California recently enacted its decanting statute. The new law allows an authorized fiduciary to modify the terms of an irrevocable trust without the beneficiaries’ consent or court approval. Nevertheless, the settlor’s intent must be preserved, and no beneficiary can object. Here’s how the law compares to the Uniform Trust Decanting Act (UTDA) and other state decanting statutes.
Decanting
Decanting a trust is analogous to decanting a bottle of wine. To decant a trust, the trustee distributes the principal of the first trust to a second trust with modified terms. Decanting is becoming popular as a practical and cost-efficient way to modify the provisions of an existing irrevocable trust.
For decades, states have used common law principles to support the technique of decanting. Under common law, a trustee’s discretion to distribute trust principal is akin to a power of appointment (POA). Generally, the holder of a POA may appoint trust principal in further trust for the benefit of a beneficiary. A trustee with discretion over principal may distribute it to a different trust for the benefit of the beneficiary, unless the trust instrument provides otherwise. Many states codified these principles by enacting decanting statutes, but those statutes were far from uniform.
The UTDA
The National Conference of Commissioners on Uniform State Laws, also known as the Uniform Law Commission, approved the UTDA in 2015. The UTDA is designed to allow fiduciaries to modify irrevocable trusts while reducing the burden on the courts. The UTDA frees courts from needing to hear and approve minor modifications that maintain the trust’s purpose. Through decanting, fiduciaries can easily correct outdated trust terms or address unforeseen events, such as a beneficiary who becomes disabled. Decanting is also useful to accommodate changes in the federal tax laws. Fiduciaries and beneficiaries who wouldn’t otherwise seek a court modification because of the burden and expense could use decanting as a convenient way to modify an irrevocable trust. An exercise of the decanting power can be used to correct drafting errors, achieve tax benefits, update administrative provisions such as trustee succession, and in some circumstances, modify dispositive provisions.
California’s UTDA
SB 909 was introduced in California on Jan. 18, 2018 to enact a modified version of the UDTA. That bill contained additional safeguards to protect a settlor’s intent and the beneficiaries’ interests. The bill was sponsored by the California Commission on Uniform State Laws and supported by the Trusts and Estates Section of the California Lawyers Association.
Effective Jan. 1, 2019, California’s UDTA1 (California’s Act) allows an authorized fiduciary to modify the terms of an irrevocable trust without beneficiaries’ consent or court approval, provided the settlor’s intent is preserved and no beneficiary objects. California’s Act doesn’t limit the trustee’s ability to petition for instructions, or other approval under a trust, or to petition for modification of a trust.
Both California’s Act and the UTDA seek to strike the right balance between enabling a fiduciary to modify the terms of a first trust and preserving the settlor’s intent in the second trust. The first trust is the trust over which the fiduciary may exercise the decanting power. The second trust is either a first trust after modification by decanting or a separate trust that will receive a distribution of property from the first trust. Both acts protect the decanting power from abuse by providing methods for court oversight and ensuring that impacted beneficiaries receive notice of the proposed changes.
California’s Act modifies the UTDA to align with existing California trust law principles; however, some of California’s modifications aren’t compatible with the provisions of the UTDA. This incompatibility creates uncertainty with interpretation and implementation of California’s Act. California advisors should be cautious when advising fiduciary clients about the decanting power. Many advisors agree that California’s Act needs legislative improvements, and no advisor wants her client to be the test case in California’s courts. Until there’s more guidance on decanting in California, practitioners may want to go beyond the minimum requirements of the statute.
Applicability
A trustee may decant an irrevocable trust established on, before or after Jan. 1, 2019. California’s Act applies to a trust that has its principal place of administration in California or provides by its trust instrument that it’s governed by California law or is governed by California law for the purpose of administration, construction of the trust terms or determining the meaning or effect of the trust terms.
If a first trust instrument doesn’t provide otherwise, the terms of the first trust are deemed to include the decanting power. This rule is significant for trusts created on or before Jan. 1, 2019. A trust created in California before California’s Act was enacted likely won’t contain terms restricting or prohibiting exercise of the decanting power. A settlor who wishes to restrict or prohibit the decanting power may want to amend his revocable trust or seek court modification of an irrevocable trust.
Exercise of the Decanting Power
In California and under the UTDA, fiduciary duties apply to the exercise of the decanting power. There’s no affirmative duty to exercise the decanting power or to inform beneficiaries of the existence of the decanting power. A fiduciary may exercise the decanting power without the consent of any person and without court approval, provided that the fiduciary gives the required notice and no beneficiary objects. Although court approval isn’t required, a fiduciary may still petition the court for instructions, to appoint a special fiduciary or to approve the exercise of the decanting power.
Notice Requirements
Several states, such as Nevada, South Dakota and Delaware, don’t require notice to beneficiaries before the exercise of the decanting power. In contrast, California’s Act and the UTDA have similar notice requirements. The fiduciary must give notice at least 60 days before the decanting to: (1) each settlor of the first trust, if living, (2) each qualified beneficiary of the first trust, (3) each holder of a presently exercisable POA over any part or all of the first trust, (4) each person who currently has the right to remove or replace the fiduciary, (5) each other fiduciary of the first trust, (6) each proposed fiduciary of the second trust, and (7) the Attorney General, if the first trust has a determinable charitable interest.
