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On a Beach in Bali: For Revocable Trusts With Living Settlors, is it Safe for Trustees To Go Back in the Water?

If the trustee of a revocable trust lets the trust’s settlor make an extravagant purchase or risky investment can he or she get into trouble with the trust beneficiaries later? This issue was explored in a recent California case and the court’s answer would allow trustees to approve the settlor’s luxury beach getaway with impunity.

The court of appeal in Estate of Giraldin (2011) 199 CA4th 577 poses this hypothetical, which is much sexier than the facts presented: The dying settlor of a revocable trust decides that “his last wish is to take his mistress on a deluxe, six-month cruise around the world—dissipating most of the assets held in his trust.” The trustee’s duties are owed to the settlor at that point, so he has no basis to deny that last wish. But “if the trustee’s duties were deemed to be retroactively owed to the trust beneficiaries—say, the settlor’s widow and children—as soon as the settlor breathes his last breath on a beach in Bali, the trustee would find himself liable for having failed to sufficiently preserve their interests in the trust corpus prior to the settlor’s death.”

The facts of the actual case are a bit less sensational. Shortly before his death, the settlor named his son as trustee of his revocable trust and invested two-thirds of the trust assets in his son’s company (a maker of GPS equipment called “SafeTZone”), which promptly went broke. Ordinarily, such an investment would violate the prudent investor rule for lack of diversification, among other problems, and would represent a conflict of interest for the trustee.

In concluding that the son was not liable for breach of trust, the court cited Prob C §15800, which states that “[t]he person holding the power to revoke, and not the beneficiary, has the rights afforded beneficiaries under this division” and “[t]he duties of the trustee are owed to the person holding the power to revoke.”

The court declined to follow the court of appeal decision in Evangelho v Presoto (1998) 67 CA4th 615, 79 CR2d 146, in which the court held that the beneficiaries could demand an accounting from the trustee after the settlor’s death for actions taken during his lifetime.

But there’s a catch: Section 15800 applies “during the time that a trust is revocable and the person holding the power to revoke the trust is competent.” Under case law, a revocable trust with an incompetent settlor is essentially treated as an irrevocable trust, although the beneficiaries still may not have rights to information because the settlor’s conservator may retain the power to revoke the trust. Johnson v Kotyck (1999) 76 CA4th 83, 90 CR2d 99.

Does this mean a trustee may owe those fiduciary duties to the beneficiaries when the settlor is found to be incompetent in retrospect? According to the court, the answer is No:

Until such time as a settlor is adjudicated incompetent to handle his or her own affairs, the trustee has to do what the settlor wants with the trust assets, including ‘financially risky or downright stupid things.’

Further, the trustee has no special obligation to question the settlor’s “competency or capacity to make decisions.”

So is it safe for trustees in this situation to go back in the water? Well, it seems possible that the trustee might still have a duty to the settlor to preserve the trust assets if the trustee knows or has reason to believe the settlor is incompetent—especially when the trustee has a potential conflict of interest.

Trustees should also get written directions for any unusual investment decisions. Under Prob C §16001, the trustee of a revocable trust “shall follow any written directions…by the person having the power to revoke.” In this case, the trustee acted on the settlor’s oral instructions even though the trust instrument required written directions.

The bottom line: Trustees of revocable trusts with living settlors can go ahead and get their toes wet. But keep an eye out for lawyers in sharkskin suits.

For a detailed discussion of the case, see the October issue of the Estate Planning and California Probate Reporter. For an overview of trustee’s duties, standards, and powers, see California Trust Administration, chapter 2. On the investment standard of care, see chapter 5. On the duties and powers of conservators, see California Conservatorship Practice, chapter 14. On some of the thornier issues in trust administration, check out CEB’s program Practical Problems in Trust Administration, available On Demand.

© The Regents of the University of California, 2011. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited.

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