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D.         SUMMARY - THE FIDUCIARY OBLIGATION






The standards
        a) imposed on the trustee

1) are harsh.



        a) The policies
                i) behind
                        (a) such stringent standards and
                        (b) remedies
                                (i) for their violation

1)) are:
        (i) deterrence of wrongful conduct, and
        (ii) easing the burden of
                i) proving a breach of duty,
                ii) should that become necessary.



Do not overlook mentioning policy reasons in your answer.

Watch for a bar exam question
        a) regarding
                i) self-dealing,
                ii) diversification,
                iii) improper investment, and
                iv) offsetting
                        (a) gain from one breach
                        (b) against loss from another.

You should ask the following questions:

        1. Was the act one
                i) that the trustee was authorized to perform
                        (a) under
                                (i) the terms of the trust and
                                (ii) applicable law?

          If not,
                i) there is a breach of trust
                ii) regardless of the good faith, skill, and diligence
                        (a) with which the trustee performed the act.  


        2. If the act was proper (i.e., authorized)
                i) for the trustee to perform,

           did the trustee perform
                i) in a manner
                        (a) that satisfies the standard of conduct
                                (i) required of her?

           i.e., Did she
                i) act
                        (a) prudently, diligently, and in good faith,
                ii) exercising the appropriate amount of
                        (a) care, skill, and caution
                                (i) of a reasonably prudent person
                                        (A) under the circumstances?

E.         LIABILITIES OF TRUSTEE

1.         Enforcement by Beneficiaries

The beneficiaries may seek
        a) to have the trustee
                i) surcharged (i.e., pay damages suffered by the trust) or
                ii) removed from office
1) if the trustee breaches her duties.

The settlor may sue
        a) if he is also a beneficiary,

but third parties may not seek
        a) to enforce the trust.

a.        Prior to Breach

A court of equity
        a) will compel the trustee
                i) to perform her duties or
        b) will enjoin her
                i) from committing the breach.

b.         After Breach

The trustee is liable
        a) to the trust estate
        b) for losses
                i) resulting from the breach and
        c) for
                i) any profit
                        (a) that clearly would have accrued to the trust
                                (i) but for the breach, as well as
                ii) any profit
                        (a) made by the trustee
                                (i) as a result of her breach.

The trustee will also be liable
        a) for interest
                i) on her liability
        b) from the time of the breach.

c.        Defenses

Equity may not enforce the trust

1) if the beneficiaries
        a) expressly or impliedly
        b) consented to or
        c) joined in
                i) the breach of trust (by the trustee).

The beneficiary must sue
        a) within a reasonable time
                i) after the breach or

1) he will be barred from enforcing the trust
        a) by the doctrine of laches.

Note that :

the mere failure to object
        a) when the trustee commits a breach of tr ust

1) does not constitute consent.

2.        More than One Breach of Trust -Losses Cannot Be Offset

Where a trustee is liable for losses
        a) resulting from one breach of trust,

1) she cannot reduce the amount of this liability
        a) by offsetting it
                i) against a gain
                        (a) resulting from another breach of trust.

Example:   Trustee is required by the trust instrument to invest in bonds. She invests one-half the corpus ($50,000) in Green Co. stock and one-half ($50,000) in Purple Co. stock. Purple Co. stock becomes worthless, but Green Co. stock doubles in value; so there is no net loss.

        Even so, the trustee has been dealing with different portions of the trust property. The gain in Green Co. stock cannot be offset against the loss in Purple Co. stock.

        Therefore, Trustee is personally liable for the $50,000 loss in Purple Co. stock.

3.         Trustee's Liability for the Acts of Others

a.         Agents

A trustee is not liable
        a) to the beneficiaries
        b) for the acts of
                i) her agents

1) unless the trustee:

        1)         i) Directs,
                ii) permits, or
                iii) acquiesces in
                        (a) the act of the agent, or
                iv) conceals the act, or
                v) negligently fails to compel the agent
                        (a) to redress the wrong;

        2) Fails to exercise reasonable supervision over the agent;  

        3) Permits the agent
                i) to perform duties
                        (a) that the trustee was not entitled to delegate; or

        4) Fails to use reasonable care
                i) in
                        (a) the selection or
                        (b) retention
                                (i) of her agents.

b.         Co-Trustees

A trustee is not liable
        a) to the beneficiaries
        b) for a breach of trust
                i) committed by a co-trustee

1) unless the trustee:

