfies their duty to treat beneficiaries fairly is to create a written plan. For investing, the trustee can use an IPS to create and implement a proper investment plan. For managing other trust assets or making trust distributions, written documentation is also critical. For example, the trustee can ask the current beneficiary to provide a list of their needs in writing, or the trustee can meet with the current beneficiary and create a list of needs together. The trustee can then obtain whatever supporting documentation they feel is appropriate to justify the list of needs. Finally, the trustee can make the distributions. A thorough and well-documented plan of action helps protect the trustee from future attack and helps ensure the beneficiaries are treated fairly.

As with all duties of a trustee, a little forethought, documentation, and planning goes a long way to satisfying trustee duties. Trustees who take the time to execute their duties properly are the best trustees you can have.

In the case of Miguel, he was simply acting unfairly. A trustee must treat each beneficiary equally and fairly. A trustee is not allowed to play favorites. Even though Miguel was mad at Lupe, he had no right to use his position as trustee to take out his revenge against her. Luckily, Lupe can stand up and fight for her beneficial rights in court. Miguel can try to abuse Lupe, but Miguel’s abuse cannot continue once he must answer for his actions before a judge.

Intra-family fights fuel many trust disputes. With Miguel, the fight was for real estate, but similar disputes can arise with family businesses as well, which is the subject of the next chapter.