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III Trust Arbitration as a Matter of National Law, 8 Trust Arbitration in the United States Courts

Mary F Radford

From: Arbitration of Trust Disputes: Issues in National and International Law

Edited By: SI Strong, Tony Molloy (Consultant Editor)

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2015. All Rights Reserved. Subscriber: null; date: 03 August 2020

Arbitrability — Arbitral agreements — Arbitral tribunals — Arbitrators

(p. 175) Trust Arbitration in the United States Courts

I.  Introduction

8.01  This chapter discusses cases in the state and federal courts of the United States in which arbitration has been used or sought to be used to resolve internal trust disputes. This chapter begins with a discussion of those situations in which all of the interested parties (ie the beneficiaries and the trustee) agree to take the dispute to arbitration. This situation will be referred to in this chapter as ‘consensual arbitration’. Next, the chapter explores those cases in which the settlor1 includes a provision in the trust document that requires the parties to resolve disputes through binding arbitration. Because the beneficiaries typically do not sign the trust instrument itself, the question in these cases is the degree to which beneficiaries can be bound by this arbitration mandate. The chapter concludes with a description of four recent cases that illustrate the types of issues that parties and courts will encounter in the future as the use of arbitration in internal trust disputes becomes more prevalent. This chapter does not discuss the arbitration of external trust disputes—that is, disputes between trustees and third parties with whom the (p. 176) trustee works, such as agents, financial advisors, and brokerage firms—except to the extent that these cases are relevant to the theories used to compel beneficiaries to submit their disputes to binding arbitration. Because wills and trusts are so similar in nature (each being a document through which a donor transfers property gratuitously to beneficiaries and appoints a fiduciary to manage the property and facilitate the transfer of the property), this chapter includes some discussion and citation to cases in which questions about the validity and probate of wills and the administration of estates are submitted to arbitration.

II.  Consensual Arbitration

8.02  Beneficiaries and trustees are relatively free to choose to have disputes relating to the trust resolved in a forum other than a court of law. As shown by the cases described in this section, the US statutory and common-law schemes generally favour this choice. For example, section 816(23) of the Uniform Trust Code (UTC) authorizes all trustees to ‘resolve a dispute concerning the interpretation of the trust or its administration by mediation, arbitration, or other procedure for alternative dispute resolution’.2 Section 111 of the UTC encourages interested parties to a trust dispute to enter into a ‘binding nonjudicial settlement agreement with respect to any matter involving a trust’.3 In In re Frank, the Court of Appeals of Ohio reversed an Ohio probate court’s refusal to enforce a settlement agreement between the trustee of a testamentary trust and the beneficiary that was entered into pursuant to the Ohio Trust Code’s codification of UTC section 111.4 The Ohio Court of Appeals enjoined the probate court to construe the settlement agreement liberally so as to favour its validity and enforcement.

8.03  Arbitration is one of the mechanisms that the parties may choose to settle their trust disputes. In a recent set of unpublished opinions in the matter of Young v Richardson, the Court of Appeals of Kentucky confirmed a series of arbitration orders and issued an order dismissing judicial proceedings in the cases that had been resolved by arbitration.5 The parties in this case were the surviving children (p. 177) and grandchildren of a husband and wife who had established trusts that benefitted each other for life and then their descendants. After the wife died, a series of disputes and court battles ensued on the issues of who had the proper authority to act as trustee and whether certain transfers of trust property were valid. In the midst of the litigation, the children and grandchildren attended a mediation and entered into a settlement agreement. The settlement agreement provided that all further disputes would be decided by binding arbitration. Although some of the parties persisted in continuing the litigation, the court appointed an arbitration team to resolve the disputes. When arbitration orders were rendered, the trial court then issued an order that dismissed as settled most of the cases and otherwise confirmed the arbitration orders, including orders that two of the parties pay US$100,000 and US$25,000 from their shares of the estate for breaching the mediation agreement. The aggrieved parties appealed to the Court of Appeals on numerous substantive and procedural grounds, including the ground that the trial court exceeded its jurisdiction in affirming the arbitration orders.

8.04  The Court of Appeals of Kentucky noted first that the parties had the right to settle disputes at any time, even when a case is on appeal.6 The Court of Appeals also pointed out that a settlement agreement is an enforceable contract between the parties and that, in this case, all parties had signed the settlement agreement and participated in the mediation. The enforceability of the contract was not dependent upon any ongoing jurisdiction by any court.7 The court found that there was no evidence that the settlement agreement was unconscionable8 and that none of the statutory grounds for vacating an arbitration award under Kentucky law applied.9 The Court of Appeals also stated that the confirmation of the arbitration orders did not deny the parties any of the due process and equal protection rights guaranteed by the constitutions of the United States and the State of Kentucky.10

8.05  Agreements among the parties to arbitrate trust disputes have been favoured not only by state courts but also by the US federal courts. In Brown v Brown-Thill, siblings who were co-trustees of their parents’ trust, entered into a comprehensive arbitration agreement to resolve the many disputes between them about how to handle the trust assets.11 The arbitrator issued several orders, including an order removing one of the co-trustees. In removing the co-trustee, the arbitrator invoked the state statutes that allow a court to remove a co-trustee for failure to cooperate with other co-trustees and for failing to administer the trust correctly. The federal Court of Appeals for the Eighth Circuit determined that while the arbitrator had not exceeded his authority in addressing the trustee removal issue, he had not based (p. 178) his decision on any provisions in the trust instrument itself. Rather, the arbitrator had incorrectly based his decision on grounds that, in the eyes of the Court of Appeals, are ‘exclusively judicial’.12 The Court of Appeals noted also that, under the relevant statutes, a court probably would not have removed the co-trustee without the required notice to all interested parties.13 Although this trust was executed in Missouri, the trust instrument provided that the law of Florida would govern the provisions of the trust.14 The arbitrator cited both the Missouri and the Florida trustee removal statutes. Both states have enacted UTC section 111, described earlier, which allows binding non-judicial settlements.15 Both states have also adopted statutes that permit the enforcement of binding arbitration provisions in trusts. Within this favourable climate for arbitration, the federal Court of Appeals decision confirmed virtually all of the decisions made by the arbitrator, except for the one decision in which the arbitrator reached beyond the trust agreement and based his removal decision on statutory grounds.

8.06  Even when the trustee and all of the beneficiaries agree to a form of alternative dispute resolution, not all courts have been willing to embrace the use of a forum other than the judicial system or to enforce an award made by an arbitrator. These courts have been zealous in guarding their jurisdiction, particularly in matters relating to the competency or capacity of the settlor. This concept is illustrated by the case of In re Fellman.16 In the Fellman case, the settlors of a revocable living trust were husband and wife. They appointed themselves as co-trustees, along with a nephew. When the settlors later sought to revoke the trust and withdraw all the trust assets, the nephew refused to cooperate with them in re-conveying the trust assets to them because he felt that they lacked the requisite capacity to revoke the trust. The Pennsylvania orphans’ court refused to hear the case, stating that it lacked jurisdiction due to an arbitration clause in the trust. The arbitration clause, which expressly contemplated that competency issues would be arbitrated, provided as follows:

Any controversy or claim arising out of or relating to this Trust Agreement, or any breach thereof, shall be to the extent permitted by law settled by arbitration in the City of Miami, Florida, in accordance with the rules then obtaining of the American Arbitration Association, and judgment upon the award rendered may be entered in any court having jurisdiction thereof.17

The court went on to state that the other sections of trust:

require that a dispute concerning the competency of a beneficiary or Trustee be arbitrated. The Grantor recognizes that the issue of the competency of the Grantor, (p. 179) his spouse, his children and other descendants, all of whom are potential beneficiaries and Trustees hereunder, involves not only the financial affairs of the Trust but the family relationships among Grantor, his spouse, his children and other descendants and it his [sic] intention whenever possible to avoid litigation on the issue of competency and to resolve that issue entirely through the process of arbitration.18

8.07  On appeal, the Superior Court of Pennsylvania held that the competency of the settlors to revoke the trust was not an issue that was appropriate for arbitration. The court pointed out that the state statutes provided a judicial proceeding for determining incompetency and that that proceeding incorporated constitutional notions of due process, including the right to notice and the opportunity to be heard and defend oneself. In contrast, the court found that these constitutional rights would not be guaranteed in an arbitration. The court quoted from the United States Supreme Court’s decision in Alexander v Gardner-Denver Company19 a list of numerous perceived problems with arbitration, including fact-finding that was not equivalent to that of a judicial proceeding, the relative incompleteness of the record of an arbitration proceeding, the fact that the rules of evidence may not apply, and the severe limitations on procedures such as discovery, compulsory process, cross-examination and testimony under oath. The Pennsylvania court concluded that only the judicial system was equipped to handle issues of incompetency and that it was against the public policy of Pennsylvania to oust the jurisdiction of the Pennsylvania courts and submit issues of incompetency to arbitration.

