Gifts from Revocable Trusts

Take-Away: The Michigan Court of Appeals recently provided guidance on when gifts are authorized to be made from a Trust, including gifts to the trustee and the trustee’s children.

Reported Decision: In re Estate of Vernon Stephenson, Michigan Court of Appeals, No. 348207, (July 30, 2020) Unpublished

Facts: The parents created reciprocal durable powers of attorney and a revocable joint Trust in 2010. Each parent was named as the agent for the other, and they named themselves as the initial trustees and soleopriate beneficiaries of their joint Trust. The parents named their son, Randal, as successor agent under the durable powers of attorney and as successor trustee of their joint Trust. The beneficiaries of the Trust, after the parents’ deaths, were Randal, his sister Christina, and their respective children. The mother died in 2014 and the father, Vernon, a week later, was declared incompetent and unable to perform his duties as trustee. In steps Randal as ‘back-up’ agent under his father’s durable power of attorney, and also as the successor trustee of the Trust.

The durable power of attorney gave to Randal, the agent, gift-giving authority to “make gifts to third parties or to the agent as individual, in the sole discretion of the agent, as he deems appropriate provided said gifts qualify for the annual exclusion under the [Tax Code’s] Sections 2503(b), 2503(c) or 2503(e).”
The Trust instrument directed the successor trustee, Randal, to use the trust estate “for the benefit of anyone else authorized by Article One or Two of this living trust” which Articles referenced any beneficiaries of the Trust, that included Randal and his children and Christina and her children.
In addition, the Trust instrument also provided: “..the successor trustee shall be fully authorized to make gifts from this trust to third parties or to the successor trustee as individual as determined in the sole discretion of the successor trustee, provide that said gifts qualify for the annual exclusion under Sections 2503(b), 2503(c) and 2503(e) of the Internal Revenue Code, as amended.”

Shortly after his father was declared incompetent, Randal made substantial distributions from the Trust and from his father’s estate. The amount of $147,000 was used to pay for Randal’s children’s educational expenses, and Randal distributed $56,000 to himself, leaving about $700.00 in the Trust.

Petition: Christina and her children brought an action in the probate court against Randal. They claimed that he violated fiduciary duties and by the Trust’s terms, Randal engaged in self-dealing to exhaust the Trust’s assets to Christina and her children’s detriment. They also claimed that Randal had failed to include in the Trust’s assets a $120,000 Demand Note that Randal and his wife had given the parents in 2009.

Response: Randal responded that both the durable power of attorney and the Trust gave him the authority, what he claimed to be unbridled discretion, to make trust and estate distributions. Randal also claimed that his late mother forgave the Demand Note, although there was nothing in writing to document that the demand note was ever forgiven.

Probate Judge: The probate judge found that Randal was authorized under the durable power of attorney and his parents’ Trust to make distributions to himself and his children. However, that authority was limited to gifts that “will qualify for the annual exclusion under the Internal Revenue Code.” The probate judge also found that the Demand Note was not forgiven, and thus it remained an estate asset.

Both Randal and his sister Christina and her children cross-appealed these decisions from the probate judge.

Court of Appeals:

Power to Make Gifts Under Durable Power of Attorney: The appellate Court initially observed that durable powers of attorney are to be strictly construed and cannot be enlarged by construction. However, the Court also found that the durable power of attorney clearly gave Randal, as the agent under the instrument, the authority to make limited gifts to himself and his children.

While Christina conceded that express language in the durable powers of attorney, she still claimed that Michigan law prohibited her brother, as attorney-in-fact, from any self-dealing, relying on In re Cummin Esate, 474 Mich. 1117 (2006.) Cummin was explicitly distinguished by the Court because in this case, the durable power of attorney explicitly gave the agent the authority to self-deal. The Court then said that the explicit authority to self-deal “must be strictly construed and cannot be expanded or limited” and thus, by implication, the common law prohibition on self-dealing by a fiduciary.