Both California’s Act and the UTDA define the term “qualified beneficiary” in the same way, but California’s modification to the notice requirements isn’t compatible with this definition. A qualified beneficiary is a beneficiary that, on the date the beneficiary’s qualification is determined, satisfies one of the following conditions: (1) is a distributee or permissible distributee of trust income or principal, also referred to as a “current beneficiary,” (2) would be a distributee or permissible distributee if the interests of the current beneficiaries terminated, or (3) would be a distributee or permissible distributee of trust income or principal if the trust terminated.
The UTDA doesn’t require the fiduciary to give notice to a qualified beneficiary who’s a minor and has no representative or to a person who’s unknown to the fiduciary or is known to the fiduciary but can’t be located by the fiduciary after reasonable diligence. California’s modification to the notice requirement provides that the fiduciary must give notice to the guardian ad litem for a qualified beneficiary who’s a minor and has no representative or who’s an unborn or unascertained person. The fiduciary must seek the appointment of a guardian ad litem if one hasn’t already been appointed. The court may appoint a guardian ad litem if the only matter before the court is that appointment.
California’s requirement for a guardian ad litem for unborn or unascertained beneficiaries conflicts with the definition of the term “qualified beneficiary.” All trusts that provide for issue have potential unborn beneficiaries. Each test to be a qualified beneficiary relates to a possible distributee on the date of decanting. Unless you have a trust that expressly permits or requires distributions to an unborn person, unborn people can’t be qualified beneficiaries. Many California attorneys are wary about decanting under California’s Act because the requirements aren’t clear. The guardian ad litem requirement conflicts with the legislature’s intent to reduce the burden on the courts but is in line with the legislature’s generally protective stance. California’s Act fails to strike a balance between the two.
Contents of the Notice
The notice required under the UTDA must include: (1) a description of the manner in which the fiduciary intends to exercise the decanting power, (2) the proposed effective date for the exercise of the power, (3) a copy of the first trust instrument, and (4) a copy of all second trust instruments. California’s Act retains these requirements but also requires the fiduciary to include a statement of the reason for the proposed decanting and an explanation as to the differences between the first trust and second trust or trusts. In addition, California’s Act requires the notice to contain a warning, set out in a separate paragraph in not less than 10-point bold type, or a reasonable equivalent, that states: “If you do not bring a court action to contest the proposed trust decanting (the proposed changes to the trust) within 59 days of this notice, you will lose your right to contest the decanting.” These California-specific modifications to the UTDA reflect the state’s policy emphasis on disclosure by trustees to beneficiaries.
Objection to Decanting
California’s Act doesn’t expressly provide the manner in which a person may object to the exercise of the decanting power, but the language required to be included in the notice implies that a court action is necessary to contest a proposed decanting. In contrast, the UTDA doesn’t require specific warning language in the notice and has no provision as to the manner by which a person can object. California’s more burdensome requirements may inhibit a person’s ability or desire to object, if the person can’t or doesn’t want to initiate a court action. An objection under California’s Act would likely require the objector to incur the expense of an attorney and will definitely require the objector to incur the costs of filing an action with the court.
Mechanics of Decanting
Some states require the decanting to be accomplished by distributing some or all of the principal of the first trust to a newly created second trust or trusts. Both the UTDA and California’s Act permit such distribution but also allow the fiduciary to identify the specific provisions that are to be modified, as one would do in an amendment to the trust. The fiduciary could either treat the second trust as a new trust or treat the second trust as a continuation of the first trust.
If all of the property of the first trust is distributed to a new second trust, the first trust would terminate. The termination may require the fiduciary to provide reports or accountings to the beneficiaries and file final income tax returns. The fiduciary of the new second trust would have to obtain a new tax identification number for the second trust and retitle all of the first trust’s assets to the second trust.
If the second trust is treated as a continuation of the first trust, there may be no need to terminate the first trust for income tax purposes, obtain a new tax identification number and retitle assets. This approach would reduce the burden and expense of the decanting.
Practice Tips
California’s Act is ambiguous and imposes burdens on the fiduciary that aren’t required in other states. In some circumstances, it might be better for a fiduciary to move the situs of the trust to a jurisdiction that has more favorable decanting rules or where the practice of decanting is well-established.
It’s possible to draft around the more problematic aspects of California’s Act. For example, the trust instrument can expressly provide that notice needn’t be given to unborn or unascertained beneficiaries. This would eliminate the necessity of a guardian ad litem.
In contentious situations, the fiduciary should consider getting court approval of the decanting, even though it’s not required. Decanting isn’t appropriate in all circumstances. Decanting is less likely to cause problems if the affected individuals get along well and the decanting modifies only administrative provisions in a logical way. The more the proposed decanting will affect the disposition of assets, the more the fiduciary is exposed to liability. The fiduciary should consider whether more significant modifications would be best achieved through standard court modification.
Endnote
1. Cal. Prob. Code Section 19501- 19530.