In February, the South Dakota Supreme Court injected uncertainty into lending transactions involving trust assets when it rejected a lender’s efforts to foreclose on trust property pledged as collateral for a loan. In Plains Commerce Bank, Inc. v. Beck, the Court upheld a spendthrift provision where a beneficiary, who was also the trustee, pledged trust assets as collateral for a personal loan. As explained below, this decision may have substantial impacts on whether and how lenders extend credit secured by trust assets in the future.
In 1999, Gary and Betty Beck executed a Trust Agreement thereby creating B&B Farms Trust (“Trust”). Gary and Betty were the grantors and primary beneficiaries of the Trust. Their three children were the secondary beneficiaries. One of those children, Matthew, was also named Trustee. The Trust was an irrevocable spendthrift trust, meaning it could only be terminated in specific circumstances and, among other things, restricted the ability of creditors to reach trust distributions. The Trust Agreement did not allow the trustee to self-deal or provide for a means for the beneficiaries to permit the Trustee to do so.
In 2015, Matthew sought a large personal loan with Plains Commerce Bank (“PCB”) to be secured, in part, by a mortgage on $800,000 worth of the Trust’s real property. Prior to approving the loan, PCB obtained a Certificate of Trust outlining the powers of Matthew as Trustee. Significantly, PCB also had a copy of the actual Trust Agreement. Although the Certificate of Trust provided Matthew, as Trustee, had broad authority to act on behalf of the Trust, the spendthrift provision limited a beneficiary’s power to encumber trust assets. To induce PCB to extend the loan to Matthew, all beneficiaries of the Trust signed consents permitting him to mortgage the trust property. Matthew pledged the $800,000 in collateral with the representation it reflected his future interest in the trust property as a beneficiary. Matthew signed the mortgage of the trust real estate in his capacity as Trustee, although the promissory note was entered into by Matthew and his wife in their individual capacities. Matthew and his wife used some of the loan proceeds to pay off existing mortgages on the Trust property.
A few years later, Matthew and his wife defaulted on the loan and Plains Commerce commenced a foreclosure action. Matthew’s sister Jamie, a fellow secondary beneficiary, intervened on behalf of the Trust and the lower court appointed her as Trustee in Matthew’s place. As Trustee, Jamie was charged with defending the best interests of the Trust and its beneficiaries, although a different bank was later named Successor Trustee. Jamie claimed the mortgage on the Trust land was void and unenforceable. The circuit court agreed and entered summary judgment for the Trust, thereby resulting in an appeal to the South Dakota Supreme Court.
The Supreme Court’s Decision
The Supreme Court addressed several issues pertinent to lending transactions involving trusts and trust property. Those issues are summarized below.
- Did Matthew have authority under the Trust Agreement or from the consents signed by the beneficiaries to mortgage trust property to obtain a personal loan?
The Court held that Matthew did not have authority under the Trust Agreement to pledge trust property for a personal loan. Matthew’s use of the $800,000 of trust property as collateral for the loan represented the value of the one-third share he expected to inherit as a beneficiary. However, the spendthrift provision unambiguously barred beneficiaries from encumbering trust property for personal debt. Although Matthew might have been granted certain powers as Trustee, the use of his one-third expected inheritance was an action that he took as a beneficiary. The Court concluded that as a beneficiary, he had no such power under the terms of the Trust Agreement
Similarly, the consents signed by the beneficiaries were insufficient to give Matthew the authority to mortgage trust property to obtain a personal loan. The Court held that although the beneficiaries consented to Matthew’s self-dealing as the Trustee, the spendthrift provision prevented the beneficiaries from consenting to Matthew’s self-dealing as a beneficiary. The Court noted that “[s]elf-dealing by a trustee and a beneficiary encumbering an anticipated future interest in a trust are not synonymous actions, and spendthrift provisions, like the one here, limit the type of self-dealing transactions by a trustee who is also a beneficiary that might otherwise be authorized” under the South Dakota statute providing for a limited exception to the prohibition on trustee self-dealing.
Ultimately, Matthew’s use of his expected one-third inheritance was done as a beneficiary, and neither the Trust Agreement nor the consents from the beneficiaries authorized Matthew to encumber trust assets in that capacity.
