The majority of jurisdictions now allow for trust beneficiaries and fiduciaries to resolve trust matters by consent through the use of a nonjudicial settlement agreement (NJSA).1 Resolving a matter by NJSA is almost always more expedient and cost effective than petitioning a court. Additionally, virtual representation statutes have made it possible to obtain the consent of all beneficiaries. As a result, the demand for NJSAs has dramatically increased in recent years. Rarely does a day go by without receiving a request from a beneficiary or fiduciary to use an NJSA to resolve a matter of trust administration, modify a trust agreement, terminate a trust, change the situs of a trust or remove and appoint trustees. For those reasons, the NJSA seems to have become the all-purpose answer to every trust problem.
The NJSA isn’t, however, without limitations. Most importantly, an NJSA can’t completely ignore the established parameters of the governing instrument, because an NJSA is generally only valid to the extent it doesn’t violate a material purpose of the trust.2 Although critical to the effectiveness of the NJSA, “material purpose” is largely undefined by state statutes and has only rarely been explored by the courts. Moreover, a trust may have more than one material purpose. The unsettled nature of this limitation often leaves the parties uncertain as to the validity of the NJSA and fiduciaries unclear of their liability for participating. So, when your client requests a “quick” NJSA to solve their current trust dilemma, how do you know if the proposed course of action violates a material purpose of the trust?
NJSA Definition
An NJSA is a contract among the trust beneficiaries, fiduciaries and other interested parties to the trust that can be used, among other purposes, to resolve disputes, modify the trust terms, change situs, remove and appoint trustees or terminate the trust without court involvement. In many states, an NJSA can be used for “any matter involving a trust.”3 The NJSA statute in some states provides a non-exclusive list of matters that an NJSA can address,4 while other states limit the use of an NJSA only to certain matters.5 But in almost all jurisdictions,6 an NJSA is “valid only to the extent it does not violate a material purpose of the trust and includes terms and conditions that could be properly approved by the court . . .”7
Accordingly, in most jurisdictions, to resolve a trust matter by NJSA (at least without the consent of the settlor), the interested parties must determine whether the NJSA would violate a material purpose of the trust, which necessarily involves investigating the settlor’s intentions when creating the trust. Occasionally, a settlor will provide a “purpose statement” in the governing instrument outlining their intentions in creating the trust. Most settlors, however, don’t include such a statement and don’t explicitly identify the trust’s material purpose. Therefore, the material purpose generally must be derived from the terms of the governing instrument and the extrinsic evidence surrounding its creation.
Conferring with the drafting attorney regarding the circumstances surrounding the creation of the trust is one way to shed light on the trust’s purpose. Although, if many years have passed since the trust’s creation, this option can be impossible or impractical. In most cases, when attempting to identify a trust’s material purpose, the provisions of the governing instrument are the only available reference—and drawing the line between a material purpose and a boilerplate trust provision is often no simple task.
Claflin and the Restatement Third
Any analysis of the material purpose limitation must begin with the Claflin rule. The Claflin rule, derived from Claflin v. Claflin,8 stands for the proposition that the settlor has the right to dispose of their property subject to any restrictions and limitations they wish, and unless in violation of the law or public policy, the settlor’s intent should prevail.9 As a result, even when all beneficiaries consent, a court won’t modify or terminate a trust if the proposed action violates a material purpose of the trust. Claflin’s material purpose limitation, however, generally doesn’t apply if the settlor is still living and willing to consent to the termination or modification. For example, as codified by the Restatement Third of Trusts (Restatement Third), the Claflin rule provides that the material purpose restriction may be bypassed if: (1) the settlor is living and able to consent, or (2) after the settlor’s death, the court determines that the reasons for termination or modification outweigh the material purpose.10
Dispositive Provisions
