By Jeffrey C. Blumenthal. © All Rights Reserved.

 

A.   PREFATORY COMMENT

             Exculpatory or limiting provisions of a trust will protect a trustee from liability provided the trustee does not engage in willful misconduct, acts in good faith and/or without reckless indifference to the interests of beneficiaries. Accordingly, if a trust instrument specifically provides that the trustee will not be held liable for negligence or for failure to diversify the holdings or for allowing the trust to hold a specific percentage of stock in a given company, those clauses are enforceable in Illinois and will protect the trustee from liability.

             However, exculpatory clauses should be drafted with care. Because exculpatory provisions are strictly construed, the clauses on which the trustee relies must be broad enough to justify the conduct being challenged. On the other hand, where exculpatory clauses are drawn to completely absolve the trustee from liability, at least under certain circumstances, there is a risk that the over-breadth could cause the court to rule that the clause is unenforceable as a matter of public policy. Additionally, where a trustee has derived a “profit” from a breach of trust, an exculpatory clause will not preclude a court from requiring the trustee to disgorge the profit; and could lead the court to deny the trustee fees for services rendered.

              Finally, in order to protect himself from claims of intentional or reckless misconduct or bad faith, a trustee should keep a written record of the reasons why any given significant discretionary decision was made, as well as documentation of the steps the trustee took in making the decision. Where a trustee believes that a significant or controversial decision that needs to be made could lead to litigation against the trustee, the trustee may wish to petition the Court for instructions before making that decision. Including the Court in the decision should insulate the trustee from liability.

B.   EXCULPATORY CLAUSES ARE GENERALLY ENFORCEABLE

          Paragraph 1 of Section 3 of the Trust and Trustees Act (“Trustees Act”), entitled “Applicability” (760 ILCS 5/3) provides:

A person establishing a trust may specify in the instrument, the rights. powers, duties, limitations and immunities applicable to the trustee, beneficiary and others and those provisions where not otherwise contrary to law shall control, notwithstanding this Act. The provisions of this Act apply to the trust to the extent that they are not inconsistent with the provisions of the instrument.

             “Through 760 ILSC 5/3 “the legislature intended that the settlor [i.e., the grantor]of a trust have the freedom to direct his bounty as he sees fit, even to the point of giving effect to a provision regarding the rights of beneficiaries that might depart from the standard provisions of the Act, unless ‘otherwise contrary to law’. In re Estate of Feinberg, 235 Ill. 2d 256, 267, 919 N.E. 2d 888, 335 Ill. Dec. 863 (2009). The exercise of discretion by the trustee is not subject to interference by the court absent proof of fraud, abuse of discretion or bad faith.” Carter v. Carter, 965 N.E. 2d 1146, 1153 (1^st Dist. 2012) appeal denied 2012 Ill. LEXIS 837(2012).

             Consistent with the statutory directive, Illinois Courts have repeatedly held that: “Although exculpatory provisions . . . do not enjoy special favor in the law, if they are inserted in a trust instrument they are generally held effective except as to breaches of trust committed in bad faith or intentionally or with reckless indifference to the interest of the beneficiary.” Axelrod v. Giambalvo, 129 Ill. App. 3d 512, 517, 472 N.E. 2d 840,844 (1^st Dist. 1984); Accord: MAJS Investment, Inc. v. Albany Bank & Trust Co., 175 Ill. App. 3d 478, 488, 529 N.E. 2d 1035, 1037 (1^st. Dist. 1988); Jewish Hosp. v. Boatmen’s Nat’l Bank, 261 Ill. App. 3d 750, 767 (5^th Dist., 1994) appeal den’d 157 Ill. 2d 503 (1994) (Exculpatory clause in a trust relieved co-trustee bank from liability for alleged negligence characterized as a breach of fiduciary duty); Metz v. Independent Trust Corp., 994 F. 2d 395, 400 (7^th Cir. 1993)[1]; But See:  Hashim v. First Nat’l Bank , 1994 U.S. Dist. Lexis 2187*45 (N.D. Ill. 1994) ( Summary Judgment denied in case involving an exculpatory provision, where there were disputed issues of fact as to whether the trustee acted in bad faith and/or with reckless indifference to the beneficiary’s interest.)

