Keeping Trusts Out of Court

Texas joins the short list of states to address the enforceability of arbitration clauses

As trusts have become more prevalent in the past few decades, trust litigation has increased. Some settlors are trying to keep their trusts out of the courts by inserting an arbitration clause in the instrument. An arbitration clause mandates that any disputes arising from the trust must go through alternative dispute resolution rather than through the courts. A sample clause, and some background, is available from the American Arbitration Association.

An arbitration clause has many benefits. For the settlor, it prevents litigation from undermining a lot of a trust’s appeal: transferring wealth with the least time, effort and cost, and keeping private information out of the courts. For trustees and beneficiaries, it helps resolve issues quickly and efficiently so they don’t get mired in more expensive lawsuits. And for our perpetually over-burdened courts, it cuts down on a category of cases that are often more about family squabbles than genuine legal issues.

There’s just one problem: courts keep finding arbitration clauses unenforceable.

Court Applies Contract Rules

Texas recently became one of the few states to directly address the question of the enforceability of trust arbitration clauses. In Rachal v. Reitz,1 a trustee appealed the trial court’s order denying his motion to compel arbitration and to stay litigation initiated by a trust beneficiary. The beneficiary’s father, now deceased, had created the trust and inserted the following provision: “Despite anything herein to the contrary, I intend that as to any dispute of any kind involving this Trust or any of the parties or persons concerned herewith (e.g. beneficiaries, Trustees), arbitration as provided herein shall be the sole and exclusive remedy . . .” The sole issue was whether this clause was enforceable.

The appellate court, sitting en banc, noted that a party seeking to compel arbitration must first show that an arbitration agreement exists and was agreed to by all parties to the dispute. Such an agreement, the court reasoned, is contractual in nature and must therefore meet the foundational contractual elements: offer, acceptance, meeting of the minds, each party’s consent to the terms and execution and delivery. The trust couldn’t meet this burden. It was deemed evidence of nothing more than the settlor’s intent. Since the arbitration clause wasn’t contained in a contract between the beneficiary and the trustee, it couldn’t be enforced against either in a dispute between them.

Two judges disagreed with this reasoning, although one concurred with the result on other grounds. Justice Murphy in dissent argued that, first, it’s not clear that trusts can’t usefully be considered contracts for this purpose. They bind parties to rights and obligations. They require acceptance by the trustee and the beneficiary (in that beneficiaries could disclaim). And as a principle of trust construction, they’re interpreted as contracts would be. Moreover, Justice Murphy noted that the Texas General Arbitration Act requires written agreements, not written contracts, as a necessary element of compelled arbitration, and agreements represent a broader and looser category. Finally, Justice Murphy observed that respecting a settlor’s intent is the guiding principle of resolving trust disputes. It seems peculiar to ignore that intent on so fundamental a matter as how those disputes will be resolved, particularly when the settlor’s preference is eminently reasonable and indeed favored by courts in most other contexts.

To the limited extent that other jurisdictions have examined the enforceability of trust arbitration clauses, the majority’s approach clearly prevails. Rachal drew its reasoning from Schoneberger v. Oelze, 96 P.3d 1078 (Ariz. Ct. App. 2004), which informed similar opinions in California and Washington, D.C.2 As best we can determine, no other jurisdictions have addressed the issue. Although four cases is a small sample size, the lack of deviation may signal that the trust-contract distinction will be the primary lens through which courts address the issue.

Legislatures to the Rescue?

One would expect legislatures to undo or preemptively guard against this result. Trust arbitration is popular with courts, trustees and settlors. Moreover, states generally favor unclogging their courts’ dockets through any means possible. Finally, arbitration doesn’t seem to represent a threat to anyone’s rights in any concrete, identifiable way. One would expect a flurry of legislative proposals mandating the enforceability of trust arbitration clauses.

Surprisingly, only two states have taken that step. Florida was the first, in 2007,3 and Arizona–perhaps reacting to Schoneberger–followed suit two years later.4 Hawaii considered a similar bill in 2005-2006, but it died in committee. So for now, most jurisdictions leave the question up to the judiciary–the branch of government most likely to arrive at a result that almost everyone wants to avoid, including the court itself.

This is particularly vexing because the Schoneberger rationale may rest on shaky ground. Michael Bruyere and Meghan Marino explain in their comprehensively-titled article “Mandatory Arbitration Provisions: A Powerful Tool to Prevent Contentious and Costly Trust Litigation, But Are They Enforceable?”5 that the trusts-are-not-a-contract view comes largely from the work of one author, Austin W. Scott, writing in the Columbia Law Review in 1917. Scott reasoned that contract law wouldn’t recognize two-party trusts, in which the settlor appoints himself trustee, because a person can’t make a contract with himself; and that English contract law didn’t recognize a third-party beneficiary contract, which is essential to enforcing trust agreements. Both points are irrelevant in this context: the enforceability of arbitration provisions generally comes up with three-party trusts, and third-party beneficiary contracts are no longer controversial and, in fact, are routinely enforced. Moreover, write Bruyere and Marino, developments in both contract law and trust law have brought the two increasingly together since Scott wrote his article, such that contract law is now perfectly adequate to explain trust agreements.

Of course, that’s all rather academic, especially when we’re dealing with a result that offers no obvious practical benefits. But until legislatures declare arbitration clauses enforceable, courts may feel compelled to address the issue from the Schoneberger perspective, which focuses on whether trusts are contracts rather than on practical considerations and on the settlor’s intent. If so, Bruyere and Marino’s reasoning could give courts a useful theoretical underpinning to justify upholding arbitration clauses.

For drafters, meanwhile, if a client wants to insert such a clause, it may be worth having the beneficiaries sign a contract accepting it. If that’s impossible or impractical, it could help to add a line to the arbitration clause language noting that all bequests in trust are contingent on accepting it.

1. Rachal v. Reitz, No. 05-09-01422-CV (Tex. App.-Dallas July 22, 2011, no pet. h.).
2. Diaz v. Bukey, 125 Cal. Rptr. 3d 610 (Cal. Ct. App. 2011) and In re Calomiris, 894 A.2d 408 (D.C. Ct. App. 2006), respectively. Note that Diaz has been appealed to the California Supreme Court, while Calomiris had slightly different facts from the other cases.
3. Fla. Stat. Ann. Section 731.401 (West).
4. Ariz. Rev. Stat. Ann. Section 14-10205 (West).
5. 42 Real Property, Probate and Trust Journal 351 (Summer 2007).

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