The Fiduciary Exception to the Attorney-Client Privilege and Its Application in Litigation. by George O. Peterson

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1 The Fiduciary Exception to the Attorney-Client Privilege and Its Application in Litigation by George O. Peterson I. INTRODUCTION Trusts and estates attorneys who represent fiduciaries may have little occasion to consider whether communications with the client as a fiduciary are subject to the attorney-client privilege and simply assume its application. When a trusts and estates attorney represents a fiduciary with the administration of either an estate or trust, it is fairly clear there is no attorney-client relationship between the attorney and the beneficiary and that the attorney owes no duties to the beneficiary. So if the attorney owes no duties to the beneficiary then how would a beneficiary potentially gain access to attorney communications intended only for the fiduciary-client? While there is sparse decisional authority on this subject in Virginia, the prevailing authority from other jurisdictions suggests that the answer flows from the fact that the fiduciaryclient is the holder of the privilege, and law on attorney-client privilege recognizes a fiduciary exception to attorney-client privilege. In essence, the exception holds that fiduciaries, such as trustees of a trust, may not assert the attorney-client privilege against the beneficiaries of the trust with respect to advice regarding trust administration. The rationale for this exception stems from the fiduciary s obligations of good faith and disclosure to the beneficiaries and, to a lesser extent, is based upon the fact that the fiduciary s legal advice is generally paid for by trust or estate funds and, as such, becomes part of the trust corpus. In most instances, a fiduciary will not end up in litigation where the assertion of attorneyclient privilege is subject to challenge. If, however, a fiduciary does wind up in litigation with a beneficiary, there is a decent chance that the attorney-client communications may be at issue and subject to potential disclosure at least with respect to advice given during the ordinary course of a trust or estate s administration. The goods new is that courts, however, at least appear willing to recognize that that a fiduciary may maintain the attorney-client privilege when the fiduciary s interests have diverged from those of the beneficiary, although it is not entirely clear what test a court might employ to determine when such interests diverge. Earlier cases have appeared to rest the decision on whether the attorney-client privilege applies based upon whether the fiduciary was seeking advice in his personal capacity and was paying his own attorney s fees for representation. The more modern approach places less emphasis on who pays the attorney s fees and more on the policy reasons behind whether the attorney-client privilege should apply in a particular instance. This approach seems to tacitly recognize that the Hobson s choice of a fiduciary paying his own attorney s fees, which could be significant, or foregoing the protections of the attorney-client privilege creates disincentives for individuals to serve as fiduciaries in the first instance or encourages fiduciaries to resign at the first sign of potential friction with a disgruntled fiduciary.

2 What seems clear is that the courts in Virginia should fashion a rule balancing a beneficiary s right to information with protections for a fiduciary when it is clear that there is a divergence of interests between the fiduciary and beneficiary. Such a rule should not be dependent upon fiduciaries paying their own legal expenses at least in instances where selfdealing is not at issue. In disputes not involving claims of self-dealing, the trust or estate should advance legal fees and permit the court to determine whether those fees should be assessed at the end of the controversy if there is a finding in favor of the beneficiaries at the conclusion of the matter. II. BACKGROUND ON TRUSTEE S FIDUCIARY DUTIES AND THE CREATION OF THE FIDUCIARY EXCEPTION TO THE ATTORNEY-CLIENT PRIVILEGE Trustees owe fiduciary duties to beneficiaries, including the duty to disclose information. 1 This includes providing complete and accurate information to the beneficiaries concerning his management of the trust. 