Why she shouldn’t be totally exculpated from liability
There’s little question about the newfound popularity of trust protectors, which they’re undoubtedly enjoying. And why not? They’re entitled to a fee for “services,” even when none are required, and it’s common practice to absolve them from any liability for acting or not acting, regardless of the circumstances. At least that’s what many of the relevant statutes and most trust documents say when protectors are named in lawsuits. Is it that simple?
As many of us are aware, a trust protector can be extremely important in the administration of a trust, allowing for trust amendments, situs change and trustee replacement, all without the need for court proceedings or beneficiary consent.1 But the decision to perform any of these actions can be serious and can materially affect the purpose of the trust and the beneficiaries’ interests. Accordingly, one would think that a hasty, inappropriate or reckless decision would expose the protector to liability, were it not for express provisions in the trust, the local law or both, permitting total exculpation of the protector. For instance, relevant Cook Islands law provides, “a protector of a trust shall not be liable or accountable as a trustee or other person having a fiduciary duty …”2 Similarly, Alaska law specifically declares that:
Subject to the terms of the trust instrument, a trust protector is not liable or accountable as a trustee or fiduciary because of an act or omission of the trust protector taken when performing the function of a trust protector under the trust instrument.3
Let’s take a closer look at just what that means.
If a protector truly is completely and unconditionally exculpated from liability for exercising or not exercising her powers, those powers would have to be regarded as personal powers. Otherwise, the power would be, to some extent, fiduciary, and there would be exposure to a breach of duty claim for acting, failing to act or failing to consider acting.4 If, in fact, the protector’s powers are personal (as opposed to fiduciary), then the protector never has to consider exercising the power, even if a matter critical to the trust’s purposes and the beneficiaries’ interests comes to her attention. She could simply ignore it, with no liability for doing so. Further, if she wished, she could exercise her powers on a whim or even in retaliation against a beneficiary who offended her. And, unlike a fiduciary power, she could release any or all of her personal powers, if she chooses.5 What settlor would want this arrangement in naming an independent protector to watch over her trust and the interests of her beneficiaries? And what motivates attorneys and legislators to act in a manner that clearly allows, if not invites, prejudice to the trust’s purposes and the beneficiaries’ interests?
Origins of Attitude
This attitude towards blanket exculpation of protectors originated with offshore trusts as they became popular as asset protection vehicles in the 1980s and 1990s. To help clients feel more comfortable with moving large amounts of their liquid assets to an irrevocable trust thousands of miles and multiple time zones away, they were offered the option of naming an independent party who could, at any time, terminate the trust and return the clients’ money to them. And, usually, it was not so tacitly suggested that the protector’s decision to terminate the trust (or order a principal distribution) would coincide with the settlor/client’s needs or wishes, which proved a huge comfort factor. To induce the offshore protector to serve as such under a trust for the benefit of individuals about whose lives and circumstances she hadn’t a clue, she would, of course, have to be totally exculpated for anything she did or didn’t do. Realizing this, and the concomitant need to have such a party involved for the comfort of the settlor/client, the offshore jurisdictions enacted laws that exculpated protectors for their actions and inactions, as illustrated above in the language of the Cook Islands statute. Notably, the term “protector” was a new and unique term to U.S. advisors and, at least initially, regarded by most attorneys and many commentators as a creature of the offshore trust. Thus, advisors assumed that the exculpation issue was a requirement of the position. From these hasty assumptions, suggested forms followed that further promulgated the conclusion that the default position, if not the recommended one, ought to be that the protector should not be deemed a fiduciary and, at the same time, should be completely exculpated from liability.6 Few would dispute the powerful effect the printed and suggested form has on the average practicing attorney. Further, and equally unfortunate, total exculpation was actually seen as an advantage (though certainly not for the settlor and beneficiaries). To compound the problem, a number of legislatures of asset protection states also played “follow the leader,” and, in their protector statutes, they repeated the exculpation language to the effect that, unless stated otherwise in the trust, the protector shall not be a fiduciary.7
Protector as Fiduciary
Anyone taking a sensible look at the purposes and objectives in naming a protector in the typical trust—onshore or offshore—would have to conclude that it’s not a whimsical or irresponsible position given on a personal basis, but, rather, should carry with it a duty to act in the best interests of the trust and the beneficiaries. Except when a beneficiary or an immediate family member is named protector, who would argue that the power to change trust situs, approve distributions or approve accounts wasn’t one that required the care, diligence and loyalty that one would expect from a fiduciary?
