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Trustees: Duties and Discretion, in Two Parts
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THIS MATERIAL IS PRESENTED WITH THE UNDERSTANDING THAT THE PUBLISHERAND THE AUTHORS DO NOT RENDER ANY LEGAL, ACCOUNTING OR OTHERPROFESSIONAL SERVICE. IT IS INTENDED FOR USE BY ATTORNEYS LICENSED TOPRACTICE LAW IN VIRGINIA. BECAUSE OF THE RAPIDLY CHANGING NATURE OFTHE LAW, INFORMATION CONTAINED IN THIS PUBLICATION MAY BECOMEOUTDATED. AS A RESULT, AN ATTORNEY USING THIS MATERIAL MUST ALWAYSRESEARCH ORIGINAL SOURCES OF AUTHORITY AND UPDATE INFORMATION TOENSURE ACCURACY WHEN DEALING WITH A SPECIFIC CLIENT'S LEGAL MATTERS.IN NO EVENT WILL THE AUTHORS, THE REVIEWERS, OR THE PUBLISHER BE LIABLEFOR ANY DIRECT, INDIRECT, OR CONSEQUENTIAL DAMAGES RESULTING FROM THEUSE OF THIS MATERIAL. THE VIEWS EXPRESSED HEREIN ARE NOT NECESSARILYTHOSE OF THE VIRGINIA LAW FOUNDATION.
© 2012 Virginia Law Foundation. All rights reserved.
These materials may be shared only with those who are authorized to attend, view, or listen tothe associated seminar
ABOUT THE SPEAKERS
Michael H. Barker, McGuireWoods / Richmond
Mr. Barker's practice focuses primarily on the representation of high net worth
individuals and families as well as closely-held businesses with respect to a variety of tax
and estate planning matters.
Mr. Barker received his J.D., cum laude, from Georgetown University Law Center in
2008, his Master of Public Policy from Georgetown Public Policy Institute, and his B.A.,
summa cum laude, from California Lutheran University in 2003.
Prior to working for McGuireWoods, Mr. Barker was an associate at Moore & Van Allen
PLLC in Charlotte, North Carolina.
Mr. Barker co-authored “UK Remittance Basis Charge to Offset U.S. Income Tax” with
Helena S. Whitmore, W. Birch Douglass III and Jonathan G. Neal (Practical
International Tax Strategies, September 2011) and “State Conservation Income Tax
Credits” with Justin S. Steinschriber (The Will and The Way, September 2010).
Mr. Barker is a member of the American Bar Association, Real Property Trust & Estate
Law Section, the Virginia Bar Association, Wills, Trusts & Estates Section, and the
North Carolina Bar Association, Estate Planning and Fiduciary Law Section.
William I. Sanderson, McGuireWoods / Richmond
Mr. Sanderson is part of the firm’s Fiduciary Advisory Services and Private Wealth
Services groups. He represents both high-net worth individuals and families on a variety
of sensitive and complex estate and business planning matters. His practice focuses on
the areas of estate planning and estate and trust administration.
Mr. Sanderson received his J.D. from the University of Virginia in 2006 and his B.A.
from the University of Virginia in 1998.
Mr. Sanderson co-authored “Estate Tax Deferral, Planning Now and Being Prepared
Later” with Dennis I. Belcher (ABA Trusts & Investments Magazine, March – April
2008). He taught Federal Taxation Practice and Procedure at Virginia Commonwealth
University School of Business in the Fall 2008 and the Fall 2010. He has also
participated in many speaking engagements, most recently including, “The Good, the
Bad, and the Litigation Over Investment Concentrations” at the Virginia CLE Trust
Administration Seminar (February 2012), “The Estate Planning Toolbox: A Practical
Guide for Advisors” at the Central Arizona Estate Planning Council (February 2012), and
“Health, Support & What? Distribution Provisions: Understanding the Issues and
Options” at the Family Office Exchange Workshop for Grantors, Trustees and
Beneficiaries (Chicago, March 2012).
Mr. Sanderson is a member of the American Bar Association, Section of Real Property
Trust & Estate Law, Co-Vice-Chair of the Estate Planning and Administration for
Business Owners, Farmers and Ranchers Committee, a member of the Virginia Bar
Association, Trusts & Estates Legislative Committee, Young Lawyers Division Member,
and was on the Board of Directors for the Epilepsy Foundation of Virginia, 2000–2003.
Trustees: Duties and Discretion in Two Parts
Presented by:
William I. Sanderson
McGuireWoods LLP
And
Michael H. Barker
McGuireWoods LLP
Materials Prepared by:
William I. Sanderson
Michael H. Barker
McGuireWoods, LLP
901 East Cary Street
Richmond, Virginia 23219
Portions of Part Two of these materials were initially prepared by Schiff Hardin LLP © 2007
and presented at Northwestern University School of law. Reprinted here with permission.
ii
Trustees: Duties and Discretion in Two Parts
Table of Contents
Part One: The Role of the Trustee – Understanding Duties and Powers ............................... 1
I. Historical Context of Fiduciary Duties .......................................................................... 1
a. What is a trust? Title is key ................................................................................... 1
b. Brief History of Trusts ........................................................................................... 1
c. Context of Fiduciary Duties ................................................................................... 1
II. Fiduciary Duties Under the Virginia Uniform Trust Code (VUTC) .......................... 1
a. General Trustee Duties .......................................................................................... 1
b. Trustee’s Fundamental Duties ............................................................................... 2
c. Duty to Administer Trust in Good Faith ................................................................ 2
d. Duty of Loyalty ...................................................................................................... 3
e. Duty to Exercise Reasonable Care and Skill ......................................................... 4
f. Duty of Impartiality ............................................................................................... 5
g. Duty to Protect Trust Property ............................................................................... 9
h. Duty to Give Personal Attention to the Affairs of the Trust .................................. 9
i. Duty to Furnish Information ................................................................................ 11
j. Duty of Efficient Spending .................................................................................. 12
k. Duty to Keep Adequate Records .......................................................................... 13
l. Duty to Enforce and Defend Claims .................................................................... 13
m. Duties Concerning Co-Trustees ........................................................................... 13
n. Duties of Former Trustees ................................................................................... 14
o. Prudent Investor Act ............................................................................................ 14
III. Fiduciary Powers Under the Virginia Uniform Trust Code (VUTC) ....................... 15
a. General Powers .................................................................................................... 15
b. Specific Powers .................................................................................................... 16
c. Decanting Power .................................................................................................. 19
d. Grantor Trust Powers ........................................................................................... 20
e. Power of Amendment .......................................................................................... 26
f. Power to Delegate Investment Authority ............................................................. 26
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g. Directed Trustee ................................................................................................... 34
IV. Exculpation of Trustees ................................................................................................. 49
a. Validity of Exculpation Clauses .......................................................................... 49
b. Exculpation in Virginia ........................................................................................ 50
c. Communication and Ethical Issues ...................................................................... 51
Part Two: Health Support and What?!?! ................................................................................ 53
I. Overview ......................................................................................................................... 53
a. Understanding Discretion .................................................................................... 53
b. Mandatory Distribution Provisions ...................................................................... 53
II. Trusts with Discretionary Distributions ...................................................................... 54
a. Grantor’s Intent .................................................................................................... 54
b. Trustee’s Duties ................................................................................................... 54
c. Sole and Absolute Discretion............................................................................... 55
d. Abuse of Discretion ............................................................................................. 57
III. Common Discretionary Distribution Standards ......................................................... 57
a. Health, Education Maintenance and Support ....................................................... 57
b. Comfort, Happiness and Best Interests ................................................................ 60
c. Emergency, Necessary and Necessities ............................................................... 62
IV. More Than Words: Other Issues in Discretionary Distributions .............................. 63
a. Standard of Living ............................................................................................... 63
b. Availability of Other Resources ........................................................................... 64
c. Establishing Priorities .......................................................................................... 67
d. Making Gifts ........................................................................................................ 68
1
Part One: The Role of the Trustee – Understanding Duties and Powers
I. Historical Context of Fiduciary Duties
a. What is a trust? Title is key.
i. The quintessence of a trust is a circumstance under which a trustee holds
title to property for the benefit of another person or persons.
ii. See: Restatement Second of Trusts § 2: A trust is a “fiduciary relationship
with respect to property, subjecting the person by whom the title to the
property is held to equitable duties to deal with the property for the benefit
of another person, which arises as a result of a manifestation of an
intention to create it.”
iii. A trust cannot own property. In contrast to a corporation, a trust is not a
legal entity.
iv. A trust cannot act.
b. Brief History of Trusts
i. Development of English law dating back to the knights of the Middle
Ages.
ii. Development of the distinction between legal and equitable ownership of
an asset and the management of an asset without deriving personal benefit.
iii. Parallel estates: the legal estate and the equitable estate.
1. The legal estate is the owner of title.
2. The equitable estate is the beneficial owner.
c. Context of Fiduciary Duties
i. A trust cannot operate unless a trustee has responsibilities to the equitable
owners.
ii. What would a trust be if a trustee had no duties to the beneficiaries?
II. Fiduciary Duties Under the Virginia Uniform Trust Code (VUTC)
a. General Trustee Duties. A trustee is one who holds property for the benefit of
another, and this role is defined by the many duties of a trustee. The following
list is not exhaustive of all of the duties of a trustee but identifies several of the
important duties that relate to the role of a trustee with respect to any given trust.
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b. Trustee’s Fundamental Duties
i. Code of Virginia § 55-541.05. Default and Mandatory Rules. Under the
VUTC, a grantor may override many of the default provisions of the
VUTC by the terms of a trust. Therefore, the terms of a trust prevail over
any provision of the VUTC, except, inter alia, “[t]he duty of a trustee to
act in good faith and in accordance with the terms and purposes of the
trust and the interests of the beneficiaries.”
ii. The duty to act in good faith and in accordance with the terms and
purposes of the trust and the interests of the beneficiaries is non-waivable
by either the grantor or the trustee.
c. Duty to Administer Trust in Good Faith
i. Code of Virginia § 55-548.01. Duty to administer trust and invest.
Similar to the mandatory duty described in Code of Virginia § 55-541.05,
this section states that a “trustee shall administer the trust and invest trust
assets in good faith, in accordance with its terms and purposes and the
interests of the beneficiaries, and in accordance with this chapter. In
administering, managing and investing trust assets, the trustee shall
comply with the provisions of the Uniform Prudent Investor Act and the
Uniform Principal and Income Act.”
ii. It has been said that the “first and most important duty of the trustee is to
study and become thoroughly familiar with the provisions of the trust
instrument, and thereafter to follow them out implicitly.” (Charles E.
Rounds, Jr., Loring: A Trustee’s Handbook, 1998).
iii. See: Code of Virginia § 55-548.14. Discretionary powers; tax savings.
“Notwithstanding the breadth of discretion granted to a trustee in the terms
of the trust, including the use of such terms as “absolute”, “sole”, or
“uncontrolled”, the trustee shall exercise a discretionary power in good
faith and in accordance with the terms and purposes of the trust and the
interests of the beneficiaries.” Thus, in Virginia a trustee never has
unrestrained discretion over trust assets and the discretion must always be
exercised in good faith.
iv. See: Rinker’s Adm’r v. Simpson, 159 Va. 612 (1932): Broad discretion
may be vested in trustees, so long as the trustee exercises the discretion in
good faith and performs a “sound and honest execution of the trust.”
v. See: NationsBank of Virginia, N.A. v. Grandy, 248 Va. 557 (1994): A
trustee’s “actions must be an exercise of good faith and reasonable
judgment to promote the trust’s purpose.”
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vi. See also: Restatement Third of Trusts §76: “[t]he trustee has a duty to
administer the trust, diligently and in good faith, in accordance with the
terms of the trust and applicable law.”
vii. See also: Restatement Third of Trusts § 75: “[i]f the terms of a trust
reserve to the settlor or confer upon another a power to direct or otherwise
control certain conduct of the trustee, the trustee has a duty to act in
accordance with the requirements of the trust provision reserving or
conferring the power and to comply with any exercise of that power,
unless the attempted exercise is contrary to the terms of the trust or power
or the trustee knows or has reason to believe that the attempted exercise
violates a fiduciary duty that the power holder owes to the beneficiaries.”
d. Duty of Loyalty
i. Code of Virginia § 55-548.02. Duty of loyalty. Under the VUTC, every
“trustee shall administer the trust solely in the interests of the
beneficiaries.”
ii. The duty of loyalty is said to be “the most fundamental duty of a trustee.”
A trustee must administer the trust assets, and make decisions regarding
the trust investments, solely for the benefit of the beneficiaries of the trust.
iii. A trustee may not administer the assets in such a way as to advance the
trustee’s own interest and the expense of the beneficiaries. (Scott and
Ascher on Trusts §17.2).
iv. “A trustee is held to something stricter than the morals of the market
place. Not honesty alone, but the punctilio of an honor the most sensitive,
is then the standard of behavior. As to this there has developed a tradition
that is unbending and inveterate. Uncompromising rigidity has been the
attitude of courts of equity when petitioned to undermine the rule of
undivided loyalty by the ‘disintegrating erosion’ of particular exceptions.”
Meinhard v. Salmon, 249 N.Y. 458, 464 (N.Y. 1928).
v. Any transaction between the trustee in his fiduciary capacity and the
trustee individually is voidable unless the terms of the trust instrument
authorize the transaction.
1. Sample Language: I hereby waive the rules of law prohibiting
self-dealing between my Trustee in a fiduciary capacity and my
Trustee in an individual capacity, entities with which my Trustee
may be affiliated in an individual capacity, or entities in which my
Trustee may have an interest in an individual capacity, but all
such transactions shall be at arm’s length. I intend by this
provision to relieve my Trustee of any liability for decisions or
actions that would constitute self-dealing by a fiduciary if such
decisions or actions are made in good faith.
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vi. Duty of Confidentiality.
1. Part of the trustee’s duty of loyalty is the duty to keep the specific
affairs of the trust confidential except as otherwise required by
law.
2. See also Restatement Third of Trusts § 170, comment s: “The
trustee is under a duty to the beneficiary not to disclose to a third
person information which he has acquired as trustee where he
should know that the effect of such disclosure would be
detrimental to the interest of the beneficiary.”
e. Duty to Exercise Reasonable Care and Skill
i. Under the VUTC, a trustee must exercise the diligence of the “prudent
person” in carrying out the affairs of the trust, including making
investment decisions for the trust. It is not enough that a trustee act in a
manner as the trustee would towards his or her own investments. A
trustee is held to an objective standard.
ii. A trustee who has special knowledge or expertise, more than the objective
“prudent person,” must exercise his or her duties with all of the trustee’s
skill and knowledge. Such a trustee is held to a higher standard.
iii. The prudent person standard is a standard of conduct, not performance.
1. A trustee is a guarantor of process, not of outcome.
2. So long as a trustee exercises reasonable care and skill in making
the investment decisions and taking other actions for a trust, a
trustee will not be held liable for the outcomes of those decisions
even if they harm a beneficiary. (Scott and Ascher on Trusts
§17.6).
iv. See: Code of Virginia § 55-548.04. Prudent administration and § 55-
548.06. Trustee’s Skill.
v. See: Parsons v. Wysor, 180 Va. 84 (1942): A trustee must “exercise the
same degree of discretion in the management of the trust that a prudent
man of discretion and intelligence would exercise in his own like affairs.”
vi. In the early twentieth century case of Shepherd v. Darling, 120 Va. 586
(1917), the court cites with approval the prudent man standard and
reasoning as drafted by Professor John B. Minor in 2 Minor’s Inst. (4th
Ed.) p. 255: “But nothing more is in general required than that he should
act in good faith, and with the same prudence and discretion that a prudent
man exercises in his own affairs. If more than this were exacted, it would
tend to the disadvantage of persons interested in trusts in general because
5
it would discourage competent persons from accepting the administration
of trusts.”
vii. See also: Restatement Third of Trusts § 227: “The trustee is under a duty
to the beneficiaries to invest and manage the funds of the trust as a prudent
investor would, in light of the purposes, terms, distribution requirements,
and other circumstances of the trust. This standard requires the exercise of
reasonable care, skill, and caution, and is to be applied to investments not
in isolation but in the context of the trust portfolio and as a part of an
overall investment strategy, which should incorporate risk and return
objectives reasonably suitable to the trust.”
viii. “All that can be required of a trustee to invest, is, that he shall conduct
himself faithfully and exercise a sound discretion. He is to observe how
men of prudence, discretion and intelligence manage their own affairs, not
in regard to speculation but in regard to the permanent disposition of their
funds, considering the probable income, as well as the probable safety of
the capital to be invested.” Harvard College v. Amory, 26 Mass. 446, 461
(Mass. 1830).
ix. By way of a practical example, a “beneficiary has a right to expect that his
checks will arrive on time, that tax returns will be filled out property and
filed when due, that investment decisions will be made and executed in a
timely fashion, and that accountings will be submitted at regular
intervals.” Rounds, Loring: A Trustees Handbook, 111.
f. Duty of Impartiality
i. Code of Virginia § 55-548.03. Impartiality. If a trust has more than one
beneficiary, “the trustee shall act impartially in investing, managing, and
distributing the trust property, giving due regard to the beneficiaries’
respective interests.”
ii. Because a trust may have more than one beneficiary, in making all
decisions with regards to investments, a trustee must act impartially
towards all beneficiaries unless the terms of the trust otherwise direct.
iii. A trustee must act impartially towards simultaneous beneficiaries – those
with similar interests in the trust – and successive beneficiaries – those
whose interests are in succession. Where there are life and remainder
beneficiaries, a trustee must invest the assets in a way that is impartial to
both sets of beneficiaries. Scott and Ascher on Trusts §17.15.
iv. The duty of impartiality may be waived by the settlor in some
circumstances and the settlor may direct that one beneficiary be designated
as a “primary” beneficiary and be preferred over other beneficiaries.
