Trustee’s Duty of Impartiality vs. Ability to Decant – Where to Draw the Line?

Take-Away: There is a tension between the trustee’s duty to treat trust beneficiaries impartially and the trustee’s power to decant the trust assets to a new trust to remove trust beneficiaries or curtail the rights of existing trust beneficiaries under an trust. Balancing that fiduciary duty of impartiality with the exercise of the trustee’s statutory authority to modify the terms of the trust will present considerable anxiety for a trustee, and sadly not much guidance from the courts.

Background: I have been preoccupied over the past few years with the interplay between the Michigan Trust Code and its numerous provisions that involve the trustee in the modification or alteration of the terms of an irrevocable trust, with the trustee’s co-existing common law, and statutory, duty to treat trust beneficiaries impartially and to administer the trust solely in their interests. I have not come up with any simple answers to that ‘balancing act.’

Fiduciary Duties: The Michigan Trust Code requires a trustee to administer a trust in good faith, expeditiously, in accordance with its terms and purposes, for the benefit of the trust beneficiaries. [MCL 700.7801.] Accordingly, a trustee must administer the trust solely in the interests of the trust beneficiaries, i.e. the duty of loyalty. [MCL 700.7802(1).] A trustee is also required to act as a prudent person would act in dealing with the property of another, which includes following the standards of the Michigan prudent investor rule to reflect the trustee’s duty to administer the trust impartially. [MCL 700.7803.]
Modifications: The Michigan Trust Code also gives the Trustee considerable latitude to modify, or enter into agreements, or to file petitions to modify the express terms of the trust. [Non-judicial settlement agreements- MCL 700.7111; Modify or terminate the terms of the trust- MCL 700.7410, 7411 and 7412; Terminate an uneconomic trust- MCL 700.7414; Modify a trust to achieve the settlor’s tax objectives- MCL 700.7416.]
Decanting: A few years ago the Michigan Trust Code was amended to permit the trustee to decant the trust assets into a new trust, created by the trustee, the effect of which is to alter the terms of the existing trust. [MCL 700.7820a] Michigan’s Power of Appointment Act [MCL 556.115a] was amended at the same time to permit alterations to a trust’s dispositive provisions (the Michigan Trust Code’s decanting authorization primarily being limited to changing the administrative provisions of the trust instrument.)
Duty of Impartiality: A trustee’s duty of impartiality has been frequently defined by the courts over the decades. One judicial observation of that duty that I always try to keep in mind when confronting a trustee’s duty of impartiality is from the decision The Northern Trust Company v. Heuer, 560 N.E. 2d 961 (Ill. App. 1990.) In that case the trustee had advocated a construction of the trust that was unfavorable to one trust beneficiary. The court held that while it was proper for the trustee to seek the court’s construction of the irrevocable trust by filing the complaint for construction and in gathering and presenting the information necessary for the court to interpret the trust, the trustee nonetheless breached its duty of impartiality and exceeded its duty as trustee when it argued before the court for an interpretation of the trust that was adverse to that one trust beneficiary: The court stated “… it is preferable that we reiterate established precedent and foster every incentive for a trustee to adhere to its well-established duty of impartiality.” As part of its finding that the trustee acted inappropriately when it asserted a position in the court proceedings contrary to the interests of one trust beneficiary, the court denied Northern Trust’s petition for costs and attorney’s fees: “generally the costs of litigation to construe a trust in which there are adverse claims are paid by the trust estate,… where a trustee breaches its duty to administer the trust according to its terms and performs in a manner which favors one beneficiary over another, the trustee is not entitled to attorney’s fees and costs even though the breach is technical in nature, done in good faith, and causes no harm.” In short, even when the trustee acts in good faith, if it ends up in the opinion of the court of formally taking a position that is contrary to the interests of just one trust beneficiary, the trustee will have breached its fiduciary duty of impartiality.
Question: The rhetorical question is: how does the trustee balance its duty of impartiality to all of the trust beneficiaries with the trustee’s statutory authority to alter the terms of the trust, where the interests of the those same trust beneficiaries may be affected by that exercise of the trustee’s decanting power? While normally a trust beneficiary cannot be added to a trust through a decanting, trust beneficiaries can effectively be removed through a decanting or their interests in the trust substantially altered. That was the question posed in a recent New Hampshire Supreme Court decision where the question litigated with was the propriety of the trustee’s decision to exercise its power to decant the trust when it removed some, but not all, of the trust beneficiaries.

New Hampshire Court Decision: Hodges v. Johnson, 2017 WL 6347941 (New Hampshire Supreme Court, 2017.)

