An interesting case, Diaz v. Bukey, was decided on May 10, 2011 by California’s Second Appellate District pertaining to the issue of whether a mandatory arbitration clause in a trust applies to a trust beneficiary. Justice Steven Z. Perren, writing for a unanimous Court, held that the beneficiary of a trust who did not agree to arbitrate disputes arising under the trust may not be compelled to do so. And this decision makes sense. Under California law, only parties to an arbitration contract may enforce it or be required to arbitrate.
The Case Facts. In Diaz, parents set up a trust, which included an arbitration provision that required all disputes arising in connection with the parents’ trust, including disputes between a trustee and a beneficiary, to be settled by arbitration. After the parents’ deaths, a trust beneficiary made a filing with the probate court demanding an accounting from the trustee of the Diaz Trust. In response, the trustee filed a demurrer (a request to have the beneficiary’s filing summarily thrown out of court without a trial) and a petition asking the probate court to order the trust beneficiary to arbitrate the dispute. The trust beneficiary opposed the demurrer and the petition to compel arbitration, basing his argument on the facts that he had not agreed to nor was he a signatory to the arbitration provision in the Diaz Trust. The probate court agreed with the trust beneficiary overruling the trustee’s demurrer and denying the trustee’s petition to force arbitration. The probate court reasoned that the beneficiary was not contractually bound to submit disputes with the trustee to arbitration. The Court of Appeal agreed with the probate court and affirmed its decision.
The Parents’ Intent. After reading Diaz, I thought about the parents “intent” being defeated by legal rules they likely were not aware of when they created the trust. All the parents knew, at the time they created the trust, was that they wanted to require all disputes pertaining to the trust to be decided at a private arbitration, rather than in the probate court. The idea behind this is that generally arbitration costs less than a full blown trial in the probate court. In any event, the parents’ intent, as reflected in their trust, was to require less formal adjudication of all disputes pertaining to their trust. Clearly that did not happen in Diaz.
Possible Solutions. How should attorneys draft arbitration clauses in trusts after Diaz? I think arbitration provisions could still be used in trusts and made enforceable against non-signatory beneficiaries after Diaz. But how? By requiring the beneficiary to agree to arbitration as a condition of receiving their gift under the Trust. For example, if one additional sentence had been added to the arbitration provision in Diaz, I believe the beneficiary would have agreed to the arbitration. That sentence is:
“If any beneficiary under this trust refuses to agree to arbitrate any and all disputes pertaining to the trust, then that beneficiary’s (or beneficiaries’) distribution shall not be made, and that beneficiary lose any and all interests in the trust estate and shall not share in any portion of the trust estate.”
Would a trust beneficiary, who did not sign the arbitration agreement in the trust, be willing to risk an inheritance by not agreeing to binding arbitration? Not likely.