When a trustee gets legal advice, can the trustee shield from the trust beneficiaries the communications between the trustee and the lawyers? That’s a tough question. There are three options: yes, no, and it depends. Different jurisdictions have taken different approaches, but add Arizona to the list of jurisdictions that has decided “it depends.”
In In the Matter of The Kipnis Section 3.4 Trust, an Arizona appellate court adopted the “fiduciary exception” to the attorney-client privilege. In reaching this decision, the appellate court rejected the theory that the trust beneficiaries are the “real clients” of the lawyers, but instead found that the trustee’s duty to furnish information about the trust to its beneficiaries includes furnishing the trustee’s attorney-client communications.
To this point, Arizona had neither accepted nor rejected the applicability of the fiduciary exception in the trust context. With its adoption, this means that in Arizona, if a trustee seeks legal advice in its fiduciary capacity on matters of trust administration, the trustee is required to disclose those communications to the beneficiaries and, if there is one, the successor trustee. However, the attorney-client privilege still extends to legal advice sought by the trustee on matters not of trust administration, such as the seeking of legal advice related to the trustee’s own defense to potential liability.
This “fiduciary exception” is a topic very much in flux. Few jurisdictions have actually formally adopted it. Some have dealt with it by implication. And others have outright rejected it. When a court considers whether it applies, a part of the inquiry is often whether the trustee used trust funds to pay the lawyers. If trust resources were used to pay the lawyers, the needle may start to move in the direction of the exception. However, there may be a lot of reasons why using trust funds to pay lawyers shouldn’t move that needle. For example, the trust instrument may allow broad use of trust resources to hire lawyers or statutory or common law may permit a trustee to charge its defense to the trust and reimburse the trust at the conclusion of the litigation if the trustee is not vindicated. So, it’s a gray area. Indeed, the Arizona appellate court specifically recognized that “[t]he question whether the trustee acted in a fiduciary capacity cannot be resolved simply by asking who paid for the advice” though it may be relevant. In fact, to order a trustee to disclose all attorney-client communications based solely on the fact that the trustee paid for them with trust funds is reversible error because a trust does not have an absolute right to information that it paid for.
The take away here for trustees is to be aware of the potential risk. If things start to turn sour with a beneficiary, the trustee should stop and consider the possible risk that some court may order communications between the trustee and its lawyers disclosed and consider taking steps to minimize that risk.