§ 11 An Overview  [81-83]

 

This chapter supplements the introduction appearing on pages 8-9 of the text.

 

A.  Living v. Testamentary Trusts

 

To establish a living trust, the settlor can either give the property to someone else (or an institution, like a bank) to hold as trustee or declare herself to be the trustee.  Testamentary trusts are created by a will, which simply gives estate assets to someone to be held in trust according to directions.  

 

In general, living trusts are more complicated to set up, but are more flexible once they are in operation. Testamentary trusts are easier to establish, but generally subject to more restrictions when funded.

 

B.  Reasons for Creating Trusts

 

Common reasons for creating trusts include:

 

·        Providing asset management for disabled persons or minors

·        Avoiding probate (if a living trust)

·        Saving estate taxes

 

§ 12  Creation  [83-98]

 

An important reason that trusts are so wonderfully flexible is that the law requires so little to create a trust.  The key concept is creation of a fiduciary relationship by separating ownership into two parts: “legal title” in a trustee with management duties, and “equitable title” in a beneficiary who can enforce those duties.

 

A.     Intent

 

Usually the intention to create a trust is quite clear:  a multi-page document is labeled “Trust Agreement,” or a will section is titled “Family Trust.”  However, trusts can arise easily without such formalities.  See Jimenez v. Lee, 547 P.2d 126 (Or. 1976) (father held to be trustee of savings bond his mother purchased for his daughter’s education).

 

               1.  Mandatory v. Precatory Language

 

Poorly drafted documents may not make clear whether the settlor intended to impose duties on a particular beneficiary, or only expressed a desire that the beneficiary behave in a certain way. The result will depend upon whether a court finds the language regarding the children to be “mandatory” (a trust) or “precatory” (no obligation).  Cases like these tend to be resolved very much on their own facts.  See, e.g., In re Estate of Martin, 300 N.Y.S.2d 751 (N.Y. App. Div. 1969) (“request” was mandatory); Brannon v. Morgan, 106 S.W.2d 841 (Tex. Civ. App. 1937) (“request” was precatory).  The lesson:  be specific.  If a trust is intended, say so.  If not, use language like “I hope, but I impose no obligation.”

 

         B.  Trust Property

 

To have a trust, there must be trust property.  After all, there must be something for a trustee to protect. In many cases, there is really no question about trust property. 

 

In some situations the items claimed to be held in trust can be very insubstantial, like future profits or the beneficial interest in a life insurance policy.  Then the question becomes whether the item can be defined as “property” for the purpose of sustaining a trust.  In answering that question, some courts are quite rigid, while others are very flexible.  Compare Brainard v. Commissioner, 91 F.2d 880 (7th Cir. 1937), with Speelman v. Pascal, 178 N.E.2d 723 (N.Y. 1961).

 

A.     Beneficiary

 

1.  Separation of Title

 

Doctrinally, beneficiaries are required in order to achieve the separation of legal and equitable title which characterizes the trust relationship.  A trustee must owe duties to someone else. See Morsman v. Commissioner, 90 F.2d 18 (8th Cir. 1937).

 

2.      Identifiability

 

Even if the separation of title question is not present, beneficiaries of a private trust must be identifiable.  The trustee must be able to tell who should get the property, and a court should have a standard by which to judge whether the trustee distributes trust benefits to the right persons.

 

This rule does not apply to charitable trusts, which are characterized by the lack of particular, identified beneficiaries.  See text pages 112-116.

 

3.      Chosen by the Trustee?

 

When the settlor names someone, usually the trustee or executor, to choose among the members of an indefinite group (like “friends”), courts traditionally have said no trust can arise.  See Clark v. Campbell, 133 A. 166 (N.H. 1926).  Restatement (Second) of Property § 12.1 comment e, seeks to reform the rule.  It says that rather than failing, a provision like that in Clark “should be construed to give the [trustees] a power of appointment exercisable within a reasonable period of time . . . .”  See also Restatement (Second) of Trusts § 122; Restatement (Third) of Trusts § 46(2).  Uniform Trust Code § 402(c) is direct: “A power in a trustee to select a beneficiary from an indefinite class is valid.”

