Directed Trusts – What a Trustee Needs to Look For in the Trust

Take-Away: As more modern trusts incorporate the use of a trust director, or trust protector, it is important for the proposed trustee to closely read the trust instrument to clarify when, how, and in what circumstances that the trustee must follow the directions of the trust director. The narrower the trust director’s powers are described in the trust instrument, the clearer the roles of both the trust director and the directed trustee will be without any overlap.

Background: Michigan is one of 16 states that have adopted the Uniform Directed Trust Act. Both that Uniform Act and Michigan’s statute [MCL 700.7703a] treat a trust director as a fiduciary. However, a couple of states, Delaware being one, provide that the trust director does not have to serve as a fiduciary. This dual fiduciary scenario can result in confusion as to responsibilities, liabilities, and accountability in their respective roles when engaging in the trust’s administration.

Michigan Directed Trustee Act: The following are the critical provisions of Michigan’s extensive, i.e., 5 pages, single spaced,  directed trust statute when the two fiduciaries act with regard to the same trust.

“(7) A directed trustee shall take action to comply with the exercise or nonexercised of a power of direction or further power of a trust director under subsection (3)(a). A directed trustee is not liable for taking an action required under this subsection. However, a directed trustee shall not comply with the exercise or nonexercise of a power described in this subsection if the exercise or nonexercise was obtained with the directed trustee’s collusion or by the directed trustee’s fraud, or compliance would be in pursuance of that collusion or fraud.

(8) An exercise of power of direction under which a trust director may release a trustee or another trust director from liability for breach of trust is not effective if any of the following apply:

1. The breach involved the trustee’s or other director’s bad faith or reckless indifference to the purposes of the trust or the interests of the trust beneficiaries.
2. The release was induced by improper conduct of the trustee or other director in procuring the release. Or,
3. At the time of the release, the director did not know the material facts relating to the breach.”

(11) A trustee does not have a duty to do either of the following:

1. Monitor a trust director;
2. (b)Inform or give advice to a settlor, beneficiary, trustee, or trust director concerning an instance in which the trustee might have acted differently than the director.

(12) By taking an action described in subsection (110, a trustee does not assume the duty excluded by subsection (11).”

What to Look For?: When we review a proposed trust instrument prior to acceptance, consider the following:

Trustee’s Role: As trustees, our primary concern when reviewing a proposed directed trust instrument will be to confirm that there is a clear delineation of responsibility, appropriate exoneration of the trustee, and clarity as to what actions trust directors can direct within, and under, the trust instrument. At the same time, as trustees we need to be comfortable that we can work with the trust directors to fulfill the purposes of the trust and to act in the best interests of the trust beneficiaries. As trustee, we can take some comfort that there is statutory protection when, as trustee, we execute the trust director’s direction with no obligation to oversee the trust director, and with no responsibility to warn trust beneficiaries of potential adverse consequences from the trust director’s actions, and no responsibility to advise trust beneficiaries where we would have exercised our fiduciary discretion in a different manner. While that is what Michigan’s directed trustee statute provides, it would be wise to include such provisions in the trust instrument to alert others who may be interested persons in the trust’s administration.

Trust Director’s Role: With the above in mind, the trust instrument should also provide that the trust director:  (i) is deemed to have acted within the scope of his/her/its authority; (ii) is deemed to have exercised reasonable care, diligence, and prudence; and (iii) is deemed to have acted impartially as to all persons interested in the trust, (iv) unless the contrary is proved by affirmative, clear and convincing evidence of which the directed trustee is aware. These suggested trust  provisions with regard to the trust director’s implied actions will help to minimize the trustee’s responsibility to follow the trust director’s directions.

Drafting: Accordingly, it is important for the trust instrument to be very specific rather than allow for flexibility through vagueness, which is often how complex trusts are drafted these days. Thus, it is more important to be very narrow, to be very specific and not overbroad, in what is intended to be accomplished by adding a trust director to the trust instrument and their expected role in the trust’s administration. While the Uniform Directed Trust Act does not specify express trust director powers, instead leaving that to the drafting attorney, some states have included provisions in their adoption of the Uniform Act with regard to the scope of the trust director’s authority. In particular, care should be taken with regard to powers to lend, borrow or pledge trust assets in order to clearly define each party’s role and the scope of that authority.

