Background

Curt Bullock appointed his son, Chris Bullock, as trustee of the Curt Bullock Trust No. 2.  Chris and his siblings were the only beneficiaries of the trust.  The trust was a common life insurance trust with the only asset being Curt’s life insurance policy.  The terms of the trust prevented the trustee from borrowing from the trust except to pay life insurance premiums or to satisfy a withdrawal request from another trustee.  Nevertheless, Curt convinced Chris to make a loan to Chris’s mother, Imogene, so she could repay a debt to the family business.  Chris made two more improper loans from the trust.  He loaned money to himself and Imogene to invest in a mill.  A few years later he made another loan to his mother and himself to purchase some real estate.  Each of these three loans was repaid in full at an interest rate of 6 percent – the same rate the trust was earning from the insurance company.

Breach of Fiduciary Duty Judgment

Chris’s brothers ended up suing him for breach of fiduciary duty on the grounds that the loans constituted improper self-dealing.  The brothers moved for summary judgment and the Illinois state trial court granted it.  Under Illinois state law, in order for a trustee to self-deal, the trust instrument must provide for, not prohibit against, it.  The trust instrument here did not specifically prohibit self-dealing, but it did not permit it either.  In its initial summary judgment order, the trial court indicated there was a material issue of fact on whether Chris acted in good faith in making the prohibited transactions, and in its final order awarding damages the trial court noted that Chris did not appear to have “malicious motive” in making the prohibited transactions.  Indeed, there was no finding in the state court as to Chris’s mental intent – only that Chris engaged in impermissible self-dealing, which created a conflict of interest between him and the trust beneficiaries.  Nevertheless, the Illinois court ordered Chris to pay $250,000 in damages which represented the improper benefits he received from the trust, ordered Chris to pay $35,000 in his brothers’ attorney’s fees, and placed the mill Chris purchased with trust funds in a constructive trust controlled by BankChampaign.  BankChampaign also replaced Chris as the trustee of Curt’s life insurance trust.

Chapter 7 Bankruptcy Proceeding

BankChampaign allegedly blocked Chris’s efforts to sell the mill to satisfy the judgment, so Chris filed for Chapter 7 bankruptcy protection in the U.S. Bankruptcy Court for the Northern District of Alabama and sought to discharge his debt from the Illinois state court judgment.  BankChampaign started an adversary proceeding in bankruptcy court and argued that the debt was non-dischargeable because it arose out of Chris’s fraud.  According to the bank, Chris’s conduct that garnered the state court judgment constituted defalcation which is non-dischargeable under Section 523(a)(4) of the Bankruptcy Code.  The bankruptcy court agreed, and the U.S. District Court for the Northern District of Alabama and the 11th Circuit Court of Appeals did, too.

Meaning of “Defalcation” and Implications

The Supreme Court, however, disagreed.  It held that “defalcation” is a state of mind “as one involving knowledge of, or gross recklessness in respect to, the improper nature of the relevant fiduciary behavior.”  That isn’t all that helpful, so the Court explained:

[W]here the conduct at issue does not involve bad faith, moral turpitude, or other immoral conduct, the term requires an intentional wrong.  We include as intentional not only conduct that the fiduciary knows is improper but also reckless conduct of the kind that the criminal law treats as the equivalent. . . . Where actual knowledge of wrongdoing is lacking, we consider conduct as equivalent if the fiduciary “consciously disregards” (or is willfully blind to) “a substantial and unjustifiable risk” that his conduct will turn out to violate a fiduciary duty.  That risk “must be of such a nature and degree that, considering the nature and purpose of the actor’s conduct and the circumstances known to him, its disregard involves a gross deviation from the standard of conduct that a law-abiding person would observe in the actor’s situation.”