6
1. Sample Language: My wife shall be deemed the primary
beneficiary of this trust during her lifetime, and my primary
purpose in creating this trust is to provide for her support as
provided herein.
v. Further, the settlor may grant the trustee the authority to make
distributions, tax elections, and other discretionary decisions in a manner
that would prefer one beneficiary or class of beneficiaries over another.
1. Sample Language: My Trustee may make discretionary payments
to the beneficiaries of any trust in unequal shares and may, but
shall not be required to, consider other resources available to any
beneficiary. My Trustee may make tax elections without regard to
the relative interests of any beneficiaries and may, but shall not
be required to, make equitable adjustments among beneficiaries.
In making payments or applications of income or principal under
this agreement, my Trustee shall have full power and discretion to
exclude any beneficiary from any of such payments or
applications, without any obligation to maintain or achieve
equality or any other relationship at any time among the
beneficiaries.
vi. See also: Restatement Second of Trusts § 183: “When there are two or
more beneficiaries of a trust, the trustee is under a duty to deal impartially
with them.” Comment a: This rule “is applicable whether the
beneficiaries’ interests in the trust property are concurrent or successive.”
vii. See also: Restatement Second of Trusts § 232: “If a trust is created for
beneficiaries in succession, the trustee is under a duty to the successive
beneficiaries to act with due regard to their respective interests.”
Comment b: This rule is applicable to all of a trustee’s duties and thus is
important: (1) in making or continuing investments; (2) in the general
management of the trust estate (such as in decisions about the making of
repairs and replacements); (3) in the allocation of receipts and
expenditures between principal and income accounts; and (4) in decisions
concerning the making of discretionary distributions to beneficiaries.”
viii. See also: Restatement Second of Trusts § 232, comment c: “If by the terms
of a trust the trustee is directed to pay the income to a beneficiary during a
designated period and on the expiration of the period to pay the principal
to other beneficiaries, the trustee is under a duty to the income beneficiary
to exercise care not merely to preserve the trust property but to make it
productive of trust income so that a reasonable amount of income will be
available for that beneficiary. The trustee is also under a duty to the
remainder beneficiaries to exercise reasonable care in an effort to preserve
the trust property, and this duty ordinarily includes a goal of protecting the
property’s purchasing power.
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The precise meaning of the trustee’s duty of impartiality and the balancing
of competing interests and objectives inevitably are matters of judgment
and interpretation. Thus, the duty and balancing are affected by the
purposes, terms, distribution requirements, and other circumstances of the
trust, not only at the outset but as they may change from time to time. For
example, the trust’s risk tolerance and expected duration are factors to be
considered, as are distribution requirements and the time horizons these
factors may impose on the trust’s investment strategy.
In short, trustees have a duty of impartiality with respect to the diverse
beneficial interests they serve. Thus, a trustee has a duty to seek to
balance the income and principal elements of total investment return. This
balance is to be achieved in a manner that is fair to all beneficiaries as a
reflection of the trust’s purposes, terms, and obligations and in light of the
circumstances of the trust and the relevant circumstances of its
beneficiaries.”
ix. See also: Restatement Third of Trusts § 227, comment i concerning the
duty of impartiality with respect to income productivity of a trust:
1. “The typical private trust provides for successive enjoyment by
different beneficiaries. The trustee of such a trust has a duty of
fairness to all of the beneficiaries and of impartiality among them.
The obligation to act impartially applies not only between life and
remainder beneficiaries but also among concurrent beneficiaries.
Concurrent life beneficiaries may appear to be similarly affected
by investment decisions but are likely to differ, for example, in
their tax positions and in their needs or desires for income as
against growth of principal. These problems may be eased by
trust arrangements that provide separate trusts or shares for
sibling life beneficiaries, but even then multiple potential
remainder beneficiaries are unlikely to have objectives that are
identical either among themselves or to those of a life beneficiary.
The requirement of impartiality in these varied contexts, usually
complicated by vagueness of settlor intentions, has important
investment implications. These appear primarily in the form of
issues involving the “productivity” of trust investments, here
meaning productivity of trust accounting income. Most pointed
and common is the competition between the interests of
beneficiaries entitled to income and of those who may later be
entitled to the principal.
The fact that an income beneficiary may also receive principal in
the trustee’s discretion reduces but does not eliminate the
productivity problem, much as it diminishes but does not remove
8
the related income-and-principal accounting questions. Similarly,
if the life beneficiary’s rights are discretionary but payable only
from income, the significance of the possible underproductivity or
overproductivity of investment properties is lessened but not
eliminated.
Wholly discretionary interests, with or without standards (such as
“support”) for the trustee’s guidance, involve distributive interests
that do not distinguish between income and principal sources, and
therefore allow the trustee virtually to disregard income
productivity in managing investments.
The nature and significance of these productivity concerns vary
with the trust’s circumstances and terms. Usually, however, much
is left to interpretation and inference. If a beneficiary is entitled
to all of the net income of the trust, it is clear that the trustee has a
duty to make the trust estate reasonably productive. But this does
not make the character and extent of that duty clear. Thus, for
example, the extent to which the needs, or any particular needs, of
a life income beneficiary are relevant to the productivity
objectives of a trustee’s investment program is a question of
interpretation.
To whatever extent a requirement of income productivity exists,
placing the trustee under a duty not to pursue an investment
strategy unduly favorable to one beneficiary or group of
beneficiaries at the expense of others, the requirement applies not
investment by investment but to the portfolio as a whole.
It is the trust estate, not any particular asset, that must not be
underproductive. Nor does it matter that particular assets are
overproductive of income, as long as the remainder interests are
reasonably protected by a balanced trust portfolio that is not
overly productive overall. For example, wasting assets are
overproductive in isolation, and even corporate or municipal
bonds may be so viewed because of inflation, but the presence of
such investments in a portfolio may be offset by the inclusion of
growth-oriented (low-yield) stocks in the trust estate. Particular
trust purposes may justify even a portfolio that otherwise might be
considered, as a whole, to be overproductive or underproductive.
In short, only when beneficial rights do not turn on a distinction
between income and principal is the trustee allowed to focus on
total return without regard to the income component of that
return. In other trust situations there exists a fiduciary duty to
make the trust estate productive of trust accounting income. The
9
trustee then has a duty to consider two aspects of the productivity
question. First, what is an appropriate level or range of income
productivity for the particular trust? As noted above, this is a
matter for interpretation and fiduciary judgment. Second, how
should that productivity objective be incorporated into an overall
portfolio strategy? In resolving the latter question the trustee is
not governed by the productivity standard in the selection and
retention of each individual investment. The standard applies to
the portfolio as a whole.
“Overproductivity” problems involving depreciation, depletion, or
other forms of arguable waste are initially problems to be dealt
with through the applicable principal-and-income accounting
rules. The problems of fairness that remain become matters to be
addressed, if possible, through a balancing of the trust portfolio.
Thus, in such matters and also in the problem of underproductive
properties, the trustee is under a duty to dispose of or not to
acquire an overproductive or underproductive investment only
when an appropriate overall balance is not otherwise reasonably
and prudently achieved.”
g. Duty to Protect Trust Property
i. Code of Virginia § 55-548.09. Control and Protection of Trust Property.
“A trustee shall take reasonable steps to take control of and protect the
trust property.”
ii. This is a codification of common law. See: Halstead’s Ex’rs v. Ingram,
163 Va. 223 (1934): “It is well settled that it is the duty of a trustee to
preserve and protect the trust property for the benefit of the beneficiaries;
and it is the general rule that a trustee will be reimbursed from the trust
estate for all necessary and reasonable expenditures which he has made,
and all necessary and reasonable expenses incurred in carrying out the
directions of the instrument, and all reasonable expenses incurred in
protecting and preserving the trust property.”
iii. See also Restatement Second of Trusts § 175 comment f: “The duty of the
trustee is not only to take and keep control, but to take and keep exclusive
control.”
iv. See Comment to UTC § 809: The duty to safeguard trust property is an
aspect of the trustee’s duty of prudent administration.
h. Duty to Give Personal Attention to the Affairs of the Trust
i. Under common law, a trustee generally had a duty to perform all the
responsibilities of the trusteeship personally. However, as trust law has
10
developed, trustees have gained the right to delegate certain tasks to
others.
ii. Code of Virginia § 55-548.07. Delegation by trustee. “A trustee may
delegate duties and powers that a prudent trustee of comparable skills
could property delegate under the circumstances.” A trustee must exercise
reasonable care, skill and caution in selecting the agent, establishing the
scope of the delegation, and ensuring that the delegation is consistent with
the terms of the trust instrument.
iii. The delegating trustee must periodically review “the agent’s actions in
order to monitor the agent’s performance and compliance with the terms
of the delegation.” Code of Virginia § 55-548.07(A)(3).
iv. See also: Restatement Second of Trusts § 171: “A trustee has a duty
personally to perform the responsibilities of the trusteeship except as a
prudent person might delegate those responsibilities to others. In deciding
whether, to whom and in what manner to delegate fiduciary authority in
the administration of a trust, and thereafter in supervising agents, the
trustee is under a duty to the beneficiaries to exercise fiduciary discretion
and to act as a prudent person would act in similar circumstances.”
v. A trustee may not delegate all of his or her fiduciary duties to another,
unless specifically permitted to do so by the trust instrument. See
Restatement Second of Trusts § 171 comment e: “the trustee cannot
properly commit the entire administration of the trust to an agent, co-
trustee, or other person, unless permitted to do so by the terms of the trust.
This does not preclude extensive temporary delegation on a prudent basis
during a reasonable absence by the trustee or during the trustee’s inability
to perform the duties of the trusteeship. This delegation may be justified
when it would not be practical or in the interests of sound administration
to require appointment of a substitute trustee. Extensive temporary
delegation may be appropriate, for example, to enable the trustee to take
reasonable vacations, including overseas travel, or to cover the trustee’s
absence due to illness or the necessities of other employment that is not
inappropriate to the responsibilities and circumstances of the trusteeship.”
vi. “In considering whether and under what circumstances and conditions a
particular delegation of fiduciary authority is proper, the following
circumstances, among others, may be of importance to the trustee or to a
reviewing court: (1) the nature and degree of discretion involved; (2) the
amount of funds or the value and character of the property involved; (3)
efficiency, convenience, and cost considerations in light of the situs of the
property or activities involved; (4) the relationship of the act or activities
involved to the professional skills or facilities possessed by the trustee;
and (5) the fairness and appropriateness of the responsibilities in question
11
to the burdens and compensation of the trustee.” Restatement Second of
Trusts § 171 comment f.
vii. See also Scott on Trusts § 171: A trustee can be charged with abuse of the
trustee’s discretionary authority if the trustee fails to delegate when the
trustee does not have the ability to handle a significant trust function,
makes an imprudent decision to delegate, fails to exercise prudence in the
manner of degree of delegation, or fails to monitor the agent after
delegation.
viii. The consequences of an improper delegation can be severe. The trustee
would be breaching fiduciary duties and could be held liable for the acts
and omissions of the agent.
i. Duty to Furnish Information
i. Code of Virginia § 55-548.13. Duty to Inform and Report. “A trustee shall
keep the qualified beneficiaries of the trust reasonably informed about the
administration of the trust and of the material facts necessary for them to
protect their interests. Unless unreasonable under the circumstances, a
trustee shall promptly respond to a beneficiary’s request for information
related to the administration of the trust. A trustee who fails to furnish
information to a beneficiary or respond to a request for information
regarding the administration of the trust in a good faith belief that to do so
would be unreasonable under the circumstances or contrary to the
purposes of the settlor shall not be subject to removal or other sanctions
therefor.”
ii. Upon request of a beneficiary, a trustee must provide the beneficiaries
basic information about the trust. This information includes: the trust
instrument and other governing documents, the nature and amount of trust
property, the accounts of the trustee, and other relevant information.
iii. Even if no request is made for information, a trustee should keep the
beneficiaries reasonably informed of the trust matters, sufficient to allow
the beneficiaries to monitor their interests. Scott and Ascher on Trusts
§17.5.
iv. See Restatement Second of Trusts § 173: “The trustee is under a duty to
the beneficiary to give him upon his request at reasonable times complete
and accurate information as to the nature and amount of the trust property,
and to permit him or a person duly authorized by him to inspect the
subject matter of the trust and the accounts and vouchers and other
documents relating to the trust.”
v. See Restatement Second of Trusts § 173 comment c: “Although the terms
of the trust may regulate the amount of information which the trustee must
give and the frequency with which it must be given, the beneficiary is
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always entitled to such information as is reasonably necessary to enable
him to enforce his rights under the trust or to prevent or redress a breach
of trust.”
vi. See Fletcher v. Fletcher, 253 Va. 30 (1997), citing Restatement Second of
Trusts § 173 and noting the importance of disclosure to the beneficiaries:
“The information not disclosed may have a material bearing on the
administration of the Trust Agreement insofar as the beneficiary is
concerned. For example, without access to the Trust Agreement … the
beneficiary has no basis upon which he can intelligently scrutinize the
Trustees’ investment decisions made with respect to the assets…. The
beneficiary is unable to evaluate whether the Trustees are discharging their
duty to use reasonable care and skill to make the trust property productive.
Also, the beneficiary is entitled to review the trust documents in their
entirety in order to assure the Trustees are discharging their duty to deal
impartially with all the beneficiaries within the restrictions and conditions
imposed by the Trust Agreement.” [Internal citations omitted].
j. Duty of Efficient Spending
i. Code of Virginia § 55-548.05. Costs of Administration. In administering a
trust, a “trustee may incur only costs that are reasonable in relation to the
trust property, the purposes of the trust, and the skills of the trustee.”
ii. See also Restatement Second of Trusts § 188 comment a: “The trustee can
properly incur expenses which are necessary or appropriate for performing
his duties as trustee. Thus, he can properly incur expenses necessary or
appropriate to get in the trust property, or to preserve it, or make the trust
property productive, or to perform any other duties which he may have as
trustee. So also, he can properly incur expenses which are necessary or
appropriate for the performance of powers conferred upon him even
though he has no duty to exercise the powers.”
iii. See also Restatement Second of Trusts § 188 comment d: “The trustee can
properly incur expenses necessary in the management of the trust
property. Thus, a trustee who is directed to manage a farm can properly
incur expenses necessary for carrying on the farm, such as the purchase of
livestock, feed, fertilizer and farm implements. Similarly, where the
trustee is directed to carry on a mercantile business he can properly incur
expenses for purchasing merchandise, fixtures and delivery wagons and
for hire of clerks.”
iv. Primary areas of concern: trustees’ fees and attorneys’ fees.
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k. Duty to Keep Adequate Records
i. Code of Virginia § 55-548.10. Recordkeeping and identification of trust
property. Paragraph A provides that a “trustee shall keep adequate records
of the administration of the trust.”
ii. What recordkeeping is adequate?
1. In the Maryland case of Green v. Lombard (Md. Ct. Spec. App.
1975), the court held that the trustee failed to meet this duty
where the trustee kept “sloppy, incomplete and inaccurate”
records. The court described the duty as a duty to keep “accurate,
precise, complete, and regular” records.
