Wills, Trusts, and Estates

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
UPIA § 2
  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

A trustee must earmark funds as being separate from his own. But a failure to earmark must be shown to cause a lose for it to really matter.

Administrative Function