8.08  In similar cases, courts have stated that the competency of a testator to make a will is not an issue that can be decided by arbitrators, even when all of the parties have agreed to the arbitration.20 For example, in In re Jacobovitz’ Will,21 some of the survivors of the testator entered into an agreement to submit all controversies among them relating to the estate of the decedent, including the question of the validity of his will, to a rabbinical court, which is a type of arbitration governed by Jewish religious law. The Surrogate’s Court of Nassau County, New York, held that, under the state’s laws and constitution, the validity of a will and the disposition of a decedent’s estate could not be the subject of an arbitration. The court added that any attempt to do so was contrary to the public policy of the state.22

(p. 180) 8.09  On the other hand, in In re Ismailoff (Golan),23 the same court allowed an arbitration to proceed on the question whether a trust was the product of undue influence. The trust in question contained an arbitration clause requiring all disputes to be submitted to ‘a panel consisting of three persons of the Orthodox Jewish faith, which will enforce the provisions of this Declaration of Trust and give any party the rights he is entitled to under New York law’.24 The probate court had ruled that the clause was enforceable and the only open question on appeal was the method of selecting the arbitrators. The selection had fallen by default to the probate court. Despite the provision of the trust that clearly contemplated the use of a beth din (rabbinical tribunal), the Surrogate’s Court held that this provision within the arbitration clause was unenforceable because the First Amendment to the US Constitution prohibits the appointment by the probate court of a religious tribunal. The Surrogate’s Court set out the parameters for the selection of arbitrators (three attorneys licensed to practice in New York, chosen by the parties). The court did point out that, although the probate court could not appoint a religious tribunal, the parties were free to select arbitrators who met the religious requirement. The court did not express any concern that sending the dispute to arbitration would oust the jurisdiction of the court.

8.10  Two cases from Michigan are similarly illustrative of how courts’ attitudes toward the use of arbitration to resolve probate disputes, including disputes relating to capacity, have evolved. In 1936, in In re Meredith’s Estate,25 the Supreme Court of Michigan refused to accept an arbitrator’s opinion relating to the testator’s capacity to execute a codicil. The court grounded its decision in the concept that such an act would oust the rightful jurisdiction of the probate court to decide probate disputes. In 2009, in In re Nestorovski Estate,26 the Michigan Court of Appeals substantially limited the precedential effect of the Meredith holding when it affirmed an award reached after the parties to a probate dispute agreed to arbitrate the dispute. The issues in Nestorovski included both whether the testator had been unduly influenced and whether he had the requisite testamentary capacity. The Court of Appeals found that arbitration did not oust the jurisdiction of the probate court and cited legislative developments and changes in court rules, including new rules that encouraged courts and litigants to submit disputes to alternative dispute resolution. The Court of Appeals observed that ‘[t]he aversion to arbitration articulated in In re Meredith Estate must give way to the substantial changes in the substantive and procedural law governing probate practice, as well as jurisprudential recognition of the “desirability of arbitration as an alternative to the complications of litigation”.’27

(p. 181) III.  Mandatory Arbitration

8.11  This section examines cases in which the settlor of the trust has sought to compel the trustees and beneficiaries to submit their disputes to binding arbitration rather than to a court of law. Although the cases discussed herein are relatively recent, historically settlors and testators have exercised the option to choose certain individuals, usually their fiduciaries, to resolve disputes that arise under the trust or will. The oft-quoted provision in President George Washington’s will directed the resolution of all disputes arising under his will to ‘three impartial and intelligent men’ whose decision was to be ‘be as binding on the Parties as if it had been given in the Supreme Court of the United States’.28 Another example is the will of John Pray, which contained the following provision:

Whereas my will is lengthy, and it is possible I may have committed some error or errors. I do therefore authorize and empower, as fully as I could do myself, if living, a majority of my acting executors, my wife to have a voice as executrix, to decide in all cases, in case of any dispute or contention: whatever they may determine is my intention shall be final and conclusive, without any resort to a Court of Justice.29

8.12  The enforcement of such clauses by the courts has met with mixed results. Some courts have allowed the chosen arbitrators to exercise the power given them but have retained the right to intervene if there is an abuse of arbitral power.30 Other courts have clarified that the arbitrators’ power does not extend to changing the terms of the will or trust.31 When Mr Pray’s will dispute was examined by the Supreme Court of the United States, Chief Justice John Marshall described the effect of such provisions as follows:

Even when the forfeiture of the legacy has been declared to be the penalty of not conforming to the injunction of the will, Courts have considered it, if the legacy be (p. 182) not given over, rather as an effort to effect a desired object by intimidation, than as concluding the rights of the parties. If an unreasonable use be made of the power, one not foreseen, and which could not be intended by the testator, it has been considered as a case in which the general power of Courts of Justice to decide on the rights of parties ought to be exercised.32

8.13  In some of these earlier cases, courts took the position that the testator has the right to attach limitations to the devises in his will and that those who benefit from the will must abide by those limitations. For example, in Moore v Harper, the testator stated in his will that any difficulties as to the construction of his will or disputes among the beneficiaries were to be submitted to a named individual ‘whose written opinion shall be final between them’.33 Despite the fact that none of the parties had questioned this provision of the will, the Supreme Court of Appeals of West Virginia mused about its effect. The court analogized the provision to those in contracts and noted that the effect of such a provision is to make the named person an arbitrator. The court went on to observe:

Of course a will is not an agreement between two or more contracting parties, but it is certainly no less binding upon the parties who take a benefit under it than if they had contracted with the testator for that benefit. The testator has full dominion over his property with the absolute right, subject only to the limitations fixed by law, to do with and dispose of it in any manner or to whomever his will or caprice may suggest. Within the rules of law he may subject it to any limitation, restriction or condition he chooses, and the devisee or legatee, if he elects to take under the will, will be bound to respect and observe the same. It, therefore, seems to me entirely clear that a testator has the power not only to appoint a person or arbitrator to interpret and settle difficulties among the devisees and legatees growing out of the dispositions made by the will, but that he has the right to make the decision of such arbiter, if made without fraud or corruption, final and conclusive upon the beneficiaries under the will.34

This theory bears a striking similarity to that used by the Texas Supreme Court over 100 years later in Rachal v Reitz (discussed later in this chapter)35 to explain why trust beneficiaries should be bound to a mandatory arbitration clause in a trust agreement.

8.14  In modern times, courts have taken a generally benign attitude toward the use of binding arbitration to resolve will and trust disputes in those cases in which no objection is raised by the will or trust beneficiaries. For example, in Roehl v Ritchie, the trust in question contained a clause that provided for mandatory arbitration ‘[i]n the event of a dispute arising under this Trust Agreement, including, without limitation, any dispute arising after the death of the Survivor concerning any allocation or apportionment of Trust assets ….’36 When the beneficiaries (p. 183) began disputing over various issues relating to the administration of the trust, the trial court sent the parties to arbitration, pursuant to the arbitration clause. Evidently none of the parties objected to the arbitration because the appellate opinion revolved not around whether the parties could be forced to arbitrate but rather whether the arbitrator had overstepped his authority in issuing a second award after his first award had been confirmed by the court. The appellate court made no mention of whether requiring the parties to arbitrate was appropriate. In fact, the court seemed to approve of the use of arbitration to resolve trust administration issues through a multi-step process, citing with favour the trustee’s observation that ‘the ongoing and changing nature of trust administration’ may require ongoing proceedings ‘for instructions, to settle accounts, to fix compensation … [and] to allow, compromise or settle claims’.37

8.15  When faced head-on, however, with a beneficiary who refuses to be forced into arbitration, the courts have not been as obliging. In these cases, the central question has been whether arbitration, which is traditionally a creature of contract, can be compelled when some of the parties to be bound were not parties to any actual agreement to arbitrate. In Schoneberger v Oelze, now superseded by statute, the beneficiaries of three trusts sued the trustees for breach of trust, conversion, and fraudulent concealment.38 Each of the trusts contained identical mandatory arbitration clauses.39 The defendant trustees filed a motion to compel arbitration. The Arizona Court of Appeals analysed whether arbitration was appropriate by applying the Arizona arbitration statute, which provided as follows:

A written agreement to submit any existing controversy to arbitration or a provision in a written contract to submit to arbitration any controversy thereafter arising between the parties is valid, enforceable and irrevocable, save upon such grounds as exist at law or in equity for the revocation of any contract.40

(p. 184) 8.16  The Court of Appeals affirmed the trial court’s refusal to require arbitration on the theory that a trust is not a contract. The trustees argued that the trust clearly was a contract and that the only real question for the court was whether the beneficiaries, who were not signatories to the trust, would be bound by the trust provisions. The trustees argued that the beneficiaries should be bound because they were third party beneficiaries or, alternatively, because they were equitably estopped from avoiding arbitration because they had accepted direct benefits from the trust. The third party beneficiary theory and equitable estoppel theories are theories that have been used to bind parties who did not actually sign the contract in question. Under the third party beneficiary theory, a person who is not a party to a contract may sue or be sued for breach of that contract if the contract evidences a clear intent to primarily and directly benefit that person.41 Under the equitable estoppel theory, a person cannot assert a claim that is based on an agreement while simultaneously seeking to disavow a portion of the agreement.42

