The Extent of the Trustee’s Attorney-Client Privilege
When the trustee seeks and obtains the advice of counsel, the trustee cannot automatically assume that it may maintain the confidentiality of those communications.
The following information was presented by John Fitzpatrick as part of an October 7, 2014, State Bar of Arizona CLE seminar, “Probate Issues Confronting Trustees, Beneficiaries and New Developments with the Attorney-Client Privilege.” This material was also presented to Valley Estate Planners on September 18, 2014.
In handling property for the benefit of another person, a trustee faces competing interests, including:
- the trustee’s right to consider and act in self-defense vis-à-vis a beneficiary;
- the beneficiary’s right to trustee loyalty and to information necessary to protect their interests; and
- the successor trustee’s rights to information needed to protect the trust and to address the beneficiaries’ informational rights as expressed above.
When the trustee seeks and obtains the advice of counsel, the trustee cannot automatically assume that it may maintain the confidentiality of those communications.
The Hammerman Case
In a recent case, In re The Kipnis Section 3.4 Trust, 235 Ariz. 153, 329 P.3d 1055 (2014), a.k.a. Hammerman v. Northern Trust, the Arizona Court of Appeals (the “Court”) addressed the issue of the trustee’s attorney-client privilege.
In Hammerman, the beneficiary and successor trustee sought to compel the predecessor trustee to release information concerning the trust and its administration, and in particular, to disclose all e-mails exchanged between the trustee and its counsel. There were more than 1,100 of such e-mails. The trustee produced nearly all of the e-mails but sought to withhold approximately 4% of them based upon the attorney-client privilege, asserting those particular communications were focused on the trustee’s self-defense in the midst of controversy between it and the beneficiary. Recognizing that the trust paid for the attorney’s time and advice, the Probate Court granted the beneficiary and successor trustee’s motion to compel, ordering production of all e-mails between the predecessor trustee and its counsel, essentially eviscerating the attorney-client privilege. The Probate Court stayed its ruling to allow for the appeal. The Court reversed the Probate Court’s ruling and remanded the matter back to the Probate Court to further address the issue.
Statutory and Common Law Basis of the Privilege
Statutory Basis of the Trustee’s Disclosure Duty
Subject to a significant exception discussed below, A.R.S. § 14-10813(A) imposes on a trustee the duty to keep the beneficiaries reasonably informed about the administration of the trust and of the material facts necessary for them to protect their interests.
The Common Law Basis for the Trustee’s Disclosure Duty
Although the Court in Hammerman focused primarily on the statutory basis, it also referenced the trustee’s common law duty to disclose information to beneficiaries, citing, in particular, Section 82 of the Restatement (Third) of Trusts (2007), cmt. f.
The Holding
Concerning the extent of the trustee’s attorney-client privilege, relative to the rights of the beneficiaries, the Court held:
a component of a trustee’s duty under A.R.S. § 14-10813(A) is a duty to disclose ‘legal consultations and advice obtained in the trustee’s fiduciary capacity concerning decisions or actions to be taken in the course of administering the trust.’
329 P.3d at 1062.
Under the facts of the Hammerman case, the Court applied the same principles and standards to the rights of successor trustees to review the predecessor trustee’s otherwise privileged communications. That is, even though there may be other bases for recognizing greater informational rights to a trustee’s successor, the Court held that the successor trustee’s rights were at least as broad as the rights of the beneficiary. Until the issue is further addressed, the exceptions to the privilege are co-extensive.
As noted above, the Court articulated its holding based upon the trustee’s duty to disclose under A.R.S. § 14-10813(A). The Court did not address (perhaps because the parties did not raise it as an issue) the rather significant exceptions to that statutory duty of disclosure. The first sentence of A.R.S. § 14-10813(A), which imposes upon the trustee a duty to affirmatively disclose important information to the beneficiaries, starts with the words, “Unless the trust instrument provides otherwise…” The second and final sentence of A.R.S. § 14-10813(A), which imposes on a trustee the duty to respond to a beneficiary’s requests for information, begins with the words, “Unless the trustee determines that it is unreasonable under the circumstances to do so….” Thus, A.R.S. § 14-10813(A) is plainly qualified.
