The Legal Duties of California Trustees, the Investment of Trust Assets, and the Importance of Choosing a Successor Trustee Wisely

If you are serving as a trustee, executor or administrator, conservator, or guardian, you are termed a “fiduciary” under California law.  The procedure for the investment and handling of assets in the trust, estate, conservatorship, or guardianship is established by California law.  If you, as a fiduciary, fail to correctly carry out your duties, you may be liable for any losses that occur in the investments and for your failure to produce sufficient income and growth in the investments, depending upon market conditions.

How many fiduciaries are aware of their legal responsibilities and obligations?  Probably, very few.

The responsibilities of an executor or administrator, conservator, or guardian are set forth in detail in the California Probate Code.  While assets can be sold, sometimes only with a court order, they generally cannot be purchased without a court order.  This article does not address these responsibilities, only those of a trustee of a living or testamentary trust.

Trusts, generally last for longer periods of time than other fiduciary accounts, and the trustee or trustees who manage the trust are generally given broad authority under the trust document and California law to handle investments and other matters, but are held to a strict standard for their actions.

In undertaking the administration of a trust, a trustee does not have to accept the appointment unless he or she wishes to.  If Uncle Fred dies and you are notified that you are the sole trustee of his living trust, you can decline to serve without having to give any reason.  No one, no matter what he or she has said or written in the past, is obligated to initially take on the job of a trustee.  However, once you agree to serve, or start acting as a trustee, then you become obligated to carry out all of the legal duties of a trustee.  You can, of course, resign at any time, but you are liable for actions taken while serving as trustee, and you must continue in your capacity as trustee until a successor trustee agrees to serve and takes over the duties of the trustee.

References below to “PC” are to the pertinent code sections of the California Probate Code.

If there are two or more trustees acting, then they must act only by “unanimous action” (PC 15620).  All are then jointly liable for the action taken.

Trustee’s areas of responsibility

The responsibilities of a trustee cover a wide range of obligations.  They include:

  1. A number of general duties of all trustees (PC16000-16015).
  2. A standard of care in the administration of the trust (PC 16040-16041).
  3. Investing funds and assets under the California Uniform Prudent Investor Act (PC 16045-16054).
  4. Reporting information and accounting to all trust beneficiaries, usually annually (PC 16060-16064).
  5. Exercising any discretionary powers reasonably (PC 16080-16082).
  6. Keeping detailed records and allocation of all receipts and disbursements under California Uniform Principal and Income Act (PC 16320-16375).

A Trustee who is initially undertaking the administration of a trust should carefully read the trust document (trust agreement or trust declaration), no matter how long, and make notes about the powers and duties of the trustee and payments to be made from the trust.  These should also be discussed with the attorney advising the trustee (the trustee should have an attorney to advise him or her).

General duties of a trustee

The general duties of all trustees are set forth in California Probate Code sections 16000-16015).  These include:

  1. Following provisions in the trust document–particularly if the trust has special provisions for handling certain assets such as a parcel of real property or a private business (PC 16000).
  2. Treating all trust beneficiaries with loyalty and impartiality–not favoring one party over the other and not discussing communications from one beneficiary with another (PC 16002-16003).
  3. Avoiding any conflict of interest with the trust and avoiding any adverse interests–such as buying or selling assets from or to the trust or benefiting personally in any way from trust transactions (PC 16004-16005).
  4. Controlling and preserving trust assets and making the assets productive (PC 16006-16007).
  5. Keeping trust assets segregated and identifiable (PC 16009).
  6. Enforcing any legitimate claims against third parties (PC 16010).
  7. Defending any actions against the trust (PC 16011).
  8. Avoiding improper delegation of the trustee’s responsibilities and duties and supervising performance of any proper agent appointed by the trustee-primarily in the investment area (PC 16012).
  9. If a co-trustee, participating in the administration of a trust and preventing other co-trustees from committing a breach of the trust, or seeking reimbursement if a co-trustee has breached the trust (PC 16013).
  10. To apply any skills the trustee has to the administration of the trust (PC 16014).

Trustee’s standard of care

California Probate Code section 16040 provides that “The trustee shall administer the trust with reasonable care, skill, and caution under the circumstances then prevailing that a prudent person acting in a like capacity would use in the conduct of an enterprise of like character and with like aims to accomplish the purposes of the trust as determined from the trust instrument.”   The standard of care is not affected by the trustee’s fee or lack of fee if the trustee does not choose to take a fee.

This “prudent man rule” means that the courts may later review a trustee’s action upon complaint from a beneficiary and analyze in detail what the trustee did and whether the trustee’s actions were correct.  It is the trustee’s responsibility to prove what he or she did and also to prove that his or her actions were “prudent” under the circumstances.  If the trustee fails to prove this, then the trustee may be liable for damages and forced to financially reimburse the trust for what the court determines is the “loss” involved.

Trustee’s duties regarding investments

California has enacted the Uniform Prudent Investor Act (PC 16045-16054) which sets forth the duties and standards for investing in connection with a trust.  These provisions contain the “standard of care” regarding investments and also the many factors to be considered by the trustee in investing trust assets (PC 16047).

