Wills, Trusts, and Estates

Trust


A trust is a legal arrangement where a settlor conveys property to a trustee to hold as a fiduciary for one or more beneficiaries.

Trusts can either be testamentary trusts or inter vivos trusts.

Testamentary Trust

Testamentary trusts are trusts created by will that arise during probate.

All testamentary trusts are inherently irrevocable trusts.

They are often used with pour-over wills.

Inter Vivos Trust

Inter vivos trusts are trusts created when the settlor is alive.

Declaration of Trust

A declaration of trust is when one declares himself to be a trustee of his property for another. UTC § 401(2). No special formalities are required. (Though it is a bad idea to rely on an oral declaration of trust.)

The settlor can also be named as a beneficiary of the trust but not the only beneficiary or his titles would merge.

Unlike a deed of trust or an outright gift, a declaration of trust does not require delivery of the property. If something seems to be a gift but does not deliver the property, it might be a declaration of trust.

Inter vivos trusts are the most common and useful type of trust.

At common law, inter vivos trusts were presumed to be irrevocable.

Under the UTC, inter vivos trusts are presumed to be revocable unless declared otherwise. UTC § 602(a).

Irrevocable Trust

Irrevocable trusts are trusts that cannot be altered or revoked by the settlor.

Revocable Trust

Irrevocable trusts are trusts that can be altered or revoked by the settlor.

Upon the death of the settlor of a revocable trust, the trust naturally becomes irrevocable because the potential revoker is dead.

Although often very similar to a will, revocable trusts do not require wills formalities. Under modern law, settlors can just opt in or out of the probate laws applying.

Revoking a trust is pretty similar to revoking a will. Tearing up the trust document is effective.

Trustees of revocable only owe fiduciary duties to the settlor. Beneficiaries have no rights.

Under the UTC, revocable trusts can be amended at any time by any method that manifests clear and convincing evidence of his intent to do so. UTC § 602(c).

A revocable trust is subject to the claims of the settlor's creditors during life and at death. UTC § 505(a)(3).

UPC § 2-804, revoking provisions to a former spouse, also applies to will substitutes.

Trusts, while often just used in place of a will, can also be used to maintain control of one's property after death. This can allow it to provide for disabled persons or minors, to ensure that it is is slowly, to go to those in the lowest tax brackets, or to ensure to goes to someone else after the first beneficiary's death.

Bifurcation

Trusts bifurcate ownership. The trustee has legal title, while the beneficiary has equitable title.

Trusts can also be bifurcated in time. The most common form is giving someone the right to the income now, while giving someone else the right to the remainder in the future.

To create a trust, there must be:

  1. Intent to create a trust
    • The settlor does not have to understand trust law or even know the term "trust". He just has to manifest intent to create the fiduciary relationship that a trust comprises. E.g., transferring property "for the use and benefit" of another creates a trust.
  2. Ascertainable beneficiaries
    • They do not need to be ascertainable when the trust is created. Only at some point within the period of the rule against perpetuities.
    • Ascertainable beneficiaries are not needed for trusts made for charitable purposes. All states also allow pet trusts for pet animals and statutory-purpose trusts for certain other non charitable purposes, like grave maintenance. UTC § 408 & UTC § 409.
  3. Specific property—a res
    • You can always just staple like $10 to a trust to ensure it has some property. Most people just transfer all their property to their trusts with themselves as trustees.
  4. A writing (if it is a testamentary trust or a trust to hold land)

UTC § 402.

A trust will not fail for want of a trustee. A court can just appoint one.

Precatory Trust

A precatory trust is when someone expresses his wishes on how his property be used but does not expressly require so. Courts may or may not find such language to be actual intent to form a trust. (Probably not)

Deed of Trust

Deeds of trust are documents that create inter vivos trusts while the settlor is alive. UTC § 401(1). No special formalities are required. (Technically, deeds of trust do not even have to be written unless they are for real property, but relying on oral deeds of trust is a horrible idea.)

Deeds of trust require delivery of the property to the trustee.

Declaration of Trust

A declaration of trust is when one declares himself to be a trustee of his property for another. UTC § 401(2). No special formalities are required. (Though it is a bad idea to rely on an oral declaration of trust.)

The settlor can also be named as a beneficiary of the trust but not the only beneficiary or his titles would merge.

Unlike a deed of trust or an outright gift, a declaration of trust does not require delivery of the property. If something seems to be a gift but does not deliver the property, it might be a declaration of trust.

