Below, our Modesto estate planning lawyers explain how to protect yourself from claims of self-dealing when serving as a trustee.
What Is Self-Dealing in Trust Administration?
A trustee usually has quite a bit of discretion in their management of a trust’s accounts, money, and property (known as assets). At the same time, as a fiduciary, a trustee also owes the trust’s beneficiaries a duty of loyalty, which prohibits the trustee from self-dealing. In the simplest terms, self-dealing happens when a trustee uses the trust’s assets for their own benefit instead of for the beneficiaries’ benefit. Despite this simple definition, self-dealing can be much harder to identify in practice and is often done in ignorance, particularly when there are complicating factors such as the trustee also being a trust beneficiary.
Some common examples of self-dealing are a trustee
- making gifts to themselves from the trust’s assets;
- borrowing money from the trust;
- investing the trust’s assets in their own business;
- investing in high-risk investments for their own benefit;
- selling property to or buying property from the trust;
- mixing the trust’s assets with their personal assets;
- paying themselves more than a reasonable amount of compensation;
- receiving kickbacks from a third party compensated from the trust’s assets; and
- making a distribution to themselves as a beneficiary but not to any other beneficiary or making a larger distribution to themselves than to any other beneficiary.
Examples of Innocent Self-Dealing
Let us look at some real-life scenarios that demonstrate how a trustee may engage in self-dealing without even realizing it or while thinking that they are benefiting the beneficiaries.
Example 1. Tom is the eldest son of Dad and Mom. Over the years, Tom has proven himself to be hard-working and reliable and has assumed most of the responsibility for running the family business that supports Dad, Mom, Tom, and Tom’s three siblings. Not surprisingly, Dad and Mom select Tom as the trustee of their trust, with Tom and Tom’s brother and two sisters as beneficiaries. Prior to Dad’s death, Dad instructs Tom that the trust’s assets are available for Tom to use so long as, in the end, all the beneficiaries (Tom and his three siblings) receive equal shares from the trust. After Dad’s death, Tom spends many hours doing trust administration tasks and does not take one cent of compensation from the trust even though, under the trust agreement and state law, he is entitled to reasonable compensation for his time. Tom and his brother decide to buy a yacht together. Unfortunately, neither one of them has enough money in his personal bank account to buy the yacht. Tom makes a loan of trust money to himself and his brother to buy the yacht but does not make a similar loan to either of his sisters. Is this self-dealing? What if Tom makes the loans to himself and his brother under arm’s-length terms, charging a reasonable rate of interest and requiring security for the loan? Under these additional facts, is this self-dealing?
Example 2. Tom from Example 1 wants to expand the family business. Tom, his brother, and one of his sisters own equal one-third shares of the company as partners. Tom’s other sister has no ownership interest in the company but is a paid employee. Tom uses trust money to fund his business expansion plans. Is this self-dealing?
Example 3. Sue, a successful physician, and her two brothers are the beneficiaries of a family trust. Sue is the trustee. The trust owns a lake house that Sue’s parents purchased when she and her brothers were young, and many happy family memories were made at that vacation home. Unfortunately, the trust cannot afford to pay the mortgage and property taxes and keep up the required maintenance on the lakefront home, and neither of Sue’s brothers can afford even a one-third share of the amount needed for mortgage, taxes, and maintenance. Sue knows that the home must be sold, but she cannot bear to part with the property that represents so many happy childhood memories. Sue decides that she will buy the vacation home from the trust at fair market value. Is this self-dealing? What if, prior to Sue’s buying the home, the market crashes and the property loses a fourth of its value, but Sue purchases the home at the higher value? Under these additional facts, is this self-dealing?
How Do I Avoid a Claim of Self-Dealing?
As these examples demonstrate, there is not always a clear-cut answer to whether a trustee is engaging in self-dealing. An inexperienced trustee may not even realize that they are breaching their fiduciary duties. However, there are a few safe harbor rules that a trustee can follow to ensure that they will not be accused of self-dealing and find themselves involved in an unwanted lawsuit.
First, a trustee can engage in an action that might otherwise be categorized as self-dealing if the trust instrument authorizes it. So in Example 1 above, if Dad had wanted to allow Tom to use the trust’s assets in any way Tom saw fit as long as in the end all beneficiaries received equal shares, Dad should have made sure that such an instruction was included in the written trust instrument instead of being a separate oral instruction.
Second, a trustee can seek the approval of the trust beneficiaries for any action or inaction. If, after all facts are fully disclosed, the beneficiaries consent to the trustee’s proposed course of action or later ratify it, a trustee will not be guilty of self-dealing. So in Examples 2 and 3, if Tom and Sue had approached their siblings and explained what they planned to do, and their siblings had given them the go-ahead (preferably in writing), Tom and Sue would not be engaging in self-dealing.
Finally, a trustee can seek court approval of their actions. Nevertheless, any trustee looking to protect themselves from claims of self-dealing would be wise to avoid any transaction in which they stand to benefit unless the trust instrument specifically authorizes such action or they are transparent about the transaction and the beneficiaries consent to it.
Contact Our Modesto Estate Planning Lawyers for Guidance
If you are or will be a trustee of a trust in the future and have questions about the best way to fulfill your trustee duties, contact us. We would be happy to sit down with you and assist you with your role. Call us at (209) 340-1110 or fill out our online contact form and we will be in touch with you soon.