Supreme Court of Texas Enforces Arbitration Provision In Trust
The Supreme Court of Texas recently ruled that a trust provision requiring arbitration of disputes was enforceable against a beneficiary who had sued the trustee for breach of fiduciary duty and failure to account. Rachal v. Reitz, No. 11-0708, 2013 WL 1859249 (May 3, 2013). The trial court and a divided court of appeals had held that the arbitration provision could not be enforced under the Texas Arbitration Act (TAA) because a trust is not a contract and the beneficiary had not agreed to arbitrate. The Supreme Court unanimously reversed for two reasons: (1) the settlor’s clear intent to arbitrate disputes should be honored, and (2) the beneficiary had agreed to the trust’s terms — including the arbitration provision — by accepting the benefits of the trust. As the court put it, “a beneficiary who attempts to enforce rights that would not exist without the trust manifests her assent to the trust’s arbitration clause.”
Rachal is likely to encourage greater use of arbitration provisions in trust instruments. Not only does the decision establish that such provisions are enforceable in Texas, but given the scarcity of precedent on the issue, the case may have a significant impact in other jurisdictions as well.
Background and Lower Court Rulings.
The facts of the Rachal case are straightforward. The beneficiary of an irrevocable trust (Reitz) sued the trustee (Rachal) alleging that Rachal had misappropriated trust assets and failed to provide an accounting to the beneficiaries as required by law. Invoking the trust’s arbitration provision, Rachal moved to compel arbitration of the dispute under the TAA. The arbitration provision stated:
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.
The Texas courts analyzed the case through the lens of the TAA, which provides that “a written agreement to arbitrate is valid and enforceable if the agreement is to arbitrate a controversy that: (1) exists at the time of the agreement, or (2) arises between the parties after the date of the agreement.” Tex. Civ. Prac. & Rem. Code § 171.001(a).
As the Rachal court observed, “[t]here is a dearth of authority as to the validity of an arbitration provision in a trust.” Although intermediate appellate courts in Arizona and California have addressed the issue, both of these decisions have been superseded. In Schoenberger v. Oelze, 96 P.3d 1078 (Ariz. Ct. App. 2004), and Diaz v. Bukey, 125 Cal. Rptr. 3d 610 (Ct. App. 2011), the courts held that a trust’s arbitration provision is not enforceable because a trust is not a contract and therefore does not bind those who do not sign it. (Arizona’s arbitration statute required an arbitration provision to be in a contract; California’s required only a written agreement.) But the Arizona legislature amended that state’s trust code to include a specific section authorizing arbitration provisions in trust instruments, A.R.S. § 14-10205, and the California Supreme Court vacated Diaz for reconsideration in light of a decision that enforced a contractual arbitration provision against a non-signatory.
Arbitration provisions have long been a fixture in contracts, whether they involve large corporate acquisitions, an investor’s relationship with her financial advisor, or a customer’s agreement with his cell phone provider. Unlike court proceedings, arbitrations are typically private, and they are often viewed as being less costly and time-consuming than regular litigation, in part because discovery is limited and the arbitrator’s decision usually cannot be appealed. They also allow for a decisionmaker with more technical or specialized expertise. All 50 states and the District of Columbia have statutes governing agreements to arbitrate.
Despite their prevalence in contracts, historically arbitration provisions have not been common in trust instruments. But more recently, interest in these provisions has grown, perhaps driven by the considerations that commend their use in the commercial context. In 2006, the American College of Trust and Estate Counsel issued a report on the subject that generally supported the idea of trust arbitrations and included model arbitration provisions for trust instruments, and the American Arbitration Association has adopted a set of rules to govern arbitrations of trust and estate disputes.
The Rachal decision may further encourage estate planners to include arbitration provisions in trust instruments. And because there are limited precedents on the issue of enforceability, the decision’s impact may well extend beyond Texas. Certainly the concept of “direct benefits estoppel” on which the Rachal court relied is not unique to Texas. For example, earlier this year the Illinois Supreme Court declined to decide whether the doctrine of election (which holds that someone taking under a will cannot turn around and contest the will) should extend to trusts, but also commented that “there is a general principle of equity which holds that once one accepts some benefit, one cannot then challenge the validity of the thing by which the benefit was conferred.” Estate of Boyar, 2013 IL 113655, ¶ 40. That rationale is very similar to the direct benefits estoppel analysis that was applied in Rachal.
Note that some issues may not be arbitrable under a particular state’s law. For example, many state arbitration statutes provide that a court must decide whether an agreement to arbitrate exists or a controversy is subject to such an agreement. See, e.g., Wash. Rev. Code § 7.04A.060(2). And a Pennsylvania case declined to enforce an arbitration provision in a revocable trust where the issue to be arbitrated was the settlor’s competency because “[a]s a matter of public policy, issues of incompetency cannot be submitted to arbitration.” In re Fellman, 604 A.2d 263, 269 (Pa. Super. Ct. 1992).
A related question is whether a settlor or trustee’s agreement with a third party to arbitrate disputes also binds the trust’s beneficiaries. Compare Merrill Lynch Pierce Fenner & Smith v. Eddings, 838 S.W.2d 874, 878-79 (Tex. Ct. App. 1992) (beneficiaries bound by arbitration provision in account agreement signed by trustee because “[i]f the settlor and the beneficiaries of a trust could bring suit independently of the trustee and thereby avoid the arbitration agreement, the strong [Texas] state policy favoring arbitration would be effectively thwarted”), with Clark v. Clark, 57 P.3d 95, 99 (Okla. 2002) (beneficiary not bound by trustee’s agreement to arbitrate dispute concerning trust’s investment account in part because beneficiary was not aware of agreement and did not consent to it).
These and other issues remain to be resolved on a state-by-state basis as the law of trust arbitration continues to develop.