Articles – Page 6 – Law Offices of Randolf Krbechek

Trustee’s Foreclosure Sale Is Valid, Despite Substantial Error in Opening Bid

A recent case illustrates the need for a beneficiary to exercise care when making a bid at a trustee sale. In Biancalana v. TD Service Company (Oct. 31, 2011) 2011 DJDAR 15972, the secured debt was $219,105. However, due to error by the beneficiary, the trustee was instructed to make an opening bid of only $21,894. “The auctioneer was not instructed by TD to make any further because of the property over above the opening bid.”

The buyer made a successful bidder $21,896. A day later, the beneficiary discovered the error, and instructed the trustee not to issue a trustee’s deed to the buyer. The buyer sued to compel the trustee to issue a deed for the sales price. The court of appeal held in favor of the buyer, rejecting the beneficiary’s argument that there had been a “procedural defect” in the sale.

The Court of Appeal explained the nonjudicial foreclosure process as follows. “The purposes of this comprehensive scheme are threefold: (1) to provide the creditor/beneficiary with a quick, inexpensive and efficient remedy against a defaulting debtor/trustor; (2) to protect the debtor/trustor from wrongful loss of the property; and (3) to ensure that a properly conducted sale is final between the parties and conclusive as to a bona fide purchaser.”

The court rejected the argument that the sale was not “bona fide” because of the substantial difference between the fair market value for the property and the opening bid. (The successful buyer was the only bidder at the sale.) “Mere inadequacy of price, absent some procedural irregularity that contributed to the inadequacy of price of otherwise injured the trustor, is insufficient to set aside a nonjudicial foreclosure sale.”

The court distinguished the decision in Millennium Rock Mortgage, Inc. v. T.D. Service Co. (2009) 179 Cal.App.4th 804. In Millennium Rock Mortgage, the auctioneer was set to sell two properties on the same street in Sacramento. “The script prepared for the 13th Avenue auction contained the proper trustee sale number and legal description of the property, but due to a clerical error, listed the address for the Arcola Avenue property, rather than the 13th Avenue property.”

The Millennium Rock Mortgage sale was reversed for the following reasons. “”The auctioneer called out the legal description and credit bid applicable to one property, while announcing the street address of a different property. This created a fatal ambiguity in determining which property was being auctioned. Due to the contradictory descriptions of the property, the auctioneer’s mistake went to the heart of the sale. Since irregularity, gross inadequacy of the price, and unfairness were all abundantly present, the sale was voidable at the option of the trustee.”

No such facts were present in Biancalana. “The beneficiary’s servicing agent miscalculated the amount owed on the subject property … This error, which was wholly under the agent’s control and arose solely from the agent’s own negligence, falls outside the procedural requirements for foreclosure sales described in the statutory scheme.”

“In the instant case, TD was acting as the beneficiary’s agent in preparing the property for the foreclosure sale. It submitted the incorrect credit bid to the auctioneer, and twice confirmed the incorrect bid when the auctioneer called to inquire just prior to the sale.”

“Consequently, the mistake was made by TD in the course and scope of its duty as the beneficiary’s agent, not by the auctioneer as in Millennium Rock. The auctioneer simply announced the bid submitted by TD. The error was wholly under TD’s control and arose solely from its negligence … As a result, there was no procedural irregularity in the foreclosure sale and TD’s motion for summary judgment should have been denied.”

The moral of the story – a beneficiary should always be diligent to confirm the proper amount of the opening bid at a foreclosure sale, or suffer the loss.

Biancalana v. TD Service Company (Oct. 31, 2011) 2011 DJDAR 15972

Strict Compliance Regarding Three-Day Notice Essential for Eviction Proceeding

A recent case reinforces the necessity to comply with the technical requirements for prosecuting an unlawful detainer complaint in California. [Commonly known as an eviction.] Specifically, the issue at trial was whether the three-day notice had been served properly. The trial court held that service was defective. This was reversed on appeal, based on the statutory presumption arising from service by a registered process server.

The take away rule is that you should always have a registered process server serve the three-day notice. If you do not, make sure that the person who effected service of the three-day notice is present in court to testify on behalf of the landlord.

The situation in Palm Property Investments, LLC v. Yadegar (2011) 194 Cal.App.4th 1419 involved years of unpleasant litigation. In 2002, the “penthouse apartment” was been leased out for $3,500 per month. The rent was later increased slightly, followed by a third addendum in 2003 which reduced the rent to $32,000 per year, subject to rent being prepaid one year in advance.

The prior owners had engaged in bitter litigation with the tenant. The landlord was not successful in its prior eviction lawsuit, and was ordered to pay $109,062 in attorney’s fees to the tenant. The landlord took that matter up on appeal, lost, and was ordered to pay a further $70,770 in attorney’s fees to the tenant.

