Designing a trust entails understanding a settlor's aspirations, wishes and objectives and melding them into an organisational regime that can endure through many generations. The design process requires an understanding of trust law – an area of law that is continuously evolving – as well as tax law and ancillary legal matters. Thankfully, for the international private client, numerous US and non-US jurisdictions have progressive trust laws to provide an array of flexible options.
Trust design involves many facets. This chapter explores several key aspects of modern trust design. Specifically, it considers the following questions:
- What is the optimal governance structure for the trust?
- How can a family-controlled entity play a role in the governance structure?
- How can we preserve settlor intent?
- What are the appropriate dispositive terms?
- What is the appropriate duration for the trust?
- How can we mitigate litigation risks?
Each of those questions focuses on an essential part of a trust. Addressing each question involves thoughtful legal drafting, as well as strategic situs selection.
II TRUST GOVERNANCE MODELS
The design of a trust's internal governance is one of the most important aspects of trust design. The governance structure determines who is responsible for each aspect of administering a trust.2 There are three primary functions of a trustee: distributing trust property to beneficiaries, investing trust property and administering the trust. There are four governance models to utilise the three primary trustee functions:
- unitary trustee;
- directed trust;
- divided trust; and
- hybrid model.
These models represent an evolutionary progression. This evolution began with the unitary trustee model, which was the original governance model. The directed trust subsequently emerged in an effort to improve upon the unitary trustee model. Likewise, the divided trust evolved from the directed trust. Although it can potentially be a sensible design in some cases, the hybrid model tends to be an evolutionary anomaly. This evolutionary progression has been more pronounced in the leading US jurisdictions.
i Unitary trustee
In the unitary trustee model, the trustee is vested with all of the trustee powers (distributions, investments and administration). The unitary trustee model is the traditional model. In its simplest form, one trustee is vested with all of those powers. A trust, however, may have two or more co-trustees. If there is more than one trustee, the trustees share the trustee powers and collectively must decide how to exercise each of those powers together.
The mechanism for a named trustee of a unitary trust to divvy up responsibility for performing various powers is to delegate such powers to a co-trustee or to one or more agents. For example, a trustee may delegate investment powers to a professional investment manager. A delegation must be prudent and the trustee making the delegation must monitor the delegatee, ensuring that the delegatee is acting within the scope of the delegation and ensuring that the delegatee is acting prudently. Thus, a trustee who delegates powers does not fully absolve himself or herself of liability arising from the exercise (or non-exercise) of the delegated power. To the extent that the delegation may have been imprudent or the trustee fails to adequately monitor the delegatee, the trustee is potentially liable for any harm caused by the delegatee.
Certain powers, however, are non-delegable. Notably, a trustee generally cannot delegate the power to make discretionary distributions. In some instances, a power is non-delegable because its delegation contravenes the settlor's intent. For example, a settlor may have specifically appointed a person as trustee based on the person's particular experience or expertise – such as in managing a business – expecting that the person would personally exercise the related powers. In such instances, the trustee cannot delegate the powers that the settlor intended the trustee to exercise personally. The trustees are always responsible for participating in the exercise of non-delegable powers.
The principal advantage of a unitary trustee model is its simplicity. In many cases, a single trustee or a small number of cotrustees can efficiently administer a trust. As a rule, those trusts involve uncomplicated family situations and uncomplicated trust holdings. For those trusts, a more complex governance structure – in which trustee powers are assigned to two or more persons – may be unwarranted.
The unitary trustee model's simplicity is its weakness in more complex situations. The unitary trustee model tends not to be well suited for trusts involving complicated family situations or complicated trust holdings. For those trusts, the ability to divide trustee powers among two or more persons – and partially or fully insulate each of those persons from liability for another person's misfeasance or malfeasance – can promote more efficient trust administration and more efficacious fulfilment of the settlor's intent. Unlike other trust governance models, the unitary trustee model does not allow the assignment of a defined set of trustee powers to a specific person and the power to delegate does not fully protect the delegating trustee from liability.
ii Directed trusts
In a directed trust, the trustee is vested with all of the trustee powers, but, with respect to certain powers, the trustee only acts in accordance with another person's direction. For example, a person other than the trustee may have the power to direct the investment of the trust property, whereupon the trustee only invests trust property in accordance with such direction. Depending on the being exercised, the person who has the power to direct the trustee may be the settlor, a beneficiary or another person and is typically referred to as an Investment Advisor or Distribution Advisor.
A directed trust offers the potential benefit of assigning trust powers to two or more persons in a manner that better achieves the trust's purposes. At least in theory, if not always in practice, a directed trust allows a settlor to assemble a team of persons who are collectively better able to achieve the trust's purposes than a single trustee. A settlor may wish to appoint an institutional trustee to make decisions concerning discretionary distributions and handle administrative matters, such as record-keeping, reporting and tax compliance. The settlor, however, may prefer to have someone else – perhaps an investment management firm with which he or she has a long relationship (or even the settlor) – manage the trust property. A directed trust allows the settlor to create that structure for governing the trust's internal affairs.
A directed trust avoids the limitations associated with delegation. A trustee generally cannot delegate its discretionary distribution power, because the power is generally viewed as a non-delegable trustee power. With a directed trust, a person other than the trustee can have the power to direct the trustee to make distributions. A directed trust mitigates the risks associated with delegation. If the trustee does not have any duty to monitor the powerholder, then the trustee in fact may avoid those risks altogether. A trustee can delegate only to the extent that the delegation is prudent, and the trustee has an ongoing duty to monitor the delegatee. Thus, for example, a trustee may be reluctant to delegate investment powers to a beneficiary who lacks investment management skill or experience. With a directed trust, the trustee is not selecting the person exercising a specific power and thus is not liable for an imprudent selection. For example, the trust deed may specify that a beneficiary has the power to direct the trustee concerning the investment of the trust property.