It’s significant that most, if not all, of the major commentators leave open the question of the protector being a fiduciary, as it would be foolhardy to state conclusively that all protectors are fiduciaries. Thus, they argue both ways, which is fine if you live in that wonderful land called Academia. Unfortunately, their erudite arguments on both sides of the issue fail to reflect the real world of trust administration as it relates to protectors. Surely, there are cases in which the protector isn’t a fiduciary, but those are the overwhelming minority. To rest one’s argument on the trust language, for example, is a huge oversight, because, as noted earlier, many drafters simply follow forms and state that the trust protector isn’t a fiduciary. But here’s a tip: Why not ask the settlor directly? And consider this: Settlors don’t draft their own trusts! We drafters can easily resolve this seemingly troublesome issue. If the settlor is relying on the protector to use good judgment and exercise her powers in the best interests of the trust and the beneficiaries, why would we act contrary to the settlor’s objectives by giving the protector a personal power with no duty to act or even consider acting?
What we also must consider is the possible effect of total exculpation, both in the document and under an applicable statute, which, in turn, often exculpates the trustee for following the directions of the protector.8 For example, say that a settlor establishes a trust for the benefit of her children, naming her accountant as protector. The trust expressly states that the protector isn’t a fiduciary and exculpates the protector from any liability. There’s also a local statute that says that unless otherwise provided in the trust, the protector shall not be a fiduciary. In addition, the local statute provides that the trustee shall not be liable for acting as directed by the protector. The protector/accountant is given the power to remove the trustee and to direct the trustee with respect to investments. The trust is funded with diversified investments and cash. The protector/accountant’s CPA firm represents a small technology company in need of cash, without which it may have to terminate, or at least suspend, the CPA firm’s services. Otherwise, the technology company is doing reasonably well, but still considered a start-up. The protector/accountant directs the trustee to invest $100,000, about 10 percent of the trust corpus, into shares of the small company. The company continues with the CPA firm, but after about 12 months, business suddenly dries up, the company is forced to enter bankruptcy and the entire $100,000 trust investment is lost. Is there any liability on the part of the protector? The trustee? Or, because of the terms of the trust and the law, do we have a situation in which neither is liable? Does anyone care about the beneficiaries?
First, in dealing with the question of the trustee’s liability, the trustee would deny any liability on the basis that the responsibility was taken away by the local statute and the grant of investment power to the protector. We would argue that, even so, it didn’t mean the trustee should buy the Brooklyn Bridge if the protector so directed. There was a clear breach of duty—the trustee should have known of the protector’s personal interest in the company. The trustee would respond again, noting the absence of any investment responsibility on the trustee’s part and, at the time of the investment, the company was in acceptable financial health and that we should look to the protector as the responsible party. There is at least some case law and commentary on this and, in the absence of a clear breach of fiduciary duty, when the trustee’s duty of investment has been granted to another advisor, the trustee won’t be held liable for the advisor’s poor judgment.9 In all of the applicable cases, however, the investment advisor (that is, the protector) was regarded as a fiduciary and exposed to liability for breach of fiduciary duty.10 So, what do we do when the advisor (protector) is exculpated not only by the settlor, but also under applicable law?
If we examine this question at face value, we would have to conclude that the protector/accountant in our hypothetical has no liability. And she would as well argue that both the trust language and applicable law made her power a personal power, and therefore she is without liability. We would argue (solely in response to that position) that because she has a personal interest in and benefitted from the exercise, this was a fraud on the power,11 and liability should attach to it. She would then respond that there’s nothing in the trust or the law that says she can’t indirectly benefit from exercising that power and so, once again, we have no recourse.
