Trusts Flashcards
ISSUE: Could the trustee have properly distributed trust assets to the son to enable him to pay his hospital bill, child support obligations, or loan to purchase the computer-gaming system? ANSWER: The settlor created a discretionary support trust subject to a spendthrift clause. The hospital bill and child support debt are support expenses for which the trustee could distribute trust assets to the son. The loan to purchase a computer-gaming system is not likely to be characterized as support.
The settlor created a discretionary support trust subject to a spendthrift clause. 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 expenses, the trustee’s judgment controls unless the trustee abuses his discretion.
This trust is also subject to a spendthrift clause. This clause 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.
The meaning of the term “support” is fact-dependent. Support includes 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 does 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 invariably treated as support. Support also invariably includes reasonable amounts for the support of minor children who reside elsewhere but for whom the beneficiary either chooses or is required to provide support.
Here, the trustee could properly have distributed trust assets to the son to pay the son’s hospital bill and child support obligation.
On the other hand, without more facts, a distribution to allow repayment of the son’s debt incurred for the purchase of a computer-gaming system would not appear to be a distribution for the son’s support. Of course, if the son could establish that such a system is necessary to allow him to live in accordance with his accustomed lifestyle, then it might be considered a support expense. However, the facts state that the son’s income is about $35,000, a modest sum in light of the son’s child support obligation and expenses for basic needs such as health care, food, clothing, shelter, and transportation. Given this income, it is unlikely that the son could establish a lifestyle that would warrant the trustee’s conclusion that the recreational computer-gaming system is a support expense.
ISSUE: Did the trustee abuse his discretion in refusing to make any distributions to the son? ANSWER: Yes. The trustee likely abused his discretion in failing to make any distributions to the son, including distributions for the payment of the hospital bill and child support.
The fact that the son’s hospital bill and child support obligations should be characterized as support is not the end of the matter. When the trust instrument grants a trustee discretion to pay a beneficiary’s support-related expenses, the trustee’s judgment controls unless the trustee abuses his discretion. A trustee’s discretionary power is subject to judicial control only to prevent abuse of the discretion by the trustee. Trustees may have a number of legitimate reasons to withhold payments from a beneficiary, including discharging the trustee’s duty to act impartially with respect to all trust beneficiaries and the beneficiary’s ability to pay the expenses from other resources. However, if a court finds that a trustee acted in bad faith or with an improper motive, it may overrule his decisions.
What constitutes an abuse of discretion, 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 judgments have been or will be made. Furthermore, a trustee abuses discretion by acting in bad faith or with an improper motive.
As section 50 of the Restatement (Third) suggests, where, as here, there are multiple trust beneficiaries, the trustee’s duty of impartiality requires that, in making distributions, the trustee act with due regard for the diverse beneficial interests created by the terms of the trust. 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 interests.
It would be overly simplistic, and therefore misleading, to equate impartiality with some concept of ‘equality’ of treatment or concern—that is, to assume that the interests of all beneficiaries have the same priority and are entitled to the same weight in the trustee’s balancing of those interests. Impartiality does mean that a trustee’s treatment of beneficiaries or conduct in administering a trust is not to be influenced by the trustee’s personal favoritism or animosity toward individual beneficiaries, even if the latter results from antagonism that sometimes arises in the course of administration.
Here, there is a strong argument that the trustee abused his discretion by withholding support distributions from the son. He ignored the son’s repeated requests for distributions, without offering any reason for his refusals. He made substantial distributions to the daughter, whose income was not, on average, different from the son’s. The trustee made disparaging comments about the son (that the son was a “bum,” a “terrible father,” and an “adulterer,” and was “rude” to the trustee). Together, these facts support an inference that the trustee withheld distributions from the son because of personal animus rather than a valid reason. All of this supports the conclusion that the trustee abused his discretion in withholding distributions from the son.
[NOTE: Although the question does not ask whether the son could successfully sue based on the trustee’s abuse of discretion or what he could recover if his suit were successful, in cases like this one, if the court finds an abuse of discretion, it will typically make an independent judgment of what the trustee would have distributed when carrying out his fiduciary duties and then direct that such payment be made from the trust, if trust assets are available, or otherwise surcharge the trustee.]
ISSUE: In light of both the discretion granted the trustee and the spendthrift clause in the trust, may the son’s three creditors obtain orders requiring the trustee to pay their claims against the son from trust assets? ANSWER: Despite the trust’s spendthrift clause, the son’s former wife and, assuming that the necessaries doctrine applies, the hospital may reach the son’s interest in the trust to satisfy their claims if the trustee abused his discretion. However, the friend cannot reach the son’s interest to satisfy his claim against the son.
