Estates, Trusts & Gifts
The issue of trustee compensation comes up more often than most people would suspect. Although disputes about compensation do not flood the courts, when they do occur they are often hotly contested and unpleasant for all involved. The purpose of this item is to illuminate the issues that can lead to litigation on trustee compensation.
It is a rare trust document that says anything more specific about compensation than to note that the trustee is entitled to “reasonable compensation.” This is a question of state, not federal, law. The Uniform Trust Code (UTC), a model law adopted in 20 states (albeit with slight differences), provides:
- If the terms of a trust do not specify the trustee’s compensation, a trustee is entitled to compensation that is reasonable under the circumstances.
- If the terms of a trust specify the trustee’s compensation, the trustee is entitled to be compensated as specified, but the court may allow for more or less compensation if:
- The duties of the trustee are substantially different from those contemplated when the trust was created; or
- The compensation specified by the terms of the trust would be unreasonably high or low (UTC §708).
States that have not yet adopted the UTC follow common law, which provides for reasonable compensation under the circumstances. (See, e.g., Hartford Nat’l Bank & Trust Co. v. Donohue, 402 A.2d 1195 (Conn. Super. Ct. 1979); Alexander v. Harris Trust & Sav. Bank, 401 N.E.2d 1168 (Ill. App. Ct. 1980).) The UTC basically codifies common law that applies in the absence of the UTC or a specific state statute (see Restatement (Third) of Trusts §38 comment c(1) (2003)). The Restatement of Trusts is a well-recognized treatise that provides insight and commentary about all matters relating to trusts and is followed by much of the judiciary, unless in direct conflict with state law.
The obvious and immediate conflict of interest that exists with respect to trustee compensation is that the trustee, the person who may unilaterally take a fee from the trust’s assets, is also the person who decides what is reasonable. That dynamic is reason enough for beneficiaries and their advisers to keep a vigilant eye on the compensation component of the trust relationship.
Reasonable Compensation Defined (Perhaps)
It is well settled that factors to be considered when evaluating the reasonableness of a trustee fee include but are not limited to:
- The value and character of the trust property and the risk and responsibility of administering the property;
- The time spent and the quality and character of the services provided by the trustee;
- The character and cost of services provided by others;
- The trustee’s skill and experience; and
- The results obtained (UTC §708 and comment).
Each case will be different, and a court has almost unfettered discretion to award whatever trustee fee it deems appropriate under the circumstances. As the reader can discern, it is a fuzzy test at best, and one that becomes even fuzzier if the trustee does not take a fee annually in accordance with the rules of fiduciary accounting (which require that half the fee be taken from principal and half from interest).
Depending on the size of the trust and the fee claim, experts will likely be asked to testify about a fee claim. An expert opinion usually addresses not only the factors identified above but also fees charged by corporate trustees and professional money managers. For example, a corporate trustee generally has a sliding fee schedule based on the amount of trust assets. It will also offer different services for different fees. To act as a fiduciary and administer the assets, but not manage the assets (instead using money managers selected by the beneficiaries), a corporate trustee may charge 30 basis points for the first million dollars, 25 basis points for the next five million, and so on. These fees are charged on an annual basis but are paid out of trust assets on a quarterly basis. If the corporate trustee actually manages the assets, the fee can range anywhere from 30 basis points to 100 basis points depending on the size of the trust, the expertise required, and the risk involved.
On the other hand, fees for individual trustees are usually negotiated and agreed upon. The best practice includes full disclosure of the fee to the beneficiaries. Under the UTC, trustees must inform the beneficiaries if they are going to change their fee (UTC §813(b)(4)), and the beneficiaries have a limited time within which to object to the change. (This varies from state to state. In Ohio, beneficiaries must make objections within two years.) Where the trustees disclose their fees to the beneficiaries annually and they fail to object, unless the beneficiaries can convincingly argue that they did not understand the fee information the trustees gave them, they are deemed to have waived their right to later complain about the fee. Beneficiaries cannot agree to a fee about which they are informed and then later complain about it absent extraordinary circumstances that would excuse their delay and the trustee’s reasonable reliance on their silence.