Res

A res is a specific piece of property included in a trust.

The res of an inter vivos trust must be delivered to the trustee if created by a deed of trust.

Resulting Trust

A resulting trust is an equitable reversionary interest that arises by operation of law in two cases:

  1. An express trust fails or makes an incomplete disposition
    • Examples:
      • O gives X property in trust to pay the income to A for life, then to A's descendants. A dies without descendants. X becomes trustee of the property for O then. The remainder interest of the trust just results back.
      • O gives $10,000 in trust to pay $4,000 to A over 5 years. $6,000 reverts to being in trust for O.
  2. One person pays the purchase price for property and causes title to be taken in the name of another who is not a natural object of his bounty
    • Examples:
      • If A buys a farm but puts it in B's name, B becomes a trustee for A.
      • If A gives B money to buy a farm, B becomes a trustee for A.
      • If A gives B money to buy a farm or buys him a farm himself but says that the money/farm is a gift, A just owns the farm.

The trustee never gets the property.

The beneficiary of a resulting trust can demand to get the property in trust back. It does not have to be held in trust forever.

Rule Against Perpetuities

No interest is good unless it must vest, if at all, within 21 years of the death of a life in being at the time the interest is created.

Oral Trust

Oral trusts are valid unless it is a testamentary trust or a trust holding real property but it must be established by clear and convincing evidence. UTC § 407.

You can transfer property at death by pre-death oral instructions though. Fournier.

Secret Trust

Secret trusts are where the will makes an absolute bequest, without manifested intent to create a trust, but where the beneficiary promised to use the property in a certain way. This promise is then enforceable (creating a constructive trust) to prevent unjust enrichment, and extrinsic evidence is allowed to establish the proof of the promise.

Semi-Secret Trust

A semi-secret trust is when the will names a trustee, but not a beneficiary. Semi-secret trusts fail for want of an ascertainable beneficiary, even if the testator told the trustee outside the will how to distribute it.

The more modern approach is to allow extrinsic evidence to find a beneficiary for semi-secret trusts, but most states do not follow this.

Revocable Trust

Irrevocable trusts are trusts that can be altered or revoked by the settlor.

Upon the death of the settlor of a revocable trust, the trust naturally becomes irrevocable because the potential revoker is dead.

Although often very similar to a will, revocable trusts do not require wills formalities. Under modern law, settlors can just opt in or out of the probate laws applying.

Revoking a trust is pretty similar to revoking a will. Tearing up the trust document is effective.

Trustees of revocable only owe fiduciary duties to the settlor. Beneficiaries have no rights.

Under the UTC, revocable trusts can be amended at any time by any method that manifests clear and convincing evidence of his intent to do so. UTC § 602(c).

A revocable trust is subject to the claims of the settlor's creditors during life and at death. UTC § 505(a)(3).

UPC § 2-804, revoking provisions to a former spouse, also applies to will substitutes.

Fiduciary Duty

While a trustee has basically unlimited power over trust property, his fiduciary duties require him to exercise or not exercise his powers in good faith in the best interests of the beneficiaries. UTC § 815

Trustees' primary fiduciary duties are those of loyalty and prudence.

Loyalty

The fiduciary duty of loyalty requires the fiduciary to act in the best interests of his principal.

Prudence

The fiduciary duty of prudence or care requires the fiduciary to act in in accordance with an objective reasonableness standard informed by industry norms and practices.

No-Further-Inquiry Rule

If a trustee undertakes a transaction that involves a conflict of interest between his fiduciary capacity and personal interests, courts will find that to be a violation of his fiduciary duty and make no further inquiry.

The only defenses are that the settlor authorized the conflict in the terms of the trust, the beneficiaries consented after full disclosure, or that the trustee obtained judicial approval beforehand. R3T § 78.

Exception exist to the no-further-inquiry rule, like investing in a mutual fund managed by the trustee or paying himself reasonable compensation for managing the trust.

The no-further-inquiry rule does not apply to structural conflicts created by the settlor. E.g., a trustee on a company's board is given shares in that company. He can vote for himself still if it is in the best interests of the beneficiaries.

Exculpation

Exculpation clauses excuse trustees from liability for breaches of their fiduciary duties except for "willful neglect or default."

The modern trend is for an exculpation clause to be presumed to be invalid unless the trustee can show that the clause is fair and knowingly consented to by the settlor.

A trustee's fiduciary duty applies to all of the functions of a trustee.