[No, I am not exaggerating. These are the dollar amounts recited in the appellate decision.]

Not surprisingly, the tenant applied the judgment amount to offset future rent payments. Thereafter, the property went into foreclosure and was sold to a third party, who then sought to enforce the lease against the tenant. The new owner filed an unlawful detainer action, asserting that the property was held on a month-to-month tenancy, with rent payable amount of $3,500 per month.

The new owner lost at trial. Specifically, the “the trial court sustained the [tenant’s] objection to the admission of the proof of service of the three-day notice and found that appellant failed to meet its burden to show that the notice was properly served.”

As discussed below, this decision was reversed on appeal. The appellate court made the following observations regarding the unlawful detainer process in California.

“Unlawful detainer is a unique body of law and its procedures are entirely separate from the procedures pertaining to civil actions generally … An unlawful detainer action is a statutory proceeding and is governed solely by the provisions of the statute creating it. As special proceedings are created and authorized by statute … the statutory procedure must be strictly followed.”

Importantly, “proper service on the lessee of a valid three-day notice to pay rent or quit is an essential prerequisite to a judgment declaring a lessor’s right to possession under section 1161, subdivision 2. A [landlord] must allege and prove proper service of the requisite notice. Absent evidence the requisite notice was properly served pursuant to section 1162, no judgment for possession can be obtained.”

In the case on appeal, the three-day notice had been served by a registered process server. The appellate court cited to Evidence Code section 647, which provides that “the return of a process server registered pursuant to Chapter 16 [] of Division 8 of the Business Professions Code upon process or notice establishes a presumption, affecting the burden of producing evidence, of the facts stated in the return.”

The court then reversed the trial court for the following reasons. “Where service is carried out by a registered process server, Evidence Code section 647 applies to eliminate the necessity of calling the process server as a witness at trial. This conclusion is consistent with the purpose of the unlawful detainer procedure to afford a relatively simple and speedy remedy for specific landlord-tenant disputes …

“The trial court erred by failing to apply the evidentiary presumption afforded by Evidence Code section 647. The excluded proof of service established that a registered California process server served the three-day notice …

“As explained in Evidence Code section 604, ‘the effect of a presumption affecting the burden of producing evidence is to require the trier of fact to assume the existence of the presumed fact unless and until evidence is introduced which would support a finding of its nonexistence, in which case the trier of fact shall determine the existence or nonexistence of the presumed fact from the evidence and without regard to the presumption. Thus, the [tenants] were required to come forth with evidence – beyond their answer – in order to overcome the presumption …

“The [tenants] offered no evidence to show that they were not properly served and instead relied on their answer and appellant’s asserted failure to satisfy its burden of proof. On retrial, they will have the opportunity to present evidence to rebut the presumption afforded by Evidence Code section 647 … [The landlord] is awarded its costs on appeal.”

Always be careful with your three-day notices. Make sure they comply with the requirements established by law, and make sure that they have been properly served on the tenant. Otherwise, the landlord will not prevail at trial.

Palm Property Investments, LLC v. Yadegar (2011) 194 Cal.App.4th 1419

The Long-Standing Connection Between Real Estate Law and Probate

I am reading a series of lectures delivered in 1972 by S.F.C. Milsom and collected in The Legal Framework of English Feudalism (Cambridge University Press 1976). The text is difficult, as it frequently refers to rights, remedies, and procedures that long ago ceased to be relevant in the law of English-speaking nations.

Still, as I read along, I can see contours develop that explain how the law evolved from the year 1200 forward. The lecturer concentrates on legal writings from the early 1200s, when England was still operating under a feudal system.

Scholars tell us that the law of real property and the law of descent (i.e., succession to real property) were closely connected, at least through 1850. So intimately connected that both topics were covered in one treatise, which focused on grants in real property.

Considering the feudal roots of English law, this connection makes sense. The feudal system was dependent on duties and obligations owed by the holder of a tenement to his lord. (Note that I did not say “tenant” – this word implies a more modern relationship.)

Feudal duties were greater than those relating to (i) payment of rent and (ii) the maintenance and use of the real property, which are the predominant issues in contemporary landlord-tenant relationships.

Obviously, the lord wanted to have control over the person in possession of his property, so that he could obtain proper satisfaction of the obligations owed in connection with the land.

Listen to Prof. Milsom’s explanation. “Conveyance, inheritance, litigation: for us these are distinct processes transferring or determining abstract rights. The ancient reality, preserved into later times only in the formalities of copyhold, saw all three as preliminaries to what mattered: the lord’s acceptance of this tenant …

“The lord must consent lest he be forced to receive homage for his fee from an enemy or some otherwise unsuitable person … Only the lord’s acceptance can make a tenant.”

