JULY 5, 2011 VOLUME 18 NUMBER 24
Family members sometimes assume that an estate will be ready for distribution within days or weeks of a death. Those familiar with the probate process usually appreciate that it is more likely that distribution will be between six months to a year after death ? and sometimes longer. When the decedent established a living trust, though, survivors often expect the final distribution to be faster. Everyone has gathered for the funeral, including out-of-town children and grandchildren ? shouldn?t there be a check ready to hand out while the whole family is together?
The reality is that administration of an estate, even when a trust is involved, can take much longer. A good rule of thumb: it may still take six months to a year to prepare final income tax returns, gather trust assets, liquidate those which need to be sold (and not all will need to be sold in most cases), make calculations and actually complete the distribution. If there are more complicated issues, like estate tax liability, it may take even longer.
Delay in distribution of a trust estate was the issue involved in a recent Indiana Court of Appeals case. Harrison Eiteljorg?s will had provided a trust for his widow, Sonja Eiteljorg. When she died in 2003, the trust was to be divided into two shares ? one each for Harrison?s sons Nick and Jack. Nick, a stepson and Harrison?s accountant were the co-trustees.
The trust was large ? it held about $13 million of assets. That meant that an estate tax return had to be filed, and taxes totaling $6.2 million paid (remember that in 2003 tax was imposed on estates greater than $1 million). That was accomplished by late 2004, but the trustees were worried about closing out the estate and distributing the remaining assets. What would they do if the IRS disagreed with their calculations of values and imposed an additional tax liability.
At a heated meeting between the co-trustees and the two sons, Nick demanded a partial distribution of $2 million (half each to himself and Jack). The other trustees declined, saying that they worried that additional tax of up to $2 million might be imposed, and a distribution as large as Nick wanted would leave the trust with too little cash if that happened. They proposed instead to distribute $1 million to the two sons. Nick and Jack left the meeting without agreeing, and both sides hired new lawyers to battle out the timing and amount of a distribution.
A few months later Nick and Jack filed a petition with the Indiana probate court asking for removal of the co-trustees and entry of a judgment against them. Their argument: there was no reason not to distribute the requested $2 million when demanded, and failure to do so breached the trustees? duty to the beneficiaries. The trustees answered, arguing that they needed to retain substantial liquidity until the IRS finally accepted the estate tax return (or imposed additional tax liability, if that was to be the outcome).
About a year after their original demand for partial distribution, Jack and Nick secured an order from the probate judge requiring that $1.5 million be divided between them. The co-trustees complied. The court proceedings then shifted gears to address a two-part question: did the delay in distribution amount to a breach of fiduciary duty, and (if it did) what were the damages due to Nick and Jack?
The probate judge found that the delay did amount to a breach of fiduciary duty. Nick testified that he would have put his distribution into two mutual funds, and that it would have grown significantly during the months he was deprived of its use. Jack testified that he had planned to purchase real estate in Texas, and that it would have appreciated. In addition, Nick and Jack had incurred attorneys fees totaling $403,612.81.
Based on the damages testimony, the probate judge awarded Nick $156,701 in ?lost? profits from the funds he could not invest in. Jack was awarded $112,046.77 in missed real estate gains. The remaining co-trustees were ordered to pay those amounts from their own pockets, as well as all but $50,000 of the attorneys fees.
The Indiana Court of Appeals had a different take on the case, and significantly reduced the damages award. First, two of the three appellate judges agreed with the trial judge that failure to distribute the funds earlier was a breach of fiduciary duty. Rather than giving Nick and Jack the profits they said they would have earned, however, the two judges limited their damages to the interest that the $1.2 million would have earned during the nine months it was delayed ? and even that damage award was to be reduced by the amount of interest the money actually earned in the trustees? hands. The appellate court also reduced the attorneys fee award to a total of $150,000 ? what they called ?a more appropriate assessment.? In the Matter of Trust of Eiteljorg, June 27, 2011.
One appellate judge would not have gone even that far. According to the dissenting opinion he authored, there was no breach of fiduciary duty. After all, he reasoned, the co-trustees offered to distribute almost exactly what was ordered a few months later, and Nick and Jack rejected the partial distribution plan. Retaining at least $2 million in liquid assets until the estate tax return had been accepted was a reasonable and prudent course, according to the dissenting opinion.
What lessons can we draw from the Eiteljorg case? Several come to mind:
- Even with a trust, it may take months or years after a death to complete the administration and make final distribution. That is not the usual circumstance, but it can happen.
- Although avoidance of litigation is one common goal of trust planning, it is not always effective. And the cost of probate or trust litigation can be significant ? note that Nick and Jack incurred legal fees of about one-third of the total amount they sought as distribution, and that the question was not whether they were entitled to the money, but only when.
- In addition to increasing cost, litigation can slow down the process. Here, the co-trustees were ready to make a significant distribution at the first meeting, but the court-ordered distribution (of almost exactly the same amount) was delayed for nine months.
- Acting as trustee can sometimes be costly. The co-trustees in this case will be liable for at least $150,000 out of their own pockets. We can anticipate that Nick and Jack will object to any attempt to pay the trustees? own lawyers from trust assets, or to pay any fees to the co-trustees.
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