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George F. Bearup, J.D. Senior Legal Trust Advisor

2-Nov-20

Trust Decanting in Michigan – One Court’s Interpretation

Take-Away: The Michigan Court of Appeals had what may be its first occasion to expressly apply Michigan’s trust decanting statute last month. While the Court focused on an administrative trust decanting,  it neither mentioned  nor applied a decanting under the Michigan Powers of Appointment Act which generally pertains to substantive or material changes to a beneficiary’s interest in the trust. Of interest was the decanting trustee’s claim that the trust created for the one beneficiary of the decedent’s Trust to hold and distribute his inheritance was a revocable trust controlled by the successor trustee, which would terminate only on the trustee’s death (and not the death of the trust beneficiary.) Suffice it to say, this is a strange case.

Background: In 2012 Michigan adopted two statutes with regard to authorizing a decanting of trust assets by the trustee to a second trust.

  • Decanting Under the Trust Code: The Michigan Trust Code generally authorizes a trust decanting that alters the administrative provisions of the first trust by decanting trust assets to a second [MCL 700.7820a.] However such a decanting cannot be used to materially change the beneficial interests of the beneficiaries of the first trust. [MCL 700.7820a(1)(a.)]
  • Decanting Under the Power of Appointment Act: This decanting statute is an amendment to the Michigan Power of Appointment Act. [MCL 556.115(a).] This decanting statute normally will be used by a trustee that seeks to make material changes to the trust’s dispositive provisions that affect the beneficiary’s rights and interests in the first An example of when the Power of Appointment Act decanting statute would be used is if the trustee of the first trust wants to extend the duration of that first trust by transferring its assets to the second trust which has a longer duration.
  • Relation Back Concept: Inherent in the concept of a trust decanting is that while the assets are moved from the first trust to the second trust, the second trust is still treated as if it originated when the first trust came into existence for rule against perpetuities purposes. The second trust is not treated as if it created vested interests when the first trust’s assets- it relates back to the first trust’s creation.

Discretionary Trust: The Michigan Trust Code provides that the beneficiary of a purely discretionary trust possesses no property interest in the discretionary trust, which is intended, in part, to protect the trust’s assets from the beneficiary’s creditors. [MCL 700.7815(1).] However, that beneficiary’s interest in the trust must be respected and protected by the trustee’s fiduciary duties.

We now have a Michigan appellate court decision that applied MCL 700.7820a to reach its decision. In doing so, it rejected the successor trustee’s claim that the beneficiary’s interest in the discretionary trust as a non-interest. The second trust is not a revocable trust controlled (owned?) by the decanting trustee. However, the trustee prevailed and even picked up an attorney fee award in the process. It is, though, a hard decision to follow to understand the result that the Court reached (or I am just really slow these days!)

In re Lakeside Trust Number 1, Michigan Court of Appeals, No. 351047 (October 15, 2020)

Estate Plan- the First Trust: Ethelwyn created a revocable trust of which her daughter Lori was named the sole successor trustee. After a couple of trust amendments, Ethelwyn directed the successor trustee on her death to divide the balance of her trust estate into shares of equal value among her 5 children: Jeffrey (the petitioner), Lori (the successor trustee), Jon, Jerrold (for whom a trust was created) and Mari. Each child, other than Jerrold, was to receive their trust share outright on Ethelwyn’s death. The successor trustee was directed to create and hold Jerrold’s share of the trust estate on Ethelwyn’s death in a separate trust to be established for his benefit.  Therefore, under Ethelwyn’s trust, the successor trustee was not directed to continue to hold Jerrold’s share under her estate planning trust; rather, the successor trustee was directed to create a trust to hold Jerrold’s share of Ethelwyn’s trust estate, effectively directing an act of decanting some of the trust assets to a new trust that is created by the successor trustee. The actual trust language that required this is omitted from the Court’s decision; the Court only noted: “Ethelwyn further directed the successor trustee to place Jerrold’s share, if he survived Ethelwyn, into a separate trust for his benefit.”

