Wills, Trusts & Estates Prof Blog

Editor: Gerry W. Beyer
Texas Tech Univ. School of Law

Tuesday, November 22, 2005

Breach of Trust and Economics

Peter T. Wendel (Professor of Law, Pepperdine University School of Law), has recently published an article entitled The Evolution of the Law of Trustee's Powers and Third Party Liability for Participating in a Breach of Trust: An Economic Analysis, 35 Seton Hall L. Rev. 971 (2005).

Here is the conclusion of Prof. Wendel's article:

The UTC grants broad powers to each trustee and abolishes the common law broad duty of inquiry. The net effect, vis-a-vis third parties interested in dealing with a trustee, is to turn each trustee into an agent. Having transformed the trustee, the UTC then applies the prevailing standard of liability for third parties interested in dealing with an agent. Third parties are protected as long as they act in good faith. The problem is that the UTC does not give trust beneficiaries the same power and control over the trustee that a principal has over an agent. Courts and juries intuitively recognize the inequity of holding trust beneficiaries responsible for the actions of their trustee when the trust beneficiaries neither select nor control the trustee. Courts and juries will couple hindsight bias with the fact-sensitive good faith standard to apply a de facto strict liability standard to third parties who participate in a breach of trust.

The most efficient way to counter the natural bias courts and juries have in favor of trust beneficiaries is to adopt an actual knowledge standard of liability. It is inequitable, however, to allow third parties who intentionally decide not to investigate suspicious facts to prevail over trust beneficiaries. A good argument can be made that a bad faith standard of liability best balances the competing economic and equitable considerations. Those jurisdictions that are inclined to adopt the UTC should consider revising section 1012 to provide that a third party who deals with a trustee is not liable unless he or she had actual knowledge of the breach or acted in bad faith. Those jurisdictions that are inclined to adopt the most efficient approach should consider Professor Fratcher's actual knowledge standard.

In those jurisdictions where the Uniform Trust Code's good faith standard is adopted, from a law and economics perspective one would predict greater use of trust protectors. A trust protector is a relatively new development, used primarily in offshore asset protection trusts. A trust protector can be given complete control over the trust, including the power to terminate the trust or replace the trustee if he or she deems it appropriate. Inasmuch as the Uniform Trust Code shifts more of the risk of loss to the trust beneficiaries, law and economics would predict settlors of private trusts to respond by increasingly appointing trust protectors to facilitate greater control and supervision over the trustee - thereby facilitating greater precautions on behalf of the trust beneficiaries to offset the increased risks they now bear. Where a trust protector is appointed, however, interesting issues will arise as to the scope of the trust protector's duty to monitor and supervise the trustee. No doubt some trust protectors will charge a fee for their services. In addition, in the event of a breach of trust, trust beneficiaries will sue the trust protector in addition to suing the third party who participated in the breach of trust. The use of trust protectors will only further increase the costs of administration associated with the good faith standard.

Maybe Professor Fratcher was not so wrong after all.


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