          In Axelrod v. Giambalvo, 129 Ill. App. 3d 512, 517, 472 N.E. 2d 840,844 (1^st Dist. 1984), owners of a certificate of beneficial interest in a trust that owned two 26 story cooperative apartment buildings brought an action against the managing trustees for numerous alleged breaches of trust. The trial court granted judgment for the defendant trustees relying on trust provisions that gave broad authority to the trustees and especially on an exculpatory provision contained in section 4.10 of the trust that provided at 129 Ill. App. 3d 512 at 517:

“Neither the Managing Trustees nor the Trustee shall be liable for errors of judgment in exercising any of the powers or discretions conferred hereby, nor for failure to sue for or collect any money or property belonging to the Trust, nor for any act or omission to act performed or omitted by the Managing Trustee… , nor for the acts of any agent in good faith and reasonable care… The Managing Trustees … shall be fully protected in respect of any action under the agreement taken or suffered by the Managing Trustee… in accordance with the opinion of counsel and in acting upon any resolution, vote, declaration, request, demand, order, notice, waiver, appointment, consent, certificate, affidavit or statement, or upon any other paper or document believed to be genuine.”

 The appellate court in Axelrod further held at 129 Ill. App. 3d 512 at 517:

“In Illinois language expressly exempting or exculpating a trustee from personal liability, if contained in the instrument creating the trust, has …been recognized.”

          The Axelrod Court reasoned at 129 Ill App. 3d 512 at 517 that: “In purchasing their interest in the trust, plaintiffs impliedly acquiesced in the exculpation set forth in section 4.10”.

             In MAJS Investment, Inc. v. Albany Bank & Trust Co., 175 Ill. App. 3d 478, 482, 529 N.E. 2d 1035, 1037 (1^st. Dist. 1988), the Court relied on Axelrod to dismiss an action that a trust beneficiary brought against the land trustee for sending notice of a foreclosure action on the property to the husband of the sole shareholder of the trust beneficiary rather than to the sole shareholder of the beneficiary or the beneficiary itself. While the trial court found that there was a technical violation of the bank’s duty to give notice of legal process to the beneficiary, the trust agreement contained an exculpatory clause relieving the land trustee from liability. The clause in MAJS, supra at 481 provided that: 

             It is further understood and agreed that neither the Albany

             Bank & Trust Company, N.A. individually or as Trustee,

             nor as successor or successors in trust, shall incur any

             personal liability or be subjected to any claim, judgment or

             decree for anything it or they , or their agent or attorneys, may

             do or omit to do in or about the said real estate or under the

             provisions of said deed or deeds in trust or this Trust Agreement,

             or any amendment thereof, or for injury to person or property

             happening in or about said real estate or for any improvident

             conveyances, any and all such liability being expressly waived

             and released. (Emphasis in original).

             In MAJS Investment, Inc. v. Albany Bank & Trust Co., 175 Ill App 3d 478, 481, 529 N.E. 2d 1035, 1037 (1^st. Dist. 1988), the appellate court agreed with the plaintiff land trust beneficiary that “exculpatory provisions are strictly construed against the person seeking its protection[2].” Accordingly, a draftsman of an exculpatory clause needs to make sure that the terms of the provision are broad enough to permit the possible Trustee action or inaction that the settlor seeks to immunize. This was not a real issue in the MAJS case because as the court pointed out the exculpatory provision expressly applied to “claims made against the defendant for doing or omitting to do anything” (Id.) Therefore, there could be no ambiguity as to whether the omission at issue was covered by the exculpatory clause. In fact, the plaintiff might have had a better result had it argued that the exculpatory clause was so overbroad that it was contrary to public policy. Since the exculpatory clause provided for blanket immunity, there was at least a colorable argument that the clause should be rejected as an improper attempt to exclude liability for intentional misconduct and/or reckless indifference to the interests of the beneficiary. See: e.g. discussed infra: Vena v. Vena, 387 Ill. App. 3d 389, 394, 397-398 (2^nd Dist. 2008) appeal denied 231 Ill. 2d 688 (2009) (Striking a trust provision as “an improper method for exculpating the trustee for serious misconduct”).

