The COVID-19 pandemic has idled workers and the coming weeks will bring more news of business closures and bankruptcies. After a decade of sustained growth, we are facing a recession of uncertain depth and duration. The New York Times recently reported that some Americans are turning (or perhaps returning) to “financial therapy” for support.
In the trust and estate world, how dark are the approaching storm clouds? More specifically, how might the economic downturn cause California trust and estate litigation? From this blogger’s perspective, claims are likely to increase as a result of declining asset values, growing demands for trust distributions, and anxiety associated with economic insecurity. As always, however, allegations are easier to make than to prove.
Falling Markets May Reveal Imprudent Asset Management
Just as a rising tide lifts all boats, broad economic growth helps trustees who are managing assets. An undiversified asset portfolio may rise if all sectors are rising. Benign neglect in asset management may not cause harm or concern when times are good.
A downturn, on the other hand, is likely to have disparate impacts. Consider two examples.
If Dad (a former pilot) was loyal to airline company stocks, and Daughter now manages that same group stocks as his successor trustee, the portfolio likely was flying high until February 2020, but US airline stocks have now lost over half their value.
If Mom held a Northern California shopping center and residential rental properties in her trust, and Son became trustee a few years ago, the portfolio may experience sharply reduced income in the short term with long term effects hard to fathom.
The beneficiaries of such trusts, often siblings and other relatives of the trustee, may worry about the losses and blame the trustee for not doing enough to prevent them.
Under California’s version of the Uniform Prudent Investor Act, trustees have a duty to manage trust assets in accord with the “prudent investor rule.”
Probate Code section 16047 explains that a trustee shall invest and manage assets as would a prudent investor “by considering the purposes, terms, distribution requirements and other circumstances of the trust.” The trustee’s handling of individual assets and courses of action “must not be viewed in isolation, but in the context of the trust portfolio as a whole and as part of an overall investment strategy having risk and return objectives reasonably suited to the trust.”
As to diversification, Probate Code section 16048 provides that the trustee has a duty to diversify trust investments when making investment decisions unless it is not prudent to do so.
Importantly, the person who creates a trust (known variously as the settlor, grantor or trustor) may include provisions in the trust instrument that excuse the trustee from complying with all aspects of the prudent investor rule. Trust documents often do allow successor trustees to retain the assets they receive, thus relaxing the general duty to diversify. Returning to the above example, if Dad wrote into the trust instrument that his successor trustee could hold onto the airline stocks, Daughter may be protected from sibling claims that she should have better diversified the portfolio.
Diligent trustees who followed the prudent investor rule before the downturn are better positioned to weather the economic storm, but all trustees should exercise reasonable care, skill and caution as they manage assets in these turbulent times, seeking out professional advice where appropriate.
While beneficiaries may be inclined to fault the trustee for not seeing an economic downturn coming, trustees may draw comfort from Probate Code section 16051, which states that compliance with the prudent investor rule “is determined in light of the facts and circumstances existing at the time of a trustee’s decision or action and not by hindsight.”
Whether a trustee failed to meet the standard of care under prudent investor rule will turn on the unique circumstances of each situation. Concerned beneficiaries should consult with their own legal counsel to assess the viability of potential claims.
Requests for Discretionary Income and Principal Distributions May Increase
Many trusts provide that beneficiaries are entitled to distributions of trust income and/or principal as needed for their health, education, maintenance and support – often referenced as the “HEMS” standard.
In an economic downturn, beneficiaries may find it more difficult to support themselves, leading them to request increased distributions from the trustee. At the same time, the trustee may project decreased income from the assets in the trust’s portfolio.
As a fiduciary with a duties of loyalty and impartiality, the trustee will need to consider discretionary distribution requests carefully with all terms of the trust in mind. The needs of current beneficiaries may require balancing with rights of future beneficiaries.
The trustee may not have as broad discretion in making distributions as the trust instrument indicates. Probate Code section 16081 states that even a trustee with “absolute” discretion under the trust instrument “shall act in accord with fiduciary principles” and not in “bad faith or in disregard of the purposes of the trust.” A trustee who can make discretionary distributions to himself or herself still must act reasonably.
Family Members May Be More “Grabby” as Wealth Shrinks
When a watering hole dries up, animals may clash as they compete for what remains. Similarly, with job losses and furloughs, and shrinkage in retirement account values, family members may be more assertive in competing for resources.
Children who have no rights to trust distributions may ask for money from aging parents, setting the stage for later disputes about whether it was a loan or a gift. A child who takes the lead role in caring for Mom or Dad while the other siblings live far away may advocate for a larger share of the trust assets upon the parent’s passing. Such advocacy potentially could rise to the level of undue influence.
When the surviving parent has passed, children may be more motivated to pursue will and trust contests, and/or financial elder abuse claims. For example, Johnny may have been distant from Mom over the past decade, but if he is fretting about his own resources he may be more inclined to contest the trust amendment that favored his sister Claire. Of course, unless Johnny can find counsel who will take his case on a contingency basis, he will need cash to file and pursue a contest at a time when he may be more reluctant to spend down his resources.