Beneficiaries often request that a trustee secure a loan from a third party. In an economic downturn, such requests are even more prevalent. As a general rule, a trustee should not want to do so as it should assume that the beneficiary will default and the trustee will then be placed in a situation of having pay the debt of beneficiary with trust assets and then potentially taking action against a beneficiary, a person to whom the trustee owes a fiduciary duty. Yet, the trustee may have pressure to make such a transaction.
A trustee should consider its fiduciary duties before agreeing or denying such a request. A trustee has a duty of loyalty to the beneficiaries. Texas Property Code Section 117.007 provides: “A trustee shall invest and manage the trust assets solely in the interest of the beneficiaries.” Tex. Prop. Code § 117.007; InterFirst Bank Dallas, N.A. v. Risser, 739 S.W.2d 882, 898 (Tex. App.—Texarkana 1987, no writ). A trustee owes a duty of loyalty to each beneficiary, therefore, the trustee should weigh whether securing a loan for one beneficiary may violate a duty of loyalty owed to another beneficiary.
In this regard, a trustee has a duty to treat all beneficiaries with impartiality. Texas Jurisprudence states:
A trustee must act for all the beneficiaries; he or she may not properly act for only some of them. The trustee owes the same fiduciary duty to all to protect their respective interests, without partiality or favor to some at the expense of others; thus, a trustee is bound, in the absence of instructions to the contrary, to administer the trust with an eye to a remainder interest, as well as to the interest of a life tenant, and he or she cannot slight one interest for the benefit of the other. Additionally, a trustee owes the same fiduciary duty to a contingent beneficiary as to one with a vested interest, insofar as necessary for the protection of the rights of the contingent beneficiary in the trust property. This duty of impartiality has been codified in the Uniform Prudent Investor Act, which states that if a trust has two or more beneficiaries, the trustee must act impartially in investing and managing the trust assets, taking into account any differing interests of the beneficiaries.
Tex. Jur. 3rd, Trusts, § 64. So, a trustee has to weigh whether securing a loan for one beneficiary complies with a duty of impartiality: is the trustee impermissibly favoring one beneficiary over another?
A trustee also has a duty to properly manage trust assets: “A trustee’s fundamental duties include the use of the skill and prudence which an ordinary, capable, and careful person will use in the conduct of his own affairs as well as loyalty to the trust’s beneficiaries.” Herschbach v. City of Corpus Christi, 883 S.W.2d 720, 735 (Tex. App.—Corpus Christi 1994, writ denied). Texas Property Code Chapter 117 (The Uniform Prudent Investor Act) provides that a trustee may manage trust property and invest and reinvest in property of any character on the conditions and for the lengths of time as the trustee considers proper. Tex. Prop. Code Ann. § 113.006. Chapter 117 limits this rather broad grant of authority and provides that a trustee who invests and manages trust assets owes a duty to the beneficiaries to comply with the prudent investor rule. Tex. Prop. Code Ann. § 117.003(a). Under the statute, the prudent investor rule provides, in part: “(a) A trustee shall invest and manage trust assets as a prudent investor would, by considering the purposes, terms, distribution requirements, and other circumstances of the trust. In satisfying this standard, the trustee shall exercise reasonable care, skill, and caution.” Id. The trustee must address whether it is a prudent investment and management of trust assets to secure a loan for a beneficiary.
A trustee, however, should keep in mind that because securing a loan for a beneficiary is inherently different than for a third party, a trustee should consider whether the security is more akin to a distribution. The Restatement provides:
Sometimes a beneficiary requests funds for a purpose that falls within the reasonable discretion of the trustee but which the applicable standard would not require the trustee to furnish. If the trustee is reluctant for some reason to make the requested distribution, and particularly if the trustee’s concern is one of impartiality, the trustee has discretion to make a loan or advance to the beneficiary. The loan need not qualify as a prudent investment under § 90. RESTATEMENT THIRD, TRUSTS (Prudent Investor Rule) § 227. It is a form of discretionary benefit, and may be made at a market rate of interest or at low or no interest; and funds may be advanced with recourse only against the beneficiary’s interest, without personal liability.
RESTATEMENT (THIRD) TRUSTS, § 50, cmt. d(6). Accordingly, a trustee should consider whether the trust allows the trustee to treat a security transaction as a type of benefit and/or distribution to the beneficiary (and there may be certain tax considerations resolved as well).
