Trustees, Loans, and the Duty of Loyalty

While there are Illinois statutes telling executors and trustees what they may do, there really aren't many statutory references to what they can't do, or to the general duties a trustee or personal representative owes to the beneficiaries.  These duties are generally a creature of caselaw, which makes secondary sources an important research tools when disputes arise over a fiduciary's conduct.

Take, for instance, the trustee who loans money from the trust to himself.  The first question is whether the trust document allows this (most trusts don't).  If not, the trustee may ask, "but what's wrong with doing this?"  One answer comes to us from Bogert’s Trusts and Trustees (§543(J)), which says that a trustee who loans trust funds to himself…

brings into play a conflict of private and representative interests. As lender it is his duty to get the best terms possible as to interest, security, and maturity. As debtor his impulse is naturally in the direction of getting the money at the lowest rate and often on other terms not advantageous to the lender. If he lends to himself, he cannot give an impartial judgment as to the adequacy of the security offered.

In other words, think about the terms and conditions a trustee would impose if a third-party came to him and asked for a loan from the trust.  Would he make the loan?  What would the terms (interest rate, repayment dates, etc.) be?  Even if the trustee isn't trying to put himself ahead of the trust beneficiaries, he can do so in ways large and small.

What's the penalty if a trustee loans money to himself?  Traditionally, when a fiduciary makes a loan to himself, “he is chargeable with principal and interest, or with any profits he makes thereby, at the option of the beneficiaries. Where a trustee uses trust funds in his own business, he is chargeable with principal and interest or with a pro rata share of the profits of the business at the option of the beneficiaries.” Scott on Trusts, §170.17 at 387.