A directed trust poses some administrative inefficiencies, and depending upon the applicable law, it may not eliminate the trustee's liability with respect to the exercise or non-exercise of powers that another person holds. With a directed trust, the trustee is in the middle of the action. A powerholder directs the trustee to take a certain action – say, make an investment – and the trustee generally must act in accordance with the direction. This two-step process – direction and action – is administratively less efficient than an arrangement in which the decision-maker is also the person taking the action. That said, having the trustee in the middle of the action helps ensure the cohesive organisation of documents and trust information. Because the trustee is in the middle of each action, the trustee remains an attractive target when something goes wrong. A disgruntled beneficiary is likely to argue that the trustee should have taken steps to prevent the alleged harm caused by the powerholder's action or failure to act, or at least taken steps to warn the beneficiary. A trustee, in fact, may be tempted to communicate to the powerholder its concerns about the powerholder's actions; as illustrated by the Mennen case, succumbing to that temptation may invite questions about whether the trustee assumed certain duties to the beneficiaries.3 A well-drafted trust will anticipate this reality and make clear that all liability and responsibility for various decisions rests with the person making the decision and not with the trustee carrying out the decisions and that the trustee has no liability or responsibility whatsoever for carrying out various directives.
Some critics assert that directed trusts (and divided trusts) eviscerate the concept of a trust. By shifting the decision-making about distributions or investments from a trustee to a person who may or may not be a fiduciary or who may or may not have any liability exposure under the terms of the trust, there may be no one who can be held accountable if something goes awry. This criticism is more properly directed towards the design of specific trusts, rather than a broadside against the governance model. Directed trusts (and divided trusts) are not immune from poor design and poor implementation. While not all trusts are drafted this way, it is the author's belief that any person carrying out one of the three fundamental trustee powers (distributions, investments or administration) should be a fiduciary.
In most jurisdictions that allow them, directed trusts (and divided trusts) are largely creatures of statute, reflecting a legislative intent to shape the evolution of the concept of trusts. In those jurisdictions, the assertion that directed trusts (and divided trusts) impermissibly deviate from the fundamental concept of trusts is at best weak.
Some critics also complain that directed trusts (and divided trusts) create confusion, because two or more persons are involved in administering the trust and sometimes it can be unclear who is responsible for what. Here again, the criticism is more properly directed toward the design of specific trusts, rather than a broadside against the governance model. In some circumstances, a unitary trustee governance model is optimal. For example, the unitary trustee model is often perfectly adequate for a trust that only holds a modest portfolio of publicly traded securities. As the complexity of the trust's objectives and the value of the trust property increases, however, a more sophisticated governance model usually is warranted.
In non-US jurisdictions, the reserved powers trust is an example of a directed trust. The Bahamas, Bermuda, the British Virgin Islands, the Cayman Islands, Guernsey and Jersey recognise reserved powers trusts. Under the statutes recognising reserved powers trusts, the settlor generally may reserve certain enumerated powers. In Bermuda, for example, a settlor may reserve the power to direct the distribution of trust property, the power to add or exclude beneficiaries, and the power to direct the investment of trust property.4
In some non-US jurisdictions, the statutes recognising reserved powers trusts recognise the 'reservation' of powers to a person other than the settlor, such as a protector or beneficiary. Bermuda is an example. In contrast, in other non-US jurisdictions, it can be unclear whether, during the settlor's life, a person other than the settlor may have one or more of the powers and whether, upon the settlor's incapacity or death, another person can succeed the settlor in possessing and exercising a power that the settlor had reserved to himself or herself.
Leading US jurisdictions
The leading US jurisdictions recognise directed trusts. Delaware, New Hampshire and South Dakota have comprehensive statutes governing directed trusts.5 Notably, each of those states ring-fences the trustee's and the powerholder's respective powers and duties, such that a trustee does not have any duty to monitor a powerholder's conduct, advise the powerholder, or warn a beneficiary concerning any matter in which the trustee might exercise a power in a different manner from the powerholder. To the extent that the terms of the trust provide that a trustee must follow another person's direction, the trustee is not liable for acting in accordance with that direction and is not liable for the powerholder's other acts or omissions.
Delaware, New Hampshire, and South Dakota notably recognise trust protectors. A trust protector is a person who is not a trustee, but who has one or more trust powers, typically the power to remove and appoint trustees, to veto distribution or investment decisions, and to amend the trust.
Other US jurisdictions
Many other US jurisdictions recognise the power to direct, but the statutory authority fails to address many critical issues. The Uniform Trust Code, which a majority of states has adopted in some form, recognises the power to direct, unless the direction is manifestly contrary to the terms of the trust or the direction is a serious breach of a fiduciary duty that the powerholder owes to the trust's beneficiaries.6 Thus, a trustee has a duty to monitor the powerholder's exercise of the power to direct and make an independent assessment of whether the exercise is proper. The trustee likely also has a duty to warn the beneficiaries if it determines that the exercise or non-exercise of the power to direct may be improper or otherwise may be detrimental to their interests. For many trustees, the imposition of those ongoing duties is unattractive because the directed trust does not lessen the trustee's potential liability.
