Take-Away: A so-called modern trust is one that is highly flexible to adapt to changing laws and the evolving needs of the trust’s beneficiaries. One flexible feature of a trust is the trustee’s ability to change the situs of the trust to another jurisdiction that has more favorable laws. Chasing another state’s trust laws may make sense, but be sure you don’t create new problems with which to contend.

Background: So-called modern trust often contains many provisions that are intended to make the trust highly flexible and responsive to the needs of the beneficiaries. Some states have adopted favorable laws to attract trust ‘business’ by promoting such flexibility through their laws. Examples of these laws might include: (i) non-judicial settlement agreements; (ii) enhanced virtual representation of contingent and unborn trust beneficiaries; (iii) special purpose trusts; (iv) private family trust companies; (v) silent trusts; (vi) self-settled trusts; (vii) broad definitions of creditor-protected discretionary trusts; (viii) limited or no income taxes on accumulated trust income; (ix) low insurance premium taxes; (x) anti-alter-ego statutes; (xi) sole remedy charging orders for limited liability companies; and (xii) the repeal of the rule against perpetuities.

Similarly, trust instruments often contain provisions that are intended to make the trust instrument more flexible and adaptable to the changing needs of the trust beneficiaries or the ever-shifting tax laws. These provisions might include: (i) limited powers of appointment; (ii) directed trusts; (iii) trust protectors, or in Michigan trust directors; (iv) specific decanting provisions to remove trust beneficiaries; (v) discretionary trust provisions designed to shield the trust from the beneficiaries’ creditors, including ‘exception’ creditors; (vi) grantor trusts with ‘toggles;’ and (vii) the power to change situs of the trust to another more favorable jurisdiction for income and estate tax purposes without triggering a constructive addition to the exempt GST trust for generation skipping transfer tax purposes.

Michigan Law: The Michigan Trust Code defines a trust’s governing law, but only for the purpose of determining the meaning and effect of the trust’s terms. The law of the jurisdiction designated in the terms of the trust will apply, unless the designation of the jurisdiction’s law is contrary to a strong public policy of the jurisdiction that has the most significant relationship to the question at issue. In the absence of a controlling designation in the terms of the trust, the law of the jurisdiction that has the most significant relationship to the question will apply. [MCL 700.7107.] Consequently, a settlor is not stuck choosing Michigan law to apply to the meaning and effect of their trust. See also MCL 700.7108 for the rules associated with the principal place of administration for a designated jurisdiction in the trust. It should also be noted, in passing,  that the Michigan Trust Code does not automatically confer on a trustee the ability to change the situs of a trust; the trust instrument should expressly give that power to the trustee, if so desired.

Change in Trust Situs: Trustees or trust beneficiaries may want to change an irrevocable trust’s situs for a variety of reasons, such as to : (i) improve its governance structure; (ii) change the law applicable to the trust when its terms do not facilitate a change to its governing law; (iii) change the trust’s dispositive provisions; (iv) change the trust’s administrative provisions to ensure that the trust provides the necessary tools for the trust’s fiduciaries (trustees, trust directors, advisory committees) to better manage the trust; or (v) simply modernize an ‘old’ trust.

Risk with Situs Change: A change in situs can affect which jurisdiction’s law applies. A new state’s law may actually change the dispositive provisions when a trust changes its governing law. This can come as a surprise (good or bad) to the trust beneficiaries.