8.17  The Court of Appeals did not feel the need to address the trustees’ third party beneficiary and equitable estoppel arguments due to the threshold determination that a trust was not a ‘written contract’ as contemplated by the state arbitration law. The court cited its earlier opinion in In Re Naarden Trust, which discussed at length the distinction between a trust and a contract.43 In making this distinction, the Naarden court pointed out that a fiduciary duty exists between a trustee and a beneficiary but does not generally exist between parties to a contract. Furthermore, the Naarden court noted that a beneficiary of a trust receives a beneficial interest from a trust while the ‘beneficiary’ of a contract is one who has a personal claim against the promissor and that, unlike a contract, a trust does not depend upon an exchange of promises.44 In Schoneberger, the Court of Appeals criticized the trustees for ‘[g]lossing over the distinctions between a contract and a trust’45 by citing cases in which trust beneficiaries had been compelled to arbitrate as a result of contracts entered into by trustees when they opened accounts at brokerage firms or other financial institutions. The Court of Appeals pointed out that the cases cited by the trustees were grounded in actual contracts signed by the trustees and were not cases that involved ‘internal trust disputes’.46 The Court of Appeals also (p. 185) criticized as irrelevant the trustees’ argument that the beneficiaries should be compelled to arbitrate because, under Arizona law, a trustee is authorized to settle claims through arbitration.47

8.18  Finally, the Court of Appeals addressed the argument that a settlor (‘trustor’) may require arbitration of trust disputes in the same manner that a settlor may reserve or create powers in herself or others relating to trust administration. The Court of Appeals observed, ‘We can see why a trustor creating an inter vivos trust might wish to require arbitration of disputes involving the trust’, citing the ‘expeditious and inexpensive’ features of arbitration.48 But the Court of Appeals concluded that ‘[a] trustor’s right to reserve power over trust administration matters is not, however, absolute and a trustor of an inter vivos trust may not unilaterally strip trust beneficiaries of their right to access the courts absent their agreement.’49 The Schoneberger decision was superseded in 2009 when Arizona enacted legislation authorizing a trust instrument to provide mandatory procedures to resolve trust administration disputes. However, as discussed subsequently in this section, the reasoning of the Schoneberger decision continues to be applied in cases that arise in those states that have no statute relating to trust arbitration.

8.19  In 2006, the District of Columbia Court of Appeals reached a result similar to that in the Schoneberger case in In Re Calomiris.50 The controversy in this case arose when siblings, all of whom were trustees of a trust, sought to have each other removed. The will that established the trust contained a provision that required that any material difference of opinion among the trustees was to be resolved by arbitration.51 The Court of Appeals looked to the provision of the District of Columbia arbitration statute that mirrored the Arizona statutory provision referencing a ‘provision in a written contract to arbitrate’.52 Citing at length the Schoneberger decision, the DC Court of Appeals concluded that ‘in the present case, the arbitration is not contained in a written agreement or a contract’.53 The Court of Appeals noted that the arbitration clause in the Calomiris case was in a will rather than a trust instrument but found that ‘[t]his distinction makes no difference … because a will is not a contract either.’54

(p. 186) 8.20  The next court to address the question whether trust beneficiaries could be compelled to arbitrate by an arbitration clause contained in the trust was the California Court of Appeal in Diaz v Bukey.55 This case arose in the now-familiar scenario of a family trust that contained an arbitration clause56 and an attempt by the beneficiary to remove the trustee for breach of fiduciary duty. The trustee moved to compel arbitration, asserting that the trust was a contract and that the non-signatory beneficiary was bound to arbitration under the same third party beneficiary and estoppel theories that were argued by the trustee in Schoneberger. The Court of Appeal stated that under the California Arbitration Act, only those who are parties to a contract or agreement to arbitrate could be compelled to do so.57 After examining the California statutory definition of a contract, the court concluded that the ‘[t]rust does not meet the statutory definition of a contract because there is no evidence that the beneficiaries gave either their consent or consideration to achieve the status of beneficiary.’58

8.21  The Diaz court noted that no California case had ever addressed whether a beneficiary could be bound by an arbitration clause in a trust. The court pointed out, however, that the Supreme Court of California had determined that the matter of the probate of a will could not be submitted to arbitration59 and that the same reasoning should apply in the case of a trust. The Court of Appeal dismissed as inapposite the trustee’s reliance on a set of California cases in which the court had found that a trust was a contract, at least as it related to the compensation of the trustee, and noted that the present case was different because it involved a dispute between the beneficiaries and the trustee over the ‘internal affairs of the trust’ rather than a dispute over compensation.60

8.22  The Diaz court also dismissed the trustee’s third party beneficiary argument, citing a California case in which the California Supreme Court had refused to allow trust beneficiaries to bring a cause of action as third party beneficiaries of a contract between a trustee and an agent of the trustee.61 Finally, the Court of Appeal quoted at length the Schoneberger opinion, ‘find[ing] its reasoning persuasive’.62 The Court of Appeal concluded that, just as in Schoneberger, the trustee had not proved the (p. 187) existence of a written contract to arbitrate. The Court of Appeal reiterated the Schoneberger statement that ‘as a matter of law, the trusts at issue here were not contracts’.63

8.23  A few months after it was rendered, the Court of Appeals’ decision in Diaz v Buckey was suspended by the Supreme Court of California,64 pending a decision in another case, Pinnacle Museum Tower Association v Pinnacle Market Development (US), LLC.65 When the Pinnacle case was decided, Diaz v Bukey was transferred back to the California Court of Appeal with direction to vacate its earlier opinion and reconsider it in light of the Pinnacle decision.66 The reconsidered decision was never rendered, however, because Diaz v Bukey was dismissed pursuant to a stipulation of the parties.67 Furthermore, the original Court of Appeal decision in Diaz is no longer considered valid under California procedural law.

8.24  The California Court of Appeal would examine the arbitration issue again in 2014. However, prior to that time, the Texas Supreme Court issued its landmark decision in Rachal v Reitz.68 In this case, the Texas Supreme Court became the first state court to enforce an arbitration clause in a trust against the direct objections of a beneficiary of the trust. The trust was an inter vivos trust for which the settlor initially served as trustee. When the settlor died, Rachal, the lawyer who had drafted the trust, became the trustee. The trust contained the following provision:

Arbitration. 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, and no legal proceedings shall be allowed or given effect except as they may relate to enforcing or implementing such arbitration in accordance herewith. Judgment on any arbitration award pursuant hereto shall be binding and enforceable on all said parties.69

8.25  One of the beneficiaries sued Rachal on the grounds that he had misappropriated trust assets and failed to provide an accounting. Rachal sought to compel arbitration of the dispute under the Texas Arbitration Act (TAA). The trial court and the (p. 188) intermediate court of appeals denied Rachal’s motion to compel arbitration. The Court of Appeals, noting that an arbitration agreement must be part of an enforceable contract between the parties, stated that such a contract does not exist in the trust context. The Court of Appeals gave two reasons for its holding: 1) there is no consideration in a trust and 2) the beneficiaries did not consent to the arbitration provision. The Court of Appeals went on to point out that it would be up to the state legislature rather than the courts to decide the extent to which a settlor of a trust could bind the trust beneficiaries to arbitrate.

8.26  The Supreme Court of Texas reversed the judgment of the Court of Appeals. The Supreme Court began its opinion by emphasizing its consistent practice of enforcing the intent of the settlor of a trust ‘which we divine from the four corners of unambiguous trusts’.70 The court looked to the unambiguous wording of the arbitration provision and found that the settlor had ‘unequivocally stated his requirement that all disputes be arbitrated’.71

8.27  The Texas Supreme Court then turned to application of the TAA. The court noted first that the wording of the TAA differed from that of other arbitration statutes in that it spoke of enforceable ‘agreements’ to arbitrate rather than ‘contracts’ to arbitrate. The court pointed out that the Texas legislature specifically chose to use the term ‘agreement’ rather than contract, stating, ‘[i]f the Legislature intended to only enforce arbitration provisions within a contract, it could have said so.’72 The court, looking to secondary authorities, including Black’s Law Dictionary, then opined that an agreement is broader than a contract in that it may not require all of the formalities of a contract. The court concluded that the hallmark of an agreement is mutual assent. While mutual assent is typically exhibited by the parties signing an agreement, the court pointed out that there are several theories under which non-signatories can be bound to arbitration agreements.73 The court applied the direct benefits estoppel theory in this case.74 Under this theory, an individual (p. 189) who is seeking or accepts the benefits of a contract cannot simultaneously attempt to avoid the burdens of the contract, including the obligation to arbitrate.

8.28  In discussing the direct benefits estoppel theory, the Rachal court referred to its earlier decision in In Re Weekley Homes, LP.75 In this case, a father contracted with Weekley Homes for the construction of a house. The agreement between the father and the construction company included an arbitration provision. When the house was completed, the father transferred it to his revocable family trust. The father and the daughter were the only trustees of the trust and the daughter was the sole beneficiary following her father’s death. Throughout the construction the daughter often dealt directly with Weekley. At some point, the daughter sued Weekley, claiming that defects in the construction had caused her to contract asthma. Weekley invoked the arbitration clause but the trial court refused to order the daughter to arbitration as she was not a party to the arbitration agreement. The daughter also asserted that her claim was a non-contractual personal injury claim and thus not one that was based on the contract in which the arbitration provision appeared. The Supreme Court of Texas disagreed. The court focused on the daughter’s conduct during the course of the contract. The court found that she had exerted control in her dealings with Weekley and that Weekley had complied. The court concluded that because the daughter deliberately sought substantial benefits from the contract, and Weekley had agreed to comply, she could not then avoid the arbitration clause that was part of that agreement.