2. This duty is related to the duty of prudent administration and the
prudent person standard likely applies.
iii. Paragraph B of Code of Virginia § 55-548.10 requires the trustee to “keep
trust property separate from the trustee’s own property.” The duty to
segregate trust property stems from the common law and is unchanged by
the VUTC.
iv. See also Restatement Second of Trusts § 179: “The trustee is under a duty
to the beneficiary to keep the trust property separate from his individual
property, and, so far as it is reasonable that he should do so, to keep it
separate from other property not subject to the trust, and to see that the
property is designated as property of the trust.”
l. Duty to Enforce and Defend Claims
i. Code of Virginia § 55-548.11. Enforcement and Defense of Claims. “A
trustee shall take reasonable steps to enforce claims of the trust and to
defend claims against the trust.”
ii. When a trustee is aware of a claim to which the trust is entitled must
engage in a reasonable process to enforce the claim. The trustee need not
pursue the claim if it would be a waste of trust assets to do so. But, the
trustee, taking into consideration the likelihood of recovery, must
determine whether pursuit of the claim is appropriate under the
circumstances.
iii. A trustee must take reasonable steps to defend against a claim against the
trust.
m. Duties Concerning Co-Trustees
i. Duty to Act. Code of Virginia § 55-547.03. Cotrustees. Paragraph C
states that when more than one trustee is then serving, each co-trustee
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“shall participate in the performance of a trustee’s function unless the
cotrustee is unavailable to perform the function because of absence,
illness, disqualification under other law, or other temporary incapacity, or
the cotrustee has properly delegated the performance of the function to
another trustee.”
ii. Duty to Prevent and Redress Breach of Trust. Code of Virginia § 55-
547.03. Cotrustees. Paragraph G provides that each trustee must exercise
reasonable care to “[p]revent a cotrustee from committing a serious breach
of trust and [c]ompel a cotrustee to redress a serious breach of trust.”
n. Duties of Former Trustees
i. A trustee retains fiduciary duties until a successor trustee takes office.
ii. Code of Virginia § 55-547.03. Delivery of property by former trustee.
Under paragraph A, “until the trust property is delivered to a successor
trustee or other person entitled to it, a trustee who has resigned or been
removed has the duties of a trustee and the powers necessary to protect the
trust property.”
iii. This rule does not apply when a co-trustee remains in office.
o. Prudent Investor Act
i. Uniform Prudent Investor Act
1. The Uniform Prudent Investor Act has been adopted in 43 states
and an additional state has adopted a substantially similar version.
Those states that have not adopted the Act include Delaware,
Florida, Georgia, Louisiana, New York, Kentucky, Illinois, and
South Dakota – although most of these states have statutory
provisions addressing trustee delegation.
2. The Prefatory Note to the UPIA state that the objectives of the act
are:
a. to apply the “standard of prudence” in investing to the
entire trust portfolio rather than individual assets;
b. to introduce the concept of risk and return as the central
concern of the fiduciary;
c. to eliminate categorical restrictions on investments and to
encourage the trustee to invest in any asset with the
appropriate risk/return profile;
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d. to integrate the “duty to diversify investments” into the
concept of prudent investing by trustees; and
e. to reverse the long-held rule forbidding the trustee from
delegating investment and management functions.1
3. Virginia Prudent Investor Act - Code of Virginia § 26-45.3, et seq.
ii. Waiver of the “prudent investor” rule
1. Although the “prudent investor” rule has evolved to adopt more a
modern understanding of investment theory and techniques, the
rule still places liability on the trustee for managing the
investment of trust assets and maintaining sufficient
diversification. Virginia courts have explained that the rule,
under the Virginia Prudent Investor Act, “may be expanded,
restricted, eliminated, or otherwise altered by the provisions of a
trust.” at the creation of the trust by the settlor. W.A.K. v.
Wachovia Bank, N.A., 712 F. Supp. 2d 476, 481 (E. D. Va. 2010).
In doing so, the trust agreement can allow for the trustee to hold
assets and positions that may otherwise violate the rule.
2. Including this language does not absolve the trustee of all of his or
her duties. It does permit investment in assets that may otherwise
be prohibited.
Sample Language: I may contribute assets to this trust that would
not meet the standard in Virginia as suitable investments to be
held by my Trustee. My Trustee may retain such assets for as
long as my Trustee may deem appropriate even if such assets
represent an overconcentration or do not meet the “prudent
investor” rule. My Trustee may continue the operation and
participate in the management of such assets without liability for
any decisions or actions made in good faith.
III. Fiduciary Powers Under the Virginia Uniform Trust Code (VUTC)
a. General Powers
i. Code of Virginia § 55-548.15. General powers of trustee. A trustee,
without authorization from the court, and except as limited by the terms of
the trust instrument, may exercise “[a]ll powers over the trust property that
an unmarried competent owner has over individually owned property,
[a]ny other powers appropriate to achieve the proper investment,
management, and distribution of the trust property, and [a]ny other powers
conferred” by the VUTC.
1 Uniform Prudent Investor Act, Prefatory Note.
16
ii. The official comment of the Uniform Trust Code states that “[t]his section
is intended to grant trustees the broadest possible powers, but to be
exercised always in accordance with the duties of the trustee and any
limitations stated in the terms of the trust.”
b. Specific Powers
i. Code of Virginia § 55-548.16. Specific powers of trustee. In addition to
granting trustees broad authority to act on behalf of a trust, the VUTC
adds a list of specific powers granted to a trustee. Each of these specific
powers may be eliminated or amended by the terms of the trust
instrument.
ii. The specific powers listed in the statute are as follows.
1. Collect trust property and accept or reject additions to the trust
property from a settlor or any other person;
2. Acquire or sell property, for cash or on credit, at public or private
sale;
3. Exchange, partition, or otherwise change the character of trust
property;
4. Deposit trust money in an account in a regulated financial-service
institution;
5. Borrow money, with or without security, and mortgage or pledge
trust property for a period within or extending beyond the
duration of the trust;
6. With respect to an interest in a proprietorship, partnership, limited
liability company, business trust, corporation, or other form of
business or enterprise, continue the business or other enterprise
and take any action that may be taken by shareholders, members,
or property owners, including merging, dissolving, or otherwise
changing the form of business organization or contributing
additional capital;
7. With respect to stocks or other securities, exercise the rights of an
absolute owner, including the right to:
a. Vote, or give proxies to vote, with or without power of
substitution, or enter into or continue a voting trust
agreement;
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b. Hold a security in the name of a nominee or in other form
without disclosure of the trust so that title may pass by
delivery;
c. Pay calls, assessments, and other sums chargeable or
accruing against the securities, and sell or exercise stock
subscription or conversion rights; and
d. Deposit the securities with a depository or other regulated
financial service institution;
8. With respect to an interest in real property, construct, or make
ordinary or extraordinary repairs to, alterations to, or
improvements in, buildings or other structures, demolish
improvements, raze existing or erect new party walls or buildings,
subdivide or develop land, dedicate land to public use or grant
public or private easements, and make or vacate plats and adjust
boundaries;
9. Enter into a lease for any purpose as lessor or lessee, including a
lease or other arrangement for exploration and removal of natural
resources, with or without the option to purchase or renew, for a
period within or extending beyond the duration of the trust;
10. Grant an option involving a sale, lease, or other disposition of
trust property or acquire an option for the acquisition of property,
including an option exercisable beyond the duration of the trust,
and exercise an option so acquired;
11. Insure the property of the trust against damage or loss and insure
the trustee, the trustee’s agents, and beneficiaries against liability
arising from the administration of the trust;
12. Abandon or decline to administer property of no value or of
insufficient value to justify its collection or continued
administration;
13. With respect to possible liability for violation of environmental
law:
a. Inspect or investigate property the trustee holds or has been
asked to hold, or property owned or operated by an
organization in which the trustee holds or has been asked to
hold an interest, for the purpose of determining the
application of environmental law with respect to the
property;
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b. Take action to prevent, abate, or otherwise remedy any
actual or potential violation of any environmental law
affecting property held directly or indirectly by the trustee,
whether taken before or after the assertion of a claim or the
initiation of governmental enforcement;
c. Decline to accept property into trust or disclaim any power
with respect to property that is or may be burdened with
liability for violation of environmental law;
d. Compromise claims against the trust that may be asserted
for an alleged violation of environmental law; and
e. Pay the expense of any inspection, review, abatement, or
remedial action to comply with environmental law;
14. Pay or contest any claim, settle a claim by or against the trust, and
release, in whole or in part, a claim belonging to the trust;
15. Pay taxes, assessments, compensation of the trustee and of
employees and agents of the trust, and other expenses incurred in
the administration of the trust;
16. Exercise elections with respect to federal, state, and local taxes;
17. Select a mode of payment under any employee benefit or
retirement plan, annuity, or life insurance payable to the trustee,
exercise rights thereunder, including exercise of the right to
indemnification for expenses and against liabilities, and take
appropriate action to collect the proceeds;
18. Make loans out of trust property, including loans to a beneficiary
on terms and conditions the trustee considers to be fair and
reasonable under the circumstances, and the trustee has a lien on
future distributions for repayment of those loans;
19. Pledge trust property to guarantee loans made by others to the
beneficiary;
20. Appoint a trustee to act in another jurisdiction with respect to trust
property located in the other jurisdiction, confer upon the
appointed trustee all of the powers and duties of the appointing
trustee, require that the appointed trustee furnish security, and
remove any trustee so appointed;
21. Pay an amount distributable to a beneficiary who is under a legal
disability or who the trustee reasonably believes is incapacitated,
19
by paying it directly to the beneficiary or applying it for the
beneficiary’s benefit, or by:
a. Paying it to the beneficiary’s conservator or, if the
beneficiary does not have a conservator, the beneficiary’s
guardian;
b. Paying it to the beneficiary’s custodian under the Uniform
Transfers to Minors Act or custodial trustee under the
Uniform Custodial Trust Act, and, for that purpose,
creating a custodianship or custodial trust;
c. If the trustee does not know of a conservator, guardian,
custodian, or custodial trustee, paying it to an adult relative
or other person having legal or physical care or custody of
the beneficiary, to be expended on the beneficiary’s behalf;
or
d. Managing it as a separate fund on the beneficiary’s behalf,
subject to the beneficiary’s continuing right to withdraw the
distribution;
22. On distribution of trust property or the division or termination of a
trust, make distributions in divided or undivided interests, allocate
particular assets in proportionate or disproportionate shares, value
the trust property for those purposes, and adjust for resulting
differences in valuation;
23. Resolve a dispute concerning the interpretation of the trust or its
administration by mediation, arbitration, or other procedure for
alternative dispute resolution;
24. Prosecute or defend an action, claim, or judicial proceeding in any
jurisdiction to protect trust property and the trustee in the
performance of the trustee’s duties;
25. Sign and deliver contracts and other instruments that are useful to
achieve or facilitate the exercise of the trustee’s powers; and
26. On termination of the trust, exercise the powers appropriate to
wind up the administration of the trust and distribute the trust
property to the persons entitled to it.
c. Decanting Power
i. On April 4, 2012, Virginia Governor Robert McDonnell signed into law
Senate Bill 110, which permits a trustee to exercise a discretionary
distribution power by appointing the trust principal or income to the
20
trustee of a second trust. Virginia has now joined at least fourteen other
states with so-called “decanting” statutes that recognize this power in
trustees. Virginia’s statute, Code of Virginia § 55-548.16:1, became
effective on July 1, 2012, and, unless expressly prohibited by the terms of
the trust instrument, will be available to any trust administered under
Virginia law.
ii. A decanting power allows a trustee, generally without the approval of a
court or the beneficiaries, to appoint the income or principal, or both, of a
trust to a second trust that may have different terms. For example, a
trustee could use this power to appoint the assets of an older trust to a new
trust with modern administrative provisions. Other examples of common
uses of a decanting power include adding a trust advisor or trust protector,
changing the trust situs, or changing the trustee or trustee succession
provisions.
iii. Code of Virginia § 55-548.16:1 limits the trustee’s decanting power by
requiring that the beneficiaries of the second trust include only
beneficiaries of the original trust and prohibiting the addition of
beneficiaries. Also, where the trustee’s power to distribute income and
principal is subject to an ascertainable standard, the distributions from the
second trust must be limited by the same ascertainable standard and such
distribution power must be exercisable in favor of the same current
beneficiaries, unless a court approves otherwise, with an exception being
made for distributions to a special needs trust. The second trust may not
accelerate the interest of a beneficiary who has only a future interest in the
original trust. The statute also includes several tax savings provisions
addressing the application of the rule against perpetuities and preserving
marital and charitable deductions.
iv. In order to exercise the decanting power, a trustee must give sixty days’
written notice of the trustee’s intention to exercise the power to the grantor
of the original trust, to the original trust’s qualified beneficiaries as
defined in the VUTC, and to any person serving as an advisor or protector
of the original trust.
v. Virginia trustees who do not use this new power are protected by statutory
language providing that there is no duty to exercise the power and no
inference of impropriety where the power is not exercised.
d. Grantor Trust Powers
i. A grantor trust is a trust as to all of which the grantor is treated as the
owner under § 671.
1. Grantor trusts are beneficial for a variety of estate and tax
planning techniques.
21
2. Bottom line: For income tax purposes, a grantor trust is disre-
garded. There can be no transactions between a grantor and the
trust. The trust is simply a pocket of the grantor.
ii. Warning – proceed with extreme caution
1. The details of when and how to use grantor trusts in estate
planning contexts are beyond the scope of these materials, but
grantor trust status may have profound tax effects on a trust in
both the income tax and estate tax arenas.
2. The grantor trust rules (§ 671 through § 677) are nuanced and
complicated and can lead to adverse consequences if not utilized
properly.
iii. Advantages of using a grantor trust.
1. No capital gain is realized on any sale. Rev. Rul. 85-13, 1985-1
C.B. 184.
2. Since there is no tax, there is no concern about the additional
interest under § 453A on certain deferred tax liability.
3. The trust may be a shareholder of an S corporation, under §
1361(c)(2)(A)(i).
4. The grantor, not the trust or the beneficiaries, will pay all the
income taxes on income attributable to the trust.
5. If a residence is held by a grantor trust, the grantor-beneficiary
will be treated as the owner of the residence and the exclusion
rules of § 121 will apply. Treas. Reg. § 1.121-1(c)(3)(i).
iv. Power of related or subordinate trustee to distribute trust assets without an
ascertainable standard. § 674.
1. A trust will be treated as a grantor trust if more than one-half of
the trustees are “related or subordinate parties who are subservient
to the wishes of the grantor” and are able to make distributions to
the beneficiaries that are not limited by an ascertainable standard.
a. Whether a trustee is a related or subordinate party is a
factual determination under § 674(c).
b. Grantor trust status is not triggered if the trustee, under §
674(c) is an independent trustee.
22
c. Grantor trust status is not triggered if the trust instrument
limits distributions of trust assets by an ascertainable
standard such as “health, education, support, and
maintenance.”
v. Power of an independent trustee to add beneficiaries and cause a
distribution to be made to them. § 674.
1. This is the feature most frequently used by those who are
concerned about the 2036 or 2038 implication of a § 675(4)(C)
substitution power.
2. The reason for specifying an “independent” trustee (or other
person) is to avoid an “adverse party,” whose consent would
prevent the power from rendering the trust a grantor trust. §
674(a). An “adverse party” is a person with a substantial
beneficial interest in the trust that would be adversely affected by
the exercise or nonexercise of the power. § 672(a). Nearly any
beneficiary’s interest would be adversely affected by the addition
of new beneficiaries and a distribution to them.
3. The reason for specifying the addition of beneficiaries is that it is
essential to fail to “qualify” for any of the exceptions in §§ 674(b)
and (c).
a. Section 674(c) does not apply when the grantor or the
grantor’s spouse is a trustee or when more than half of the
trustees are “related or subordinate parties who are
subservient to the wishes of the grantor.”
b. But it is awkward to rely on the identity of trustees for
grantor trust status, because trustees can die or become
incompetent (while corporate trustees are generally not
related or subordinate or subservient) or can simply resign.
It can also artificially limit the recruitment of capable
trustees.
4. On the other hand, the flush language in § 674(c) provides that the
exceptions in that subsection do not apply when someone has the
power to add to the beneficiaries or to a class of beneficiaries
designated to receive income or corpus, other than to provide for
after-born or after-adopted children.
5. The reason for specifying that the power to add beneficiaries
include the power to cause a distribution to be made to them is
that § 674(a) is triggered only by a “power of disposition.” If an
independent trustee has the power to add beneficiaries to a
discretionary trust, but the consent of a co-trustee, who might be
23
an adverse party, is required to actually make a distribution, the
power might not go far enough to ensure grantor trust status. It is
important not only to fail to qualify for the exceptions in §§
674(b) and 674(c), which often get most of the attention, but also
to trigger the general rule of section 674(a) itself.
6. The beneficiaries that might appropriately be added by an
independent trustee or other independent person in “violation” of
§ 674(c) are spouses (or companions) of descendants, their
ancestors or siblings (i.e., a descendant’s in-laws), their siblings’
descendants (i.e., a descendant’s “nieces” and “nephews” by
marriage), their descendants (i.e., a descendant’s stepchildren),
and charitable organizations.
a. In the case of a power to add spouses or in-laws, such a
power can permit the trustee to avoid the hardship that
might otherwise result when a descendant who is dependent
largely on the trust for support dies, perhaps at a relatively
young age, leaving a spouse without support. This result is
aggravated when there are no descendants who could
otherwise become successive beneficiaries. In the case of a
power to add charities, such a power can have significance,
when, for example, it is contemplated that the trustee will
shift the beneficial interest away from a descendant or other
beneficiary who engages in some conduct that the grantor
presumably would want to discourage.
b. In drafting any standards for adding beneficiaries, though,
care must be taken to avoid simply designating the class in
the instrument and, in effect, taking away the trustee’s
discretion to “add” beneficiaries that is relied on under §
674. In addition, the power to “add” beneficiaries might
create too many “potential current beneficiaries” under §
1361(c)(2)(B)(v) and thereby prevent the trust from
electing to be an electing small business trust (“ESBT”), if
necessary, after the grantor’s death. Cf. section 1361(e)(2),
as amended by the American Jobs Creation Act of 2004
and Gulf Opportunity Zone Act of 2005, under which
powers of appointment are ignored in counting the
“potential current beneficiaries” of an ESBT.
c. Under section 674(a) itself, however, it is not enough that a
person merely have the power to add beneficiaries to a
discretionary trust. That person must also have the power,
without the approval or consent of an adverse party, to
direct a distribution to such added beneficiaries.
