The law bestows on trustees significant responsibilities and obligations. Because of this, many trustees retain legal counsel to assist in administering the trust. An attorney-client relationship is formed between the trustee and the attorney such that the confidential communications between the two are privileged.
While this concept may appear obvious, what many often overlook or don't know is that the privilege does not belong to the trustee as an individual. Rather, the privilege belongs to the trustee currently holding the office of trustee. For this reason, when a trustee is succeeded by a new trustee, the privilege transfers from the former trustee to the new trustee. The new trustee is entitled to all prior confidential communications.
This arrangement can provide for some very awkward disclosures. More importantly, the disclosure of prior privileged communications to a new trustee may illuminate breaches of fiduciary duty by the former trustee.
There is an exception to the disclosure rule, but it is narrow and difficult to establish. Nevertheless, former trustees facing a demand to disclose trust documents and communications may wish to fight tooth and nail to maintain the confidentiality of some of those communications. Being aware of the potential future disclosure is the primary tool to maintain the privilege. This article will address how the attorney-client privilege functions in the realm of trust administration and how to establish the exception to the disclosure rule above.
Attorney-client privilege is entirely statutory and is founded in Evidence Code sections 952 and 954. While it seems people are universally familiar with the concept of privileged communications, the statutory definition is far more exacting. To be privileged, the communication must be:
■ information transmitted between a client and his or her lawyer;
■ in the course of that relationship; and
■ in confidence by a means which, so far as the client is aware, discloses the information to no third persons other than those necessary to further the interests of the client.
Cal. Evid. Code, § 952.
The Moeller case
These same requirements apply to trustees when communicating with the attorney the trustee has retained. SeeMoeller v. Superior Court, 16 Cal.4th 1124, 1129-1130 (1997). In Moeller, the state supreme court made it clear that a trustee who retains an attorney to assist in trust administration is permitted to claim attorney-client privilege. Id. The Probate Code explicitly provides trustees with authority to retain counsel. Id. at 30; Cal. Prob. Code, § 16247. Thus, a trustee, in the trustee's capacity, may become a client to the attorney and satisfy the requirements of Evidence Code section 952 for privilege. Id.
The fact a trustee may become a client and thus claim attorney-client privilege may seem basic, but the twist is when a successor trustee requests the privileged information from the former trustee. In Moeller, a successor trustee, Roger Moeller, objected to the accounting submitted by the former trustee, Sanwa Bank. Moeller, supra, 16 Cal.4th at 1128. After filing his objection, Mr. Moeller issued requests for production and sought documents related to Sanwa Bank's administration of the trust. Id. The bank withheld some of the documents on the basis of attorney-client privilege. Id. The trial court denied the successor trustee's motion to compel, but the court of appeal granted Mr. Moeller's writ of mandate and ordered disclosure. Id. The bank appealed to the California Supreme Court. Id.
Contrary to the bank's position, the supreme court held that the privilege belongs to the trustee currently holding the office of trustee, and that a predecessor trustee may not withhold from a successor trustee documents related to trust administration. Moeller, supra, 16 Cal.4th at 1129-1131. The court reasoned that a privilege may only be claimed by one who holds it. Id. at 1130; see also Cal. Evid. Code, § 954. In the realm of trusts, the current individual in the office of trustee is the privilege holder. Id. at 1131. This is because a successor trustee succeeds to all the rights, duties, and responsibilities of the predecessor trustees. Id. (quoting from Fatjo v. Swasey, 111 Cal. 628, 636 (1896)). Thus, a successor trustee assumes all the powers of the predecessor trustee, "including the power to assert the privilege with respect to confidential communications between a predecessor trustee and an attorney on matter of trust administration." Moeller, supra, 16 Cal.4th at 1131.
The state supreme court, however, did leave a small window of opportunity: an exception, by which a predecessor trustee may be able to claim the privilege against the current trustee. The court made a distinction between communications regarding trust administration and communications regarding personal preservation or defense. Moeller, supra, 16 Cal.4th at 1134. The phrase, "trust administration" is the pivotal distinction between what must be disclosed to the successor trustee. As stated by the supreme court in Moeller: "...the successor trustee inherits the power to assert the privilege only as to those confidential communications that occurred when the predecessor, in its fiduciary capacity, sought the attorney's advice for guidance in administering the trust." Id. (original italics).
The court went on to state: "If a predecessor trustee seeks legal advice in its personal capacity out of a genuine concern for possible future charges of breach of fiduciary duty, the predecessor may be able to avoid disusing the advice to a successor trustee by hiring a separate lawyer and paying for the advice out of its personal funds." Id. The court summarized this distinction as administrative communications and defensive communications. Id. at 1135.