The trust created by the settlor was discretionary. If the terms of a trust provide for a beneficiary to receive distributions in the trustee’s discretion, a creditor of the beneficiary is entitled to receive any distributions the trustee is required to make in the exercise of that discretion.
This general principle does not apply, however, when a trust includes a spendthrift clause. A spendthrift clause puts trust assets out of the reach of most creditors of a trust beneficiary until such time as trust assets are distributed to that beneficiary.
However, even when a trust provides spendthrift protection, claims against a beneficiary for unpaid child support may still be enforced against the trust. A court may order the trustee to pay the child such amount as is equitable under the circumstances but not more than the amount the trustee would have been required to distribute for the benefit of the beneficiary had the trustee complied with the support standard or not abused the discretion. Here there is a strong argument that the trustee breached his discretion, such that the former wife will be able to obtain payment from the trustee.
In some jurisdictions, creditors who provided the beneficiary with “necessaries” such as health care may reach the beneficiary’s interest in satisfaction of any unpaid debt despite a spendthrift clause. Comments to the Restatement (Third) of Trusts suggest that the creditor may reach the beneficiary’s interest but may not force a sale of the interest. In such a case, the court could direct the trustee to distribute trust income to the creditor until the claim is paid. Medical care is invariably treated 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 consistent with prior trust Restatements, is not followed in some U.S. jurisdictions. In these jurisdictions, the hospital cannot reach the son’s interest in the trust in satisfaction of its claim.
In jurisdictions that follow the necessaries doctrine as applied to a spendthrift clause, the hospital’s claim is not barred by the spendthrift clause. But because distributions from the trust are discretionary, the hospital will not be able to reach the son’s interest unless the trustee abused his discretion. Here, there is a strong argument that the trustee abused his discretion, thus allowing the hospital to reach the son’s interest and obtain some payment from the trustee.
The friend should not succeed in his suit against the trustee. The friend’s claim is not a claim for support, and here, the facts cannot support an assertion that a $5,000 computer-gaming system is a “necessary” for the son.
ISSUE: Did the trustee breach the duty of loyalty by renting a trust-owned apartment to himself at a market rate? ANSWER: Yes. The trustee breached his duty of loyalty when he rented a trust-owned apartment to himself even though he paid a market rate.
A trustee owes trust beneficiaries a duty of loyalty. 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. The duty of loyalty prohibits two types of transactions: 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.” Here, the trustee’s lease of a trust-owned apartment to himself was self-dealing. The lease thus breached the trustee’s duty of loyalty.
Because of the so-called “no-further-inquiry” rule, the fact that the trustee paid a market rate is irrelevant to the conclusion that the trustee engaged in self-dealing. The trustee is strictly prohibited from engaging in transactions that involve self-dealing or that otherwise involve or create a conflict between the trustee’s fiduciary duties and personal interests. As noted in the Restatement (Third), under the no-further-inquiry rule, “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 the settlor or an affected beneficiary) that beneficiaries will not be deprived of a trustee’s disinterested and objective judgment.”
The Uniform Trust Code takes a similar approach. It adopts the no-further-inquiry 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.”
ISSUE: Did the trustee breach the duty of prudent administration (a/k/a duty of care) by failing to purchase fire/casualty insurance on trust property, resulting in a $50,000 uninsured loss? ANSWER: Yes. The trustee breached his duty of prudent administration (a/k/a duty of care) when he failed to purchase fire/casualty insurance on the real property
Both the Restatement of Trusts and the Uniform Trust Code impose on trustees a “duty of prudent administration.” Under the Restatement, the trustee has a duty to administer the trust as a prudent person would, in light of the purposes, terms, and other circumstances of the trust. Under the UTC, a trustee shall administer the trust as a prudent person would, by considering the purposes, terms, distributional requirements and other circumstances of the trust. 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 of and protect the trust property.” This section is based upon the Second Restatement of Trusts § 176. A comment to § 176 of the Restatement specifies 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).
Here, the trustee failed to purchase a fire/casualty policy on the trust’s rental property, resulting in a loss to the trust. This is a breach of trust because a prudent person would have purchased such a policy on the property.
[NOTE: An accurate analysis of the legal standards is more important than the examinee’s conclusion regarding whether the purchase of insurance would have been prudent.]
