How to Protect Yourself from Claims of Self-Dealing When Serving as a Trustee

What Is Self-Dealing in Trust Administration?
A trustee is usually given quite a bit of discretion in how they manage a trust’s assets. Because a trustee is acting as a fiduciary, a trustee also owes all the beneficiaries of the trust a duty of loyalty. The trustee is to act in the best interest of all the trust beneficiaries and not in their own interest. This fiduciary standard prohibits the trustee from self-dealing. Simply put, self-dealing happens when a trustee uses the trust’s assets for their own benefit instead of for the benefit of all the beneficiaries. Despite this simple definition, self-dealing can be much harder to identify in practice and is often done in ignorance, particularly when there are complicating factors such as the trustee also being a trust beneficiary.

Some common examples of self-dealing are a trustee

  • making gifts to themselves from the trust’s assets;
  • borrowing money from the trust;
  • investing the trust’s assets 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
  • making a distribution to themselves as a beneficiary, 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 or while thinking that they are benefiting the beneficiaries.

Example 1. Bill is the eldest son of Dad and Mom. Over the years, Bill has proven himself to be hard-working and reliable and has assumed most of the responsibility for running the family business that supports Dad, Mom, Bill, and Bill’s three siblings. Not surprisingly, Dad and Mom select Bill as the trustee of their trust, with Bill and Bill’s brother and two sisters as beneficiaries. Prior to Dad’s death, Dad instructs Bill that the trust’s assets are available for Bill to use so long as, in the end, all the beneficiaries (Bill and his three siblings) receive equal shares from the trust. After Dad’s death, Bill spends many hours doing trust administration tasks and does not take any compensation from the trust even though, under the trust agreement and state law, he is entitled to reasonable compensation for his time. Bill and his brother decide to buy a boat together. Unfortunately, neither one of them has enough money in his personal bank account to buy the boat. Bill makes a loan of trust money to himself and his brother to buy the boat but does not make a similar loan to either of his sisters. Is this self-dealing? What if Bill makes the loans to himself and his brother under arm’s-length terms, as he would to third parties, charging a reasonable rate of interest and requiring security for the loan? Under these additional facts, is this self-dealing?

Example 2. Bill from Example 1 wants to expand the family business. Bill, his brother, and one of his sisters own equal one-third shares of the company as partners. Bill’s other sister has no ownership interest in the company but is a paid employee. Bill uses trust money to fund his business expansion plans. Is this self-dealing?

Example 3. Betty, a successful physician, and her two brothers are the beneficiaries of a family trust. Betty is the trustee. The trust owns a lake house that Betty’s parents purchased when she and her brothers were young, and many happy family memories were made at that vacation home. Unfortunately, the trust cannot afford to pay the mortgage and property taxes and keep up the required maintenance on the lakefront home, and neither of Betty’s brothers can afford even a one-third share of the amount needed for mortgage, taxes, and maintenance. Betty knows that the home must be sold, but she cannot bear to part with the property that represents so many happy childhood memories. Betty decides that she will buy the vacation home from the trust at fair market value. Is this self-dealing? What if, prior to Betty’s buying the home, the market crashes and the property loses a fourth of its value, but Betty purchases the home at the higher value? Under these additional facts, is this self-dealing?

How To 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. However, there are a few safe harbor rules that a trustee can follow to ensure that they will not be accused of self-dealing and find themselves involved in an unwanted lawsuit.

First, a trust can authorize actions that might be seen as self-dealing. In Example 1, if Dad had wanted to allow Bill to use the trust’s assets in any way Bill saw fit as long as in the end all beneficiaries received equal shares, Dad could have made sure that such an instruction was included in the written trust instrument instead of being a separate oral instruction.

Second, a trustee can seek the approval of the trust beneficiaries for any action or inaction. If, after all facts are fully disclosed, the beneficiaries consent to the trustee’s proposed course of action or later ratify it, a trustee will not be guilty of self-dealing. So in Examples 2 and 3, if Bill and Betty had approached their siblings and explained what they planned to do, and their siblings had approved (preferably in writing), Bill and Betty 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 transaction in which they stand to benefit unless the trust instrument specifically authorizes such action or they are transparent about the transaction and the beneficiaries consent to it.

If you are or will be a trustee of a trust in the future and have questions about the best way to fulfill your trustee duties, please contact us. We would be happy to sit down with you and assist you with your role.