Most US jurisdictions do not statutorily recognise trust advisers and trust protectors, and there is a dearth of common law concerning those roles. In the absence of developed law in those jurisdictions, there is considerable uncertainty concerning the nature and scope of the duties and powers that a person designated as a trust adviser or trust protector may have. Depending upon the nature and scope of the powers with which a trust adviser or trust protector is vested under the terms of a trust, a court could potentially conclude that the trust adviser or trust protector is a de facto trustee. Florida does not statutorily recognise trust advisers or trust protectors; however, in a 2015 case, a Florida appellate court recognised the role of a trust protector, concluding that the trust protector's limited role as defined by the terms of the trust was a proper manifestation of the settlor's intent.7 California and New York do not statutorily recognise trust advisers or trust protectors.
In 2017, the Uniform Law Commission approved the Uniform Directed Trust Act, a uniform act governing directed trusts. The Uniform Law Commission is an association of academics and practitioners who work to develop model laws that US states can adopt. In 2018, New Mexico became the first state to adopt the Uniform Directed Trust Act, followed by Georgia, Indiana, Colorado, Maine, Nebraska, Connecticut, Michigan, Utah, Arkansas, Washington, West Virginia and Virginia. As other states adopt that Act, the use of directed trusts will likely become even more widespread.
US tax considerations
The settlor's retention of powers can have US income, gift and estate tax implications. The settlor's retention of certain powers may cause the trust to be classified as a grantor trust for US income tax purposes,8 which means the settlor is the deemed owner of the trust property and is taxable on the income and capital gains derived from that property. The settlor's retention of certain powers may also cause the trust property to be includible in the settlor's gross estate for US estate tax purposes,9 most notably, the power to make distributions not subject to an ascertainable standard. Although there is more flexibility in designing a trust in which a beneficiary has the power to direct, potential income, gift and estate tax issues lurk there too. In addition, if a non-US person possesses a power to direct, the trust may be classified as a non-US trust for US income tax purposes.10 For US income tax purposes, a trust that is classified as a non-US trust is taxable only on certain US-source income. In light of the various tax issues, the settlor and his or her advisers must take care in structuring a directed trust in a manner that avoids undesirable tax consequences.
iii Divided trusts
The divided trust is an increasingly popular governance model. The divided trust entails the division of trustee duties and powers among one or more trustees and other persons. Like a directed trust, a divided trust is a multiparty governance structure.
A divided trust empowers each person who is a part of the trust's governance to take direct action. In contrast, in a directed trust, a powerholder acts indirectly, directing the trustee to take a specific action.11 In a divided trust, each powerholder acts independently and acts directly. For example, the settlor may serve as investment trustee in a divided trust and have the power to invest the trust property without directing a trustee (in a directed trust) to carry out such investment decisions.
Divided trusts share the advantages of directed trusts, but generally are more efficient to administer, because each person involved in the trust's governance can act directly. In addition, a divided trust potentially better insulates a trustee from liability, because the trustee is not involved in another person's exercise of a distribution power, investment power, or other trustee power.
Divided trusts generally share the disadvantages of directed trusts, except that divided trusts generally avoid the administrative inefficiencies inherent in directed trusts. Divided trusts can be more challenging to draft than directed trusts. In a directed trust, the trustee is vested with all of the trust powers, so the trustee unilaterally can exercise any power to the extent that another person does not have the power to direct the trustee with respect to that power. In a divided trust, there is a risk that the drafting attorney will fail to assign a trust power to a person. Another disadvantage is that with various advisers and trustees operating independently of each other, there is the potential for a lack of centralised organisation and record keeping, whereas with a directed trust, everything flows through the trustee, who typically has responsibility to, among other things, keep detailed records about the administration of the trust.
Although leading US jurisdictions are the vanguard of this evolutionary development of trust law, many non-US jurisdictions have at least partially embraced the concept of divided trusts. For example, the Cayman Islands allows a settlor to grant certain powers to another person.12 Those powers may include powers to revoke the trust, vary or modify the terms of the trust, distribute trust property, and change the trust's situs. The Bahamas, Bermuda, Jersey and Guernsey have enacted similar laws.13
Leading US jurisdictions
The leading US jurisdictions recognise divided trusts. Delaware, New Hampshire and South Dakota have comprehensive statutes governing divided trusts.14 Notably, each of those states generally ring-fences the powers, duties and liabilities of the trustees, trust advisers and trust protectors.
New Hampshire's highest court was the first US court that expressly upheld divided trusts. In the Tamposi case decided in 2013, the New Hampshire Supreme Court affirmed the division of investment and distribution powers between two classes of trustee, which, under the terms of the trust, were called 'investment directors' and 'trustees'.15 In that case, the trustee had the power to make distributions, and the investment directors had the exclusive power to invest and manage the trust property. One of the settlor's daughters sued both the trustee and investment directors for breach of trust, alleging in part that the investment directors had improperly managed the trust property. In construing the terms of the trust, the court concluded that the trustee did not have any duty with respect to investment matters, because the investment directors were exclusively vested with the investment powers. The court similarly concluded that the investment directors did not have any duties with respect to distributions, because the trustee was exclusively vested with the discretionary distribution powers.
Other US jurisdictions
Nevada, Tennessee and Wyoming recognise divided trusts. In many other US jurisdictions, like California, Florida and New York, the statues lack clear authority for divided trusts.
