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Many people do not realize that a trustee of a will or inter vivos trust faces a myriad of legal and fiduciary responsibilities that, if breached, may result in personal liability. This is especially concerning since most clients appoint family members or close friends to this role.

Clients often attempt to protect loved ones from the risk of personal liability by inserting an exemption clause into a will or trust document. Typically, the clause reads something like this: “No trustee acting in good faith shall be held liable for any loss, except for loss caused by his or her own dishonesty, gross negligence or a wilful breach of trust.”

You may be asked whether an exemption clause fully protects a trustee, since the trustee owes a duty of utmost good faith to beneficiaries. Limiting the trustee’s liability also denies a beneficiary the fundamental right to seek compensation when a duty is breached. This conflict between a beneficiary’s right and the settlor’s desire to protect a trustee has been examined in a few recent court cases. The key issue facing the court was whether to uphold an exemption clause.

Read: Minimize executor liability

Case #1: Clause not upheld

In Steven Thompson Family Trust v. Thompson, the beneficiaries of a trust objected to payments made by the trustee when obtaining accounting advice. The trust owned 50% of the shares of a family business that had received a buyout proposal. The beneficiaries alleged the accountant had a conflict of interest, since he had acted for both parties to the proposal. The trustees felt they were protected by two clauses in the trust deed:

1. “The Trustees shall be fully indemnified out of the assets in the trust fund from and against any liabilities, costs, charges and expenses arising because for their mistakes or errors in judgment made by them in good faith and in the exercise of due care and diligence in connection with any business carried on by them as Trustees of this Trust and shall not be liable to the Settlor or his Estate or any of the beneficiaries of this Trust by reason of any such mistake or error in judgment.”

And:
2. “All determinations which the Trustees are authorized to make and all powers and discretions which are given to the Trustees to exercise, shall be made and exercised by them in what they consider to be the best interests of the beneficiaries. They are absolute and are not to be controlled or reviewed by any beneficiaries, Court or tribunal.”

In his judgment, Justice McCarthy wrote: “an exculpatory clause cannot be a license to a trustee to act in any manner he wants.” The judge ordered the trustee to reimburse most of the disbursements and then listed four fundamental areas where an exemption clause cannot prevent a beneficiary from suing:

  1. failing to exercise a discretion provided to him or her in the trust deed;
  2. acting dishonestly;
  3. failing to exercise the level of prudence expected of a reasonable businessperson; and
  4. failing to hold an even balance between the beneficiaries or acting in a manner prejudicial to the interest of the beneficiaries.

Read: How to remove an executor

Although this is an Ontario case, the law appears to be similar in the other common law-provinces.

Court case #2: Clause not upheld

Fox v. Fox Estate is another case where a trustee’s discretion was reversed by the court, despite the presence of an exemption clause. A testator named his widow, Miriam, as the trustee of a testamentary trust. Under the terms of the trust, the assets were to be enjoyed by Miriam and her only son Walter. Upon their deaths, the assets were to be given to Walter’s children.

But Miriam also had the right to distribute the assets to Walter’s children while she and Walter were still alive. And she eventually did just that, giving them most of the assets — preventing Walter from inheriting. One of her primary motivations was to punish Walter for marrying outside the Jewish faith.

Walter took Miriam to court in a bid to remove her as a trustee and return the assets to the trust. Miriam argued the court could not review her decision, as the will creating the Trust contained the following clause:

“… to pay such amount or amounts as my Trustee may, in its absolute discretion, consider advisable from time to time to or for the benefit of my said son’s issue or such one or more of them as my Trustee may select from time to time.”

In other words, she felt her ability to pay capital to the children was absolute. The court disagreed, holding that a trustee must act in good faith and be fair to all beneficiaries. In this case, the exercise of discretion was based on considerations the court felt were irrelevant and improper.

Read: Executor duties burdensome

Case #3: Clause upheld

Some provinces appear to provide protection for a trustee who is in breach of duty, but acted in good faith, and where damages were nominal.  The Ontario Trustee Act, for example, provides that where a trustee has acted honestly and reasonably, the court may relieve him or her from personal liability. Other provinces give limited protection for investment decisions.

Villa v. Villa is a good example of the application of this legislation. Enzo Villa had been power of attorney for his mother. His brother Renzo argued that Enzo had comingled their mother’s assets with his own, breaching his duty as a fiduciary. Renzo further argued that Enzo should not receive compensation for acting as a trustee.

The court agreed there had been a breach of duty, but said Enzo’s action was not malicious, noting that he returned his mother’s funds to her estate with no loss. The court therefore excused the trustee from liability.

Read: When an executor declines

In conclusion, while exemption clauses are often honoured by the courts, there are limitations. If you have clients who want to incorporate these clauses in their wills or trusts, or who are trustees planning to act on their authority, advise them to seek legal advice to ensure they understand their limits.

Keith Masterman, LLB, TEP is vice-president, Tax, Retirement and Estate Planning at CI Investments. He can be reached at kmasterm@ci.com.
Originally published on Advisor.ca

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