At the Sacramento Estate Planning Council’s 2016 Technical Forum on Tuesday an elderly gentleman sitting next to me said “old accountants never die, they just lose their balance” and “old attorneys just lose their appeal(s).” Sometimes both happen when an unbalanced accounting results in a lost appeal. The California Court of Appeal issued a rare decision on January 6, 2016 concerning trust accountings, finding in Gray v. Jewish Federation of Palm Springs and Desert Area that Probate Code section 16373 allows a trustee to rob Peter to pay Paul (as long as Peter gets his money back eventually).
Just the Facts, Jack
Laura Gray (“Gray”) was the sole income beneficiary of her friend Ed Cantor’s Trust. Cantor set up a Net Income Charitable Remainder UniTrust (“NICRUT”), which annually paid Gray the Trust’s net income and at her death would pay the remainder to three charities. Cantor would have received income tax, gift tax and/or estate tax deductions from the arrangement. But in these sorts of situations there is an inherent conflict between the lifetime income beneficiary and the charitable remainder beneficiary as to who bears which financial obligations related to the trust property.
The main charitable beneficiary of Cantor’s Trust was the Jewish Federation of Palm Springs and the Desert Area (“Jewish Federation”). The primary asset of the Trust was a piece of commercial rental property in Las Vegas. Gray was a trustee of the Trust along with a rotating cast of co-trustees.
In 2007, the trustees prepared an accounting to which the Jewish Federation objected based on the allocation of certain disbursements between income and principal. Over the course of the next three-or-so years the trustees filed seven amended accountings in response to repeated objections. At some point a petition was filed by Gray that the probate court called “bogus,” there was an appeal, more amendments to the accounting were prepared, and then there was another trial. This appellate decision arises from that second trial, which the Court of Appeal seems to have viewed as little more than finger pointing: the attorneys blamed the accountants who blamed the trustees who blamed the attorneys.
At the end of trial, Riverside County Judge James Cox said that in 16 years he had “seen few trust accounting proceedings wherein the trustees have so obstinately refused to address the sustained objections to the filed accounts…” Although the judge approved the seventh amended accounting, he ordered Gray to pay $14,000 in damages related to the faulty accounting, $28,000 for a portion of the Jewish Federation’s attorneys’ fees, and $12,500 in trustee fee reimbursement.
Coaching Point: The Court held the trustees to task for their failure to act in accordance with their duties under the Probate Code. A trustee has a serious job to do and must not take the job lightly. This is true even if the trustee does not have a financial or legal background. The Probate Code requires even inexperienced family trustees to hold themselves to a fiduciary standard. If you become a trustee, you should be sure to keep detailed financial records and document the time and effort you spend fulfilling your duties.
The Precedential Impact
The only reported part of the decision, and thus the only part that has any bearing on future probate cases, concerned a hyper-technical interpretation of California Probate Code section 16373, which concerns the allocation of trust distributions between principal and income.
The statute would put any non-CPA quickly into a state of extended slumber, but it generally says that a trustee may make a substantial payment from principal for an expense that should properly be attributable to income as long as the trustee transfers future income to reimburse principal. For example, if the trustee has to pay a significant broker commission in year one of a lease, the trustee can pay that up-front commission from principal, provided that the trustee subsequently applies income to reimburse the principal.
In Gray, the lifetime beneficiary, who of course has an interest in maximizing her income, claimed that leasehold improvements, broker commissions, and capital improvements should have been charged to principal instead of income. The Court disagreed and ordered that the amount paid from principal be reimbursed from income.
Coaching Point: Probate Code section 16370 describes items to be paid from income, Probate Code section 16371 describes items to be paid from principal, and Probate Code section 16373 allows a trustee make large, upfront payments from principal as long as an appropriate amount of income is repaid over time. The accounting side of trusts can be complicated, and trustees without accounting expertise should retain an accountant well versed in trust accountings. When there are competing beneficiaries, the accounting will be under a microscope.
The Unpublished Portion
While the Court only designated its discussion of income vs. principal for publication, parts of the unpublished portion are interesting:
- The trial court required Gray to pay $28,000 for bad faith and unreasonable responses to Jewish Federation’s objections to accountings. Per Probate Code section 17211(b), if a beneficiary or a trustee acts in bad faith and without reasonable cause related to an objection to an accounting, the Court may require the bad actor to pay its adversary’s fees. Among other things, Gray failed to produce paper duplicate records that she had in her garage after telling the Court she could not produce any records because her computer had crashed.
Coaching Point: This is not 1993 and computer operating systems are more stable than before. Plus, hardly anything really goes away when you delete it or have computer trouble. A forensic computer expert can often find it. Don’t expect the crashing computer excuse to get you too far in hotly contested litigation, especially if you have paper copies of everything in your garage!
- The Court of Appeal also upheld a denial of Gray’s trustee fees under California Rule of Court, rule 7.776. The trial court found that the trustee had been so “deficient, improper, in breach of her duty of impartiality, and outrageous delays of performance of her duties” that she was entitled to zero, zilch, nada, nothing in trustee fees. The Court of Appeal ruled that it was in the discretion of the trial court to completely strip the trustee of any fees.
Coaching Point: Per my January 4, 2016 post, trustee fees are often a hotly contested issue in trust and estate disputes, and the court may stiff a trustee who falls down on the job.