ISSUE: Did the trustee breach the duty to administer in accordance with applicable law by allocating the entire $50,000 expense occasioned by the unexpected roof repair to trust income? ANSWER: Yes. The trustee breached his duty to administer the trust in accordance with applicable law by allocating the $50,000 repair expense exclusively to income.
A trustee has a duty to administer the trust “diligently and in good faith, in accordance with the terms of the trust and applicable law.” Because of the trustee’s obligation to comply with applicable law, the trustee must comply with the Uniform Principal and Income Act, or other state statutes of like effect, in allocating receipts and disbursements between trust income and principal.
Under the Uniform Principal and Income Act, “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.”
Here, the $50,000 roof repair was extraordinary because it was required by an unforeseen occurrence, a fire. It should therefore have been allocated to principal, not income, and paid from the trust principal’s $120,000 in liquid assets. This conclusion is bolstered by the fact that, had the trustee obtained insurance on the property, the insurance proceeds, representing the value of needed repairs, would have been allocated to principal.
[NOTE: The duties discussed in this section are sometimes referred to as an aspect of the duty of impartiality.]
ISSUE: Upon Albert’s death, should the trust principal be distributed to Betty’s husband, Betty’s daughter, equally to both of them, or to the testator’s heirs? ANSWER: Under the common law, upon Albert’s death, the trust principal should be distributed to Betty’s husband because she devised her vested remainder in the trust to him.
Under the terms of the trust, the testator created a life estate in Albert and a remainder interest in Betty. Under the common law, Betty’s interest was vested because it was subject to no contingencies (such as “to Betty if she survives Albert”) that would cause her to lose her interest should she predecease Albert. Vested remainders are devisable. Thus, if the remainderman is not living when the remainder becomes possessory, it passes to the devisee of the interest under the deceased remainderman’s will.
Here, trust principal became possessory at Albert’s death, and Betty was not living at that time. The trust principal thus should go to the devisee named in Betty’s will, her husband. Under the common law, the testator’s son would not take a share of trust principal as there is no reversionary interest to pass to the testator’s heirs.
[NOTE: If Betty’s trust interest were subject to a survivorship contingency, that would have caused Betty’s interest to fail because she predeceased Albert. In that case, her interest would have reverted to the testator’s estate. In such case, it would have passed to his heirs if he died intestate or to his beneficiaries if he died with a will.]
ISSUE: Can the trustee of a revocable trust, who is required by the terms of the trust instrument to pay all trust income to the settlor, accumulate income upon the settlor’s written direction? ANSWER: Yes. It was proper for the trustee to accumulate trust income because Settlor retained a power to revoke the trust during her lifetime in a written instrument, and the trustee accumulated income based on written directions from Settlor during her lifetime.
A retained power to revoke a trust includes the power to 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.
The Uniform Trust Code (UTC) follows this approach; under the UTC, a trust is both 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.
Here, the trust instrument required the trustee to distribute all trust income to Settlor during her lifetime; Settlor retained the power to revoke the trust “during Settlor’s lifetime”; and the trustee accumulated trust income at Settlor’s written direction, drafted during her lifetime. Settlor’s written direction effectively amended the terms of the trust as initially created. Thus, no improper accumulation of income occurred.
ISSUE: Can the holder of a testamentary power of appointment exercisable in favor of the holder’s children exercise the power by appointing trust assets to the holder’s grandchildren? ANSWER: No. Settlor could not appoint an interest in the trust to her son’s children (Settlor’s grandchildren) because they were not permissible objects of her power of appointment.
The donee of a special (nongeneral) power can appoint the property over which the power is exercisable only to “permissible appointees” or “objects” of the power. 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, as here, property is appointed in further trust, the trustee is not an impermissible appointee.
Although the trustee is not an impermissible appointee, Settlor’s grandchildren (her son’s children) are impermissible appointees. Under the trust instrument, Settlor’s “children” were the only permissible objects of her testamentary power of appointment. It might be argued that Settlor intended to include more remote descendants, such as grandchildren, when she used the word “children” when creating the power of appointment. However, Settlor’s will – executed contemporaneously with the trust instrument – includes a $50,000 bequest to her “descendants other than my children,” clearly evidencing Settlor’s ability to distinguish between children and more remote descendants. The argument that Settlor intended to include more remote descendants in the term “children” is thus highly likely to fail, and Settlor’s appointment of trust assets to the children of Settlor’s son thus should be ineffective.
The trust instrument allowed for amendments during Settlor’s lifetime by a written instrument. However, the appointment in Settlor’s will cannot be treated as an amendment made during Settlor’s lifetime by a written instrument.