 

The trust provisions for Jerrold’s ‘trust share’ contained the following language which led to the litigation: “The trustee is further authorized to distribute nothing to Jerrold if the trustee determines, in [her] sole and absolute discretion, that it is not in Jerrold’s best interest to receive any such funds, and in such case the trustee is authorized to terminate the trust [for Jerrold] and disburse all trust [share] assets, whether it be principal, interest, or income, to my surviving children at the time Jerrold’s trust is terminated, share and share alike…In the event there are assets in Jerrold’s trust at the time of Jerrold’s death, the trustee shall disburse all remaining assets held in trust to my surviving children at the time of Jerrold’s death, share and share alike. I nominate and appoint my daughter, Lori E. Alexander, as the trustee of Jerrold’s trust …”

  • Observation: Candidly, I never envisioned the decanting statute was one that would be followed to create a trust following the settlor’s direction. Rather, I always thought that the decanting power was a tool that was used by the trustee to ‘fix’ a problematic problem encountered with the first
  • Observation: It seems that Lori held a general power of appointment over the trust created for Jerrold, since she could at any time and for any reason terminate Jerrold’s trust and distribute one quarter of its assets to herself. The Court’s decision did not make note of this. Arguably if Lori had her own creditor problems, they could reach 25% of the assets held in trust created with Jerrold’ inheritance. The same creditor exposure might have existed following Lori’s arguments (more on those below) that she created a revocable trust naming herself as its settlor.

Lakeside Trust- the Second Trust : Ethelwyn died in 2013. Lori, then acting in her role as the successor trustee, created the Lakeside Trust for the benefit Jerrold to hold the inheritance from his mother. In creating the Lakeside Trust for Jerrold,  Lori identified herself as the ‘grantor, settlor and trustee.’ There is no indication from the Court’s summary of these facts if Lori was then relying upon the Michigan decanting statutes. Rather, it just said that Lori transferred Jerrold’s share of his late mother’s trust into a ‘new’ trust called the Lakeside Trust.  The initially created Lakeside Trust complied with Ethelwyn’s directive to, according to the Court, “create the beneficiary trust for Jerrold” that contained dispositive provisions consistent with Ethelwyn’s Trust.

Petett, LLC: In 2015, Lori and her sister Mari formed Petett, LLC, which held investments and real estate, each as a 33% member. The Court’s decision does not say, but it may be safe to presume that the two sisters took some, or all, of their inheritances received on their mother’s death and pooled their assets to form Petett, LLC. Nor was the Court able to explain how it came to pass that the remaining 33% of Petett, LLC’s membership units were held by Lakeside Trust  i.e. the trust Lori created for Jerrold. At the time of distribution the Lakeside Trust’s assets, the LLC held assets worth $560,000. A fair assumption is that Lori, acting as successor trustee of Ethelwyn’s Trust and as the trustee of the Lakeside Trust established for Jerrold’s benefit, took Jerrold’s trust share’s assets and added them to the LLC’s capital, resulting in the Lakeside Trust holding the remaining 33% membership interests in Petett, LLC.

Lakeside Trust Amendment: In 2017, Lori acting as trustee of the Lakeside Trust, and claiming that she retained the right to amend Lakeside Trust as its settlor since that Trust was revocable, amended the Lakeside Trust to provide that on Jerrold’s death, the Lakeside Trust’s remaining assets were to be distributed to Ethelwyn’s then surviving children, consistent with Ethelwyn’s Trust directions. The Court does not say if this amendment was the equivalent of a decanting under MCL 700.7820a. That trust amendment created by Lori provided:

“It is Jerrold’s desire that the trust’s 1/3 interest in Petett, LLC go to Lori E. Alexander and Mari A. Pettis. Jon A. Alexander and Jeffrey L. Alexander shall receive equal cash value of the interest of Petett, LLC…The remaining assets [of Jerrold’s Lakeside Trust] shall be distributed  equally among the surviving children of Ethelwyn.”

Probate Court Litigation: Jerrold died in 2018. The litigation dealt with the distribution of assets held in the Lakeside Trust among Jerrold’s 4 surviving siblings, and specifically the amendment to that Trust created by Lori.