 

4.      Honorary Trusts

 

Recognizing that funds to care for a pet or an inanimate object—like a grave site—serve a social purpose, courts usually allow them under a theory of “honorary trusts.”  The “trustee” who is given the money has the choice of honoring the trust or of returning the money to the estate.  Uniform Trust Code sections 408(b) & 409 allow a settlor (or a court) to appoint someone to enforce the trust.

 

         D.  Trustee

 

If a trust is intended, but no trustee is named, or if a sitting trustee dies or resigns, a court will appoint a trustee rather than let the trust fail.

 

1.      Choosing Trustees or Trust Advisors

 

Settlors should choose trustees with great care.  They must handle both the financial and the personal sides of administration.  Settlors sometimes appoint co-trustees, one a corporation and the other an individual.  The corporate trustee, usually a bank, provides investment expertise, and the individual provides the personal touch.  A co-trustee arrangement can be unwieldy, however, because all trustees traditionally must join in acting on the trust’s behalf.

 

To avoid that problem, clients may want to name a single trustee and also identify a trusted friend or relative to serve as a “trust advisor.”  The trust document could require the trustee to consult with, or get the approval of, or follow the directions of, the advisor before distributing the trust’s funds.

 

         E.   The Problem of Revocability

 

A testamentary trust, as part of a will, is revocable under wills law.  Living trusts will be recognized even though the settlor reserves a power to revoke.  In most states, the power to revoke a living trust must be reserved expressly in the document.  In contrast, UTC § 602(a) puts the burden on those who want irrevocable trusts to say so.

 

The validity of revocable living trusts was open question because these trusts can look a lot like wills, but usually do not meet the local Statute of Wills requirements.  Consider a settlor who creates a trust giving a remainder to his wife, but retaining a life estate (to secure present enjoyment of the property) and a power to revoke (in case he changes his mind).  The form is different, but the substance is close to the situation of a testator who retains ownership and executes a will leaving everything to his wife.  The parallel is even closer if the settlor declares himself to be the trustee.  Nonetheless, virtually all courts will sustain such a trust when created in reliable circumstances.  See Farkas v. Williams, 125 N.E.2d 600 (Ill. 1955).

 

1.      Ignoring Trust Form

 

The law is coming to recognize that a trust might be recognized for one purpose, but not for another.  For example, State Street Bank & Trust Co. v. Reiser, 389 N.E.2d 768 (Mass. App. 1979), allowed creditors of an estate to reach the assets of a valid living trust, even though the trust assets would otherwise pass outside the probate system.  See also Sullivan v. Burkin, 460 N.E.2d 572 (Mass. 1984).

 

         F.   Formalities (and Constructive and Resulting Trusts)

 

               1.  A Writing

 

Oral living trusts for land typically run afoul the Statute of Frauds’ writing requirement.  Oral testamentary trusts conflict with the Statute of Wills.

 

2.      Constructive Trusts

 

Not allowing an oral trust may enrich a grantee unjustly. Suppose Javier delivers a deed of Blackacre, absolute on its face, to Maria, but Maria orally promises to hold the land in trust for Javier for life and then transfer it to Frank.  If Maria refuses to turn over the land to Frank, we have a conflict between the policy of limiting oral evidence (and thereby the danger of false claims) and the policy of preventing people from unjustly enriching themselves.  To avoid unfair results, courts sometimes will apply a “constructive trust” against a donee like Maria to prevent the donee from holding in her own behalf.

 

The constructive trust theory does not impose management duties on the “trustee.”  Rather, constructive trust is a remedy.  The constructive trust theory is a device for preventing unjust enrichment by moving legal title from a person who has title but should not, to someone who should.  The remedy is appropriate in a wide variety of situations.

 

               3.  Resulting Trusts

 

Unjust enrichment can also arise when there is a semi-secret trust.  These occur when will shows a trust intention on its face, but the details are oral.  To prevent the “trustee” from becoming unjustly enriched by keeping the property, a court may impose a “resulting trust” under which the trustee holds the property for the benefit of the estate.  Olliffe v. Wells, 130 Mass. 221 (1881).  This is just one example of a resulting trust theory applying to an express trust that fails.