             In Metz v. Independent Trust Corp., 994 F. 2d 395 (7^th Cir. 1993), plaintiff sued in connection with an IRA account he had opened at the direction of his investment advisor. Plaintiff had executed a number of documents in connection with the investment, including an authorization allowing plaintiff’s investment adviser to withdraw the amount the plaintiff deposited in the IRA. After the documents were executed by the plaintiff, the investment advisor came to the defendant’s office to withdraw the amount that the plaintiff had deposited. Before allowing the investment adviser to withdraw the funds, the defendant’s in-house counsel asked the plaintiff by telephone as to whether he permitted the transaction and plaintiff assured the in-house attorney that he wanted it to proceed. Shortly thereafter, the investment adviser absconded with the money. Plaintiff sued the trustee for breaching the prudent man rule in failing to ascertain the background of the investment adviser before releasing the funds to him. The trial court entered summary judgment for the trustee and the 7^th Circuit affirmed.

              The Seventh Circuit first reviewed the terms of the subject trust agreement and determined that the defendant “was a nondiscretionary trustee who was merely obligated to follow the directives of [the plaintiff] and/or his agent [the investment advisor].” (Metz, supra, at 398).

The Court also recited a “hold harmless” provision from the trust agreement that provided:

             “the grantor agrees to hold the Trustee harmless from all

              Liabilities and expenses incurred in connection with any

              actions taken or failures to act in reliance upon the Grantor’s

               or his authorized agent’s written instructions, designations,

               and representations, or in the exercise of any right, power or

             duty of the Trustee in good faith and with reasonable care.” (Id).

             The Court thereafter recited other “disclaimers, hold harmless provisions, and full acceptance of liability and responsibility” provisions contained in the various documents that the plaintiff had executed that were inconsistent with the plaintiff’s claims of fiduciary breach.

              Among other things, the Court rejected the plaintiff’s contention that exculpatory provisions in a trust agreement violated the “Prudent Man Rule” for trust investments and management contained in 760 ILCS 5/5 of the Trustees Act. To the contrary, the Court stated that paragraph 6(b) of Section 5 of the Trustees Act (760 ILCS 5/5(6) (b)) specifically allows the creator of the trust (the Settlor) to provide different investment rules to govern his/her/its “gift”. As the Metz Court recognized, paragraph 6(b) provides that: “The provisions of this Section [relating to investments] may be expanded, restricted, eliminated, or otherwise altered by express provisions of the trust instrument. The trustee is not liable for the trustee’s reasonable and good faith reliance on those express provisions.”

   Accordingly the court interpreted the statute “to mean that exculpatory clauses are compatible with the prudent person rule.” (994 F. 3d 400). The Court buttressed its ruling by reference to Axelrod and MAJS Investment where exculpatory clauses in trust agreements were upheld. (Id). The court concluded its ruling by stating at 994 F. 3d 400 that: “We are of the opinion that the Illinois Trusts and Trustees Act as well as case law mandate judicial enforcement of a clear and unambiguous  exculpatory clause in a trust agreement unless the claimant demonstrates ‘bad faith’ or ‘reckless indifference’ on the part of the defendant,”

             In Jewish Hosp. v. Boatmen’s Nat’l Bank, 261 Ill. App. 3d 750, 767 (5^th Dist., 1994) appeal denied 157 Ill. 2d 503 (1994) the Court held that an  exculpatory clause in a trust relieved  a co-trustee bank from liability for alleged negligence, which the plaintiff charitable corporate beneficiaries had characterized as a breach of fiduciary duty in their complaint.

             In Jewish Hosp., supra, the exculpatory clause provided that:

             I specifically absolve my Trustee from any responsibility for

              any loss which may result to the trust or to others in connection

             with the exercise of the powers granted, except responsibility for

              willful misconduct.

             Citing to MAJS Investment, supra, 175 Ill. App. 3d 481, which in turn quoted from the Axelrod case, the Jewish Hospital Court held at 261 Ill. App. 3d 767 that: “Although exculpatory provisions … are not given special favor in the law, they are generally held effective except as to reckless or intentional breaches or those committed in bad faith.”