When you consider the feudal obligations, and the impact that the death of the tenement holder would have on the discharge of these obligations, you can understand why real property law and the law of inheritances were closely connected.

Another matter of interest is the shift from trial by combat to trial by jury. Again, with consideration to the substantial impact of the law real estate law as it pertains to a feudal society, the procedural shift (who is the trier of fact?) makes sense. In a dispute between a tenant and his lord, the lord always could be expected to produce a better, stronger champion for his cause. Thus, the deck was stacked against the tenant, and preservation of fairness required that the dispute be resolved by recourse to peaceful means, such as a jury.

Estate of Giraldin – Trustee Does Not Owe Duties Future Beneficiaries of Estate Planning Trust

This author has often complained that the trust laws have not kept pace with modern practice as it relates to estate planning. Estate planning trusts (a.k.a. “living trust”) are used as will substitutes. The rules pertaining to wills are well known, and are established by case and by code.

In contrast, the statutory rules relating to estate planning trusts come from general trust law, which law was developed in response to traditional property management trusts. Yet, the property management trust is functionally different from an estate planning trust. Typically, a property management trust manages property for benefit of current third-party beneficiaries. In contrast, an estate planning trust does nothing until the death of the trustor, when the trust assets are distributed according to the “trust” agreement.

The recent decision in Estate of Giraldin (Sept. 28, 2011) 2011 DJDAR 14642 fully reinforces the proposition that an estate planning trust is a will substitute, and that no duties are owed to the heirs or beneficiaries prior to the death of the trustor. The same result applies in connection with a will – an heir cannot sue on the ground that the testator sold or gifted property owned by the testator before death, such that the property was not included in the estate after death.

Bill Giraldin was a savvy investor, with a fortune worth $6,000,000 or more before his death. He placed his assets into his estate planning trust. The trust was fully revocable and/or amendable by him during his lifetime. He appointed one of his sons to act as trustee. (Nine children qualified as future beneficiaries under the trust. Later, four filed suit.)

Following the instruction of the father, the son invested $4,000,000 in a company called SafeTzone. Thus, one son (Tim) was the trustee of the trust; at the instruction of his father, Tim invested a substantial amount of his father’s wealth in Tim’s company.

Needless to say, the SafeTzone investment went badly, “and by the time Bill died in May of 2005, the family trust’s stake in the company was worth relatively little.” In response, four children sued Tim for breach of his fiduciary duties, alleging that the investments he made as trustee during his father’s lifetime were in violation of the fiduciary duties owed to them as successor beneficiaries under the trust.

Comment – The court found that Bill invested in SafeTzone of his own free will, and was not unduly influenced by Tim, the trustee.

Tim lost badly at trial, but the appeal court fully vindicated him. Specifically, the court of appeal focused “on the question of whether respondents have standing to maintain claims for breach of fiduciary duty and to seek an accounting against [Tim] based upon his actions as trustee during the period prior to Bill’s death.”

The court’s analysis was as follows. “In this case, the family trust was revocable by Bill during his lifetime, and thus Tim’s duties as trustee were owed solely to Bill, as settlor, and not to respondents …As explained by our Supreme Court, ‘property transferred to, or held in, a revocable inter vivos trust is deemed the property of the settlor.’”

The court continued. “A settlor with the power to revoke a living trust effectively retains full ownership and control over any property transferred to that trust. Any interest that beneficiaries of a revocable trust have in trust property is merely potential and can evaporate in a moment at the whim of the settlor.”

As explained by the court, “statutes recognize that when property is held in a revocable trust, the settlor and lifetime beneficiary has the equivalent of full ownership of the property. Thus, during Bill’s lifetime, Tim’s duties as trustee were owed solely to Bill – the settlor with the power to revoke – and not to respondents. Instead, respondents occupied a position analogous to heirs named in a will.

“Revocable living trusts are merely a substitute for a will. And just as a will ‘speaks’ only as of the date of the testator’s death, a revocable trust confers enforceable property interests to the beneficiaries only at the time it becomes irrevocable. Prior to that time, those beneficiaries have no rights to the trust property, and thus no say in how it is managed.”

The court made plain its position. “In our view, the statute supports the conclusion beneficiaries lack standing – ever – to assert claims based upon conduct occurring during the settlor’s lifetime.”

Also, Tim owed no “duty” to stop his father from making an “unwise” investment. “That was not a claim Bill himself could have brought. ‘Stop me before I do something I’ll regret’ is not a recognized cause of action, even against the trustee of one’s revocable trust …

“Bill remained legally entitled to do what he wanted with the trust assets – which were effectively his own property – including doing financially risky or downright stupid things. No one – including Tim – had the authority to stop him. Thus, in the absence of an adjudication of Bill’s incompetency, we cannot discern any legal basis on which Bill might have justified holding Tim liable for carrying out Bill’s own wishes with regard to the assets in the family trust – even if those wishes appeared to be objectively unreasonable.”