In 2017, the Uniform Law Commission approved the Uniform Directed Trust Act, a model act governing directed and divided trusts. In 2018, New Mexico adopted the Act, followed by Georgia, Indiana, Colorado, Maine, Nebraska, Connecticut, Michigan, Utah, Arkansas, Washington, West Virginia and Virginia. Other US jurisdictions will likely follow. Accordingly, the use of divided trusts will likely become more commonplace throughout the US.
US tax considerations
The division of trust powers can affect the trust's status for US income tax purposes, and it can affect whether the person vested with certain powers may be subject to US income, gift and estate taxes. Accordingly, the settlor and his or her advisers must take care in structuring a divided trust in a manner that avoids undesirable tax consequences.
iv Hybrid governance model
A hybrid governance model incorporates elements of a directed trust and a divided trust. For example, a trust instrument may grant to a person the power to direct the trustee to make distributions, while granting to another person the exclusive power to manage the trust property. Too often, a hybrid governance model arises by accident, as the product of inartful drafting. A drafting attorney may attempt to create a divided trust using a directed trust as a form but fail to address fully the division of the trust powers.
III USE OF FAMILY-CONTROLLED ENTITIES IN TRUST GOVERNANCE
Some families seek to include family-controlled entities in the governance structure of the family's trusts. Those entities include a family-controlled holding company under a trust, non-bank trust advisers and trust protectors, and private trust companies.
i Holding companies
In both US and non-US jurisdictions, a common technique for enabling the settlor or other family members to control investments is the use of a holding company. The trust generally holds an operating cash account and an interest in the holding company. The trustee uses the operating cash account to pay trust expenses and make distributions, but the holding company holds the investments. The settlor or one or more family members serve as the directors or managers of the holding company and any subsidiary companies. In their capacity as directors or managers, the settlor and the family members control the investments.
The use of a holding company minimises the trustee's involvement in any investment activity, because the investment activity is occurring one or more levels below the trust. At the trust level, a key consideration is the waiver of the duty to diversify, so that holding an undiversified portfolio (an operating cash account and an interest in a holding company that may or may not hold a diversified portfolio) is not a breach of any fiduciary duties. In the case of a directed trust or divided trust, a person other than the trustee may be vested with the investment powers and thus would make any determination whether to retain the interest in the holding company. Most practitioners taking advantage of modern trust laws will specifically draft into the trust a waiver that allows the trustee to hold concentrated positions, thereby overriding the default duty to diversify under the prudent investor rule.
ii Non-bank advisers and protectors
New Hampshire and South Dakota expressly allow a non-bank company to act as a trust adviser or trust protector (i.e., possess certain trust powers).16 Those states have statutory safe harbours that, subject to certain conditions, permit a company to act as a trust adviser or trust protector without obtaining a charter as a bank or trust company. Coupled with a divided or directed trust, a non-bank trust adviser or trust protector enables a family to create a structure that generally emulates a private trust company, while avoiding the regulatory and compliance issues involved in forming and operating a private trust company.
New Hampshire has a safe harbour, which was enacted in 2017, that generally allows a corporation, limited liability company or foundation to act as a trust adviser or trust protector, so long as the company does not provide services to the general public. For example, instead of naming an individual to serve as a distribution adviser in charge of distributions of a trust, a settlor can name an LLC to serve as distribution adviser. So long as the entity does not provide services to the general public, the company does not need to register with the state's banking commission.
South Dakota's safe harbour allows the company to have a broad array of trust powers but requires the trustee to be a South Dakota-chartered bank or trust company or US-chartered bank with trust powers. In addition, South Dakota imposes a notice filing requirement. The entity acting as a trust adviser or trust protector must register with the state's banking commission and file an annual report with the banking commission.
Unlike New Hampshire and South Dakota, Delaware does not have a statutory safe harbour for non-bank companies that act as trust advisers or trust protectors. Nonetheless, some practitioners form Delaware companies that act in those capacities.
iii Private trust companies
A private trust company is a company that is qualified to exercise trust powers for the members of a family and their related trusts, companies and charities. A private trust company can be attractive because it enables a family to have a family-controlled institutional trustee for their trusts, develop governance and succession plans within a single entity (rather than across many trusts) and potentially develop a more professional system for administering the family's trusts and managing its wealth.
The Bahamas, Bermuda, the British Virgin Islands, the Cayman Islands, Guernsey and Jersey allow private trust companies.
Leading US jurisdictions
New Hampshire and South Dakota allow the formation of private trust companies.17 New Hampshire allows the formation of licensed and unlicensed private trust companies. South Dakota allows only the formation of licensed private trust companies.
A licensed (or regulated) private trust company is chartered and supervised by the state's banking commission. An unlicensed (or unregulated) private trust company is not subject to the supervision of the state's banking commission. A licensed private trust company generally is exempt from registration as an investment adviser with the US Securities and Exchange Commission (SEC). An unlicensed private trust company that provides investment advisory services generally must register as an investment adviser with the SEC, unless it qualifies for the family office exemption.18 The choice between a licensed private trust company and an unlicensed private trust company often turns on whether the family values the discipline that a state banking commission generally demands and the supervision that it imposes, as well as the need for an exemption from the regulation of the SEC.
New Hampshire does not require a private trust company to maintain an office within the state or impose any residency or citizenship requirements on its directors. Although maintaining an office in the state is unnecessary under New Hampshire law, it often is advisable for purposes of creating a sufficient nexus to take advantage of the state income tax or other advantages of New Hampshire law. Notably, New Hampshire also allows a private trust company formed in another jurisdiction, including a non-US jurisdiction, to operate within the state. In New Hampshire, a private trust company may be formed as a corporation, limited liability company or foundation.19
Like New Hampshire, South Dakota does not require a private trust company to maintain an office within the state.20 (Again, it may be advisable to do so.) Unlike New Hampshire, South Dakota requires a private trust company to have at least one resident director and requires at least one-half of its directors to be US citizens.21
New Hampshire and South Dakota require a licensed trust company to maintain at least $200,000 of capital.
