September 2, 2016
Authored by: Luke Lantta
Settlors often want to give their trustees peace of mind that they can administer the trust without a court looking over their shoulder and second-guessing every act they take. So, estate planners will often put a broad exculpatory clause in the trust instrument to relieve the trustee from liability for certain actions in administering the trust. But, just as we have seen in other jurisdictions, in In re Scott David Hurwich 1986 Irrevocable Trust, the Court of Appeals of Indiana recognized that there is a limit as to how far the relief from liability can extend.
A settlor/beneficiary of a trust sued the trustee, alleging mismanagement of trust assets, commingling trust assets with the trustee’s own funds, conversion of trust assets, waste of trust property, and breach of fiduciary duty. Among other defenses, the trustee pointed to an exculpatory clause in the trust, which she alleged prevented a court from reviewing her actions:
[T]he Trustee shall have (to the extent the power of election is not otherwise vested in a person other than the Trustee) the right, power and privilege to make elections….The actions of the Trustee in making any election shall be binding upon all beneficiaries and the Trustee shall not be liable to anyone for exercising a right, power of privilege to elect. The Trustee may make distributions and allocations without regard to the income tax basis of any property distributed or allocated to any beneficiary. No compensating adjustments between principal and income, nor with respect to any trust, need be made even though the actions of the Trustee may affect (beneficially or adversely) the interests of the beneficiaries. The actions of the Trustee in making distributions and allocations shall be binding upon all beneficiaries and the Trustee shall not be liable to anyone for exercising the Trustee’s discretion in this regard.
This is a broad relief from liability, but certainly not as broad as some we’ve seen. The appellate court recognized that, while this language generally limits the trustee’s liability when making certain discretionary distributions, it does not extend to insulating the trustee from liability for conversion, waste, mismanagement, or other breaches of fiduciary duty. The court stated that these wrongful acts cannot be construed as “valid discretionary decision[s].”
Sure, stealing money from a beneficiary is not a “valid” discretionary act, but casting the analysis as whether the act is a “valid” discretionary act doesn’t seem like the right answer because it puts the court in a position of second-guessing which discretionary acts of a trustee are “valid” and which were not. This is not what a settlor wants when they use broad exculpatory language. The better approach, perhaps, is what we have seen before: a broad exculpatory clause will relieve a trustee from liability unless the act was infected with bad faith. This analysis would seem to address the appellate court’s concerns without a trial court having to decide whether or not the exercise of discretion was “valid.”