Though exculpation clauses are contained in many wills and trusts, for many if not most scriveners little thought is given to their use or enforceability or the means to maximize their effectiveness. Rather, exculpation clauses are treated as boilerplate deserving little attention in the practice of a busy attorney. This article addresses several important aspects of exculpation clauses that can enable trusts and estates attorneys to better serve their clients.
What Is an Exculpation Clause?
An exculpation clause is a provision in a trust designed to relieve a trustee from liability for certain breaches of fiduciary duty that might otherwise give rise to surcharge. The common rationale for use of the clause is to induce an individual to act as trustee. Whether the clause actually serves that purpose is often questionable, however, as it seems doubtful that attorneys commonly explain either to settlors or prospective trustees the nature or significance of the clause.
In general, an exculpation clause is enforceable, but only to the extent it is in compliance with the law of the jurisdiction that governs the administration of the trust. Presently, 35 states have enacted the Uniform Trust Code, which contains an exculpation provision in Section 1008, entitled “Exculpation of Trustee.” Under Section 1008, a provision in a trust that purports to relieve a trustee from liability for breach of trust is unenforceable to the extent it excuses the trustee for breach committed either “in bad faith” or “with reckless indifference to the purposes of the trust or the interests of the beneficiaries.”
Section 1008 is a mandatory provision under the UTC. That means that the “bad faith” and “reckless indifference” standards prevail over an express provision in a trust instrument that purports to apply more forgiving standards to a trustee’s conduct.
Drafting Exculpation Clauses
Some non-UTC states use different criteria than the UTC standards on exculpation. For example, in Delaware an exculpation clause is unenforceable if it purports to relieve a trustee for liability for the trustee’s “own willful misconduct.” 12 Del. C. § 3303(a). The Delaware standard is decidedly less rigorous than the UTC standard. In contrast, in New York, which is presently considering adoption of the UTC, it is against the state’s public policy to exonerate a trustee for liability for failure to exercise “reasonable care, diligence and prudence.” NY EPTL 11-1.7(a)(1). Since the New York standard tracks a trustee’s fiduciary duties in general, the use of an exculpation clause in a New York trust would seem to be of limited utility in providing additional protection to a trustee.
Courts sometimes struggle to construe exculpation clauses or come to differing conclusions as to the meaning of the standards. In Mennen v. Wilmington Tr. Co., C.A. No. 8432-ML, 2015 Del. Ch. LEXIS 122 * (Del. Ch. Apr. 24, 2015) (unreported decision), the court explained the difficulty in construing a “willful default” standard contained in the statute as compared to “an absence of good faith” standard contained in a trust instrument. The Mennen court stated that “it is not easy to delineate a precise distinction between the two, and one might credibly argue that willful misconduct is one subset of bad faith conduct; it is arguable that all willful misconduct is bad faith conduct, but not all bad faith conduct may be characterized as willful misconduct.” In Newcomer v. National City Bank, 19 N.E.3d 492 (Ohio Ct. App. 2014), the court construed whether the “willful default” standard contained in the trust instrument was violative of the “bad faith” and “reckless indifference” standards contained in Ohio’s UTC provision, and noted that “bad faith, willful default [and] reckless indifference constitute distinct and separate bases of liability.” Id. at 505. In contrast, in Schwartz v. Barker, 2013 Kan. App. Unpub. LEXIS 37, 2013 WL 189686 (Kan. Ct. App. Jan. 11, 2013), a court found the “willful default” standard contained in the trust would excuse acts or omissions done in “bad faith” or with “reckless indifference” to the interests of the beneficiaries, the standard contained in the statute.
There appears no good reason to include a standard in an exculpation clause that deviates from the applicable state law standard. Any modest benefit that could accrue would seem outweighed by the possible confusion that might arise in construing the standard under the clause versus the standard under the statute. Rather, to eliminate potential confusion, scriveners should draft exculpation clauses using the same standard contained in the statute of the state in question.