2 Because of these fiduciary duties, the attorney-client privilege does not generally apply. English courts initially adopted the fiduciary exception to the attorney-client privilege, 3 and the Delaware Chancery Court first adopted the exception in the U.S. in 1976 in Riggs National Bank v. Zimmer. 4 Accordingly, the legal advice a fiduciary receives during the ordinary course of administration will not be privileged from disclosure from a beneficiary. In Riggs, the beneficiaries sought to compel the production of a legal memorandum in anticipation of potential tax litigation on behalf of the trust with the State of Delaware Division of Revenue. 5 The fees for the preparation of the memorandum were paid by the corpus of the trust. 6 The trustees claimed that this memorandum was protected from disclosure by the attorney-client privilege and the work product doctrine. 7 The court found that: [The] memorandum was prepared ultimately for the benefit of the beneficiaries of the trust and not for the purpose of the trustees own defense in any litigation against themselves. At the time it was prepared the litigation which was then pending was a petition for instructions, the very nature of which normally indicates that the trustees were not implicated in any way. There was also the possibility of potential litigation against the State of Delaware, Division of Revenue. Both of these actions suggest that the legal assistance to the trustees would be rendered only in their service to the beneficiaries. In both instances, the ultimate or real clients were the beneficiaries of the trust, and the trustee in his capacity as a fiduciary, was, or at least should have been, acting only on behalf of the beneficiaries in administering the trust. At that stage, there were no procedings [sic] requiring the trustees to seek legal advice personally. As of that time there are in the record no allegations of litigation, or even threats of it, against the trustees. Moreover, there is nothing before the Court to suggest that the purpose of the [attorney s] memorandum was defensive on the trustees part. Clearly then, the rights of the beneficiaries would have been the foremost consideration in [trustee s] consultations and communications with his legal advisers. Moreover, the payment to the law firm out of the trust assets is a

3 significant factor, not only in weighing ultimately whether the beneficiaries ought to have access to the document, but also it is in itself a strong indication of precisely who the real clients were. I conclude that the legal services were performed at the request of the trustee for the benefit of the beneficiaries of the trust. Indeed, were this not the case, it may have been improper to charge the trust estate with cost of the legal services. 8 [Emphasis added.] The court went on to hold that as the documents were prepared for benefit of beneficiaries, the trustee s invocation of the privileges cannot shield the document involved herein from the beneficiaries desire to examine it. 9 In so holding, the court found that [t]he policy of preserving the full disclosure necessary in the trustee-beneficiary relationship is here ultimately more important than the protection of the trustee s confidence in the attorney for the trust. 10 Many other courts have adopted the holding in Riggs. 11 In Lawrence v. Cohn, the Southern District of New York considered whether documents prepared by a law firm in connection with an executor s action to obtain advice and direction of the court were protected by the attorney-client privilege. 12 The court found that a trustee has an obligation to provide complete and accurate information to its beneficiaries and, as a consequence, may not invoke the attorney-client privilege against the beneficiaries to bar disclosure of communications with the attorney who is advising the trustee about the management of the trust. 13 Because the court found that the executor owed fiduciary duties to the estate and its beneficiaries and instituted the action for aid and direction in his capacity as executor, the law firm s services, which are paid for by the estate, were rendered, in effect, on behalf of the estate and, by extension, on behalf of the beneficiaries. 14 The court found that the fact that the executor had his own interest in the outcome of action for which he ultimately retained personal counsel did not change the fact that he brought the action as the executor and for the benefit of the estate. Thus, the court concluded the attorney-client privilege could not stand, and found that the beneficiaries were entitled to see the legal advice obtained. 