The only concrete guidance on what qualifies as a material purpose comes from the often cited comments to Section 65 of the Restatement Third, which describe a material purpose as “some showing of a particular concern or objective on the part of the settlor, such as concern with regard to the beneficiary’s management skills, judgment, or level of maturity” and explain further that, “the very nature or design of a trust suggests its protective nature or some other material purpose.”11 With this in mind, some courts have looked at the design of the trust’s distribution terms and the discretionary nature of the trust to illustrate the trust’s material purpose. For example, the Supreme Court of Vermont in Estate of Brown12 found that language in the governing instrument stating that trust income should be used “for and during the remainder of [the beneficiaries’] natural lives” indicated that assurance of life-long income for the beneficiaries was a continuing material purpose of the trust. Similarly, an Ohio appellate court in Vaughn v. Huntington Natl. Bank Trust Div.13 determined that the design of the trust at issue, which allowed for $250 of monthly income distributions to the beneficiaries, illustrated that the material purpose of the trust was to provide the beneficiary secure monthly income as long as the trust corpus was still intact. Additionally, in Estate of Bonardi,14 the New Jersey Superior Court found the fact that the trustee was vested with “absolute discretion” over principal distributions indicated that it was a material purpose of the settlor to deny the beneficiary control over the distribution of the trust and the outright ownership of the trust corpus. Several courts have also identified principal postponement provisions, which delay a beneficiary’s full enjoyment of the trust corpus before a certain age or the occurrence of a certain event, as a material trust purpose.15
Spendthrift Provisions
The materiality of the spendthrift provision has been fiercely debated. In some jurisdictions, the answer is abundantly clear because the jurisdiction’s trust code explicitly provides that a spendthrift provision in a trust instrument is presumed to constitute a material purpose of the trust.16 Other jurisdictions follow the non-presumption approach adopted by the Restatement Third and the Uniform Trust Code (UTC).17 Under this approach, “spendthrift restrictions are not sufficient in and of themselves to establish, or to create a presumption of, a material purpose that would prevent termination by consent of all of the beneficiaries.”18 The comments to the UTC are clear that a spendthrift provision isn’t presumed a material purpose of a trust, and whether spendthrift protection was a material purpose of the settlor “is instead a matter of fact to be determined on the totality of the circumstances.”19 This issue is far from settled—almost half of the states with NJSA statutes simply don’t specify whether a spendthrift provision is presumed a material trust purpose.
Administrative Provisions
Materiality isn’t limited to the dispositive trust provisions and spendthrift clauses. In some circumstances, administrative provisions can constitute a material trust purpose. For example, in In re Trust Created by Fenske,20 the Supreme Court of Nebraska denied a request for a trust modification that would have effectuated the removal of a bank and appointment of a family member as trustee. The court concluded that the appointment of the bank was a material trust purpose because circumstantial evidence indicated that the settlor had a prior relationship with the bank and intended the trustee to be an independent party. In another case, however, the Superior Court of Pennsylvania found that removal of a corporate trustee wasn’t in violation of a material trust purpose, because the initial trustee that the settlor had selected no longer existed due to a series of mergers and acquisitions.21 The comments to the Restatement Third should also be considered when analyzing these types of administrative provisions:
[A] proposed modification might change the trustee or create a simple, inexpensive procedure for appointing successor trustees, or it might create or change procedures for removing and replacing trustees. Modifications of these types may well improve the administration of a trust and be more efficient and more satisfactory to the beneficiaries without interfering with a material purpose of the trust. On the other hand, repeated modifications to change trustees or even a particular change of trustee, or an amendment of provisions relating to the trusteeship, might have the effect of materially undermining the contemplated qualities or independence of trustees. A given change might even have the effect of shifting effective control of the trust in such a way as to be inconsistent with a protective management purpose or other material purpose of the trust.22
Potential Consequences
Although NJSAs will continue to be helpful and perhaps the most used tool in the trusts and estates practitioner’s toolbox to resolve trust matters, practitioners must question whether the NJSA in each and every case violates any and all material purposes of the trust. Recent cases invalidating NJSAs demonstrate the consequences of overlooking the material purpose requirement.
In a Nebraska case from earlier this year,23 the current and remainder beneficiaries (the settlor’s wife and children) and the trustee (the settlor’s wife) modified a trust’s residuary distribution provisions by NJSA to, among other things, allow for outright distributions (rather than distributions in further trust) for the settlor’s children after the death of the settlor’s wife. Six years later, the wife purported to revoke the NJSA via email. The settlor’s son then attempted to have the NJSA court-approved; however, the Nebraska Supreme Court ultimately found that because the trust contained a spendthrift clause, the NJSA’s modifications to the residuary provisions violated a material purpose of the trust. Thus, the court invalidated the NJSA, and the modified trust terms propounded by the NJSA never came to fruition.