Exculpation Clauses Drafted by or Caused to Be Drafted by a Trustee
Under Section 1008, an exculpation clause is unenforceable it if was “inserted as the result of an abuse by the trustee of a fiduciary or confidential relationship to the settlor.” Subsection (b) of Section 1008 explains the circumstances under which the fiduciary or confidential relationship is abused. Under that provision, if an exculpation clause is drafted or caused to be drafted by the trustee, then it is treated as being invalid as an abuse of the fiduciary or confidential relationship unless the trustee proves (1) that the clause is fair under the circumstances, and (2) that its existence and contents were “adequately communicated to the settlor.” The comments to Section 1008 note that the requirements of subsection (b) are satisfied if the settlor is represented by independent counsel. Section 1008 is of particular interest to attorneys who serve as trustee of their clients’ trusts.
In determining whether the clause is fair under subsection (b), the relevant factors are (i) the extent of the prior relationship between the settlor and trustee, (ii) whether the settlor received independent advice, (iii) the sophistication of the settlor with respect to business and fiduciary matters, (iv) the trustee’s reasons for inserting the clause; and (v) the scope of the particular provision inserted.
As to the requirement of subsection (b) of communication to the settlor, years after the trust is created it may be exceedingly difficult to prove that both the existence of the exculpation clause and its contents were adequately communicated to the settlor. A sufficient proof would seem to be a contemporaneous writing advising the settlor about the clause when the trust is created, and countersigned by the settlor. Such a writing would need to explain the reason for including the clause and the clause’s benefit to the settlor and the trust beneficiaries.
The inadequacy of other forms of proof was illustrated in Marsman v. Nasca, 30 Mass. App. Ct. 789, 800, 573 N.E.2d 1025 (Mass. App. Ct. 1991). There, the attorney-scrivener testified at trial that he discussed the clause with the settlor and she wanted it included in the trust. Though the testimony was unrefuted, the court still questioned whether the attorney specifically called the exculpatory provision to the client’s attention, and refused to enforce the clause.
Marsman demonstrates that proof of the fairness of the clause years after the trust is created and after the settlor’s death may be quite difficult. Therefore, where the settlor does not have independent counsel, and particularly where the attorney-scrivener is named as the trustee in a trust containing an exculpation clause, it is imperative that a contemporaneous writing be created that is signed by the settlor and makes clear that the existence and contents of the exculpation clause were fully explained to the settlor.
Impact of Exculpation Clause on Burden of Proof
Litigators should consider how an exculpation clause might impose a greater burden of proof on a claimant. Where a valid exculpation clause is contained in a trust and claims against the trustee are brought, not only must there be proof of the trustee’s breach of fiduciary duty, but there must also be proof of the trustee’s violation of the exculpation clause. Many acts of trustees, while constituting a breach, do not rise to the level of bad faith or reckless indifference or other standards contained in statutes of non-UTC states. A trustee might act negligently or with a good faith honest belief in the propriety of its acts, and in these situations the heightened standard of the exculpation clause might offer complete protection notwithstanding proof of breach.
In Tatoian v. Tyler, 194 Conn. App. 1, 220 A.3d 802 (2019), the trustee argued that the claimant not only had to show probable cause for bringing the claim in question, but also that he reasonably believed he could overcome the exculpatory clause, which required a showing that trustee engaged in “willful misconduct” in order to demonstrate liability. The appellate court agreed, and reversed and remanded for factual findings to the trial court to consider whether the beneficiaries reasonably believed that they could overcome the exculpatory clause. The exculpatory clause was a highly relevant factor in determining whether a man of ordinary caution, prudence and judgment would have entertained the claims at issue against the trustee in the prior action. It is a potentially effective tool to be utilized in litigation in an appropriate case.
Effective use of exculpatory clauses requires knowledge of the jurisdiction’s statutory standard, an imperative to inform the settlor in writing where the clause is used to protect a trustee who drafts or causes the trust to be prepared, and an awareness of the tactical benefits of the clause when defending a trustee in litigation.
Reprinted with permission from the February 3, 2022 issue of The Legal Intelligencer. ©2022 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.