As we’ve mentioned in part 1 of this series, trustees are fiduciaries and, as such, trustees owe a variety of fiduciary duties to multiple parties. These obligations include both the duty of loyalty and duty of impartiality, which we will discuss this week. To prove a trustee breached of one of these duties, one must show three things: (1) the existence of a fiduciary relationship; (2) the breach of a fiduciary duty; and (3) damages proximately caused by the breach of the duty.[1]
It is important to keep in mind that the express terms of the trust can modify the duties of the trustee. So, if the settlor foresees a potential conflict of interests, he or she would be wise to identify such a conflict and specify how the trust should handle the issue ahead of time.
Duty of Loyalty
The duty of loyalty is codified at N.C. General Statute § 36C-8-802. It requires a trustee to administer the trust solely in the interests of the beneficiaries. This means the trustee cannot: (1) engage in self-dealing; or (2) act in a way that conflicts with the interests of the beneficiaries. Self-dealing occurs when the trustee uses trust property to directly or indirectly benefit him or herself. This could involve selling or personally purchasing property in the trust.
Financial Institutions as Trustees:
Often, a financial institution serves as the trustee. Given their experience, institutional trustees often invest the trust’s assets in familiar financial ventures, which are sometimes offered by affiliate organizations. In such cases, these financial institutions can earn compensation in addition to their fees for administering the trust. It is arguable this compensation constitutes a breach of the duty of loyalty. Nevertheless, the Uniform Trust Code provides an exception, explaining that these dealings are not automatically presumed to create a conflict of interest. However, the financial institution must follow the prudent investor rule of Article 9 and annually report the details of their compensation.
Third Parties:
Trustees must also be careful when dealing with third parties. Their financial decisions must not be guided by the interests of third parties, that is, those parties that are not beneficiaries of the trust. If the trustee sells a trust asset to benefit a third party rather than the beneficiaries, the trustee breached the duty of loyalty. For example, if the trustee leases property to a friend for below market value, and the trust suffers a loss of potential income as a result, the trustee has likely breached the duty of loyalty.
Remedies:
If a trustee transfers assets to a third party and breaches the duty of loyalty, the affected beneficiaries can potentially void the transfer.[2] In such cases, the trustee may also be held liable for any loss in the value of the trust caused by the breach.[3]
Duty of Impartiality
Many trusts have multiple beneficiaries, and some have both current and contingent beneficiaries. Current beneficiaries are typically paid from the income of the trust, while the contingent beneficiaries are paid from the principal balance in the trust at the time the current beneficiaries die.[4] When there are multiple beneficiaries, or more than one type of beneficiary, the trustee has a duty to treat each “group” fairly and impartially by giving “due regard to the beneficiaries’ respective interests.”[5] If there are both current and contingent beneficiaries, it would be improper for a trustee to exhaust the entire principal of the trust for the benefit of the current beneficiaries and at the expense and exclusion of the contingent beneficiaries. To completely neglect – or otherwise treat unfairly – one class of beneficiaries at the expense of the other, would constitute a breach of the duty of impartiality.
Equal Treatment? Not exactly.
This does not mean, however, that the trustee must treat them equally. Keep in mind that each trust has its own unique facts and circumstances, and the trustee must take into account the particular purpose and terms of the trust when making his or her investment or distribution decisions. Some settlors may stipulate in the trust instrument that some beneficiaries’ interests be favored over others. This generally occurs when the beneficiaries vary in ages. For example, parents may choose to allow their younger children in college to take a larger trust distribution than their grown children who have other sources of income.
Bringing a Claim Against a Trustee
If one wishes to assert a claim for breach of the duty of loyalty and/or impartiality against the trustee, they will have to prove that the trustee abused his or her discretion when administering the trust. The court will consider the powers granted to the trustee by the terms of the trust and the action(s) taken to determine whether a breach occurred.
Alleging a breach of fiduciary duty is a complicated matter and one that an experienced fiduciary litigator can assist you with. If you have questions or would like more information regarding fiduciary litigation and your legal options, visit us at www.lindleylawoffice.com.
[1] Green v. Freeman, 367 N.C. 136, 749 S.E.2d 262, 268 (2013).
[2] THZ Holdings, LLC v. McCrea, 753 S.E.2d 344 (N.C. Ct. App. 2013).
[3] Restatement (Second) of the Law of Trusts §§ 205 and 206 (1987).
[4] Browne C. Lewis, The Law of Trusts, Chapter 11, http://lewislawoftrusts.lawbooks.cali.org/chapter/duty-of-impartiality/.
[5] N.C.Gen.Stat. § 36C-8-803 (2015).
