Trustee's Duties Upon Trust Termination
Last week in The Estate of Phillis Worrall v. J.P. Morgan, the Kentucky Supreme Court addressed the issue of a trustee withholding trust distribution pending the beneficiary’s indemnification of the trustee. The Kentucky Supreme Court said a trustee must move reasonably and expediently to distribute the trust’s corpus upon termination and may not delay the distribution to entice the beneficiary’s signature on an indemnification agreement. The Court held Kentucky’s Uniform Trust Code specifically bars this type of conduct, and the delay was a breach of J.P. Morgan’s fiduciary duties to the beneficiary.
Upon the death of James Thompson in 1958, his will created a trust for the benefit of his daughter Phillis Worrall (nee Thompson). J.P. Morgan Bank served as the corporate trustee. The Trust held specific securities, and the trustee had the discretion to use the security to make payments to Phillis. The Worrall Trust specified that it terminated upon Phillis’ death and directed the trustee that “said shares of stock shall in that event be paid over to her estate.”
Phillis Worrall died in 2018. Her son, James Worrall, was the sole beneficiary of Phillis’s estate and was appointed executor. J.P. Morgan requested James sign an indemnification of J.P. Morgan for any actions it took as trustee before closing out the trust and transferring the assets to Phillis Worrall’s estate. J.P. Morgan emphasized that signing would permit the Bank to move forward much more expediently and avoid the expense and formality of a court action.
James refused, and over the next year, J.P. Morgan sought court permission three times to liquidate the Trust assets and pay the proceeds to the Court. The Bank argued to the District Court that the liquidation, attendant payment of trustee’s and attorney’s fees, and release of the trustee was necessitated by James’s “repeated refus[al] to sign a receipt and release as required by the [Bank] to liquidate and transfer the assets to the Executor.”
James countered that he was unwilling to indemnify the Bank without knowing what actions the Bank took while the trustee, and he did not want the trust liquidated but rather transferred in-kind as directed in the trust. The District Court sided with the Bank and signed the Bank’s tendered order permitting it to liquidate the Trust’s assets, pay trustee’s and attorney’s fees, and transfer the remaining balance to the Court.
The Court of Appeals affirmed the District Court, and the Kentucky Supreme Court granted James Worral’s request for review.
Kentucky Supreme Court Opinion
The Kentucky Supreme Court relied on a plain reading of KRS 386B.8-170, Distribution Upon Termination (part of Kentucky’s Uniform Trust Code) to find that the District Court erred in adopting the Bank’s tendered order. KRS 386B.8-170 reads in its entirety:
1) Upon termination or partial termination of a trust, the trustee may send to the beneficiaries a proposal for distribution. The right of any beneficiary to object to the proposed distribution terminates if the beneficiary does not notify the trustee of an objection within thirty (30) days after the proposal was sent, but only if the proposal informed the beneficiary of the right to object and of the time allowed for objection.
(2) Upon the occurrence of an event terminating or partially terminating a trust, the trustee shall proceed expeditiously to distribute the trust property to the persons entitled to it, subject to the right of the trustee to retain a reasonable reserve for the payment of debts, expenses, and taxes.
(3) A release by a beneficiary of a trustee from liability for breach of trust is invalid to the extent:
(a) It was induced by improper conduct of the trustee; or
(b) The beneficiary, at the time of the release, did not know of the beneficiary’s rights or of the material facts relating to the breach.
The Supreme Court said J.P. Morgan failed to adequately argue its distribution notice met the standards of paragraph (1). Specifically, the Court said there was no evidence that it included the required notice to James of his right to object or the requisite thirty (30) day time limit. Therefore, the Bank could not distribute the trust according to the terms they outlined in the distribution proposal, which formed the basis of their tendered order.
The Court said paragraph (2) provided the basis for distribution which required the Bank to move “expeditiously to distribute the trust property.” Under a distribution according to paragraph (2), when a beneficiary objects to the proposed distribution, KRS 386B.8-180, Duties Of Trustee Upon Termination Or Removal outlines the information owed to the beneficiaries and the court. This information includes, but is not limited to, the fair market value (FMV) of the assets to be distributed and a five-year trust accounting. Furthermore, KRS 386B.8-180(5) specifically says that a trustee may not request that beneficiaries indemnify the trustee in exchange for its foregoing court approval of its accounts and distribution.
In this case, J.P. Morgan delayed distribution for more than a year, attempting to induce James to indemnify the Bank. A fact explicitly stated in the Bank’s letters to James. Once J.P. Morgan did move forward with the distribution action, James objected to its proposed method of distribution, which required the liquidation of all the trust assets and the resulting tax consequences. Furthermore, in terminating the trust, the Bank failed to fulfill the information requirements of KRS 356B.8-180. The Court said the District Court erred in approving the Bank’s motion and approving the Bank’s distribution method.
The Court also found J.P. Morgan breached its fiduciary duty to the trust beneficiaries in the manner of the trust’s termination. The terms of the Trust specifically called for “said shares of stock shall in that event to be paid over to [the] estate.” The Court said that while Trustees have powers to sell or exchange trust assets, where the beneficiaries desire to receive the assets of a trust in-kind the trustee should honor the request unless there are good reasons to deny the request. (citing Lucas v. Mannering, 745 S.W.2d 654 (Ky. App. 1987)). The Court found the trustee’s actions were “punitive and vindictive” in response to what the Bank viewed as James’s “unreasonable” desire to deny indemnification.
Having reversed the District Court and Court of Appeals, the Court remanded the case to the District Court to determine James’s damages. The Court stated in addition to a proper trust accounting, James was possibly entitled to financial damages, including reimbursement of capital gains taxes, reimbursement of trustee and attorney fees for 2019, reimbursement of commissions paid by the trust for liquidation of the securities, James’s attorney fees, and the value of any appreciation of the securities between the time of liquidation and the Court’s opinion.
What’s this Mean to You?
If you are a Beneficiary, you are entitled to an accounting. It may make sense to work with a trustee to terminate the trust informally, but it should be a red flag if the trustee insists on indemnification to pursue the more informal processes. Either way, you should not sign an indemnification unless you are satisfied there was nothing to indemnify, and without a proper accounting, that is difficult.
If you are a Trustee, it may seem self-evident, but you have fiduciary duties to the trust beneficiaries until you are relieved. While you can request beneficiaries indemnify you, statutes preclude you from making any of your actions contingent upon getting that indemnification. The start of trust termination does not transform your relationship with the beneficiaries into an adversarial one. Any actions you take in wrapping up the trust must be with an eye to the beneficiaries’ best interest, including the tax consequences of your actions.