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A Trustee’s Reasonable Reserve

November 16, 2016

In a trust administration, a “reserve” is money the trustee retains for a period of time after the trustee believes the trust administration is complete. The key here is the world believes, because sometimes, when it seems all the work is done—property sold, tax returns filed, taxes paid, creditors’ claims extinguished, and beneficiaries’ gifts distributed—things happen. The IRS might audit a tax return; a disgruntled beneficiary might initiate or resume litigation or try to disavow a settlement agreement; or a creditor might try to enforce a claim that is time-barred by statute. A careful and diligent trustee will probably ultimately prevail against these claims, but this can take months or longer, and usually requires the services of lawyers, accountants, or other professionals. Without trust funds to pay these professionals, the trustee is in a terrible predicament.

For this reason, most trust attorneys advise trustees to hold a reserve for a reasonable period of time. What happens when a trustee distributes all of the trust’s assets and then needs funds to pay attorneys, accountants, taxes, or other creditors?

A trustee can recover trust funds from beneficiaries after distribution under California Probate Code §15685, which states:

The trustee has an equitable lien on the trust property as against the beneficiary in the amount of advances, with any interest, made for the protection of the trust, and for expenses, losses, and liabilities sustained in the administration of the trust or because of ownership or control of any trust property.

One commentary on this Section states that “A probate court may order beneficiaries to return assets previously distributed in order to compensate the trustee’s attorneys.” This comment is supported by the holding of Kasperbauer v. Fairfield, 171 Cal. App. 4th 229 (2009), where the court ordered the distribution of trust assets, but withheld a certain amount for attorney’s fees. The fees, however, exceeded the amount withheld, so the court ordered the beneficiaries to return trust assets to pay the trustee’s attorneys’ fees. Strangely, the case does not cite §15685, but reasons that the common law, as set forth in the Restatement Second of Trusts, provides a right to indemnification from beneficiaries, and California law has not modified that common law right.

Although §15685 provides a theoretical remedy, in practice relying on §15685 could be enormously problematic. First, the trustee will probably need a court order requiring the beneficiary to return the funds. The beneficiary would likely object, and trust litigation could ensue over whether the beneficiary must return the money. If the beneficiaries have spent the money, the issues get even more complex. All of this takes time and money, and if the trust has no money, who will pay the trustee’s attorneys to litigate for the return of trust funds? The answer, probably, is the trustee…personally.

So unless a trustee is certain there will be no problems, and confident that the beneficiaries will return trust funds if asked, the trustee should hold on to a reasonable reserve.

What’s reasonable depends of the size of the potential liability and the attorneys’ fees that could be incurred to vindicate the trustee in the worst case scenario. It could be tens of thousands of dollars for small, low-risk trusts, or several hundred thousand dollars or more if litigation is likely or there is a substantial risk of audit.
We have represented trustees throughout the San Francisco Bay Area, including Walnut Creek, Oakland, and Danville, as well as many trustees outside California. If you have questions about probate, trust administration, or estate and trust litigation, please call us for a free consultation.


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