Functions of a Trustee

A trustee has four functions he must carry out:

  1. Distribution Function
  2. Investment Function
  3. Custodial Function
  4. Administrative Function
Distribution Function
Mandatory Trust

In a mandatory trust, the mustee must make specified distributions.

Discretionary Trust

In a discretionary trust, the trustee has discretion over how the property is distributed, but must still exercise this discretion prudently, in good faith, and in accordance with the terms of the trust in light of the needs and circumstances of the beneficiaries.

A discretionary trustee has a duty to inquire into the beneficiaries' finances so he can determine whether a distribution is needed or not.

Investment Function

Trustees have a duty to invest the trust assets prudently.

Prudent Investor Rule
  1. A trustee shall invest and manage trust assets as a prudent investor would, by considering the purposes, terms, distribution requirements, and other circumstances of the trust. In satisfying this standard, the trustee shall exercise reasonable care, skill, and caution.
  2. A trustee's investment and management decisions respecting individual assets must be evaluated not in isolation but in the context of the trust portfolio as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the trust.
  3. Among circumstances that a trustee shall consider in investing and managing trust assets are such of the following as are relevant to the trust or its beneficiaries:
    1. general economic conditions;
    2. the possible effect of inflation or deflation;
    3. the expected tax consequences of investment decisions or strategies;
    4. the role that each investment or course of action plays within the overall trust portfolio, which may include financial assets, interests in closely held enterprises, tangible and intangible personal property, and real property;
    5. the expected total return from income and the appreciation of capital;
    6. other resources of the beneficiaries;
    7. needs for liquidity, regularity of income, and preservation or appreciation of capital; and
    8. an asset's special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries.
  4. A trustee shall make a reasonable effort to verify facts relevant to the investment and management of trust assets.
  5. A trustee may invest in any kind of property or type of investment consistent with the standards of this [Act].
  6. A trustee who has special skills or expertise, or is named trustee in reliance upon the trustee's representation that the trustee has special skills or expertise, has a duty to use those special skills or expertise.

One of the most important requirements is to have prudent risk management. If low risk is needed, bonds should be used. If high risk is acceptable, stocks should be used to get better returns. However, there's never a reason to have a single company's stock. That exposes one not only to the risks of the general economy and of that industry, but also of the individual company. A single company is not going to have a high enough rate of return to justify that level of risk.

Principal and Income Problem

It used to be an issue that portfolios had to have the right balance of capital growth and dividend income to maintain impartiality between income beneficiaries and remainder beneficiaries. However now, you can just make an adjustment and distribute the growth as income. (Or alternatively, use a unitrust.)

Adjust

A trustee's power to adjust allows him to distribute the principal as income or to add income to the principal, as needed.

UPIA § 104 allows one to make an adjustment for impartiality problems.

Typically, trustees who are also beneficiaries do not have the power to adjust. However, they may be able to convert the trust into a unitrust with judicial review.

Unitrust

A unitrust is a trust where the settlor just sets a percentage of the trust income to be paid to the income beneficiaries each year. This solves the principal and income problem.

Compensatory Damages for Imprudent Investment

There are two main paradigms as to how to determine compensatory damages:

  1. Capital Lost Plus Interest Measure

    The capital lost plus interest measure of compensatory damages pays the amount of capital lost in the trust plus a set interest rate.

    Common interest rates are the inflation rate, government bond rates, and statutory legal rates.

  2. Total Return Measure

    The total return measure of compensatory damages pays the difference between the value of the trust and the value of the hypothetical prudently-invested trust portfolio.

    (This seems basically the same as the capital lost plus interest measure except it uses the interest rate of a prudently-invested portfolio.)

Just because one is allowed to retain stock (like in his own company), that does not mean that it is prudent to do so. The trustee must still comport with not only the duty of care, but also the duty of prudence.

A trust can authorize a trustee to hold an undiversified portfolio though. A trust can even require a trustee to hold an undiversified portfolio in a certain company.

Custodial Function
Administrative Function
Impartiality

If there are multiple beneficiaries, the trustee has a duty of impartiality. This duty requires him to give due regard to the beneficiaries' respective interests.

This duty does not require a trustee to treat beneficiaries equally. If there is a life-time beneficiary and a remainder beneficiary, the possible investment types will have benefits to one of the beneficiaries to the detriment of the other. The trustee will have to prefer one. Who should be preferred should be set in the terms of the trust.

