Trust and Future Interests

Question 1

Uniform Principal and Income Act (the Act)

Answer 1

Receipts earned during the administration of a trust are allocable either to income or to principal.

Under the Act, rents and cash dividends received from a corporation are allocable to income and are distributable to the income beneficiary of the trust.

Sales proceeds and dividends paid in the stock of the distributing corporation are allocable to principal and added to the principal of the trust.

Question 2

Rule of convenience principle

Answer 2

when a trust remainder is given to a class, the class closes when there is no outstanding income interest, and at least one member of the class is then entitled to demand possession of his or her share of the remainder. This principle is called the rule of convenience.

Question 3

A class member may demand possession of his or her share of the remainder upon termination of the income interest only when

Answer 3

the class member’s interest is not otherwise subject to a condition precedent.

Question 4

Beneficairy disclaims

Answer 4

when a beneficiary timely disclaims an interest in a trust, that beneficiary is treated as if he had predeceased the testator.

The common-law rule allows disclaimers (aka renunciations) at any time.

Question 5

when trust principal is not immediately distributable

Answer 5

the trustee must continue to hold trust assets until the ultimate remainder men are ascertained. During this period, trust income will be distributed or retained according to any instructions contained in the trust instrument.

Question 6

Three approaches when the testator does not specify what the trustee should do with trust income in the event the disclaimer does not comply with state statute

Answer 6

One approach would have the trustee distribute the trust income to the testator’s heirs on the theory that the income represents property that was not disposed of by the testators will and which thus passes by partial intestacy to the testators heirs.

A second approach would have the trustee accumulate trust income for distribution to the ultimate remainder men. Under this approach, only those individuals ultimately entitled to the principal would share in the income.

A third approach would have the trustee distribute trust income to those individuals who would be the reminder men if the trust were to terminate when the income is received by the trustee. This approach could result in individuals not ultimately entitled to pricinpal, say bc they do not survive the son, receiving income. It could also result in a disproportionate distribution of income among the individuals ultimately entitled to income

Question 7

Trust provisions that terminate a trust upon marriage

Answer 7

violate public policy and are void. Thrust provisions that restrain a first marriage have generally been held to violate public policy.

However, a restraint on marriage might be upheld if the trustee’s motive was merely to provide support for a beneficiary while the beneficiary is single.

Question 8

A trustee owes a fiduciary duty of loyalty to a trust

Answer 8

self dealing, such as a purchase of trust assets by the trustee in his individual capacity violates this obligation.

Under the “no further intuiry” rule, there is no need to insure into the motivation for the self-dealing transaction or even its fairness.

Any trust beneficiary can cause a self-dealing purchase by a trustee to be set aside or obtain a damages award.

Question 9

If the beneficiary elects to set aside the trasaction

Answer 9

the trust property purchased by the trustee is retuned to the trust and the amount the trustee paid for the property is refunded by the trust.

Question 10

if a beneficiary seeks damages

Answer 10

those damages are based on the difference in the fair market value of the trust assets at the time of the self-dealing transaction and the amount paid by the trustee.

Question 11

A trustee has a duty to invest trust assets in a prudent manner

Answer 11

a trustee shall administer the trust as a prudent person would using reasonable care, skill, and caution. One of the hallmarks of prudent investing is diversification. A balanced portfolio reduces aggregate risk by investing in different investment categories. Diversification thus is strong evidence of prudent investing.

Question 12

How to evaluate a trustees managemenet decisions

Answer 12

a trustees investment and management decisions respecting individual assets must be evaluated not in isolation but in the context of the trust portfolio as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the trust.

Question 13

The prudent investor rule applies to both

Answer 13

investment and management decisions.

Management includes monitoring; thus, the trustee has a duty to monitor investments prudently made to assure that retention of those investments remains prudent. if retention is not prudent, the trustee should sell the imprudent investments and reinvest the proceeds in prudent investments. a trustee, however, is not liable for declines in value due to a downturn resulting from general economic conditions

Question 14

A revocable trust includes the power to

Answer 14

modify or amend the trust instrument.

Courts have taken this position to avoid the triumph of form over substance; the contrary position would require a settlor who wants to amend a trust and lacks clear authority to do so to first revoke, and then to completely restate, the terms of the trust with the intended amendment.

Such cumbersome formalities should not be encouraged; thus, the power to revoke includes the power to amend.

Question 15

The Uniform Trust Code (UTC) S 6-2, a trust is both

Answer 15

revocable and amendable unless the trust instrument expressly provides otherwise. Under the UTC, the power to revoke or amend is exercisable by will unless, as here, the trust instrument provides otherwise.