  • Jeffry: Jeffry, one of Jerrold’s two surviving brothers, filed a petition with the probate court that sought to remove Lori as trustee of the Lakeside Trust. Jeffry asked for court supervision of the Lakeside Trust, an accounting from Lori, and the appointment of an independent successor trustee of the Lakeside Trust. Specifically, Jeffry claimed that Lori had failed to follow the disbursement directions contained in their late mother’s Trust and also the disbursement provisions contained in the initial Lakeside Trust. Jeffry claimed that Lori did not possess the right or authority to amend the Lakeside Trust. While Jeffry admitted that he received a distribution of $66,878 from the Lakeside Trust after Jerrold’s death, he claimed that he was entitled to receive an additional $50,783 from the Lakeside Trust. The Court decision does not specifically say what Jeffry wanted, or how he felt that he had been shortchanged with Lori’s distributions, but it would seem that he may have wanted an equal share of Petett, LLC membership interest along with his sisters and surviving brother.
  • Comment:  Maybe Jeffry felt that the LLC units to be received by his sisters on Jerrold’s death under the trust amendment were undervalued (valuation discounts applied for lack of marketability and/or lack of control?) which resulted in Jeffry receiving a smaller share of the Lakeside Trust’s assets upon Jerrold’s death, if the LLC was undervalued (there was no appraisal of the LLC, just a cost- inventory of the LLC’s assets.)
  • Lori: Lori responded to Jeffry’s claims asserting that the Lakeside Trust was, and remained, revocable by her as its settlor, and her sole duty as trustee was owed exclusively to herself. [See MCL 700.7603(1).] Lori further responded that the Lakeside Trust would only become irrevocable on her [Lori’s] death, as she was the settlor of Jerrold’s Lakeside Trust and she was the only person with the ability to revoke or amend the Lakeside Trust. Since the Lakeside Trust was a revocable trust that was created by her, Lori argued that she had no obligation to provide any accounting to the named beneficiaries of the Lakeside Trust, i.e. there was no duty to account under MCL 700.7603(1) because it is not applicable to a revocable trust.

Probate Court: The probate judge granted summary disposition in favor of Lori and against Jeffry. The probate judge found: “If [Lori] as the trustee had the authority to amend the Lakeside Trust, then she had the inherent authority of the settlor to distribute trust assets contrary to their terms as set forth in [MCL 700.7808]….As I indicated, whether we follow the strict compliance with Ethelwyn’s Trust that gets us to a quarter- a 25% distribution to each of the surviving siblings or whether we follow [Lori’s] argument that-that [Lori] is the settlor and therefore had authority to distribute contrary to the specific terms of the trust amendment, her proposed final distribution of the trust is the same as Ethelwyn’s which could be a quarter percent- I’m sorry, 25% interest to each of the four children.”

  • Comment: If you have followed this summary to the point (and have not had your eyes glaze over too badly) what you are reading is that Jerrold’s inheritance on the death of his mother was to be held in trust for his benefit, albeit under a fully discretionary trust. When Lori used Jerrold’s inherited assets to fund the Lakeside Trust established for his benefit, Lori claims, or acted as if Jerrold’s inherited assets were her own because she set up the Lakeside Trust as a revocable trust, and thus she claims that she had no duty to report or to account to anyone, arguably including Jerrold whose inherited assets funded the Lakeside Trust. At this point in the Court’s decision there was no mention of Lori’s fiduciary duty to preserve and maintain Jerrold’s inheritance for his own benefit.

Appellate Court: The Michigan Court of Appeals sustained the probate judge’s grant of summary disposition against Jeffry’s claim for more assets to be distributed to him, including the award of attorney’s fees against Jeffry.