ISSUE: Who takes trust assets that have been impermissibly appointed? ANSWER: As the named taker in default of appointment, Charity is entitled to the portion of the trust ineffectively appointed to Settlor’s grandchildren. It is not entitled to any interest appointed to the son.
“If part of an appointment is ineffective and another part, if standing alone, would be effective, 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” (here, Charity) designated by the donor of the power (here, Settlor).
Thus, assuming that the appointment to Settlor’s son’s children is ineffective, the share they would have received upon the son’s death passes to Charity. The appointment in trust to the son is permissible. Thus, Charity has no claim to the trust income interest appointed to the son.
ISSUE: Can the surviving spouse of the decedent settlor of a revocable trust claim an elective share of assets in that trust even though the spouse is not a named beneficiary of the trust? ANSWER: Yes. Settlor’s husband may be entitled to an elective (i.e., forced) share of Settlor’s revocable trust assets under the illusory-transfer doctrine, the fraudulent-transfer doctrine, or a like doctrine. He is also entitled to one-third of the probate assets.
Although 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, here, the jurisdiction’s elective-share statute provides that the spousal right of election extends only to probate assets. Because the disposition of assets in a revocable trust is determined by the terms of the trust instrument, trust assets are not probate assets. Thus, the statute does not give Settlor’s husband any claim to assets in her revocable trust. Assuming that the husband has no claim to the trust assets, he will not claim an elective share because that share ($33,333) would be less than the amount he is entitled to under the will ($50,000).
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.
Under the illusory-transfer doctrine, a surviving spouse 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.
Under the fraudulent-transfer doctrine, a surviving spouse can reach assets transferred into a revocable trust on the theory that, as to the surviving spouse, the transfer was “fraudulent.” The assumption behind this doctrine is that a state statute 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.
Thus, if this jurisdiction recognizes one of these doctrines or another similar doctrine, Settlor’s husband will be entitled to receive one-third of the combined probate ($100,000) and trust estate ($500,000) or $200,000 (1/3 of $600,000). However, this $200,000 would be reduced to $150,000 to take account of the fact that he received $50,000 under the will.
Not all jurisdictions recognize such a doctrine, however. In those jurisdictions that do not, the husband would receive nothing beyond the $50,000 he would receive under the will because that amount exceeds the elective share (1/3 of $100,000).
[NOTE: If an examinee concludes that the husband can elect against the trust assets, the examinee may also discuss who would bear the burden of paying the husband’s share. No credit should be given for this discussion, as the payment issue is beyond the scope of the question.]
%] ISSUE: Is the trust condition providing for the termination of an income interest upon marriage invalid as a matter of public policy? ANSWER: No. The son’s income interest in the trust would not terminate upon his marriage because the condition against marriage is void as a matter of public policy.
Provisions of trusts that violate public policy are void. Trust provisions that restrain a first marriage have generally been held to violate public policy. Under the Second Restatement of Property, a provision restraining any first marriage is invalid and the transfer takes effect “as though the restriction had not been imposed. “The common law has a well-defined interest in preserving freedom of marriage and in the preservation of the family relation. Hence provisions in a trust instrument which provide that a beneficiary shall have no interest under the trust unless he obeys the instructions of the settlor regarding marriage may be held illegal as against public policy.” Although courts have upheld some restrictions on marriage – for example, remarriage – none have upheld a complete restraint on a first marriage. Thus, because the son’s income interest would terminate upon his marriage, no matter what the circumstances of that marriage, the provision is void and the son’s income interest continues.
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. Here, there are no facts to support that motive. In fact, because this is a mandatory income payout trust, the trust income is payable to the son without regard to his support needs.
ISSUE: Did the trustee violate his duty of loyalty by purchasing the stock of the closely held corporation from the trust and, if so, what damages or other remedies are the trust beneficiaries likely to obtain? ANSWER: Yes. The trustee breached his duty of loyalty by purchasing stock from the trust, an act of self-dealing. In such a case, trust beneficiaries may obtain an order setting aside the transaction or seek damages based on the difference between the purchased assets’ fair market value at the time of purchase and the sales price paid by the trustee.
A trustee owes a fiduciary duty of loyalty to a trust; self-dealing, such as a purchase of trust assets by the trustee in his individual capacity, violates this obligation. Under the “no further inquiry” rule, there is no need to inquire 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. If a beneficiary elects to set aside the transaction, the trust property purchased by the trustee is returned to the trust and the amount the trustee paid for the property is refunded by the trust. If a beneficiary seeks damages, 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. Where, as here, the assets purchased by the trustee have declined in value since the self-dealing transaction, trust beneficiaries are likely to seek damages instead of setting aside the transaction.
