The greatest transfer of wealth in the history of the world is underway. According to a study from the consulting firm Accenture, baby boomers are expected to transfer approximately $30 trillion in assets to their heirs over the next 30-40 years. South Dakota is poised to be a focal point in that transfer of wealth. In 2013, there were 65 trust companies chartered in South Dakota, most of which had been authorized over the past 15 years, and total assets surpassed $120 billion. Putting that in context, at the same time Minnesota had combined assets of just over $7 billion with three non-bank trust charters, and there had been no new charters since 2005. (https://www.minneapolisfed.org/publications/fedgazette/in-south-dakota-we-trust). The purpose of this article is to provide a brief history of how South Dakota became a magnet for trust assets, and then to discuss strategies for litigating trust disputes.
Understanding South Dakota Dynasty Trusts
Several states, including Minnesota, still have remnants of the arcane “rule against perpetuities.” As you may recall, this essentially requires that a trust extinguish and funds be distributed within a limited period of time, generally less than 100 years from the formation of the trust. In application, the rule has many complexities that risk the effectiveness of the trust and minimize tax savings that would exist if the trust could last longer. In 1983, South Dakota abolished the rule against perpetuities. See SDCL 43-5-8. This allowed for the creation of a true dynasty trust, a trust that lasts in perpetuity. The popularity of South Dakota dynasty trusts has also been the product of our state tax code. Of all the states that allow for true perpetual trusts, South Dakota is the only one that does not impose any type of tax on trust assets. In sum, properly implemented, a South Dakota dynasty trust is one of the most powerful estate planning tools in existence.
Litigating Trust Disputes in South Dakota
As South Dakota’s trust industry matures, it is expected that we will also become home to an increasing number of high-stakes trust disputes. The challenge for South Dakota attorneys interested in developing a trust litigation practice is that in South Dakota, the court is required to seal court filings and orders relating to trust actions if requested by a living trustor or by any fiduciary or beneficiary. See SDCL 21-22-28. These documents are generally protected in perpetuity and are not available to the public. This is an added benefit for those interested in a South Dakota dynasty trust, but it provides a practical challenge to attorneys looking to develop their practice in this area of the law. Accordingly, the remainder of this article will provide examples of trust litigation that our firm has been involved with outside of South Dakota and some of the most important lessons learned.
Examples of Trust Disputes
In one matter, we represented a trustee of a testamentary trust with two categories of beneficiaries. Class A beneficiaries (several charitable entities) received the proceeds of the sale of real estate, while Class B beneficiaries (heirs and friends of the settlor) received the remainder of the trust assets after the payment of specific distributions and trust expenses. After the death of the settlor of the trust, the trustee discovered a serious environmental hazard on the real estate that required extensive and expensive clean-up before it could be sold and the profits distributed. The trustee allocated the cost of the clean-up as a general trust administration cost. Class B beneficiaries disputed the allocation, arguing that it should have been charged against the proceeds received from the sale of the real estate. Despite the trustee’s numerous attempts to reach an out-of-court settlement, Class B beneficiaries filed suit in a court of general jurisdiction. The complaint included allegations of breaches of fiduciary duty for such allocation of clean-up costs, misappropriation of trust assets, and several other claims. While ruling that the trustee did not breach his fiduciary duty, the court held that the clean-up costs should have been deducted from the sale proceeds only.
In another matter, a husband and wife owned and controlled a one-hundred-year-old family funeral home business. The couple created a testamentary trust with their two sons as co-trustees. The trust provided that upon the death of the surviving spouse, their two sons would inherit the family business and their three daughters would receive reasonably equivalent value from the sale of all remaining assets. Not only was there a dispute about what “reasonably equivalent value” meant, but the co-trustees had competing claims regarding operation of the business. As a result, the three daughters and one co-trustee filed separate suits, resulting in competing litigations in different courts. On behalf of the other co-trustee, we filed suit in probate court, seeking instructions on valuation of the assets. The parties successfully mediated the valuation issue. However, the co-trustees could not agree on the terms of operating the business and ran the risk of liquidating the business. Ultimately, during the course of litigation and on the eve of trial, the two brothers settled their dispute with the operational brother buying out the other.