15 While the Virginia Supreme Court has not addressed the fiduciary exception, a 1994 decision by the Circuit Court for Fairfax County, Virginia initially found such an exception. 16 In this case, the complainant sought to compel the production of documents from the law firm of Shaw Pittman, and the defendants objected on the grounds of attorney-client privilege. 17 In finding a fiduciary exception to the attorney-client privilege, the Court stated: Although the trustee s counsel owes no fiduciary duty to the beneficiaries, the trustee does owe such a duty. That duty includes the duty to disclose all information and documents relating to the trust and its administration. Such documents include opinions of counsel obtained by the trustee in discharging his representative duties. The right of the beneficiaries to the trust-related documents flows from the trustee s fiduciary obligation to the beneficiaries, not from any attorney-client relationship between the beneficiaries and the lawyer for the trustee. The advice and counsel received by the trustee in his representative capacity becomes part

4 of the trust corpus, especially in light of the fact that the legal advice is paid for from estate funds. As the beneficiaries have access to the entire trust corpus, they have access to the advice and counsel received by the trustee. The duty to disclose extends to representation and advice received by the trustee in his representative capacity, not that received in solely his individual capacity. 18 [Emphasis added.] Later, on a motion to reconsider, the court modified its position, but rested its decision on the fiduciary seeking advice for his own personal protection for which the fiduciary paid the attorney s fees. IV. WHEN FIDUCIARY EXCEPTION MAY NOT APPLY The courts appear more willing to recognize a carve-out to the fiduciary exception when a trustee s interests diverge from that of the beneficiaries. In such cases where [A] fiduciary retains counsel and seeks legal advice for his or her own protection against plan beneficiaries, the legal fiction of trustee as representative of the beneficiaries is dispelled, notwithstanding the fact that the legal advice may relate to the trustee s administration of the trust. In these situations, the fiduciary s interests diverge from that of the beneficiaries so as to render the fiduciary exception inapplicable and protect the plan administrator s interest in the attorney client privilege. 19 Thus, [w]hen a fiduciary seeks legal advice for its own personal defense in contemplation of adversarial proceedings against its beneficiaries, the advice falls outside the fiduciary exception and remains protected by the attorney-client privilege. 20 [Emphasis added.] In Dotson v. Lillard, the Circuit Court for Fairfax County stated, upon reconsideration of complainant s motion to preclude trustee from advancing funds to pay for individual counsel, that the Court has upheld the attorney-client privilege as between the fiduciary and his individual counsel, once (as here) a conflict has arisen and the retention of individual counsel for the fiduciary is appropriate or necessary. 21 Similarly, despite its holding in Lawrence v. Cohn that the attorney-client privilege did not apply, the Southern District of New York noted that: This is not a case in which a fiduciary acts on behalf of a trust or other protected interest and his actions are then subjected to challenge by one or more beneficiaries. In such a circumstance-exemplified by the [proceeding commenced by the beneficiaries to compel disclosure from the executor]-the fiduciary is entitled to retain counsel to defend him, and his communications with that attorney for that purpose are ordinarily protected. By contrast, in filing the petition [for aid and direction], the executor took steps in his fiduciary status to obtain a judicial decree concerning how he was to manage the estate, and separately sought, in his person status, to obtain a ruling that favored his own personal interests. His communications with the firm that represented him personally are protected, but his communications with the firm that represented him in his fiduciary status are not. 22 [Emphasis added.]