Power to Make Gifts Under the Revocable Trust: Christina and her children argued that the Trust instrument was ambiguous. Specifically, they pointed to other provisions in the Trust that provided that the successor trustee was to pay income to or for the benefit of the settlors ‘as long as they are alive,’ which suggested that assets needed to be retained in the Trust to care for the surviving settlor and that support treated as a priority. Thus, with that ambiguity, the Court should consider extrinsic evidence to resolved the ambiguity. The Court found no ambiguity due to the express language used in the Trust that authorized lifetime gifts and self-dealing by the successor trustee. Again, the Court found that the terms of the revocable trust gave to Randal, the successor trustee, the authority to make disbursements and limited annual exclusion gifts to himself and to his children. “A trust must be read in its entirety and, if possible, with harmony among its provisions.” [MCL 700.7112 and In re Raymond Estate, 483 Mich. 48 (2009.)] “There is nothing defective, obscure or insensible about the language used in those [Trust] provisions and that provision is clear that the Trust is created for the use and benefit of the Trustees (the descendants.)”
Discretionary Trust: Randal appealed the probate judge’s determination that there were limits to Randal’s unbridled discretion when acting as successor trustee. The Court agreed that the probate judge made a mistake by limiting the trustee’s discretion to the limited amounts that could be given by the trustee from the Trust, i.e. there were no arbitrary limits on the amount that could be distributed pursuant to the trustee’s discretion (in contrast to the limit on the trustee’s ability to gift trust assets constrained by the annual exclusion amount.)

However, while the terms of a Trust generally control over a statute, the terms of the Trust cannot prevail over the “duty of a trustee to administer the trust in accordance with MCL 700.7801.” [MCL 700.7105(2)(b).] Specifically a trustee must administer the Trust in good faith, expeditiously, and in accordance with its terms and purposes, and always subject to a trustee’s fiduciary duties. [MCL 700.7101 and MCL 700.7816(2).]

“[Randal] contends that he had unbridled discretion to distribute the Trust assets according to the Trust’s plain, unambiguous terms. We agree that Article Four, Section D unambiguously empowers [Randal] to distribute the Trust’s assets for the beneficiaries’ benefit within his discretion. We disagree that this discretion is unfettered and without limitation. Michigan law clearly places restrictions upon a trustee exercising his or her judgment under a discretionary trust, especially in circumstances in which the trustee is also a beneficiary.”

The Court distinguished the clear language of the Trust that authorized limited gifts to beneficiaries, from the language where the successor trustee, as a fiduciary, was to exercise discretion in making distributions of trust assets to or for the benefit the trust beneficiaries, including the surviving, albeit incapacitated, settlor and himself as one of many beneficiaries. Accordingly, the case was remanded to the probate court for an evidentiary hearing with regard to whether gifts or discretionary distributions were made primarily for the settlors’ grandchildren’s educations.

Discharge of Demand Note: The probate judge’s decision that the Demand Note was not forgiven by Randal’s late mother was sustained by the Court. The Court found that the discharge of the Note was controlled by MCL 556.1, which requires that the discharge of the Note [or a contract, lease, mortgage, or security interest] where no consideration is furnished, must be in writing and signed by the party against whom the change, modification, or discharge is to be enforced. Here, there was no writing to document the mother’s alleged intent to forgive, i.e. discharge, the Demand Note. Consequently, the Demand Note was determined to still exist as an asset owned by the disabled settlor.

Conclusion: This case is a sad reminder of the many situations I encountered when practicing law when a family member, named as agent under a durable power of attorney, or successor trustee, acted as if there were no limits to, or constraints on, the authority given to him, or her, under the durable power of attorney or the Trust. Apparently many individuals who serve in the role of a fiduciary feel that only corporate or professional fiduciaries are bound by fiduciary duties. Unfortunately, it often takes a probate court hearing, and considerable legal fees, to disabuse the individual of this notion that they possess ‘unfettered or unbridled discretion.’