A second recent opinion reinforces the fundamental rule that an inter-vivos revocable trust is not an entity separate from the trustee.  In Presta v. Tepper, 2009 DJDAR 16603 (Nov. 27, 2009), the court provided the following analysis:

“Two men enter into a real estate investment partnership, each acting in his capacity of trustee of a family trust.  The question is: who are the ‘partners,’ the men, or the trusts?

“The answer is ‘the men.’  A trust of the type formed by both men in this case is simply a fiduciary relationship, governed by the Probate Code, by which one person or entity owns and controls property for the benefit of another.  Such a trust is not an entity separate from its trustee, and cannot independently do anything – it cannot sue or be sued; it cannot enter into agreements; and it cannot fulfill the fiduciary duties of a partner.”

Oh boy.  You can’t say it much more clearly than that.

The litigation followed the death of one of the partners.  The partnership was formed by Ronald and Robert, each of whom signed the partnership agreement on behalf of his respective estate planning trust.  The court made short order of the argument that the trust, not the individual, was the partner.  Said the court.

“We have no trouble concluding, as a matter of law, that it was they, and not their respective ‘trusts,’ who were the partners in the two agreements at issue herein.

“The fundamental flaw in Renee’s argument is that it assumes a trust is an entity, like a corporation, which is capable of entering into a business relationship such as a partnership.  It is not.  It has long been established under California law that an express trust of the type created by Presta and Tepper is merely a relationship by which one person or entity holds property for the benefit of some other person or entity:  A trust is any arrangement which exists whereby property is transferred with an intention that it be held and administered by the transferee (trustee) for the benefit of another.”

The court further explained that the tax status of the trusts did not change its analysis in one iota.  True, the trust had its own taxpayer identification number and true again, the trust was required to report income and file a tax return.  Yet, the court sliced to the heart of the matter, explaining that:

“The tax status of these trusts is nothing more than a reflection of their essential purpose:  to establish a special category of property ownership by which the property is divided between the trustee who holds record title and controls it, and those who are entitled to receive its benefits.

“The fact that the taxing authorities chose to create a separate category for assessing the tax liabilities associated with such properties suggests nothing more than a determination that there are tax liabilities associated with such properties – and that since neither the trustee nor the beneficiaries owns the entirety of the trust property, those liabilities cannot simply be assigned to either of those in their individual capacities.  Nothing in that determination changes the nature of such trust relationships, nor conveys ‘entity’ status upon them.”

Hooray for the court, which got it right on all points.  The popular revocable estate planning trust is not an entity, it is a relationship.  (Of course, the trust also partakes of contract, but many obligations arise outside of the contract.)

A pair of decisions from last month reinforce the fundamental rule that an inter-vivos revocable trust is not an entity separate from the trustee.  The first opinion, 1680 Property Trust v. Newman Trust, 2009 DJDAR 16161 (Nov. 17, 2009) states the rule with elegant simplicity, to wit:

“Unlike a corporation, a trust is not a legal entity.  Legal title to property owned by a trust is held by the trustee.  A trust is simply a collection of assets and liabilities.  As such, it has no capacity to sue or be sued, or to defend an action.”

In 1680 Property Trust, it was alleged that the trustee had made fraudulent statements.  The trustee had died more than one year before the lawsuit was filed.  California law provides that an action against the decedent must be filed within one year from the date of death.  (The one-year rule applies to claims that existed as of the date of death.  If the claim arises subsequent to death, then an action can be filed after the general one-year period.)

To circumvent the application of the one-year rule, plaintiff sought to sue the trust itself.  The court held that there were no such claims against the trust, only claims against the trustee.  And, because the trustee had died more than one year before the lawsuit was filed, the action was barred.

Explained that the court, “It appears that whatever its form, the substance of the claims in this case is for the personal misconduct of the settlor/trustee on behalf of and for the benefit of the trust, that was completed entirely before the settlor/trustee died, and for which the settlor/trustee could have been held personally liable.  The action is one that could have been ‘brought on a liability of the person’ (Code of Civil Procedure section  366.2, subd. (a)), and is based ‘on a debt of the decedent’ even though brought against the successor trustee . . . Section 366.2 was intended to impose a time limit on such claims, regardless of whom the action was brought against.  Accordingly, the claims against Newman Trust are barred by section 366.2.”

