California Weighs In: No Mandatory Arbitration For Dispute Over Validity Of Trust Instrument

by Ervin Cohen & Jessup LLP

A hot topic in estate planning these days is whether mandatory arbitration clauses should be included in trusts. The idea is to require trust beneficiaries to arbitrate their disputes rather than going through the time and expense of going to court. Proponents argue that it will streamline trust disputes by speeding up the process and greatly reduce costs, just as it has done for employment and contract disputes. Opponents argue that arbitration often doesn’t save time or money and that it robs beneficiaries of their ability to effectively enforce their rights. Everyone agrees on what it does, but whether you think it is a good result or a bad result depends on who you are: if you are a trustee or the person creating the trust, you generally think it is a good thing. If you are a beneficiary, you generally think it is bad.

For example, one aspect of arbitration is an inability to challenge the result. If you lose in court, you can always have another court review the result on appeal. But if you lose in arbitration, you have only very limited rights to have the result reviewed. This shortens the process and reduces costs, but tends to turn arbitration into a one shot, “winner takes all”, situation.

Another aspect of arbitration is that it generally limits both sides’ ability to gather evidence. In court, everyone can basically take whatever time is required to get the evidence to prove their case, but in arbitration these timelines can be drastically shortened. Because the defending party generally has all the evidence, this means that arbitration usually helps them and hurts the attacking party. In the trust context, it is almost always the beneficiary who is the attacking party, so arbitration tends to benefit the trustee. This rule is intended to limit the amount of time and expense spent on information gathering and to avoid “fishing expeditions” by beneficiaries who don’t really have any real claims. But it also allows the trustee to stall and avoid turning over the very evidence that the beneficiary may need to prove his or her claim.

Only a few jurisdictions have addressed the issue and California is finally weighing in. In McArthur v. McArthur (March 11, 2014, A137133), the Court of Appeal held that an arbitration clause in a trust was not enforceable against a beneficiary’s claims seeking to invalidate a trust instrument. Essentially, the beneficiary was attacking the trust document, which happened to give her sister more money, on the basis that her sister took unfair advantage of their mother while she was alive. The court said that she should be able to have those claims heard by a court instead of being forced to go to arbitration. This is good news for beneficiaries who feel, as the sister did here, that they have unfairly lost out on their inheritance due to someone else’s actions.

What the case does not address is whether an arbitration clause in a trust will be enforceable for disputes about the administration of the trust, such as if a trustee is investing the assets properly, making proper distributions, or even stealing money from the trust. The Court’s reasoning was that a clause in a document could not apply to a dispute regarding the validity of that very same document, because the beneficiary had not gotten any benefit from that document, so it leaves open the possibility that future courts will find that a beneficiary can be bound by such a clause for claims about how a trust is administered once they have accepted the trust instrument which gave them their interest.

If arbitration clauses are upheld for trust administration disputes, drafters will need to be very careful in deciding whether to include such a clause in a trust instrument. The parties can always agree to take a dispute to mediation or arbitration if that makes sense at the time, but including a provision which requires beneficiaries to arbitrate and denying them access to the courts will do nothing to keep trustees on the straight and narrow path and may even encourage them to stray.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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