Here, the beneficiaries should elect to seek damages from the trustee, not rescission. First, with rescission, the trustee would return the shares to the trust, and the trust would have to refund the purchase price to the trustee. This would leave the trust with assets worth only $450,000. Furthermore, because of the market declines, the trust assets are currently worth only $1,000,000; thus the trust doesn’t have sufficient assets to refund the purchase price. On the other hand, by seeking damages, the trust would collect $300,000, representing the difference between the value of the shares when purchased by the trustee ($1,500,000) and the purchase price ($1,200,000), leaving the trust with $1,300,000 in assets.
The trustee also breached his duty of care when selling the stock because of his failure to test the market.
ISSUE: Did the trustee violate the prudent investor rule by investing trust principal in a balanced portfolio of mutual funds with potential for growth and current income and retaining those investments after they declined in value? ANSWER: No. A trustee has a duty to invest trust assets in a prudent manner. Here, there are no facts suggesting that the trustee breached any prudent investment duty with respect to the selection and management of the investments he made.
Under the Uniform Trust Code, a trustee must 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. Indeed, failure to diversify is likely the reason why the trustee in this case was advised to sell the closely held corporate stock.
“A trustee’s 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.” The trustee should consider the purposes, terms, distribution requirements, and other circumstances affecting the trust. The prudent investor rule applies to both 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.
Here, the trustee’s investment of the sale proceeds seems to satisfy the diversification requirement. The trustee selected a balanced group of mutual funds; the portfolio included both stock and bond funds; it contained both growth and income funds. The trustee also appears to have considered the needs of both the income beneficiary and remainderman; growth funds are aimed at achieving principal appreciation and income funds at producing current income. The funds’ decline in value during a period of general economic decline – when most types of investments may well have fallen in value – does not evidence lack of prudence, and there are no facts to show any failure to monitor the portfolio.
ISSUE: How should rents, dividends, and sales proceeds received by the trustee prior to receipt of the son’s letter have been allocated between trust income and principal? ANSWER: Cash dividends and rents are allocable to income; sales proceeds and stock dividends are allocable to principal. Items allocable to income for the period prior to the son’s attempted disclaimer were distributable to the son.
Receipts earned during the administration of a trust are allocable either to income or to principal. Almost all states have adopted the most recent or an earlier version of the Uniform Principal and Income Act (the Act), which specifies how such receipts should be allocated.
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.
Here, the cash dividends and office building rents should have been allocated to income and, until the trustee received the son’s letter, should have been distributed to him as the sole income beneficiary of the trust. The stock dividend and proceeds from the sale of the office building should have been allocated to principal and held by the trustee for future distribution to the ultimate remaindermen of the trust.
ISSUE: Did the remainder interest in the trust accelerate and become immediately payable to the daughter’s minor child upon the trustee’s receipt of the son’s letter, and, if not, how should the trustee handle the distribution of the principal in the future? ANSWER: No. Because the son did not disclaim within nine months of the testator’s death, there is no valid disclaimer under state law. Therefore, the son is not deemed to have predeceased the testator. Furthermore, because of the express survivorship contingency in the will, the remainder in the trust does not accelerate and become distributable until the son in fact dies. When the son dies, the trust principal will be distributable to the testator’s then-living grandchildren, or if none, then to the testator’s then-living heirs.
When a trust remainder is given to a class, the class closes (i.e., no new persons can join the class) 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. A class member may demand possession of his or her share of the remainder upon termination of the income interest only when the class member’s interest is not otherwise subject to a condition precedent. When a beneficiary timely disclaims an interest in a trust, that beneficiary is treated as if he had predeceased the testator. Here, had the son disclaimed within nine months of the testator’s death as required by the state statute, he would have been deemed to have predeceased the testator. This would have closed the class of remaindermen, and the testator’s then-living grandchildren (i.e., the daughter’s child) would have been entitled to the trust principal. However, under the state statute, the son’s disclaimer was not timely because he did not disclaim within nine months of the testator’s death. Thus, because the statute is inapplicable and the son is still alive, the class of grandchildren entitled to share in trust principal did not close. Because, here, the statute is inapplicable due to the son’s failure to comply with the statutory time requirements, then presumably the common-law rule allowing disclaimers (a/k/a renunciations) at any time should apply. Under the common law, if a life estate is renounced, the remainder interest accelerates and becomes immediately distributable to the remaindermen of the trust if the remainder is vested but not if the remainder is contingent. Here, because the remainder is contingent upon there being grandchildren who survive the son, the remainder will not accelerate. It will remain open until the son dies, leaving open the possibility that additional grandchildren will be included in the class, or the daughter’s child could fall out of the class because that child fails to survive the son. And if none of the testator’s grandchildren survive the son, the trust principal will be distributed to the testator’s heirs living at the son’s death.
