ESSAY 4 Testator Bequeathed Her Residuary Estate “To Trustee, As Trustee,” on the Following Terms

ESSAY 4 Testator bequeathed her residuary estate “to Trustee, as trustee,” on the following terms:

I direct Trustee to distribute the income from the trust to my son, Adam, until he reaches the age of 30. In addition, I authorize Trustee to invade the principal of the trust if, in its absolute discretion, it deems it necessary to provide for Adam’s education. At Adam’s 30th birthday, I direct Trustee to terminate the trust and to distribute the trust principal equally between my two children, Adam and Betsy.

When Testator executed her will, her estate was large enough so that her residuary estate would have been valued at $800,000. However, business reverses during the two years between execution of the will and Testator’s death reduced the value of the residuary estate to $300,000. Testator died last year survived by her husband, Husband, by their son, Adam, and by Betsy, Testator’s daughter from a prior marriage.

Adam is currently 23 years old, has no assets other than the interest in the trust, and has just entered dental school.

Husband has an annual income of $80,000 and assets of $400,000. Last month, Husband loaned Adam $25,000 to pay tuition at dental school.

The trust income is currently $18,000 per year, which Adam uses to pay for rent and food. Adam now asks Trustee to invade the trust principal to permit Adam to purchase a $50,000 automobile and to repay the $25,000 tuition loan from Husband.

1. Should Trustee invade the trust principal to enable Adam to purchase the automobile? Explain.

2. Can Trustee refuse to invade the trust principal to enable Adam to repay the loan he received from Husband? Explain.

3. If Trustee distributes trust principal to Adam to enable him to purchase the automobile, what are the rights and liabilities of Trustee, Adam, and Betsy? Explain.

TRUSTS AND FUTURE INTERESTS ANALYSIS (Trusts and Future Interests I.F)

ANALYSIS

Legal Problems:

(1) Should Trustee invade trust principal for the purpose of enabling Adam to purchase an automobile?

(2) Can Trustee refuse to invade trust principal to enable Adam to repay a loan to Husband incurred to permit Adam to continue his education?

(3) If Trustee invades principal improperly on Adam’s behalf, does Trustee or Adam bear personal liability for the improper invasion?

DISCUSSION

Point One (20-30%) Trustee should not invade trust principal for the purpose of permitting Adam to purchase a $50.000 automobile.

In general, unless the trust instrument authorizes the trustee to invade trust principal, an income beneficiary is entitled only to trust income. See Restatement (Second) of Trusts § 128 comment i. While in some cases a power of invasion can be implied, here Testator demonstrated that she knew how to create a power of invasion, since she expressly created one to provide for Adam’s education. The inference is strong that she did not intend to confer on Trustee any other power of invasion for Adam’s benefit. Trustee should refuse to make the distribution from principal without a court order because the trust does not expressly permit the requested $50,000 distribution and, therefore, the distribution without a court order would be a breach of trust.

However, when the income beneficiary will ultimately receive the trust principal, as here, a court may permit the trustee to invade principal to assist the income beneficiary, unless an invasion of trust principal would be inconsistent with the testator’s express directions in creating the trust. Restatement (Second) of Trusts § 168. If Adam were the only trust beneficiary, a court might authorize Trustee to invade principal to permit Adam to purchase the automobile. Of course, that is not the case here.

A court might also permit an invasion due to a significant change in circumstances since the execution of Testator’s will. Cf. Restatement (Second) of Trusts § 167(1). For example, when Testator executed the will, she undoubtedly believed that the trust income (possibly $48,000 annually assuming a 6% interest rate) would have been adequate to meet Adam’s needs until Adam reached the age of 30. Testator’s business misfortunes significantly reduced her expectation that Adam would receive such amount.

The problem, however, is that an invasion of principal to pay for the automobile when not specifically authorized would adversely affect the interests of the other beneficiary, Betsy. Accordingly, a court should not authorize invasion absent express language in the trust instrument or Betsy’s consent. See Restatement (Second) of Trusts § 168 comment d, illus. 4.

Although Adam might argue that any depletion in principal could be subtracted from Adam’s own share of the remainder, that argument is not plausible in light of Trustee’s power to invade principal for Adam’s education. That is, since Trustee has the express power to invade principal for Adam’s education, Adam’s share of the principal when the trust terminates may be too small to cover the cost of the car. As a result, invasion would threaten the interest of Betsy, and hence would be unjustified.

Adam might argue that buying a car helps to further his education, particularly if a car is necessary to permit Adam to go to and from school. While there may be some merit to that argument, it would not warrant a $50,000 invasion.

Point Two (35-45%) Because Trustee was granted absolute discretion to determine whether to invade trust principal to provide for Adam’s education, Trustee need not invade the principal to permit Adam to repay the loan to Husband, and Trustee’s failure to do so would not be an abuse of discretion. On the other hand, Trustee would not be violating the terms of the trust should Trustee decide to invade the corpus to permit Adam to repay the education loan to Husband.