The holding’s reliance on the dictates of A.R.S. § 14-10813(A) might reasonably lead one to conclude that the extent of the trustee’s attorney-client privilege is a function of trust drafting and trustee discretion. While that conclusion is the rational extension of the words used by the Court and the Legislature, I suggest one not rely exclusively on that rationale. After all, as the Court noted, there is common law recognition of a beneficiary’s informational rights, and the common law of trusts continues to supplant the Arizona Trust Code. A.R.S. § 14-10106(A).
Also, one must bear in mind the dictates of A.R.S. § 14-10105(B)(8) which expressly prohibits the effective drafting around the “duty to respond to the request of a qualified beneficiary of an irrevocable trust for trustee's reports and other information reasonably related to the administration of a trust.”
Although draft-around language might be successfully employed, the rest of this analysis will assume that no draft-around has been invoked and the trustee has limited discretion to assert its determination that “it is unreasonable under the circumstances” to provide the beneficiary with communications between the trustee and the trustee’s counsel.
The Court expressly adopted that which it called “the fiduciary exception” to the privilege, leaving one to wonder why the Court did not call it the “trustee exception.” The prospect exists that the Hammerman holding will someday be extended to fiduciaries other than trustees, such as personal representatives, guardians, and conservators, and to other persons who assume fiduciary duties, including agents, partners and corporate officers and directors.
Application of the Rule
The exception to the privilege applies only when the trustee is acting in its fiduciary capacity, thus drawing a distinction between when a trustee is acting in its personal capacity.
Interestingly, the Court also mentioned several times that the exception does not apply when the trustee is acting in its “corporate capacity.” The trustee in Hammerman happened to be a corporate trustee, and perhaps it framed its argument based upon the rather obvious distinction between its interests and the beneficiary’s interests, but it seems to be a poor choice of words by the Court given that a trustee’s corporate status is technically irrelevant to the analysis.
Fiduciary Capacity Distinguished
The Court expressly rejected the notion, and the Probate Court’s rationale, that the exception issue turned exclusively on who paid for the legal advice. Other courts have used that as the criterion and held that if personal funds are used, the trustee’s attorney-client privilege remains intact, and vice versa. Instead, the Court indicated that it is the purpose and content of the communication that matters most.
The Court explained, “a trustee’s attorney-client privilege vis-à-vis a beneficiary extends to all legal advice sought in the trustee’s personal capacity for purposes of self-protection.” Thus, if the legal communication relates to how to handle, for instance, a trust tax issue, or the negotiations relating to the sale of an asset – things that are purely administrative, then the exception applies and those legal communications are subject to disclosure. If the legal communication relates to protecting the trustee from a claim or is otherwise related to the trustee’s personal interests, the communication remains protected.
In handling a particular trust situation, a trustee often simultaneously considers: (a) the interest of the trust and its beneficiaries, and (b) its own personal risks and considerations. If the trustees seeks and/or receives legal advice with both concerns in mind, where is that line drawn, and who decides?
Assuming a beneficiary’s request for all communications has been made, as a first step, the trustee will have to divulge non-privileged communications and assert the privilege as to communications it intends to withhold. Naturally, if otherwise privileged communications are revealed, there is nothing over which to argue. If the beneficiary takes issue with the trustee’s assertion of the privilege and the parties cannot satisfactorily resolve the issue, the beneficiary must invoke judicial assistance or capitulate (at least for the time being). If the beneficiary submits the controversy to the court, the trustee will again have to assert the privilege or be deemed to have waived it. The court will have to decide if the privilege actually applies to each communication. The Court remanded the Hammerman case to the Probate Court for an in-camera review of all communications for which the privilege was asserted. Our over-taxed judiciary will have to take on this new workload.
Choose well when asserting the attorney-client privilege. In a trust litigation or arbitration matter, the court/arbitrator has fee shifting discretion. A.R.S. § 14-11004(B). If the controversy arises in the context of a discovery dispute, bear in mind that Rule 37, Ariz. Rules Civ. Proc., contains a presumptive sanction.