Postponing Compensation: Not a Good Idea
For a variety of reasons, there are times when a trustee does not take an annual fee or even raise the issue. Sometimes the trustee is a family member or family friend and does not consider taking a fee because he or she does not need the money. But if circumstances change, the trustee may begin taking a fee, and the beneficiaries may then complain. Sometimes a trustee may try to take a fee on resigning or simply decide that he or she should have been taking a fee in the past because the beneficiary is now challenging his or her stewardship of the trust assets. Or perhaps in the past the trust lacked liquidity and there was no cash from which to take a fee. Whatever the reason, in the absence of clear consent as the fee accrues, reaching back for a fee is unlikely to sit well with the beneficiaries.
For example, in Lyons v. Holder, 163 P.3d 343 (Ky. Ct. App. 2007), Lyons, the primary beneficiary of a trust, filed suit against the trustee who had paid himself $56,850 before resigning after 12 years of service. It was undisputed that for most of the life of the trust the trustee properly performed all his duties as trustee, regularly visited the beneficiary, and helped with her care. In 2003 the beneficiary started a relationship with a new friend of whom the trustee was suspicious. This led to a rapid deterioration of the relationship between the parties and ultimately to the trustee’s resignation.
The beneficiary contended that the trustee had waived his right to take a fee for prior years’ service (no argument was made about the amount of compensation, which amounted to about $4,000 a year for assets averaging between $400,000 and $600,000 in value). The lower court found in favor of the trustee, holding that as a matter of law waiver was not to be inferred from the failure to take a fee. The court of appeals, however, reversed the lower court, holding that “[w]e fundamentally disagree with this holding. Kansas law has consistently recognized that intention to relinquish a known right may be inferred from conduct.” The beneficiary argued that the trustee’s failure to assert his right to compensation for nearly 12 years should be considered waiver by inference. She bolstered this argument by highlighting the trustee’s failure to address fees in the accountings that had periodically been provided to the beneficiaries. The court of appeals wrote, “Although we decline to ascertain the weight of such evidence, we conclude that [the trustee’s] standing mute on his right to compensation for 12 years under these circumstances was some evidence of waiver.” Accordingly, the appellate court remanded the case to the lower court for a trial on the issue of waiver.
Waiver is a common law concept, and, while each state may differ slightly in its interpretation of waiver, the legal principle lies in wait for those trustees who postpone taking compensation and remain silent on the issue during their tenure. This issue was litigated in Jacobs v. Jacobs, 2008 WL 4966889 (N.D. Ohio), a case in which the trustee sought compensation for a period of more than 12 years. During that time the trustee had provided to the beneficiaries annual audited financial statements that did not contain any liability or footnote dealing with the issue of trustee compensation. Jacobs is noteworthy for the trustee’s novel argument that his claim for compensation came into existence only when he decided to take compensation, an argument that the court did not find persuasive. (The Jacobs litigation was resolved by a confidential settlement in 2009. The author represented the beneficiaries in that case from 2006 through to its conclusion.)
When fee disputes arise, a trustee is generally entitled to reimbursement of fees incurred in his or her defense as a trust administrative cost. However, the right of reimbursement does not allow for payment on a current basis unless so specified in the trust (which is extremely rare). Rather, reimbursement takes place by court order at the conclusion of the fee dispute. (Of course, a trustee likely will not be entitled to reimbursement of such fees from the trust if the court finds that he or she is liable for wrongdoing.)
In sum, trustees should take a fee annually, with full disclosure (and, if possible, written consent from the beneficiaries) and in accordance with the rules of fiduciary accounting. In the event that a trustee decides to defer taking a fee, the trustee should notify the beneficiaries of this decision in a writing that also expressly reserves the right to take the deferred compensation at a later time. Ideally, the trustee should also obtain a signed acknowledgment from the beneficiaries. To do anything else is to open the door to a challenge.
Wearing Multiple Hats: Traps for the Unwary
Example: Q is a CPA who is a close and truly trusted adviser to a successful client. When Q assumes the role of trustee, Q, in his capacity as a CPA, manages the trust assets and provides tax and accounting services. Q is also the managing member of an LLC inside the trust that holds real estate. Q has told his client that he can manage the real estate investment without a third party.
What are some of the traps? First, in overseeing the trust assets he elects not to hire a specialist. Because he has held himself out to have specialized skills in this area, he has increased liability if he does not achieve a successful outcome in asset management in the eyes of one or more of the beneficiaries. Second, he is taking compensation as the managing member of the LLC on top of his trustee fee (amounting to double dipping). Third, he neglects to detail his time spent in his CPA capacity (for which he may charge market rates), thereby exposing himself to charges of overbilling.
