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

18-Jun-18

Agent Created Trust: Duty to Reasonably Inform?

Take-Away: Individuals often execute durable powers of attorney at the same time they execute a will or a revocable trust. If no trust exists to which an incapacitated individual’s assets can be transferred, where they can be managed by the successor trustee and thus avoid probate, does the agent under the durable power of attorney possess the power to create a trust for the principal? Not at common law. And even if such power to create a trust exists in a durable power of attorney, what are the implications that the trust may be later challenged if the agent names himself as trustee of the trust he/she just created for his/her incapacitated principal?

Background:

  • Definition of Trust: The Michigan Estates and Protected Individuals Code [EPIC] furnishes a broad definition of what is a Specifically a trust includes, but is not limited to, an express trust, private or charitable, with additions to the trust, whenever and however the trust is created. A trust is not limited to a trust that is created or by a judgment or court order under which the trust must be administered in the manner of an express trust. However, the definition of a trust does not extend to a constructive trust or a resulting trust, which are equitable remedies that a court can impose to rectify a wrong, e.g. correct an unjust enrichment by imposing a trust on the assets held by the wrongdoer. Nor does the concept of a trust apply to a conservatorship, a personal representative, a custodial arrangement under the Uniform Gift to Minor’s Act, or a nominee  or an escrow arrangement. [MCL 700.1107(n).]
  • IRA Trust: The Reporter’s Commentary to EPIC suggests that an individual retirement trust, i.e. an IRA that is set up as a trust rather than a custodial account, falls within EPIC’s definition of a trust, and thus by definition it subjects an individual retirement trust (IRT) to all of the Trust Code’s rules of construction as well as its limitations.
  • Definition- Terms of a Trust: The definition of trust is different from yet another EPIC definition, terms of a trust. The latter term of art is defined to mean a manifestation of the settlor’s intent with regard to a trust’s provisions as expressed in the trust instrument or as may be established by other evidence that would be admissible in a judicial proceeding. [MCL 700.1107(k).]
  • Trust Relationship: Despite contemporary literature and the propensity of the Tax Code and the IRS to frequently treat a trust as a separate legal entity, like a corporation or LLC, in fact a trust is strictly speaking only a legal relationship. The Restatement (Third) of Trusts, Section 2 provides:’ A trust, as the terms is used in this Restatement when not qualified by the word ‘resulting’ or ‘constructive’ is a fiduciary relationship with respect to property, arising from a manifestation of intention to create that relationship and subjecting the person who holds title to the property to duties to deal with it from the benefit of charity or for one or more persons, at least one of whom is not the sole trustee.’ This principle of a legal relationship, not a separate legal entity,  is reflected in the Trust Code provisions that describe the methods used to create a trust.
  • Creating a Trust: A trust may be created by any of the following methods under the Trust Code: (a) Transfers of property to another person as trustee during the settlor’s lifetime or by will or other disposition taking effect upon the settlor’s death; (b) Declaration by the owner of property that the owner holds identifiable property as trustee; (c) Exercise of a power of appointment in favor of a trustee; (d) Exercise of a power described in section 7820a [a trustee’s decanting power to change administrative provisions of the trust]; and (e) A promise by one person to another person whose rights under the promise are to be held in trust for a third person. But these means named in the Trust Code are not exclusive; a trust relationship can be created through a variety of means, e.g. a court appointed conservator can be granted powers to create a trust for the ward.
  • Oral Trusts: The Michigan Trust Code only requires that the owner declares that he holds assets in trust as trustee for there to be a valid trust relationship established. No formal reregistration of title to assets is required for the trust relationship to exist, which can make identifying an oral trust relationship  a challenge. The Uniform Trust Code also acknowledges that under certain circumstances a trust may be created orally. However, ‘oral’ trusts of real property are not permitted in most states. Obviously the biggest problem with an oral trust is its interpretation and enforcement, which often leads to legal disputes over the very existence of the ‘oral’ trust.
  • Trust Res: Under the common law a res, or trust corpus, must exist for the trust to be valid. The  Michigan Trust Code makes it clear, however, that a trust instrument is valid even when the trust is not yet hold any assets. But until assets are actually transferred to the trustee’s control, there is no fiduciary duty imposed on the trustee. [MCL 700.7401(2).]
  • Conditions for a Valid Trust: Specific requirements exist to create a trust in Michigan, all of which must exist: (i) the settlor possesses the mental capacity to create a trust; (ii) the settlor indicates an intention to create a trust; (iii) the trust has a definite beneficiary, or it is either a charitable trust or a trust for a noncharitable purpose or the care of animals (limited in duration to 21 years); (iv) the trustee has duties to perform; and (v) the same person is not the sole trustee and sole beneficiary. [MCL 700.7402(1).] The term definite beneficiary means that the beneficiary can be ascertained now or in the future, limited however by the applicable rule against perpetuities. [MCL 700.7402(2).]

