Take-Away: Michigan’s decanting statutes may not be as limiting as initially believed to be the case, depending on the distribution language that is used in the irrevocable trust instrument.

Context:  The name of the game is flexibility these days in drafting irrevocable trusts so that the trust can be modified in the future, especially for dynasty trusts that are designed to avoid the generation skipping transfer tax for multiple generations and to provide creditor protection to the trust beneficiaries. In response to this goal to modify long-running irrevocable trusts when circumstances warrant, Michigan in 2012 adopted two decanting statutes that give trustees flexibility to modify an irrevocable trust. Two separate statutes were amended to expressly give a trustee decanting powers. The first is Section 5a of the Powers of Appointment Act.[MCL 556.115a] The other statute is a new provision added to the Michigan Trust Code. [MCL 700.7820a]

Key Observation: An irrevocable trust cannot be decanted if the original trust instrument expressly prohibits a decanting of its assets by the trustee.

Statute’s Rank: On a recent ranking of the flexibility of various state decanting statutes, Michigan’s decanting statute was ranked 21st, much lower than Delaware [5th] but higher than either New York or Florida’s decanting statutes. Michigan’s  low rank was attributable to several  features contained in its Trust Code section:

  • A trustee cannot decant a trust where the trustee’s discretion is limited by an ascertainable standard;
  • A trustee must give 63 days advance notice to trust beneficiaries before it exercises its intent to decant the trust;
  • A trustee cannot decant a trust subject to an ascertainable distribution standard into a fully discretionary trust; and
  • A trustee cannot decant  to a new trust that removes a beneficiary’s mandatory income interest.

Other Statute Limitations: Probably two other limitations contained in Michigan’s Trust Code decanting statute that were not identified in the ranking were: (i) a decanting cannot materially change the beneficial interests of the original trust; and (ii) a decanting cannot be inconsistent with a tax benefit intended in the original trust.

Trust Duration: Fortunately, extending the duration of the original trust via the trustee’s exercise of a decanting power is not considered to materially change the beneficial interests of the trust beneficiaries. But the Trust Code’s decanting authorization can be fairly limiting due to its ‘no material change’ and ‘ascertainable standard’ prohibitions.

Options: If the Trust Code’s decanting limitations are too constraining to enable a trustee to decant the assets of an irrevocable trust,  a couple of options may still be available:

  • Settlor Authorizes a Decanting: An irrevocable trust can expressly authorize the trustee to decant the trust’s assets, potentially eliminating the restrictions and limitations imposed by the Trust Code’s decanting statute.  Obviously this ‘express authorization’ option would be available only for those trusts that are adopted after 2012.
  • Powers of Appointment Act: The limitations on a trustee’s decanting power identified in the Trust Code section might be circumvented by fitting within the decanting powers that are identified in the Powers of Appointment Act [MCL 556.115a], which arguably is a bit more flexible than the Trust Code’s  decanting authorization, but admittedly it is hard to reach this conclusion if you are not a law professor attuned to statutory nuances. The Trust Code version of the decanting power uses the Trust Code’s formal definition of discretionary trust provision [MCL 700.7103(d)], while the Powers of Appointment Act simply says that a power to make distributions is not discretionary ‘if it is limited by a definite and ascertainable standard’ but this statute then goes on to state that that directions to a trustee to ‘consider a beneficiary’s best interests, welfare, comfort, happiness or general development do not in themselves constitute a definite and ascertainable standard.’ [MCL 556.115a(3)(b).]
  • Common Law: It may be possible to find a common law power to decant or to interpret the trust instrument in a manner that concludes that the settlor intended to give the trustee  broad enough powers to include an expansive decanting authority. The Trust Code’s decanting statute includes the following provision:

“(9) This section shall not abridge the right of a trustee who has a power to distribute trust property in further trust under the terms of a trust instrument, any other statute, or the common law. The provisions of this section shall not abridge any right of a trustee who has a power to amend or terminate a trust.”