In reaching its decision, the Court recognized that the scienter requirement it adopted ”will most likely help” nonprofessional trustees administering family trusts which are difficult to evaluate in terms of comparative fault.  While a fiduciary may still be found liable for a breach of fiduciary duty where the applicable state law imposes a simple negligence standard of care, that judgment may be dischargeable in bankruptcy unless the fiduciary acted with bad faith, intentional wrong, or gross recklessness.

Charles and Liddia Porter executed a deed conveying their home to Terry and Brenda Mays.  Liddia sought to set aside the deed claiming that she was coerced into signing it through undue influence and fraud.  There was a bench trial in which numerous witnesses testified that Terry and Brenda attempted to influence Charles and Liddia.  There was also testimony that Charles was of poor health and mental condition at the time the deed was executed, and Liddia had a history of complying with Charles’ business decisions despite her own personal misgivings.  What makes this case unique is that the trial court concluded that the deed was the result of undue influence over Liddia by Charles - not Terry and Brenda.

The appellate court determined that Charles’ undue influence over Liddia was sufficient to set aside the deed.  There was evidence from the attorney who prepared the deed that Liddia attempted to ask questions about the deed, but that Charles did not permit her to do so prior to executing the deed.  There was also evidence that Charles had previously exerted physical force over Liddia and that she refrained from going against Charles’ wishes because she feared for her safety.  As a result, there was sufficient evidence to support a finding that Liddia did not wish to execute the deed and she would not have done so absent Charles’ insistence.

Arthur L. Hamel’s trust instrument gave the trustee broad authorization to control and administer trust property, including “the power to do all acts that might legally be done by an individual in absolute ownership and control of the property” and provided the trustee with “the power to lend money to . . . any beneficiary under [the] Trust . . . as may be agreed upon between my Trustee and such parties, provided, however, that any such loan shall be adequately secured and shall bear a reasonable rate of interest.”  The trust also granted to the trustee “any power my Trustee needs to administer my Trust Estate, which is not hereinafter listed.”  This same paragraph provided the trustee with “the power respecting property in [the] Trust Estate that an absolute owner of such property would have.”

But the trust also contained a specific provision relating to the sale of a farm held in the trust:

Upon my death, my Trustees shall have the farmland appraised.  Based upon that appraisal, DENNIS HAMEL has the option to purchase any or all of the farmland for three years immediately following my death at the appraised price.  During such time period, the trust shall continue to hold the farmland not yet purchased by DENNIS HAMEL.  All net income from the farmland shall be distributed annually to the beneficiaries in accordance with the above listed beneficiary’s fractional share of the trust.  If DENNIS HAMEL has not purchased the farmland within the allotted time period, then it shall be divided in accordance with the above beneficiary’s fractional shares.

Dennis executed a contract for deed between himself and his wife, as buyers, and the trustees, as sellers, to purchase the farmland for $244,000 to be paid over 6 years with 5 percent interest and a down payment of $10,000.  The Kansas Supreme Court determined that the trustees lacked authority to sell the farm to Dennis under the terms of this contract for deed.

Notwithstanding the broad powers granted to the trustees under the trust instrument, the specific provision regarding the farmland conveyed Arthur’s clear intent that the farmland would be disposed of within 3 years of his death – either through Dennis’ purchase of the farm or by a division among the beneficiaries.  Arthur’s intent was frustrated when the trustees entered into an impermissible 6-year contract.  Thus, the purchase of the property would not be final until more than 6 years – rather than 3 years – after Arthur’s death.

For the family law readers out there, the other interesting question answered by the appellate court was that the trial court had jurisdiction to enter a judgment of divorce between married persons of the same sex even though Michigan’s state constitution prohibits recognition of a marriage entered into by two individuals of the same sex.  Click on the link above for more details.

First, some quick facts.

Robert E. Boyar’s will distributed all of his property to a trust for the benefit of his five children and his grandchildren.  Under the trust, one son (Robert A. Boyar) and a bank were to be co-trustees.  The trust, however, also provided that a trustee could be removed by a majority of the beneficiaries.  Shortly before his death, Robert E. Boyar amended his trust to name a different trustee and to provide that he would not be subject to removal by any of the other trust beneficiaries.  The trust also provided that certain personal property should be divided among the children pursuant to their own agreement, which the children started to do shortly after Robert E. Boyar’s death.