Facts: Hodges created two irrevocable trusts in 2004. The trust beneficiaries were Mr. Hodges then-spouse, 5 children, his step-children, and all of their descendants. One trust held GST exempt assets; the other trust was not GST exempt. Both trusts held non-voting stock in Mr. Hodge’s business and LLCs that were associated with that operating business. While Mr. Hodges was alive each trust gave to his spouse, children and step-children the right to withdraw contributed property to the trust in a 60 day ‘window period’- a crummey withdrawal power. Each trust also provided for discretionary distributions of income and principal to the beneficiaries, those distributions then being deposited into ‘distributee trusts’ which were also subject to the beneficiaries’ withdrawal rights. Each trust had a ‘no contest’ provision as well. The co-trustees were the lawyer who worked for the settlor and an executive of the business interests held in the two trusts. There was also an investment committee that guided the trustee on investments; Mr. Hodges controlled the composition of that investment committee.
Decanting: In 2009 Mr. Hodges got upset with some of the trust beneficiaries. In 2010 3 separate trust decantings occurred, each superseding the earlier versions of the trusts, that eliminated the beneficial interests of 4 of the 6 named trust beneficiaries, including some of his children, his step-children, and Mr. Hodges now former wife. Mr. Hodges died in 2015. Prior to Mr. Hodges’ death some of the eliminated trust beneficiaries filed petitions with the probate court to void the trustee’s decantings and also to remove the co-trustees [who apparently were more than willing to follow Mr. Hodges’ marching orders.]
Court Decisions: The probate court held in favor of the eliminated trust beneficiaries finding that the trustee had exercised the power to decant ‘without considering the plaintiff beneficiaries’ beneficial interests’ [which, if litigated in Michigan, would be based on MCL 700.7801- the duty to administer the trust for the benefit of the trust beneficiaries.] Apparently in a fit of candor, one of the co-trustees testified that he never even considered the financial circumstances of the removed beneficiaries in exercising the power to decant the trusts. In its decision the trial judge also noted that the settlor’s initiated the co-trustee’s decantings and “the deeply personal and harsh nature of the decantings.” That decision was appealed to the New Hampshire Supreme Court, which issued a divided opinion. The Supreme Court rejected the trial court’s decision that was based on the co-trustee’s failure to consider the ‘interests of the beneficiaries’ and instead found that the trustee had violated its common law, and it statutory duty under New Hampshire’s trust code, to act impartiality with regard to all of the trust beneficiaries [ comparable to Michigan’s MCL 700.7803 duty to administer the trust impartially]. Consequently, the Supreme Court’s decision was based on a finding that the trustee did not fulfill its duty of impartiality to all of the trust beneficiaries in implementing its decanting authority.
Duty of Impartiality: To reach its conclusion the Supreme Court found that by requiring the trustee to act in accordance with the provisions of the state’s trust code, the statutory requirements to administer the trust in the interests of the trust beneficiaries includes the statutory duty to act impartiality. “..it is difficult to imagine the factual scenario where the trustee would not violate its fiduciary duty of impartiality owed to that beneficiary.” In describing the trustee’s duty of impartiality, the Supreme Court noted that the trustee must treat the beneficiaries ‘equitably in light of the purposes and terms of the trust.’
Balancing Decanting with Impartiality: The Court, reading all of the statutes that pertained to the co-trustee’s duties and their ability to decant found that a co-trustee who, through decanting, makes unequal distributions among trust beneficiaries or who eliminates a beneficiary’s non-vested interest in a trust violates the statutory duty of impartiality ‘only if in doing so the trustee does not treat the beneficiaries equitably in light of the purposes and terms of the trust.’ In this case, the Court found that one of the purposes of the trust, albeit after the settlor’s death, was to support the beneficiaries, since the trust instrument ‘directed’ the trustee to make reasonable and appropriate distributions for the ‘welfare, enjoyment, and education’ of the beneficiaries. [The dissenting Justice did not believe that this trust provision with regard to discretionary support was an actual purpose of the trust.] It was this purpose that the Court focused upon in finding the trustee’s exercise of its decanting power violated its duty to act impartially with regard to all trust beneficiaries, whether or not those beneficiary’s interests were vest or not vested, and whether or not those interests were contingent- ‘the duty of impartiality is owed to all beneficiaries no matter the nature of their interests’ in the trust instrument.
Decision: The New Hampshire Supreme Court thus found the co-trustees to have breached its duty of impartiality to all trust beneficiaries and it reinstated the removed trust beneficiaries to the trust. The Supreme Court also affirmed the trial judge’s order that removed the co-trustees based on that judge’s findings that the trustee had ‘committed a serious breach of trust.’ However, the Supreme Court did not go so far as to conclude any exercise of a decanting power by a trustee is a breach of fiduciary duty: just that“ [A decanting] that eliminates a beneficiary’s non-vested interest in an irrevocable trust is a breach of duty only when the trustee fails to treat the beneficiaries equitably in light of the purposes and terms of the trust.”