The Powers of Appointment statute contains a similar ‘shall not abridge the right of a trustee’ provision. [MCL 556.115a(7)] In addition, the Powers of Appointment Act also contains the following statement:

(8) It is the intent of the legislature that this section be a codification of the common law of this state in effect before the effective dates of the amendatory act that added this section.” [MCL 556.115a(8)]

Practical Example: An example of this latter, common law, implied power to decant is a recent New York decision which permitted a trustee’s decanting of a life insurance policy held in an ILIT to a new ILIT which eliminated specific beneficiaries who were identified in the original trust.  The facts were easy to follow. In 2004 father created an ILIT, with crummey withdrawal powers, for the benefit of his 4 children and their spouses and descendants. The original ILIT provided that the independent trustee possessed the discretion to distribute principal to one or more beneficiaries ‘to the exclusion of other beneficiaries’ and/or to a trust for the benefit after providing written notice to all beneficiaries.’  In 2008 father had a falling-out with his daughter, her husband, and her descendants. Initially the father exercised his retained right over the ILIT to exclude that daughter (and her husband and children) from any crummey withdrawal rights, which did not make the daughter happy. The relationship between father and daughter further deteriorated to the point that the daughter filed a lawsuit against her father regarding another trust. It was not surprising then that the father  informed the ILIT’s independent trustee that if it did not decant the policy to a new ILIT where daughter and her husband and children were removed as beneficiaries, the father would cease to make annual contributions to the ILIT to enable the trustee to pay the premium on the $10 million life insurance policy. The ILIT trustee decanted the policy to a new ILIT where the daughter and her family were excluded as its beneficiaries. The daughter challenged the trustee’s distribution of the policy in an annual accounting proceeding. The court held in favor of the trustee’s exercise of its common law power to decant. In finding that the trust instrument authorized the decanting of the policy the court focused on a couple of provisions contained in the original ILIT:

  • The trustee possessed the authority to “pay such sums out of the principal of the trust (even to the extent of the whole thereof) to the settlor’s descendants, living from time to time, in equal or unequal amounts to any one or more of them to the exclusion of the others, as the trustees in their absolute discretion shall determine..”
  • The trustee was authorized to make distribution of trust property “by payment to a trust for the beneficiary’s benefit.”
  • While the trust instrument required notice given to the trust beneficiaries at least 45 days before the distribution was to be made, only the actual notice of the trustee’s intent to make the distribution was required, neither the magnitude of the proposed distribution nor the identity of the recipient of the proposed distribution—in short, only  a naked notice was contemplated by the trust, nothing more than that.

After the settlor died and the $10 million death benefit was paid to the new ILIT. The daughter then filed a claim to void the transfer arguing that the trustee’s decanting was contrary to New York’s decanting statute. The court rejected this last argument because New York’s decanting statute provided:

[this]section shall not be construed to abridge the right of any trustee to appoint property in further trust that arises under the terms of the governing instrument of a trust or under any other provision of law or    under common law.” [EPTL Section 10-6.6(k)]

Thus, the court held that a decanting by the trustee can take place pursuant to the terms of the trust instrument without having to follow the specific terms or procedures of the state’s enabling decanting statute.

Conclusion: While New York’s statute is a bit different from Michigan’s, the point in each statute is that the existence of the decanting statute ‘does not abridge the right of a trustee to make a distribution in further trust’ which seems to open the door to a decanting if a broad discretionary distribution power is generally authorized by the trust instrument’s distribution terms, even when the decanting statute would not technically authorize the trustee’s decanting. Thus, even for those irrevocable trusts that do not expressly authorize the trustee to decant the trust’s assets, it may be possible to find a common law power to decant depending on the scope of the distribution language used in the trust instrument (or the absence of limitations on the exercise of the trustee’s discretion to distribute ‘to or for the benefit of’ a trust beneficiary, or ‘to the exclusion of other beneficiaries’.) In sum, while Michigan’s Trust Code’s decanting authorization appears to be fairly limited, it may still be possible to decant a trust by relying upon a common law authorization to decant implicit in the ‘to or for the benefit of’ discretionary distribution provision.