Question 16

The donee of a special (non general) power can appoint the property over which the power is exercisable only to “permissible appointees” or “objects” of the power.

Answer 16

Permissible appointees are “the persons to whom an appointment is authorized.” Appointments to impermissible appointees are invalid. However, objects of a power include only those who receive a “beneficial interest.”

Thus, when property is appointed in further trust, the trustee is not an impermissible appointee.

Question 17

If part of an appointment is ineffective and another part, if standing alone, would be effective,

Answer 17

the effective part is given effect, except to the extent that the donee’s scheme of disposition is more closely approximated by concluding that some or all of the otherwise effective part should be treated as ineffective.

To the extent that a power is ineffectively appointed, the ineffectively appointed property passes to the so-called “taker in default of appointment” (for example charity) designated by the donor of the power (usually the Settlor)

Question 18

Many states have statutes under which a surviving spouse’s elective (forced) share of the decedent spouse’s estate extends to assets placed into a revocable trust by the decedent spouse

Answer 18

The disposition of assets in a revocable trust is determined by the terms of the trust instrument, trust assets are not probate assets.

Ex: the statute would not give Settlor’s husband any claim to assets in settlor’s revocable trust.

However, in many states, case law permits a surviving spouse to claim an elective share of assets contained in a revocable trust under either the illusory-transfer doctrine, the fraudulent-transfer doctrine, or a like doctrine.

Question 19

Under the illusory-transfer doctrine, a surviving spouse

Answer 19

can reach assets transferred during the marriage by the deceased spouse into a revocable trust on the theory that the transfer is economically “illusory” because, by the simple expedient of exercising the power of revocation–typically with nothing more than a signature on a piece of paper–the deceased spouse could have recaptured the assets she had placed in the trust.

Question 20

Under the fraudulent-transfer doctrine, a surviving spouse can reach assets transferred into a revocable trust on the theory that,

Answer 20

as to the serving spouse, the transfer was “fraudulent.” The assumption behind this doctrine is that a state statue providing surviving spouses with an elective-share entitlement gives spouses a legitimate expectancy in assets that would have been included in the decedent spouse’s probate estate but for their transfer into a revocable trust; such a transfer is treated as defrauding the surviving spouse of his or her expectancy.

Question 21

A trustee owes trust beneficiaries a duty of loyalty

Answer 21

this duty arises under the common law and by statute. Under the common law, a trustee is prohibited from making transactions that place the interest of the trustee or another above the interest of trust beneficiaries.

Question 22

The duty of loyalty prohibits two types of transactions:

Answer 22

self-dealing, where the trustee deals with trust property for the trustee’s personal benefit, and conflict of interest, where the trustee acts on “behalf of others to whom the trustee also owes obligations.”

Question 23

No further inquiry rule, The Restatement (Third) provides that

Answer 23

“it is immaterial that the trustee may be able to show that the action in question was taken in good faith, that the terms of the transaction were fair, and that no profit resulted to the trustee.”

This strict approach is justified on the grounds that “it may be difficult for a trustee to resist temptation when personal interests conflict with fiduciary duty. In such situations, for reasons peculiar to typical trust relationships, the policy of the trust law is to prefer (as a matter of default law) to remove altogether the occasions of temptation rather than to monitor fiduciary behavior and attempt to uncover and punish abuses when a trustee has actually succumbed to temptation.

This policy of strict prohibition also provides a reasonable circumstantial assurance (except as waived by Settlor or an affected beneficiary) that beneficiaries will not be deprived of a trustee’s disinterested and objective judgement.

Question 24

The Uniform Trust Code takes a similar approach to the no-further-inquiry rule

Answer 24

it adopts the rule and provides that a self-dealing transaction is voidable by trust beneficiaries. As noted in the comments, “transactions involving trust property entered into by a trustee for the trustee’s own personal account [are] voidable without further proof . . . . It is immaterial whether the trustee acts in good faith or pays a fair consideration.”

Question 25

Both the Restatement of Trusts and the Uniform Trust Code impose on trustees a “duty of prudent administration” aka duty of care

Answer 25

Both authorities agree that, to satisfy the duty of prudent administration, a trustee must “exercise reasonable care, skill, and caution.” The Uniform Trust Code further provides that a “trustee shall take reasonable steps to take control and protect the trust property.” This section is based upon Restatement (second) of Trusts s 176. A comment to section 176 specific that a trustee’s failure to purchase fire/casualty insurance for trust property when such “insurance is customarily taken by a prudent” person is a breach of the duty to protect (a subset of the duty of care/prudent administration).