Commentary: The Hodges decision shows just how complex the interplay is between a trustee’s fiduciary duties to the trust beneficiaries (loyalty, impartiality, act in their best interests) and its extraordinary decanting power, based upon the dispositive terms of the irrevocable trust, to remove trust beneficiaries or dramatically curtail their rights or expectations under the trust. The lack of limits on a trustee’s decanting power, which in Michigan is dependent upon the nature of the trustee’s discretionary power under the trust to distribute trust assets, might cause a probate court to seek limits elsewhere under the Michigan Trust Code to curtail that apparently expansive authority. It is possible, too, that Hodges merely represents a court’s visceral reaction to what appears to be co-trustees exercising their decanting power over an irrevocable trust following the directions of the trust’s settlor who wanted to change ( or punish?) the existing trust beneficiaries. Nor did it help the co-trustees of the Hodges trust when one co-trustee testified that he ‘never gave the plaintiffs’ financial interests any consideration.’

But there is another decision with regard to a trustee exercising its decanting powers where the court seemed to apply almost carte blanche to its exercise without much, if any, discussion of the implications of the trustee’s co-existing fiduciary duties to the trust beneficiaries. Consider the somewhat infamous Ferri v Powell-Ferri, 476 Mass. 651, 72 N.E. 3d 541 (2017); Powell-Ferri v. Ferri 326 Conn. 457 (2017) case(s) where the lifetime trust beneficiary faced a divorce from his wife. His brother, acting as a co-trustee of an irrevocable trust that their father had created for the husband, in anticipation of the divorce action filed by his sister-in-law, exercised a common law decanting power and created a new trust for his brother. But in the newly decanted trust the husband-beneficiary’s withdrawal right to take almost all of the assets held in the trust was eliminated (trust assets that would then have come into the marital estate subject to the division of the divorce court had the power of withdrawal of the trust corpus continued to exist.) The divorce took place in Connecticut, but the trust was governed by Massachusetts law. Invited by the Connecticut court to address the trustee’s decanting power in Massachusetts, the Massachusetts Supreme Superior Court found that the trustee’s decanting of the trust assets to remove the beneficiary’s presently exercisable right of withdrawal was valid and binding, with little to no discussion with regard to the public policy of intentionally removing assets from a trust beneficiary (or more accurately from the control of a divorce court in another state) and with no reference to the trustee’s duty to treat that trust beneficiary impartially. With that decision on state law, the Connecticut divorce court then found that the trust’s assets could not be included in the marital estate to be divided between the husband-beneficiary and his former wife.

But courts, particularly divorce courts, do not like to be manipulated, which the trustee’s decanting attempted to do. In the final Connecticut divorce court decision, while the judge did not include the trust’s assets in the divisible marital estate, he nonetheless approved a spousal support award to the former Mrs. Ferri of $300,000 a year [when in Mr. Ferri’s annual earnings prior to the divorce were only about $200,000.] While Mr. Ferri thought he was the winner when the trustee’s decanting removed millions of dollars of assets from the marital estate by eliminating the beneficiary’s withdrawal right over those assets, with hindsight he may now feel he was the ultimate loser: Mr. Ferri’s withdrawal rights were eliminated by the decanting, he was now the beneficiary of a wholly discretionary trust for the rest of his life, and he finds himself subject to a court order that compels him to pay spousal support 50% higher than his annual non-trust income.

Conclusion: Perhaps one common thread in both the Hodges and Ferri decisions is the direction provided by the trust settlor to the trustee. In Hodges, clearly the trust settlor changed his mind about who he wanted as beneficiaries of the irrevocable trusts that he had created years earlier, and the co-trustees were more than happy to accommodate his change of mind. In Ferri the Massachusetts court accepted an affidavit prepared by the settlor-father of the son beneficiary, who expressed in his affidavit that it was never his intent to have the trust assets pass to his daughter-in-law in a divorce, something that court found to be persuasive. While there are plenty of cases at common law where trustees are directed to implement the settlor’s intent that is manifest in the trust instrument, and the Uniform and Michigan Trust Codes regularly mention fulfilling (or not frustrating) the settlor’s material purposes in establishing their trust, it would seem that at least one court thought a decanting could permit the trustee to respond to the settlor’s intent and directions, not when the irrevocable trust was signed, but many years later, when the settlor has second-thoughts about who might actually benefit from the irrevocable trust.

When exercising a power to decant trust assets, does the trustee act impartially and with loyalty in the sole interest of the trust beneficiaries, or does the trustee listen to the settlor, not by reading the trust instrument but by accommodating a newer expression of settlor intent and purpose? It will be interesting to see in the years to come the impact of trust modifications and statutory decanting authority on the trustee’s historic duties to act impartially and solely in the trust beneficiaries’ best interests. I still do not see how there can be a clear balance between that fiduciary duty and that fiduciary power; more likely I am just missing something (and not for the first time.)