Free Rider No More — When Can a California Trust Beneficiary Shift Legal Fees to Other Beneficiaries?

Downey Brand LLP

American courts (including our California state courts), in contrast to courts in England, do not typically award attorneys’ fees to a lawsuit’s “victor.”  There are, of course, exceptions to this so-called “American Rule.”  Among them is the “common fund” exception, which provides that one who incurs fees winning a lawsuit that creates a fund for others may require those passive beneficiaries to bear a fair share of the litigation costs.  As the word “fund” suggests, the benefit must be a tangible, easily calculable sum of money.  Courts have applied this exception to will and trust disputes where one beneficiary’s litigation causes other beneficiaries to receive a larger inheritance than they otherwise would have received.

But what happens when a trust beneficiary prevails in a lawsuit that doesn’t result in a tangible, monetary benefit but rather one such as removing an incompetent trustee or causing a trustee to prepare an accounting?  May beneficiaries who receive such benefits, but who take no part in the litigation, be required to pay for a portion of the litigating beneficiary’s legal expenses?  Last month the California Court of Appeal, in Smith v. Szeyller (2019) ____ Cal.App.5th ___, answered the question with a tantalizing “very possibly.”

In Smith, one of a trust’s beneficiaries, Don Smith, Jr., took issue with the management of a trust, including the trustees’ accountings.  Specifically, Don questioned over two million dollars worth of expenditures, gambling, and gifts to the trustees from the trust.  He asked the court to freeze the trust accounts and remove the trustees, alleging financial elder abuse as well.  Three of the trust’s beneficiaries were given notice of the litigation but chose not to participate.  Don asked one of the beneficiaries to participate in the litigation but she declined.

During the litigation, the trustees agreed to freeze trust assets and revise accountings.  After a years-long fight, Don ended up settling the case with the trustees.  As part of that settlement, the trustees agreed to pay Don’s attorney and expert fees – totaling a hefty $721,258.28 – out of the trust.  The trial court entered an order confirming the settlement terms, and the passive beneficiaries who wanted nothing to do with the litigation were therefore on the hook for hundreds of thousands of dollars in fees.

As could have been predicted, one of the passive beneficiaries filed post-trial motions challenging this award on the basis that it was a denial of due process and disproportionate with any benefit she received.

The Court of Appeal agreed with the trial court that the so-called “substantial benefit” exception applied to require that the passive beneficiaries pay their part of the legal fees.  The “substantial benefit” exception is an outgrowth of the “common fund” exception, except broader because it applies to both tangible and intangible benefits.  Specifically, it permits an award of fees when a litigant obtains a decision resulting in the conferral of a tangible or intangible “substantial benefit.”  Acknowledging that this was the first published decision to apply the “substantial benefit” exception in the trust context, the Court of Appeal reasoned that Don’s litigation provided a substantial benefit because it preserved trust assets by freezing the accounts and causing the trustees to assume tax liabilities.

The decision is notable for a few reasons.  For one thing, it’s a cautionary tale to free riding beneficiaries that they can’t sit back while another beneficiary litigates and assume they won’t ever have to pay for the other beneficiary’s legal expenses.  A beneficiary can help shape litigation by participating in it as an interested party, including having a seat at the negotiation table when legal expenses are allocated in a settlement.  A beneficiary who sleeps through litigation may awake to discover an obligation to pay a hefty fare for a long litigation ride that he or she did not want to take, thus substantially reducing the beneficiary’s distribution from the trust.

In addition, given the stakes, a trustee might be quick to agree to have the trust pay for a grumpy beneficiary’s legal expenses so as to end the litigation and mitigate the trustee’s own personal exposure.

Beneficiaries who are outraged by a trustee’s conduct may be encouraged to sue even when co-beneficiaries are unwilling or financially unable to join the fight.  As long as the petitioning beneficiary can fund the litigation for its duration, he or she may be able to spread the expense to others when the litigation is done.

Of course, courts will be looking for whether the beneficiaries received a substantial benefit before requiring them to pony up from their shares of the trust, and the outcome will be variable depending on the facts of each case.

[View source.]

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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