HOW TO PROTECT YOURSELF AGAINST CLAIMS OF SELF-DEALING AS A TRUSTEE
WHAT IS SELF-DEALING IN TRUST ADMINISTRATION?
A trustee usually has some discretion in their management of a trust’s assets (accounts, money, and property). At the same time, as a fiduciary, they also must act in the best interests of the trust’s beneficiaries. Trustees are prohibited from self-dealing. In the simplest terms, self-dealing happens when a trustee uses the trust’s assets for their own benefit instead of for the beneficiaries’ benefit. Despite this simple definition, self-dealing can be much harder to identify in practice and is often done in ignorance. Self-dealing is especially common when the trustee is also a beneficiary.
Some common examples of self-dealing are a trustee
● making gifts to themselves from the trust’s assets;
● borrowing money from the trust;
● using trust assets to invest in their own business;
● investing in high-risk investments for their own benefit;
● selling property to, or buying property from, the trust;
● mixing the trust’s assets with their personal assets;
● paying themselves more than a reasonable amount of compensation;
● receiving kickbacks from a third party compensated from the trust’s assets; and
● when also a beneficiary, making a distribution to themselves but not to any other beneficiary, or making a larger distribution to themselves than to any other beneficiary.
EXAMPLES OF INNOCENT SELF-DEALING
Let us look at some real-life scenarios that demonstrate how a trustee may engage in self-dealing without even realizing it.
Example 1. Tom is the eldest son of Dad and Mom. Over the years, Tom has proven himself to be hard-working and reliable and has assumed most of the responsibility for running the family business. Not surprisingly, Dad and Mom select Tom as the trustee of their trust, with Tom and Tom’s three siblings as beneficiaries. Before Dad’s death, he instructs Tom that the trust’s assets are available for Tom to use so long as, in the end, all the beneficiaries (Tom and his three siblings) receive equal shares from the trust. After Dad’s death, Tom spends many hours doing trust administration tasks and does not take one cent of compensation from the trust, even though he is entitled by law to reasonable compensation for his time.
Then, Tom and his brother decide to buy a yacht together. Unfortunately, neither one of them have enough money in the bank to buy the yacht. Tom loans trust money to himself and his brother to buy the yacht but does not make a similar loan to either of his sisters. Is this self-dealing?
Example 2. Tom from Example 1 wants to expand the family business. Tom, his brother, and one of his sisters own equal one-third shares of the company. Tom’s other sister has no ownership in the company but is a paid employee. Tom uses trust money to fund the business expansion plans. Is this self-dealing?
Example 3. Sue, a successful physician, and her two brothers are the beneficiaries of a family trust. Sue is the trustee. The trust owns a lake house that Sue’s parents purchased when she and her brothers were young. Unfortunately, the trust cannot afford to pay the mortgage and property taxes to keep the lakefront home, and neither of Sue’s brothers can afford even a one-third share of the amount needed. Sue knows that the home must be sold, but she cannot bear to part with the property that represents so many happy childhood memories. Sue decides that she will buy the vacation home from the trust at fair market value. Is this self-dealing?
HOW DO I AVOID A CLAIM OF SELF-DEALING?
As these examples demonstrate, there is not always a clear-cut answer to whether a trustee is engaging in self-dealing. An inexperienced trustee may not even realize that they are breaching their fiduciary duties. This is why it's important to consult a trust attorney for guidance. If you're not ready to talk to an attorney, there are a few safe harbor rules that you can follow to ensure that you won't be accused of self-dealing and get sued.
First, a trustee can engage in an action that might otherwise be categorized as self-dealing if the trust agreement authorizes it. So in Example 1 above, if Dad had wanted Tom to use the trust’s assets in any way Tom saw fit, as long as in the end all beneficiaries received equal shares, Dad should have made sure that instruction written down in the trust instrument. Oral instruction does not count.
Second, a trustee can seek the approval of the trust beneficiaries for any action or inaction. If, after all the facts are stated, the beneficiaries consent to the trustee’s action, the trustee will not be guilty of self-dealing. So in Examples 2 and 3, if Tom and Sue had approached their siblings and explained what they planned to do, and their siblings had given them the go-ahead (preferably in writing), Tom and Sue would not be engaging in self-dealing.
Finally, a trustee can seek court approval of their actions. Nevertheless, any trustee looking to protect themselves from claims of self-dealing would be wise to avoid any suspicious action.
If you are a trustee and have questions about the best way to fulfill your trustee duties, contact us at 614-389-9711. Talking to a trust attorney now can avoid costly mistakes in the future. We would be happy to sit down with you and assist you with the role.