 

§ 13  The Size of a Beneficiary’s Interest  [98-107]

 

         A.  Discretionary and Support Trusts

 

               1.   Discretionary Trusts

 

Trusts that authorize the trustee to pay the beneficiaries “such amount of income or principal as the trustee in its absolute discretion shall deem advisable” are commonly called “discretionary trusts.”  Sometimes the discretion applies only to income or only to principal.

 

               2.   Support Trusts

 

Trusts that attempt to control the trustee’s discretion by limiting distributions to those “necessary for the comfortable support of the beneficiary” are commonly called “support trusts.”

 

               3.   Hybrids

 

Sometimes a settlor will create a hybrid, a “discretionary support trust,” by giving the trustee “uncontrolled discretion” to pay funds “for support.”  To clarify these categories, Restatement (Third) of Trusts § 50 and Uniform Trust Code § 504 treat support trusts as a type of discretionary trust.

 

               4.   Why Trustees Are Often Conservative

 

Trustees can often be more stingy than their settlor would have wanted.  See,  e.g., Old Colony Trust Co. v. Rodd, 254 N.E.2d 886 (Mass. 1970).  Trustees tend to be conservative because the law presents them with different risks.  If they are too generous, they risk a court later ordering the trustee to repay to the trust the money which should not have been distributed.  On the other hand, if they are too stingy, they are likely only to suffer a slap on the wrist and an order to be more generous in the future. The selection of the trustee or trust advisor is probably the most important factor for achieving the balance between the flexibility and control appropriate for any particular client.  Words of guidance in a document can also help.  For some suggestions, see text pages 100-101.

 

B.     Alienability

 

Two principles underlie much of the law surrounding the transfer of a trust beneficiary’s interest.  First, unless a statute or the trust document provides otherwise, a trust beneficiary can transfer his or her interest to someone else.  Second, creditors’ rights typically follow alienability: the creditor usually can get what the beneficiary can transfer.  For a good illustration of how various trust devices affect creditors’ claims see Shelley v. Shelley, 354 P.2d 282 (Or. 1960).

 

1.      Voluntary Transfers

 

Just as you can give an old armchair to a friend or sell it at a garage sale, so can a trust beneficiary give away or sell a life estate or a remainder interest in trust.  Sometimes, with an eye to protecting beneficiaries against against their own foolishness, a settlor may want to restrict a beneficiary’s power to make such transfers.  A discretionary or a support trust can achieve that result.  So can a spendthrift trust (discussed below).

 

Discretionary, support, and spendthrift trusts are often viewed primarily as devices for avoiding creditors.  However, such devices can also affect the ability of both trustees and beneficiaries to adjust to changing situations. 

 

2.      Involuntary Transfers: Creditors’ Claims

 

Unless a document or statute provides otherwise, creditors can satisfy their claims by reaching a trust beneficiary’s interest.  The procedure varies among the states, but familiar creditors’ devices like attachment, garnishment and execution tend to be available.  See UTC § 501.

 

a.      Spendthrift Clauses

 

Spendthrift clauses both prohibit a beneficiary from transferring his trust interest and protect that interest from creditors’ claims.  The clauses do not mean the creditor can never get paid, but they do put the creditor at a distinct disadvantage.  Rather than obtaining their debtor’s beneficial interest in a spendthrift trust, or forcing the trustee to pay them directly, creditors must wait until the trustee pays the beneficiary and then try to catch the money there.

 

Commentators have long debated the merits of spendthrift clauses, but they have been approved overwhelmingly (but not universally) by courts and legislatures.

 

1.   Exceptions

 

In some situations, spendthrift clauses have not been effective.  The most common rule is that one cannot create a spendthrift trust for oneself (a “self-settled” trust).  But some states are abandoning that limitation.  See Alaska Stat. § 34.40.110.   Many states eliminate the spendthrift shield when a claim comes from some of the following classes of creditors:  alimony, spousal support, providers of “necessary” services, state claims, federal claims, and (in a few cases) some kinds of tort claims.  See Restatement (Third) of Trusts § 59; UTC § 503. 

