Settlement agreements are an often used alternative to lengthy, expensive probate, trust and estate litigation and trial in Arizona. A settlement agreement is typically a binding agreement that usually disposes of the case without further litigation.

Under most circumstances, only parties to the agreement will be bound by the terms of a settlement agreement. This method of resolution may get sticky when the litigation involves the trustee or trustees of a trust and some of the trust beneficiaries, but not all of them. Further issues may arise if the trustees agree to resign and be replaced by a successor trustee and the successor trustee is purportedly bound by the agreement. In those situations, further disputes and further litigation may arise over the enforceability and scope of the settlement agreement under Arizona law.

These issues were address in Matter of Book, a recent Arizona Court of Appeals decision.  There, a settlement agreement that released the original co-trustees individually, personally, and in their fiduciary capacities was held to be unenforceable against the new trustees because the terms of the agreement were deemed antagonistic towards the interests of the contingent beneficiaries of the trust who were not parties to the settlement agreement.

The person who established the trust (called the trustor) designated $2.1 million to be paid to four specific beneficiaries (the “primary beneficiaries”) in specific cash gifts within thirty days after the trustor’s death. The remaining assets of the trust were to be distributed to two universities (the “contingent beneficiaries”) in designated percentages.

After the trustor’s death, two trustees assumed control of the administration of the trust. They failed to distribute the four specific gifts to the primary beneficiaries within the thirty-day deadline and allegedly engaged in other wrongdoing. Two of the four primary beneficiaries filed a complaint against the co-trustees for breach of fiduciary duty, seeking removal of the co-trustees and an award of damages. A third primary beneficiary intervened during the litigation. While the fourth did not participate, he signed the settlement agreement once it had been reduced to writing. However, the contingent beneficiaries did not participate in the litigation or sign the settlement agreement, although they appeared through counsel during negotiations.

The terms of the settlement agreement provided that mutual releases were given by the beneficiaries of the trust, that claims against the original co-trustees were released in their individual, personal, and fiduciary capacities, and that the agreement settled “all claims known an unknown, liquidated and unliquidated, foreseen and unforeseen that would in any way arise out of the claims and disputes that have been asserted in [the litigation].” Further, the co-trustees agreed to resign and be replaced by successor trustees. Effectively, the settlement agreement purported to release the original trustees from any liability in any of their capacities and precluded claims against them by the successor trustees under the prior litigation or that could be brought in the future pertaining to the co-trustees’ breach of fiduciary duties.

The Court found that, while the settlement agreement acknowledged that the contingent beneficiaries were not parties to the agreement and were not bound by it, the agreement itself was antagonistic towards the interests of the contingent beneficiaries because the agreement purported to release and discharge all claims against the original trustees. The contingent beneficiaries maintained an interest in the trust property as they still had a remainder interest after the four specific cash gifts were distributed. Since the contingent beneficiaries were not parties to the settlement agreement, they did not release the original co-trustees from liability for the purported breach of fiduciary duties. As such, the Court found that the settlement agreement could not preclude the new trustees, on behalf of the contingent beneficiaries, from bringing a new action against the original co-trustees for breach of their duties.

In doing so, the Court rejected the original trustees’ argument that they could insulate themselves from liability by entering into the settlement agreement on behalf of the contingent beneficiaries under A.R.S. § 14-1406. Basically, that statute permits a trustee to represent and bind the beneficiaries of a trust, but only “to the extent there is no material conflict of interest between the representative and the person represented or among those being represented with respect to a particular question or dispute.” (Emphasis added.) The Court found that the attempt to release and cancel any claims that could be brought by or on behalf of the contingent beneficiaries was against public policy and, therefore, unenforceable and void.

Pursuant to Arizona’s trust law, trustees have various duties. For example, under A.R.S. § 14-10802(A), a trustee is required to “administer the trust solely in the interests of the beneficiaries.” Pursuant to A.R.S. § 14-108011, the trustee must “take reasonable steps to enforce claims of the trust.” The new trustees were required to fulfill those trustee duties like any other trustee in Arizona. The Court reasoned that, since the original trustees breached their duties, resigned, and were replaced by the successor trustees, the successor trustees could not be foreclosed by the settlement agreement from bringing claims on the contingent beneficiaries’ behalf. Such a foreclosure would be a violation of legislation and public policy.

Thus, the Court held that the settlement agreement could not be applied to prevent the successor trustees from bringing new litigation against the original trustees on behalf of the contingent beneficiaries. Because the settlement agreement at issue did not include a severability provision (a provision that the remainder of the agreement would be enforceable even if part was not), the entire agreement was unenforceable. So, the Court “unwound” the entire settlement.

If you have a question regarding settlement agreements in a probate matter or this recent Court of Appeals decision, or need help administering an estate or trust, please contact us.