24
d. Care is needed in drafting “takers in default” clauses to
dispose of the trust property if there ever are no living
descendants. A clause giving the trustee the power to
distribute the trust property at that time to charities of the
trustee’s choice might be construed as making all potential
charitable distributees contingent beneficiaries of the trust
already, thereby making the power to “add” charitable
beneficiaries meaningless. This problem might be avoided
by making the power to add beneficiaries clearly applicable
during the life of the trust, not just at termination. A better
approach might be to limit the charities specified in the
takers in default clause to certain purposes (which could be
very broadly expressed, so long as some charities are left
out), and giving the trustee the power to add any charity.
7. The power to add charitable beneficiaries was acknowledged to
render a trust a grantor trust in Madorin v. Commissioner, 84 T.C.
667 (1985) (holding that the trustee’s renunciation of that power
was a deemed disposition of trust assets and a realizing event).
The Service has followed Madorin. See, e.g., Letter Rulings
9710006 (Nov. 8, 1996), 9709001 (Nov. 8, 1996), and 9304017
(Oct. 30, 1992).
8. Because §§ 674(a) and 674(c) explicitly refer to both income and
corpus, they leave no doubt that under those provisions a grantor
would be treated as the owner of the entire trust.
vi. Toggling of Grantor Trust Status
1. The easiest type of toggle is to provide that the power that makes
the trust a grantor trust terminates at the grantor’s death, if
desired. Grantor trust status is no longer relevant, and there seem
to be no tax issues with such a provision.
2. Enabling the trustee to renounce or terminate a grantor trust
power may be desirable to permit reaction to unknown financial
or personal circumstances or changes in trust or tax law.
3. It helps if there is specific authority for the relinquishment of the
power – either in the instrument or in applicable trust law. See,
e.g., Code of Virginia § 64.1-57(3) (authorizing a trustee’s
“disclaimer” of certain administrative powers). But such
authority, especially in local law, might not necessarily extend to
the powers (typically powers of distribution) that are relied on for
grantor trust status.
25
4. One must face the dilemma that a trustee ordinarily would have
no reason consistent with fiduciary duty to voluntarily relinquish
powers that might be exercised in the future in the best interests of
the trust beneficiaries. This is particularly true when an obvious
result of such relinquishment would be to subject the trust or its
beneficiaries to an income tax that they otherwise would avoid.
Broad discretion in the trust instrument might not be sufficient to
authorize the trustee to relinquish a power when there is no reason
to do so. Mere accommodation of the grantor does not appear to
ever be a proper reason.
5. One solution may be to provide that the trustee acquires a
desirable power by relinquishing the power that makes the trust a
grantor trust. For example—
a. A trust instrument with an independent trustee might
provide that during the grantor’s life the trustee, in general,
does not have the power to vary the shares of the grantor’s
children (or other living descendants), perhaps on the
theory that the grantor, who knows those beneficiaries, has
adequately determined their shares and that the grantor,
while alive, is able personally to make any necessary
adjustments by other inter vivos arrangements. To allow a
response to subsequent changes (for example, in a
beneficiary’s lifestyle), the trust instrument might give the
trustee the power to divert any beneficiary’s share to
charity (but not to siblings or other family members),
thereby rendering the trust a grantor trust by failing to
qualify for the section 674(c) exception. In that way, while
the grantor is alive, the trustee will escape possible
badgering by family members to increase their shares.
b. The trust instrument could also provide that during the
grantor’s life the trustee could acquire the power to vary the
shares of family members, but only if the trustee
irrevocably relinquishes the power to add charitable
beneficiaries during the grantor’s life. In that way, while
the trustee would then be exposed to possible badgering by
family members, at least the family members would have
the assurance that the entire pot available to them would
not be depleted by a diversion to charity.
c. A variation, not so dependent on the provision of
mandatory distributions, would be to simply allow an
independent trustee, by relinquishing the power to add
charitable beneficiaries, to expand the standard of
distributions to family members from an “ascertainable”
26
standard to a broader standard including such objectives as
“welfare” or “happiness” (such standards to be discussed in
detail in Part Two below). To make such a relinquishment
“real,” it might be desirable for such a distribution to
actually be contemplated and actually be made.
vii. Fiduciary Duties and Grantor Trusts
1. Trustees are frequently granted authority to take certain actions
that would affect or alter the grantor status of the trust. Before
taking these actions, the trustee should consider his or her
fiduciary duties to the beneficiaries.
a. Duty of Loyalty
i. Income tax benefits for the beneficiaries.
b. Duty of Impartiality
i. Tax benefits for certain beneficiaries but not others.
e. Power of Amendment
i. Frequently, a settlor desires to provide flexibility in the trust instrument by
allowing for the amendment of the trust. In the case of irrevocable trusts,
where the settlor cannot himself amend the trust instrument, the settlor
may authorize the trustee to exercise this authority.
ii. A trustee exercising the power to amend a trust instrument acts in his
fiduciary capacity and is subject to all of the fiduciary duties described
above. So, a trustee must act prudently when exercise his power to amend
a trust.
iii. Sample Language: Subject to the restriction on fiduciary powers provided
in this agreement, my corporate trustee, if any, shall have the power,
acting alone, to amend this agreement in any manner required to facilitate
the accomplishment of the trust objectives, but any such amendments shall
not increase the class of beneficiaries or make me a beneficiary. Any such
amendments may be made by a written instrument signed by my corporate
trustee and delivered to the other trustee or trustees then serving under
this agreement.
f. Power to Delegate Investment Authority
i. Role of Delegation of Investment Authority
1. At common law, a trustee was charged with the personal duty to
perform all aspects of handling a trust and the trustee was
27
forbidden from delegating the trustee’s duties and
responsibilities.2 As a trustee’s duties and responsibilities became
more complex and varied, the law developed where a trustee has
the personal duty to perform the trustee’s responsibilities, except
as a prudent person would delegate those responsibilities to
others.
2. See Scott on Trusts § 171: Under the law of most states, a trustee
is under a duty to exercise fiduciary discretion and to act as a
prudent person would act in similar circumstances in determining
when and to whom to delegate fiduciary authority in the
administration of a trust. In addition, the trustee has a continuing
duty to supervise the agent to whom the trustee delegated the
trustee’s duty.
a. A trustee should consider the following factors in
determining whether and under what circumstances and
conditions the trustee should delegate the trustee’s
authority:
i. The terms of the governing instrument of the trust,
ii. The matter being delegated,
iii. The size of the trust,
iv. The nature of the trust assets,
v. The amount of discretion granted the trustee,
vi. The skill and expertise of the trustee regarding the
activity being delegated, and
vii. The economics of the delegation.
b. A trustee needs to exercise care and caution in the selection
of agents and establishing the terms of any delegation.
Some of the significant terms of a delegation include the
compensation of the agent (and the compensation of the
trustee following the delegation), the duration of the
delegation, the conditions of the delegation, and the
mechanism for supervising the agent.
3. The common law does not have clear rules on when and how a
trustee can safely delegate trustee duties and responsibility.
Because of the lack of clear rules in delegating investment
2 Uniform Prudent Investor Act, Section 9, comments.
28
responsibility, the National Conference of Commissioners of
Uniform State Laws prepared the Uniform Prudent Investor Act
which, in part, addresses the issue of trustee delegation. Those
trustees serving under instruments governed by jurisdictions that
have adopted the Uniform Prudent Investor Act benefit from
clearer rules governing the delegation of investment
responsibility.
ii. Delegation under the Uniform Prudent Investor Act
1. The Uniform Prudent Investor Act was approved by the National
Conference of Commissioners of Uniform State Laws in 1994.
Among the purposes of the Act was to reverse the rule of trust law
forbidding the trustee to delegate investment and management
functions.3 Section 9 of the Uniform Prudent Investor Act allows
a trustee to delegate investment and management functions
subject to certain safeguards. The Act’s allowance of trustee
delegation was a continuation of the trend in trust law and
followed the Prudent Investor Rule in the Restatement Third of
Trusts4 and the delegation rule under Employee Retirement
Income Security Act of 1974 (referred to as “ERISA”).5
2. Section 9 of the Uniform Prudent Investor Act reads in its entirety
as follows:
“A trustee may delegate investment and management functions
that a prudent trustee of comparable skills could properly delegate
under the circumstances. The trustee shall exercise reasonable
care, skill, and caution in:
a. selecting an agent,
b. establishing the scope and terms of the delegation,
consistent with the purposes and terms of the trust, and
c. periodically reviewing the agent’s actions in order to
monitor the agent’s performance and compliance with the
terms of the delegation.
d. In performing a delegated function, an agent owes a duty to
the trust to exercise reasonable care to comply with the
terms of the delegation.
3 Uniform Prudent Investor Act, Section 9, comments. 4 Restatement of Trusts 3rd, Prudent Investor Rule, Section 171 (1992). 5 ERISA Section 403(a)(2), 29 U.S.C. Section 1103(a)(2).
29
e. A trustee who complies with the requirements of subsection
(a) is not liable to the beneficiaries or to the trust for the
decisions or actions of the agent to whom the function was
delegated.
f. By accepting the delegation of a trust function from the
trustee of a trust that is subject to the law of this state, an
agent submits to the jurisdiction of the courts of this State.”
3. The Comments to the Uniform Prudent Investor Act state that the
trustee’s duties of care, skill, and caution in framing the terms of
the delegation should protect the beneficiary against the trustee
making an overbroad delegation. For example, a trustee cannot
prudently agree to an investment management agreement
containing an exculpation clause that leaves the trust without
recourse against reckless mismanagement. According to the
Comments, leaving the beneficiaries without a remedy against
willful wrongdoing is inconsistent with the trustee’s duty to use
care and caution in formulating the terms of the delegation.
iii. Delegation under the Code of Virginia
1. Code of Virginia § 55-548.07. Delegation by trustee.
“A. A trustee may delegate duties and powers that a prudent
trustee of comparable skills could properly delegate under the
circumstances. The trustee shall exercise reasonable care, skill,
and caution in:
1. Selecting an agent;
2. Establishing the scope and terms of the delegation,
consistent with the purposes and terms of the trust; and
3. Periodically reviewing the agent’s actions in order to
monitor the agent’s performance and compliance with the terms
of the delegation.
B. In performing a delegated function, an agent owes a duty to the
trust to exercise reasonable care to comply with the terms of the
delegation.
C. A trustee who complies with subsection A is not liable to the
beneficiaries or to the trust for an action of the agent to whom the
function was delegated.
D. By accepting a delegation of powers or duties from the trustee
30
of a trust that is subject to the law of the Commonwealth, an agent
submits to the jurisdiction of the courts of the Commonwealth.”
2. A trustee in Virginia may properly delegate investment
management functions pursuant to Code of Virginia § 55-548.07.6
iv. Trustee’s Duties and Liabilities When Delegating Investment Authority
1. In delegating investment responsibility, a trustee has several
duties. If the trustee fails in any of these areas, the trustee may
face liability from the beneficiaries. A trustee who delegates
investment responsibility generally has greater exposure to
liability than a trustee who is directed as to investments. The first
duty is to review the governing instrument and state law to verify
that delegation is permitted. Assuming delegation is authorized
by the governing instrument and applicable law, a trustee has
these duties in delegating investment responsibility:
a. Determining whether the trustee should delegate all or a
portion of the investment responsibility,
b. Exercising reasonable care in the selection of the
investment manager,
c. Determining the scope and terms of the delegation, and
d. Reviewing and monitoring the delegation.
2. Although a trustee should not be a guarantor of success, a trustee
must be process-oriented and follow a process in carrying out the
trustee’s duties. The trustee should document the process
followed in each of the steps mentioned below.
3. After determining that investment delegation is authorized, the
trustee must determine whether the trustee should delegate all or a
portion of the investment responsibility. In making this decision,
a trustee should consider the following factors:
a. The skill and capabilities of the trustee (the greater the skill
and capabilities, the less reason for delegation),
b. The size of the trust (the larger the trust, the more reason a
trustee should delegate all or a portion of the investment
responsibility),
6 W.A.K. v. Wachovia Bank, N.A. at 486.
31
c. The costs of the delegation (the additional expense may
outweigh the potential benefits), and
d. The skill and expertise of the individual or entity to whom
the trustee is delegating the investment responsibility.
4. A delegating trustee must exercise reasonable care in the selection
of the investment manager. The first step should be the
development of a written investment policy. This will involve
determining the investment horizon (how long is the trust
expected to last), the projected distributions to be made on an
annual basis, the allocation of the trust assets, and the number of
managers to be used to accomplish the objectives. After
developing the investment policy, the trustee should conduct and
document a search process to select the appropriate investment
manager or managers. If the trustee is not a professional, the
trustee may want to use a consultant to assist in this process.
Special problems arise if the investment manager is affiliated with
the trustee. These problems are discussed later in this paper.
5. It is important that a delegating trustee determine the scope and
terms of the delegation. Otherwise, the trustee may not be
fulfilling the trustee’s fiduciary obligations. In delegating the
investment responsibilities, the trustee should have a written
agreement with the party to whom the delegation is made. If
possible, the beneficiaries should also acknowledge the
delegation. Among the matters to be covered in the written
instrument of delegation are the following.
a. The investment manager should acknowledge receiving a
copy of the governing instrument and the applicable
statutory law.
b. The investment manager should agree to accept the
delegation of the investment function of the trust pursuant
to applicable law, the governing instrument, and the
trustee’s investment policy.
c. The investment manager should agree to invest the trust
assets in accordance with the terms of the governing
instrument and applicable law.
d. The trustee and the investment manager should agree on
the investment objectives, the asset allocation, the
appropriate measuring benchmarks, and the reporting
requirements (including format and the recipients of the
reports).
32
e. The investment manager should agree to meet periodically
(in person or by teleconference) with the trustee and the
beneficiaries to review the investment objectives, asset
allocation, and investment performance.
f. The trustee should have the right to remove the investment
manager for any reason after appropriate notice to the
manager.
g. The trustee may want to ask for indemnification from the
investment manager for the manager’s acts outside the
scope of the delegation.
h. If there is a question concerning the propriety of the
delegation, the beneficiaries should direct the trustee to
enter into the delegation and agree to indemnify the trustee
for any losses incurred by reason of the delegation.
6. Under the Uniform Prudent Investor Act, a delegating trustee has
the duty to monitor the delegation. Thus, the trustee’s duties have
not ended after the trustee has delegated the investment function
to one or more investment managers. A delegating trustee should
review the manager’s actions in order to monitor the agent’s
performance and compliance with the terms of the delegation.
The trustee’s review should evaluate the performance of the
manager compared to the benchmarks mutually agreed upon at
the commencement of the delegation. The review should also
evaluate consistency of investment style and any turnover in
personnel. The review should be periodic and no less frequently
than annually (and quarterly is better).
7. Trustee Fees and Costs in Delegating Investment Authority
a. Fees are an important factor in overall investment
performance. Because the investment manager to whom
the investment responsibility is delegated will charge the
trust an additional fee, administrative costs generally will
increase when a trustee delegates the investment
responsibility to a third party manager. As a result of the
line of cases subjecting a trust’s investment management
fees to the two percent limitation on itemized deductions,7
delegation to an investment manager who charges a fee
separate from the trustee will in all likelihood increase the
costs of delegating investment responsibility.
7 See: Knight v. Commissioner, 552 U.S. 181 (U.S. 2008).
33
b. Many institutional trustees will reduce the trustee’s
standard fees if the trustee is delegating the investment
responsibility to a third party. This reduction is appropriate
because the trustee will have fewer duties and less
responsibility (assuming an otherwise proper delegation)
than if the trustee were handling all aspects of the trust.
v. Drafting to Delegate Investment Authority
1. If a client desires to allow the trustee to delegate investment
authority to a third party investment manager, it is important that
the governing instrument contain certain provisions. The
provisions that the drafter should consider inserting in the trust
instrument are the power to delegate, the permissible scope of the
delegation, and the trustee’s responsibility for the actions of the
third party manager. If the investment manager to whom the
trustee will be delegating the investment authority is an affiliate of
the trustee, it will be necessary to add additional language
covering the self-dealing aspects of using an affiliate.