8.29  After discussing the application of the direct benefits estoppel theory in the Weekley Homes case, the Rachal court then went on to examine whether this theory could be applied to compel a beneficiary to arbitrate under the terms of a trust. The court noted first that a beneficiary is not forced to accept benefits under a trust in that the beneficiary may ‘opt out’ of the trust arrangement that is established by the settlor, either by disclaiming her interest in the trust or by challenging the validity of the trust instrument. On the other hand, the court said that a beneficiary who attempts to assert rights that would not exist without the trust has clearly assented to the terms of the trust. In this particular case, the court pointed out that Reitz, the beneficiary, had not disclaimed the trust and that his suit against the trustee revolved around him seeking to enforce the provisions of the trust. Specifically, Reitz was claiming that Rachal had violated the trust provisions that prevented the trustee from making distributions to himself that did not meet an ascertainable standard, required the trustee to make annual accountings, and prohibited the trustee from converting trust assets. The court stated that in accepting the benefits of the trust and suing to recover damages for violation of the terms of the trust, Reitz had clearly indicated acceptance of the terms and validity of the trust. In response to Reitz’s argument that there was no underlying contract, the court (p. 190) responded that the direct benefits estoppel theory, just like the theory of promissory estoppel,76 does not require the existence of an underlying contract. Rather, these ‘equitable defensive theories’ are designed to ‘promote fairness by holding a party to its position in the performance of an agreement or in bringing litigation’.77

8.30  The Rachal court next proceeded to justify its holding in light of the contrary holdings and reasoning in the Schoneberger and Diaz cases. The court began by noting simply that both cases had been decided by intermediate courts of appeals, that Schoneberger had been superseded by the new Arizona statute rendering enforceable arbitration provisions in trust agreements, and that Diaz had been vacated by the California Supreme Court. The Rachal court then went on to point out further distinctions among the cases. The court noted first that, unlike the TAA, the Arizona arbitration statute at issue in Schoneberger applied only if the agreement to arbitrate appeared in a ‘written contract’. As to the Diaz case, the Rachal court pointed out that the California arbitration statute, like the Texas statute, addressed arbitration provisions in ‘written agreements’. However, the Rachal court noted that Diaz had been vacated pending a decision by the California Supreme Court in Pinnacle Museum Tower Association v Pinnacle Market Development (US), LLC.78 In Pinnacle, the California Supreme Court permitted enforcement of an arbitration provision in a condominium development’s recorded declaration of covenants, conditions, and restrictions even though only the individual owners (rather than the owners’ association) had signed it. The Rachal court noted that the Pinnacle decision rested on the Federal Arbitration Act, which referred to a ‘written contract’, and noted that the Pinnacle court had found the recorded declaration to be contractual in nature.

8.31  Finally, the Rachal court turned to the question whether the dispute in question was within the scope of the arbitration agreement. Reitz had argued that the trust terms indicated an intent on the part of the settlor to exempt from arbitration claims of trustee misconduct. To bolster his claim, Reitz relied on a provision of the trust regarding the exoneration of trustees, stating that this provision indicated an intent to allow litigation in certain circumstances. The provision in question allowed the trustee to fund from the trust litigation or dispute-related costs in the case of unintentional misconduct and required those costs to be deducted from the share of a beneficiary if the beneficiary initiated proceedings in bad faith. The court noted first that, by its own terms, the arbitration provision prevailed ‘despite anything herein to the contrary’.79 Second, the court stated (p. 191) that the exoneration provision could still be effective in certain cases. The two scenarios described by the court were scenarios in which a dispute was initiated in court but then ended up in arbitration and in which theories such as the direct benefit estoppel theory were not applicable to compel arbitration. As to the second scenario, the Rachal court repeated its earlier admonition that the direct benefits estoppel theory would not apply if the validity of the trust itself was challenged as such a challenge would indicate a lack of the mutual assent required in order for arbitration to be ordered. As discussed later in this chapter, the year after the Rachal case was decided, the California Court of Appeal examined a set of facts that replicated this second scenario.

8.32  In 2014, the California Court of Appeal again addressed the question whether an arbitration clause in a trust could be enforced to compel to arbitration a beneficiary’s claim that the trust was invalid. The court refused to compel arbitration. In Mc Arthur v McArthur,80 the beneficiary who filed suit, Pamela, was one of three daughters who had been an equal beneficiary with the other daughters under the trust settled by their mother in 2001. In 2011, the trust was amended to make one of the other daughters, Kristi, the primary beneficiary and co-trustee with the mother and to add an arbitration clause.81 The mother died soon after the trust was amended.

8.33  A few months after the mother’s death, Pamela sought to have the 2011 trust declared void and to have Kristi removed as a beneficiary under a California statute that prohibits a beneficiary from inheriting from an elderly person whom the beneficiary had abused. Pamela alleged undue influence on Kristi’s part, lack of capacity on the mother’s part, and elder abuse by Kristi in the form of a wrongful taking (p. 192) of property from her mother. Kristi sought to compel arbitration but the trial court found that the arbitration clause was not enforceable because there was no evidence that the beneficiaries had consented to the arbitration clause. On the eve of the hearing on Kristi’s motion, Pamela filed a brief citing the Schoneberger case. After the hearing but before the judgment was rendered, the California Supreme Court handed down its opinion in Pinnacle.82 As noted earlier, in Pinnacle, the Supreme Court compelled a homeowners association to arbitrate its dispute with the developer even though the association itself had not signed the recorded declaration of covenants, conditions, and restrictions that contained the arbitration provision. As also noted earlier in this chapter, the pending decision in the Pinnacle case caused the suspension of the decision in the Diaz case. The Diaz case was never revisited after the Pinnacle decision because Diaz was eventually dismissed pursuant to a stipulation of the parties. However, the McArthur court took it upon itself to complete the assignment that the Supreme Court had issued to the Diaz court.83

8.34  The McArthur decision began with a recognition by the court that there was no published California decision that addressed whether trust beneficiaries could be bound to arbitrate by a provision in a trust instrument.84 The court noted also that there was not a great deal of case law on the subject from other jurisdictions. The court did look for guidance to the two out-of-state cases that had discussed the issue—the Schoneberger case and the Rachal case. The McArthur court reiterated the Schoneberger reasoning that a trust is not a contract and that the Arizona arbitration statute then in effect applied only to an agreement in a written contract to submit a dispute to arbitration.

8.35  The court also articulated the Rachal holding that the Texas Arbitration Act’s use of the broader term ‘agreement’ signalled an intent by the legislature that the Act apply to any agreement that was supported by mutual assent. The McArthur court examined the Rachal court’s conclusion that the beneficiary could be bound to arbitrate under the direct benefit estoppel theory. The McArthur court then stated that ‘[o]ther courts have similarly concluded that a beneficiary who seeks to enforce rights under a trustee’s contract with a third party may be compelled to arbitrate the dispute pursuant to an arbitration clause in the contract.’85 To bolster this statement, the court cited cases in which a trustee, in the course of administering the trust, had entered into a contract with a third party (typically a broker or financial institution) which contained an arbitration clause. When the beneficiary sought to sue the trustee and the third party in these cases, the court compelled arbitration even though the beneficiary had not signed the underlying contract under the (p. 193) theory that the beneficiary had accepted the benefits of the contract.86 However, the McArthur court did not find these cases controlling because Pamela had not accepted benefits from the amended trust and was not attempting to enforce any rights under that amended instrument.

8.36  The McArthur court refused to apply the Rachal court’s direct benefit estoppel theory, quoting language from the Rachal opinion stating that a beneficiary’s challenge to the validity of the trust belied the theory that she had accepted benefits under that trust. In McArthur, Pamela had challenged the validity of the amended trust due to her mother’s lack of capacity and Kristi’s undue influence. The McArthur court dismissed Kristi’s argument that Pamela, in trying to assert her rights under the original trust agreement, had accepted benefits from the amended trust. The court said that Kristi was conflating the two trusts and that it was not logical to argue that in seeking to enforce the original trust Pamela was accepting or seeking to enforce benefits under the amended trust. The court also refused to accept Kristi’s argument that Pamela had forfeited her right to contest the validity of the amended trust because she had not countered Kristi’s evidence establishing the validity of that trust. The court pointed out that the validity of the amended trust had not been adjudicated by the motion to compel arbitration.

8.37  The McArthur court then addressed the effect of the Pinnacle decision on its current holding. Kristi had argued for a broad application of that decision to all cases involving non-signatories to an arbitration agreement. The court, on the other hand, found the Pinnacle decision materially distinguishable in that it relied heavily on the California Supreme Court’s interpretation of a statutory scheme that was specific to condominium developments and that contained consumer protection provisions. The McArthur court noted that no similar statutory scheme existed relevant to trust arbitrations and that, unlike the Arizona Code as revised after Schoneberger, the California Probate Code contained no provision relating to pre-dispute arbitration provisions in trusts.