 

b.      Special Needs Trusts

 

Many jurisdictions authorize individuals to create “special needs trusts” on behalf of disabled persons.  These trusts allow supplemental support without endangering the beneficiaries’ rights to government benefits.  The rules vary considerably from state to state.  See generally Joseph A. Rosenberg, Supplemental Needs Trust for People With Disabilities: The Development of a Private Trust in the Public Interest, 10 Boston Univ. Pub. Int. L.J. 91 (2000).

 

 

§ 14  Modification and Termination  [107-112]

 

         A.  Beneficiaries’ Consent

 

If the settlor has not reserved a power to revoke, a trust cannot be terminated without all the beneficiaries’ consent.  Here there are two catches.  First, all of the beneficiaries might not consent. 

 

Second, and more likely, some of the beneficiaries may be unidentified or unborn, and obtaining consent on their behalf can be difficult.  Two different theories have arisen to help solve the latter problem.  Guardians ad litem might be appointed to represent the unborn, or the doctrine of “virtual representation” might allow older relatives to waive claims of ones not yet on the scene. UPC § 1-403 codifies both doctrines.  See In re Wolcott, 56 A.2d 641 (N.H. 1948).

 

         B.  Material Purpose

 

A trust cannot be changed without the settlor’s consent if to do so would violate a material purpose of the trust.  Since in most cases, the settlor is dead, changes are particularly hard to achieve.

 

Courts have struggled to determine what a trust’s “material purpose” might be, and whether a particular change would violate it. See Claflin v. Claflin, 20 N.E. 454 (Mass. 1889).  Courts typically have interpreted the inclusion of spendthrift, discretionary or support trusts as indications that a “material purpose” of the trust would be thwarted if the trust were modified or ended early.  This approach may be changing.  Under UTC § 411(c), a spendthrift clause “is not presumed to constitute a material purpose of the trust.”  See also Restatement (Third) of Trusts § 65, comment.

 

C.     Indestructible Trusts

 

The Rule Against Perpetuities has served to limit the time landowners and settlors can tie up wealth. In recent years, however, the Rule has been under attack.  See text pages 316-317 for discussion of that issue, but note that indestructible trusts could become a problem.  The guardian ad litem and virtual representation approaches cannot help, because terminating the trust would deprive those unknown beneficiaries of benefits they might enjoy if the trust continued.

 

§ 15  Charitable Trusts  [112-116]

 

Charitable trusts operate under some different rules.  First, a charitable trust need not have definite beneficiaries.  Second, a charitable trust is not subject to the Rule Against Perpetuities.  Finally, there is a long tradition allowing courts to modify charitable trusts to further trust purposes in the face of changed circumstances.

 

         A.  Charitable Purposes

 

The basic concept of a charitable purpose is something that benefits the community in general. According to Restatement (Third) of Trusts § 28, “Charitable purposes include: (a) the relief of poverty; (b) the advancement of education; (c) the advancement of religion; (d) the promotion of health; (e) governmental or municipal purposes; (f) other purposes the accomplishment of which is beneficial to the community.”  Accord UTC § 405(a).

 

         B.  Modification (Cy Pres)

 

Sometimes settlors give property for charitable purposes which later become impossible or impractical to pursue. If the settlor also had a general intention to support charitable purposes, a court can apply the trust proceeds to another charitable purpose consistent with the settlor’s general intention.  See Restatement (Third) of Trusts § 67; UTC § 413.

 

§ 16  Trusts and Pour-Over Wills  [116-118]

 

“Pour-over” is the name given to wills that designate a trust as one beneficiary. Often pour-over wills include a number of dispository provisions (cash to individuals, real estate or specifically identified items of personal property to particular family members), and then give the rest of the testator’s property to a preexisting trust. The effect is to pour probate assets into the trust.

 

The most common estate plans using the pour-over device work this way (see Figure 4-1 on text page 117):

 

·        the client creates a living trust, but intends it as a shell to be activated later.

·        the client creates a will naming the trustee of the living trust as a will beneficiary.

·        the client names the trustee as beneficiary of life insurance policies. after the client’s death, the will pours probate property, and the life insurance policy pours insurance proceeds, into the trust.