2. Section 9 (c) of the Uniform Prudent Investor Act provides that a
trustee who complies with the delegation procedure described in
Section 9 (a) is not “liable to the beneficiaries or to the trust for
the decisions or actions of the agent to whom the function was
delegated.” Thus, the trustee should not have any liability if the
trustee has properly carried out the trustee’s duties in exercising
“reasonable care, skill, and caution” in selecting the manager,
establishing the scope of the delegation, and monitoring the
manager’s actions.
3. One who agrees to serve as trustee may wish to engage a
professional investment advisor for recommendations regarding
trust investments, and a trust should specifically permit this. This
does not relive the trustee of the liability for exercising reasonable
care and diligence in selecting the advisor and carrying out the
investment activity of the trust. It does indicate the grantor’s
intent and understanding that the trustee may best serve the
beneficiaries by seeking additional advice regarding trust
investments.
Suggested language: My Trustee may employ a professional
investment advisor in managing the investments of any trust. My
Trustee may rely upon the investment recommendations of the
advisor without liability to any beneficiary.
A grantor should carefully consider requiring the trustee to
employ a specific investment advisor. Given the changing nature
34
of the financial services industry, the changing nature of the trust
assets and investment strategies, and the relationships between
trustee and beneficiaries, the trustee should have the ability to
employ the agents best suited to provide the needed investment
advice.
If any of the assets of the trust will be maintained in any funds or
accounts managed by the same entity that serves as investment
advisor, the trust agreement should provide language permitting
the investment in affiliated funds.
Suggested language: My Trustee may invest the trust assets in a
money market, other short-term fund or mutual fund whether or
not my corporate Trustee or its affiliates are the sponsor, advisor,
manager or custodian of, or provider of services to, such fund
vi. Process not Results
A trustee is not a guarantor of performance of an investment manager to
whom the trustee has delegated the investment responsibility. But, a
trustee must follow the proper process in delegating investment
performance as well as reviewing and monitoring the performance of the
manager.
g. Directed Trustee
i. Role of a Directed Trustee
1. Common law has traditionally recognized that the Trustee must
personally perform all aspects of trust administration. Over the
last century, the concept of the grantor specifically directing the
Trustee to follow the direction has gained traction.
2. Other areas of the law that utilize trusts have integrated the
concept of a directed trustee: both asset protection trusts and
ERISA trusts recognize the role trust advisors, who have the
specific authority and fiduciary duty to manage certain functions
normally reserve to the trustee.8
3. A trust director may direct a trustee in a variety of circumstances.
The most common instance for using a trust director is a trust
director for investments. A trust director may provide a settlor of
a trust an avenue for maintaining a specific investment strategy
8 For a discussion of the role of directed trustees in ERISA and asset protection trusts, see Slicing and Dicing
Responsibilities and Duties of Trustees, Dennis I. Belcher (43rd annual Philip E. Heckerling Institute on Estate
Planning, January 2009).
35
when a trustee’s fiduciary duties might otherwise compel the
trustee to diversify the trust investments.
4. An investment director/directed trustee relationship may be
useful:
a. In the case of a family business held in trust, where a
corporate trustee will manage distributions and
administrative matters and a trusted advisor or family
member will take responsibility for investments.
b. In the case of a trusted advisor or family member serving as
trustee who lacks experience in making investment
decisions.
c. In the case of a trust that holds a significant concentration
is a specialized asset that requires unique skill and
management, and where settlor or beneficiaries intend to
maintain the concentration to promote the creation of
wealth. This situation might include private
equity/alternative investments or concentrations of publicly
traded stocks.
ii. Code of Virginia § 55-548.08. Powers to direct.
“A. While a trust is revocable, the trustee may follow a direction of the
settlor that is contrary to the terms of the trust.
B. If the terms of a trust (i) confer upon a person other than the settlor of a
revocable trust power to direct certain actions of the trustee and (ii)
subsection E does not apply, the trustee shall act in accordance with an
exercise of the power unless the attempted exercise is manifestly contrary
to the terms of the trust or the trustee knows the attempted exercise would
constitute a serious breach of a fiduciary duty that the person holding the
power owes to the beneficiaries of the trust.
C. The terms of a trust may confer upon a trustee or other person a power
to direct the modification or termination of the trust.
D. A person, other than a beneficiary, who holds a power to direct is
presumptively a fiduciary who, as such, is required to act in good faith
with regard to the purposes of the trust and the interests of the
beneficiaries. The holder of a power to direct is liable for any loss that
results from breach of a fiduciary duty.
E. The provisions of this subsection shall apply if the settlor incorporates
this subsection into the trust instrument by specific reference. The
36
provisions of this subsection shall also apply if this subsection is
incorporated into the trust instrument by a nonjudicial settlement
agreement under § 55-541.11 by specific reference.
1. For the purpose of this subsection, a “trust director” means any person
who is not a trustee and who has, pursuant to the governing instrument, a
power to direct the trustee on any matter. No person shall be a “trust
director” for purposes of this subsection merely by holding a general or
limited power of appointment over the trust assets.
Notwithstanding anything in the trust instrument to the contrary, the trust
director shall be deemed a fiduciary who, as such, is (i) required to act in
good faith with regard to the purposes of the trust and the interests of the
beneficiaries and (ii) liable for any loss that results from a breach of a
fiduciary duty.
2. A trustee who acts in accordance with a direction in the governing
instrument that the trustee is to follow the trust director’s direction or act
only with the trust director’s consent or direction shall not, other than in
cases of willful misconduct or gross negligence on the part of the directed
trustee, be liable for any loss resulting directly or indirectly from any act
taken or not taken by the trustee (i) pursuant to the trust director’s
direction or (ii) as a result of the trust director’s failure to direct, consent,
or act, after receiving a request by the trustee for such direction, consent,
or action.
3. A trustee shall not, except as otherwise expressly provided in the trust
instrument, have any duty to (i) monitor the trust director’s conduct; (ii)
provide the trust director with information, other than material facts
related to the trust administration expressly requested in writing by the
trust director; (iii) inform or warn any beneficiary or third party that the
trustee disagrees with any of the trust director’s actions or directions; (iv)
notify the trust director that the trustee disagrees with any of the trust
director’s actions or directions; (v) do anything to prevent the trust
director from giving any direction or taking any action; or (vi) compel the
trust director to redress its action or direction.
4. The actions of the trustee pertaining to matters within the scope of the
authority of the trust director, including confirming that the trust director’s
directions have been carried out and recording and reporting actions taken
pursuant to the trust director’s direction, shall, absent clear and convincing
evidence to the contrary, presumptively be considered administrative
actions by the trustee and not be considered to constitute either monitoring
the trust director’s actions or participating in the actions of the trust
director.”
37
iii. Restatement Second of Trusts § 185
a. “If under the terms of the trust a person has power to
control the action of the trustee in certain respects, the
trustee is under a duty to act in accordance with the
exercise of the power, unless the attempted exercise of the
power violates the terms of the trust or is a violation of a
fiduciary duty to which such person is subject in the
exercise of the power.”
b. The Restatement distinguishes between powers held
personally and powers held in a fiduciary capacity. If the
power is held personally, the directed trustee must follow
the directions and the trustee’s only duty is to verify that
the exercise does not violate the terms of the trust. On the
other hand, if the power is held in a fiduciary capacity, the
directed trustee has a duty under the Restatement approach
to verify that the exercise of the power does not violate a
fiduciary duty that the power holder has to the beneficiaries
of the trust. The Restatement treats a power holder who
holds a power in a fiduciary capacity as a cofiduciary.
c. The Restatement should not give much comfort to a
directed trustee since the trustee will have to treat the
power holder as a cofiduciary. According to one
commentator, two states, Indiana and Iowa, have statutes
based on the Restatement approach. The Indiana statute
provides, in part: “If the person holds the power as a
fiduciary, the trustee has a duty to refuse to comply with
any direction which he knows or should know would
constitute a breach of a duty owed by that person as a
fiduciary.” Although the Iowa statute puts a duty on the
directed trustee to determine the capacity of the power
holder, the directed trustee does not appear to have a duty
to determine whether the exercise of the power violates a
fiduciary duty owed by the power holder to the
beneficiaries.
iv. Restatement Third of Trusts
1. The draft restatement recognizes the ability of a grantor to give a
third party the power to direct the actions of a trustee. Section 75
of the Restatement provides:
“Except in cases covered by section 74 (involving powers of
revocation and other ownership-equivalent powers), if the terms of
a trust reserve to the settler or confer upon another a power to
38
direct or otherwise control certain conduct of the trustee, the
trustee has a duty to act in accordance with the requirements of the
trust provision reserving or conferring the power and comply with
any exercise of that power, unless the attempted exercise is
contrary to the terms of the trust or power or the trustee knows or
has reason to believe that the attempted exercise violates a
fiduciary duty that the power holder owes to the beneficiaries.”
v. Directed Trustees Under Other Specific State Statutes
1. Although case law has allowed a grantor to provide that a third
party may direct the fiduciary actions of a trustee for some time,
statutory authority has been slow to be enacted in the United
States. Although according to one commentator the first directed
trustee statute in the United States was adopted by South Dakota
in 1997 followed by Idaho in 1999.9 Florida
10 and Georgia
11
enacted more than 50 years ago statutory protection for a trustee
serving under a trust instrument which grants a power of direction
to a third party.12
2. According to one knowledgeable commentator,13
state statutes
addressing directed trustees fall into one of three categories, those
states which follow the approach of § 185 of the Restatement
Second of Trusts, those states which follow the approach of
section 808 of the Uniform Trust Code, and those states which
have enacted more protective statutory protection for directed
trustees.14
3. Protective State Statutes
a. Some states have not followed either the approach of the
Restatement or the Uniform Trust Code, but have adopted
their own statutes which are more protective of directed
trustees. These states include Colorado, Delaware,
Georgia, Idaho, Indiana, New Hampshire, Ohio, Oklahoma,
South Dakota, Tennessee, and Wyoming.15
b. State statutes generally authorize a grantor to give a third
party the power to direct the actions of a trustee and give a
9 Bove, The Trust Protector: Trust(y) Watchdog or Expensive Exotic Pet?, 30 Estate Planning Journal Number 8,
August 2003. 10 Fla. Stat. Section 691.04(8) (1961). 11 Ga. Laws 1964, No. 732, at 258. 12 Note, Trust Advisers, 78 Harvard Law Review 1230, 1234 (1965). 13 Richard Nenno, Directed Trusts: Can Directed Trustees Limit Their Liability? Chapter RWN – 18, 2006 Notre
Dame Tax and Estate Planning Institute. 14 Nenno, page RWN – 18-5. 15 Nenno, RWN-18-5.
39
trustee protection from liability for following the directions
of a third party authorized to give directions by the grantor.
State statutes vary in the duties and types of protection
given a trustee for relying on the direction of a trust
advisor. An example of a protective statute is Delaware.
Delaware specifically covers trust advisors and provides
that a trustee is liable only for “willful misconduct.” 16
Delaware’s statute is discussed in more detail later in this
paper.
vi. Trustees Duties When Directed
1. The duty of a directed trustee to supervise or monitor the actions
of the trust director is important because it determines, in part, the
liability of the trustee for the trust director’s actions. In
determining a directed trustee’s duties, the trustee must review the
trust instrument and applicable state law. In reviewing the trust
instrument, the trustee should pay particular attention to:
a. The characterization of the role of the trust advisor
(whether the power is held in a fiduciary capacity or
personally),
b. The terms of the grant of authority to the trust director,
c. The duty of the trustee to supervise and monitor the
directions given the trustee by the trust director,
d. The procedure, if any, for the directed trustee to question
the directions given the trustee by the trust director, and
e. Whether there is any limitation on the liability of the
directed trustee for following the trust director’s directions.
2. In some jurisdictions, trustees are fortunate to have the benefit of
state statutes providing clarity as to the characterization of the
trust advisor’s capacity and the directed trustee’s duty to review
the trust advisor’s actions. State statutes address these issues
from a variety of viewpoints. Some state statutes treat the trust
advisor as a cofiduciary and limit the duties of the directed trustee
to a limited monitoring role. This is the approach taken by the
Uniform Trust Code. Some states, including Virginia, expressly
permit the exclusion of a trustee from exercising investment
16 12 Del. C. § 3313(a). See Peter S. Gordon, Directed Trusts: The Use of Trust Advisers and Protectors: Can
Fiduciaries Limit Liability Through Directed Trusts? Empowering Trust Protectors While Minimizing Their
Liability, Or Can a House Divided Long Stand? 2006 Notre Dame Tax and Estate Planning Institute.
40
power and make the directed trustee “liable, if at all, only as a
ministerial agent.”
3. It is instructive to review the provisions of the Uniform Trust
Code covering the issue of the duty of a directed trustee to
supervise the actions of the trust advisor. Paragraph (d) of section
808 of the Code provides a presumption that a trust advisor is a
fiduciary (which creates certain duties on the part of the directed
trustee and potential liability on the part of the trust advisor).
Paragraph (b) of section 808 provides rules for when the trustee
must question the directions of the trust advisor. That section
provides, in part that the trustee: “shall act in accordance with an
exercise of the power unless the attempted exercise is manifestly
contrary to the terms of the trust or the trustee knows the
attempted exercise would constitute a serious breach of a
fiduciary duty that the person holding the power owes to the
beneficiaries of the trust.” Thus, the Uniform Trust Code
significantly limits a directed trustee’s liability but does not
eliminate all liability that a directed trustee has for the actions of a
trust director.
vii. Trustee Liabilities When Directed - Investments
1. As stated earlier, a trustee does not have the duty or responsibility
to guarantee investment performance or other outcomes but must
be process-oriented. In contrast to a non-directed trustee, a
directed trustee has minimal responsibility over investment
performance. But, a directed trustee is not relieved of all
responsibilities regarding the actions of a trust director.
Disappointed beneficiaries have tried, generally unsuccessfully, to
hold a directed trustee responsible for investment losses. Some of
the allegations include the directed trustee failed to follow the
directions of the trust director, the trust director exceeded the trust
director’s authority set forth in the trust instrument, the directed
trustee breached the trustee’s duty of investment responsibility,
the directed trustee breached the trustee’s duty to supervise the
actions of the trust director, and the directed trustee is responsible
for the actions of the trust director as a co-trustee.
2. Liability of Directed Trustee under the Uniform Trust Code
a. Under the Uniform Trust Code, a directed trustee has the
duty to monitor the actions of the trust director to make
sure that the trust advisor’s exercise of the director’s power
is not “manifestly contrary to the terms of the trust” or “the
attempted exercise would constitute a serious breach of a
fiduciary duty.” The key issues under the Uniform Trust
41
Code are: What is manifestly contrary to the terms of the
trust? and When is an attempted exercise a serious breach
of a fiduciary duty?
b. The trustee will only know for sure when the exercise of a
power is not manifestly contrary to the terms of the trust
when the jury or judge finds the directed trustee liable for
the following the directions of the trust director. Until
there is case law on these subjects, a directed trustee will
not know for certain when the trustee is protected in relying
on the directions of a trust director.
3. Liability of Directed Trustee under Delaware Law
a. Delaware provides better protection for a directed trustee
than the Uniform Trust Code. First, Delaware classifies a
trust advisor as a fiduciary. §3313(a) of Chapter 12 of the
Delaware Code provides:
“Where 1 or more persons are given authority by the terms
of a governing instrument to direct, consent to or
disapprove a fiduciary’s actual or proposed investment
decisions, distribution decisions or other decision of the
fiduciary, such persons shall be considered to be advisors
and fiduciaries when exercising such authority unless the
governing instrument otherwise provides.”
b. In addition, Delaware amended its trust advisor statute in
2003, 12 Delaware Code §3313, to read as follows:
“(a) Where one or more persons are given authority by the
terms of a governing instrument to direct, consent to, or
disapprove a fiduciary’s actual or proposed investment
decisions, distribution decisions, or other decision of the
fiduciary, such persons shall be considered to be advisors
and fiduciaries when exercising such authority unless the
governing instrument otherwise provides.
(b) If a governing instrument provides that a fiduciary is to
follow the direction of an advisor, and the fiduciary acts in
accordance with such a direction, then except in cases of
willful misconduct on the part of the fiduciary so directed,
the fiduciary shall not be liable for any loss resulting
directly or indirectly from any such act.
(c) If a governing instrument provides that a fiduciary is to
make decisions with the consent of an advisor, then except
42
in cases of willful misconduct or gross negligence on the
part of the fiduciary, the fiduciary shall not be liable for any
loss resulting directly or indirectly from any act taken or
omitted as a result of such advisor’s failure to provide such
consent after having been requested to do so by the
fiduciary.
(d) For purposes of this section, ‘investment decision’
means with respect to any investment, the retention,
purchase, sale, exchange, tender or other transaction
affecting the ownership thereof or rights therein, and an
advisor with authority with respect to such decisions is an
investment advisor.”
c. R. Leigh Duemler v Wilmington Trust Company, C.A.