Some Questions Regarding the Holding
Q. What about the privilege during the life of the settlor?
A. The life of the settlor is irrelevant except to the extent it affects the revocability of the trust. A.R.S. § 14-10603(A) conditions the rights of the beneficiaries to the control of the settlor while the trust is revocable.
Q. What if only one settlor has passed?
A. Then, to the extent a trust has become irrevocable as a result of the death, the surviving settlor would have to reveal otherwise privileged communications at least as to the on-going administration of the irrevocable portion of the trust.
Q. After the trust becomes irrevocable, may the attorney be examined as to administration advice given while the trust was revocable?
A. It is not clear whether the beneficiary’s right to access those communications, once sprung, relates back – whether it is retroactive. There is no case law in Arizona that tells us whether A.R.S. § 14-10603(A) bars the beneficiary permanently from seeing that information, or if that statute simply postpones during the time the trust is revocable the beneficiary’s right to review the information. There are competing interests at play. On the one hand, the settlor/trustee could have done whatever he or she wanted, and the advice given to such person was nobody else’s business. On the other hand, communications from the time period when the trust was revocable might reveal a claim that the beneficiary might want to see pressed, possibly even against the attorney or the fiduciary.
Q. Why can the trustee use trust funds to reimburse itself for the legal expenses of defending itself?
A. Because many trusts expressly grant this right, and, in any event, the law allows the trustee to do so (A.R.S. § § 14-11004(A) and 14-10816), but legal expenses are subject to court review, and if already paid for with trust funds, the attorney faces possible fee disgorgement.
Q. Might the attorney face a conflict of interest if the attorney is representing the trustee in its fiduciary capacity and then also begins to attend to the trustee’s individual exposure?
A. Yes. The Court even noted this potential situation in the footnote highlighted in the case. The better practice is to separate the roles if things start to get dicey.
Q. Can the in camera review process be exploited by a Machiavellian trustee or attorney intent on “poisoning the well?” It is, after all, an opportunity for de facto ex parte communications. If the privilege is upheld as to such a communication, only the judicial officer will see it.
A. That is certainly possible, but that doesn’t make it ethical or professional, however fun it might be.
Q. How shall we act in the future?
A. Carefully and conscientiously. There is no bright line for when a communication relates to the trustee’s purely personal interests. Consider having administration counsel and controversy counsel, and insist that communications between them not disclose sensitive information. Make certain your counsel/client knows the new rule early in the representation, and discuss the privilege with client/counsel anytime the question is in doubt. When writing, try to segregate the two types of communications, refraining from covering both topics in a single communication. Designate conspicuously in a written communication that it is intended to be privileged. Be mindful that it is a myth that digital communications are less significant than letters. When drafting, consider draft-around language, possibly along the lines set forth below, to help preserve the privilege. Keep in mind that disclosure might reveal not only substantively sensitive information, but embarrassing information too (and possibly even things that embarrass the attorney). Don’t write anything you wouldn’t want the judicial officer, your opponent, the beneficiary or your mother to see. Inasmuch as spoken conversations can sometimes be less well preserved, talk on the phone, preferably on a land line.
Proposed Draft-Around Language
For those who would like to see maximum confidentiality given to the attorney-trustee communications, consider including some synthesis of the following language, perhaps in the “trustee’s powers” section of the trust document:
In connection with the administration of the Trust, the Trustee may engage counsel and accountants at Trust expense to assist the Trustee with administration, tax and related matters, as well as to defend the Trust, its assets and the governing documents which constitute the Trustor’s estate plan, and to defend the Trustee, the Trustee’s administration, conduct and reporting. Communications among the Trustee, its counsel and/or accountants, even if related to purely administrative matters, shall be privileged and disclosure may not be compelled by a beneficiary or successor trustee. In addition, the Trustee shall enjoy the maximum discretion allowed by law to determine the reasonableness of any request for such disclosure. The Trustee’s election to reveal some otherwise privileged communication shall not waive the Trustee’s privilege to decline disclosure of other privileged communications.
In adopting a derivative of the above language, the drafter should compare it to other provisions of the existing trust document to assure substantive consistency and similarity of nomenclature.
Article © 2014. John R. Fitzpatrick