Several months after Robert E. Boyar’s death, the new trustee informed Robert A. Boyer of the trust amendment and demanded a personal property itemization.  Robert A. Boyar contended that, while the amendment didn’t change the substantive dispositions to be made by the trust, it was improperly orchestrated by the new trustee to gain control of the trust and to collect trustee fees.

Robert A. Boyar filed an action challenging the validity of the amendment on the grounds of undue influence and lack of capacity.  The trial court dismissed the petition on the grounds that, because Robert A. Boyar accepted some of Robert E. Boyar’s personal property under the terms of the trust, he didn’t have the right to challenge the amended trust provision.  In other words, the trial court applied the doctrine of election.

With that background, now, let’s get a quick refresher on the doctrine of election.  In the context of wills, it means that “once a beneficiary under a will has accepted a benefit granted by the will, he will be estopped from asserting any claim contrary to the validity of the will.”  Put differently, “[w]hen a person is presented with the choice between two inconsistent or alternative claims to property devised by the testator and elects to accept benefits pursuant to the provisions of the will, that person will then normally be estopped from challenging the will or any part of it.”  The lower courts extended this doctrine to the trust.

The Illinois Supreme Court, however, decided that the doctrine of election shouldn’t have been considered by the lower courts.  The reason was that Robert A. Boyar’s challenge was not to the distribution provision.  He did not make a choice between accepting the property or challenging the trust.  Thus, he could take under the distribution provision and still challenge the amendment changing the trustees.

Last week, over at Bryan Cave‘s Private Client Group blog, TrustBryanCave, Kathy Sherby and Stephanie Moll wrapped up a three part series on this topic.  Readers of this blog will definitely be interested:

Part 1 takes a look at Pennell v. Alverson, which we previously looked at here.

Part 2 explores the ongoing saga of In re Estate of Giraldin, which we briefly reviewed here.

Part 3 wraps up the discussion with In the Matter of Trust #T-1 of Mary Faye Trimble, which we took a look at here.

Thomas and Michael filed an ex parte petition to remove Frederick as trustee and install Michael as the trustee of the Smillie Trust for the benefit of Thaddeus.  Nearly simultaneously, Thomas fraudulently created a second trust for Thaddeus.  Through alleged fraud, forgery, and subterfuge, Thomas convinced the insurance company to pay the death benefit to the fraudulent trust rather than to the correct trust.  Thaddeus sued the insurance company for breach of the insurance contract by making out the insurance proceeds check to the wrong trust thereby allowing Thomas to steal the money.

In Jakobiec v. Merrill Lynch Life Insurance Co., a New Hampshire federal court dismissed the claims against the insurance company and a federal appellate court agreed.  The reasoning was that, even if the insurance company made a mistake by making out the check to a fraudulent trust, the insurance company was not the cause of the beneficiary’s loss.  Because the Tessiers were hellbent on stealing the money and because they had gained control of the legitimate trust, too, they would have stolen the money even if the insurance company had made the check out to the correct trust.

You have to wonder how far this protection extends.

These were pretty bad facts – the wrongdoers here admitted that they were hellbent on getting the money.  Would an insurance company be granted the same protection if it made the erroneous distribution to a run-of-the-mill identity thief?  Based on the court’s reasoning, perhaps, because the criminal activity was an intervening cause.  In other words, it’s still the criminal – not the insurance company – who is the actual cause of the damage.

Here, also, the claims agent appears to have done some digging before cutting the check.  What if he hadn’t?  Would it have made a difference if the agent was reckless or merely negligent?  Maybe, because in that case the agent would have arguably caused the damage as opposed to a third party.

