A majority of states have repealed or extended the rule against perpetuities, abrogating any real limit on how long a settlor can control the disposition of trust property. In response to the changing legal landscape, wealthy clients are increasingly creating trusts intended to last well beyond the life expectancies of their children, grandchildren and even great-grandchildren. Although many factors influence whether a trust will stand the test of time, the most significant impediments to a trust’s likelihood of success—challenges by the beneficiaries, a failure in fiduciary succession and the trust’s inability to adapt to changed circumstances—can be mitigated with careful planning and drafting. By clearly documenting the settlor’s objectives and intent in creating the trust, establishing a forward-thinking comprehensive plan of fiduciary succession and incorporating appropriate mechanisms to allow the trust to adapt to changing circumstances, a practitioner can significantly increase the likelihood that the trust will continue to serve the client’s family, tax and other objectives over many successive generations.
Rights and Interests of Beneficiaries
Capturing the settlor’s objectives may require reconsidering certain drafting conventions. For example, historically, many trusts intended to be held for the settlor’s family members limited the class of beneficiaries to an individual’s “lawful descendants,” excluding descendants born out of wedlock and those who would take through them. The rise in blended families, same-sex parents, single parent families and other more expansive family-building alternatives reflects an evolving notion of what constitutes a family unit. With a perpetual trust, it’s important to incorporate flexibility to the extent necessary to allow the trust to conform to the settlor’s thinking on these issues. This flexibility can be accomplished through various mechanisms, including the use of powers of appointment (POAs), powers granted to trust protectors or mechanisms for third-party certification of beneficiaries.
The extent of the trustee’s discretion will determine the degree to which courts may interfere with the trustee’s discretionary decisions, as well as impact the beneficiaries’ ability to enforce their interests in the trust. Thus, the trust should clearly establish the scope of the trustee’s discretion in any discretionary matter (for example, distributions, investments and allocations). A well-drafted discretionary distribution provision, in particular, will provide ample guidance for the trustee to exercise that power in accordance with the settlor’s intent. Unclear or inconsistent distributive provisions may be a catalyst for litigation, placing both the trust and its fiduciaries in harm’s way. Accordingly, any priority the settlor intends among the beneficiaries should be clearly specified in the trust, including any authority the trustee does (or doesn’t) have to exhaust trust principal in making distributions to current beneficiaries. In addition, the trust should include any standard for distributions and/or any factors the trustee should (or must) consider in making distributions. If the settlor intends to grant the trustee sole and absolute discretion with respect to distributions (or any other matter), that grant of authority should be explicit, and language protecting the trustee against challenges for the exercise of that discretion should also be included.
State law varies regarding the information required to be communicated to a trust’s beneficiaries. Some state laws require the trustee of a trust to account to the trust’s income beneficiaries annually, while others authorize the settlor to establish a “silent” or “quiet” trust, allowing the trustee to withhold trust information from the beneficiaries for a significant period of time. The beneficiary notification requirements, or lack thereof, of applicable state law will have significant implications for the beneficiaries as well as the trustee. The practitioner should discuss the potential advantages, disadvantages and limitations of the various available approaches with the settlor, and the trust’s governing law should facilitate the settlor’s objectives.
Flexibility Under the Trust
Long-term trusts must be able to accommodate changes in laws and circumstances that were unanticipated or unforeseeable at the time the trust was established. Although modern trust statutes allowing non-judicial modification of trusts and trust decantings have made trust modification a significantly easier undertaking than in the past, sometimes the use of these statutes may ultimately thwart a settlor’s intentions. If the settlor is hesitant to give the trustee and beneficiaries the latitude afforded them under applicable state law, the trust can limit the availability of these remedies and, instead, rely on provisions contained in the trust, such as POAs, trust amendment powers and trustee distribution powers, tailored to allow the trust to be modified consistent with the settlor’s intentions. Likewise, a settlor may wish to give the trustee broader decanting and modification powers than are granted by statute, in which case the trust document should include such broad authority.
A POA may be granted to a beneficiary or trusted third party, may be exercisable during the power holder’s lifetime or at death and may have as its objects a large class of beneficiaries or a select few. POAs are generally non-fiduciary powers, so the power holder has no duties to any beneficiary of the trust or any object of the power. Depending on the scope of the POA, the power holder may in effect have the power to rewrite the trust.
