Trust Disclosure – Devil Is in the Details

Trust Disclosure – Devil Is in the Details

Greed and misunderstandings can throw sand into the workings of family trusts, and one of the primary ways the law protects beneficiaries is to require trustees to make regular accounting disclosures of how they manage trusts. If disclosure suggests a trustee has breached a fiduciary duty, beneficiaries can challenge a trustee’s decisions and go to court, if necessary.

A Florida case that pitted a brother and sister against each other illustrates how far disclosure may have to go to be considered adequate. “The court took an incredibly broad view of what is required for adequate disclosure,” says Joseph K. Naberhaus, a trust and estate litigator in Dean Mead’s Viera office. The case also illustrates one of the pitfalls of making a beneficiary the controlling trustee of a family trust, Naberhaus says.

Mother and Son Deplete Trust to Pay IRS

The case, Turkish v. Brody, decided in Florida’s Third District Court of Appeal, involved a brother and sister who were beneficiaries of a trust created by their mother. The mother made the son and his daughter trustees and gave them carte blanche authority to manage the trust.  The trust gave them “absolute discretion” to make distributions from the principal to either the brother or sister “in equal or unequal amounts” and “to the exclusion of the other,” according to the Third District Court’s decision.

This arrangement worked well for the trustee-son, who, the court said, “maintained an extravagant lifestyle without significant employment.” The son supported himself with distributions from the trust, along with additional gifts from the mother. While this might not seem fair to the sister, the mother was within her rights to favor one child.

The seed of the eventual court case between the brother and sister was planted when the mother faced a gift tax liability of more than $1 million for the money she had given to the son over the years. Unable to pay the Internal Revenue Service, the mother and son came up with a clever plan. He would take a distribution of slightly more than $1 million from the trust and then turn it over to his mother to pay the IRS bill. In return, she would give the son an unsecured promissory note for the same amount, and thus the distribution would not appear to be a gift to the mother that would create a gift tax liability for the son.

When the daughter discovered this scheme, however, she brought a claim against the son and his daughter for breach of fiduciary duty.  Eventually, the trustees and the daughter settled the claim.  Pursuant to the settlement agreement, the son contributed the promissory note to the trust, and the daughter – who was represented by counsel – released all claims against the trustees.  Contemporaneous with the settlement agreement, the trustees served the daughter with a trust accounting that contained the six-month limitation notice pursuant to Fla. Stat. §736.1008 for all claims that were “adequately disclosed” in the accounting.  The accounting listed the promissory note as a trust asset and accurately stated its principal balance.

After the mother died three (3) years later, the daughter discovered that the mother’s estate did not have any assets from which to repay the promissory note .  The daughter filed another breach of fiduciary duty claim against the trustees claiming that they knew the promissory note was worthless at the time the mother signed it.  The trustees asserted that this claim was barred because 1) the daughter had released the claims in the settlement agreement; and 2) the promissory note transaction was disclosed in the annual accounting and the six-month limitations period had run out.  The case had several other legal and factual nuances, but the daughter’s primary claim was that her brother had breached his fiduciary duty by not disclosing that the mother would never be able to pay the promissory note.

Disclosure and Due Diligence

The law wisely provides time limits on challenges to trustees’ decisions, because trustees who fulfill their responsibilities in good faith shouldn’t be subject to the uncertainty of whether there may be future litigation. On the other hand, beneficiaries should have the information they assess whether the trust is being managed properly. Disclosure with time limits for claims provides the balance between the sometimes-competing interests. Under Florida law, the statute of limitations for bringing an action against a trustee is reduced for actions that are adequately disclosed.

The law provides a generous 40-year window after a trust terminates or the trustee resigns to bring an action when there is no disclosure. This litigation window is extended to 70 years if the trustee engaged in deception.

But for matters that are adequately disclosed, the window for litigation narrows to four years. That window, however, can be further narrowed to six months if the accounting disclosure is accompanied by a “limitation notice” that tells beneficiaries they have just six months after receipt of disclosure to initiate an action.

Unfortunately for the trustees in this case, the court said they failed to make adequate disclosure because they did not inform the sister that their mother’s estate would not have any assets to repay the promissory note.  Because the Court found the trustees’ disclosure inadequate, it ruled that the release was not enforceable and the six months limitation period did not apply.  Therefore the Court ruled that the sister’s claims were not barred. Naberhaus notes that the sister’s claim didn’t allege fraudulent concealment of these facts, and she or her attorney could have done due diligence on the promissory note but did not.

Takeaways for Trustees and Beneficiaries

For trustees, the six-month statute of limitation provides certainty and reduces the possibility that decisions they made in good faith will be challenged years later. However, the Third District Court took an expansive view of the need to disclose “all pertinent facts,” signaling that – at least in the view of this court – any deception by omission will negate the statute of limitations. “Specifically, in this case the court is saying you have to disclose the risks of assets held in the trust,” Naberhaus says, “and it will hold trustees’ feet to the fire in any scenario where it obtained a release but didn’t disclose all the risks.” While the defendant in this case was the poster child for self-dealing, the court takes an incredibly wide view of what “adequate disclosure” means, says Naberhaus.  It remains to be seen whether other courts will apply this broad definition to other, less egregious breach of fiduciary duty claims.

For beneficiaries, the court’s strict view of disclosure will protect their right to make claims, but the narrow window to challenge matters when the limitation notice is invoked should be a wake-up call, Naberhaus says. Absent deception on the part of the trustee, beneficiaries’ rights to go to court to challenge management of their trust will disappear before the next annual accounting disclosure is due. Beneficiaries must pay attention to management of their trusts in order to protect their rights.