Question 26

Under the Uniform Principal and Income Act,

Answer 26

“all . . . ordinary expenses incurred in connection with the . . . preservation of trust property . . . including ordinary repairs” are allocated to income. Extraordinary repairs are allocated to principal.

Ordinary repairs are repairs required by day-to-day wear and tear. Extraordinary repairs are repairs required by “an unusual or unforeseen occurrence that does not destroy the [asset] but merely renders it less suited to its intended use, a repair that is beyond the usual, customary, or regular kind.”

Question 27

Under the common law, upon a life estate holder’s death the trust principal

Answer 27

should be distributed to the remainder man. If the remainder man is not living when the remainder becomes possessory, it passes to the devisee of the interest under the deceased remainder man’s will.

If the interest was not subject to any contingencies (such as “to B if she survives A”) the interest vests and vested remainders are divisible.

Question 28

A discretionary support trust subject to a spendthrift clause

Answer 28

A support trust permits distributions from the trust to enable the beneficiary to maintain his or her accustomed standard of living. When a trust instrument grants the trustee of a support trust discretion whether or not to pay a beneficiary’s support-related expense, the trustee’s judgement controls unless the trustee abuses his discretion.

Question 29

The spendthrift clause

Answer 29

may prevent a beneficiary’s creditors from reaching trust assets, but it does not prevent the beneficiary himself from reaching trust assets if the trustee has abused his discretion in failing to make payments to the beneficiary.

Question 30

Support in a discretionary support trust is fact defendant, Support includes

Answer 30

more than necessities or bare essentials. Most courts measure support in terms of the lifestyle to which the beneficiary has become accustomed even if the trust instrument odes not expressly refer to that lifestyle.

A beneficiary’s accustomed lifestyle is determined at the time the beneficiary’s trust interest is created, but is subject to adjustment to accommodate the beneficiary’s changing needs.

Necessary medical care is invariable treated as support. Support also invariably includes “reasonable amounts for the support of . . . minor children who reside elsewhere but for whom the beneficiary chooses or is required to provide support.”

Question 31

Abuse of discretion by a trustee

Answer 31

According to the Restatement (Third), depends upon the terms of the trust instrument and the other duties of the trustee, such as the duty to administer the trust in accordance with its terms, the duty to act impartially, and the duty of care. These duties read together, entitle the beneficiary to “general information concerning the bases upon which the trustee’s discretionary judgements have been or will be made.

Furthermore, a trustee abuses discretion by acting in bad faith or with an improper motive.

The duty of impartiality is an extension of the duty of loyalty to beneficiaries but involves, in typical trust situations, unavoidably and thus permissibly conflicting duties to various beneficiaries with their competing economic interest. Impartiality dos not mean that a trustee’s personal favoritism or animosity toward individual beneficiaries, even if the latter results from antagonism that sometimes arises in the course of administration.

Question 32

In some jurisdictions, creditors who provided the beneficiary with “necessaries” such as

Answer 32

health care may reach the beneficiary’s interest in satisfaction of any unpaid debt despite a spendthrift clause. Medical care is invariable rated as a necessary.

But if in addition to a spendthrift clause, distributions are discretionary with the trustee, the creditor who provided the beneficiary with a necessary cannot compel a distribution if the beneficiary could not do so. In other words, the creditor cannot compel a distribution in the absence of an abuse of discretion.

The necessaries exception is not recognized in the Uniform Trust Code. Comments to the Restatement also suggest that the necessaries rule, while constant with prior trust Restatements, is not followed in some U.S. jurisdictions.

Question 33

If a gift is made to a class of persons, the class closes when

Answer 33

the named person dies or the gift becomes possessory

Question 34

when a remainderman predeceased the life tenant, the trust assets

Answer 34

are distributed based on the directives contrained in the trust instrument.

In states that have adopted the Uniform Probate Code, or a like state, the outcome is different.

Question 35

Under the Uniform Probate code s 2-207, if a gift is made in trust to a class or persons described as “children”a deceased child’s

Answer 35

descendants take the deceased child’s share by representation.

Question 36

Disclaimer

Answer 36

Almost all states have enacted disclaimer statutes that permit beneficiaries of wills and trusts to disclaim their interests in the estate or trust property. In most states, a disclaimer is not effective unless it is in writing and is made, for a testamentary transfer, within nine months of the decedent’s death or, for a future interest in a non testamentary transfer, within nine months after the future interest would become “indefeasibly vested.”

