Construing the Terms of a Trust

Take-Away: Courts and trustees are often called upon to construe the terms of a trust instrument to carry out the settlor’s intent. Many of the rules of construction that generally apply to Wills are, after the adoption of the Michigan Trust Code, also applicable to interpret the terms of a trust instrument.

Background: The Michigan Trust Code provides that the rules of construction in the Estates and Protected Individuals Code (EPIC) that apply to the interpretation of and disposition of property under a Will also apply to the interpretation of the terms of a trust instrument and the disposition of trust property. [MCL 700.7112.] These are default rules of construction that can be overridden by the settlor in the trust instrument; if the trust instrument is silent as to the settlor’s intent on these questions, and then these default rules will apply and guide the trustee. While this Michigan Trust Code provision seems relatively innocent on its face, importing rules of construction from Wills to trust instruments can produce some surprises for the trust beneficiaries who read the literal words of the trust instrument. Four different rules of construction may now apply, as default rules, in the interpretation of a Michigan trust instrument. While the EPIC provision refers to a devisee, a literal translation in the discussion that follows is a trust beneficiary.

Distribution of Securities: If the settlor’s trust specifically gives stock or securities to an individual, that specific gift will include additional stock or securities owned by the settlor at death to the extent that the additional stock or securities were acquired by the settlor after the trust was executed, as a result of the settlor’s ownership of the described stock or securities in the trust. [MCL 700.2605.] The scope of this rule of construction covers stock or securities that were issued by the corporation and stock that was acquired because of the merger, consolidation, reorganization of the issuing corporation or any successor or acquiring organization. Example: a provision under a trust that gifts of all my Google stock to my daughter, will include any Google stock that was acquired in the settlor’s name after the trust was signed.

Nonademption of Specific Devises: A specific gift (devise) of property under a trust instrument grants or includes all of the following: (i) if the identified property is under a contract of sale, the balance of the purchase price, together with any security agreement; (ii) the amount of a condemnation award for the involuntary taking of the identified property that is unpaid at the settlor’s death; (iii) unpaid proceeds on fire or casualty insurance on, or other recovery for injury to the identified property;  (iv) identified property owned or acquired by the settlor as a result of foreclosure, or obtained in lieu of foreclosure, and the security interest for a specifically gifted obligation owed to the settlor; (v) real property or tangible personal property owned by the settlor at death that the settlor acquired as a replacement for the specifically devised real property or tangible personal property; (vi) if the facts and circumstances of the trust instrument indicate that ademption of the gift was intended by the settlor, or an ademption of the gift is consistent with the settlor’s manifested plan of distribution, the value of the specifically gifted property to the extent the property is not in the settlor’s estate (or trust) at death and its value or its replacement is not covered by other provisions of the nonademption statute. [MCL 700.2606.] When a specific asset is bequeathed in a trust, but it is not owned by the settlor at death that begs the question what was intended by the settlor when the asset is no longer owned by the settlor. Nonademption is a rule of construction that can result in a replacement for the identified bequeathed asset that no longer exists. Example: Settlor devises Condominium A under his trust to his daughter. Settlor later replaces Condominium A with Condominium B, which is next door, which was purchased because it has a better view. Daughter takes Condominium B, even though it is not mentioned in the Settlor’s trust instrument, as Condominium B replaced Condominium A. However, the Reporter’s Comments to this EPIC section note: “The testator’s [settlor’s] voluntary disposition of an asset, by sale or gift during his or her lifetime, would generally reflect an intent not to give the asset at death, i.e. it is reflective of an intent to revoke the testamentary transfer.”

Nonexoneration: “A specific devise {gift} and a transfer of property under an exercise of a power of appointment that is equivalent to a specific devise {gift}, including the exercise of a right to withdraw specific property, passes subject to any mortgage or other security interest that exists on the date of death, without the right of exoneration, regardless of a general directive in the Will (or trust) to pay debts.” [MCL 700.2607.] Example: Settlor expressly devises his home to his son under his trust’s distribution provisions. Settlor later obtains a home equity loan against his home and uses the home equity line of credit to pay for vacations and travel abroad. Son takes title to the home on the Settlor’s death, subject to the home equity loan, i.e. son becomes responsible to pay for the home equity line of credit used by his father for travel while alive, or the home will be sold to satisfy the unpaid home equity line of credit.