Such a sound and well-reasoned opinion is welcome in an area that suffers from needless confusion.

Estate of Giraldin (Sept. 28, 2011) 2011 DJDAR 14642

Weinberger v. Morris – Why Doesn’t the Merger Doctrine Extinguish Many Living Trusts?

This writer has commented regularly that the modern estate planning trust is a legal fiction. A convenient legal fiction, mind you, but still a legal fiction.

The estate planning trust (also known by the unfortunate term, “living trust”) is a merely a will substitute. It takes effect – meaning, it provides a benefit to a third party – upon the death of the settlor. That’s precisely what a will does – it transfers property at death. The difference is, the administration of a decedent’s will is subject to the jurisdiction of the probate court, whereas many estate planning trusts operate extra-judicially.

Remember the essential legal premise of an estate planning trust – one person (sometimes a married couple) acts simultaneously as the settlor (trustor), trustee, and beneficiary. The same person retains the full power to amend or revoke the trust, and/or to withdraw all of the assets for his or her own benefit.

Enter the merger doctrine. The merger doctrine is conventionally considered a principle of real estate law. It holds that temporary (or partial) interests in real property become joined – unified – when held by one person. The legal doctrine (whether or not intended) causes the partial interest to merge into the greater fee interest.

Thus, when one person is both the tenant and the landlord at the same time, the lease “merges” into the fee ownership, and ceases to have legal significance.

Likewise, when the owner of real property is simultaneously the beneficiary of a deed of trust encumbering the property, the beneficial interest under the deed of trust merges into the fee ownership, and is no longer independently enforceable.

One more common example. If the same person holds a fee interest in real property and also holds an easement against the property, the easement will merge into the fee ownership, and cease to function for legal purposes as an easement (at least while the ownership is unified).

Why doesn’t the same result occur with estate planning trusts? We know that real estate trusts have their genesis in real estate law, starting in about 1250 in England. (Other Continental legal systems do not recognize trusts.)

When one person is simultaneously the grantor, the grantee, and the beneficiary, why don’t the legal interests merge so that the trust is disregarded? That’s an interesting question: a recent case brushes against it, but fails to consider the full impact of this analysis.

Thus, we find the following discussion in Weinberger v. Morris (2010) 188 Cal.App.4th 1016:

“Robert’s argument implicates the ‘merger doctrine,’ which may be summarized as follows: when the sole trustee of a trust and the sole beneficiary of the trust become one-and-the-same person, the duties of the person, in his or her role as trustee, and the interests of the person, in his or her role as beneficiary, ‘merge,’ meaning that the trust terminates as a matter of law, and the trust’s assets irrevocably vest in the beneficiary. (See Ammco Ornamental Iron, Inc. v. Wing (1994) 26 Cal.App.4th 409, 417.)

“The determination whether the duties of a trustee and the interests of a beneficiary have become united in a single person is a question of law resolved by construction of the trust instrument.”

(Interesting observation by the court of appeal. Why isn’t the legal construction of the document an issue of law to be resolved by the court?)

Continued the court. “In the current case, the trial court rejected Robert’s claims for the following stated reasons: ‘The Sue Weinberger Trust did not terminate upon Sue Weinberger’s death. The merger doctrine does not apply. In interpreting Sue Weinberger’s intent, as expressed in the Sue Weinberger Trust, the Sue Weinberger Trust continued until there was a final distribution of the assets of the Sue Weinberger Trust …

“Upon Sheila Weinberger’s death the real property continued to remain in the Sue Weinberger Trust and was distributed by Lee Davis acting as trustee of the Sue Weinberger Trust to himself. Upon Lee Davis’ distribution of the real property, the Sue Weinberger Trust terminated.” Based thereon, the court concluded that the trust interests had not merged at an earlier time.

To me, that’s a legal conclusion: it’s not a matter for resolution strictly by factual reference to the decedent’s estate planning trust. The reality is that conventional trust law is applied carelessly in the case of estate planning trusts, because the round peg doesn’t fit the square hole. We advance the fiction of estate planning “trusts,” with the result that probate administration is avoided. We need a coherent body of law controlling the treatment of estate planning trusts, because the Restatement of Trusts does not fit well.

In Weinberger, the court offered no analysis as to why the merger doctrine did not apply, as a matter of law. The question is profound, and worthy of further thought.