        1) Improperly delegated her authority
                i) to the co-trustee
                ii) because, (one trustee cannot delegate to a co-trustee
                        (a) power to manage the property);

        2)         i) Participated,
                ii) approved, or
                iii) acquiesced in
                        (a) the breach by her co-trustee, or
                iv) negligently disregarded her own duties of administration
                        (a) so as to facilitate the breach
                                (i) by her co-trustee; or

        3)         i) Concealed the breach or
                ii) failed to take proper steps
                        (a) to compel redress of it
                                (i) by the co-trustee.

c.         Predecessor Trustees

A trustee is not liable
        a) to the beneficiaries
        b) for breaches of trust
                i) committed by a predecessor trustee

1) unless she:

        1)         i) Knew or
                ii) should have known of
                        (a) the breach and

                iii) failed to take proper steps
                        (a) to prevent further breach or
                        (b) to compel redress
                                (i) of a prior breach; or

        2)         i) Negligently failed
                        (a) to determine the amount of property
                                (i) that should have been turned over
                                        (A) to her, or

                ii) otherwise neglected
                        (a) to obtain delivery of the full trust property
                                (i) from the predecessor.

d.         Successor Trustees

A successor trustee can maintain the same actions
        a) as could be maintained by the original trustee.

1) She can sue third persons
        a) for damaging trust property
                i) before she became trustee, and

2) she can sue predecessor trustees
        a) to redress a breach of trust.

4.         Effect of Exculpatory Clauses

An exculpatory clause is one that
        a) attempts
                i) to relieve the trustee of liability for breach of duty
                        i) in the administration of the trust or
        b) lowers the standard of conduct
                i) required of her.

Generally, courts
        a) tend to frown upon these clauses and
        b) will construe them narrowly.

An exculpatory clause
        a) designed to absolve the trustee
                i) of all liability

1) will be held void
        a) as against public policy.

Limited exculpatory clauses are valid
1) except insofar as they:
        (i) attempt to relieve the trustee from liability for
                i) bad faith,
                ii) intentional breach of trust, or
                iii) recklessness; or
        (ii) appear
                i) in the trust instrument
                ii) because of the trustee's abuse
                        (a) of a confidential relationship with the settlor. [Rest. 2d ��222]


Example:    The trust agreement authorizes Trustee to continue the settlor's business, and provides that Trustee shall not be personally liable for negligence.

         A large hole develops in the front steps of the business. Trustee is aware of this and does not remedy it within a reasonable period.

        Z falls in the hole and is injured.

         Trustee is liable because his conduct was reckless, not simply negligent.  


5.         Trustee's Liability to Third Parties

a.         Contract Liability

Unless the contrary is
        a) explicitly
        b) provided in the contract,

1) the trustee is
        a) personally
        b) liable to third parties
                i) on contracts
                        i) entered into with them
                        ii) in the course of the trust administration.

1)         Indemnification Rights

As long as the trustee acted
        a) properly
        b) in making the contract
                i) (i.e., the contract was within her powers, and
                ii) she acted with reasonable prudence and care),

1) she is entitled to indemnification either
        a) by paying the creditor
                i) directly from the trust property or
        b) by paying the claim herself and
                i) obtaining reimbursement from the trust estate.

2)         Reimbursement for Legal Fees

The trustee is also entitled to reimbursement
        a) for legal fees incurred
                i) in defending suits brought
                        (a) against her
                        (b) by third parties,

1) unless the suit arises
        a) out of a breach of duty or
        b) from some fault of the trustee.

b.         Tort Liability

The trustee is
        a) personally
        b) liable to third parties
                i) for torts
        c) to the same extent
                i) as would be an ordinary owner.

She is liable for torts
        a) committed by
                i) herself or
                ii) her agents.

1)         Indemnification

The trustee is entitled to indemnification
        a) from the trust

1) if she is not
        a) personally
        b) at fault and

2) if the tort liability is a risk
        a) that is a normal incident
                i) of the type of activity
                        (a) in which the trustee was properly engaged.


Example:   T holds in trust an apartment house as a proper investment. T does not take out liability insurance, which is a breach of duty.

        A is injured when a painter negligently leaves a ladder in the hall.

        T is liable to A in tort.

        T is not entitled to indemnification from the trust because, although T was not personally at fault, the loss results from T's breach of duty in not insuring.

2)         Creditors

If the trustee is entitled to indemnification,

1) tort creditors can reach the trust assets
        a) to satisfy their claims.