  • Perhaps the easiest way to explain the Court’s ultimate decision was ‘no harm, no foul.’ Since Jeffry did not dispute the value of the assets held in the Lakeside Trust, and according to the distribution formula under the trust amendment, he and his brother were going to receive the exact same value of that trust’s assets as their sisters after Jerrold’s death, and thus the spirit of Ethelwyn’s Trust was carried out- each surviving child received an equal share in value of Jerrold’s trust share on his death, with no material change in the beneficial interests of the beneficiaries of Ethelwyn’s trust, i.e. the first [MCL 700.7815(1).]
  • The probate judge did not agree that the Lakeside Trust was a revocable trust solely within Lori’s control, a conclusion seemingly also reached by the Court. The Court found that Lori had an obligation to comply with the terms of Ethelwyn’s Trust, which in turn governed the terms of the Lakeside Trust, and thus the beneficial interests of the Lakeside Trust could not be materially changed by the Lakeside Trust in the manner of Lori’s amendment to it.
  • The Court noted that Lori, as successor trustee of Ethelwyn’s Trust, was required to create [not continue] a trust for Jerrold’s benefit with his share of his late mother’s trust estate. That share was to be distributed to Jerrold in Lori’s discretion. Lori then created the Lakeside Trust for Jerrold in 2013, identifying herself as the ‘grantor and settlor’ of the Lakeside Trust, reserving to herself broad discretionary rights to control the trust’s assets and ‘to revoke the Lakeside Trust’ in her sole discretion. The Court agreed with Lori that under the Michigan Trust Code, the rights and duties of the trustee of a revocable trust are owed exclusively to the settlor. [MCL 700.7603(1).]However, the Court inferred, but did not expressly hold, that the Lakeside Trust was an irrevocable trust that Lori created to reflect and carry out the directives of the Ethelwyn Trust.
  • The Court then launched into a discussion of MCL 700.7820a “which governs irrevocable trusts that include discretionary trust provisions.” [Emphasis mine.] “The plain language of [Ethelwyn’s] Trust directed the creation of a beneficiary trust subject to [Ethelwyn’s] Trust. The initial Lakeside Trust document respecting distribution upon Jerrold’s death provided as directed by the [Ethelwyn] Trust that Ethelwyn’s surviving children would receive equal distributions of assets of the Lakeside Trust.”
  • Under the ultimate distribution of the Lakeside Trust each surviving sibling of Jerrold received the same value of assets as the others, the intent of Ethelwyn’s Trust was carried out, thus adhering to the requirements of the Michigan decanting statute that there must be no material change to the beneficial interests after a trust decanting.
  • Lori had argued that as the trustee of the Lakeside Trust, a revocable trust during her lifetime because as the settlor, she could follow her own directions contrary to the terms of the  initial Lakeside Trust’s distribution provisions. “ In other words, despite the Lakeside Trust’s amendment requirements for distribution, she could distribute the trust’s assets in the manner that she as settlor decided.” The probate judge disagreed with this assertion of her ultimate control since Lori had the obligation to comply with the terms of Ethelwyn’s Trust which controlled the ‘beneficiary trust’ and established the beneficial interests of the beneficiaries which could not be materially changed by the Lakeside Trust in the manner of her amendment to it.
  • So, if you have followed along to this point, the Lakeside Trust was created by Lori to carry out the Ethelwyn Trust. A decanting. Lori’s attempted amendment of the Lakeside Trust was not legally enforceable as a decanting. Yet Lori and her sister were still awarded the Lakeside Trust’s interests in Pettet, LLC, and not equally among the 4 surviving children, as Ethelwyn’s Trust, and the initial Lakeside Trust  had required. Apparently that was okay with the probate judge and the Court of Appeals, so long as in the end, the value of the distributed assets received by the four surviving children were equal in value.

Conclusion:  Even after reading the decision is still not clear what Jeffry sought to accomplish with his petition filed with the Probate Court. Nor is it clear how Lori’s amendment to the Lakeside Trust, which gave Lori and her sister, the Lakeside Trust’s 33% membership interest in Pettet, LLC,  was held to be unenforceable, yet they were entitled to retain that Trust’s share of Pettet, LLC.  The creation of the Lakeside Trust was a decanting, but her efforts to amend the Lakeside Trust was an impermissible decanting (my conclusions, not the Court’s as it did not say as much.) So long as the value of what each child ultimately received was equal on the termination of the Lakeside Trust,  and their beneficial interests were not materially changed, as required by the Michigan Trust Code’s decanting provision. The last surprising result was Jeffry got tagged with an attorneys fee obligation even after Lori presented the argument that she controlled (arguably owned) the assets held in the Lakeside Trust, since she had made it a revocable trust, which prompted her failure to provide accountings to the beneficiaries. I am not sure what key take-aways are associated with this decision, at least the Court seemed to want to apply MCL 700.7820a, but how it was applied leads to more confusion.