Weinberger v. Morris (2010) 188 Cal.App.4th 1016

Paul Ronald vs. Bank of America – Court Closes Door on Another Exotic Theory of Mortgage Liability

The trend in the courts has been to reduce the legal theories available to persons who suffered losses during the mortgage meltdown. Traditional theories based on breach of contract, fraud, and promissory estoppel, remain viable causes of action.

Yet the more exotic theories seeking to impose liability have been narrowed and often eliminated. Such is the case in Bank of America v. Superior Court (Paul Ronald) (August 25, 2011) 2011 DJDAR 12942. In the Paul Ronald action, the plaintiff sought to hold Bank of America, as successor-in-interest to Countrywide Mortgage, liable for the general decline in property values triggered by Countrywide’s bad lending practices. The court would have none of it.

According to the complaint, “Countrywide’s founder and CEO, Angelo Mozilo determined that Countrywide could not sustain its business ‘unless it used its size and large market share in California to systematically create false and inflated property appraisals throughout California. Countrywide then used these false property valuations to induce Plaintiffs and other borrowers into ever-larger loans on increasingly risky terms.’

The complaint continued. “Mozilo knew ‘these loans were unsustainable for Countrywide and the borrowers and to a certainty would result in a crash that would destroy the equity invested by Plaintiffs and other Countrywide borrowers. Mozilo and others at Countrywide ‘hatched a plan to ‘pool’ the foregoing mortgages and sell the pools for inflated value. Rapidly, these two intertwined schemes grew into a brazen plan to disregard underwriting standards and fraudulently inflate property values.’”

Unfortunately, those allegations describe the general problems that swept through the mortgage industry. “This writ petition relates solely to plaintiffs’ cause of action for fraudulent concealment.”

The trial judge noted the scope of the issue presented to it. On January 11, 2011, the matter came on for hearing. At the outset, the trial court indicated, “the issues presented by the many plaintiffs in this case as against their current mortgage lender and/or loan servicer are part of a larger socioeconomic problem that confronts our society in California and all of the other states in this union, an issue of great concern to the U.S. Congress, state Legislature, and the bank regulators, given that in our banking system the banks are insured by the full faith and credit of the United States government for all intents and purposes, so the continued solvency of the banking industry as a whole is a matter of intense interest to the U.S. Congress as well as the central bank.”

That’s the real problem. This is not a matter that should be dumped into a trail court. Our entire justice system has shrugged its shoulders and refused to impose liability on anyone for the manipulations that developed into the mortgage crisis. Shame on us.

It seems there are some 20 cases rolling around in Los Angeles and Orange Counties based on the same charging allegations. As explained by the court of appeal, “We conclude the plaintiffs/borrowers cannot state a cause of action against Countrywide for fraudulent concealment of an alleged scheme to bilk investors by selling them pooled mortgages at inflated values, the demise of which scheme led to devastated home values across California.”

Explained the court, “we conclude that while Countrywide had a duty to refrain from committing fraud, it had no independent duty to disclose to its borrowers its alleged intent to defraud its investors by selling them mortgage pools at inflated values.”

More specifically, “Due to the generalized decline in home values which affects all homeowners (borrowers of Countrywide, borrowers who dealt with other lenders, and homeowners who owned their homes free and clear), there is no nexus between Countrywide’s alleged fraudulent concealment of its scheme to bilk investors and the diminution in value of the instant borrowers’ properties.”

Further, the court noted that the complaint embraced a general decline in property values across the state. “Irrespective of whether a homeowner obtained a loan from Countrywide, or obtained a loan through another lender, or whether a homeowner owned his or her home free and clear, all suffered a loss of home equity due to the generalized decline in home values. That being the case, there is no nexus between the alleged fraudulent concealment by Countrywide and the economic harm which these plaintiffs/borrowers have suffered.”

The final holding – “We merely conclude plaintiffs failed to state a cause of action against Countrywide for fraudulent concealment of its alleged scheme to bilk investors by selling collateralized mortgage pools at an inflated value, the demise of which led to a generalized decline in California residential property values.”

This writer is as upset about the mortgage debacle, and the refusal of governmental authorities to take action, as anyone else. But the right place for action is the Department of Justice, or the Securities and Exchange Commission, not a trial court.

Most commendable is the speed at which the court issued this decision. The lawsuit was filed in March 2009. The trial court issued its order dismissing the claim for fraudulent concealment on January 11, 2011. This writ proceeding was resolved by decision entered on August 25, 2011. Justice is not always delayed.

Bank of America v. Superior Court (Paul Ronald) (August 25, 2011) 2011 DJDAR 12942

Tracing the Origin of the English Trust to the Year 1350

Here is the clearest explanation I have found to date regarding the rise of trusts in English law. Bear in mind that England was still a feudal system in the year 1350. Also bear in mind that a court of law could not enforce a trust – such jurisdiction lay within the court of equity, which was still developing.

