It can be hard for the trustee of a special needs trust to figure out what expenditures are permitted. The trust document might give some direction. Medicaid and Social Security eligibility workers will review the actual expenditures. And often, a court is looking over the trustee, as well. The court is the only one, though, that can enter a surcharge order against the trustee.
What is a surcharge order?
When a trustee is required to account to the court, expenditures are usually reviewed after the fact. For example, the trustee might determine that it makes sense to purchase a vehicle for the beneficiary, or pay tuition expenses. The trustee might also collect a fee.
Once the trustee submits her account for court review (most often, an annual report), the court might agree that the expenditures all make sense. On the other hand, the court might rule that the trustee should have exercised more caution. The judge might order the trustee not to make similar distributions in the future, but allow the past expenditures.
In rare cases, though, the judge might decide that payments from the trust violated the trustee’s fiduciary duty. The challenged expenditures might have been self-serving, or just poor decisions. The court might decide that the trustee’s decisions violated her fiduciary duty.
When the trustee misbehaves, the court has several choices. The trustee can be removed, and a new trustee appointed. The trustee can also be ordered to return the disapproved expenditures to the trust. That latter type of decision, a surcharge order, can mean that the trustee must dip into her own funds to repay the trust.
Melodie Scott’s failures as trustee
In 2004, Californian Melodie Z. Scott, of Conservatorship and Resources for the Elderly (CARE), Inc, was appointed as trustee of a special needs trust. The beneficiary, a then 7-year-old girl with cerebral palsy, attention deficit hyperactivity disorder and seizures, lived with her mother in Riverside County, California.
The initial funding for the special needs trust was a little under $230,000. It came from a medical malpractice settlement arising from the beneficiary’s birth. For the next seven years, Ms. Scott administered the trust. In 2012, she filed a petition for approval of her trust account, and for termination of the trust.
In her report to the court, Ms. Scott acknowledged that she had charged over $34,000 in trustee’s fees. She had also paid for travel for the beneficiary, her mother and (sometimes) her grandmother or great-aunt. The vacation trips included Jamaica, London, Hawaii and Washington, DC. The special needs trust also purchased a vehicle for the beneficiary’s mother, and paid caretaking fees to the beneficiary’s mother.
When the trust had diminished to a little more than $15,000, the trustee decided it made no sense to continue. At that point, she simply distributed the remaining balance to the beneficiary’s mother for purchase of a residence. The trustee did not, however, monitor the expenditure or insist on any interest in the residence for the trust. In fact, the distribution was not used to purchase a residence but to pay the mother’s household expenses.
Other items contributing to the surcharge order
As the court considered Ms. Scott’s 7-year accounting, several other points became apparent:
- Ms. Scott’s license to operate as a professional fiduciary had been suspended for a little over two years, during which time she (a) did not inform the court and (b) continued to collect a fee.
- Trustee fees had been paid without prior court approval — possibly in violation of California rules about court-created trusts.
- The trustee had not looked at the trust’s terms for guidance about distributions; she testified that the trust was a “cookie-cutter” special needs trust.
- The beneficiary’s mother, who had received significant distributions from the trust, failed a background check and was disqualified from serving as the beneficiary’s caretaker just as the trust was winding down.
- Although the trust called for annual court accountings, the trustee did not submit anything for the court’s review or approval until the “first and final” accounting over seven years later.
The probate court’s surcharge order
At a hearing on Ms. Scott’s trust accounting, the court took evidence from several witnesses. It heard from Ms. Scott herself; she testified that she was entitled to a reasonable fee, and that she had been interested primarily in benefitting the trust’s beneficiary. The mother testified that it was in her daughter’s best interests to go on numerous vacation trips, including to family weddings in Hawaii and Washington, DC. A California trustee testified about how he would have administered the trust.
After all that, the judge determined that Ms. Scott had breached her fiduciary duty as trustee. Her accounting was approved, but subject to a $93,036.75 surcharge order.
To justify the surcharge order, the trial judge made several key observations:
- Ms. Scott mostly allowed the beneficiary’s mother to have anything she asked for, which paved the way for her to charge larger fees without any objection from the mother.
- If Ms. Scott had submitted her accountings annually, she presumably would have been reined in long before misspending the bulk of trust assets.
- The trust itself called for expenditures “reasonably necessary in providing for this Beneficiary’s special needs,” and not for the mother’s convenience or wishes.
- The final distribution of over $15,000 to the beneficiary’s mother was not supportable as for the child’s benefit.
The Court of Appeals decision
The California Court of Appeals agreed with the trial judge, and upheld the surcharge order. The appellate court did find that one $1,000 expenditure was permissible, however. The trust had paid for an attorney to advocate for the beneficiary’s during her school’s IEP (individualized education program) meetings. That single expenditure was allowed by the Court of Appeals.
The bottom line: the surcharge order against Ms. Scott was reduced to $92,036.75. She will now have to repay that amount to the trust. Scott v. McDonald, August 22, 2018.