5 The issue, however, is when the trustees and beneficiaries interests begin to diverge. There is relatively little case law specifically addressing this issue, but the Middle District of North Carolina found that whether a particular communication falls outside the fiduciary exception is a factual question: Whether any particular communication falls within this liability limitation requires close examination of the circumstances and whether the legal advice to the plan fiduciary can be considered in anticipation of litigation, as opposed to advice obtained as part of the fiduciary s ordinary administration of the plan. The mere prospect of post-decisional litigation against the plan by a disappointed beneficiary can exist whenever the plan denies a claim, and is not sufficient to render all pre-decisional legal advice privileged as against the beneficiary. Rather, only once there is a divergence of interests and a threat of litigation is it warranted for the fiduciary to obtain confidential legal advice and assert attorney-client privilege on the matter against the beneficiary. 23 [Emphasis added.] The court then found that where the plaintiff told the trustee he had retained a lawyer and was considering a class action lawsuit, there is sufficient evidence of a divergence of interests even before Plaintiff filed his administrative claim, giving Defendants reason to seek legal advice to protect themselves from liability related to Plaintiff s legal claim against them The court concluded that Defendants act of engaging outside counsel from Kilpatrick Stockton in May 2001, specifically and solely to provide legal advice and services with respect to Plaintiff s anticipated lawsuit, reflects the divergence of interests and is a reasonable response to the Plan fiduciaries concern for their personal liability arising out of Plaintiff s threat of litigation. 25 Whether the divergence of interests carve-out of the fiduciary exception to the attorney-client privilege will apply necessarily requires a case-specific factual determination as to when a trustee s interests diverge from that of the trust s beneficiaries. A fact based inquiry rightfully balances the interests of beneficiaries while permitting fiduciaries to maintain attorneyclient privileged communications in appropriate circumstances. In instances where self-dealing is alleged and colorable, the court s should take a more cautious approach on applying the divergence of interests test when the trust as opposed to the trustee is called upon to pay the attorney s fees in the first instance. In other cases, where the dispute centers on the interpretation of the trust s governing documents or issues related to management, the courts ought to side with protecting the privilege. V. PAYMENT OF FEES BY TRUST OR TRUSTEE? There is some case law in Virginia suggesting that in order to protect their communications with counsel from disclosure, trustees should pay for legal advice from their own resources. In Dotson, the Circuit Court for Fairfax County found: Part of the reason for not upholding the privilege as between the trustee in his representative capacity and his counsel is that fees for such services are incurred for the benefit of the trust and to protect the trustee in his representative capacity,

6 and are paid for out of the trust estate. Conversely, in the present litigation the trustee s attorney serves to protect the trustee in his individual (not representative) capacity. At this stage, payment of those fees should come from the trustee's individual resources, not from the trust estate. To hold otherwise might subject the trustee to having to disclose advice received in his individual capacity as well. Therefore the Court denies partial summary judgment as requested by the Complainant, but enjoins the Complainant from further paying from the residuary estate his attorney s fees in this proceeding in which he is named solely in his individual capacity. Such a ruling is without prejudice to the trustee to seek reimbursement of these fees at the time of any final accounting should he believe it appropriate. 26 [Emphasis added.] This, however, does not indicate that the fact that a trustee s legal advice in his, her or its personal defense is paid for by trust funds renders the attorney-client privilege inapplicable. Rather, the court only found that advice and counsel received by the trustee in his representative capacity becomes part of the trust corpus, in light of the fact that the legal advice is paid for from estate funds. 