Profs. Maitland and Montague take the stage with the following concise statement of legal history.

“From the field of the common law the chancellor was slowly compelled to retreat … It seems possible that this nascent civil jurisdiction of the chancellor would have come to naught but for a curious episode in the history of our land law.

“In the second half of the fourteenth century many causes were conspiring to induce the landholders of England to convey their lands to friends, who, while becoming the legal owners of those lands, would, nevertheless, be bound by an honorable understanding as to the uses to which their ownership should be put. There were feudal burdens that could thus be evaded, ancient restrictions which could thus be loosened.”

There it is. The wealthy landowners sought to avoid the feudal burdens owed to their lords. The Chancellor, acting on behalf of the king, recognized these arrangements.

“The chancellor began to hold himself out as willing to enforce these honorable understandings, these ‘uses, trusts, or confidences,’ as they were called, to send to prison the trustee who would not keep faith.”

Add Maitland and Montague, “It is an exceedingly curious episode. The whole nation seems to enter into one large conspiracy to evade its own laws, to evade laws which it has not the courage to reform. The Chancellor, the Judges, and the Parliament seem all to be in the conspiracy.”

“And yet there is really no conspiracy: men are but living from hand to mouth, arguing from one case to the next case, and they do not see what is going to happen. Too late the king, the one person who had steadily been losing by the process, saw what had happened. Henry VIII put into the mouth of a reluctant Parliament a statute [the Statute of Uses, enacted in 1535[ which did its best – a clumsy best it was – to undo the work.”

“But past history was too strong even for that high and mighty prince. The statute was a miserable failure. A little trickery with words would circumvent it. The chancellor, with the active connivance of the judges, was enabled to do what he had been doing in the past, to enforce the obligations known as trusts.”

How fascinating is this history to our current law of trusts. The “traditional” trust arose during a 50-year period, as the wealthy sought to avoid the obligations of feudal society. They employ an exceedingly flexible device, which accomplishes its purpose, but only because many learned people look away during this period.

So also it is with our current law of “living trusts.” These estate planning trusts came to prominence during the last 50 years. They suffer from an intellectually deficient legal platform; it makes little sense to contend that one person can simultaneously serve as trustor, trustee, and beneficiary.

Such trusts exist solely to transfer property at death, and solely to avoid the jurisdiction of the probate court. And yet, with a collective nod, we in the legal profession have said, “Yes, this quasi-will should be valid, and we should honor it, notwithstanding its failure to comply with centuries of law relating to wills.”

The old is new again.

Maitland and Montague, A Sketch of English Legal History (G. P. Putnam’s Sons 1915)

Bellows v. Bellows – Further Proof That Estate Planning Trusts Are Not Always a Good Idea

The fees in a probate case trigger a reaction that sometimes borders on panic. Part of the reasoning behind the use of an estate planning trust (sometimes referred to as an inter vivos trust) is that the trust will save on attorney’s fees.

However, as I tell clients, it only works if the beneficiaries get along. If not, the attorney’s fees in a trust dispute will greatly exceed the regular probate fees. A case in point is the recent decision in Bellows v. Bellows (June 13, 2011) 2011 DJDAR 8530. The estate was in the range of $65,000. Under California law, the probate fees would have been around $2,600 (four percent of the estate). Yet the trust litigation has triggered attorneys fees in excess of $20,000, which surely was not the intended result.

The case also stands for the proposition that a trustee cannot demand a release as a condition to making a distribution as required under the trust agreement. (Again, such a release comes part and parcel with a probate, as the court approves all distributions by the executor.)

Here are the facts. “In 2003, Beverly Bellows established the Beverly Bellows trust, naming her and Frederick as cotrustees. As restated in 2005, the trust provided that on her death, the trust assets would be divided equally between Frederick and Donald. Following Beverly’s death in 2008, Donald requested distribution of his share of the trust.”

Watch as the wheels start to slip – the two brothers did not get along. “In September 2009, when the distribution had not been made, Donald filed a petition in the probate court pursuant to section 17200 seeking an accounting and distribution of the trust assets. On November 13, the court ordered Frederick to provide an accounting of the trust assets and to distribute one-half of the assets to Donald within 10 days. The order awarded Donald attorney fees in the amount of $9,800.”

Ouch. That fee award – long before the fees on appeal – was four times the total probate fees, had the estate been subject to probate. But it only gets worse, as Donald also claimed that “Frederick had improperly deducted from the remaining corpus of the trust approximately $13,000 of his own attorney fees prior to dividing the trust assets in half.”

Never forget Molly Ivins’ first rule of holes – When you find yourself in one, stop digging. These two brothers amassed more than $25,000 in collective attorney’s fees, before they ever took the matter up on appeal.