Principal and Income Problem

It used to be an issue that portfolios had to have the right balance of capital growth and dividend income to maintain impartiality between income beneficiaries and remainder beneficiaries. However now, you can just make an adjustment and distribute the growth as income. (Or alternatively, use a unitrust.)

Adjust

A trustee's power to adjust allows him to distribute the principal as income or to add income to the principal, as needed.

UPIA § 104 allows one to make an adjustment for impartiality problems.

Typically, trustees who are also beneficiaries do not have the power to adjust. However, they may be able to convert the trust into a unitrust with judicial review.

Unitrust

A unitrust is a trust where the settlor just sets a percentage of the trust income to be paid to the income beneficiaries each year. This solves the principal and income problem.

Account

A trustee also has a duty to inform and account. UTC § 813.

This duty requires that a trustee respond promptly to a beneficiary's request for information about the administration of the trust and also to make affirmative disclosures to the beneficiaries of significant developments or intended transactions.

The settlor of a trust can limit the trustee's duty to account to the beneficiaries, but he can not completely eliminate it. A beneficiary always has a right to information reasonably necessary for the protection of his interest in the trust.

UTC § 813 allows trusts to be kept secret from the beneficiaries until they are 25 years old, however many states have rejected these rules.

A trustee is not liable to a beneficiary for a breach if the facts of the breach are fairly disclosed in a formal accounting, filed with the court and served on the beneficiary, to which the beneficiary does not timely object.

A settlor can provide that an informal accounting will have the same effect as a formal accounting.

Functions of a Trustee

A trustee has four functions he must carry out:

  1. Distribution Function
  2. Investment Function
  3. Custodial Function
  4. Administrative Function
Distribution Function
Mandatory Trust

In a mandatory trust, the mustee must make specified distributions.

Discretionary Trust

In a discretionary trust, the trustee has discretion over how the property is distributed, but must still exercise this discretion prudently, in good faith, and in accordance with the terms of the trust in light of the needs and circumstances of the beneficiaries.

A discretionary trustee has a duty to inquire into the beneficiaries' finances so he can determine whether a distribution is needed or not.

Investment Function

Trustees have a duty to invest the trust assets prudently.

Prudent Investor Rule
  1. A trustee shall invest and manage trust assets as a prudent investor would, by considering the purposes, terms, distribution requirements, and other circumstances of the trust. In satisfying this standard, the trustee shall exercise reasonable care, skill, and caution.
  2. A trustee's investment and management decisions respecting individual assets must be evaluated not in isolation but in the context of the trust portfolio as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the trust.
  3. Among circumstances that a trustee shall consider in investing and managing trust assets are such of the following as are relevant to the trust or its beneficiaries:
    1. general economic conditions;
    2. the possible effect of inflation or deflation;
    3. the expected tax consequences of investment decisions or strategies;
    4. the role that each investment or course of action plays within the overall trust portfolio, which may include financial assets, interests in closely held enterprises, tangible and intangible personal property, and real property;
    5. the expected total return from income and the appreciation of capital;
    6. other resources of the beneficiaries;
    7. needs for liquidity, regularity of income, and preservation or appreciation of capital; and
    8. an asset's special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries.
  4. A trustee shall make a reasonable effort to verify facts relevant to the investment and management of trust assets.
  5. A trustee may invest in any kind of property or type of investment consistent with the standards of this [Act].
  6. A trustee who has special skills or expertise, or is named trustee in reliance upon the trustee's representation that the trustee has special skills or expertise, has a duty to use those special skills or expertise.

One of the most important requirements is to have prudent risk management. If low risk is needed, bonds should be used. If high risk is acceptable, stocks should be used to get better returns. However, there's never a reason to have a single company's stock. That exposes one not only to the risks of the general economy and of that industry, but also of the individual company. A single company is not going to have a high enough rate of return to justify that level of risk.

Principal and Income Problem

It used to be an issue that portfolios had to have the right balance of capital growth and dividend income to maintain impartiality between income beneficiaries and remainder beneficiaries. However now, you can just make an adjustment and distribute the growth as income. (Or alternatively, use a unitrust.)

Adjust

A trustee's power to adjust allows him to distribute the principal as income or to add income to the principal, as needed.

UPIA § 104 allows one to make an adjustment for impartiality problems.

Typically, trustees who are also beneficiaries do not have the power to adjust. However, they may be able to convert the trust into a unitrust with judicial review.