ISSUE: Following the trustee’s receipt of the son’s letter, how should the trustee distribute future receipts of income prior to the distribution of the principal? ANSWER: Until the trust terminates, the trustee must continue to hold the trust assets. The distribution of income in the meantime is unclear. There are at least three possibilities. Income earned on the undistributed assets could be distributed to the son and daughter as the testator’s heirs, accumulated and added to principal for distribution to the ultimate remaindermen, or distributed from time to time to those persons who are presumptively remaindermen.
When trust principal is not immediately distributable, the trustee must continue to hold trust assets until the ultimate remaindermen are ascertained. During this period, trust income will be distributed or retained according to any instructions contained in the trust instrument.
Here, the testator did not specify what the trustee should do with trust income in the event the son’s disclaimer did not comply with the state statute. There are at least three approaches. 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 testator’s will and which thus passes by partial intestacy to the testator’s heirs. A second approach would have the trustee accumulate trust income for distribution to the ultimate remaindermen. 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 remaindermen if the trust were to terminate when the income is received by the trustee; under this approach, trust income would be distributed to the daughter’s minor child until another presumptive remainderman is born. This approach could result in individuals not ultimately entitled to principal, say because 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.
[NOTE: Examinees should demonstrate a recognition and understanding of the income-allocation problem and the alternatives available to address that issue. There is no widely accepted solution to the problem. Examinees who cite any of these possible problem-solving approaches may receive credit.]
ISSUE: Was the revocable trust amendable? ANSWER: Yes. Settlor retained the right to amend the inter vivos trust despite her failure to expressly reserve this power.
Settlor retained the right to amend the inter vivos trust despite her failure to expressly reserve this power.
At issue here is whether a retained power of revocation includes the power to amend, sometimes referred to as the power to modify. The Second Restatement of Trusts § 331 provides that if a settlor has a power to revoke, that retained power ordinarily includes a power to modify (amend) as well. Comment g also notes that the power to amend includes both a power to withdraw trust assets and a power to “modify the terms of the trust.” The Uniform Trust Code, which provides that a power to revoke includes the power to amend, is consistent with this view. The theory is that even though a power to amend was not expressly retained by a settlor, the goal of amendment, assuming the power was not included in the power to revoke, could easily be achieved by first revoking the trust and then creating a new trust with the same terms contemplated by the amendment. To require this would put form over substance.
Thus, by expressly retaining the power to revoke the trust, Settlor retained a power to amend the inter vivos trust despite her failure to expressly reserve this power.
[NOTE: Under the common law, a trust is irrevocable unless the settlor expressly retains a power to revoke the trust. Conversely, under the Uniform Trust Code, a trust is revocable unless the terms of the trust expressly provide otherwise. The Trust Code’s position on revocation follows the minority view in the United States and is inconsistent with prior Restatements of Trusts. Here, the trust is revocable because Settlor expressly retained a power of revocation.
The Uniform Trust Code has been adopted in 24 states.]>
ISSUE: If the trust amendment was valid, does the amendment apply to the probate estate assets passing to the trust pursuant to Settlor’s will? ANSWER: Yes. Under the Uniform Testamentary Additions to Trusts Act, a revocable trust may be amended at any time prior to the settlor’s death, and the amendment applies to probate assets poured into the trust at the settlor’s death pursuant to the settlor’s will even when the will was executed prior to the date of the amendment.
Neither the common law nor state statutes require a trust instrument or an amendment to a trust instrument to be executed in accordance with the formalities prescribed for execution of a will. Indeed, an inter vivos trust that does not involve real estate can be created orally. Under the Uniform Trust Code, the only requirements for creating a valid inter vivos trust are intent, the specification of beneficiaries, and the designation of a trustee.
Here, the amendment meets the requirements of both the Uniform Trust Code and the common law. Thus, the fact that Settlor’s signature was not witnessed when she signed the amendment to the trust does not make the amendment invalid.