We also represented a trustee facing allegations of breaches of fiduciary duty and unfair dealing. In this matter, the wife died first, and the husband created an estate plan whereby he deliberately disinherited one child and bequeathed his assets in trust for the benefit of his remaining five children. His assets included $2 million in cash, 3 beachfront properties and his residence. The trustee was a neutral, third-party, charged with paying income to the 5 children for their lifetimes. The trustee also had the authority to invade the principal for the “serious health or life-altering circumstances” of the 5 children. Finally and to the extent all beneficiaries agreed, the trustee was authorized to sell any of the beachfront properties to any one or more of the beneficiaries. A dispute arose as to the trustee’s attempt to sell the beachfront properties and faced accusations that the sales were not arms’ length and of preferential treatment to certain buyers.
When a trust relies on valuation of assets for distributions to beneficiaries, such as in the last two examples in the previous section, a trustee should immediately commission an appraisal completed by a reputable and qualified appraiser using commercially acceptable valuation methods and procedures. Without it, disputes will most definitely arise as to the reasonableness of the trustee’s actions, whether the sale price of an asset represented fair market value, and delay of distribution payments, to name just a few.
Trustees should be wary of a catch-22 type situation when the trust has multiple beneficiaries. Trustees have several duties with which they must comply while administering the trust, including the fiduciary duty and the duty to treat all beneficiaries equally and in strict accordance with the trust terms. But, at times, compliance with all duties may force a trustee into a situation where any beneficiary could raise an issue. Take the first example of a trust dispute in the previous section. The trustee allocated the clean-up cost as a general trust administration cost. It was reasonable for her to do so since the trust required her to sell the property and distribute the proceeds. However, it is equally reasonable for the trustee to have charged the clean-up costs against the sale proceeds since the two are intertwined. The trustee’s decision has a necessary impact on the amount of distributions. Whichever allocation the trustee chose, one class of beneficiaries would be able to argue that the trustee did not treat them equitably, in accordance with the terms of the trust, or as intended by the settlor. Trustees must be mindful that this type of situation could arise in any trust with more than one beneficiary.
One potential resolution of the catch-22 type situation described above is going to court early. One lesson we have learned is that seeking instructions from the probate court, or other court of specialized jurisdiction, early in the administration of a trust may be the most efficient and cost-effective way to resolve disputes with beneficiaries. This lesson may seem counter-intuitive as formal court proceedings have been known to be lengthy and expensive. But, if done with careful thought and consideration, going to court early may avoid a lengthy and expensive trust administration process before a trust can be closed. And going to court early is key. Trustees tend to wait too long before going to court, allowing disputes to simmer. But, trust disputes are not like red wine – they do not improve with age.
Going to court early is most effective when a trustee is faced with particularly aggressive beneficiaries whose only focus is on the bottom line – the dollar amount of their distributions. With a court order in hand, such beneficiaries will have no choice but to accept the distributions, rather than refusing to assent to the accounting and forcing the trustee to continue to manage the trust assets and incur cost. If the trustee does not go to court first, she risks being brought into court by the aggressive beneficiaries, who may deliberately choose a court of general jurisdiction, as opposed to a specialized court with the relevant experience. Such proceedings are almost always unduly lengthy and expensive.
Trustees must also be careful in their choice of litigation counsel. While a trust typically allows a trustee to hire counsel, the trustee must always act reasonably. A trustee cannot accrue substantial legal fees on the assumption that the trust will cover the cost. Instead, the trustee must carefully choose a law firm, with legal fees reasonable and proportionate to the dispute at issue. Trustees should insist on a reasonable budget and ensure that counsel does not exceed that budget. Consequences of a trustee’s failure to keep a close watch on growing legal fees include being found to have breached the fiduciary duty and being held liable for payment of the legal fees, whether charged against compensation owed to the trustee or direct payment from the trustee to counsel.
(Originally published in the South Dakota Trial Lawyers Association's Barrister Newsletter, March/April 2016)
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