F.         LIABILITY OF THIRD PARTIES TO THE TRUST

1.         Property Improperly Transferred to Party Who Is Not Bona Fide Purchaser


The trustee's transactions
        a) with third parties
        b) that constitute a breach of trust

1) can be set aside by
        a) a beneficiary or
        b) successor trustee,
2) provided it does not result in
        a) taking property
                i) from a bona fide purchaser.

The third party can be compelled
        a) to return the trust property
                i) improperly transferred to him or
        b) to restore the proceeds or product of that property,
                i) if it can be traced into his hands.

2.         Transfer to Bona Fide Purchaser Cuts Off Beneficiaries' Interests

A third party
        a) who acquires the legal title to trust property
                a) for value and
                b) without notice of the trust

1) takes the property
        a) free of the equitable interests of the beneficiaries.


a.         Third Party Deemed to Have Notice If Knows Facts Requiring Inquiry

The third party will be deemed
        a) to have notice of
                i) the existence of the trust

1) if he knows of facts
        a) requiring an inquiry
                i) that,
                        (a) if pursued,
                        (b) would have disclosed the existence of the trust.

If the third party knows
        a) that the property is held
                i) in trust
        (e.g., the existence of the trust appears
                i) on the face of a document
                        (a) representing the property),

1) courts have generally held that
        a) he has a duty
                i) to inquire into the trustee's authority;
2) therefore, he will be charged with such information
        a) as a reasonable inquiry would produce.

Some cases and many statutes relieve persons
        a) dealing with trustees
        b) of the duty
                i) to inquire into
                        (a) the propriety of the trustee's actions.

b.         Innocent Donee Is Not Liable for Damages

An innocent donee
        a) of trust property

1) must restore the property
        a) to the trust but
2) cannot be held liable
        a) for damages.

If the donee has exchanged the trust property
        a) for other property,

1) he can either
        a) restore the value of the property
                i) when received or
        b) its substitute,

        c) whichever value is lower.

3.         Participation in Breach of Trust

Clearly, a third party
        a) who
                i) knowingly
                ii) participates in a breach of trust by the trustee

1) is liable for the resulting loss to the trust estate.

One who
        a) innocently
        b) participates in a breach of trust

1) is generally not liable to the beneficiaries,
        a) except to the extent
                i) he is obligated
                        (a) to return property transferred to him
                ii) when not protected as a bona fide purchaser.

4.         Direct Suit by Beneficiary

Generally, the beneficiaries of a trust cannot bring an action
        a) in law or
        b) in equity
                i) against a third party who
                        (a) damages the trust property or
                        (b) is liable to the trustee
                                (i) on a contract.

The trustee is the proper person to sue the third party.

However, the beneficiaries can sue the trustee for breach of trust.

The exceptions
        a) to the general prohibition
                i) on a direct suit by the beneficiaries

1) are:

a.         Trustee Participates in Breach

If the trustee participates
        a) with the third party
        b) in a breach,

1) the beneficiaries can sue the third party
        a) directly.

Rationale:

The third party has directly wronged the beneficiaries
        a) by inducing the trustee
                i) to commit a breach of trust.

b.         Trustee Fails to Sue

If the trustee fails to sue a third party
        a) liable in
                i) tort or
                ii) contract,

1) the beneficiaries can bring a suit
        a) in equity
        b) to compel her to perform her duty.

To prevent multiplicity of actions,

1) the third party can be joined in this suit.

c.         Trustee Abandons Office

If
        a) the trustee
                i) has abandoned her office or
                ii) has left the jurisdiction and
        b) a successor trustee has not been appointed,

1) the beneficiaries can sue the third party
        a) in equity
        b) without joining the trustee.

G.         ALLOCATION OF RECEIPTS AND EXPENSES
BETWEEN INCOME AND PRINCIPAL ACCOUNTS


Assets
        a) received by the trustee

1) must be allocated to either
        a) principal or
        b) income.

For example,  suppose a trust is created for A for life, remainder to B.

        A is to receive the income for life; at A's death, B is to receive possession of the principal.

The trustee will usually
        a) credit the assets received
                i) to principal, and
        b) credit all income earned
                i) to income.

However,

1) certain receipts are of a mixed nature (both income and principal),
        a) depending upon how they are viewed, and
2) certain expenses are made
        a) to protect both income and principal.

Thus, allocation problems occur.

1.         Unif

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