ISSUE: If the trust amendment was valid, does the amendment apply to the probate estate assets passing to the trust pursuant to Settlor’s will? ANSWER: Yes. Under the Uniform Testamentary Additions to Trusts Act, a revocable trust may be amended at any time prior to the settlor’s death, and the amendment applies to probate assets poured into the trust at the settlor’s death pursuant to the settlor’s will even when the will was executed prior to the date of the amendment.
Historically, property owned by an individual at her death passed to the individual’s heirs or to beneficiaries designated in a will executed with the formalities (writing, signing, witnessing) prescribed by state law. However, when a will devises property to the trustee of an inter vivos trust, then the provisions of the trust – which may not have been executed in accordance with the formalities required for wills – effectively determine who will receive the property. Because of this possibility, some early cases held that if an inter vivos trust was not executed with the same formalities required for a valid will, then the trust was ineffective to dispose of probate assets poured into the trust at the settlor’s death pursuant to the settlor’s will.
This line of cases has been overturned by the Uniform Testamentary Additions to Trusts Act (the Act), now Uniform Probate Code § 2-511. Under the Act, adopted in almost all jurisdictions, a testamentary bequest to the trustee of an inter vivos trust established by the testator during his or her lifetime is valid if the trust is in writing, it is identified in the testator’s will, and the trust instrument was executed before, concurrently with, or after the execution of the will. The Act further specifies that such a bequest is valid even if the trust is amendable or revocable and that a later amendment applies to assets passing to the trust by a previously executed will.
Thus, because the trust amendment is valid, its terms apply to assets received by Bank from Settlor’s estate.
ISSUE: If the trust amendment was valid, should the trust property be distributed to University? ANSWER: Yes. If the trust amendment was valid, then the trust assets, including assets passing to the trust under Settlor’s will, should go to University.
Under the trust amendment, all trust assets (including the assets of Settlor’s probate estate poured into the trust) pass to University. The facts provide no basis for failing to comply with Settlor’s stated intentions.
ISSUE: If the trust amendment was not valid, should the trust property be distributed to Settlor’s grandchild (her only heir) or held in further trust in accordance with the terms of the original trust instrument? ANSWER: If the trust amendment was invalid, trust assets, including assets received pursuant to Settlor’s will, should be held in accordance with the terms of the original trust instrument because those terms do not violate the Rule Against Perpetuities
Under the dispositive terms of the original trust instrument, Settlor created successive income interests in her surviving children and grandchildren with a remainder interest in her great-grandchildren. Because the trust was revocable, the period during which the common law Rule Against Perpetuities requires that interests vest (i.e., 21 years plus lives in being) began to run from the date Settlor no longer had a power of revocation (here, her death), not the date on which the trust was created.
Under the common law Rule Against Perpetuities, Settlor’s trust is thus valid. At the time of Settlor’s death, she was survived by no children, one granddaughter, and no great-grandchildren. Because Settlor cannot have more children after her death, the only income beneficiary of the trust is Settlor’s surviving granddaughter. This granddaughter is the only person who can produce great-grandchildren of Settlor; thus, all great-grandchildren must, of necessity, be born during the lifetime of Settlor’s only surviving granddaughter, who is a life in being. The granddaughter’s interest vested at Settlor’s death, and the great-grandchildren’s interest will vest at the death of the granddaughter. There is no need to wait the additional 21 years permitted under the Rule. Thus, under the common law and the statute given in the facts, the nonvested interest in the great-grandchildren is valid.
[NOTE: Both modern wait-and-see statutes and the Uniform Statutory Rule Against Perpetuities upon which the statute in the facts is modeled provide that before using either reform to validate an otherwise invalid nonvested interest, one should first determine if the nonvested interest violates the common law Rule. If it does not, then there is no need to reform. This proposition, which is applicable in all jurisdictions that have not simply abrogated the rule, is tested by this problem.]
ISSUE: Is there a material purpose of the trust yet to be performed? ANSWER: Yes. Husband and Settlor’s four children may terminate the irrevocable trust if a court finds that there is no material purpose of the trust yet to be performed. However, if a court were to find that the limitation on remarriage was a material purpose, the trust could not be terminated merely with the consent of Husband and the four children.
Generally, even an irrevocable trust can be terminated prior to the death of all income beneficiaries if both the income beneficiaries and the remaindermen unanimously consent. However, if there is a material purpose of the trust yet to be performed, the beneficiaries alone may not terminate the trust.