Agent Creating Trust: While the Michigan Trust Code recites as a requirement that the settlor must possess mental capacity in order to create a trust, conventional practice is to include in many durable powers of attorney  the agent’s ability to create a trust for the agent’s principal and to transfer the principal’s assets to the created trust to facilitate the management and administration of the incapacitated principal’s assets. Many provisions of the Michigan Trust Code recognize that an individual’s lack of mental capacity does not preclude establishing a trust for the incapacitated principal through the principle of substituted representation. For example, the Estates and Protected Individuals Code (EPIC)  provisions with regard to the authority of a conservator appointed for a legally incapacitated individual (the ward) include the power given to the conservator to create a trust that may extend beyond the life of the ward. [MCL 7005407(2)(c)(v).] In addition, a probate judge can authorize, direct, or ratify a trust that relates to an incapacitated individual’s property, if it is in that ward’s best interest to do so. [MCL 700.5408.] The power to create a trust which is authorized for conservators under EPIC is logically extended to agents who act under a durable power of attorney, since the agent is usually intended to act in lieu of a court appointed conservator.

  • Common Law Limitation: But the common law of agency, which normally governs the principal-agent relationship created under a power of attorney, specifies that powers that are given to the agent under the power of attorney instrument are to be strictly construed. Griswatch v Niedzwiecki, No. 275188, 2008 Mich. App LEXIS 831 (April 24, 2008.) Thus, in order to avoid imposition of this ‘strictly construed’ common law rule of construction to a power of attorney that would otherwise prevent an agent from creating a trust for the agent’s principal, the power held by the agent to create a trust must be expressly granted to the agent under the durable power of attorney instrument, as that power will not otherwise be inferred in a general grant of authority to the agent, e.g. ‘my agent can do anything that I am legally able to do with my assets’ is legally insufficient to confer on the agent the power to create and fund a trust.
  • Agent’s Duty to Account?: We know that when the settlor of a revocable trust becomes incapacitated, and the successor trustee steps in to administer the trust in the absence of the settlor-initial trustee, the successor trustee is required to keep the settlor’s designated agent, or if the agent is also the trustee, each qualified trust beneficiary informed of the existence of the trust and reasonably informed of the trust’s administration. [MCL 700.7603(2).] Yet EPIC is silent with regard to specifying what reporting obligations, if any, an agent has when the agent, acting under the principal’s durable power of attorney, creates, and funds, a trust using the principal’s assets. EPIC only requires that the agent keep the principal informed of  the agent’s actions and also inform any conservator or guardian appointed on behalf of the principal. [MCL 700.5501(3)(c).] But in the absence of a court appointed guardian or conservator, and when the principal is then incapacitated, thus prompting the agent to act under the durable power of attorney to create and fund the trust, there is no obligation, consistent with MCL 700.7603(2), to keep others reasonably informed of the trust and its administration. The Michigan Trust Code only contemplates the settlor’s incapacity after he/she has created and funded their trust, not a trust relationship that is created after the individual’s incapacity by an agent who acts under a durable power of attorney. Conceivably the agent could establish and fund a trust for the principal,  name himself as trustee, and never tell anyone of those steps taken on behalf of the principal, albeit with full authority to do so under the durable power of attorney under which he/she acts. The agent-acting-now-as-trustee must always acts as a fiduciary, but unlike the Trust Code which requires the successor trustee to keep others reasonably informed of the trust and its administration, no such duty is expressly imposed on the agent-acting now–as-trustee.
  • Revocable or Irrevocable Trust: Often in durable powers of attorney where the power is given to the agent to create and fund a trust using the principal’s assets, it is not always clear from the power granted if the trust created using the power is revocable or irrevocable. If it is irrevocable, and the agent is also named as a trust beneficiary, that is probably an act of self-dealing by the agent, which is voidable if the power to make gifts to themselves  is not expressly granted in the durable power of attorney. For example the Michigan Court of Appeals held that if an agent lacks authority under a durable power of attorney to make gifts to himself, the agent may not create a joint tenancy between the principal and the agent over the principal’s assets. Smith v. Onaway Community Federal Credit Union, No. 246196, 2004 Mich. App LEXIS 2785 (October 21, 2004.)

Suggestion: An obvious suggestion is that if a power is given to an agent under a durable power of attorney to create and fund the trust on behalf of the incapacitated principal, that power should be coupled with a corresponding obligation to timely report to any successor agent named under the durable power instrument of the agent’s exercise of authority to create and fund the trust and its administration, consistent with the behavior that is expected from successor trustees under MCL 700.7603(2). Or, the durable power of attorney should impose an obligation on the agent/trustee to inform the principal’s attorney and/or accountant, or some other independent third party shortly after the creation of the trust exercising the power granted to the agent, and to require the agent-trustee to periodically account with respect to the trust so long as the trust exists. This may be less of a concern if the trust created by the agent names someone other than the agent to serve as trustee of the incapacitated individual’s trust, as that third-party trustee would have a duty to perform and account consistent with the Michigan Trust Code’s obligations under MCL 700.7603(2), but it is not clear if the Trust Code’s duties imposed on successor trustees extends to a trust that is created by an agent who act under durable powers of attorney after the principal’s incapacity.

Conclusion: It is fairly common to find durable powers of attorney where in the litany of robust powers given to the agent over several pages is the authority to make and fund trusts on behalf of the principal. But there are far fewer durable power of attorney instruments that go further and require the agent who exercises that authority to periodically report what steps that they have taken under the durable power of attorney to third-parties, to enable those third-parties to monitor the agent’s actions under the durable power of attorney, and arguably monitor the performance of the trustee who acts under the agent-created trust that holds the principal’s assets. If Michigan ever gets around to adopting the Uniform Durable Power of Attorney Act, the agent’s obligation to report to an independent third party the agent’s exercise of authority under the durable power of attorney will go a long way to address this situation.