When a testator confers discretion (or absolute discretion) on a trustee to make or withhold distributions, courts do not compel trustees to exercise that discretion unless the trustee’s failure constitutes an abuse of discretion. See Restatement (Second) of Trusts § 187; Bogert, Trusts and Trustees § 560; see also Gulf National Bank v. Sturtevant, 511 So. 2d 936 (Miss. 1987); Restatement (Second) of Trusts § 187; Dunkley v. Peoples Bank & Trust Co., 728 F. Supp. 547 (W.D. Ark 1989). Likewise, courts do not enjoin trustees from exercising such power unless an exercise of the power would be an abuse of discretion. See Restatement (Second) of Trusts § 187; Dunkley, 728 F. Supp. 547. The question here is whether Trustee would be abusing its discretion by paying, or by refusing to pay, for Adam’s tuition. The facts do not warrant that conclusion. Therefore, Adam cannot compel Trustee to distribute principal to him.

Because the trust instrument provides a standard by which Trustee’s conduct may be judged— are funds necessary for Adam’s education—a court “will control the trustee in the exercise of a power where he acts beyond the bounds of a reasonable judgment.” Restatement (Second) of Trusts § 187 comment i. If, contrary to the actual facts, Adam had been without other funds to pursue an education, Trustee would likely have been obligated to invade the trust principal to provide Adam with assistance, absent some strong argument that even then an invasion would be inadvisable. See Restatement (Second) of Trusts § 187 comment i, illus. 11. Here, however, Adam’s father, Husband, had assets and actually advanced Adam a loan to pay for Adam’s tuition. These facts should permit Trustee to argue, if it chose not to invade principal, that it was exercising its discretion reasonably because Adam’s educational expenses had been met by the

loan from his father and thus Adam’s need was fulfilled, and the fact that ultimately a beneficiary, in addition to Adam, would be entitled to some share of the trust principal.

Courts generally presume that a testator intended the beneficiary to receive support or education from the trust, regardless of other sources of support, unless the trust instrument otherwise provides. See Restatement (Second) of Trusts § 128 comment e; Godfrey v. Chandley, 248 Kan. 975,811 P.2d 1248 (1991). Moreover, since Adam has reached the age of majority, Husband was under no legal obligation to provide for Adam’s education. Therefore, Adam could argue that Trustee would be abusing its discretion if it did not invade principal to repay Husband. However, this argument does not seem compelling.

Point Three (30-40%) If Trustee wrongfully invades the trust principal, without court approval, to pay Adam money to purchase the automobile, Trustee is personally liable to Betsy, but it will be entitled to indemnity from Adam unless Adam has detrimentally relied on the wrongful payment. Trustee might also be removed as trustee for this breach of the trust. Adam, a participant in the breach, would also be liable to Betsv.

When a trustee abuses discretion and makes excessive payments to a beneficiary or distributes the trust property to a beneficiary in breach of the terms of the trust, the trustee is liable for the resulting loss to the trust and other beneficiaries. See Dunkley v. Peoples Bank & Trust Co., 728 F. Supp. 547 (W.D. Ark. 1989); Austin v. U.S. Bank of Washington, 73 Wash. App. 293,869 P.2d 404 (1994). Here, if Trustee paid Adam money to purchase a car, such payment would be inconsistent with the terms limiting principal invasions only for education, and Trustee would be liable to reimburse the trust for resulting losses.

At the same time, however, when a trustee overpays one of the beneficiaries, the trustee is entitled to recover the overpayment, unless the beneficiary has so changed his position that it would be inequitable to require repayment. Restatement (Second) of Trusts § 254; Dunkley v. Peoples Bank, 728 F. Supp. 547. If Adam had already spent the money advanced, and if it were impractical to recover the money from Adam, Trustee would be entitled to subject Adam’s own remainder interest to a charge in the amount of the overpayment, thus effectively reimbursing Betsy for any losses she would otherwise have suffered. Restatement (Second) of Trusts § 254.

If Trustee’s unjustified payments to Adam reduced Adam’s share of the principal to such a degree that reimbursement from Adam’s share would not make Betsy whole, she would be entitled to recover from Trustee personally. Moreover, if a trustee breaches the terms of a trust, another remedy is the trustee’s removal from office. That remedy is more likely to occur where the trustee personally benefits from the breach, which did not occur in this case. Thus, it is unlikely that Betsy could successfully seek Trustee’s removal.

When a beneficiary is unjustly enriched by a trustee’s breach of trust, the beneficiary can be liable to the other beneficiary for any loss he or she sustains. Thus, Adam would also be liable to Betsy if neither Trustee nor the trust assets satisfied her claim for breach of trust. Bogert, Trusts § 167.