Discretion and Its Many Abuses – Part II

Yesterday I discussed some basics about how trusts and trustees operate. Trustees have a lot of power when the trust instrument gives them discretion to apply their own judgment about what’s the best thing to do with trust property, so much power that a judge will defer to the trustee’s judgment unless an “abuse of discretion” can be proven.

Think about that – a judge in a courtroom, whose job it is to, well, judge things, will defer to the judgment of someone else. If he disagrees with the trustee’s judgment, the judge is to actually disregard his own judgment about what is best under the circumstances in favor of the trustee’s – again, unless the judge can be persuaded the trustee’s decision was so crazy that an abuse of discretion has occurred.

Now with all that power the trust instruments can give them, you might think there should be some built-in safeguards so that trustees behave themselves. And, indeed, there are.

First, in a classic trust situation, the trustee does not stand to personally benefit from his decisions. He’s managing money that isn’t his, for the benefit of someone else, and he gets the same fee for his services regardless of what his decisions are. In that way, the trustee is able to bring to bear his own unfettered judgment about what the best thing to do is, and not be influenced by any concerns about personal gain.

Second, the law imposes upon trustees what has been called the highest duty known to the law – a fiduciary duty. That has varying definitions in varying situations, but basically it means the trustee has to put someone’s else’s interests first, ahead of his own or anyone else’s. If you hire a lawyer, for example, the lawyer has a fiduciary duty to you regarding the representation: your interests come first, including at the expense of your lawyer’s own interests. The same thing applies to a trustee: the trust beneficiary’s best interests is all that is supposed to matter, and the trustee is supposed to disregard anything other than that in making his discretionary judgments.

Third, the trustee only has all this power in the first place because someone else – the trustor or settlor of the trust – wanted him to. The trustor is the person who originally created the trust, contributed some money or other property to the trust, and authored or approved the terms of the trust instrument, including the terms giving the trustee all that power. In other words, when your rich-and-dead parents funded a trust fund for you, they were the ones who decided to confer all that discretionary power in the trustee – the trustee didn’t just unilaterally assume that power.

Now, under ERISA your health insurance company is all too often treated as if it is a trustee, and the insurance company’s decisions are all too often given the same sort of deference. But as you might gather from the foregoing, there are some very significant differences between an insurance company and a classic trustee. Next we’ll take a look at whether it makes any sense to overlook those differences and pretend an insurance company is a trustee. Here’s some foreshadowing: it doesn’t.