Example : The Michigan Trust Code’s definition of a discretionary trust, where the trust beneficiary does not possess a property right, is highly protective against creditor claims. Michigan gives the trustee any discretion in making a trust distribution, regardless of whether there is a standard or guideline associated with that discretion. Specifically the Michigan Trust Code provides that a “discretionary trust provision means a provision in a trust, regardless of whether the terms of the trust provide a standard for the exercise of the trustee’s discretion and regardless of whether the trust contains a spendthrift provision…” [MCL 700.7103(d).] The result of this provision is that the beneficiary of the discretionary trust cannot force the trustee to make a distribution even if a standard tied to that discretion. [MCL 700.7505.] Thus, there is neither a right nor a property interest to be enforced against the trustee. [MCL 700.7815(1).] Assume the trustee changes the trust’s situs to Michigan from Ohio. Ohio’s trust code uses a far more restrictive definition of a discretionary trust; the Ohio definition restricts a discretionary trust to one that has “no standards or guidelines.”  Accordingly, if an Ohio trust moved its situs to Michigan, the trust beneficiary’s interests would be reduced from having an enforceable right to pursue a distribution from the trust (due to the presence of a standard coupled with the trustee’s discretion), akin to a property interest, to no enforceable right to a distribution and no property interest once the situs of the trust is changed to Michigan.

For the trustee or trust beneficiary who does not want a change in the beneficial interests with a change in situs, the state’s statute must provide for keeping an enforceable right in place.

Delaware:  Sometimes a trust’s situs will be changed to take advantage of a state’s rule against perpetuities or other favorable laws. The Delaware Supreme Court made this clear in a famous decision 8 years ago. The Court stated with regard to several trusts that were created under other states’ laws, and none of which had ever been administered in Delaware:

[W]ithout evidence that the settlor intended for the law governing administration of the trust at its inception, to ‘always’ govern a trust, a settlor’s initial choice of law is not absolute and unchangeable.” Thus, even in the face of a choice-of-law provision, a trustee may more the situs of the trust to take advantage of a new jurisdictions laws of administration….Whether the trust instrument expressly or implicitly authorizes a change in the trust’s administrative governing law, the law governing the administration of the trust thereafter is the local law of the other state and not the local law of the state of original administration. That rule applies even when the trust instrument contains a choice-of-law provision. Therefore, when a settlor does not intend his choice of governing law to be permanent and the trust instrument includes a power to appoint a successor trustee, the law governing the administration of the trust may be changed.”

In this case the trustees of these trusts attempted to resign and name a local corporate successor trustee in Delaware to hasten the departure of their trusts from the present states of domicile. The Delaware court was receptive to this tactic.   that the ability to appoint a trustee in Delaware reflects the settlor’s implied intent that Delaware law will govern the administration of that trust. The Court held that Delaware law will govern the administration of any trust that allows for the appointment of a successor trustee without geographic limitation once a Delaware trustee is appointed and the trust is administered in Delaware, unless the choice of law provision in the trust expressly provides that another jurisdiction’s law shall always govern the administration (even if the place of administration or situs changes.) In re Peierl’s Family Inter Vivos Trusts, 77 A.3d 249 (Del 2013).

Observation: In some instances, moving the situs of a trust may not allow the trust to escape state taxation. Many state’s laws determine nexus based on the location of the trustees, assets, or beneficiaries. Some trusts do not permit successor trustees to be named outside specified geographic boundaries. However, moving a non-grantor trust to a tax ‘haven’ like Delaware can create new options to minimize and even avoid state tax liability on undistributed trust income, which may become even more critical if Congress gets around to imposing surtaxes on irrevocable trusts and estates.

Conclusion: The ability to change the situs of trust is important to ultra-high net worth individuals who seek to shop for the most favorable laws that affect their irrevocable trusts, or to avoid state income taxes. When a trustee considers a situs change, the focus can sometimes be on the proposed jurisdiction’s rule against perpetuities to better preserve and protect a dynasty-type of trust; a change in a dynasty trust’s situs and governing law will take advantage of the other state’s liberal, or no, rule against perpetuities.  There is also the possible negative impact of such a change in situs on the GST-exempt status of the trust. Or, a situs change might be initiated simply to avoid having to pay a state income tax on the irrevocable trust’s accumulated income. There are also the possible negative repercussions of such a change in situs, such as on a GST-exempt trust’s status (resulting in an addition to the exempt trust) or on the beneficiary’s rights and interest that can be enforced against the trustee. In short, there are plenty of good reasons to consider a change in a trust’s situs, but there are also subtle consequences that must be factored into that change-in-situs decision.