Delaware does not allow the formation of private trust companies.
Other US jurisdictions
Florida, Ohio, Nevada, Tennessee and Wyoming allow the formation of licensed private trust companies. Each of those states require a licensed private trust company to maintain a minimum amount of capital. For example, the statutory minimum capital is US$250,000 in Florida, US$300,000 in Nevada and US$500,000 in Wyoming. Florida, Ohio, Nevada and Wyoming require a licensed private trust company to maintain an office in the state. In Nevada, a licensed private trust company must have at least one resident director.
Florida, Nevada, Ohio and Wyoming allow the formation of unlicensed private trust companies. Those states generally require an unlicensed private trust company to file initial and annual notices with the state banking commission; the regulatory requirements generally are more relaxed than those applicable to licensed private trust companies. Notably, however, Florida requires an unlicensed private trust company to maintain at least US$250,000 of capital and maintain an office within the state.
California and New York do not allow the formation of private trust companies.
IV SETTLOR INTENT
For some settlors, the preservation of his or her intent is critically important. Other settlors are less concerned with whether his or her specific wishes and mandates will be strictly applied to future generations, who will largely comprise individuals the settlors will have never met or known. Even for a settlor who counts himself or herself in that latter group – and in some ways more importantly, the trustees and other persons charged with administering a trust – the preservation of settlor intent is important, because it may affect the efficacy of the settlor's modification or waiver of certain duties, such as the duty to diversify or the duty to inform.
i Non-US jurisdictions
Compared to the leading US jurisdictions, non-US jurisdictions generally are less rigorous in protecting settlor intent. For example, many non-US jurisdictions allow the beneficiaries to terminate a trust. Subject to some variation, the Saunders rule is generally applicable in non-US jurisdictions.22 Under that rule, the beneficiaries of a trust can terminate the trust by unanimous agreement. Generally, all of the beneficiaries must be adults and must be competent.
ii Leading US jurisdictions
New Hampshire and South Dakota protect settlor intent. Within the US, New Hampshire may offer the strongest protection of settlor intent. New Hampshire's tradition of respecting settlor intent is long-standing, and it infuses the state's statutory regime. In Burtman, the state's highest court wrote, 'probably no jurisdiction has stood more steadfastly for giving effect to the intention of the [settlor] rather than to arbitrary rules of law than New Hampshire'.23 In Lowy, the court stated that, 'when we construe a trust, the intention of a settlor is paramount'.24 New Hampshire has incorporated this paradigm into its statutes. In interpreting or construing the terms of a trust, New Hampshire's statutes provide that, 'the settlor's intent shall be sovereign to the extent that the settlor's intent is lawful, not contrary to public policy, and possible to achieve'.25 Similarly, in applying and construing the New Hampshire Trust Code, New Hampshire's statutes provide that a court must give 'primary consideration . . . to the preservation of the settlor's intent as expressed in the terms of the trust'.26 In addition, New Hampshire eliminated the benefit of the beneficiary rule under the uniform trust code that requires a trustee to administer trusts in the best interests of the beneficiaries. Instead, settlors can create trusts in New Hampshire with confidence that their wishes will be fulfilled. Other states that have similarly repudiated the benefit of the beneficiaries rule are: Ohio, Georgia, New Jersey, Mississippi, Minnesota, Colorado and Florida.
iii Other US jurisdictions
US jurisdictions have historically rejected the Saunders rule. Instead, US jurisdictions have generally applied the material purpose test that was articulated in Claflin.27 Under that test, the beneficiaries could not terminate a trust so long as the trust's continuation was necessary to achieve a material purpose of the trust. More recently, many US jurisdictions have adopted a variation of the Saunders rule, allowing the modification or termination of a trust even if the modification or termination would violate a material purpose of the trust. In some states, the settlor's agreement is necessary to modify or terminate a trust in violation of a material purpose of the trust. Many US jurisdictions have also adopted (or at least have not expressly rejected) the benefit-of-the-beneficiary rule, which elevates the beneficiaries' interests over settlor intent.28
V DISPOSITIVE TERMS
i Discretionary distributions
Discretionary distributions provide flexibility to address changing circumstances. With discretionary distributions, the trustee can make distributions – and, importantly, refrain from making distributions – as appropriate based on the beneficiaries' circumstances at the time. So long as property remains in a (properly designed) trust and distributions are discretionary, the property is generally outside the reach of a beneficiary's creditors and, in the case of a person subject to US estate taxes, potentially excluded from his or her gross estate for US estate tax purposes.29 In addition, with discretionary distributions, a trustee is able to refrain from making distributions that may support a beneficiary's addictive behaviours (e.g., gambling or substance abuse). In the context of a divorce, for example, a beneficiary's right to receive a mandatory income distribution may be treated as marital property and, thus, subject to division.
A fully discretionary trust enables the trustee to invest for total return. A trust that contains mandatory income distributions generally forces the trustee (or whoever has investment powers) to invest the trust property in a manner that generates reasonable income, which may be less than the income generated by a portfolio invested for total return.