Ademption by Satisfaction: If the settlor gives property to a person during his/her lifetime that is expressly identified in the settlor’s trust instrument, that lifetime gift is treated as a satisfaction of the testamentary gift, in whole or in part,  if any of the following (i) to (iii)  are true: (i) the trust instrument provides for a deduction of the gifted property; or (ii) the settlor declares in a contemporaneous writing that the lifetime gift is in satisfaction of the devise {gift} or that its value is to be deduction from the value of the devise; or (iii) the recipient of the property acknowledges in writing that the lifetime gift is in satisfaction of the devise, or that its value is to be deducted from the value of the devise {gift} under the trust instrument. [MCL 700.2608.] Example: Settlor’s trust contains a provision that transfers his cottage on his death to his son. Later, the Settlor makes a lifetime gift of the cottage, by deed, to his son. A provision in the Trustee’s Deed, the Settlor, acting as initial trustee of his trust, announces that the lifetime transfer of the cottage to his son is in satisfaction of the provision in his trust instrument that directs the successor trustee to transfer title to the cottage to his son on his death. In the absence of any of the three conditions, a lifetime gift of the asset will NOT be treated an ademption of the property that is identified in the trust instrument. For purposes of partial satisfaction, the property that is given during the settlor’s lifetime is valued as of the time that the recipient came into possession or enjoyment of the gifted property, or at the settlor’s death, whichever event occurs first.

Note, however, that the lifetime gift is not required to be made to the named devisee under the trust instrument for this provision to apply; the statute only refers to a lifetime gift to ‘a person’ not the named devisee. Example: Settlor’s trust instrument gives his cottage to his son. During his lifetime, the settlor executes a Trustee’s Deed by which he conveys the cottage to his daughter. The Trustee Deed is silent as to an intent to adeem the trust instrument’s devise of the cottage to the son. Is this a nonademption situation, as there is no separate writing by the Settlor as to an intent to adeem the trust-gift to his son, entitling son to a replacement gift of equivalent value to the cottage, or is the lifetime Trustee’s Deed signed by the Settlor-trustee a manifestation of an intention to adeem the gift to the son? Applying rules of construction in this example may not eliminate litigation over the Settlor’s intention if the son asserts a claim of nonademption because the Trustee’s Deed was signed by an impartial Trustee, while if the Trustee’s Deed was signed by the Settlor acting as initial Trustee of the revocable trust, the conditions of the ademption by satisfaction arguably could be established.

Gifts by Agents: EPIC also addresses the legal implications if an agent, acting under a durable power of attorney, takes actions or makes lifetime transfers on behalf of their principal, which, in turn, affects a specific devise under the principal’s trust instrument. EPIC provides that if an agent acts within his/her authority under a durable power of attorney for an incapacitated principal and sells or mortgages specifically devised property, or if a condemnation award, insurance proceeds, or recovery for injury to the property are paid to the agent who acts within the authority for a durable power of attorney for the incapacitated principal, the specific devisee possesses the right to a general pecuniary devise equal to the net sales price, the amount of the unpaid loan, the condemnation award, the insurance proceeds, or the recovery. [MCL 700.2606(2).] If the specific devisee under the trust instrument possesses other rights under the nonredemption provisions (described above) then the amount to be paid to the devisee is reduced by what is received under the nonredemption provisions. Problematic is the implication that arises from this statute’s repeated reference to the principal being incapacitated at the time the agent acts on the principal’s behalf. Proof of incapacity is always a challenge, not to  mention that most durable powers of attorney are drafted to be effective by the agent whether or not the principal is incapacitated.

Conclusion: Rules of construction are often helpful when an ambiguity appears in a trust instrument or the need to identify which assets pass to which beneficiaries under a trust. However, those rules of construction are also awkward to implement at times. On occasion, the rules of construction can create even more interpretive problems than they are intended to solve.