Trustees can legally delegate investment functions to an agent such as a financial planner or stock broker and, if the trustee delegates this responsibility, the trustee is not liable to any trust beneficiary for decisions or actions of the agent (PC  16052).

Trustee’s duties to inform and account to trust beneficiaries

Under California law, the trustee has a duty to keep the beneficiaries of the trust informed as to what is happening in the trust and to account to all beneficiaries annually (PC 16060-16064).

The term “beneficiary” is defined in the Probate Code section 24(c) and refers to “a person who has a present or future interest, vested or contingent.”  Thus, anyone named in a trust document who may inherit in the future must receive legal notification.  If assets are in an irrevocable trust and the trust terminates in the future and goes to children, or if they are deceased to their children, or others, then all of the children, grandchildren, great-grandchildren and any other parties who could possibly inherit must be given notice (but not an accounting–see below).

When a trust becomes irrevocable or there is a change of the trustee of  this trust a specially worded notice must be sent to all trust beneficiaries within 60 days of the date the trust becoming irrevocable (usually the death of the trustor) or 60 days from the date the new trustee takes over the administration of the trust.  In the case of a trust becoming irrevocable, beneficiaries then have a 120 day period from receipt of the notice to contest the trust.  If not contested within 120 days, it cannot later be contested.

The trustee is also obligated to account at least annually, but also upon the termination of a trust and upon the change of trustee, to all trust beneficiaries who are entitled to receive principal and income payments from the trust (PC  16062).  This accounting must contain the following (PC 16063):

  1. A statement of all receipts and disbursements during the past year or since the last accounting.
  2. A statement of assets and liabilities at the end of the accounting period.
  3. A statement of the trustee’s compensation for the last year or since the last accounting.
  4. A statement of any agents hired by the trustee, their relationship to the trustee, and any compensation paid to them.
  5. Statements as to the following:
  6. The recipients may petition the court to obtain a review of the accounting.
  7. Claims for breach of trust may not be brought more than three years after receipt of the accounting.
  8. Any accounting which must be approved by the court must follow a special format.

Trustee’s duties regarding discretionary powers

The trustee must exercise any “discretionary” power with regard to trust decisions in a “reasonable” manner.  Many trust documents state that the trustee has “absolute discretion” with regard to certain matters.  Under California law this discretion is not “absolute” even though the trust wording says so; it still must be exercised in a reasonable manner (PC 16080-16081).

Allocating receipts and disbursements under the Uniform Principal and Income Act

Most trusts contain language that talk about payments from the trust or “income” and “principal.”  Income is defined as what the trust produces such as income, dividends, and net rental income (after deducting rental expenses).  Principal consist of the trust assets and also includes any gains or losses from the sale of these assets.  The Uniform Principal and Income Act (PC  16320-16347) also covers funds receive from other unusual assets such as mineral interests, patent royalties, partnership income, and other receipts.

The trustee is therefore obligated to allocate each item of income and each disbursement to income or principal and basically keep two sets of books covering these accounts.  While these two types of accounts do not have to be physically segregated (they can be kept in one bank account), the trust records must reflect the amount of income and the amount of principal held at any time.

The various code sections go into elaborate detail to list what are income and principal and the treatment of disbursements.  As an example, the payment of trustee’s fees is charged one-half to income and one-half to principal.  The trustee then becomes a bookkeeper to allocate each item received or paid to income or principal, or partially to each.  If not allocated correctly, the trust beneficiary or beneficiaries receive an overpayment or underpayment of their income from the trust.

The trustee can, under certain circumstances, make an adjustment between income and principal if the income received is not, in the trustee’s discretion, sufficient for the investments of the trust.  If the trust is receiving 2% per year for dividends and should be receiving 4% the trustee can make an adjustment.  This adjustment is limited and, in most cases, requires notice to all trust beneficiaries (PC 16336).

In addition to the power to make an adjustment, as stated above, the trustee can convert the trust from an “income” trust to a “unitrust,” where income and principal are legally merged together and the trustee does not have to keep separate records for these two accounts.  The procedure for doing this is extremely involved (PC 16336.4-16336.7) and needs to be discussed with the trustee’s attorney.

Liability of trustee

If the trustee fails to carry out all of the duties listed above the trustee is in breach of the trust.  The trustee can then be removed as trustee or have to pay for all financial losses which have been incurred, or both (PC 16420).

In some cases a co-trustee can be liable for the breach of a trust by another co-trustee and a successor trustee may be liable for a trust breach by the previous trustee (PC 16402-16403).

Financial losses which beneficiaries may claim include: any loss or depreciation in value of trust assets, profit the trustee personally made, any profit that would have accrued to the trust, plus interest, and possibly the legal costs and fees of the beneficiary’s attorneys (PC  16440-16442).

Summary

The above is a somewhat simple explanation of many of the duties and responsibilities which a trustee has in California in the administration of a trust.  While not all inclusive, it covers most of the major areas of concern.  Any trustee of an irrevocable trust should discuss in detail the above with his or her attorney in order to meet the various legal requirements under California law.

Failure to fully comply with the above can make a trustee financially liable even if the trustee acted in good faith and without receiving any compensation for acting as trustee.

©Milton Berry Scott, 2008-2016.