The newest version of the Uniform Probate Code permits a disclaimer at any time prior to acceptance of the interest. When a holder of a future interest effectvively disclaims that interest, the disclaiming is deemed to have predeceased the life tenant.

Question 37

A disclaimer under the common law

Answer 37

the disclaimed share would pass to the surviving class members

Question 38

A disclaimer under the Uniform probate code, or a like statute

Answer 38

the disclaimed share would pass to the issues (children) of the disclaimant

Question 39

Trustee’s duties

Answer 39

a trustee is under a duty to “invest and manage trust assets as a prudent investor would.” The obligation to invest and manage prudently normally requires the trustee to diversity trust investments. A trustee is also expected to consider the trust’s “needs for liquidity . . . and preservation or appreciation of capital.”

Question 40

Uniform Trust Code specifically provides with respect to a revocable trust

Answer 40

a trustee’s duties are “owed exclusively to” the settlor

Question 41

the Uniform Prudent Investor Act, section 3 provides that

Answer 41

a trustee shall diversify trust investments unless the trustee “reasonably determines that, because of special circumstances, the purposes of the trust are better served without diversifying,” and section 2 directs the trustee to “consider the purposes, terms, . . . and other circumstances of the trust” in managing its assets.

Under the Restatement of Trusts, the terms of a trust include the “intentions of the settlor manifested in any way that admits of proof.” This approach reflects the view that the settlor of a revocable trust has an interest in trust assets that is the practical equivalent of ownership. In addition, trustees are not generally liable for “consented to” acts and can defend against charges of imprudence by proving a waiver.

Question 42

Can the terms of a testator’s testamentary trust be reformed?

Answer 42

Under the common law, a court may order “equitable deviation” from the terms of a trust when an unanticipated change in circumstances would otherwise “defeat or substantially impartiality the accomplishment of the purpose of the trust.”

Question 43

The Uniform Trust Code recognizes and expand the equitable-deviation doctrine

Answer 43

Under the Code, an administrative provision of a trust may be modified “if, because of circumstances not anticipated by the settlor, modification or termination will further the purpose of the trust.” An anticipated change in the character of the community where realty held by a trust is located represents the sort of change to which the equitable-deviation doctrine is applicable.

The UTC also provides that, even if circumstances have not changed in an unanticipated manner, an administrative provision may be modified if “continuation of the trust on its existing terms would be impracticable or wasteful or impair the trust’s administration. This expansion rests on the view that “a policy of rigid adherence to the letter of the donative instrument is likely to frustrate both the donor’s purpose and the efficient use of resources.”

Question 44

Under the common law, the equitable-deviation doctrine applies only to administrative provisions of a trust

Answer 44

courts are not empowered to alter dispositive provisions that determine the allocation of trust assets and income among trust beneficiaries

(ex: the sale of the home, to pay for daughter’s rent. Daughter was a life tenant)

effectively, these provisions grant Daughter an entitlement to the trust income (but not the principal) and grant Charity the proceeds from the home’s sale. Under common law, a court may not alter the beneficial rights of Daughter and Charity in the proceeds obtained from selling the home.

Question 45

However, under the Uniform Trust Code and like statutes, a court may modify the “dispositive terms of a trust. . . if,

Answer 45

because of circumstances not anticipated by the settlor, modification . . . will further the purposes of the trust. To the extent practicable, the modification must be made in accordance with the settlor’s probable intention.”

Question 46

Under the common law, when trust property to be used for a charitable purpose could not be distributed as directed in the trust instrument,

Answer 46

the trust did not necessarily fail. Instead, the court determined whether to exercise its cy press power and redirect the charitable gift to another like charity.

Question 47

The common law cy press doctrine requires

Answer 47

an initial inquiry into the settlor’s intent: if the court determines that the settlor had a specific charitable intention limited to the charitable purpose stated in the trust instrument, the property reverts to the settlor or the settlor’s estate. If the court determines that the settlor had a general charitable intention, it substitutes for the named charity another one wit activities consistent with the settlor’s intentions. The common law and the Restatement (Third) of Trusts both presume that a settlor has a general charitable intent.

Question 48

The Uniform Trust Code on charitable intent

Answer 48

The UTC appears to establish a conclusive presumption of general charitable intention. Section 413(a) of the Code provides that “if a particular charitable purpose becomes unlawful impracticable, impossible to achieve, or wasteful: (1) the trust does not fail, in whole or in part; (2) the trust property does not revert to the settlor’s or the settlor’s successors in interest; and (3) the court may apply cy press to modify . . . the trust by redirecting that the trust property applied or distributed, in whole or in part, in a manner consistent with he settlor’s charitable purposes.”