In Moeller, there was little dispute that the communications between Sanwa Bank and its attorney were administrative, and, therefore, thebank, as predecessor trustee, was required to disclose the communications to Mr. Moeller, who was the successor trustee. Id. at 1135.
The Herbalife Dispute
The distinction between administrative and defensive communications recently came to a head in Fiduciary Trust International v. Klein, 9 Cal.App.5th 1184 (2017) ("FTI"). There, the court of appeal held that to claim the privilege personally, the predecessor trustee must have undergone some process, at the time of the communication, to distinguish the communication between administrative and defensive. Id. at 1199. In FTI, the relationship between the trustees and the beneficiaries was acrimonious from the beginning. Id. at 1191 n.1. The trust settlor was Mark R. Hughes, the founder and chief executive officer of Herbalife International Incorporation. (https://www.law360.com/articles/426266/trustees-kicked-from-herbalife-founder-s-330m-estate; last checked July 13, 2017.) Mr. Hughes established a $350 million trust for his minor son to receive when the son turned 35. Id. Mr. Hugues died in 2000, and legal action against the estate and trust began in 2001. FTI, supra, at 1191n.1. Mark Hugh's son, through his mother, initially petitioned for removal of the trustees in 2001. Id. Suffice it to say, the trustees had accumulated volumes of documents dealing with the litigation. Id. at 1192 [trustees identified 3,000 privileged documents].
Fiduciary Trust International became the successor trustee after the court granted the petition to remove Conrad Klein and the other co-trustees. FTI, supra, 9 Cal.App.5th at 1191. After its appointment as trustee, Fiduciary Trust International sent a demand letter to the former trustees for trust documents, including communications between Mr. Klein and legal counsel paid for with trust funds. Id. at 1192. Klein and the other trustees refused to produce the documents based on attorney-client privilege, arguing that the communications related to the several accounting objections filed by the beneficiaries and were thus defensive in nature. Id. at 1192-1194.
Fiduciary Trust International filed ex parte applications and motions to compel disclosure of the documents. FTI, supra, 9 Cal.App.5th at 1192. The trial court ordered Mr. Klein to prepare a privilege log. Id. The trial court upheld the claim of privilege as to forty-five of the documents withheld. Id. at 1193-1194. The court of appeal affirmed in part and reversed in part. Id. at 1191.
The court held that to claim the privilege, the predecessor trustee must have undergone some process, at the time of the communication, to distinguish the communication between administrative and defensive. Id. at 1199. The predecessor cannot use hindsight many months or years later when attempting to make the distinction. Ibid. Simply put, the trustee must take proactive, not reactive, steps when making the distinction. Id. Furthermore, the use of personal funds is material when making the distinction, but is not dispositive. Id, n. 7.
In arriving at this decision, the court focused on whether the character of the relationship between trustee and counsel was personal or fiduciary in nature. FTI, supra, 9 Cal.App.5th at 1198. In doing so, the court refuted the predecessor's ex post facto attempt to simply label the communications as administrative or defensive. Id. Such a process is contrary to California law because it ignores the dispositive inquiry into the dominant purpose of the relationship at the time the communication was made between the attorney and client. Id.
Using this rationale, the appellate court reversed the trial court's inconsistent application of Moeller. FTI, supra, 9 Cal.App.5th at 1201. The court specifically disapproved of the trial court's ruling with respect to the successor trustees' labeling of certain communications as "petition for removal or surcharge." Id. Simply adding the language "petition for removal or surcharge" is insufficient. Id. One of the trustee's primary duties is to respond to questions and objections by beneficiaries regarding fiduciary accountings. Id. at 1201-1202. "...[T]he mere fact a communication relates, however broadly, to a petition for surcharge or removal does not prove that the legal advice contained within the communication was sought or obtained by the predecessor trustee out of concern for personal liability as opposed to concern for the general health of the trust." Id. at 1202 (original italics). Labeling the communications after the fact improperly focuses on the content or nature of the communication rather than the purpose in obtaining the communication. Id.
Keys to Protection
In sum, a trustee who seeks to claim attorney-client privilege as an individual rather than as trustee must take proactive steps to make a distinction between communication that is defensive in nature rather than administrative. FTI, supra, 9 Cal.App.5th 1184 at 1199. Furthermore, communications with the trustee's attorney regarding a beneficiary's questions or objections to an accounting are not, per se, defensive. Id. at 1201-1202. The real question is the purpose with which the communication was obtained, whether it was out of concern for the trust or for personal liability. Id. at 1202.
