Even the most prudent and trustworthy of trustees may find themselves a defendant in a lawsuit brought by a beneficiary who is disappointed or disgruntled or both. The volatility of the markets and the natural human instinct to second-guess and ascribe blame when bad things happen can combine to produce such lawsuits. If that occurs, the presence or absence of an exculpatory clause in the trust may end up determining the outcome of the case.

An exculpatory clause is a provision in a will or a trust that limits the liability of the trustee/fiduciary in a specific way. An exculpatory clause will operate to release the trustee/fiduciary from liability for what might have otherwise been a breach of trust.

For example, courts have upheld exculpatory clauses that release trustees from liability for failure to diversify trust assets, for breaches of trust arising from ordinary negligence or honest mistakes of judgment, for making excessive disbursements and for self-dealing under certain circumstances
On the other hand, courts will generally not enforce exculpatory clauses that purport to prohibit judicial review of any acts or omissions by the trustee or clauses that would release the trustee from acts of bad faith, gross negligence, willful or intentional breaches of trust, dishonesty, or acts taken with reckless indifference to the interests of the beneficiaries. Some states have statutes or public policy that may prohibit enforcement of specific types of exculpatory clauses as well.

Courts may also refuse to enforce an otherwise enforceable exculpatory clause based on the circumstances under which the trust was executed. For example, courts will not enforce an exculpatory clause where the circumstances show that the inclusion of the clause in the trust was the result of fraud or the abuse of a fiduciary relationship. When determining whether the inclusion of an exculpatory clause was improper, courts will look at a number of factors, including:

1. the nature of the relationship between the trustee and the settlor;
2. whether the trust was drafted by the trustee or the trustee’s attorney;
3. the sophistication of the settlor;
4. whether the settlor was advised by independent counsel; and
5. the scope and reasonableness of the exculpatory clause.

It is thus important that the existence, content and meaning of an exculpatory clause be adequately communicated to the settlor prior to the execution of the trust. For corporate trustees, the best practice is to have the settlor retain independent counsel to prepare the trust and to review each of the provisions of the trust, including any exculpatory clause, with the settlor prior to the execution of the trust. Likewise, the trustee should retain its own counsel to ensure that the exculpatory clause is enforceable and provides the appropriate protection under the particular circumstances. The best exculpatory clauses are specifically tailored to the circumstances as opposed to using boilerplate language.

A good example of how these clauses can make the difference can be found in a dispute between two charitable remainder beneficiaries and the corporate trustee of two trusts created for the great-grandchild of Eli Lilly. The beneficiaries claimed that the trustee had failed to timely diversify the assets of the trusts. The beneficiaries asserted claims of negligence, breach of fiduciary duty and violations of the state’s Prudent Investor Act. Both the probate court and the appellate court ruled in favor of the trustee. An exculpatory clause was the key to the trustee’s victory. The clause specifically provided that any investment made or retained by the trustee in good faith would be deemed proper despite any resulting risk or losses from lack of diversification. The exculpatory clause made the difference. In ruling for the trustee, the appellate court found it significant that the beneficiaries and their counsel had participated in the drafting of the trust.

An exculpatory clause is by no means a guarantee that fiduciaries will not be sued. However, a properly drafted clause that is included in the trust under the appropriate circumstances can make the difference in the unfortunate event of a lawsuit. If you have any questions concerning this article, or would like advice regarding trust provisions or potential trust litigation, please reach out to us at SGR.