20033, V.C. Strine (Del. Ch. Oct. 28, 2004).
i. Mr. Duemler, a sophisticated investment advisor
who was a securities lawyer, was named as the sole
investment direction advisor and given the express
power under the trust instrument to direct
Wilmington Trust Company as trustee with respect
to all trust investments. While Mr. Duemler was on
vacation, Wilmington Trust Company forwarded a
prospectus to Mr. Duemler with respect to which he
should have taken action. Mr. Duemler did not
provide Wilmington Trust Company with any
directions concerning the prospectus and the
investment declined in value significantly. Mr.
Duemler sued Wilmington Trust Company alleging
that Wilmington breached its fiduciary duty to the
trust for failure to provide him with appropriate
financial information to allow him to make an
informed decision.
ii. In an unreported and unwritten decision, Vice
Chancellor Leo E. Strine, Jr. ruled in favor of
Wilmington Trust Company holding that there was
no evidence of “willful misconduct” under
Delaware’s directed trust statute (12 Del. C.
§3313(b)). The Vice Chancellor stated that the
Delaware statute requires the investment advisor to
make investment decisions in isolation, without
oversight from the trustee and to hold otherwise
would undermine the role of investment trust
advisor. The Vice Chancellor did find that Mr.
43
Duemler breached his fiduciary duty as investment
advisor to the trust.
4. Liability of Trustee under Prior Virginia Law
a. Before Virginia’s recent enactment of its revised directed
trust statute, Virginia law provided that the person who
holds the power to direct the trustee is presumed be a
fiduciary, is required to act in good faith, and is liable to the
beneficiaries of the trust for any loss resulting from a
breach of the fiduciary duty.
b. Rollins v. Branch Banking and Trust Company of Virginia,
56 Va.Cir. 147, 2001 WL 34037931 (Va. Cir. Ct. 2002).
i. In 1977, husband and wife each created separate
trusts for the benefit of each other. The trusts were
to terminate upon the death of the grantor’s spouse
and the trust assets were to be distributed to the
grantor’s then living children and the grandchildren
of any deceased child. Each grantor named a
financial institution to be the trustee. The trusts
were funded primarily with shares of publicly
traded stock in textile companies located in the
community where the grantors lived. Under the
terms of the trust agreement, the grantor directed
that “Investment decisions as to the retention, sale,
or purchase of any asset of the Trust Fund shall
likewise be decided by such living children.” The
trustee obtained the written authority of the
beneficiaries to over-concentrate the trust
investments with the textile stocks. Twenty years
after the trust was funded, the trustee sold the textile
stocks at the direction of the children. The proceeds
of sale from the stock were one-twentieth of the
value of the stock at its highest value. The
beneficiaries sued the trustee for $25,000,000
alleging breach of fiduciary duty. The trustee
defended based on the Virginia directed trust statute
then in effect.
ii. Paragraph C of the old Virginia directed trust statute
(prior to the enactment of the VUTC and § 55-
548.08), Virginia Code § 26-5.2, Liability of
Fiduciary for Actions of Co-Fiduciary, provided as
follows:
44
“Whenever the instrument under which a fiduciary
or fiduciaries are acting reserves unto the trustor,
testator, or creator or vests in an advisory or
investment committee or any other person or
persons, including a cofiduciary, to the exclusion of
the fiduciary or one or more of several fiduciaries,
authority to direct the making or retention of
investments, or any investment, the excluded
fiduciary or cofiduciary shall be liable, if at all, only
as a ministerial agent and shall not be liable as
fiduciary or cofiduciary for any loss resulting from
the making or retention of any investment pursuant
to such authorized direction.”
iii. The children argued that the corporate trustee
breached its fiduciary duty in failing to diversify,
failing to actively secure approval for the sale of the
declining stock, and failing to undertake the duties
required to preserve and protect the trust assets.
iv. In response, the Court stated: “The plain language
of the instrument, however, clearly contradicts the
beneficiaries’ argument. The beneficiaries, alone,
had the power to make investment decisions. The
statute enacted by the General Assembly recognizes
the basic principal that the court cannot hold a
trustee, or anyone else, liable for decisions that it
did not and could not have made. The statute
clearly applies in this instance and the beneficiaries
have not stated a cause of action against the trustee
for failing to diversify the trust assets. The
demurrer is granted [no claim is stated against the
directed trustee] as it relates to all claims for failure
to diversify.”
v. The court did not grant the trustee’s demurrer
(failure to assert a valid claim), however, on all
aspects of the count for breach of fiduciary duty. In
denying the trustee’s motion to dismiss that portion
of the lawsuit, the court stated:
“To ensure the trust’s conservation, a trustee also
has a duty to keep informed as to the conditions of
the trust. C.J.S., Trusts § 247. Additionally, the
trustee has a duty to impart to the beneficiary any
knowledge he may have affecting the beneficiary’s
interest and he cannot rid himself of this ‘duty to
45
warn.’ See Restatement 2d Trusts § 173. In other
words, the trustee has a duty to fully inform
beneficiaries of all facts relevant to the subject
matter of the trust which come into the trustee’s
knowledge and which are material for the
beneficiary to know for the protection of his
interests.
Mimicking language adopted by the Supreme
Court, the beneficiaries have pled that the trustee
breached a duty to use the degree of care in the
management of the trusts that a prudent person of
discretion and intelligence would exercise in his
own like affairs. This language is sufficient to state
a cause of action against the trustee for breach of
fiduciary duties.
To permit such a claim does not contradict the
language of the statute. The statute clearly prohibits
the law from imposing liability on the trustee for
failing to do what he had no ability to do. Va. Code
§ 26-5.2. The trust instruments clearly place the
authority to make investment decisions with the
beneficiaries. Their conduct in requesting the
retention of Tultex prohibits them from complaining
about the decision now. Va. Code § 26-5.2(C). As
noted in § 26-5.2(D), the prohibition on recovery
does not excuse a trustee from liability for failing to
participate in the administration of the trust or for
failing to attempt to prevent a breach of trust. Va.
Code § 26-5.2. Thus, a trustee may be held liable
for a loss caused by his conduct for actions which
he was entrusted to take. The demurrer is overruled
as to Count III, the allegations of breach of
fiduciary duty, except as they relate to failure to
diversify.”
vi. Rollins was settled after the court’s ruling without a
final determination on the merits.
vii. Rollins can be read that a directed trustee can be
protected by statute from liability for breach of
fiduciary duties relating to investment performance
but not for breach of other fiduciary duties that the
trustee owes the beneficiaries, such as the duty to
keep the beneficiaries informed. A directed trustee
is still a trustee.
46
viii. Trustee Fees and Costs When Directed
1. Similar to a delegating trustee, the compensation of a directed
trustee should be lower than a trustee with investment
responsibility to reflect less responsibility and risk.
2. From discussions with several institutional trustees, the
compensation may be reduced anywhere from 20 percent to 50
percent depending on the size of the trust assets and the policy of
the institution.
ix. Drafting for the Directed Trustee
1. Notwithstanding that a trustee is relieved statutorily of investment
responsibility, a directed trustee should not feel freed of all
liability. A directed trustee is still a trustee and not an agent. A
trustee has duties other than the duty to invest prudently. A
statute similar to the Uniform Trust Code statute may protect a
directed trustee from a claim of improper investments, but can the
trustee be held liable for breaching the trustee’s other fiduciary
duties? See Rollins, discussed above.
2. A drafter who wants to appoint an investment director for a trust
and protect the directed trustee should consider whether it is
appropriate to include the following provisions in the trust
instrument:
a. The circumstances surrounding the appointment of an
investment director, including who may appoint the
investment director and at what time.
Sample Language: My Trustee may, but shall not be
required to, appoint an Investment Director to serve for
any or all trusts under this agreement. The decision to
appoint an Investment Director shall be made by my
Trustee, in my Trustee’s sole and absolute discretion.
b. The nature and identity of those persons or entities that may
serve as investment director, including:
i. whether institutions may serve,
ii. whether separate trusts may have separate
investment directors, and
iii. whether the beneficiaries will have any voice in
determining the identity of the investment director.
47
Sample Language: The Investment Director may be an
individual or a corporation (which may include a bank,
trust company or other entity having trust powers).
Different Investment Directors may serve for different
trusts under this agreement. My Trustee may solicit and
consider nominations (which shall not be binding),
including nominations by the beneficiaries then authorized
to receive trust income who are sui juris.
c. The fiduciary relationship of the investment director and
the directed trustee.
Sample language: The Investment Director shall serve in a
fiduciary capacity. It is my specific intention that at any
time an Investment Director is serving that my Trustee
shall not be liable or responsible for any losses to the trust
estate by reason of investment actions taken or not taken by
my Trustee pursuant to directions given by my Investment
Director.
d. The process by which an investment director may resign or
be removed and replaced.
Sample Language: Any Investment Director may resign by
written notice delivered to my Trustee then serving. The
resignation shall not be effective until the appointment of a
successor Investment Director pursuant to this agreement.
The Investment Director may be removed and replaced (or
a successor may be appointed in the event the Investment
Director declines to serve, resigns, or ceases serving) by
the following person or persons in order of priority: (a) by
my Trustee, (b) if there is no Trustee serving or designated
to serve, by the adult beneficiaries then authorized to
receive trust income or the adult persons responsible for
any minor beneficiaries then authorized to receive trust
income. The removal shall be effective upon written notice
to the Investment Director being removed and appointment
of a successor Investment Director. The appointment shall
be effective upon written notice to and acceptance of
fiduciary duties by the successor Investment Director.
e. The scope and terms of the power, including what power
the investment director has with respect to the trust
investments and whether the investment director is entitled
to compensation.
Sample Language: The Investment Director shall have the
48
sole authority and responsibility for all investment
decisions and shall have full authority to direct my Trustee
to take any action with respect to the trust investments that
my Trustee is authorized to take under this agreement,
including without limitation the retention, purchase, sale,
exchange, tender, or other transactions affecting the
ownership of the assets held in the trust. Notwithstanding
the foregoing, the Investment Director may not direct my
Trustee to take any action that would violate federal, state,
or local law or the provisions of this agreement and all
powers of the Investment Director shall be subject to the
restrictions in this agreement.
Sample Language: The Investment Director shall be
entitled to reasonable compensation as my Trustee and the
Investment Director shall agree at the time services are
rendered to my Trustee. In the case of any professional
investment advisor serving as Investment Director and in
the absence of a fee agreement, reasonable compensation
means the compensation specified in its published fee
schedule in affect at the time it renders services to my
Trustee.
f. The authority of the investment director to invest in
affiliated products of funds, including whether
compensation can be derived from such investments.
Sample Language: The Investment Director may from time
to time direct my Trustee to purchase securities or mutual
funds underwritten or advised by my Trustee,
notwithstanding that the Investment Director, my Trustee,
or an affiliate of the Investment Director or my Trustee may
benefit or be directly compensated for the purchase of such
securities or funds.
g. The nature of the directed trustee’s duty to monitor or
review the actions of the investment director.
Sample Language: My Trustee shall exercise reasonable
care and diligence in monitoring the performance of the
investment director.
h. The expectations regarding the relationship between the
investment director and the directed trustee.
Sample Language: The Investment Director shall provide
my Trustee with sufficient information about the Investment
49
Director’s actions as necessary to enable my Trustee to
participate effectively in the administration of the trust and
carry out their fiduciary obligations. The Investment
Director shall timely respond to all reasonable requests for
information by my Trustee.
i. Determine whether it is appropriate to have an exculpation
clause protecting the directed trustee from liability.
IV. Exculpation of Trustees
a. Validity of Exculpation Clauses
i. An exculpation clause is a clause that exonerates a fiduciary from liability
to the beneficiaries for the actions or inactions of the fiduciary. In some
states, exculpation clauses are not enforceable. Even in those states that
recognize exculpation clauses, the clauses are not generally enforceable in
all instances.
ii. Restatement Second of Trusts § 222 provides:
1. Except as stated [below], the trustee, by provisions in the terms of
the trust, can be relieved of liability for breach of trust.
2. A provision in the trust is not effective to relieve the trustee of
liability for breach of trust committed in bad faith or intentionally
or with reckless indifference to the interests of the beneficiary, or
of liability for any profit the trustee has derived from a breach of
trust.
3. To the extent to which a provision relieving the trustee of liability
for breaches of trust is inserted in the trust instrument as the result
of an abuse by the trustee of a fiduciary or confidential
relationship to the settler, such provision is ineffective.
iii. Although exculpatory clauses are closely scrutinized by the courts, these
clauses may be appropriate in certain circumstances. For example, the
drafter should consider an exculpation clause where the trustee is
inexperienced in investment matters and it is anticipated that the trustee
will delegate investment responsibility or will be a directed trustee as to
investments.
iv. An exculpation clause may not relieve a trustee for breaches of trust
committed in bad faith. This rule “can be understood to operate as a
presumption that trust terms authorizing bad faith must have been
improperly concealed from the settlor or otherwise misunderstood by the
settlor when propounded, because no settlor seeking to benefit the
50
beneficiary would expose the beneficiary to the hazards of bad faith
trusteeship.”17
v. Sample Exculpation Clause. A trust agreement may not relieve the trustee
of all liability for actions taken in connection with the delegation of
investment or management functions. If state law allows, the trust
agreement can create a higher standard, such that the trustee may only be
liable for gross negligence, willful acts, criminal or reckless acts. The
standard should be set by the tolerance of the settlor of the trust for these
acts considering:
a. the identify (corporate or individual) of all current and
potential successor trustees,
b. the sophistication of the trustee with respect to the
management and functions which may be delegated, and
c. the relationship of the trustee to the beneficiary and the
settlor.
Sample Language: When acting in my Trustee’s fiduciary
capacity, except for willful action or omission or gross
negligence, my Trustee shall not be liable for any act, omission,
loss, damage or expense arising from the administration of any
trust hereunder, including, without limitation, the investment and
reinvestment of the trust assets with or without the advice of
investment counsel, or pursuant to or contrary to the
recommendation of investment counsel. My Trustee shall not be
liable for any acts, omissions or defaults of any agent or
depositary properly appointed, selected or delegated authority
hereunder with reasonable care. Each Trustee shall be liable only
for such Trustee’s own acts or omissions occasioned by the
willfulness or gross negligence of such Trustee and shall not be
responsible for the acts or omissions of any other Trustee; no
Trustee, in particular, shall be liable in regard to the exercise or
nonexercise of any powers and discretions delegated pursuant to
the provisions of this agreement to another Trustee.
b. Exculpation in Virginia
i. Code of Virginia § 55-550.08 – Exculpation of trustee. provides:
“A. A term of a trust relieving a trustee of liability for breach of trust is
unenforceable to the extent that it:
17
John H. Langbein, “Mandatory Rules in the Law of Trusts,” 98 NW. U. L. Rev. 1105, 1124 (Spr. 2004).
51
1. Relieves the trustee of liability for breach of trust committed in
bad faith or with reckless indifference to the purposes of the trust or the
interests of the beneficiaries; or
2. Was inserted as the result of an abuse by the trustee of a fiduciary
or confidential relationship to the settlor.
B. An exculpatory term drafted or caused to be drafted by the trustee is
invalid as an abuse of a fiduciary or confidential relationship unless the
trustee proves that the existence and contents of the exculpatory term were
adequately communicated to the settlor.”
ii. Virginia departs from the Uniform Trust Code by requiring that the
exculpation clause only be made known (“adequately communicated
to…”) the settlor of the trust. There is no requirement, as there is in the
uniform act, that the clause be “fair under the circumstances.”
c. Communication and Ethical Issues
i. Because the Code of Virginia requires that any exculpation clause be
communicated to the settlor of the trust to be effective, any drafting
attorney should take care to: (i) discuss the desired standard of liability to
be applied the trustee and (ii) specifically notify the client in writing of
any change in the standard of liability for the trustee.
Because many attorneys serve as trustees, the attorney should also
consider the ethical issues implicated in drafting a trust agreement with an
exculpation clause and agreeing to serve as trustee of a trust under such
agreement.18
Suggested Language for Disclosure to Client Regarding Waiver of
Prudent Investor Rule, Authority to Delegate Investment Authority, and
Exculpation of Trustee: Please note that paragraph ( ) of Article ( )
waives law regarding the duty of the fiduciary to follow the “prudent
investor” rule enacted by this state, and the trustee may maintain assets in
trust that would otherwise not be suitable as trust investments or would
represent an overconcentration of assets. Paragraph ( ) of Article ( ) of
the Trust Agreement provides that the fiduciary may delegate authority for
making investment decisions to an investment professional, and the funds
of the trust may be maintained in accounts or funds affiliated with the
professional investment advisor. In the management of assets made
pursuant to the investment recommendations of the professional advisor,
your trustee is not liable for any decisions or actions made in good faith.
Please also note that in paragraph ( ) of Article ( ) of the Trust
Agreement the liability of the fiduciary is limited to willful acts or
18
See Virginia Rules of Professional Conduct, Conflict of Interest: Prohibited Transactions – 1.8(h)
52
omissions or acts of gross negligence. As an alternative, you can provide
that the fiduciary is liable for acts of ordinary negligence. Please let me
know if you have any questions about these issues. These provisions have
been made in the trust agreement with your consent and at your direction.