8.38  The McArthur court next addressed Kristi’s contention that other California cases had characterized trusts as contracts between the settlor and the trustee87 and thus that the beneficiaries should be bound as third party beneficiaries of these contracts. The court pointed out that these cases spoke of contracts between the settlor and the trustee that related to the services the trustee would perform for the settlor (p. 194) and focused on the trustee’s compensation. Reiterating its earlier theme, the court stated that, despite these cases, in order for the beneficiary to be a third party beneficiary, the beneficiary would have to be claiming benefits under the trust before being bound to arbitrate.88

8.39  Finally, Kristi attempted to persuade the court that it should follow the ‘national trend’ towards favouring mandatory arbitration in the trust context, citing in particular Arizona’s statutory amendment following the Schoneberger case. The McArthur court responded that ‘[t]hese are arguments best addressed to the Legislature, not to this court.’89 The court also pointed out that, no matter what the national trend may be, Kristi had not demonstrated that any other jurisdiction would compel arbitration when the beneficiary had not accepted and was not seeking to claim the benefits of the trust that contained the arbitration provision.

8.40  Following the Rachal and McArthur cases, two more courts—a state court and a federal court—examined situations in which a trust contained a mandatory arbitration clause. However, neither of these courts addressed directly the question of whether a settlor may require the trust beneficiaries to engage in mandatory arbitration. In Diggs v Lingo, the Tennessee Court of Appeals refused to enforce an arbitration clause in a trust. The court’s reasoning revolved not around whether such clauses are binding on trust beneficiaries but rather around whether the beneficiaries can be forced to arbitrate their claims against a person who is neither the trustee nor a beneficiary.90 In this case, the beneficiaries of the trust claimed that the trustee had breached his fiduciary duty when he sold trust property to himself and his wife for less than fair market value. The trustee and his wife took title to the property as tenants by the entireties. The beneficiaries sought to have the property restored to the trust. The arbitration clause in the trust mandated arbitration of controversies between the trustee and the beneficiaries. The trustee’s wife was neither a trustee nor a beneficiary. When the trustee moved to compel arbitration, the wife offered to be bound by the arbitration but the beneficiaries refused and contended that they could not be forced to arbitrate their claims against the wife. The Court of Appeals agreed and affirmed the trial court’s denial of the trustee’s motion to compel arbitration.

8.41  In deciding this case, the Tennessee Court of Appeals looked to the Tennessee Arbitration Act, which speaks of an agreement to arbitrate that is contained in (p. 195) a written contract between the parties. The Court of Appeals pointed out that the wife was not a party to the ‘contract’ and thus she could not be bound by the arbitration clause. The trustee argued that the wife’s consent to be bound by the arbitration constituted an enforceable agreement to arbitrate but the Court of Appeals disagreed. The court characterized the wife’s consent as merely an offer to the beneficiaries; absent an acceptance of that offer by the beneficiaries, there was no agreement between them to arbitrate. Because the wife was a necessary party to any action seeking to encumber her interest in the property at issue, an underlying concern in this case was that the beneficiaries would have to resolve their dispute against the trustee by arbitration and their dispute against the trustee’s wife by litigation. The Court of Appeals pointed out that parallel proceedings of this sort would not only be impractical but would also defeat the cost and time advantages of arbitration.

8.42  In the second of these cases, FPE Foundation v Cohen, the US Court of Appeals for the First Circuit addressed not whether trust beneficiaries could be bound by an arbitration clause but rather whether a certain beneficiary had waived its right to compel arbitration.91 The court also addressed whether the trust arbitration clause applied to the asserted claims.

8.43  The trust at issue in this case contained a broad arbitration clause that provided that ‘[a]ny controversy or claim arising out of or relating to this trust agreement, or the breach thereof, shall be settled by arbitration.’92 One beneficiary sued the co-trustees for exceeding their trustee powers and for breach of fiduciary duty, while a second beneficiary counter-claimed for a share in whatever the first beneficiary recovered. The co-trustees and beneficiaries were also involved in numerous other lawsuits on claims relating to the trust in question and other probate and trust issues.

8.44  The Court of Appeals examined the parties’ conduct in the other lawsuits and concluded that that conduct did not result in a waiver of the right to compel arbitration. The Court of Appeals also concluded that the beneficiaries’ claims clearly related to the trust and thus were subject to the arbitration clause. Without addressing at any point whether a settlor can in fact bind beneficiaries with an arbitration clause, the Court of Appeals simply dismissed the case from the federal court and compelled arbitration. In doing so, the Court of Appeals invoked on three occasions the strong federal and state public policy favouring arbitration.93 This case may have little precedential value on the issue of mandatory trust arbitration due to its complicated facts and an almost intractable overlap of the roles of the various parties. On the other hand, the Court of Appeals’ lack of concern about (p. 196) the enforceability of the arbitration clause may signal an enhanced acceptability of these clauses, at least on the federal level.

IV.  Trust Arbitration Issues on the Horizon

8.45  When the arbitration of internal trust disputes becomes more prevalent, either through the agreement of the parties or because of mandatory trust provisions, the question arises as to whether the courts will be bypassed entirely, or, alternatively, whether there will still be issues that the courts will be forced to face. The cases described in this section illustrate that the courts will still be asked to weigh in on issues such as the construction of mandatory arbitration provisions, their effect on other provisions in the trust, the timing of the arbitration, and the tax treatment of trusts that contain arbitration provisions.

Construction of Arbitration Clauses

8.46  If and when including an arbitration clause in a trust instrument becomes more popular, courts will be called upon to construe or interpret the wording of these clauses. About a year after the decision of the Texas Supreme Court in Rachal, the Court of Appeals of Texas (the same court that refused to compel arbitration in Rachal) was asked to interpret another trust arbitration provision in Archer v Archer.94 As in the Rachal case, the trustee who was being sued was a successor trustee who took office when the last of the original trustees resigned. Some of the beneficiaries of the trust initiated the litigation, claiming that the trustee had breached his fiduciary duty and asking that the trustee be compelled to give an accounting. The trust contained the following provision:

Section 14.02  No Court Proceedings

This trust shall be administered expeditiously, consistent with the provisions of this agreement, free of judicial intervention, and without order, approval or action of any court. The trust shall be subject to the jurisdiction of a court only if our Trustee or another interested party institutes a legal proceeding. A proceeding to seek instructions or a court determination shall be initiated in the court having original jurisdiction over matters relating to the construction and administration of trusts. Seeking instructions or a court determination shall not subject this trust to the continuing jurisdiction of the court.

We request that any questions or disputes that may arise during the administration of this trust be resolved by mediation and if necessary, arbitration in accordance with the Uniform Arbitration Act. Each interested party involved in the dispute (including our Trustee, if involved) shall select an arbiter and, if necessary to establish a majority decision, the arbiters shall select an additional arbiter. The decision of a majority of the arbiters selected shall control with respect to the matter.

(p. 197) 8.47  The trustee sought to compel arbitration pursuant to the Texas Arbitration Act. Invoking the reasoning of the Texas Supreme Court in the Rachal case, the Archer court sought first to ascertain whether a valid agreement to arbitrate existed. The court examined the words of the trust to determine whether the settlors had intended to require arbitration. The inquiry revolved around the use of the term ‘request’ in the second paragraph of the arbitration clause.

8.48  The court dispensed quickly with the trustee’s first argument, in which he contended that the title of the relevant section (‘No Court Proceedings’) indicated an intent to direct all disputes to arbitration. The court pointed to another section of the trust that indicated that headings in the trust instrument were solely for convenient reference and had no bearing on the construction or interpretation of the instrument.

8.49  The court spent more time discussing the trustee’s second argument, which revolved around the other uses of the term ‘request’ in the trust. The trustee argued that in some other sentences in the trust instrument the settlors had added the term ‘but do not require’ to the term ‘request’. The court pointed out that the settlors had defined the term ‘shall’ to refer to mandatory performance and had used that term 450 times in the trust instrument. They fact that they had not used the ‘but do not require’ language in the specific provision relating to arbitration did not, in the eyes of the court, reflect a mandatory direction that all disputes be resolved through arbitration.