Now for the million (or rather the 100,000) dollar question: Despite the language in the trust and in the local statute exculpating the protector, can we argue that the very nature of the powers granted to the protector is inherently fiduciary, and they can no more be drafted or legislated away than could the trustee’s fiduciary duty? Considering the clear responsibility of the protector to act in the best interests of the beneficiaries and with absolute loyalty, would a court nevertheless reject outright this well-established relationship and simply declare that the protector here had no such responsibility and no liability because of the provisions of the trust and local law? Isn’t it more likely that the settlor’s intentions, which would be the controlling factor, would be interpreted to be that such behavior on the protector’s part would be unacceptable? I firmly believe that if a court were confronted with a case in which an independent protector, appointed by the settlor for the purpose of protecting the trust and having powers that can materially affect the administration of the trust, applies such powers inappropriately and against the trust’s purposes and the beneficiaries’ interests, a court would be forced to recognize the breach of fiduciary duty. In doing so, the court would also declare that the trust language and the statute totally exculpating the protector in such a case are void as against public policy. Unfortunately, no court has been faced with this dilemma, so we can’t point to any formal support to that position, except for the concept embodied in the well-established rule that a trustee can’t be totally exculpated from liability; otherwise, there would be no trust.12
Despite the foregoing argument and the lack, to date, of any U.S. precedent on the issue, what effect should we give to the settlor’s true intentions? Would anyone argue or believe that on executing the trust, the settlor was truly aware or advised of the fact that the person she put in charge of trust investments could do anything that person chose, without regard to reasonableness, sound judgment or loss of trust funds? Obviously not. The problem here lies not necessarily with the law or the trust provisions, but with the advisor who blindly follows suggested forms and with the legislatures of particular states, who blindly followed the offshore statutes exculpating protectors. This isn’t to say that the liability of protectors, advisors or even trustees, can’t be limited,13 but it is to say that protectors and advisors, unless the powers are truly intended by the settlor to be personal, can’t be totally exculpated from liability, nor would any sensible settlor agree to do so. Those of us familiar with trusts are equally familiar with language such as, “the trustee shall only be liable for any action or inaction in serving hereunder if the same are found to be the result of gross negligence, fraud, or willful misconduct.”14 Similar language can be used to limit a protector’s exposure to liability. Thus, for practical purposes, we can come very close to what some drafters and legislators seem to seek in the way of exculpating a protector, but in my opinion, with the narrow exception of a truly personal power noted earlier, we cannot and should not try to exculpate them entirely.
1. See Alexander A. Bove, Jr., “The Trust Protector: Trust(y) Watchdog or Expensive Exotic Pet?” 30 Est. Plan. 390 (2003).
2. Cook Islands International Trusts Amendment Act 1989, Part IV, Section 20.
3. Alaska Statute Section 13.36.370(d) (2011).
4. Austin W. Scott, et al., Scott and Ascher on Trusts (5th ed. 2007), Section 185, at p. 566.
6. Charles D. Fox IV and Thomas W. Abendroth (eds.), Estate Planning Strategies After Estate Tax Reform (Commerce Clearing House 2001), at pp. 135-136, par. 10080.05, Section E.
7. See, e.g., supra note 3 and S.D. Cod. Laws 55-1(B)-1(2) (Michie 1997, 2006).
8. Idaho Code Section 17–7–501(1)(a) (2003); S.D. Cod. Laws, ibid.
10. Scott, supra note 4.
11. Alexander A. Bove, Jr., “Using The Power of Appointment to Protect Assets —More Power Than You Ever Imagined,” 36 ACTEC L.J. 333, 340 (2010).
12. Armitage v. Nurse (1998) Ch. 241 (C.A.).
13. See, e.g., Charles E. Rounds, Loring: A Trustee’s Handbook, Sec-tion 7.2.6 (2012 ed.).
14. Ibid. at p. 711: “No matter how broad the provision, the trustee is liable for committing a breach of trust in bad faith or with reckless indifference to the interests of the beneficiaries.”