A trust amendment power may be granted to a trustee or trusted third party. A trustee acts in a fiduciary capacity, and therefore all amendment powers must be exercised in the best interests of the beneficiaries. This may include, for example, amending fiduciary succession for the trust and other administrative provisions. Note, however, that when the trustee has absolute distribution discretion among a class of beneficiaries and the power to distribute trust property in further trust for any one or more of them, the trustee, in effect, already has a broad amendment power, limited only by its fiduciary duties to the beneficiaries.
A trust protector or other third party who holds the amendment power isn’t subject to the same fiduciary obligations as the trustee (although such a power holder may be subject to a duty of good faith). Therefore, an amendment power granted to a trust protector can be much broader than one granted to a trustee. Often, trust protectors are granted an overarching power of amendment, subject only to certain limitations. For example, a trust protector might be authorized to amend the trust so long as the beneficiaries under the amended trust include only beneficiaries within a certain defined class, the duties and powers of the trustee aren’t changed without the trustee’s consent and the amendment doesn’t cause the trustee to be deemed to have a general POA over the trust. A grant of this scope will allow the trust protector to modify the trust to adjust for changed family, tax and other circumstances by, for example, reducing the class of beneficiaries, granting POAs if not previously granted or withdrawing or revising existing POAs.
In all cases in which a power granted may be exercised to modify the trust, practitioners must be mindful of the potential income, gift, estate and generation-skipping transfer (GST) tax implications of both the grant and the exercise of such power. If carefully crafted, the grant of an amendment power may not only add flexibility in the administration of the trust but also, if properly and timely exercised, result in significant overall tax savings to the trust and beneficiaries. For example, allowing a trustee or trusted third party to expand a beneficiary’s limited POA to a general power or confer a general POA on a beneficiary would allow the trust property to be included in the beneficiary’s estate, causing a step-up in basis for the assets subject to the power. This could be valuable if the income tax savings from the step-up exceed the estate tax cost of inclusion of the trust property in the beneficiary’s estate.
Control and Succession
Historically, one or more individuals and/or a corporate trustee assumed all of the fiduciary duties under the trust. To the extent necessary, the trustee would hire investment and other professionals to assist in the day-to-day management of trust assets, but all fiduciary responsibility remained with the trustee. Although this remains an option for long-term trusts, there’s a clear trend towards the use of directed trusts, in which the fiduciary powers and duties historically held by the trustee alone are unbundled, so that the trustee makes distributions and/or investments only at the direction of the distribution advisor or investment advisor, respectively. Directed trusts are particularly desirable when the settlor is comfortable placing administrative responsibilities in the hands of a corporate trustee but prefers for investment and distribution authority to remain with trusted individuals knowledgeable about the settlor’s views on investments and the stewardship of family wealth.
When a fiduciary breaches its duties, it can be held personally liable to the trust’s beneficiaries. Although there’s a significant body of case law regarding the traditional trustee structure, directed trusts are relatively new, and jurisprudence on fiduciary duties in that context is less robust. To minimize legal complications with a directed trust, each power and duty that would otherwise be granted to the trustee under the instrument or implied by law should either be left to the trustee or specifically assigned to another role. Similarly, the scope of the duties of each powerholder, and any standards that apply to the exercise or non-exercise of each power granted, should be clearly articulated.
For some very wealthy families, a private trust company (PTC) may be the most attractive option. A trust with a PTC as trustee functions similarly to a directed trust, but with fiduciary powers and duties addressed at the company rather than the trust level. A PTC structure can offer increased liability protection for individuals tasked with managing trust investments or directing distributions, enabling the family to attract and retain individuals to fill the various roles needed for successful trust administration. PTCs may also help reduce trust income taxes by avoiding multi-state taxation issues. In addition, the governance documents for a PTC can include a succession plan for its managers and those making discretionary decisions regarding the trusts.