27 [Emphasis added.] While the court suggests that fees for legal services in the trustee s personal capacity should be paid by the trustee and that [t]o hold otherwise might subject the trustee to having to disclose advice received in his individual capacity as well, 28 the court did not specifically find that advice obtained in the trustee s individual capacity but paid for by the trust is not subject to the attorney-client privilege. Restatement (Third) of Trusts attaches far less significance to who pays for legal services. Section 82(f) states: A trustee is privileged to refrain from communicating to beneficiaries or cotrustees opinions obtained from, and other communications with, counsel retained for the trustee s personal protection in the course, or in anticipation, of litigation.... When the roles and objectives of legal consultation are unclear, the question of who has paid for the legal services, or who ultimately will be required to pay those expenses, although potentially relevant, involves other and complicated considerations... so that this matter is not determinative in resolving issues of privilege. 29 In addition, Comment f to the Restatement (Third) states that Comment f, here, however, diminishes the significance of who pays, and the earlier Comment expressly addresses only what is privileged for these purposes, stating that a trustee need not disclose information acquired... at his own expenses and for his own protection [Emphasis added.] Thus, the fact that the trust pays the trustees legal fees in connection with their personal defense does not undermine the trustees claim of privilege. Payment by trustees of their own legal fees, at least in instances where there is no colorable claim of self-dealing, creates the wrong incentives, as individuals are less likely to serve as trustees out of fear of the threat of litigation, the waiver of the attorney-client privilege,

7 and the possibility of incurring out-of-pocket expenses. It also encourages trustees to resign at the first instance of friction if faced with the possibility of having to personally pay legal fees for a controversy involving their administration of the trust. As a practical matter, the court can always make a determination as to who will ultimately bear the attorney s fees at the end of the controversy and in appropriate instances charge the trustee with the fees incurred. VI. CONCLUSION Given that courts are not likely to find a fiduciary is entitled to maintain the attorneyclient privilege against a beneficiary for ordinary advice during the course of administration, trust and estates attorneys need to be cautious on their communications with clients. The law in Virginia is not well settled on the issue and it is not necessarily clear how the courts will rule on a carve-out of the fiduciary exception to the attorney-client privilege. Both trusts and estates attorneys and fiduciaries would be well served by the courts in Virginia weighing in on this issue and providing guidance on this matter. George O. Peterson is an attorney in the law firm of Peterson Saylor, PLC located in Fairfax, Virginia, which specializes in fiduciary and business litigation. Attorney Courtney S. Schorr provided valuable assistance in researching and drafting the article. 1 See, e.g., Riggs National Bank v. Zimmer, 355 A.2d 709, 712 (Del. Ch. Ct. 1976) (finding the trustees have substantive fiduciary duties to the beneficiaries ); RESTATEMENT (THIRD) OF TRUSTS Lawrence v. Cohn, No. 90 Civ (CSHMHD), 2002 WL , at *4 (S.D.N.Y. Jan. 25, 2002). 3 See Talbot v. Marshfield, 62 Eng. Rep. 728 (Ch. 1865) A.2d 709, 712 (Del. Ch. Ct. 1976) A.2d at Id. 7 Id. at Id. at Id. at Id. at See, e.g., United States v. Mett, 178 F.3d 1058, 1062 (9th Cir. 1999) ( The Ninth Circuit, however, has joined a number of other courts in recognizing a fiduciary exception to the attorney-client privilege. ); Tatum v. R.J. Reynolds Tobacco Co., 247 F.R.D. 488, 493 (M.D.N.C. 2008) ( A fiduciary exception to the attorney-client privilege has become well established in federal jurisprudence of some circuits. ) (citation omitted); Lawrence v. Cohn, No. 90 Civ (CSHMHD), 2002 WL , at *4 (S.D.N.Y. Jan. 25, 2002) (finding that the fiduciary exception has been consistently followed in federal courts in cases involving not only trusts, but other fiduciary relationships as well ); Dotson v. Lillard, No , 1994 WL , at *3 (Va. Cir. Ct. Nov. 23, 1994) ( The advice and counsel receive by the trustee in his representative capacity becomes part of the trust corpus, especially in light of the fact that the legal advice is paid for from estate funds. ). 12 No. 90 Civ (CSHMHD), 2002 WL , at * Id. at *4. 14 Id. 15 Id. at *5. 16 See Dotson, No , 1994 WL , at *3. 17 Id. 18 Id. at *3 (internal citations omitted).

8 19 Tatum, 247 F.R.D. at 493 (internal citations omitted). 20 Id. at 497 (quoting Wachtel v. Health Net, Inc., 482 F.3d 225, 233 (3d Cir. 2007)); see also United States v. Mett, 178 F.3d 1058, 1066 (9th Cir. 1999) ( [W]hile the fiduciary exception does apply to advice on matters of plan administration, the attorney-client privilege asserts itself as to any advice that a fiduciary obtains in an effort to protect herself from civil or criminal liability ). 21 No , 1994 WL , at *4. 22 Lawrence, No. 90 Civ. 2396, 2002 WL , at *5 (internal citations omitted). 23 Tatum, 247 F.R.D. at Id. at Id. 26 No , 1994 WL , at *4. 27 No , 1994 WL , at *3. 28 Id. at *4. 29 RESTATEMENT (THIRD) OF TRUSTS 82(f). 30 Id. at Comment f.