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

21-Jan-19

Choice-of-Law that Governs a Trust

Take-Away: The meaning and effect of the terms of the trust are determined primarily by the jurisdiction that is designated in the trust instrument. The exception to this general rule is if the selected jurisdiction’s law is contrary to the strong public policy of the jurisdiction that has the most significant relationship with the matter at issue. The challenge is finding the repository of a state’s strong public policy.

Background:  There are three separate implications that arise from a choice-of-law provision that is used in a trust instrument. First, what is the law that governs the validity of the trust? Second, what is the law that governs the meaning and effect of the terms that are used in the trust instrument? Third, what is the law that governs the administration of the trust? The Michigan Trust Code addresses a choice-of-law provision in a trust instrument. The Michigan Trust Code provides:

  • Meaning and Effect of Trust Terms: MCL 700.7107(a): The meaning and effect of the terms of a trust are determined by the following: (a) The law of the jurisdiction designated in the terms of the trust unless the designation of that jurisdiction’s law is contrary to a strong public policy of the jurisdiction having the most significant relationship to the matter at issue.” (b) In the absence of a controlling designation in the terms of the trust, the law of the jurisdiction having the most significant relationship to the matter at issue.

Note that MCL 700.7107(a) only deals with the law that is used to determine the meaning and effect of words that are used in a trust instrument.

  • Validity of Trust: A different Michigan Trust Code provision deals with the law that is used to determine the validity of a trust: MCL 700.7403: A trust not created by will is validly created if its creation complies with the law of the jurisdiction in which the trust instrument was executed or the law of a jurisdiction to which, at the time of creation, any of the following applied: (a) The settlor was domiciled, had a place of abode or was a national in the jurisdiction; (b) A trustee was domiciled or had a place of business in the jurisdiction; (c) Any trust property was located in the jurisdiction.

Note that MCL 700.7403 applies to all aspects of the trust’s creation, not just where the trust instrument was executed. As it is written, the determination of a trust’s validity is potentially under several different jurisdictions, such as the settlor’s     domicile or abode ((Florida?), any state where the trustee maintains a place of business (Delaware?), or any state where trust property is located (Nevada?), any of which may provide the sufficient contact to warrant application of that state’s law with regard to the validity of the trust. In short, this provision authorizes the recognition of a trust that is created under the law of another state that might later, or otherwise, be administered under Michigan law.

  • Lawful Purpose of Trust and Public Policy:  A Michigan trust must not be contrary to its public policies. MCL 700.7404: A trust may be created only to the extent its purposes are lawful, not contrary to public policy, and possible to achieve.

No list is provided in the Michigan Trust Code as to what trust purpose might run afoul of Michigan’s public policy, so that if there is any question about the trust possessing, or appearing to have, an illegal purpose, or it holds illegal property, e.g. unregistered firearms or an unlicensed marijuana agribusiness, or its apparent purpose is to defraud creditors or others, then the common law will have to be reviewed with regard to public policy implications with regard to the trust’s validity. See also Restatement (Third) Trusts, Sections 28 and 29 for the implications of public policy on the validity of a trust instrument.

  • Administration: The entire Michigan Trust Code provides the law for the administration of a Michigan trust, absent an express provision in the trust instrument that requires a different law to apply to an aspect of the trust’s administration.
  • General Contracts: As an aside, Michigan courts will generally recognize a contractual choice-of-law provision unless there is no substantial relationship between the parties and the selected state, i.e. virtually no contact exists, or if the application of the chosen’s state law would be contrary to Michigan’s public policy circling back again to the reality that there is no easy repository of Michigan ‘public policy’ that can be referred to when creating either a contract or a trust. Turcheck v. Amerifund Financial, Inc. 272 Mich App,341, 345 (2006). This has implications with regard to a life insurance or IRA beneficiary designation where the law of the insurer or IRA custodian controls the terms of that contractual arrangement, whether or not the subject matter of the contract is testamentary in nature.

Example: The application of law of another state was recently applied in a Michigan unpublished Court of Appeals decision with respect to a trust administered in Michigan.