8.50  Finally, the court examined the trustee’s argument that the first paragraph of Section 14.02 dealt only with ‘instructions’ or ‘determinations’ while the second paragraph was to be applied whenever there was a ‘dispute’. The court noted again the use of the word ‘shall’ in the first paragraph and stated that this paragraph mandated that the trust would be subject to the jurisdiction of the court in the event a legal proceeding was filed by an interested party. The court pointed out that in the second paragraph the language changed from an expression of command to a request. The court concluded that the settlors had ‘merely expressed a desire’ that disputes be resolved through mediation and, if necessary, arbitration and that their ‘request was precatory, not mandatory’.95

8.51  In another construction case, In re Wetzel, an unpublished per curiam opinion, the Michigan Court of Appeals narrowly construed an arbitration clause that appeared in a trust and refused to apply that provision to a question of the removal of a co-trustee.96 The arbitration clause provided as follows:

Any controversy between the Trustee or Trustees and any other Trustee or Trustees, or between any other parties to this Trust, including Beneficiaries, involving the (p. 198) construction or application of any of the terms, provisions, or conditions of this Trust shall, on the written request of either or any disagreeing party served on the other or others, be submitted to arbitration.97

8.52  The court in this case noted that by statute the probate court had exclusive jurisdiction over the removal of trustees. In addition, the trust instrument itself contained no provisions relating to the removal of a trustee. Consequently, the court found that removal was not a ‘controversy … involving the construction or application of any of the terms, provisions, or conditions’ of the trust and thus was not subject to arbitration.

Effect of Arbitration Clauses on Other Provisions in the Trust

8.53  The inclusion of an arbitration provision in a trust instrument may raise questions about the effect of this provision on other clauses in the trust. In Johnson v Greenelsch, the Supreme Court of California examined whether a beneficiary’s arbitration demand violated the no-contest clause of the trust.98 The arbitration clause in the trust was a broad one which applied to ‘[a]ny and all disputes’ between trustees or beneficiaries, ‘concerning any property owned by any trust(s) or the operation of any trust created herein’.99 The no-contest clause barred a distribution to any beneficiary who:

seeks to obtain in any proceeding in any court or before any arbitrator an adjudication that this Trust or any of its provisions is void, or seeks otherwise to void, nullify, [or] set aside this Trust or any of its provisions, … or to change provisions which are clearly and unambiguously expressed herein, … or through other means endeavors to secure or take any part of the Trust Estate in any manner other than as set forth herein.100

8.54  The matter at issue was whether a surviving spouse who was one of the original trustees and beneficiaries of the trust had the mental capacity to exercise her right to withdraw certain assets from the trust and to appoint a trustee to replace herself. Her daughter, who was also a trustee and beneficiary and who thought her mother lacked capacity, filed a petition to determine whether she would be deemed to have violated the no-contest clause if she filed a petition to compel arbitration on the matter of the mother’s capacity. The trial court and court of appeals found that her demand would violate the no-contest clause; however, the Supreme Court of California disagreed.

8.55  The Supreme Court, citing the California law relating to no-contest clauses, found that the arbitration demand was not a direct challenge to the validity of the trust nor was it an attempt to revise the trust terms. The Supreme Court stated that (p. 199) while the daughter agreed that her mother had the right under the trust to withdraw assets and to appoint a successor, the daughter had offered evidence that the mother simply lacked the capacity necessary to exercise those rights. The daughter was not attempting to thwart the estate plan set forth in the trust nor to challenge, either directly or indirectly, the trust provisions relating to the distribution of the trust assets. In the end, the court held that the daughter could proceed with her arbitration demand without fear of losing her benefits under the trust.

Timing of the Arbitration

8.56  To the extent that courts compel arbitration of trust disputes, courts may still be called upon to weigh in on procedural matters, such as the time period during which a compelled arbitration must take place. An example appears in Gren v Gren.101 The trust in this case contained an arbitration clause102 and benefitted the settlor’s current wife and his son from a previous marriage. The current wife was also the trustee.

8.57  When the son died, his mother (the settlor’s ex-wife and the personal representative of the son’s estate) filed a petition for construction of the trust terms to determine whether her son’s estate was entitled to a share of the trust. The trustee filed a motion to compel arbitration pursuant to the terms of the trust. The trial court granted the motion. Six months passed but the ex-wife took no action to commence an arbitration. The trustee then sued to have the ex-wife’s petition dismissed because her delay in filing for arbitration was preventing the trustee from winding down the affairs of the trust. The trial court dismissed the ex-wife’s petition.

8.58  The District Court of Appeal of Florida reversed the trial court’s order, stating that, once the motion to compel arbitration had been filed, the timeliness of the filing of the petition was a matter for the arbitrator, not the court, to decide. The Court of Appeals noted the general policy favouring arbitration over litigation and pointed out that the parties were not challenging the validity of the trust or whether an arbitrable issue existed. In addition, the trust contained no time limit within which the arbitration was required to proceed. The court remanded the case for reinstatement of the construction petition and arbitration of the dispute.

Tax Treatment of Arbitration Clauses

8.59  Another important issue that attorneys must confront is the effect that an arbitration clause may have upon the taxation of transfers made to a trust that contains a mandatory arbitration clause. The United States Tax Court’s decision in Mikel v (p. 200) Commissioner103 is the first case to examine whether and to what extent the Internal Revenue Service will respect the decisions reached when arbitration of a dispute is compelled.104

8.60  The trust at issue in this case was what is commonly referred to as a ‘Crummey Trust’.105 The trust was the vehicle by which a couple gave gifts to their children, their lineal descendants, and the spouses of their children and lineal descendants. The couple sought to make gifts in such a way as to legally avoid paying the federal gift tax on the gifts. Section 2501 of the Internal Revenue Code (IRC) imposes a tax on any transfer of property by gift.106 However, IRC Section 2511 excludes certain gifts from the calculation of those gifts that are subject to the gift tax. This section excludes gifts of up to $10,000 per person per year, with this amount to be adjusted for inflation. In 2007, the year in which the questioned gifts were made, the ‘annual exclusion’ amount was US$12,000. During that year, each member of the couple gave a total of US$720,000 in gifts to the trust, which had sixty beneficiaries. Under IRC Section 2503(b)(1), a gift to a trust beneficiary is eligible for the annual exclusion only if the gift is a gift of a ‘present interest’.

8.61  In Crummey, the Court of Appeals for the Ninth Circuit issued a landmark ruling about what constituted a gift of a ‘present interest’. The court in Crummey held that a gift is a gift of a present interest if the beneficiary has a reasonable right to withdraw the money that was contributed to the trust for him or her. This holding prompted estate planning attorneys to routinely set up ‘Crummey trusts’ that gave each beneficiary the right to withdraw from the trust an amount that equalled the amount for which the gift tax annual exclusion is available. In decisions subsequent to the Crummey case, the Internal Revenue Service (IRS) stated that it would ‘not contest annual gift tax exclusions for Crummey powers where the trust instrument gives the power holders a bona fide unrestricted legal right to demand immediate possession and enjoyment of trust income or corpus’.107

8.62  The trust in the Mikel case contained a Crummey provision that allowed each beneficiary that withdrawal right. However, the trust also contained an arbitration clause that provided that any disputes that arose under the trust instrument were to (p. 201) be ‘submitted to arbitration by a panel consisting of three persons of the Orthodox Jewish faith’—in other words, a beth din. The panel was instructed to ‘enforce the provisions of this Declaration … and give any party the rights he is entitled to under New York law’.108

8.63  The Internal Revenue Commissioner took the view that the gifts would not be eligible for the annual exclusion because the withdrawal rights of the trust beneficiaries were not legally enforceable in that the beneficiaries could not ‘go before a state court to demand that right’.109 The Commissioner also argued that the beneficiaries’ withdrawal rights were illusory because the trust contained a no-contest clause that would discourage them from pursuing in court or arbitration any rights that were denied to them.

8.64  The Tax Court disagreed with the Commissioner. While the bulk of the Tax Court’s opinion revolved around the effect of the no-contest clause (which the court determined did not apply to a contest regarding the beneficiary’s withdrawal rights), the court did make two interesting observations about a provision that would require a beneficiary whose withdrawal right had been frustrated to go to arbitration rather than to state court. First, the Tax Court noted that the requirement that a withdrawal right be legally enforceable was not, as the Commissioner argued, a requirement that the beneficiary must be able to take his matter to a state court. Instead, a beneficiary whose timely withdrawal request was denied could go to a beth din. Notably, the court believed that the Commissioner had ‘not explained why this is not enforcement enough’.110 Second, in a footnote the court pointed out that all of the parties agreed that, even though courts are generally opposed to upsetting decisions reached in an arbitral forum, the beneficiaries in this case probably could have resort to a state court because the New York courts do not enforce an arbitration award if the beneficiary has not consented to having the matter sent to arbitration.111 It is unclear what this latter point signals. While the Tax Court seemed to endorse arbitration as a recognizable means of enforcing rights, the court also seemed to find some comfort in the notion that New York’s antipathy to upholding mandatory arbitration clauses in trusts means that the beneficiaries would in fact be entitled to have their rights enforced in state court should they choose to do so.

8.65  It is worth noting that, as of 1998, IRC section 7123 requires the establishment by the IRS of a pilot programme that allows the IRS and a taxpayer to jointly request (p. 202) binding arbitration on any issue that is not resolved under the traditional appeals procedure. Such a programme was established by the IRS and operated for fourteen years but was shut down in September 2015 due to lack of demand.112

V.  Conclusion

8.66  As this chapter illustrates, the state and federal courts of the United States are encountering increasingly complex issues in the wake of the rising national trend toward using arbitration to resolve internal trust disputes. Courts are being asked to intervene in cases in which the parties all agree to arbitrate (consensual arbitration) as well as those in which the settlor tries to force the parties to arbitrate (mandatory arbitration).