C.   AT LEAST UNDER CERTAIN CIRCUMSTANCES, AN EXCULPATORY CLAUSE THAT PURPORTS TO EXCLUDE

INTENTIONAL OR RECKLESS TRUSTEE MISCONDUCT MAY BE DEEMEND CONTRARY TO PUBLIC POLICY AND UNENFORCEABLE

             There are limits to what an exculpatory provision can provide. In Vena v. Vena, 387 Ill. App. 3d 389, 394, 397-398 (2^nd Dist. 2008) appeal denied 231 Ill. 2d 688 (2009), the Second District Appellate Court held that a trust clause providing that “an approval of the trustee’s accounts by a majority of the ‘income beneficiaries’ would have the same effect as court approval of the accounts”[3] was unenforceable. The court concluded that such a clause was contrary to public policy because of the limitations it placed on redress for serious intentional or reckless trustee misconduct. Id. at 394.

             In Vena, the trustee had filed a declaratory judgment action asking that the court rule that his accounts were approved pursuant to a provision in the trust agreement, which provided that approval of his accounts by a majority of the trust’s income beneficiaries- which had occurred- had the same effect as court approval. One of the beneficiaries objected and filed a counter-claim alleging that Vena had breached his fiduciary duties as trustee. The trial court granted summary judgment for the trustee and dismissed the counter-claim based on the majority approval provision. The trial court supported its decision  by referring to Restatement 3^rd of Trusts, §83, Comment d, which noted that under certain circumstances, a trust agreement may provide “that the trustee need only account or submit reports to a designated person…, and that the approval of the trustee’s account or report by that person shall discharge the trustee from liability”. (Id. at 392-393).

             The appellate court reversed, without deciding whether a provision calling for submission and approval of a trustee’s accounts and reports to a designated person, who could then discharge the trustee from liability, would be valid under Illinois law (Id at. 393).  The appellate court held that the majority approval mechanism did not provide for sufficient oversight of the trustees’ accounts and reports because placing responsibility for such approval in the majority was too “diffuse” to provide any meaningful overview. The Court reasoned that the individual beneficiaries that constituted the “majority” might not inform themselves as to the contents of the trustee’s reports or accounts before approving them and might not be accountable to the other beneficiaries (Id. at 399). Additionally, the majority approval mechanism gave the trustee too much control over arranging who constituted the majority that approved his accounts and reports. Specifically, the court was concerned that the trustee could manipulate the process by picking those beneficiaries most likely to approve his reports and accounts to form the majority (Id. at 300-400). The court believed that the process could give a trustee an incentive to favor a majority of the beneficiaries, who would then approve his actions, to the possible detriment of the minority. Accordingly, the appellate court viewed the majority approval process as not protecting the rights of the minority beneficiaries from possible serious misconduct by the trustee.

             Relying on the limitation on trustee exculpation articulated in Axelrod, supra, and its progeny, the Vena Court stated at 387 Ill. App. 3d 397 that:

“We do not think that the majority- approval provision is an

 effective mechanism for holding a trustee to his or her duty.

Thus, the provision is an improper method for exculpating the trustee of serious misconduct—of acts done in bad faith, of intentional breaches of trust, or of breaches of trust committed with reckless indifference to the interest of the beneficiary.”

D.   CARE NEEDS TO BE TAKEN IN THE DRAFTING OF AN EXCULPATORY PROVISION

             The dicta from MAJS Investment case and the holding in the Vena case indicate that care needs to be taken in drafting a trustee exculpatory clause. Because exculpatory provisions are strictly construed, the provision must be broad enough to provide the protection from possible liability to the trustee that the grantor wishes to provide. On the other hand, in certain circumstances an over-broad clause is subject to being stricken.  In Vena it was the process by which the trustee’s accounts were exculpated that the court deemed improper. The Vena Court found the subject exculpatory clause bad to the core because the “mechanism” employed to exculpate the trustee was improper. Because there was no way to interpret the exculpatory provision in Vena in a fashion which eliminated what the court found was improper in the provision, it was stricken. In contrast a clause which purports to provide blanket immunity like the clause involved in MAJS Investment can be construed in a more limited fashion by the Court without “rewriting” the entire provision. However, because exculpatory clauses do not enjoy special favor, it behooves the draftsman not to draw an exculpatory clause so broadly as to purport to immunize the trustee from bad faith, willful misconduct or reckless indifference to the interests of the beneficiaries. There is no good reason to run the risk that a court might not “blue pencil” an overbroad provision and could hold such a clause as being contrary to public policy and unenforceable.