In another case,24 the beneficiaries and trustees of a Pennsylvania trust modified the current distribution provisions of the trust by NJSA, changing the needs-based payments permitted under the original trust terms to a mandatory unitrust payment to the settlor’s widow each year. Four years later, two beneficiaries and a successor trustee filed a petition to void the NJSA. The court found that the NJSA’s vast departure from the trust’s original distribution terms violated a material purpose of the trust, and the court therefore invalidated the NJSA. The court required the settlor’s widow to repay the unitrust payments she had received from the trust as a result of the new provisions, beginning from the date the petition was filed.25
No Clear Answers
As one can see, determining materiality and ensuring an NJSA is valid is no easy task, and the consequences of a subsequent invalidation of an NJSA because it violated a material purpose are unclear: Are removed trustees reinstated? Are the original trust terms revived and if so, retroactively? Are the actions of the fiduciaries unwound? Did the trustee and other fiduciaries breach their duties by acting in contravention of the original provisions? Many of these questions will certainly be answered in cases to come. For now, these potential risks should be discussed with both the beneficiaries of the trust and those fiduciaries responsible for administering it. When there’s any doubt, practitioners can seek court approval of the NJSA, which most NJSA statutes permit. This will fully and finally resolve the materiality issue, albeit with increased cost and delay. Further, fiduciaries, individual and corporate alike, should be sure to include exculpatory and indemnity provisions in the NJSA to limit their risks. Finally, remember, while a “quick” NJSA may quell your client’s trust problems for now—don’t overlook the trust’s material purpose—as it may be paramount to ensuring the NJSA doesn’t get unraveled years down the road.
Endnotes
1. Forty-two states and the District of Columbia have adopted nonjudicial settlement agreement (NJSA) statutes.
2. It should be noted that in many jurisdictions, the material purpose limitation doesn’t apply to the NJSA if the settlor is still living and willing to consent or not object to the NJSA.
3. See Uniform Trust Code (UTC) Section 111.
4. For example, Delaware and Florida’s NJSA statutes allow an NJSA to be used for any trust matter and provide a non-exclusive list of matters that may be resolved by NJSA. See 12 Del. C. Section 3338; Fla. Stat. Section 736.0111.
5. In states such as Kansas and Illinois, matters that may be addressed by NJSA are limited to those expressly listed in the statute. See Kan. Stat. Ann. Section 58a-111(d); 760 Ill. Comp. Stat. 3/111.
6. Only five states with NJSA statutes don’t include the material purpose limitation—Florida, Idaho, South Carolina, Washington and Wisconsin.
7. UTC Section 111.
8. Claflin v. Claflin, 20 N.E. 454 (Mass. 1889).
9. Claflin was a departure from the English rule propounded in Saunders v. Vautier, which provides generally that trust beneficiaries can depart from the settlor’s intentions if all beneficiaries are fully represented and of legal capacity.
10. Restatement (Third) of Trusts (Restatement Third) Section 65.
11. Ibid., cmt. d.
12. Estate of Brown, 528 A.2d 752 (Vt. 1987).
13. Vaughn v. Huntington Natl. Bank Trust Div., 2009 WL 342697 (Ohio App. Feb. 10, 2009).
14. Estate of Bonardi, 871 A.2d 103 (N.J. Super. 2005).
15. Lafferty v. Sheets, 267 P.2d 962 (Kan. 1954); Maley v. Citizens National Bank of Evansville, 92 N.E.2d 727 (Ind. App. 1950).
16. Nine states with NJSA statutes explicitly identify a spendthrift provision as a material purpose—Arkansas, Iowa, Montana, Nebraska, North Dakota, Ohio, Oregon, Pennsylvania and West Virginia. In UTC states, the presumption language (or non-presumption language) regarding spendthrift provisions generally appears in UTC Section 411, “Modification or Termination of Noncharitable Irrevocable Trust by Consent,” which contemplates modification or termination by consent with court approval. However, the same would apply to UTC Section 111, “Nonjudicial Settlement Agreements,” because the agreement must be one “that could be properly approved by the court.”
17. Fourteen states with NJSA statutes explicitly provide that a spendthrift provision isn’t presumed a material purpose—Alabama, Colorado, Connecticut, Illinois, Kansas, Kentucky, Maine, Minnesota, New Jersey, New Mexico, Utah, Vermont, Wisconsin and Wyoming. The District of Columbia also follows the non-presumption approach.
18. Restatement Third Section 65 cmt. e.
19. UTC Section 411 cmt. to Subsection (c).
20. In re Trust Created by Fenske, 930 N.W.2d 43 (Neb. 2019).
21. In re McKinney, 67 A.3d 824 (Pa. Super. 2013).
22. Restatement Third Section 65 cmt. f.
23. In re McGregor, 954 N.W.2d 612 (Neb. 2021).
24. In Re: C. Richard Johnston Irrevocable Trust, 349 Crawford County L.J. 3 (O.C. Crawford, Jan. 19, 2012).
25. The court refused to void the NJSA ab initio, as requested by the petitioners, because the petitioners initially had consented to the NJSA. Instead, the court invalidated the NJSA as of the date the petition was filed.