Although the court in FTI stated it could think of "a multitude of situations" where a trustee, in its fiduciary capacity, might communicate with a trust attorney regarding anticipated or actual objections (FTI, supra, 9 Cal.App.5th at 1202), it did not provide any historical or hypothetical examples of obtaining advice in a personal capacity. It is difficult to imagine a trustee who is not also concerned of personal liability when the trustee is seeking advice on administrative topics such as inquiries and objections to accountings. In many ways, the purpose of obtaining the advice would seem to be for both administrative and defensive reasons.
Although FTI does not specifically address this seeming duality, it should be noted that the supreme court in Moeller described the distinction-making process as scrupulous and painstaking and the court in FTI described defensive communications as a "narrow exception." See Moeller, supra, at 1135; FTI, supra, at 1201.
It seems that any concerned trustee hoping to preserve the privilege on an individual capacity must proactively do all it can do to make the distinction explicit and credible, preferably hiring personal counsel from personal funds.
A Hypothetical Helps Focus on the Privilege
In representing trustees, attorneys must have the issue of privilege and potential future disclosure at the forefront throughout the administration.
Let's use a hypothetical to apply the legal principles above. Attorney Adam represents Best Bank as trustee of the Thomas Family Trust. The Thomas Family Trust consists of $5 million, of which $3.5 million is a large piece of real property in Malibu, California. The Trust requires the trustee, Best Bank, to liquidate the real property. There are aspects of the property that need significant work: the foundation is cracking and slowly sliding down those magnificent Malibu hills, the former occupant was concocting her own chemical-heavy cleaning solution and dumping the byproduct outside, and some ancient artifacts, possibly Native American, were recently discovered when repaving the driveway. The professional engineers, professional toxic clean-up crews, and potential litigation concerning the artifacts could very well exhaust the $1.5 million of liquid funds in the Trust.
Best Bank is in a quandary. The Bank could exhaust the $1.5 million preparing the real property for sale, or it could sell the property for $1.5 million, a huge discount due to the significant issues. Attorney Adam and Best Bank have multiple and lengthy discussions on this point. Attorney Adam advises selling the property at a discount and that he knows a realtor who will still obtain a decent sale price. Best Bank is reluctant and states to Attorney Adam that it really does not want to get sued for making the wrong decision. These communications were interwoven and the Bank made no distinction between the communications. The Bank ultimately decides to sell at a discount when it is agreed the realtor will deposit the commissions and her next ten commissions with Best Bank.
The real property only sells for $1 million. More problematic, the new owner discovers the toxic materials can be removed at a fraction of the anticipated cost and that the supposed artifacts were really just old children's toys. The new owner proceeds to sell the property for $4 million after putting in $250,000 to fix the foundation.
The Trust beneficiaries are livid. Attorney Adam advises Best Bank to issue its final accounting and resign, thinking it would be better for the bank to walk away then become more entrenched. One of the beneficiaries is appointed trustee and immediately demands Best Bank hand over all Trust files and any communication with Attorney Adam. Best Bank considers all its communications with Attorney Adam regarding whether to sell the property at a discount to be privileged communications. Best Bank takes the position it was concerned of its own personal liability and sought Attorney Adam's advice at a personal level regarding the potential discounted sale.
The new trustee, on the other hand, argues that all communications regarding the sale of the real property were administrative in nature. The Trust required Best Bank to liquidate the property, so its communications regarding that process cannot be anything but administrative. Therefore, the Bank must disclose that information.
This hypothetical highlights the need to be constantly aware of potential future disclosure. When Best Bank disclosed its concern of potential liability, it should have hired its own attorney using Bank funds, not Trust funds, to obtain advice regarding the property sale. Doing so would have certainly triggered the exception to disclosure stated in Moeller and FTI. Moreover, another attorney would likely have advised the Bank that agreeing to sell the property at a discount because the Bank would receive the realtor's commission deposits would be problematic.
Even if Best Bank did not hire individual counsel, it and Attorney Adam should have proactively distinguished between administrative communications and defensive communications. Attorney Adam could have proactively labeled any emails or letters with the distinction, and could have drafted memos describing the verbal communications as defensive in nature. Because the Bank did not hire individual counsel and did not proactively distinguish between administrative and defensive, it is likely the Bank will have to disclose all the documents and communications.
The job of trustee is not for the uninformed or unaware. The same goes for counsel who provide legal advice to trustees. In particular, when advising trustee clients, do not assume the attorney-client privilege will remain or somehow automatically shield any communication from disclosure. You must actively work and advise to ensure the privilege provides protection for confidential communications, and the way to do that is to carefully segregate "administrative" advice from "defensive" advice.
It also helps if the trustee client pays the bill out of personal funds.