Trustee’s Duty – Duty Not To Undertake Adverse Trust
Are you a trust beneficiary who believes the trustee is benefiting themselves using another trust? You might be right. By the end of this article, you will be able to recognize whether a trustee used one trust to benefit themselves at the expense of another trust.
This most often comes up when there is an A-B Trust. Here is what that means. Many couples use a trust as the main part of their estate plan. In an A-B Trust, when the first member of the couple dies, the trust splits into two half halves. Trust B holds the deceased spouse’s share of the property. That means it contains the deceased spouse’s separate property and their half of the community property. Trust A has the living spouse’s separate property and their half of the community property. At least that is what is supposed to happen. I will explain in a moment how this goes wrong.
Trust B become irrevocable and unamendable when the first person dies. In other words, when the first member of the couple dies, Trust B’s terms are set in stone. Trust B typically pays all its income to the surviving spouse.
Trust A remains revocable and amendable. That means the surviving spouse has full access to all the property in Trust A, can change Trust A, and can even get rid of Trust A. There are no limitations on what the surviving spouse can do with the property in Trust A or Trust A itself.
Because the trust splits into two trusts, there must be a trustee for both trusts (i.e., Trust A and Trust B.) It can be the same person, or it can be different people. California’s Trust Law recognizes that since there is a common pool of property getting divided, there is the possibility the division could create a conflict between the trusts.
Here is what California’s Trust Law says:
The trustee of one trust has a duty not to knowingly become a trustee of another trust adverse in its nature to the interest of the beneficiary of the first trust, and a duty to eliminate the conflict or resign as trustee when the conflict is discovered.
Did your eyes glaze over? That is horrible legalese, so let’s break it down. If a person is serving as the trustee of one trust, then they cannot become trustee of a second trust if that second trust has some sort of conflict with the first trust. If a person is serving as trustee of two trusts and discovers the conflict, then:
- They either must act to eliminate the conflict OR
- They must resign as trustee when they discover the conflict.
Generally, you can be confident an A-B Trust is being properly administered when the surviving member of the couple has the property appraised (so they know what all the property is worth) and shares the financial information with you. If it is all community property, then the math is simple. One half goes into Trust A and one half goes into Trust B. If the deceased spouse had their own separate property, then that goes into Trust B too.
Keep in mind, it is perfectly fine for partial interests in property to be used to fund the trusts. For example, if the trust owns an apartment building, then the surviving spouse can record a deed conveying half of the apartment building to Trust A and half to Trust B.
The Most Common Way This Goes Wrong
Here is the most common way it goes wrong, the first member of the couple dies and never funds Trust A and Trust B. Invariably, the surviving spouse manages the trust property for their own benefit. But the failure to fund Trust B becomes an increasing problem the more time passes and the more property that is involved. The problem gets compounded if some property is sold and other property is purchased.
Below are three common examples of how things go wrong.
First Example – Two Spouses in a Second Marriage
Assume a husband and wife are both on their second marriage. The wife brings much more property into the marriage than the husband. She dies first. Husband fails to fund Trust A and Trust B. If you are the wife’s children, this is a problem for you. It becomes a bigger problem when the surviving husband remarries and creates a new trust with his new spouse. If property is transferred to a new trust he created with his new spouse, the husband is in charge of two trusts with adverse interests.
Let us make this more concrete. Suppose deceased wife brought the family home and stock portfolio to the marriage with second husband. Second husband did not have any real estate but had mutual funds. They deliberately commingled their cash in a checking account to pay for household expenses. They created a trust together. When wife died, husband should have recorded a deed conveying title to the house to Trust B. Wife’s stock portfolio should have gone into Trust B too. That is because those assets were separate property. Husband should also have transferred half the money in the checking account to Trust B because that is his late wife’s half of their community property.
When husband creates a new trust with his new wife, he puts all the cash and his late wife’s stock portfolio in it. He leaves the house in the old trust. Husband is the trustee of Trust B (even though he has not done anything with it) and the co-trustee of the new trust with his new wife. He clearly has an adverse interest because as the trustee of Trust B he should be suing himself and his new wife! He should be suing to get title to the stock portfolio and one half the cash transferred into Trust B. If this has gone on for a long time, then late wife’s children may need to trace assets to make sure they get everything back into Trust B that it should have. Husband has clearly breached his fiduciary duty by becoming the trustee of his new trust which has an adverse interest to Trust B.
Second Example – Failure to Fund Subtrusts in a First Marriage
Here is an example involving a first marriage. Almost always when this comes up in a first marriage, it involves multiple rental properties. Husband and wife are in their first marriage and have two children. They buy some single-family homes, some duplexes, and some four-plexes. They have two children. Their trust leaves everything to their son and daughter equally. When the husband dies, the wife should fund Trust A with half the property and Trust B with half the property.
That does not happen. Instead, wife leaves some property in the trust but takes some of it out. From the property taken out, some is sold, and some is mortgaged.
Along the way, wife amends Trust A to leave everything to her son and nothing to her daughter. Wife then dies. The trust appoints son as the trustee of Trust A and Trust B.
Right away, we know the trusts have an adverse interest, so the son has an adverse interest if he does not correct the problems his mother created. We know there is an adverse interest because even if son takes the remaining real estate and divides it between Trust A and Trust B, Trust B still does not have its interest in all the real estate wife took out of it. The trustee of Trust B should be suing the trustee of Trust A (and probably the executor of wife’s estate) for half the real estate she took out, half of the mortgage money from the properties taken out, and half the sales proceeds from the properties that were sold.
If son is honest and had no role in what his mother did, then he will work to get all the property back and equalize what is in Trust A and Trust B. But that rarely happens. Instead, son takes the position Trust B only gets half of what is left. By doing that, he is breaching his fiduciary duty by serving as the trustee to two trusts with an adverse interest.
Third Example – Mismanagement in a First Marriage
This is a variation of the second example. It’s still a first marriage and involves real estate. Sometimes the surviving spouse has a problem with one of the children and is determined to deny them their share of the late spouse’s assets. Let us assume husband died first. Husband’s share of the assets should go into Trust B.
The way things commonly go wrong is after Trust B is funded, wife then takes assets out of Trust B. Nearly always, she also amends Trust A to favor one child or revokes Trust A and creates new trust that favors one child. Tracing assets is very important in this situation. There are cases where there is a direct transfer of assets from Trust B to Trust A (or the new trust). There are cases where a sham sale of Trust B assets is done in order to disguise the assets being move to Trust A. It is not unusual to find the favored child had some role in the transfer of assets between the trust.
What to Do if Your Trustee Was in Charge of an Adverse Trust
If this sounds like something that happened to you, then remember this situation will not fix itself. You must act to get your rightful inheritance. If you want a more detailed understanding of California Trust Litigation then visit our Trust Litigation page. If you are ready to discuss your case then give us a call or fill out our contact form.