53
Part Two: Health Support and What?!?!
I. Overview
a. Understanding Discretion
i. The most common exercise of a trustee’s discretionary authority is making
distributions to beneficiaries. A lawyer’s involvement with distribution
standards takes place on two levels.
a. A lawyer may have an opportunity to be involved at the planning
stage, in educating the client about the standards to be used for
determining what distributions are appropriate and the impact of
various alternatives.
b. He or she also faces the practical application of those standards
during the administration of a trust.
ii. Both levels require a firm understanding of the common meanings given
to the distribution language used in trusts. These materials review the
judicial interpretations of common distribution provisions, and suggest
alternative provisions that can be used to provide more guidance. The
materials also examine various ways in which lawyers are trying to
provide greater flexibility in trusts, and to respond creatively to the
demands of the "trust consumer."
b. Mandatory Distribution Provisions
i. These materials focus on understanding the exercise of a trustee’s
discretionary authority to make distributions. However, many trusts
require the trustee to distribute assets to the beneficiary without exercising
any discretion whatsoever. The timing, amount and character of the
distributions are fixed by the terms of the trust instrument.
ii. Common examples of mandatory trust distributions include:
1. Income. A trust may require the trustee to distribute some or all of
the income to one or more beneficiaries. This is required for trusts
that are intended to qualify for the federal estate tax marital
deduction19
or the federal gift tax marital deduction20
and may
also be included by the choice of the grantor.
Sample Language: My trustee shall distribute all of the trust
income to the beneficiary in quarterly or more frequent
installments.
19
See IRC §2056. 20
See IRC §2523.
54
2. Principal. A grantor may also chose to provide for regular or
occasional distributions of trust principal to the beneficiaries. A
trust may require the trustee to distribute some or all of the trust
principal to the beneficiaries when they reach a certain age. If a
trust terminates, whether on the occurrence of an event or on a
date certain, the trustee must distribute the assets to the designated
beneficiaries.
3. Unitrust provisions. In recent years, most states have adopted a
“prudent investor” standard for the determining trustee’s liability
for investment decisions. The standard embraces modern
portfolio theory, which means that a larger percentage of a trust's
assets are invested in equities to improve the “total return” of the
trust's investments, with a corresponding decrease in the income
of the trust. If a trust allow only for the distribution of income, the
current beneficiaries are at a significant disadvantage. As a result,
many states have adopted or allowed the conversion of income-
only trusts to unitrusts, or now allow grantors to create unitrusts.21
The use of a unitrust approach to distributions bypasses the
granting of discretion to the trustee in favor of requiring a fixed
percentage of the trust assets to be distributed each year as
“income.”
II. Trusts with Discretionary Distributions
a. Grantor’s Intent
i. Grantors may provide trustees with the ability to exercise discretion in
making distributions of income or principal to the beneficiaries.
ii. The grantor’s intent controls the interpretation of any provisions of a trust
agreement and the intent should be discerned from both the language of
trust agreement,22
which includes the distribution standard and provisions
concerning the trustee’s duties and powers.
b. Trustee’s Duties
i. Several of the trustee’s duties are implicated in making discretionary
distributions from trust agreements.
ii. The trustee must decide when to exercise discretion – and when not to
exercise discretion. This requirement to act is part of the trustee’s duty to
administer the trust in good faith. See above, Part One.II.c.
21
Va. Code Ann. § 55-277.4:1. 22
Huaman v. Aquino, 272 Va. 170, 174, 630 S.E.2d 293, 296 (2006).
55
iii. The trustee must be informed about the nature and extent of the trust
property and the identity of the potential beneficiaries. The trustee must
properly interpret the trust agreement. These requirements are part of the
trustee’s duty to exercise reasonable care and skill in the administration of
the trust. See above, Part One.II.e.
iv. The trustee must identify and avoid conflicts of interest. The trustee must
not favor one of the income or remainder beneficiaries over the other.
These requirements are part of the trustee’s duty of impartiality. See
above, Part One.II.f
c. Sole and Absolute Discretion
i. In general, if the trustee's authority to make distributions is discretionary,
and the trustee uses its judgment and makes a reasonable decision, a court
will not disturb the trustee's decision to distribute or withhold trust assets
unless there has been evidence of bad faith or an abuse of discretion.23
ii. Some commentators have suggested that where the trustee's discretion is
"absolute" or "uncontrolled," a court may grant the trustee's decision even
more deference.24
While those modifiers may seem to expand the
authority of the trustee to exercise the trustee’s discretion, courts have not
always agreed. In one case, a trustee argued that his authority to make
payments for "the comfortable maintenance, support and education [of the
beneficiary] as he or it shall, in his or its sole discretion, deem advisable"
authorized the trustee to withhold any payments to the beneficiary. The
court disagreed, and found that the trustee's power was limited by the
standard of "comfortable maintenance, support and education," and that
the trustee had the duty to make distributions in accordance with that
standard. Kolodney v. Kolodney, 503 A.2d 625 (Conn. App. 1986).
iii. A trustee's power to make distributions in its sole discretion pursuant to a
particular standard, such as for the beneficiary's support, must be
distinguished from a trustee's power, in its sole discretion, to make
distributions for any purpose.
Sample Language: An Independent25
Trustee may pay to or for the benefit
of the beneficiary as much of the principal of trust as the Independent
Trustee may deem appropriate, in the Independent Trustee’s sole and
absolute discretion, for any purpose.
23
Bogert § 811 24
Id. 25
If a beneficiary is also serving as trustee and the exercise of this discretionary authority would inadvertently cause
the trust assets to be includable in the beneficiary/trustee’s estate for federal estate tax purposes, this standard should
limited to provide that only an independent trustee may exercise the discretion. Any beneficiary and any related or
subordinate party with respect to any beneficiary would be prohibited from serving as an independent trustee or
exercising this authority where
56
iv. Under this broad standard, the trustee may make distributions for any
purpose or withhold funds from the beneficiary, as long as the trustee does
not act in bad faith or arbitrarily. The Restatement of Trusts states that the
trustee's decision to distribute or withhold trust assets does not need to be
reasonable. Restatement 2d of Trusts, § 187. See In re Ledyard's Estate,
21 N.Y.S.2d 860 (1939); Estate of Zuckerman, NYLJ, January 29, 1990,
p. 30.
v. Nevertheless, many courts will impose a standard of reasonableness, even
where the trustees are given "absolute and uncontrolled discretion" to
invade principal.
1. In one case, the beneficiaries of two $8 million trusts requested
distributions of $145,000 and $150,000 in principal. The trustees
refused the request because the money was not needed and the
beneficiaries' planned use for the money was unlikely to be
productive. Although the court found that the trustees had acted
in good faith in refusing the request, the court found that the
trustees should not have applied such considerations in
determining whether or not to make the requested distribution and
directed the trustees to make the distribution. Matter of Stillman,
433 N.Y.S.2d 701 (1980).
2. In another case in which the trustees had the power to invade
principal "as the trustees in their discretion shall deem proper,"
the court held that "even where the payment of principal rests in
the uncontrolled discretion of the trustee, he must not in
exercising his authority act dishonestly, or with an improper
motive or fail to use his judgment or act beyond the bounds of
reasonable judgment." Estate of Joseph P. Sanders, NYLJ, April
19, 1991, p. 25.
3. In a Connecticut case, a trustee was given authority to distribute
as much of the income as it thought advisable in its absolute
discretion. The court found that the trustee could withhold
income from the beneficiaries as long as it acted in good faith and
without abuse of discretion. Auchincloss v. City Bank Farmers
Trust Co., 70 A.2d 105 (Conn. 1949).
4. The case law indicates that the use of the words "sole and absolute
discretion" will not necessarily free the trustee completely from
enforceable requests for distributions. If the settlor wants the
trustee to have complete latitude and the beneficiaries to have no
enforceable rights against the trustee, it may be necessary to be
more explicit.
57
d. Abuse of Discretion
i. Virginia courts have held that “…a trustee's discretion is broadly
construed, but his actions must be an exercise of good faith and reasonable
judgment to promote the trust's purpose. A trustee's exercise of discretion
should not be overruled by a court unless the trustee has clearly abused the
discretion granted him under the trust instrument or acted arbitrarily in
such a way as to destroy the trust he is to maintain.” NationsBank of
Virginia, N.A. v. Estate of Grandy, 248 Va. 557, 561-562 (Va. 1994)
ii. Restatement (Second) of Trusts § 187, comment d, provides that in
assessing whether a trustee has abused its discretion in making decisions
as to distributions:
“[t]he following circumstances may be relevant: (1) the extent of
the discretion conferred upon the trustee by the terms of the trust;
(2) the purposes of the trust; (3) the nature of the power; (4) the
existence or nonexistence, the definiteness or indefiniteness, of an
external standard by which the reasonableness of the trustee's
conduct can be judged; (5) the motives of the trustee in exercising
or refraining from exercising the power; (6) the existence or
nonexistence of an interest in the trustee conflicting with that of
the beneficiaries.”
iii. In addition, Restatement (Second) of Trusts § 187, comment h provides:
“The court will control the trustee in the exercise of a power where
its exercise is left to the judgment of the trustee and he fails to use
his judgment. Thus, if the trustee without knowledge of or inquiry
into the relevant circumstances and merely as a result of his
arbitrary decision or whim exercises or fails to exercise a power,
the court will interpose.”
iv. In a case regarding a trustee serving for a trust created to settle claims
arising out of medical malpractice suit, the Arlington County Circuit Court
quoted extensively from the Restatement (Second) of Trusts in evaluating
a claim against a trustee for abuse of discretion in making distributions.26
III. Common Discretionary Distribution Standards
a. Health, Education Maintenance and Support
i. Any decision regarding the appropriate distribution standard for a trust
must take into account the transfer tax consequences of using the
distribution standard.
26
SunTrust Bank v. Children's Nat'l Med. Ctr., 2003 Va. Cir. LEXIS 63, 26-27 (Va. Cir. Ct. 2003).
58
ii. A trustee who has the discretionary power to distribute trust property to
himself as a trust beneficiary possesses a general power of appointment
unless the discretionary power is limited by an ascertainable standard
related to his or her health, education, support or maintenance.27
iii. Treasury regulations provide guidance on the exact language which
qualifies a standard to be such an ascertainable standard: “Examples of
powers which are limited by the requisite standard are powers exercisable
for the holder's “support,” “support in reasonable comfort,” “maintenance
in health and reasonable comfort,” “support in his accustomed manner of
living,” “education, including college and professional education,”
“health,” and “medical, dental, hospital and nursing expenses and
expenses of invalidism.” In determining whether a power is limited by an
ascertainable standard, it is immaterial whether the beneficiary is required
to exhaust his other income before the power can be exercised.”28
iv. Health
1. The term "health" includes all routine medical care, medication,
surgery and hospitalization, as well as expenditures for extended
nursing care and mental health.
2. The term "medical care" may be more limited than health,
because it may not cover treatment for psychological or mental
health problems or addictions, which have not been universally
accepted as "medical" problems.
v. Education
1. In general, the term "education" includes college education, but
does not include graduate level or professional education, unless
specifically provided by the trust instrument. Bogert § 182;
Murphy v. Morris, 141 S.W.2d 518 (Ark. 1940); Epstein v.
Kuvin, 95 A.2d 753 (N.J. Super. 1953).
2. The term "college education" has been held to include the
expenses of a high school education, since a high school
education is normally required to prepare the beneficiary for
college. Security Trust Co. v. Smith, 145 S.W.2d 512 (Ky. 1940).
vi. Maintenance and Support
1. Support and maintenance encompasses more than bare necessities
of life. First Virginia Bank v. United States, 490 F.2d 532 (4th
Cir. Va. 1974). These terms include the beneficiary's normal
27
IRC §§ 2041(b)(1)(A); 2514(c)(1). 28
Treas. Reg. § 20.2041-1(c)(2)
59
living expenses, such as housing, clothing, food, and medical
care, depending on the standard of living enjoyed by the
beneficiary during the settlor's or testator's life. In re Levinson's
Will, 5 Misc. 2d 979, 162 N.Y.S.2d 287 (1957); Hill v. Comm'r,
88 F.2d 941 (8th Cir. 1937); Equitable Trust Co. v. Montgomery,
44 A.2d 420 (Del. Ch. 1945).
2. Where the trustee is directed to pay to the beneficiary or to apply
for him so much as is necessary for his maintenance or support,
the implication is that the settlor intended that he should receive
his support from the trust estate, even though he might have other
resources.29
3. Patterson v. Old Dominion Trust Co., 149 Va. 597, 614 (Va.
1927). James T. Patterson left a sum of money in trust for the
support and maintenance of his daughter. He specifically provided
that the trustee was authorized to sell any asset of the trust and use
the principal for his daughter’s support if the income of the trust
was not sufficient. In a case involving the sale of property from
the trust, Mr. Patterson’s daughter claims that she should be paid
out of the corpus of the estate “the difference between the annual
amount she has actually received and the annual sums to which
she was entitled since her father's death […] such an amount in
addition to her annual income from the trust estate as was
necessary 'for her proper maintenance and support.’” The court
held that the beneficiary was entitled to payment from the
proceeds of the sale of the property, amounting to the principal of
the trust, as it was the intent of the testator to provide for those
payments that were maintenance and support. The court had no
facts as to what amount was needed to satisfy the difference
between what was paid and what should have been paid to the
beneficiary. This decision was “a matter for the trustee to
determine…”
4. In many states, if a trustee may distribute principal for a
beneficiary's support, the trustee also may distribute principal for
the support of the beneficiary's spouse and children. The
beneficiary's legal obligations of support are a part of his living
expenses. See In re Sullivan, 12 N.W.2d 148 (Neb. 1943);
Robinson v. Robinson, 173 Misc. 985, 19 N.Y.S.2d 44 (Surr. Ct.
1940); Seattle-First National Bank v. Crosby, 254 P.2d 732
(1953); Akers v. Fidelity & Columbian Trust Co., 234 S.W. 72
(1921). However, one court limited the permissible distributions
to those for the support of the beneficiary alone, and not for the
support of his wife and dependent children. Cavett v. Buck, 397
29
19 M.J. Trusts and Trustees § 15.
60
P.2d 901 (Okla. 1964). If the settlor wishes to allow the trustee to
make distributions to spouses of the settlor's descendants, he or
she should include a specific provision in the trust instrument.
b. Comfort, Happiness and Best Interests
i. Comfort
1. In some states, the term "comfort" is limited to an ascertainable
standard related to the beneficiary's health and support. Estate of
Vissering, 990 F.2d 578 (10th Cir. 1993). In other states, the
standard is broader than "support or maintenance," and
encompasses a beneficiary's enjoyment, pleasure, happiness,
satisfaction, or peace of mind.
2. The Fourth Circuit Court of Appeals has held that the existence of
the word comfort in a discretionary distribution standard means
that the standard is not an ascertainable standard within the
meaning of IRC § 2041. First Virginia Bank v. United States, 490
F.2d 532, 533 (4th Cir. Va. 1974). In that case, a decedent left all
of his property for the use of his wife during her life and provided
that she could direct the trustee (First Virginia Bank) to sell or
dispose of the property “for her comfort and care as she may see
fit.” Following the more narrow interpretation of IRC § 2041, the
court held that the assets subject to that power were includable in
the wife’s estate because her actions were not limited by an
ascertainable standard.
3. In applying the “comfort” standard, one court allowed
distributions to purchase an automobile to enable the beneficiary's
daughter to visit the beneficiary because her visits "did much to
ease the mind" of the beneficiary. In re Mirfield's Estate, 126
N.Y.S. 465 (Sur. Ct. 1953).
4. "Comfort" has also been construed as relating to the grantor's,
rather than the beneficiary's, accustomed standard of living. The
Mississippi Supreme Court ruled that the term "comfort" should
be construed according to the grantor's understanding of the word,
which could be discovered by looking at the grantor's standard of
living. Gulf National Bank v. Sturtevant, 511 So. 2d 936 (Miss.
1987).
ii. Happiness and Best Interests
1. Under these standards, the trustee may make distributions to allow
the beneficiary to enjoy a high standard of living, including
extensive travel or the purchase of luxury automobiles and
jewelry.
61
2. The term "best interests" has been interpreted to allow
distributions for more than the beneficiary's pecuniary interests.
Best interests include peace of mind, as well as financial gain.
Wiedenmanyer v. Johnson, 254 A.2d 534, aff'd, 259 A.2d 465
(1969). In light of the broad meaning of the term and the liberal
attitude towards distributions that it encompasses, it may be
appropriate to add some limitations to the standard, such as the
language below.
Sample Language: The term "best interests" with respect to
distributions to any beneficiary shall be construed to provide the
beneficiary with the means to enjoy a comfortable lifestyle,
including recreation, cultural pursuits, and travel, but, in the case
of a descendant of mine, shall not be construed so generously as to
discourage the descendant from assuming the responsibilities of
self-support.
