There are hundreds of family business planning and family office specialists across the country whose specialty is to perform all-around planning for closely held businesses, from tax planning to succession planning, the latter in many cases being the most important for long-term considerations.1 For the most part, these planning firms are typically made up of talented, experienced and well-educated individuals whose mission is to keep the family and the family’s business on a path consistent with the owners’ objectives. In doing so, they must make it their business to keep abreast of the latest developments related to the field of family business planning.
A good example of this type of development is the private trust company (PTC).2 It wasn’t so long ago that a family with a successful business and the wealth that accompanied it was actually forced to use a corporate trustee (a bank or trust company) if it wanted to guarantee oversight and management of its business and wealth over succeeding generations. Then, laws were passed that allowed a “private” trust company to be formed that provided greater flexibility in the management of the PTC so that family members could actually participate in the management of the trust assets by participating in the management of the PTC. Of course, there are state and federal regulations, reporting and careful planning steps to follow, especially to avoid estate taxes on the deaths of the participating family members, but the PTC has nevertheless become a favorite planning idea of family business advisors. Unfortunately, not every good planning idea catches advisors’ attentions, to the disadvantage of their clients, who rely on them to know and understand the latest and best planning ideas. A conspicuous example of this is the purpose trust, which is a trust that exists to carry out a purpose, rather than to benefit individual beneficiaries.
The Purpose Trust
For a decade or more, estate-planning attorneys and other advisors have been writing about the unique advantages of the purpose trust, particularly when it comes to long-term planning for a closely held business,3 and yet, the business planning community seems to have ignored it more or less completely, for no explainable reason. There’s a handful of exceptions here in the United States, where owners of closely held companies have used a purpose trust in their planning, but from all appearances, the ideas came from their legal advisors rather than family business consultants. Please let me be clear, however. I’m not condemning the entire population of business advisors for not recommending purpose trusts, because the estate-planning legal community has fared little better. Perhaps the answer may be that the main characteristic of the purpose trust is so contrary to the traditional trust we’ve been using for hundreds of years that there’s a natural reaction to reject it. So, just what’s so unusual about the purpose trust that scares advisors and attorneys away, and what can it accomplish for family businesses that can’t be accomplished by the plain vanilla trust?
What It Can Do
First, let’s talk about what the purpose trust can do that a traditional trust can’t. Let’s posit a not-so-unusual family business situation in which ancestors have built a very successful family business, and their strong wish is to keep the business going for their family “forever.” The founding ancestors have three children and four grandchildren. There are several key employees whose input and administration are important to the business.
Ancestors could recapitalize to voting and non-voting shares. The voting shares could be non-dividend-paying, while the non-voting shares (common or preferred) would receive dividends. The voting shares could be transferred to a purpose trust that would manage the company through a committee of trustees, which could include the children. The trust would prohibit a sale of the company, and there would be many more details, such as the selection and appointment of trust enforcers, appointment of key employees to the board of trustees or advisors, etc. and consideration of tax issues. The company could pay salaries to participating family members, and the company profits would go in part to grow the company and in part to non-participating family members through dividends on non-voting shares. This arrangement could ensure the retention of the business for the family for generations into the future, as well as avoid interference on account of family disputes, divorces, disabilities, lawsuits, incompetence or death. Importantly, the plan could also be structured so that the reduced value of the voting shares of the business would materially reduce or avoid estate taxes in the parents’ estates and in all subsequent family estates.
Different From Traditional Trust
The first and most significant difference between a purpose trust and a traditional trust is that a purpose trust has no specified beneficiaries. Instead, it has a purpose, but the purpose must be reasonably attainable, legal, not frivolous and not against public policy. To illustrate, a trust established to capture and kill all the stray cats in a particular city would be considered (by most) to be against public policy and therefore void, while a trust established to capture all the stray cats in a particular city and place the cats in homes or shelters would be valid and enforceable, provided the trust wasn’t overfunded.4 And, speaking of enforceable, the second important feature of a purpose trust is that it must provide for an enforcer. In the traditional trust, the beneficiaries are the enforcers, as they have the ability to force the trustee to comply with the terms of the trust. Because the purpose trust has no beneficiaries, the enforcer stands in their shoes, but isn’t a beneficiary. The enforcer may be likened to a referee whose only interest in the game is to make sure the trustee plays by the rules.