  • Case: In re Alexander L. Ringer Testamentary Trust, Unpublished Michigan Court of Appeals, No.340450 (December 20, 2018).
  • Facts: Alexander, the settlor signed a trust and a Will. Alexander died in 2002 a resident of Illinois. Alexander was survived by his wife Claude (a female, just to keep things confusing!), two daughters, Deborah and Miriam, and three grandchildren. Alexander used a testamentary trust that divided his estate on his death into a Marital subtrust and a Family subtrust. On Claude’s subsequent death, the Family subtrust was to be divided into equal shares, one share for each of Deborah and Miriam, or Alexander’s grandchildren if his daughter did not survive Claude. Claude was also given a power of appointment over the Marital subtrust; in default of Claude’s exercise of that power of appointment, the Marital subtrust’s assets were to then be added to the Family subtrust and distributed according to its terms. Claude died in 2016.
  • After Alexander’s death in 2002, Claude, Miriam and Deborah all entered into an “Inheritance Agreement” to resolve a dispute then pending among them over their respective inheritances that arose on Alexander’s death. Under that “Inheritance Agreement” Deborah promised to “waive and disclaim all interests in Alexander’s property in North America.”  However, each of Claude, Miriam, and Deborah promised in this Agreement to waive and disclaim all rights and interests, contingent upon the other parties’ performance of their obligations under the” Inheritance Agreement.” Consequently, Deborah attempted to disclaim and transfer by agreement her beneficial interests in the Family subtrust to Claude. Suffice it to say that other assets also changed hands at that time, and Alexander’s estate was then settled premised upon this “Inheritance Agreement.” Illinois governed both of Alexander’s subtrusts. Alexander was an Illinois resident and his Will and trust were respectively executed and created in Illinois. The only relationship to Michigan in 2016 was that the subtrust was administered in Michigan because Miriam, the trustee, then lived in Michigan.
  • Issue: After Claude’s death, the grandchildren filed a petition that claimed that Deborah should receive no assets from the distributing Family subtrust because Deborah had disclaimed her beneficial interest in the Family subtrust under the “Inheritance Agreement”, and thus she should be treated as having predeceased Alexander under both Michigan and Illinois law. The grandchildren also claimed that since they were Deborah’s descendants they should receive her disclaimed interest under the Family subtrust. Adding to the confusion, Miriam the daughter-trustee [not Deborah] asked the probate court to dismiss the grandchildren’s petition in which she claimed that Illinois law barred any disclaimer that Deborah may have made with the “Inheritance Agreement” because the “Inheritance Agreement” was a ‘contract for trust assets.’ In sum, the issue was whether the “Inheritance Agreement” was a binding disclaimer of Deborah’s beneficial interest in the Family subtrust, and which state law was to be applied to determine the legal effect, if any, of the disclaimer.
  • Courts: The Michigan probate judge held that Deborah’s ‘disclaimer’ was invalid because it sought to disclaim her beneficial interest in the Family subtrust and at the same time transfer those beneficial interests directly to Claude.
  • Disclaimer Invalid: The Court of Appeals also applied Illinois’s law with regard to the validity of Deborah’s disclaimer and it found, applying Illinois law, that Deborah’s purported disclaimer under the “Inheritance Agreement” was invalid. The Court of Appeals found that Deborah’s disclaimer was invalid because: (I) it was not a complete renunciation of her interest in the Family subtrust as required by Illinois law [Deborah’s disclaimer was contingent on the other parties performing their obligations under the “Inheritance Agreement”] and (ii) Deborah’s purported ‘disclaimer’ attempted to directly transfer her disclaimed beneficial interests in the Family subtrust to Claude, which was contrary to Illinois’ disclaimer statute. With regard to the application of Illinois law in resolving this dispute, the Michigan Court of Appeals noted:

The trust and the Inheritance Agreement both provide that Illinois law governs, and there is no strong public policy for Michigan law to control the terms of the trust and Agreement because Michigan does not have ‘the most significant relationship to the matter at issue.’ See MCL 700.7107(a).

  • Illinois Law Controls: Michigan’s disclaimer statute [MCL 700.2901 et set] and also the federal qualified disclaimer rule [IRC 2518] also prohibit a disclaimant from directing the disposition of the disclaimable interest for it to be a valid, qualified But rather than refer to Michigan’s disclaimer statute, or the federal qualified disclaimer statute and the Regulations under IRC 2518, the Michigan Court of Appeals only referred to Illinois’ statutes and the Court only cited Illinois case law to reach the conclusion that Deborah’s purported disclaimer of her beneficial interests in Alexander’s Family subtrust was invalid.

Conclusion: There are essentially two ‘take-aways’ from this case. First, a settlement agreement that resolves probate litigation which is ‘pitched’ as an agreement which makes the ‘disclaimer’ of an interest contingent on the performance of the other parties is not an unconditional renunciation of an interest that is the subject of a ‘disclaimer;’ any attempt to ‘direct’ the disclaimed asset to another under the settlement agreement will also not result in a qualified disclaimer for federal gift tax purposes. Second, the choice of law provision of a trust will normally be respected by Michigan courts unless some ‘strong public policy’ is implicated. But knowing when a ‘strong public policy’ is implicated will entail a lot of guesswork because there is no clear list of what is, and what is not, Michigan’s public policy.