Unitrust

A unitrust is a trust where the settlor just sets a percentage of the trust income to be paid to the income beneficiaries each year. This solves the principal and income problem.

Compensatory Damages for Imprudent Investment

There are two main paradigms as to how to determine compensatory damages:

  1. Capital Lost Plus Interest Measure

    The capital lost plus interest measure of compensatory damages pays the amount of capital lost in the trust plus a set interest rate.

    Common interest rates are the inflation rate, government bond rates, and statutory legal rates.

  2. Total Return Measure

    The total return measure of compensatory damages pays the difference between the value of the trust and the value of the hypothetical prudently-invested trust portfolio.

    (This seems basically the same as the capital lost plus interest measure except it uses the interest rate of a prudently-invested portfolio.)

Just because one is allowed to retain stock (like in his own company), that does not mean that it is prudent to do so. The trustee must still comport with not only the duty of care, but also the duty of prudence.

A trust can authorize a trustee to hold an undiversified portfolio though. A trust can even require a trustee to hold an undiversified portfolio in a certain company.

Custodial Function
Administrative Function

The creditor of a spendthrift trust has no recourse against the beneficiary's interest.

  • If the trust does not have a spendthrift provision, creditors can attach to the trust and get the money as soon as it is distributed.
Drogo Order

A Drogo order allows a creditor to compel a trustee to give him the distributions from a discretionary trust. This lien of execution attaches to the distributed property between the time he decides to give property to the beneficiary and when he actually does. Hamilton v. Drogo & UTC § 501.

Support Trust

A support trust is a type of mandatory trust that requires payments for the support of the beneficiary.

A beneficiary of a support trust cannot alienate his interest in the trust.

Protective Trust

A protective trust is a mandatory trust with a clause that automatically converts the trust to a discretionary trust if a creditor attaches to the trust.

Generally, a creditor cannot compel the trustee to make a distribution in either a discretionary trust or a support trust. UTC § 504(b).

Spendthrift Trust

A spendthrift trust is one where the beneficiary is prohibited from transferring or otherwise alienating his beneficial interest voluntarily or involuntarily. UTC § 502.

Because the interest cannot be transferred, a creditor cannot get the trust assets until the beneficiary actually gets the money. He cannot attached to the trust with a Drogo order.

Every trust should have a spendthrift provision.

A spendthrift provision cannot be enforced against child support or alimony. UTC § 503.

Self-Settled Asset Protection Trust

A self-settled asset protection trust is a spendthrift trust made in accordance with a statute for the settlor's own benefit used to protect assets from creditors.

Traditionally, as in UTC § 505, a trust for one's own benefit does not offer asset protection.

Now, 19 states, including Virginia, have allowed self-settled asset protection trusts because people will just get them in the Cook Islands instead.

Modifying or Terminating a Trust

Traditionally in America, a trust can only be modified in one of two circumstances:

  1. All beneficiaries consent and it is not contrary to a material purpose of the settlor. (Claflin doctrine)
    • Claflin Doctrine

      The Claflin doctrine says that a trust cannot be terminated or modified on petition of all beneficiaries if doing so would be contrary to a material purpose of the settlor.

      There are four clear situations from this rule that a trust cannot be terminated:

      1. It is a spendthrift trust.
      2. The beneficiary is not to receive the principal until attaining a specified age.
        • Just requiring waiting so many years does not imply a material purpose.
      3. It is a discretionary trust.
      4. It is a trust for the support of the beneficiary.

      These are not the only situations though. Any time there is a contrary material purpose, modification or termination is prohibited.

      This has since been codified in UTC § 411(b), although not requiring every beneficiary to consent.

  2. Equitable Deviation Doctrine

    Circumstances unanticipatedly change and would defeat or substantially impair the accomplishment of the purposes of the trust.

Decant

An alternative to modifying a trust is for the trustee to "decant" it by making and giving everything to a new trust, which will then distribute the property differently.

To decant, the state must have a decanting statute. (Illinois and Virginia both do.)

The purpose of decanting is to fix staleness with the first trust.

Removing a Trustee

Under the common law, a trustee can only be removed for a serious breach of trust.

The modern approach has a similar standard, but also allows removing a trustee if there is a substantial change of circumstances or if requested by all qualified beneficiaries, if the court finds it best serves the interest of all the beneficiaries, if it is not inconsistent with a material purpose of the trust, and if a new trustee is available. UTC § 706(b)(4).