Let’s say that again so we all understand it:  An estate planning trust is a legal fiction.  It is not an entity.  Period.  The trust has no separate existence, no matter what promises may be peddled by asset-protection salesman.  For all intents and purposes, the trust and the trustee are identical.

A decision handed down this month involved an all-too-common situation.  In King v.  Johnson, 2009 DJDAR 15871 (Nov. 9, 2009), the husband provided for a testamentary trust.  After the husband’s death in 1991, his widow became the trustee.  The widow later suffered from declining health.  One of the daughters was apparently close to her mother.  The daughter influenced the widow to transfer property out of the trust.

Stop me if this story sounds familiar.  The widow also took out a personal loan secured by the property she transferred out of trust.  When the loan went into delinquency, the lender foreclosed and took title to the property.  Not surprisingly, the daughter benefitted from this arrangement, as she inherited 100% of the widow’s separate property, but held only a 30% interest in the former trust property.

Another child, who was also a beneficiary under the trust, brought an action against daughter based on these facts.  The trial court found that “[daughter] actively participated in [widow’s] breaches of fiduciary duty . . . Specifically, the court found that [daughter] was involved in the transactions that resulted in [widow] transferring property out of the trust without consideration at a time when [widow] was in failing physical and mental health, and that [daughter] exercised undue influence over [widow] with regard to these transactions.”

However, the trial court found that plaintiff lacked standing, because a successor trustee had been appointed.  On appeal, the decision was reversed in favor of the aggrieved beneficiary.

The appellate court explained that, “As a general rule, the trustee is the real party in interest with standing to sue and defend on the trust’s behalf.  Conversely, a trust beneficiary cannot sue in the name of the trust.”

This rule did not preclude the action against the daughter.  Thus, “a trust beneficiary can bring a proceeding against a trustee for breach of trust.  Moreover, it is well established [ ] that a trust beneficiary can pursue a cause of action against a third party who actively participates in or knowingly benefits from a trustee’s breach of trust.”

In this case, a successor trustee had taken office, and he had not sued daughter for her wrongful acts.  The court expressly held that “a beneficiary may bring a claim against a third party who participated in a trustee’s breach of trust, despite the appointment of a successor trustee.”

Explained the court, “Ordinarily, when a third party acts to further his or her own economic interests by participating with a trustee in such a breach of trust, the beneficiary will bring suit against both the trustee and the third party.

“However, it is not necessary to join the trustee in the suit, because primarily it is the beneficiaries who are wronged and who are entitled to sue.  The liability of the third party is to the beneficiaries, rather than to the trustee, and the right of the beneficiaries against the third party is a direct right and not one that is derivative through the trustee.”

Even more, the court held that “evidence of a conspiracy is [not] required in order to hold a third party liable for participating in or benefitting from a trustee’s breach of trust . . . Although the trial court in this case determined that [plaintiff] had not proved the existence of an actual conspiracy between [widow] and [daughter], this is of no consequence to [the beneficiary’s] standing to bring a claim against [daughter] for [her] role as a third-party participant in [widow’s] breach of trust.”

The court also addressed the liability of the daughter for her conduct as de facto trustee after her mother’s death.  During this period, the daughter collected rents for which she did not account.  This conduct also gave rise to a claim against the daughter.

Explained the court, “a trustee de son tort [is] a person who is treated as a trustee because of his wrongdoing with respect to property entrusted to him or over which he exercised authority which he lacked.”

Added the court, “It is a well settled rule in the law of trusts that if a person not being in fact a trustee acts as such by mistake or intentionally, he thereby becomes a trustee de son tort . .  A person may become a trustee by construction, by intermeddling with and assuming the management of property without authority.

“Such persons are trustees de son tort just as persons who  assume to deal with a deceased person’s estate without authority are administrators de son tort.  During the possession and management by such constructive trustees they are subject to the same rules and remedies as other trustees.”

Proof yet again that trusts can be a hotbed for litigation.  The lack of court supervision over an estate can lead family members to take advantage of the situation.  This court drew a firm line against such wrongful conduct.