Sample Language: The term "best interests" refers to all aspects
of a beneficiary's happiness and well-being within the context of
reasonable personal and social conduct, as determined in the
absolute discretion of the trustee.
3. Although distributions are permissible for a wider variety of
purposes under a best interests standard than under a standard of
support, the beneficiary may be less able to compel the trustee to
distribute trust assets since the beneficiary's best interests are less
easily defined. In other words, the standard is less enforceable
from a beneficiary's perspective and therefore grants the trustee
greater latitude.
4. Some courts have held that if the trustee is authorized to distribute
principal under a best interests or similar standard, then the trustee
has the authority to distribute the entire trust principal to the
beneficiary in a lump sum, provided that such a distribution is not
an abuse of the trustee's discretion. See e.g., Lees v. Howarth, 131
A.2d 229 (R.I. 1957). Therefore, if a best interests standard is
used, but the grantor wants to preserve trust principal for the
remaindermen, the trust instrument should contain language which
expresses that intention.
Sample Language: My primary concerns during the life of the
child are to preserve trust principal for ultimate distribution to the
child's descendants while at the same time reasonably providing
for the health, support, education and best interests of the child.
62
5. If the grantor does want the trustee to have the power to distribute
the entire trust principal to the beneficiary, the settlor could use the
following provision:
Sample Language: If at any time the trustee believes that it would
be in my child's best interests and determines that it is otherwise
appropriate under the circumstances, it may in its absolute
discretion distribute to him the entire principal of his trust and
terminate his trust, without regard to the interests of
remaindermen. My child shall have no right to require that the
trustee make any distribution that is not subject to an ascertainable
standard, and the trustee is expressly exonerated from all liability
to my child and all other interested parties by reason of the
exercise or non-exercise of its discretionary authority in such
matters.
c. Emergency, Necessary and Necessities
i. Many courts interpret the term "emergency" as a very narrow and
restrictive standard, which authorizes distributions only for the
beneficiary's unusual and unforeseen expenses, and not for the
beneficiary's routine or ordinary support and maintenance. See, e.g.,
Nardi v. United States, 385 F.2d 343 (7th Cir. 1967); Budd v.
Commissioner, 49 T.C. 468 (1968).
ii. Nevertheless, the IRS has taken the position on a number of occasions that
the term does not create an ascertainable standard for federal estate and
gift tax purposes.
1. The IRS has privately ruled that a standard of "great emergencies
which may arise in the lives and affairs of [the beneficiary], such
as extra needed medical services or hospitalization" did not
restrict distributions to emergencies relating to medical needs.
The language "such as extra needed medical services or
hospitalization" merely illustrated some of the types of
expenditures that would qualify as emergencies, but were not
intended to be an exclusive list. The IRS noted that distributions
could also be made for any "sudden or unexpected happenings,"
such as being stranded in a foreign country without funds to
return home. Letter Ruling 8304009 (Oct. 25, 1982).
2. The IRS has also ruled that the phrase "any other emergency
condition of any exigencies" did not constitute an ascertainable
standard. Letter Ruling 9044081 (July 31, 1990).
3. However, in Letter Ruling 200028008 (July 14, 2000), the IRS
gave a more favorable interpretation to the standard "proper care,
63
support and maintenance, or in the event of any other accident,
illness or other emergency." The IRS concluded that
"emergency" must be limited to the types of emergencies itemized
before the word "other" and therefore constituted an ascertainable
standard.
iii. Several courts have rejected the IRS position and held that a standard of
distribution related to "emergency" is an ascertainable standard for tax
purposes. Estate of Sowell v. Commissioner, 708 F.2d 1564 (10th Cir.
1983), rev'g 74 T.C. 1001 (1980); Wahlfeld v. United States, 47
A.F.T.R.2d (P-H) ¶ 148,432, at 81-1565 (C.D. Ill. 1980); Hunter v. United
States, 597 F. Supp. 1293 (W.D. Pa. 1984).
iv. To forestall the IRS's argument that the term emergency is not an
ascertainable standard, the lawyer may wish to specify the types of
emergencies for which distributions are authorized, such as financial
emergencies or only those related to health or maintenance.
Sample Language: The trustee shall distribute as much of the principal of
the trust, even to the extent of exhausting principal, as the trustee from
time to time determines to be required to meet the expenses of an illness or
other emergency relating to the health, support and education of the child
and his or her descendants.
IV. More Than Words: Other Issues in Discretionary Distributions
a. Standard of Living
i. A distribution standard often refers to the beneficiary's standard of living.
In most cases, it is not necessary to elaborate on this reference. However,
if there is a concern about changing standards of living, the time to which
the standard of living refers should be made clear. For example, it could
refer to the standard of living when the instrument was drafted, when the
instrument became effective (i.e., at the decedent's death in the case of the
will), or when the beneficiary's interest vested.
ii. One case has stated that a direction in a will to distribute trust property for
the beneficiary's "support or maintenance in accordance with her present
standard of living" referred to the beneficiary's standard of living at the
time the will was executed, rather than at the decedent's death. Hart v.
Connors, 228 N.E.2d 273, 275 (Ill. App. 1967).
iii. In another case, however, the court found that the trustee's authority to
invade principal to maintain the beneficiary's standard of living referred to
the beneficiary's standard of living at the death of the testator. In re
Golodetz' Will, 118 N.Y.S.2d 707 (N.Y. Sur. 1952).
64
iv. If the beneficiary's standard of living substantially improves or is reduced
between the time the instrument is drafted and the decedent's death, a
standard of distribution tied to the beneficiary's standard of living may not
carry out the grantor’s intent.
Sample Language: My trustee shall distribute to my husband so much of
the income and principal as my trustee determines to be desirable for his
comfortable support and reasonable health, considering my standard of
living at my death and all other income currently available for such
purposes.
b. Availability of Other Resources
i. In general, unless the instrument expressly provides that the trustee may
consider the beneficiary's other assets and income, the trustee may not
consider those assets in determining what distributions are required for the
support of the beneficiary. The beneficiary has the right to look first to the
trust assets for his support. See Restatement (Second) of Trusts, § 128,
comment e; Nielsen v. Duyvejonck, 236 N.E.2d 743, 747 (Ill. App. 1968);
Hart v. Connors, 228 N.E.2d 273 (Ill. App. 1967); Demitz' Estate, 208
A.2d 280 (Pa. 1965); Matter of Martin, 269 N.Y. 305 (1936); Godfrey v.
Chandley, 811 P.2d 1248 (Kan. 1991); In re Bedell's Estate, 92 N.Y.S.2d
70 (1949).
ii. In many cases, this rule may be disadvantageous from both a tax and a
fairness standpoint.
1. The grantor may wish trust property which is not needed for the
beneficiary's support to remain in trust for other beneficiaries,
especially if the trust property will not be taxable in the
beneficiary's estate. For example, it may be desirable for the
trustee of a credit shelter trust to consider the surviving spouse's
marital trust and non-trust assets before making a distribution
from the credit shelter trust, because those other assets will be
included in the surviving spouse's gross estate, whereas the credit
shelter trust assets will not.
2. If some trust beneficiaries have greater needs or less outside
income or assets than others, the grantor may wish to provide for
those beneficiaries support needs in preference to wealthier
beneficiaries.
iii. In Virginia, whether a beneficiary if entitled to distributions from a trust
when other resources are available is a question of interpretation and must
be construed in light of the grantor’s intent and the language of the
instrument. NationsBank of Virginia, N.A. v. Estate of Grandy, 248 Va.
557, 560 (Va. 1994). In NationsBank, a trust agreement required the
65
trustee to distribute all income to the beneficiary and authorized the trustee
to make additional distributions of principal to or for the benefit of the
beneficiary in the trustee’s discretion. The beneficiary had significant
medical bills that resulted from a chronic paranoid schizophrenic illness
and significant assets outside of the trust for her benefit. The trustees had
distributed all income and had made significant principal distributions to
the beneficiary. The trustees did refuse a request for a principal
distribution from the guardian of the beneficiary’s estate (during her
incapacity). The trial court compelled the trustee to make the distribution.
On appeal, the Virginia Supreme Court held that the trustee properly
exercised its authority. The Court noted: “has substantial personal assets
available for satisfaction of her debts and for payment of her future
medical costs as well as a competent guardian to oversee these assets.”
The Court indicated that a trustee may be compelled to distribute assets to
a beneficiary if the beneficiary had few or no other assets available.30
iv. In some states, if a gift to the beneficiary is conditioned on need -- for
example if the trustee is directed to make distributions "for a beneficiary's
support as it deems necessary" or "as the beneficiary needs" or "if there is
an insufficiency" -- then the beneficiary's outside assets and income must
be considered. See Boston Safe Deposit & Trust Company v. Boynton,
443 N.E.2d 1344 (Mass. App. 1983); Matter of Martin, 269 N.Y. 305
(1936); Matter of A. David Bernstein, NYLJ, December 7, 1988, p.26;
Stempel v. Middletown Trust Co., 15 A.2d 305 (Conn. 1940); In re
Tuthill's Will, 76 N.W.2d 499 (Minn. 1956); In re Martin's Will, 199 N.E.
491 (NY 1936); In re Seacrist's Estate, 66 A.2d 836 (Pa. 1949).
1. However, this is not a hard and fast rule, and in many cases the
courts have not required the trustee to consider the beneficiary's
other resources although the terms "as needed" or "necessary"
were attached to the standard of distribution. See Cross v. Pharr,
221 S.W.2d 24 (Ark. 1949); Hamilton National Bank of
Chattanooga, Tennessee v. Childers, 211 S.E.2d 723 (Ga. 1975);
McClintock v. Smith, 29 N.W.2d 248 (Iowa 1947); Sibson v. First
National Bank & Trust Co. of Paulsboro, 160 A.2d 76 (N.J.
Super. 1960); In re Stern's Will, 228 N.Y.S.2d 90 (1962).
2. Some courts have found that where the trustee was directed to pay
income and principal as needed for the support of the beneficiary,
the beneficiary's other income, but not his other assets, should be
30
See also Smith v. Gillikin, 201 Va. 149, 154 (Va. 1959)(“The situation falls within the principle that HN4a
trustee, in determining whether to make expenditures under a discretionary trust for support, is entitled to take into
consideration other means of support available to the beneficiary.”) This earlier case indicates that a trustee may
always take into consideration other assets. The more modern approach, represented by NationsBank, may be to
determine the appropriate course of action from the testator’s intent.
66
considered. Peoples Bank & Trust Co. v. Shearin, 219 S.E.2d 299
(N.C. App. 1975); Sibson V. First National Bank & Trust Co. of
Paulsboro, 165 A.2d 800 (N.J. Super. 1960).
v. Some courts have held that if the trustee is granted broad discretion in
making distributions, the trustee is permitted to consider the beneficiary's
other assets.
1. In one case, a standard which authorized the trustee to make
distributions of principal which she "in her sole discretion,
determines necessary for the support and maintenance" of the
beneficiary allowed the trustee to consider the beneficiary's other
assets. The Pennsylvania Superior Court held that such a broad
grant of discretion indicated that the trustee had the authority to
withhold trust principal from a beneficiary with independent
resources. In re Estate of Tahjian, 544 A.2d 67 (Pa. Super. 1988).
2. However, in a New York case involving similar language, the
court held that the trustees should not require the beneficiary to
use his personal assets for support before looking to the trust
assets. In that case, the trustees were authorized to distribute as
much of the trust income to the beneficiary as they in their sole
discretion deemed advisable to supplement an annuity that the
settlor gave to the beneficiary. Matter of Estate of McNab, 558
N.Y.S.2d 751 (1990).
vi. If the grantor directs the trustee to consider the beneficiary's "other
resources," there is still a question of which resources it may or must
consider. In some circumstances, the grantor may want to specify whether
the trustee is to consider only the beneficiary's liquid assets, or the
beneficiary's entire estate, including non-liquid assets such as the
beneficiary's home.
vii. The grantor may also want the trustee to consider the income tax
consequences to the beneficiary if the beneficiary must liquidate her own
assets to meet expenses and incur capital gains tax.
viii. To give the trustee the maximum amount of flexibility in this matter, the
grantor can authorize the trustee to consider a beneficiary's outside
resources, but explicitly provide that those assets need not be considered.
In one New York case, the court interpreted the following language in a
marital trust: "In exercising this discretionary power [to invade principal],
my corporate trustee may but need not consider any other resources of my
said husband." The court found that the trustee could, but was not
required to, consider the husband's other income and assets. Matter of
Payson, NYLJ, June 20, 1989, p. 26.
67
c. Establishing Priorities
i. Unequal Distributions
1. Where there are multiple current beneficiaries of a trust, and the
trustee is not given discretion to make unequal distributions to
those beneficiaries, there is a presumption that the beneficiaries
should receive equal distributions from the trust.31
The
presumption is based on the trustee's fiduciary duty to treat
beneficiaries impartially.
2. The fact that the beneficiaries are in different financial
circumstances may justify unequal distributions even absent
specific authority. However, as discussed later in this outline, the
trustee may not be able to take into account the beneficiaries'
other resources unless the trust instrument permits the trustee to
do so.
3. If the client wishes to give the trustee the power to distribute
unequal amounts to beneficiaries or to favor one group of
beneficiaries over another, the trust agreement should specify that
unequal distributions are permitted.
Sample Language: The trustee may make unequal distributions to
the descendants of the child or may at any time make a
distribution to fewer than all of them, and shall have no duty to
equalize those distributions.
ii. Priority Among Beneficiaries
1. The settlor may also wish to establish priorities among the
beneficiaries in a trust benefitting multiple generations.
Sample Language: My primary concern during the life of the
child is for the child's health, support and education and the
trustee need not consider the interest of any other beneficiary in
making distributions to the child for those purposes under this
paragraph.
2. Priorities can be made more explicit by providing that all income
is to be paid to one beneficiary except for the amount not required
for the beneficiary's support, and that only the excess may be used
for other beneficiaries.
Sample Language: Commencing with the death of the last to die of
me and my spouse, the trustee shall pay all of the net income of the
31
Bogert § 182.
68
trust to my child during his or her life. Notwithstanding the
foregoing, whenever the trustee may determine that the income of
the trust is partially or wholly in excess of that required for my
child's support and health needs, considering his or her standard
of living at my death and all other income available from time to
time for such purposes, then the trustee may in its discretion
withhold part or all of such excess income. Income not paid to my
child may be paid in whole or in part to any one or more of his or
her children, living from time to time, in such equal or unequal
proportions as the trustee determines to be desirable for the
support, education, health needs and best interests of each of them.
Income not paid out may in the discretion of the trustee be added
to principal from time to time.
d. Making Gifts
i. It is often uncertain whether a particular standard of distribution, such as a
best interests standard, will allow the trustee to make distributions to a
beneficiary for the purpose of allowing the beneficiary to make gifts.
Often distributions for this purpose are desired in order to allow a
surviving spouse to make gifts to children or grandchildren from property
held in the marital trust.
ii. In one case, the trustees were given the power to invade principal under
the following standard: "As in the absolute discretion of my Trustee shall
be appropriate and to the best interest of my wife. . . . In determining
whether or not to make these encroachments, my Trustee shall be liberal if
it considers that an actual need or reasonable request of my said wife is
involved." The South Carolina Supreme Court refused to allow the trustee
to distribute principal to the wife in order to permit her to make gifts to her
children. The court found that principal could be invaded only if it were
to be used for the wife's own welfare. In re Estate of Howard, 235 S.E.2d
423 (S.C. 1977).
iii. Similarly, the trustee was prohibited from distributing principal to the
beneficiary of a marital trust where the will authorized distributions "for
the spouse or for her use." Matter of Mandel, 46 Misc. 2d 850, 261
N.Y.2d 110 (1965).
iv. In yet another case, a trustee did not have the authority to distribute
principal to a beneficiary to allow her to make gifts to relatives where the
trust instrument gave the trustee power to distribute principal to the
beneficiary for her needs. Flowers v. Collins, 357 S.W.2d 179 (Tex. Civ.
App. 1962) (dismissed for error).
v. A Connecticut trustee was authorized to invade principal "for any reason
in its discretion for the benefit of" the beneficiary. At the request of the
69
beneficiary, the trustee distributed the entire trust principal to the
beneficiary, to be used by the beneficiary to support his stepchildren. The
court construed the term "benefit" broadly, to include anything that
worked to the "advantage, gain or happiness" of the beneficiary, and
concluded that the distribution of principal to allow the beneficiary to
support his stepchildren was for the benefit of that beneficiary. Ewing v.
Ruml, 892 F.2d 168 (2d Cir. 1989).
vi. The Illinois Supreme Court has construed the terms "comfort and
satisfaction" to allow the trustee to distribute principal to the testator's wife
to allow her to continue a program of charitable contributions. Rock
Island Bank & Trust Co. v. Rhoads, 353 Ill. 131, 187 N.E. 139 (1933).
vii. Trust language which defines the best interests of a beneficiary as
including distributions for benefit of the beneficiary's descendants would
allow the beneficiary to make gifts of trust property.
-i-