E.   AN EXCULPATORY CLAUSE WILL NOT PRECLUDE A COURT

FROM REQUIRING A TRUSTEE TO DISGORGE A PROFIT RESULTING FROM A BREACH OF TRUST AND COULD LEAD THE COURT TO DENY THE TRUSTEE FEES FOR SERVICES RENDERED REGARDLESS OF AN EXCULPATORY CLAUSE

       In Countiss v. Whiting, 306 Ill. App. 548 (1^st Dist. 1940), trustees apparently mistakenly paid income to a husband from the decedent’s trust that should have been paid to her children. The trial court entered a decree requiring the husband to return the monies he had received from the trust with interest and held that the trustees had waived their right to compensation for their services.      In affirming the holding, the appellate court rejected the trustee’s contention that they had no liability, because the trust contained a clause providing:

          The Trustees shall not be liable for any action taken by them

          in good faith and believed by them to be within the discretion or

        power conferred upon them by this agreement, nor for any loss

        unless the same shall happen through their own willful default.

    In making its ruling, at 305 Ill. App. 556,  the Court referred to the Restatement 1^st of Trusts, § 222 (2) and stated: “We hold a trustee who pays to himself funds due to other beneficiaries of the trust is not rendered exempt from action by such a provision.” Accordingly, by their conduct the trustees “waived payment for services”.  The Restatement 2^nd of Trusts, § 222 (2) provides in pertinent part that “A provision in the trust instrument is not effective to relieve the trustee… of liability for any profit which the trustee has derived from a breach of trust.” It appears that the trustee’s erroneous actions in Countiss were simply the result of mistaken judgment. However, recent cases have referred to Countiss v. Whiting, 306 Ill App. 3d 548 (1940), as being part of a group of cases that involved exceptional circumstances, including contraventions of public policy, instances of bad faith and intentionally committed breaches and acts performed in reckless indifference to the welfare of beneficiaries (Axelrod v. Giambalvo, 129 Ill. App. 3d 512, 516 (1^st Dist. 1984);   Hashim v. First Nat’l Bank , 1994 U.S. Dist. Lexis 2187*45 (N.D. Ill. 1994)). In any event, there is no reason to believe that an Illinois Court would disregard the above referenced holding of Countiss and the position of the Restatement 2^nd of Trusts, §222 (2) that a trustee will be required to disgorge any profit he receives as a result of a breach of trust regardless of an exculpatory provision. Similarly, even where an exculpatory clause may preclude holding a trustee liable for a loss, as the Countiss Court ruled, the Trustee may still be denied compensation for erroneous judgment or negligent actions or omissions. See also: Sauvage v. Gallaway, 335 Il. App. 3545 (4^th Dist. 1948) (“If a trustee has neglected his duties, exercised bad faith in the conduct of his trust, or committed a breach of obligation in any way, he forfeits his right to compensation.”)

F.    ADDITIONAL STEPS TO AVOID LITIGATION

      In an effort to make an end-run around trustee exculpatory clauses, beneficiaries are likely to characterize questionable trustee conduct as either being taken in bad faith or amounting to willful misconduct or reckless indifference to the beneficiaries interests. In Burke v. Dolan, 1993 Mass Super. LEXIS 22*14 (Mass. Super. 1993), the court held that “an honest error in judgment” did not constitute a “willful default” or bad faith. In Burke, supra, at 12, the Court held that “bad faith… imports a dishonest purpose or some moral obliquity, i.e., a conscious doing of wrong. It means a breach of known duty through some motive of interest or ill will. It partakes of the nature of ‘fraud’.” Similarly, in McDonald v. First National Bank of Boston, 968 F.  Supp. 9, 14-15 (D. Mass. 1997), the Court held that bad judgment– the trustees’ act in holding a stock investment for a longer time that might normally be considered prudent –could not be construed as reckless indifference to the interest of the beneficiary.

       As a matter of self-protection, a trustee should document and keep a written record of the reasons behind any significant discretionary decision taken and how the trustee went about making the decision, including any input he received from the beneficiaries, as well as his communications he had with the beneficiaries in making that decision.     

      Finally, when in doubt or where the trustee is faced with a significant or controversial decision that the trustee believes could lead beneficiaries to make claims against him, the trustee should consider petitioning the Court for instructions. If the Court assists the trustee in reaching a decision on a discretionary matter, the Trustee should be insulated from liability.