Corporate Law Blog

Trustee Discretion and Liability of an Individual

It's an understatement to say that the role of the trustee is fraught with pitfalls. Often times, a settlor creates a trust to suit his or her needs, but rarely does the settlor take into consideration, the difficulties the trustee will face when administering the trust. The discretion given to the trustee can provide a gateway for added liability, and the creation of a trust should take the twin concerns of trustee discretion and trustee liability into as much consideration as the disposition of the trust assets.

A settlor wants to create a trust that distributes assets, income and/or principal in a manner that fulfills that settlor's desires, but often times the settlor also wants to give the trustee discretion to act for the trust when circumstances change or for the fulfillment of the trust purposes over time. If the trustee is given discretion for the "benefit" or "general well-being," or even "health, education, maintenance and support" of a beneficiary, making or refusing to make distributions without clear instructions may expose that trustee to liability for abuse of discretion. A trustee who receives a distribution request from a current beneficiary for an elective procedure, for example, might face suit for abuse of discretion from that beneficiary for rejecting the distribution, but that trustee might also face suit for abuse of discretion from a remainder beneficiary upset that trust assets were used to pay for the procedure. Such ambiguous language, while included to provide flexibility to the trustee to provide for the beneficiaries, can often result in those same beneficiaries turning to the court for a definitive interpretation of the trustee's powers. If a beneficiary perceives that the trustee is showing preferential treatment or discriminating in distributions among beneficiaries, that trustee will likely wind up in court, having to explain his or her actions.

In addition to distributions, a trustee is also liable for decisions made in preserving or improving the trust corpus. A trustee with a broad authority to invest trust assets may be exposed to liability for investments deemed either too risky or too safe, or for underperforming assets. In Kentucky, a trustee must act as a prudent investor according to set statutory standards as well.

A settlor's grant of discretion to a trustee should be narrowly tailored as much as possible to spring out of a specific set of circumstances. While it's impossible to plan for every single contingency, a settlor must understand that trustees are personally liable in actions for breach of trust, and any judgments against a trustee will be in her or his personal capacity and against her or his individual assets. Every time a settlor gives a trustee another choice to make on behalf of the trust, the settlor gives that trustee another chance to wind up in court with his or her assets on the line.

This article is intended as a summary of federal and state law and does not constitute legal advice.