Some settlors may be uncomfortable leaving the important distribution power of trust assets to the full discretion of a trustee. In those circumstance, one option that a settlor may want to consider is a side letter of wishes that gives suggestions about distributions. New Hampshire has a statute specifically discussing letters of wishes and their enforceability.30
ii Power to add beneficiaries
The power to add beneficiaries can provide additional flexibility. The use of the power is more common in trusts that have situs in non-US jurisdictions. The less frequent use of the power to add beneficiaries in a US-situs trust likely stems from the attitudes of settlors and their advisers towards control. A well-designed trust deed, however, can include effective checks and balances so that the exercise of a power to add beneficiaries does not derail the trust's purposes while providing the additional flexibility that can help to ensure that the trust achieves the settlor's objectives in the face of changing circumstances.
In the US, there are potential tax implications if the trust deed includes a power to add beneficiaries. The trustee's power to add beneficiaries will cause the trust to be classified as a grantor trust for US income tax purposes (subject to additional conditions if the settlor is not a US person).31 Thus, the settlor would be taxable on the trust's income and gains. That result is often desirable, because it can yield more tax-efficient wealth transfer after taking into account US gift and estate taxes.
VI TRUST DURATION
In many jurisdictions, a settlor can create a perpetual or quasi-perpetual trust. The practical effect of perpetual trusts is the elimination of an arbitrary limit on the duration of trusts. Without any limit on a trust's duration, a settlor can allow the trustee to determine the proper time to terminate a trust, taking into account the beneficiaries' circumstances and the costs of administering the trust. For example, the trustee can refrain from making a terminating distribution at a time when a beneficiary is emotionally or financially immature, is suffering injurious addictive behaviours, such as gambling or substance abuse, or faces the likely loss of the distributed property to spousal claims, creditor claims or taxes. By its nature, a multigenerational trust will likely reach practical limitations on its efficient administration. As the beneficiary class expands from generation to generation, the trust may become too unwieldy to administer, or it may divide into many subtrusts that are economically inefficient to administer. In either case, the lack of any limitation on the trust's duration enables the trustee to assess the administrative costs and complexities and terminate the trust when those costs and complexities outweigh the advantages that the trust offers.
i Non-US jurisdictions
The Bahamas, Bermuda, Guernsey and Jersey allow trusts of unlimited duration. The British Virgin Islands allows a purpose trust of unlimited duration but limits the duration of a non-charitable trust to 360 years. The Cayman Islands allows a STAR trust (its form of purposes trust) of unlimited duration but limits the duration of a non-charitable trust to 150 years.
ii Leading US jurisdictions
New Hampshire and South Dakota allow trusts of unlimited duration. Delaware allows a trust of unlimited duration, except to the extent that the trust directly holds real property. Delaware limits the duration of a trust that directly holds real property to 110 years. Through proper planning, Delaware's durational limitation on trusts holding real property is avoidable. The limitation does not apply to a trust to the extent that the trust indirectly holds real property, such as through a limited liability company or partnership.
iii Other US jurisdictions
Nevada limits the duration of trusts to 365 years, Tennessee limits their duration to 360 years and Wyoming limits their duration to 1,000 years. A recent scholarly article, however, questions the validity of those states' statutes allowing for quasi-perpetual trusts.32 In each of those states, the state constitution expressly prohibits perpetuities. The article's authors assert that the statutes purportedly allowing quasi-perpetual trusts violate those constitutional prohibitions, because the statutes deviate too substantially from the traditional limits on the deferred vesting of property interests. If their analysis is correct, trusts created under those statutes may be limited in duration by the rule against perpetuities or may possibly be invalid.
In Bullion Monarch Mining Inc, Nevada's highest court held that the rule against perpetuities does not apply to a royalty provision in a commercial contract.33 In the opinion, the court mentions the 365-year period applicable to trusts, and it recognised the legislature's role in articulating current public policy. The ruling may give some people comfort. The court, however, did not expressly address whether, as it applies to trusts, the statutory 365-year rule is valid under the state's constitution.
California and Massachusetts continue to apply the rule against perpetuities but have adopted wait-and-see statutes that mitigate the rule's harsh effects. New York applies the rule against perpetuities.
VII DISPUTE MITIGATION AND RESOLUTION
i Governance structure
The design and implementation of the governance structure plays a critical role in mitigating disputes. The trust deed should specify the qualifications of trustees, trust advisers, trust protectors and enforcers. An inexperienced trustee, trust adviser, trust protector, or enforcer can wreak havoc with a trust. A governance structure that includes appropriate checks and balances helps to keep the trustees, trust advisers, trust protectors, and enforcers attentive and, as appropriate, accountable. A trust's governance structure should include procedures for removing and appointing trustees, trust advisers, trust protectors and enforcers. In some trusts, term limits and age limits are beneficial. A settlor may retain the right to remove and replace a trustee so long as the appointed trustee is not related or subordinate to the settlor.
ii No-contest provisions (forfeiture provision)
A no-contest provision is a provision that terminates a beneficiary's interest in a trust if the beneficiary contests the trust or the trustee's actions. A no-contest provision – also called an in terrorem clause or forfeiture provision – can serve as a deterrent to litigation.