8.67  The cases discussed in the first section of this chapter indicate that, when the arbitration is consensual, the courts are generally disposed to let the arbitration proceed. However, some courts continue to take issue with allowing certain questions—particularly questions relating to capacity and competency—to be decided in a non-judicial forum even if all the parties agree.

8.68  As described in the second section of this chapter, cases involving mandatory arbitration present even more vexing questions. To date, only a few courts have dealt with the effect of a mandatory arbitration provision in a trust document. The Schoneberger, Diaz, Rachal, and McArthur cases are the only cases that have addressed head-on the question whether a settlor can require the beneficiaries of a trust to arbitrate their disputes and these cases have reached differing conclusions. As a result, the resolution of this question is in its infancy. Many more state and federal courts will need to contribute to the debate before a clear consensus on this issue is reached.113

8.69  Finally, as the cases in the third section of this chapter illustrate, even if mandatory arbitration provisions do eventually gain universal acceptance, courts will continue to play a role in determining the meaning and effect of these provisions. As a result, commentators, parties, and practitioners need to remain aware of emerging developments in this field.


1  The term ‘settlor’ is used in this chapter to describe the individual who establishes the trust. Synonyms for this term, which appear in the cases described in this chapter, include grantor and trustor.

2  UTC 2000 s 816(23), <www.uniformlaws.org/Act.aspx?title=Trust%20Code>. See also Masonry and Tile Contractors Association of Southern Nevada v Jolley, Urga & Wirth Ltd, 941 P2d 486, 491 (Nev 1997) (holding that a trust that contained similarly broad language made arbitration an option but not mandatory). The UTC has been adopted in thirty US states. For a discussion of the UTC’s approach to trust arbitration, see David M English, ‘Arbitration and the Uniform Trust Code’ in SI Strong (ed), Arbitration of Trust Disputes: Issues in National and International Law (Oxford University Press 2016) paras 6.01–6.14.

3  UTC 2000 (n 2) s 111(b).

4  In re Frank, 910 NE P2d 523 (Ohio Ct App 2009).

5  The Court of Appeals confirmed the trial court’s order dismissing the suits because they had been settled following the recommendation of the arbitrators in Young v Richardson, 2014 WL 199068 (Ky Ct App 2014) (hereinafter Young I), Young v Richardson, 2014 WL 199091 (Ky Ct App 2014) (hereinafter Young II), Young v Richardson 2014 WL 199094 (Ky Ct App 2014) (hereinafter Young III), and Young v Richardson 2014 WL 199101 (Ky Ct App 2014) (hereinafter Young IV).

6  Young III, 2014 WL 199094, *10.

7  Young II, 2014 WL 199091, *10.

8  Young I, 2014 WL 199068, *12; Young III, 2014 WL 199094, *12.

9  Young II, 2014 WL 199091, *10.

10  Young I, 2014 WL 199068, *12; Young IV, 2014 WL 199101, *11.

11  762 F3d 814 (8th Cir 2014).

12  ibid 825 (emphasis in original).

13  The Court of Appeals noted, however, that its decision on this issue had no practical impact as the co-trustee had actually resigned by the time its opinion was issued. ibid.

14  ibid 816.

15  (n 2).

16  604 A2d 263 (Pa Super Ct 1992).

17  ibid 264.

18  ibid.

19  415 US 36, 57–58 (1974), cited in Fellman, 604 A2d at 287.

20  See eg In re Meredith’s Estate, 266 NW 351 (Mich 1936); In re Jacobovitz’ Will, NYS2d 527 (Sur Ct Nassau Cnty 1968). See also Spahr v Secco, 330 F3d 1266 (10th Cir 2003) (involving an adult with dementia who had opened an investment account containing an arbitration clause which the court refused to enforce in a dispute concerning whether Mr Spahr lacked the mental capacity to open the account and sign the agreement).

21  295 NYS2d 527 (Sur Ct Nassau Cnty 1968).

22  See also Matter of Berger, 81 AD2d 584 (NY App Div 1981) (‘[T]he distribution of a decedent’s estate is precluded from submission to arbitration on the ground of public policy.’).

23  836 NYS 2d 493 (Sur Ct Nassau Cnty 2007).

24  ibid.

25  266 NW 351 (Mich 1936).

26  769 NW 2d 720 (Mich Ct App 2009).

27  ibid 732.

28  George Washington’s will contained the following provision:

But having endeavoured to be plain, and explicit in all Devises—even at the expence of prolixity, perhaps of tautology, I hope, and trust, that no disputes will arise concerning them; but if, contrary to expectation, the case should be otherwise from the want of legal expression, or the usual technical terms, or because too much or too little has been said on any of the Devises to be consonant with law, My Will and direction expressly is, that all disputes (if unhappily any should arise) shall be decided by three impartial and intelligent men, known for their probity and good understanding; two to be chosen by the disputants—each having the choice of one—and the third by those two. Which three men thus chosen, shall, unfettered by Law, or legal constructions, declare their sense of the Testators intention; and such decision is, to all intents and purposes to be as binding on the Parties as if it had been given in the Supreme Court of the United States.

Last Will and Testament of George Washington, 9 July 1799, quoted in Larry E Edmondson, Domke on Commercial Arbitration, vol 1 (3rd edn, West Group 2008) 16–36.

29  Pray v Belt, 260 US 670 (1828) (emphasis in original).

30  See eg Wait v Huntington, 40 Conn 9 (Conn 1873).

31  See eg Pray, 260 US at 670.

32  ibid.

33  27 W Va 362, 364 (W Va 1886).

34  ibid 374.

35  403 SW3d 840 (Tex 2013).

36  54 Cal Rptr 3d 185, 198 n2 (Cal Ct App 2007).

37  ibid 195.

38  96 P3d 1078 (Ariz Ct App 2004), superseded by statute, Ariz Rev Stat Ann s 14-10205, as recognized in Jones v Fink, 2011 WL 601598 (Ariz Ct App 2011).

39  The clauses provided as follows:

Any dispute arising in connection with this Trust, including disputes between Trustee and any beneficiary or among Co–Trustees, shall be settled by the negotiation, mediation and arbitration provisions of that certain LawForms Integrity Agreement (Uniform Agreement Establishing Procedures for Settling Disputes) entered into by the parties prior to, concurrently with or subsequent to the execution of this Trust. In the event that the parties have not entered into a LawForms Integrity Agreement (Uniform Agreement Establishing Procedures for Settling Disputes), then disputes in connection with this Trust shall be settled by arbitration in accordance with the rules of the American Arbitration Association. Any decision rendered either in accordance with the LawForms Integrity Agreement (Uniform Agreement Establishing Procedures for Settling Disputes) or the rules of the American Arbitration Association shall be binding upon the parties as if the decision had been rendered by a court having proper jurisdiction.

ibid 1080.

40  Ariz Rev Stat Ann s 12-1501.

41  See Morgan Stanley DW Inc v Halliday, 873 So2d 400, 403 (Fla Dist Ct App 2004).

42  See Smith v Multi-Financial Securities Corp, 171 P3d 1267, 1271 (Colo App 2007). In Rachal v Reitz, 403 SW3d 840 (Tex 2013), described in paras 9.24–9.31 following, the Texas Supreme Court applied a version of the equitable estoppel theory that is known as direct benefits estoppel.

43  990 P2d 1085 (Ariz Ct App 1985). This case was not an arbitration case, but rather one in which a trustee had sought an award of attorney’s fees under a state statute that allowed such fees to the prevailing party in a ‘contract action’.

44  Schoneberger, 96 P3d at 1078 (citing Naarden, 990 P3d at 1088).

45  ibid 1083.

46  ibid. The courts that have examined these types of external trust disputes have reached mixed conclusions as to whether the beneficiaries should be bound to arbitrate disputes arising under these account contracts. See Mary F Radford, ‘Predispute Arbitration Agreements Between Trustees and Financial Services Institutions: Are Beneficiaries Bound?’ (2014) 40 ACTEC Law Journal 273. These cases are beyond the scope of this chapter.

47  Schoneberger, 96 P3d at 1083.

48  ibid.

49  ibid 1083–84.

50  894 A2d 408 (DC 2006).

51  The appeal in this case was in a somewhat unusual posture in that the trial court had denied one trustee’s motion to compel arbitration and that trustee had appealed. The Court of Appeals was faced with the task of determining whether the trial court’s order was immediately appealable as a final order. The Court of Appeals noted that the DC arbitration statute that dealt with the ripeness of such an order for appeal required the showing of a written agreement to arbitrate. Thus, the Court concluded that it had to determine whether such an agreement existed in order to decide whether it had jurisdiction to hear the pre-trial appeal. ibid 409. Once it determined that no such agreement existed, it dismissed the appeal. ibid 410–11.

52  DC Code s 16-4301 (repealed 2009).

53  Calomiris, 94 A2d at 409 (citing Schoneberger, 96 P3d at 1083).

54  894 A2d at 409.

55  125 Cal Rptr 3d 610 (Cal Ct App 2011), review granted and opinion superseded by Diaz v Bukey, 257 P3d 1129 (Cal 2011), and case transferred by Diaz v Bukey, 287 P3d 67 (Cal 2011).

