Litigation Strategies in Irrevocable Trust and Life Insurance Disputes

Shields Legal recently helped a family successfully pursue claims related to a life insurance policy their loved one had placed in a trust, and which lapsed due to non-payment of premium through no fault of the family or their loved one.

Introduction

A physician who was the patriarch of a family sought to provide for his wife and children by placing a $2 million life insurance policy into an irrevocable trust. The physician relied on professional insurance brokers to procure the policy. He appointed a trusted friend as the trustee of his irrevocable trust and entered into a trust administration agreement with his trusted friend’s company. The trusted friend was designated as the owner of the life insurance policy. Some twenty years later, the physician lost his battle with cancer. His surviving family members learned that the life insurance policy had lapsed and that there were no other assets in the trust. Although the physician thought he was protecting his loved ones, the family were left with nothing when he passed. The physician's family members reached out to Shields Legal to investigate what had happened and whether they had any legal recourse.

Problem

Approximately 20 years before death, a physician executed an irrevocable trust for the benefit of his wife and children. The trust purchased a life insurance policy with the physician as the named insured and his trusted friend and trustee named as the policy owner. The trust instrument provided that the trustee was not subject to liability for any loss which may occur by reason of (i) failure to take action; (ii) breach of fiduciary duty by virtue of mistake or error in judgment, or (iii) depreciation of value of property, except the trustee was liable for his own fraud, gross negligence, or willful misconduct.

Shields Legal determined that the life insurance policy had lapsed because the insurance brokers and the trusted friend who was not only the owner of the policy, but also the trustee of the irrevocable trust, as well as the contractual administrator of the trust (collectively, the “Professional Experts”), who had been paid fees or commissions for their services, had failed to properly and timely notify the physician that they had received one or more notices of premium, reinstatement, and lapse.

The trust instrument’s exculpatory clause arguably relieved the trustee from liability for breach of fiduciary duty. As a result, the family, whose life insurance had been active for more than 20 years with timely premium payments, was facing the prospect of losing the $2 million that the estate/trust would have enjoyed if the life insurance had not been allowed to lapse due to non-payment of premiums.

In order to devise a legal strategy and plan to help this grieving family, Shields re-examined the applicable law.

Texas Property Code §114.001(a) holds that: (a) the trustee is accountable for the trust property and for any profit made by the trustee…; (b) the trustee is not liable to the beneficiary for a loss or depreciation in value of trust property or for a failure to make a profit that does not result from a failure to perform the duties of the trustee or from any other breach of trust; and (c ) a trustee who commits a breach of trust is chargeable with any damages resulting from (1) any loss or depreciation in value of the trust estate as a result of the breach of trust; (2) any profit made by the trustee through the breach of trust; or (3) any profit that would have accrued to the trust estate if there had been no breach of trust.

Texas Property Code §114.007 holds that:

a term of a trust relieving a trustee for breach of trust is unenforceable to the extent that the term relieves a trustee of liability for (1) a breach of trust committed (A) in bad faith; (B) intentionally; or with reckless indifference to the interest of a beneficiary; or (2) any profit derived by the trustee from a breach of trust.
A term in a trust instrument relieving the trustee of liability for a breach of trust is ineffective to the extent that the term is inserted in the trust instrument as a result of an abuse by the trustee of a fiduciary duty to or confidential relationship with the settlor.
This section applies only to a term of a trust that may otherwise relieve a trustee from liability for a breach of trust. Except as provided in Section 111.0035, this section does not prohibit the settlor, by the terms of the trust, from expressly: (1)relieving the trustee from a duty or restriction imposed by this subtitle or by common law; or (2) directing or permitting the trustee to do or not to do an action that would otherwise violate a duty or restriction imposed by this subtitle or by common law.

Shields recognized that the family faced an uphill battle in attempting to establish liability against the trustee for breach of fiduciary duty due to the exculpatory clause in the trust instrument, the language of the Texas Property Code, and Texas common law, which generally permits a settlor to limit a trustee’s liability except for gross negligence or intentional misconduct.

Solution

The legal obstacles faced by the physician’s surviving family members did not prevent Shields Legal from implementing a plan to maximize the family’s likelihood of a successful outcome. Shields adopted a strategic litigation approach focused on three key claims:

Declaratory Judgment – Seeking a ruling that the exculpatory provision in the controlling trust instrument was invalid and unenforceable.
Breach of Fiduciary Duty – Alleging failure to keep the physician/settlor of the trust informed of critical notices (Notice of Premium, Notice of Reinstatement, and Notice of Lapse), which would have prevented the policy from lapsing.
Breach of Contract – Asserting that the trustee failed to provide the services promised under the trust administration agreement and as represented on the company’s website as part of its expertise in managing irrevocable trusts.

The declaratory judgment action requested a determination that the release provision in the trust instrument was not valid or enforceable on the following basis:

Where a fiduciary enters a transaction there is a negative presumption that a transaction is invalid and enforceable, and the burden is on the fiduciary to prove fairness and enforceability. Restatement (Third) Trusts, §96 (2012) cmt. 1 (c) and (d) Exculpatory and No-Contest Clauses – Effect limited by public policy; see also A Trustee’s Use of Exculpatory, Release, and Disclaimer-of-Reliance Clauses In Texas, David F. Johnson.
Under the Restatement, exculpatory clauses are strictly construed and the “trustee is relieved of liability only to the extent the provision so provides.” Id. at cmt. (1).
The release did not state that the releasing party released all future claims that it has now or may have in the future. Without that type of language, the release is only valid for claims in existence at the time the release is given. Berry v. Guyer, 482 S.W. 2d 719, 720 (Tex. Civ. App. – Houston [14th Dist.] 1972, disapproved on other grounds, Williams v. Glash, 789 S.W. 2d 261, 265 (Tex. 1990).
Generally, a contract without consideration is unenforceable. Garza v. Villarreal, 345 S.W.3d 473, 483 (Tex. App.—San Antonio 2011, no pet.). Consideration is a bargained-for exchange of promises or return performance and consists of benefits and detriments to the contracting parties. Id. There was no consideration for any release provided in the trust instrument.
As beneficiaries, the physician’s spouse and children were not represented by legal counsel in any negotiation of the trust instrument and related documents.
The physician and the beneficiaries had no involvement in the negotiation of the trust instrument.
The trustee and his trust administration company never specifically discussed the disclaimer/release clause; its impact or its meaning with the physician or the beneficiaries.
The beneficiaries did not sign the trust instrument and related documentation.

As a result of Shields Legal’s thoughtful and well executed litigation strategy and plan, the physician’s family successfully settled the litigation against the trustee for seven figures. The family is continuing to pursue its claims against the remaining Professional Experts – the insurance brokers.

Conclusion

A well-structured litigation strategy doesn’t guarantee victory, but it significantly increases the likelihood of success even where, as here, the legal documents present obstacles. By executing this clear and purposeful plan, the claims against the trustee and the trust administration company were ultimately resolved through settlement.