Here, it is unclear whether there is a material purpose yet to be performed. According to the Restatement, a material purpose should not be inferred from “the mere fact that the settlor created a trust for successive beneficiaries. In the absence of additional circumstances indicating a further purpose, the inference is that the trust was intended merely to allow one or more persons to enjoy the benefits of the property during the period of the trust and to allow the other beneficiaries to receive the property thereafter.” However, the trust provision specifying that Husband’s interest terminates upon his remarriage arguably demonstrates that a material purpose of Settlor was ensuring that trust assets did not benefit Husband’s second wife. If Settlor did have such a material purpose, the proposed distribution of $250,000 to Husband could defeat that purpose should Husband remarry.
If the court were to find that Settlor had a material purpose that would be defeated by trust termination, it is unclear whether a court would permit termination of the trust. Under the First and Second Restatements of Trusts, “if the continuance of the trust is necessary to carry out a material purpose of the trust, the beneficiaries cannot compel its termination.” Similarly, the Uniform Trust Code § 411 provides that “a noncharitable irrevocable trust may be terminated upon consent of all of the beneficiaries only if the court concludes that continuance of the trust is not necessary to achieve any material purpose of the trust.”
However, under the Third Restatement of Trusts, which no court to date has followed, even if the court finds that the settlor had a material purpose that trust termination might defeat, it may nonetheless approve trust termination if “the reason for termination or modification outweighs the material purpose.”
If the court were to employ the balancing approach approved by the Third Restatement, it is unclear what decision it would reach on the available facts. The reason for trust termination is to provide Husband with cash for his impending retirement. Without knowing more about Husband’s finances and the income available from the trust, it is impossible to assess how Husband’s goal compares to Settlor’s goal of ensuring that no future spouse of Husband receives benefits traceable to trust assets.
[NOTE: While conditioning the continuation of a child’s income interest on the child’s marriage or divorce is void on public policy grounds, a similar marriage restriction tied to the surviving spouse’s interest is not.]
[NOTE: The Uniform Trust Code has been adopted in 24 states.]
ISSUE: Do Settlor’s children have the only remainder interest in the trust? ANSWER: Yes. Under the common law, Settlor’s children are the only trust remaindermen. Because each child’s interest is vested and transmissible, it would pass to the child’s estate, not the child’s issue, should the child predecease Husband. Thus, the four children and Husband are the only beneficiaries of the trust and could consent to terminate the trust. However, under UPC § 2-707 alternative remainder interests are created in the issue of any of Settlor’s children who predecease Husband.
A class gift is a gift to a group of persons described collectively, typically by their relationship to a common ancestor. Here, the gift to “Settlor’s children” is a class gift. Under the common law, when a class gift is made to a group who are equally related to a common ancestor and the gift is not expressly subject to a condition of survivorship, the gift is not impliedly subject to such a condition. If a member of such a class fails to survive until the time of distribution (here, Husband’s death), that member’s share passes to his or her estate, not to his or her issue. Here, the remainder interest in the trust is limited to a class of “Settlor’s children.” All class members are equally related to a common ancestor, Settlor, and the trust imposes no express condition of survivorship. Therefore, each child has a vested and transmissible interest that would pass to his or her estate should the child die before the distribution date. If the common law applies, then only Husband and the four children are the beneficiaries of the trust and, if there is no material purpose to be performed, they could consent to a termination of the trust. Critics of the common law approach have argued that it fails to carry out the intentions of the typical trust settlor, permits a deceased beneficiary to transmit her share of trust assets to persons who are “strangers” to the settlor, and increases administrative costs by requiring the reopening of deceased beneficiaries’ estates and possibly successive estates. In response to these criticisms, some modern statutes do not follow the common law approach. For example, UPC § 2-707 provides that when a beneficiary does not survive to the distribution date, the beneficiary’s interest passes to his or her issue unless the trust instrument specifies an alternate disposition. Here, under the Uniform Probate Code approach, issue of a deceased child would have beneficial interest in the trust and would have to be part of any termination effort unless their interest could be represented by another. Section 304 of the Uniform Trust Code provides: “Unless otherwise represented, a minor, incapacitated, or unborn individual, may be represented by and bound by another having a substantially identical interest with respect to the particular question or dispute, but only to the extent there is no conflict of interest between the representative and the person represented.” This statute permits one group of remaindermen to represent another group of remaindermen in the absence of a conflict of interest. Here, the four children and their issue would have a conflict in light of the proposed distribution that would exclude the issue from potentially sharing in any trust assets. Thus, under UPC § 2-707 or a like statute, the trust could not be terminated merely with the consent of Husband and the four children. [NOTE: Section 2-707 of the Uniform Probate Code has been adopted in 9 states.]