“On February 23, 2010, Donald filed a motion to compel compliance with the court’s November 2009 order. Frederick opposed the motion and filed a cross-motion for abatement and for attorney fees and sanctions.”

Here’s the holding on appeal. “There is no dispute that under the terms of the trust as interpreted by the court in its November 2009 order, Frederick was required to distribute to Donald one-half of the trust assets. Under the plain language of [Probate Code] section 16004.5, subdivision (a), Frederick could not condition the payment on a release of liability . . .

“There was no dispute that Donald was entitled to receive from the trust at least $30,376.80, based on Frederick’s own accounting. Frederick, as trustee, was required to make this distribution to Donald without any strings attached. He was not entitled to condition the payment on the release of other claims or demands of the trust beneficiary.

Added the court, “[the statute] permits a trustee to seek a voluntary release or discharge. A release obtained as a condition of accepting payment to which the beneficiary is entitled is in no sense voluntary . . . Frederick could not condition such an agreement on Donald releasing his right to an accounting or of other claims he might have against the trustee. Again, such an interpretation would render subdivision (a) nugatory.”

Finally, the court added that, “subdivision (b)(4) confirms the right of the trustee to withhold any distribution that is reasonably in dispute. In such a case, as subdivision (b)(5) confirms, the trustee may seek instructions from the court, the well-established method of resolving controversies that may arise between trustee and beneficiary . . . What the trustee may not do is extract from the beneficiary an agreement to accept a compromise concerning a disputed issue as a condition of receiving a distribution to which the beneficiary is unquestionably entitled. A trustee may not under any circumstances condition a required distribution on an involuntary release of liability.”

As it looks to this writer, the two brothers spent all of the money on attorney’s fees. That’s a bad result under any standard.

Bellows v. Bellows (June 13, 2011) 2011 DJDAR 8530

William Penn Partnership – There are No Winners

The Delaware Supreme Court recently decided William Penn Partnership v. Saliba, a case in which there are no winners. In the case, one of the members breached his fiduciary obligations, but his conduct caused no damage. Nonetheless, the court awarded attorneys’ fees as an “equitable remedy.” In this author’s view, the award distorts the law of equitable remedies, creates uncertainty in the law, and rewards fruitless litigation.

The facts were as follows. The parties were members of a limited liability company called Del Bay Associates, LLC. Del Bay built the Beacon Motel in Lewes, Delaware in 1987, with 66 guest units. Later, some of the members (the Lingos) wanted to “end their business relationship” with the other members.

The Lingos concocted a story about their need to dissolve the limited liability company and sell the motel to fulfill obligations under a section 1031 tax-deferred exchange. Explained the court, “On June 10, 2003, the Lingos convinced Hoyt to sign the contract immediately so they could present it to the JGT board. The Lingos told Hoyt that if he did not sign the contract, JGT might back off.”

The court found that the representations were not true. Instead, the Lingos controlled both sides of the transaction – seller and buyer. For example, “The Lingos manipulated the sales process through misrepresentations and repeated material omissions such as (1) imposing an artificial deadline justified by ‘tax purposes;’ (2) failing to inform Saliba and Ksebe that they were matching their offer by assuming the existing mortgage; [and] (3) failing to inform Saliba and Ksebe that they had already committed to selling the property to JGT, an entity the Lingos controlled.”

So, we have a transaction in which one member abused his fiduciary duties to the other members. More bluntly, “The Lingos here acted in their own self interest by orchestrating the sale of Del Bay’s sole asset, the Beacon Motel, on terms that were favorable to them. By standing on both sides of the transaction – as the seller, through their interest in and status as managers of Del Bay, and the buyer, through their interest in JGT– they bear the burden of demonstrating the entire fairness of the transaction.”

Such proof of “entire fairness” was a burden the Lingos could not meet. “The concept of entire fairness consists of two blended elements: fair dealing and fair price. Fair dealing involves analyzing how the transaction was structured, the timing, disclosures, and approvals. Fair price relates to the economic and financial considerations of the transaction. We examine the transaction as a whole and both aspects of the test must be satisfied; a party does not meet the entire fairness standard simply by showing that the price fell within a reasonable range that would be considered fair.”

In fact, the price did fall with “a reasonable range.” The buyer paid $6,625,000 for the Beacon Motel, while the trial court found that the “retained appraisal valued the property at $5,480,000.” Thus, the price paid by the buyer was greater than the fair market value for the motel, meaning that the non-controlling members suffered no compensable injury.

The court found that this result was not satisfactory. “Merely showing that the sale price was in the range of fairness, however, does not necessarily satisfy the entire fairness burden when fiduciaries stand on both sides of a transaction and manipulate the sales process.”