A recent decision from the New York Appellate Division illustrates this point ( Estate of Witherill, 828 N.Y.S.2d (N.Y. App. Div. 2007). Although the case involved an executor of an estate who had served as a financial adviser to the decedent prior to her death, the fiduciary issues and risk also apply to trustees. The court found that the executor in Witherill had (1) overpaid himself for his services, (2) overpaid the accountants and failed to question their bills, and (3) allowed Merrill Lynch to invest estate assets in an unsuitable investment. It also found that his excessive fees and negligence in overpaying the accountants were acts for which he was personally liable.
With respect to the unsuitable investment, the court noted that the executor had claimed to be a skillful financial adviser, and the court held him to that standard. The court found that he had been obligated to “exercise such diligence in investing and managing assets as would customarily be exercised by prudent investors of discretion and intelligence having special investment skills” (emphasis added). In finding him liable for the loss of appreciation damages related to a junk bond fund, the court noted, “His gross departure from the obligation to skillfully manage the investment and failure to preserve the principal constituted faithless misfeasance and fully justified the inclusion of lost profit or lost appreciation damages.” In so holding, the court cited to a host of New York decisions in line with its own decision, including Matter of Rothko, 372 N.E.2d 291 (N.Y. 1977); Scalp & Blade v. Advest, 765 N.Y.S.2d 92 (N.Y. App. Div. 2003); Matter of Saxton, 712 N.Y.S.2d 225 (N.Y. App. Div. 2000); Matter of Janes, 643 N.Y.S.2d 972 (N.Y. App. Div. 1996), aff’d, 681 N.E.2d 332 (N.Y. 1997).
The Uniform Prudent Investor Act (UPIA) is a model act that governs the administration of trusts. This act has been adopted in 44 states, and the reader is advised to carefully review how his or her state has adopted the law. The UPIA provides a standard by which investment decisions about trust assets are measured.
The management of a closely held business or real estate holdings requires a different skill set and level of experience than managing cash or marketable securities. Although a CPA may have a lot of knowledge about a client’s business, it is strongly recommended that if serving as a trustee, the CPA should engage appropriate specialists to manage the trust’s assets. This is particularly true given the myriad emotions and desires of the various beneficiaries, which are more likely than not going to be the cause of friction and second guessing. This is almost always the case when a family member believes he or she should have been named trustee or given a position of greater stature and remuneration in the family business.
Defending Claims: Why Use a Rolls Royce When a Buick Will Do?
A recent decision by a California appellate court highlights the issue of an excessive defense. Donahue v. Donahue, 105 Cal. Rptr. 3d 723 (Cal. Ct. App. 2010), involved legal fees incurred by the trustee in defending claims for self-dealing and conflict of interest brought by the beneficiaries. At the core of this case was a complaint that the defendant trustee sold trust assets for too little and that the sale was tainted with self-interest. The beneficiary claimed that the trust’s losses were between $20 and $25 million.
In response to the trustee’s argument that it was a “bet the farm” case, the court properly observed that it was the trustee’s farm at stake, not the trust’s. “Such a spare no expense strategy calls for close scrutiny on questions of reasonableness, proportionality, and trust benefit.” The appellate court sent the case back to the trial court to decide whether 3 law firms, 14 attorneys, and over $5 million in fees was appropriate. In so doing, the court wrote that “defense by so many top-flight lawyers may have benefitted Patrick [the trustee], but was it also reasonable and beneficial to the trust? Did Patrick demand a Rolls Royce defense when a prudent trustee could have arrived at the same destination in a Buick, Chrysler or Taurus?”
There are many pitfalls facing those serving as trustees. This item is by design limited in scope. It is meant to heighten awareness of trustee compensation and to make clear that best practices mandate that a trustee be transparent about the compensation to be taken and do so in writing. Trustees that do not use qualified specialists to manage trust assets or that fail to navigate conflicts of interest properly are putting themselves at great risk. Similarly, if they are also serving as a CPA or attorney for the trust, they should be very careful to bill for those services separately, in detail, and reasonably. Trust and fiduciary litigation is often embedded with emotion and tenacity that make it especially expensive, time consuming, and something to be avoided.
Editor: Anthony S. Bakale, CPA, M. Tax.
Anthony Bakale is with Cohen & Company, Ltd., Baker Tilly International, Cleveland, OH.
For additional information about these items, contact Mr. Bakale at (216) 579-1040 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Baker Tilly International.