Because the enforcer is charged with overseeing and enforcing the trustee’s performance, it’s a corollary that the enforcer should have the right to request an accounting and any other information relevant to the trust administration from the trustee. Typically, the enforcer would even have the right to remove the trustee if the trustee breaches its fiduciary duty. So, where would we find this and other laws that apply to the purpose trust? Unfortunately, while there’s plenty of trust law to be found, there’s practically no purpose trust law to be found. Here in the United States, the concept of the purpose trust began for the most part with the increasing desire of individuals to provide for their pets on an individual owner’s death. Until the enactment of relevant law, trusts for pets weren’t enforceable, because the pet wasn’t a beneficiary who could enforce the trust. Thus, to have a valid pet trust, the law requires that the trust have an enforcer to see that the purpose of the trust (the care of the pet) was carried out. From the concept that a trust could therefore be created not for individuals but for a purpose, thoughtful planners began to envision the creation of trusts for all manners of purposes without exposure to beneficiaries requesting distributions or complaining about the performance of the trust portfolio.
George Bernard Shaw’s Trust
One of the most famous and most often-cited purpose trust was the one expressed under the will of playwright George Bernard Shaw. One of the 47 clauses of Shaw’s will directed that a trust be established and funded to develop a phonetic alphabet and to determine how many people in the world used the English alphabet. Although the English court held the purpose of Shaw’s trust invalid as impossible to attain, Shaw’s will involuntarily did a great deal for the promotion of purpose trusts, but unfortunately, not enough. Far more attention has been given by legislators to pet trusts than to non-pet purpose trusts. As a result, most jurisdictions allow pet trusts and have fairly detailed laws on the requirements for a valid pet trust, while most of those same jurisdictions have bare bones, inadequate purpose trust law or no purpose trust law at all.5 And, the laws of the great majority of those jurisdictions that do allow for non-pet purpose trusts are drafted in such disinterested fashion that it would make no sense to establish a purpose trust there. For example, they typically limit the duration of the purpose trust to 21 years and provide for limitations on the amount that may be held in the trust;6 two restrictions that would rule out use of a long-term business purpose trust in those jurisdictions.
Slow Change in Progress
Fortunately, changes are being made, but very slowly. To date, only two states have bothered to specifically address the purpose trust. South Dakota, which previously was the only state to have a purpose trust law suitable to be called that, and Oregon, which deserves a prize and special recognition for developing a thorough, well thought-out purpose trust law exclusively to hold business interests. South Dakota, favored for its friendly asset protection trust laws, recently amended its purpose trust law,7 but even with its amendment, the law could stand further improvement. Oregon made the effort to get it right the first time and passed what it calls the Oregon Stewardship Trust Law in 2019.8 Drafted by Professor Susan Gary of the University of Oregon Law School, the Oregon Stewardship Trust statute is currently the only law in the United States that thoroughly covers the creation and administration of a purpose trust established to hold a business.
Oregon (stewardship) purpose trusts must have a business purpose so that at present, one may not be used for family real estate.9 Despite that, the statute provides an excellent structure for the holding and maintenance of a business in a purpose trust, which, under this law, may be perpetual.10 In addition to the trustee and one or more enforcers, the trust must have a stewardship committee. The trustee must inform and account to the enforcer, but must also follow the instructions of the stewardship committee (in effect, a “directed” trust).11 Nevertheless, the trustee is still a trustee and must be kept informed of all trust administration activities. The stewardship committee may remove the trustee, the enforcer or both by a majority vote. Even a member of the committee may be removed by unanimous vote. Other actions are by a majority vote. Importantly, although the stewardship committee may remove a trust enforcer, it may not appoint a successor. This often overlooked issue is important to avoid the trustee and the enforcer each trying to remove the other, a problem with the South Dakota law.12 Under the Oregon statute, all the members of the stewardship committee and all enforcers are declared to be fiduciaries (South Dakota enforcers are fiduciaries). This is significant because most other states’ purpose trust laws fail to address the issue.