OK, but we have no basis on which to award damages. “Saliba and Ksebe were left without a typical damage award because the Court’s appraisal of the property came in at a value lower than the sale price.”

What to do? This court decided to award attorneys’ fees to the non-controlling members. “The Chancellor concluded it would be unfair and inequitable for Saliba and Ksebe to shoulder the costs of litigation arising out of improper prelitigation conduct attributable to the Lingos that amounted to a violation of their fiduciary duties.”

Although there was no statutory or contractual basis for an award of attorneys’ fees, the Delaware Supreme Court held that “The Chancellor’s decision to award attorneys’ fees and costs was well within his discretion and is supported by Delaware law in order to discourage outright acts of disloyalty by fiduciaries. Absent this award, Saliba and Ksebe would have been penalized for bringing a successful claim against the Lingos for breach of their fiduciary duty of loyalty.”

Which perhaps would have been the better result. This litigation was surely driven by the attorneys, not by the injured parties, with substantial attorneys’ fees. The court’s award of attorneys’ fees on equitable grounds will only foster litigation in the future, which is hardly an optimal result.

William Penn Partnership v. Saliba (Del. Supreme Court Feb. 9, 2011) 2011 Del. LEXIS 91

Trust Does Not Create Contractual Rights in Favor of Beneficiary

The courts are increasingly faced with the cases involving the interpretation and enforcement of estate planning trusts. In Diaz v. Bukey (May 10, 2011) 2011 DJDAR 6650, the court concisely framed the dispute:

“The beneficiary of a trust petitions to remove her sister as trustee of their parents’ trust. The trustee responds by seeking to compel arbitration of their dispute as provided by the trust documents.

“Though the sisters are beneficiaries of the trust, neither was party to any agreement that such disputes would be resolved by arbitration.

“Here we hold that the beneficiary of a trust who did not agree to arbitrate disputes arising under the trust may not be compelled to do so.”

It seems that the trust was a standardized form. It included the following provision:

“Any dispute arising in connection with this Trust, including disputes between Trustee and any beneficiary or among Co–Trustees, shall be settled by the negotiation, mediation and arbitration provisions of that certain LawForms Integrity Agreement (Uniform Agreement Establishing Procedures for Settling Disputes ) entered into by the parties prior to, concurrently with or subsequent to the execution of this Trust. In the event that the parties have not entered into a LawForms Integrity Agreement (Uniform Agreement Establishing Procedures for Settling Disputes ), then disputes in connection with this Trust shall be settled by arbitration in accordance with the rules of the American Arbitration Association.”

(Of course, someone needs to produce the “integrity agreement.”)

On appeal, “Bukey contends that Diaz is a third party beneficiary of the Trust and she is equitably estopped from denying her obligation to arbitrate.” Further, “Bukey relies on a trio of cases in which appellate courts have characterized a trust as a contract between a trustor and trustee.”

Explained the court of appeal, “We do not find these cases persuasive for several reasons. First, they are factually inapposite. The controversy here involves a dispute between the trustee and a beneficiary over the internal affairs of the Trust.”

Also, “In Saks v. Damon Raike & Co. (1992) 7 Cal.App.4th 419, the court rejected the argument that a trust was a third party beneficiary contract. The court said: ‘The rules governing the respective rights of action of trustees and beneficiaries of express trusts are not the same as those generally applicable to promisees and third party beneficiaries’ . . .

“The general right of a third party beneficiary to sue on a contract made expressly for his or her benefit has no application where a trust has been created in favor of that party, and the contract in question is between the trustee and an agent of the trustee.”

The court concluded that the arbitration provision was not enforceable because the trust was a relationship, not a contract (which is the correct result). “As a matter of law, the trusts at issue here were not contracts.”

“A beneficiary of a trust receives a beneficial interest in trust property while the beneficiary of a contract gains a personal claim against the promissor. Moreover, a fiduciary relationship exists between a trustee and a trust beneficiary while no such relationship generally exists between parties to a contract.”

“The legal distinctions between a trust and a contract are at the heart of why the beneficiaries cannot be required to arbitrate their claims against the defendants. Arbitration rests on an exchange of promises. Parties to a contract may decide to exchange promises to substitute an arbitral for a judicial forum. Their agreement to do so may end up binding (or benefitting) nonsignatories.

“In contrast, a trust does not rest on an exchange of promises. A trust merely requires a trustor to transfer a beneficial interest in property to a trustee who, under the trust instrument, relevant statutes and common law, holds that interest for the beneficiary.”

So, we have the correct trust litigation results for the correct reasons.

Diaz v. Bukey (May 10, 2011) 2011 DJDAR 6650, 2011 WL 1759798