What happens if an agent’s negligence or recklessness is combined with a criminal trying to steal the funds?  While that seems like a fact-intensive inquiry, under this court’s reasoning, the existence of criminal activity may trump any act by the agent because the criminal activity will be the cause of the loss.

The court determined that a purported beneficiary of a trust didn’t need to be joined as a party where:

(1) Someone else, like the trustee, would defend the same position as the absent beneficiary; and

(2) The absent beneficiary had essentially disclaimed any interest in the trust.

The second point raises an interesting question – if the sole beneficiary of a trust disclaims any interest in the trust, does a trustee still have a duty to uphold the trust insofar as defense of the trust presumably upholds the grantor’s intent?

But not all powers of attorney are created equal.  In In re: Estate of Stahling, an Illinois appellate court recently answered the important question of whether a health care power of attorney creates a fiduciary relationship with respect to the execution of a deed transferring property to the agent which, as a matter of law, raises a presumption of undue influence.

The party advocating for the existence of a fiduciary relationship under a health care power of attorney claimed that any transaction between the principal and agent of a health care power of attorney results in a presumption of undue influence.  Her reasoning was that the relationship between the principal and agent to a health care power of attorney is one involving trust and confidence which must give rise to a presumption of undue influence in transactions between the parties.

The appellate court disagreed.  In doing so, it established two important points of Illinois law on powers of attorney:

First, the power of attorney at issue was a statutory short form power of attorney, which the agent did not have to sign.  To create a fiduciary relationship, an agent must accept the powers delegated by the principal.  The execution of the form by the principal, alone and without evidence of acceptance by the named agent, is insufficient to create a fiduciary relationship between principal and agent.  Other than signing the POA, an agent could evidence acceptance by performing acts authorized under the power of attorney.  So, Illinois practice pointer – if you want to clearly establish a fiduciary relationship between principal and agent, get the agent to sign the POA or otherwise evidence acceptance of the appointment.

Second, the court ruled that, under Illinois law, a health care power of attorney, alone, cannot create a presumption of undue influence in property and financial transactions between the power of attorney’s principal and agent.  In other words, even where a health care power of attorney creates a fiduciary relationship between individuals, that relationship does not extend to matters outside the scope of the power of attorney.  The court noted this position was consistent with recent authority regarding the same topic in North Carolina.

The trust instrument there required that “[e]ach Successor Trustee shall render an account of his/her receipts and disbursements and a statement of assets to each adult vested beneficiary.”  The plaintiffs were adult vested beneficiaries of the trust who had made requests for the successor trustee to provide an accounting, which the trustee did not provide.  The federal court ordered the trustee to provide the plaintiffs with an accounting of his receipts and disbursements on behalf of the trust and a statement of the trust assets within 30 days of the order.

We’re interested in this opinion for two issues that weren’t central to the court’s decision.

First, the trustee didn’t argue that the plaintiffs’ interests were not “vested” under Illinois law.  Thus, the court didn’t have to address vesting, but it still did.   In doing so, the court reminded us of an important tenet of Illinois trust law.  The plaintiffs here weren’t entitled to any trust assets until after the grantor and his partner’s deaths.  Death is an event that is certain to occur.  Thus, a a bequest merely postponed until after the death of a life tenant is still a vested remainder.  The inclusion of the phrase “upon death” doesn’t imply the creation of a conditional interest even though the future condition of “death” must first be met before the bequest is actually made.

Second, the time period for the accounting is interesting.  The grantor died on October 19, 2009.  The court ordered the trustee to provide an accounting to the beneficiaries from October 19, 2009 to the present.  It’s unclear from this opinion whether the court was recognizing that Illinois falls into that group of states that does not require the trustee of a revocable trust to account for the period of time preceding a grantor’s death or whether the court was simply limiting the accounting to that period of time for which the successor trustee was the trustee of the trust.  Either reasoning would be significant, but the opinion leaves us to wonder.