A trustee has a duty to disclose to a beneficiary. A trustee also has a duty of full disclosure of all material facts known to it that might affect the beneficiaries’ rights. Montgomery v. Kennedy, 669 S.W.2d 309, 313 (Tex. 1984). Further, a trustee has a duty of candor. Welder v. Green, 985 S.W.2d 170, 175 (Tex. App—Corpus Christi 1998, pet. denied). Regardless of the circumstances, the law provides that beneficiaries are entitled to rely on a trustee to fully disclose all relevant information. See generally Johnson v. Peckham, 132 Tex. 148, 120 S.W.2d 786, 788 (1938). So, a trustee has a duty to disclose the securing of a loan for one beneficiary to other beneficiaries.
This may conflict with a duty of confidentiality. The duty of loyalty includes a duty to maintain the confidentiality of a beneficiary’s information. The Restatement provides: “The trustee is under a duty to the beneficiary not to disclose to a third person information which he has acquired as trustee where he should know that the effect of such disclosure would be detrimental to the interest of the beneficiary.” RESTATEMENT (SECOND) OF TRUSTS § 170. The Restatement addresses the conflicting position that a trustee is in when a duty to maintain the confidentiality of a beneficiary’s information abuts a duty to disclose to other beneficiaries:
This duty of confidentiality ordinarily does not apply to the disclosure of trust information to beneficiaries or their authorized representatives (see duties to inform and report, §§ 82 and 83) or, in the interest of one or more trust beneficiaries, to the trustees of other trusts or the fiduciaries of fiduciary estates in which a beneficiary has an interest. Even in providing information to or on behalf of beneficiaries, however, the trustee has a duty to act with sensitivity and, insofar as practical, with due regard for considerations of relevancy and sound administration, and for the personal concerns and privacy of the trust beneficiaries.
RESTATEMENT (THIRD) OF TRUSTS § 78. Where a beneficiary’s information impacts a co-beneficiary’s interest in the trust, a trustee may be in a position where a duty of loyalty requires disclosure.
After considering its fiduciary duties, a trustee should consider whether it has the authority or power to secure a loan for a beneficiary. A trustee generally has authority to encumber trust assets:
Unless prohibited by statute or the terms of the trust, a trustee has power to borrow money for trust purposes and to pledge, mortgage, grant a deed of trust, or otherwise encumber trust property. The trustee has a duty to exercise caution as well as the duty to exercise care and skill in deciding whether and under what terms to borrow money for trust purposes or to grant a security interest in trust property… Because of a trustee’s duty to respect the terms of the trust (§ 76), it is normally improper for a trustee to exercise the power to encumber trust property by granting security interests in assets that are to be specifically distributed to one or more beneficiaries on termination.
Restatement (Third) of Trusts, § 86.
A trustee should review the trust agreement. “The trustee shall administer the trust in good faith according to its terms and the Texas Trust Code.” Tolar v. Tolar, No. 12-14-00228-CV, 2015 Tex. App. LEXIS 5119 (Tex. App.—Tyler May 20, 2015, no pet.). “The powers conferred upon the trustee in the trust instrument must be strictly followed.” Id. There are potential trust provisions that expressly allow a trustee to provide security for loans to beneficiaries. One example is as follows:
The trustee, in the trustee’s discretion, is authorized to endorse, guarantee, become the surety of or otherwise become obligated for or with respect to the debts or other obligations of any person (including a beneficiary), firm, corporation, partnership, trust or other legal entity, whether with or without consideration, when the trustee believes such actions advance the purposes of any trust created or continued hereunder.
Where a trust document allows such a transaction, a trustee may generally enter into such an agreement when it is done in good faith. For example, in one case, the trust granted the trustee the power: “to lend money to any beneficiary hereunder, either with or without security and on such other terms as my executors may deem appropriate.” In re Hanes, 214 B.R. 786, 822 (Bankr. E.D. Va. 1997). The court construed this language as: “The language of the above provisions expressly permits lending to the beneficiaries and the pledging of any assets to secure borrowing.” Id. It held that the challenged loans were permissible:
Viewing the instruments and the circumstances as a whole, we find that it was Hanes, Sr.’s intention to give his sons broad authority to manage the Marital Trust in their absolute discretion. The family investment plan was a proper function of Hanes duties as Trustee. To the extent that the DCI Companies were investments made by HILP in furtherance of the family investment plan, the pledges securing lending directly to these entities was authorized.
