In the midst of a trust contest or other trust-related litigation, it’s easy for trustees to forget that their duties to the contesting beneficiaries continue notwithstanding the ongoing litigation. A trustee might assume his or her position and immediately face litigation (a demand for an accounting, an emergency conservatorship, or a challenge to the trust, for example) that demands all their time and attention. Under these circumstances, one of the most frequently overlooked duties in trust litigation is a trustee’s duty to comply with the Prudent Investor Rule.
Unless the trust provides otherwise, a trustee must invest trust funds in compliance with the Prudent Investor Rule, or Uniform Prudent Investor Act (“UPIA”), which is codified in California Probate Code 16045 and the statutes that follow. The UPIA requires trustees to meet the following standard of care:
(a) A trustee shall invest and manage trust assets as a prudent investor would, by considering the purposes, terms, distribution requirements, and other circumstances of the trust. In satisfying this standard, the trustee shall exercise reasonable care, skill, and caution.
(b) A trustee’s investment and management decisions respecting individual assets and courses of action must be evaluated not in isolation, but in the context of the trust portfolio as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the trust.
The UPIA directs the trustee to consider these factors in making investment and management decisions:
(1) General economic conditions.
(2) The possible effect of inflation or deflation.
(3) The expected tax consequences of investment decisions or strategies.
(4) The role that each investment or course of action plays within the overall trust portfolio.
(5) The expected total return from income and the appreciation of capital.
(6) Other resources of the beneficiaries known to the trustee as determined from information provided by the beneficiaries.
(7) Needs for liquidity, regularity of income, and preservation or appreciation of capital.
(8) An asset’s special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries.
A trustee also has a duty to consider diversifying trust assets. Unless the trust instrument provides otherwise or it is imprudent to do so, the trustee must reduce the risk of loss by reasonably diversifying the portfolio, i.e., the trustee must invest trust funds in more than one asset and asset class.
Trustees should consider these factors in deciding whether the trust assets are properly diversified:
- Size, terms, and purpose of the trust;
- Representation of different asset classes;
- Correlation of returns between the different asset classes;
- Needs of the beneficiaries and the type of return produced by each investment;
- General economic conditions;
- Volatility of each asset and the percentage of trust corpus that the asset represents;
- Percentage of the total company that the trust holds;
- Market for the asset;
- Tax planning implications; and
- Relative security of each investment or account (e.g., are the accounts FDIC insured?)
A trustee typically has broad discretion in investing trust assets, but must act prudently and in the best interests of the beneficiaries, even in the course of a trust contest, contested accounting, or other trust or estate dispute.