- Did the signed consents alter the trust agreement?
The Court held that the language of the consents signed by the beneficiaries did not alter the Trust Agreement or, specifically, the spendthrift provision contained in the Trust Agreement. Instead, the consents, by their express terms, applied only to the single loan transaction and not to the Trust Agreement itself. The Court noted the absence of any language in the consents that the grantors of the Trust, Gary and Betty, intended to alter the spendthrift provision contained in the Trust Agreement.
- Could Plains Commerce rely on the Certificate of Trust as authority for Matthew to mortgage trust property?
Under South Dakota law, “a certificate of trust is conclusive proof as to the matters contained in it and any party may rely upon the certificate, except a party who has actual knowledge of the facts to the contrary.” SDCL 55-4-51.1. PCB and its legal counsel reviewed the Trust Agreement prior to the loan being approved, and even undertook efforts to create Matthew’s authority to enter into the transaction through the execution of the consents. Because PCB had actual knowledge that the Trust Agreement did not allow Matthew to mortgage trust property to secure Matthew’s personal loan, PCB could not rely on the Certificate of Trust, which asserted Matthew had much broader authority as Trustee than he actually possessed.
- Did the Trust Agreement authorize Matthew, as Trustee, to mortgage trust property if the loan proceeds were partially used to satisfy trust debt?
Matthew was not authorized to mortgage trust property because the debt actually secured by the mortgage was not a debt of the trust or a debt secured by trust property at the time of creation of the trust. The Trust Agreement acknowledged that the trust’s real property could be mortgaged to secure either debts of the trust or debt secured by the real property at the time of creation of the trust. However, here, neither party contended that this debt fell into either of those two categories. Rather, both parties acknowledged that the debt secured by PCB’s mortgage was not a debt of the trust but was the personal debt of Matthew and his wife. Although proceeds from the mortgage were partially used to pay off debts of the trust and the family farm, this commingling of funds did not obligate the trust property when, by its own terms, the mortgage only secured Matthew’s personal debts.
There are lessons to be learned from the Court’s decision. For one, if PCB had not reviewed the Trust Agreement, under South Dakota law, it could have theoretically relied on the Certificate of Trust in good faith to enforce the transaction. PCB would have had no “actual knowledge” of the spendthrift restrictions contained in the Trust Agreement, which prevented Matthew from encumbering trust assets. Had PCB only relied on the Certificate of Trust, this case might have turned out differently. Instead, the Court essentially said PCB knew too much about the limitations contained in the Trust and its efforts to create Matthew’s authority to enter into the lending transaction were insufficient.
Further, the Court’s holding on the insufficiency of the signed consents may cause a lender to question whether a written consent signed by all beneficiaries and the grantors is an effective means of authorizing a certain transaction, particularly when the trust contains a spendthrift provision. The answer may very well be that the entire trust agreement will need to be modified in accordance with applicable law prior to the transaction being finalized. At the very least, consents should include specific language modifying the actual Trust Agreement and the pertinent portions thereto, such as the spendthrift provision, to avoid a finding that the consents only authorize the transaction at issue and do not amend the actual trust instrument.
For safety and soundness purposes, many lenders have loan documentation and underwriting procedures that require due diligence and documentation commensurate with the risk and dollar amount of the loan being sought. For example, some lenders require trust borrowers to provide their trust agreements to the lenders prior to advancing a loan. However, noting the outcome in Plains Commerce, lenders should consider whether they should limit their analysis to a review of the certificate of trust. In doing so, a lender should be able to rely on the certificate of trust per SDCL 55-4-51.1. If a lender believes it may have actual knowledge of a spendthrift or other provision contained in a trust agreement, a prudent lender should strongly consider having qualified legal counsel examine the trust agreement prior to extending credit.
Davenport, Evans, Hurwitz & Smith, LLP, located in Sioux Falls, South Dakota, is one of the state’s largest law firms. The firm’s attorneys provide business and litigation counsel to individuals and corporate clients in a variety of practice areas. For more information about Davenport Evans, visit www.dehs.com.