In the absence of trust language, there is general statutory authority that may allow this type of transaction. A trustee has the general power to do anything that is necessary or appropriate to carry out the purpose of the trust. Tex. Prop. Code Ann. § 113.002. There is also a specific statute that addresses encumbering trust assets:
A trustee may borrow money from any source, including a trustee, purchase property on credit, and mortgage, pledge, or in any other manner encumber all or any part of the assets of the trust as is advisable in the judgment of the trustee for the advantageous administration of the trust.
Tex. Prop. Code § 113.015 (emphasis added). This statute allows a trustee to encumber trust assets (allow them to be collateral for a loan) if the trustee finds that the lien would be advantageous for the administration of the trust. Note that this does not require the trustee to find that it is a good investment or that encumbering the assets are for consideration. Rather, a trustee may find, for example, that benefiting a beneficiary by agreeing to such a lien may be advantageous to the administration of the trust where the trust is for the primary benefit of the beneficiary and agreeing to the lien is better than making an outright distribution or a loan to the beneficiary. Other states have similar statutes that allow a trustee to secure loan for the benefit of a beneficiary. See, e.g., Oregon Rev. Stat. 130.725 (2017) (A trustee may “[p]ledge trust property to guarantee loans made by others to the beneficiary.”).
A third party lender will likely want to make sure that the trustee has the authority to encumber trust assets and may seek a copy of the trust document. When a trustee wants to enter into a transaction to secure a loan for a beneficiary, it may want to provide a certification of trust instead of providing an entire trust document. Tex. Prop. Code § 114.086.
If the beneficiary causes harm to the trust due to his or her activities, a trustee may have a claim against the beneficiary. Texas Property Code Section 114.031 provides:
A beneficiary is liable for loss to the trust if the beneficiary has: (1) misappropriated or otherwise wrongfully dealt with the trust property; (2) expressly consented to, participated in, or agreed with the trustee to be liable for a breach of trust committed by the trustee; (3) failed to repay an advance or loan of trust funds; (4) failed to repay a distribution or disbursement from the trust in excess of that to which the beneficiary is entitled; or (5) breached a contract to pay money or deliver property to the trustee to be held by the trustee as part of the trust.
Tex. Prop. Code § 114.031(a). So, if a beneficiary has caused loss to the trust due to wrongfully dealing with trust property, a trustee has a claim against the beneficiary, who is liable for the loss. Id.
One important issue is that the beneficiary may not have any assets, so suing the beneficiary may be a worthless exercise. The Texas Property Code also has a provision that allows a trustee to offset any distributions to the beneficiary due to a loss:
Unless the terms of the trust provide otherwise, the trustee is authorized to offset a liability of the beneficiary to the trust estate against the beneficiary’s interest in the trust estate, regardless of a spendthrift provision in the trust.
Tex. Prop. Code § 114.031(b). Therefore, if a trustee establishes a claim against the beneficiary, the trustee can then simply payoff that debt by offsetting distributions otherwise due to the beneficiary from the trust. However, a trustee generally does not want to rely on this statutory right to offset debts to the trust by the beneficiary, and it should be used only when necessary.
Further, a trustee that enters into such a transaction should consider methods to limit risk. The trustee can always filed suit to seek an instruction from a court on the propriety of a transaction. Additionally, there are non-judicial methods to limit risk. Once such method is to enter into a release agreement with all relevant beneficiaries. A beneficiary who has full capacity and acting on full information may relieve a trustee from any duty, responsibility, restriction, or liability that would otherwise be imposed by the Texas Trust Code, and this release must be in writing and delivered to the trustee. Tex. Prop. Code Ann. § 114.005. Further, writings between the trustee and beneficiary, including releases, consents, or other agreements relating to the trustee’s duties, powers, responsibilities, restrictions, or liabilities, can be final and binding on the beneficiary if it is in writing, signed by the beneficiary, and the beneficiary has legal capacity and full knowledge of the relevant facts. Tex. Prop. Code Ann. § 114.032. Minors are bound if a parent signs, there are no conflicts between the minor and the parent, and there is no guardian for the minor. Id. So, a trustee can limit its risk of future claims by having beneficiaries consent to the security agreement and release the trustee for any results therefrom.
In conclusion, a trustee usually has the power or authority to secure a loan for a beneficiary. However, the trustee should use caution in doing so as it has a duty to protect trust assets and invest them wisely. If a trustee contemplates securing a loan, it should seek legal advice on documenting the loan transaction with the lender and documenting the transaction with the beneficiary (and other beneficiaries) to limit risk of claims in the future.