However a long-term trust is structured, the succession plan for its trustees and advisors must be comprehensive. If there are multiple roles in the trust, practitioners should be particularly careful to include provisions that specifically address when a vacancy is required to be filled and how. There needs to be a clear succession plan for each fiduciary role, perhaps with a final consolidation of duties into a corporate trustee if there’s no longer a designated individual able to serve as a distribution advisor or investment advisor. Removal of an ineffective or problematic trustee, advisor or protector may be necessary, and the trust should include mechanisms to accomplish removal. Appointment and removal provisions should be carefully drafted and coordinated to avoid placing tax-sensitive powers in the wrong hands, inadvertently causing an adverse tax result or imposing duties on the powerholder to exercise the power or, in the case of the removal power, to monitor the performance of any fiduciary.
The investment, administrative or other powers of each fiduciary should be carefully considered and adapted as needed to reflect the settlor’s objectives and to clarify the responsibilities that come with the respective fiduciary role. Practitioners should discuss fiduciary risk issues with their clients and consider including exculpatory language to protect fiduciaries and trust protectors. Although exculpatory provisions that attempt to provide blanket immunity for fiduciaries generally aren’t enforceable, provisions that are limited in scope and tailored to the law of the state governing the administration of the trust provide substantial protection for a fiduciary acting in good faith. This, coupled with indemnification provisions, may encourage individuals who are otherwise concerned about personal risk to accept a fiduciary role under the trust. These provisions will be especially valuable when the influence of the settlor has waned and successors are needed.
Succession planning for the trust protector role requires special attention. Because trust protectors are a relatively new development and their powers and duties vary significantly from those of trustees, the law may provide no default mechanism to address vacancies or other issues related to trust protector succession. Moreover, because the expansive powers generally granted a trust protector come with significantly attenuated fiduciary duties, the settlor may intend for a trust protector to serve only so long as the trust protector is someone the settlor knows and trusts. The trust protector provisions should be tailored to reflect the settlor’s thinking. If it’s likely there will be a time when there’s no longer a trust protector serving or intended to serve, including express provisions allowing the trustee to make distributions in further trust for the beneficiaries would preserve some flexibility to address unforeseen circumstances, albeit subject to all traditional fiduciary constraints.
Settlor’s Non-directive Guidance
Although the settlor’s intent should be clearly expressed through the trust’s dispositive, distributive and administrative provisions, practitioners should also consider including a holistic articulation of the settlor’s intent to guide the fiduciaries in the administration of the trust. This can be accomplished either by incorporating a statement of intent (Statement) directly in the trust or by including a letter of wishes (Letter) in the trust’s records.
A Statement is an overarching non-binding expression of the settlor’s personal values and aspirations with respect to the trust. A Statement guides, rather than directs, the fiduciaries and can cover the full gamut of trust-related issues, from distribution objectives to the parameters for use (or non-use) of any power to modify the trust. A Statement is often more accessible to beneficiaries than the technical provisions of the trust and, in addition to providing guidance to the trust’s fiduciaries, may help manage beneficiaries’ expectations regarding their interests in and the administration of the trust. Moreover, in a trust controversy that relies on a determination of the settlor’s intent for resolution, a court is often confined to considering what’s expressed within the four corners of the trust instrument, without reference to extrinsic evidence. In these cases, a Statement ensures that the settlor’s intent will inform the court’s interpretation of the governing terms of the trust.
Alternatively, or in addition, a settlor may provide the trustee with a Letter. Like a Statement, a Letter provides non-binding guidance to the trustee regarding the settlor’s objectives in creating the trust. However, a Letter isn’t part of the trust. Letters are commonly used in discretionary trusts. They’re particularly useful for trusts that place no constraints on the trustee’s discretion or provide minimal (or even no) guidance to the trustee regarding any exercise of discretion. For an inter vivos trust, a Letter may be preferable to a Statement, because it can be amended or superseded by a subsequent Letter at any time during the grantor’s lifetime. When a Letter is executed after the creation of the trust, the Letter should by its terms be non-binding on the trustee, so as not to suggest retained control over the trust by the settlor for transfer tax purposes. Note, however, that the utility of a Letter may be limited in the event of a trust controversy, because as extrinsic evidence, it may not be admissible in court unless the provisions of the trust are found to be ambiguous.
Takeaway
A long-term trust is often the centerpiece of a settlor’s legacy. It’s the practitioner’s task to serve not only as the client’s architect in that legacy project but also as the engineer and contractor. Even the most robust trust form will need to be reconsidered and customized to best reflect the settlor’s goals and provide the foundation for a trust that stands the test of time.