Designing and Funding
The mechanics of designing and funding a purpose trust to hold and manage a business can of course be quite varied and challenging depending on the myriad of circumstances of each family and business situation. But, to offer a relatively simple example, let’s look at the family mentioned earlier. The founding ancestors started, developed and own the business, a corporation, 50/50. The business has a substantial net worth and generates over $1 million per year after-tax profit. Shares are recapitalized to non-voting redeemable preferred stock and voting common stock. The preferred stock represents most of the company’s value. All of the voting common shares are sold or contributed to a newly formed purpose trust, the purpose of which is to manage and continue the family business. The preferred shares may be sold by the purpose trust to outside investors to raise money to pay for the founders’ sale of common shares to the purpose trust. Preferred shares may also be gifted to non-participating family members (or to a trust for their benefit) to provide income. Additional preferred shares may be issued by the company in the future to generate cash for company growth if necessary. Family members and employees who are contributing to business management and growth could be part of the trust advisory (stewardship) committee, for which they may be compensated. Intentionally omitted from this discussion are the several tax considerations present with each part of the forgoing transaction, though suffice it to note that none is a deal breaker. Furthermore, there are several other ways to structure a perpetual business purpose trust transaction.13 The net result is that the founders could receive income for their lives, considerably reduce (and in some cases, eliminate) the estate tax on the value of the business in their estates, provide income for all family members, eliminate interference in the ownership and running of the business often caused by family disputes, lawsuits, death or disability and forced sale of shares and prevent a future sale or takeover of the business. And, isn’t that the purpose after all?
Endnotes
1. To get a quick idea of the number of “experts” out there, just google titles like “Family Business Planning,” “Family Business Advisors,” “Family Business Consultants” and “Family Business Succession Planning.”
2. See Christopher Weeg, “The Private Trust Company—A DIY for the Uber Wealthy,” The American College of Trust and Estate Counsel Foundation.
3. See, e.g., Alexander A. Bove, Jr., “The Purpose of Purpose Trusts,” Probate & Property (May/June 2004); Alexander A. Bove, Jr., “The Rise of the Purpose Trust, or Trusts Without Beneficiaries: Purpose Trusts for the Family Pet or the Family Business,” Trust & Estates (August 2005); Al W. King III, “Trusts Without Beneficiaries—What’s the Purpose?” Trusts & Estates
(February 2015); Professor Richard C. Ausness, “Non-Charitable Purpose Trusts—Past, Present, & Future,” Real Property Trust and Estate Law Journal (Fall 2016); Alexander A. Bove, Jr. and Ruth Mattson, “The Purpose Trust—Drafting Becomes a Work of Art,” Estate Planning Journal (October 2016), at p. 26.
4. Typical purpose trust statutes (and cases) give the court the authority to reduce the amount in the trust if it’s deemed to be more than is reasonably necessary to carry out the trust purpose. An example is the New York court’s reduction of Leona Helmsley’s $12 million trust for her dog, “Trouble.”
5. For example, Connecticut, Hawaii, Louisiana, Nevada and New York only allow pet trusts; Georgia, Rhode Island and Texas don’t allow purpose trusts at all.
6. See, e.g., Minn Stat. Ann. Section 501C. 0409.
7. So. Dakota Senate Bill 65, Sections 1-3.
8. Oregon Stewardship Trust, HB 2598 Or. Legislature Reg. Sess. 2019.
9. Clients who have several children and grandchildren and who wish to retain family-used real estate for present and future generations can do so through a purpose trust with a “use” program and enough funding to maintain the property. This strategy avoids fights to sell it and other interruptions, while holding the property for use by descendants.
10. Supra note 8, Section 14, and for an excellent analysis and discussion of not only the Oregon Purpose Trust statute but also purpose trusts in general see Susan N. Gary, “The Oregon Stewardship Trust: A New Type of Purpose Trust that Enables Steward-Ownership of a Business,” 88 Univ. of Cincinnati L. Rev. 707 (2019) (symposium on the Business Uses of Trust), http://ssrn.com/abstract=3426845.
11. Seewww.uniformlaws.org, Directed Trust Act. So. Dakota Senate Bill 65, Section 2, Section 14.
12. See Gary, supra, note 10.
13. Ibid.