A no-contest provision changes the economic calculus. This may be especially true in the US, where, in the absence of a no-contest provision, a beneficiary's downside cost of contesting a trust may be limited to the beneficiary's own legal fees. In some US jurisdictions, that cost may be nearly nil, because some attorneys are willing to pursue trust contests on a contingency fee basis and financing for trust litigation is becoming more available, collecting a fee only if the attorney succeeds in obtaining some financial benefit for the beneficiary. With a no-contest provision, the beneficiary's economic analysis changes. The beneficiary's downside cost is the loss of his, her or its interest in the trust. Thus, a rational beneficiary must have a higher degree of confidence in his, her or its claim. Of course, not all beneficiaries are rational, and a beneficiary who unsuccessfully challenges a trust that contains a no-contest provision and consequently loses his or her interest in the trust may turn on his or her advisers.34
In non-US jurisdictions, the enforceability of no-contest provisions in trust deeds is based largely on common law. The common law concerning the enforceability of no-contest provisions in wills is better established and has served as a foundation for the few cases involving trusts. The Cayman court enforced a no-contest provision in a trust deed in AN v. Barclays Private Bank & Trust (Cayman) Ltd35 and, more recently, in AB Jnr & Another v. MB & Others.36 In a 2014 case upholding the enforceability of a no-contest provision in a will, the Bermuda court favourably cited the AN case.37 The Bahamas statutorily recognises the enforceability of a no-contest provision that applies to a beneficiary who challenges the trust's validity.38
Leading US jurisdictions
Delaware, New Hampshire and South Dakota statutorily enforce no-contest provisions.39 Delaware and New Hampshire enforce a no-contest provision, even if the beneficiary acts in good faith or with probable cause in contesting the trust. Although a no-contest provision, which applies even if a beneficiary acts in good faith or with probable cause, is a strong deterrent against litigation, it may not be optimal trust design because it can severely restrict an effective check on the trust officials' conduct. In contrast to Delaware and New Hampshire, South Dakota will not enforce a no-contest provision against a beneficiary who acts in good faith or with probable cause in contesting the trust. In addition to its statutory enforcement of no-contest provisions, New Hampshire expressly authorises a trustee to suspend distributions to a beneficiary who may have violated a no-contest provision during the pendency of the 'contest'.40
Other US jurisdictions
Except for a few minor exceptions, California renders most no-contest provisions unenforceable.41 New York enforces no-contest provisions, although the enforceability is based on common law and not statute.42 In New York, the courts disfavour no-contest provision and thus narrowly construe them,43 and a no-contest provision likely is unenforceable to the extent that the beneficiary acts with probable cause in contesting the trust.44 Notably, Florida does not enforce no-contest provisions.45 Florida views a no-contest provision as contrary to public policy, because it limits a beneficiary's right to challenge a trustee's actions. Florida has codified its prohibition against the enforcement of no-contest provisions.
iii Non-judicial dispute resolution
Many wealthy families value privacy. Even families whose business or philanthropic interests expose them to significant public attention often wish to preserve the privacy surrounding their wealth and the manner in which they structure the disposition of that wealth. Thus, for many wealthy families, the private resolution of any trust disputes is an important aspect of trust design. In addition to avoiding the publicity that a judicial proceeding may entail, they wish to ensure that they have greater say in the qualifications of the individuals who decide any matters affecting the family's wealth.
Leading US jurisdictions
The leading US trust jurisdictions expressly recognise non-judicial dispute resolution provisions in trust deeds. In New Hampshire, non-judicial dispute resolution procedures are enforceable if the procedures are reasonable.46 Those procedures may govern any matter except the determination of a trust's validity or the determination of a trust's material purposes.47 Delaware and South Dakota also recognise non-judicial dispute resolution procedures.48
Other US jurisdictions
Other US jurisdictions generally do not expressly recognise non-judicial dispute resolution provisions in trust deeds. For example, California, New York and Wyoming do not statutorily recognise non-judicial dispute resolution provisions. In contrast, Arizona and Florida do.49
iv Lifetime approval of trusts
A settlor who anticipates the possibility of a dispute concerning the validity of his or her trust may value the ability to obtain a declaratory ruling affirming the trust's validity. For the settlor as well as the court, a key benefit of the settlor seeking the determination is the settlor's availability as a witness. In many instances, a challenge to a trust's validity arises after the settlor's death, at which point the best witness is unavailable. In the US, Delaware and New Hampshire statutorily allows a settlor to seek a court's determination of a trust's validity.50
1 Patrick Collins is the Senior Counsel of Perspecta Trust. The information in this chapter updates the work previously drafted by Todd Mayo.
2 For a discussion of the practical issues involved in crafting an appropriate governance structure for a trust, see Todd D Mayo, 'Trust Governance Models,' International Family Offices Journal, June 2017, pp. 28–38.
3 Mennen v. Wilmington Trust Co, No. 8432-ML (Del. Ch. 24 April 2015). The administrative trustee settled with the beneficiary before trial, so the court did not address whether the administrative trustee had assumed any investment-related duties.
4 Trusts (Special Provisions) Act 1989, Sections 2A(2)(c), 2A(2)(g) and 2A(2)(e).
5 Del. Code tit. 12, Section 3313; NH RSA 564-B:8-808 and NH RSA 564-B:12-1201 to NH RSA 564-B:12-1210; and SD Codified Laws Sections 55-1B-1 to 55-1B-11.
6 Uniform Trust Code Section 808(b) (2014). In 2017, the Uniform Law Commission promulgated the Uniform Directed Trust Act, which superseded Section 808 of the Uniform Trust Code. In 2018, the Uniform Law Commission deleted Section 808 of the Uniform Trust Code. Section 808 of the Uniform Trust Code, however, remains the basis for corresponding statute in many of the states that adopted the Uniform Trust Code before 2018.
7 Minassian v. Rachins, 152 So. 3d 719 (Fla. 4th DCA 2014).
8 26 USC Sections 671–679.