56  The arbitration clause in this trust mirrored exactly the arbitration clause in Schoneberger, 96 P3d at 1078, reproduced earlier (n 39).

57  Diaz, 125 Cal Rptr 3d at 612.

58  ibid.

59  ibid 613 (citing Estate of Bailey v Carpenter, 60 P 162 (Cal 1900)). The court in Diaz explained that the ‘stipulation’ of only two of the heirs would not be appropriate in the probate of a will and noted that the same danger lurked in the instant case because not all of the trust beneficiaries were even parties to the case.

60  ibid 614.

61  ibid (citing Saks v Damon Raicke & Co, 7 Cal App 4th 419 (Cal Ct App 1992)).

62  ibid 615.

63  ibid.

64  257 P3d 1129 (Cal Ct App 2011).

65  282 P3d 1217 (Cal 2012). This case did not involve an arbitration clause in a trust but rather a clause in a condominium development’s recorded declaration of covenants, conditions, and restrictions. The arbitration provision purported to bind the homeowners’ association as well as all of the individual homeowners who had signed the declaration. The Court of Appeal held that the homeowners’ association was bound by the arbitration agreement even though technically the association had not signed the declaration. In McArthur v McArthur, 168 Cal Rptr 3d 785 (Cal Ct App 2014), which is discussed in detail later in this section, the California Court of Appeal found the holding in Pinnacle materially distinguishable because it rested primarily on statutory grounds rather than on whether the declaration was a contract.

66  287 P3d 67 (Cal Ct App 2012).

67  See McArthur, 168 Cal Rptr 3d at 795 n 5.

68  403 SW3d 840 (Tex 2013).

69  ibid 842.

70  ibid 844.

71  ibid.

72  ibid 845.

73  The court listed six theories: (1) incorporation by reference (the parties have entered into a separate contractual relationship that incorporates an existing arbitration clause), (2) assumption (a nonsignatory party’s subsequent conduct indicates an assumption of the responsibility to arbitrate), (3) agency (a nonsignatory is bound by the agreement of a person who was acting as the nonsignatory’s agent), (4) alter ego (a corporate parent and its subsidiary are treated as one so that the nonsignatory corporation is bound by the agreement of the other corporation), (5) equitable estoppel (the nonsignatory is estopped from denying the applicability of an agreement from which the nonsignatory has derived a direct benefit), and (6) third party beneficiary (the nonsignatory is the intended beneficiary of the contract containing the arbitration clause). The court noted that the direct benefits estoppel theory that it applied was a version of the equitable estoppel theory. ibid 851 n 5.

74  The direct benefits estoppel theory is a federal doctrine but the court noted that the doctrine had been applied in the context of arbitration agreements under state law in In re Kellogg Brown & Root Inc, 166 SW3d 732 (Tex 2005).

75  180 SW3d 127 (Tex 2005).

76  Promissory estoppel is an equitable theory that renders binding a promise made by one that the promisor should reasonably expect to induce some action on the part of the promisee and which does in fact induce such action. Restatement (Second) of Contracts (1981) s 90.

77  Rachal, 403 SW3d at 848.

78  Pinnacle Museum Tower Assn v Pinnacle Market Development (US), LLC, 282 P3d 1217 (Cal 2012).

79  Rachal, 403 SW3d at 842.

80  McArthur v McArthur, 168 Cal Rptr 3d 785 (Cal Ct App 2014).

81  The arbitration clause provided as follows:

The Trustor and Co–Trustees [Frances and Kristi] are Christians and believe that the Bible commands them to make every effort to live at peace and to resolve disputes with each other in private or within the Christian church (see Matthew 18:15–20; 1 Corinthians 6:1–8). Therefore, the Trustor and Co–Trustees agree that any claim or dispute arising from or related to the Trust as amended shall be settled by biblically based mediation and, if necessary, legally binding arbitration before the Institute for Christian Conciliation TM, a division of Peacemaker® Ministries, in accordance with its Rules of Procedure for Christian Conciliation (the ‘Rules’ found at www.peacemaker.net). To the extent authorized by the Rules, the provisions of California Code of Civil Procedure section 1283.05 (right to discovery in arbitration) are incorporated herein and made a part hereof. Judgment upon an arbitration decision may be entered in any court otherwise having jurisdiction. The Trustor and Co–Trustees understand that these methods shall be the sole remedy for any controversy or claim arising out of the Trust Agreement and expressly waive their right to file a lawsuit in any civil court against one another for such disputes except to enforce an arbitration decision. This Section shall also be binding on all successor trustees and benefices for the Trust as amended.

ibid 795 n 2.

82  Pinnacle Museum, 282 P3d at 1217.

83  McArthur, 168 Cal Rptr 3d at 791.

84  The court noted that Diaz was the only case that had addressed that issue and that it had been vacated by the California Supreme Court.

85  ibid 790.

86  See Smith v Multi-Financial Securities Corp, 171 P3d 1267 (Colo 2007); In re Jean F Gardner Amended Blind Trust, 117 Wash App 235, 70 P3d 168 (Wash App 2003); In re Blumenkrantz, 14 Misc 3d 462, 824 NYS2d 884 (Sur Ct Nassau Cnty 2006). In all of these cases, the beneficiaries were compelled to arbitrate their claims. However, the court did not point out that in cases with similar facts, the courts have not forced the beneficiaries to arbitrate their claims. See eg Clark v Clark, 57 P3d 95 (Okla 2002); Morgan Stanley v Halliday, 873 So2d 400 (Fla Dist Ct App 2004). For a detailed discussion of these cases, see Radford (n 46).

87  The McArthur court cited Estate of Bodger, 279 P2d 61 (1955), Estate of Guasti, 256 P2d 629 (1953), and In Re Whitney’s Estate, 248 P 754 (1926).

88  In a footnote, the court listed scholarly articles cited by Kristi for the third party beneficiary theory. Those articles included Michael P Bruyere and Meghan D Marino, ‘Mandatory Arbitration Provisions: A Powerful Tool to Prevent Contentious and Costly Trust Litigation, But Are They Enforceable?’ (2007) 42 Real Property, Probate and Trusts Journal 351; John H Langbein, ‘The Contractarian Basis of the Law of Trusts’ (1995) 105 Yale Law Journal 625; and SI Strong, ‘Arbitration of Trust Disputes: Two Bodies of Law Collide’ (2012) 45 Vanderbilt Journal of Transnational Law 1157 (hereinafter Strong, Two Bodies).

89  McArthur, 168 Cal Rptr 3d at 795.

90  2014 WL 7431466 (Tenn Ct App 2014).

91  2015 WL 5138182 (1st Cir. 2015).

92  2015 WL 5138182, *5.

93  2015 WL 5138182, *2, *5, *7.

94  2014 WL 2802735 (Tex Ct App 2014).

95  ibid *5.

96  2005 WL 1684688 (Mich Ct App 2005).

97  ibid *2.

98  217 P3d 1194 (Cal 2009).

99  ibid 1202 n 3.

100  ibid 1196.

101  133 So3d 1066 (Fla Dist Ct App 2014).

102  The opinion does not indicate what law would govern the trust. However, the trust was litigated in Florida, one of the states that now authorizes trust mandatory arbitration clauses by statute, so it is likely that Florida law would be applicable.

103  TC Memo 2015-64 (2015).

104  Internal Revenue Service Chief Counsel Advisory (CCA) 201208026 (24 February 2012) contained a ruling on this subject that was requested by private parties whose names are not revealed in the ruling. As the facts in this ruling are so similar to those in the Mikel case, it is assumed that the ruling pertained to the same case. The decision in the ruling resembles closely what is described in the case itself as the opinion of the Commissioner of the Internal Revenue Service.

105  A ‘Crummey trust’ is so named because the gift tax consequences of such a trust were first defined by the Court of Appeals for the 9th Circuit in Crummey v Commissioner, 397 F2d 82 (9th Cir 1968).

106  In 2015, the Internal Revenue Code also allows individuals to exempt the first $5,430,000 in lifetime and death-time transfers from the federal transfer (estate and gift) tax.

107  Internal Revenue Service Action on Decision (AOD) 1996-10 (15 July 1996), 1996 WL 380089.

108  TC Memo 2015-64 *2 (2015).

109  ibid.

110  ibid *17.

111  ibid *11–12 and n 4. The Tax Court did not cite the basis for this opinion, so it is unclear whether the parties were relying on cases such as In re Jacobovitz’ Will, NYS2d 527 (Sur Ct Nassau Cnty 1968), described earlier in this chapter (n 20), or on general law that allows a court to review an arbitration award.

112  IRS Rev Proc 2015-44.

113  Additional cases are discussed in SI Strong, ‘Institutional Approaches to Trust Arbitration: Comparing the AAA, ACTEC, ICC, and DIS Trust Arbitration Regimes’ in SI Strong (ed), Arbitration of Trust Disputes: Issues in National and International Law (Oxford University Press 2016) paras 5.01–5.135. See also Strong, Two Bodies Collide (n 88) 1157–248.