9 26 USC Sections 2031–2046.
10 26 CFR Section 301.7701-7.
11 In practice, some people bypass the trustee of a directed trust. Under the theory that the powerholder is acting as the trustee's agent or in some cases with less forethought, an accommodating trustee sometimes allows a powerholder to take the action directly (for example, taking the actions necessary to buy the asset). That approach is not without risk. The trustee may be breaching its fiduciary duties depending upon the terms of the trust and the applicable law.
12 Cayman Islands Trust Laws (2011 Revision), Section 14.
13 Bahamas Trustee Act 1988, Section 3; Bermuda Trusts (Special Provisions) Act 1989, Section 2A; Jersey Trusts Law 1984, Article 9A; Guernsey Trusts Law 2007, Section 15.
14 Del. Code tit. 12, Section 3313; NH RSA 564-B:8-808 and NH RSA 564-B:12-1201 to NH RSA 564-B:12-1210; and SD Codified Laws Sections 55-1B-1 to 55-1B-11.
15 Shelton v. Tamposi, 164 NH 490 (2013).
16 NH RSA 293-A:3.05 (relating to corporations), NH RSA 304-C:22-a (relating to limited liability companies), NH RSA 564-F:8-802 (relating to foundations) and NH RSA 383-C:12-1201 to NH RSA 383-C:12-1202; and SD Codified Laws Section 51A-6A-66.
17 For a general discussion of private trust companies, see Miles C Padgett, 'Private Trust Companies: A Practical Introduction to a Bespoke Solution', Investments & Wealth Monitor, January/February 2016, pp. 37–41.
18 See 15 USC Section 80b-2(a)(11)(G).
19 NH RSA 293-A:3.05 (relating to corporations), NH RSA 304-C:22-a (relating to limited liability companies), NH RSA 564-F:8-802 (relating to foundations) and NH RSA 383-D:5-501A(a)(3) (governing licensed private trust companies).
20 See SD Codified Laws Sections 51A-6A-11.1, 51A-6A-12 and 51A-6A-13 (governing trust companies other than private trust companies).
21 SD Codified Laws Section 51A-6A-13.
22 Saunders v. Vautier, EWHC Ch J82 (1868).
23 Burtman v. Butman, 97 NH 254, 258 (1952). Although the Burtman case involved the construction of a will, New Hampshire's courts take the same approach for settlor intent as they do for testator intent. Katz v. Katz, 104 NH 478, 481–482 (1963).
24 In re Lowy, 156 NH 57, 61 (2007). See also Shelton v. Tamposi, 164 NH 490 (2013).
25 NH RSA 564-B:1-112.
26 NH RSA 564-B:11-1101.
27 Claflin v. Claflin, 149 Mass. 19 (1889).
28 For a flavour of the academic debate on the benefit-of-the-beneficiaries rule, see Jeffrey A Cooper, 'Shades of Gray: Applying the Benefit-of-Beneficiaries Rule to Trust Investment Directives', 90 BUL Rev. 2383 (2010); and John H Langbein, 'Burn the Rembrandt?: Trust Law's Limits on the Settlor's Power to Direct Trust Investments', 90 BUL Rev. 375 (2010).
29 Pfannenstiehl v. Pfannenstiehl, 475 Mass 105 (2006).
30 NH RSA 564-B:1-113. For a good article on letters of wishes, see Grant Hendricks, 'Letters of Wishes: An Administrative and Moral Headache in Disguise?', X Nat'l L. Rev. 201 (2020)
31 26 USC Section 674.
32 Steven J Horowitz and Robert H Sitkoff, 'Unconstitutional Perpetual Trusts', 67 Vanderbilt Law Review 1769-1822 (2014). The authors also question the validity of similar statutes in Arizona and North Carolina.
33 Bullion Monarch Mining Inc v. Barrick Gold Strike Mines Inc, 345 P.3d 1040 (2015).
34 See, e.g., Tamposi v. Denby, 136 F. Supp. 3d 77 (D. Mass. 2015).
35 AN v. Barclays Private Bank & Trust (Cayman) Ltd  CILR 365.
36 AB Jnr & Another v. M.B. & Others (18 December 2012),
37 In the Matter of the Estate of PQR, Deceased  Bda No. 205.
38 The Bahamas Trustee Act, Section 87A.
39 Del. Code tit. 12, Section 3329; NH RSA 564-B:10-1014; and S.D. Codified Laws Section 55-1-46 to 55-1-51.
40 NH RSA 564-B:10-1014(f).
41 Cal. Prob. Code Sections 21310 to 21315. See also Whelan v. Sanford, 2017 BL 145888 (Cal. App. 1st Dist.) (unpublished opinion); and Colburn v. Northern Trust Co, 151 Cal.App.4th 439 (App. 2d Dist. 2007).
42 Matter of Nadler, 2017 BL 182054 (NY Sur. Ct.); and Matter of Stralem, 695 N.Y.S.2d 274 (Sur. Ct. 1999).
44 See N.Y. EPTL Section 3-3.5(b).
45 Fla. Stat. Section 736.1108(1). See also Dinkins v. Dinkins, 120 So.3d 601 (Fla. 5th DCA 2013).
46 NH RSA 564-B:1-111A.
48 SD Codified Laws Section 55-1-54.
49 Ariz. Rev. Stat. Section 14-10205 and Fla. Stat. Ann. Section 731.401.
50 Del. Code tit. 12, Section 1311; and NH RSA 564-B:4-406(d).