Examples: To date there does not appear to be any reported Michigan court decision that addresses a trustee following a trust director’s direction and the trustee’s exposure to liability for following, or not following, that direction. A few reported cases from other states may, however, provide some insight into a trustee’s exposure to liability when it follows a trust director’s directions, or the scope of a trust director’s authority.

Delaware: In the 2014 Delaware Mennen decision, the directed trust (established in 1970) provided that only four of the trustee’s powers, to wit., buying, selling, participating in mergers, and voting stock, were delegated from the trustee to the trust director. However,  the trust director directed investments in failing companies, and even directed the trustee to lend trust assets to those failing companies that were held as trust investments. This particular power to lend was not clearly subject to the direction by the trust director. The directed trustee was sued, but settled out of court. The important point is that when directed trustee powers are included in the trust instrument, it is important to consider all of the trustee’s financial powers, and to the extent prudent, address how the trustee is intended to be directed, in order to clearly define the scope of the trust director’s authority vis-à-vis the directed trustee. A power to buy, sell, or vote is not the same as the power to lend trust assets.

New Hampshire: In the New Hampshire case, Shelton v. Tamposi, the directed trustee and a trust beneficiary sought to remove the trust’s investment directors. Their goal with the removal petition was to decouple the administration of subtrusts from other subtrusts under the same trust instrument. The petitioners also sought a declaratory ruling that the trustee could compel the trust directors to make distributions to the subtrusts in order to then allow the trustee to make distributions to the beneficiaries of those enhanced subtrusts. The court found that because the trust directors were given exclusive authority over the investment and management of trust assets, including the sale of trust assets, the trustee was an ‘excluded fiduciary’ in that regard, and accordingly the trustee and beneficiary were prohibited from compelling the trust directors to sell assets and make distributions to the subtrusts. In short, the trustee could not force the trust directors to sell trust assets in order to enable the trustee to make a distribution of the sales proceeds.

South Carolina:  A federal court in Schwart v Wellin (South Carolina) was called upon to interpret South Dakota law which governed the trust instrument. The Court dismissed a complaint for breach of fiduciary duty filed by the ‘trust protector’ against the trustee based on the real-party-in-interest jurisdictional requirement. The trust protector argued that under the trust instrument, which he purportedly amended in his capacity as trust protector, that amendment expressly authorized the trust protector’s complaint  because the amendment that he made to the trust conferred on himself the power to engage in litigation that involved the trustee or the protection of trust assets. The Court held that the real-party-in-interest ‘test’ is one for the courts to decide, not one for private parties to decide or create in trust amendments. In other words, the Court found that South Dakota’s directed trust statute did not address the trust protector’s authority to bring a lawsuit on the trust’s behalf. Accordingly, because the trust protector did not demonstrate that he personally suffered an actual or threatened injury, he was not a real-party-in-interest, and thus had no standing to file the breach of trust complaint. The Court found that the trust protector lacked the authority to amend the trust instrument to expand his own powers to include a power to initiate litigation against the trustee. Thus, one take-away from this case is that the trust director’s power to amend the trust instrument should clearly spell out the limits of that power to amend and for what purpose.

Delaware: In its 2004 Duemier decision, the Court upheld Delaware’s directed trustee statute. In that case the trustee received a prospectus about a stock tender offer and it forwarded that prospectus to the trust’s investment advisor and the trust director. The trust director took no action and did not direct the trustee in any manner concerning that prospectus. Then, a loss arose in the trust’s assets. The trust director promptly sued the directed trustee for not investing in the suggested tender offer. The Court held in favor of the directed trustee because, under Delaware’s statute, as long as the directed trustee did not act with its own willful misconduct, it would not be liable for the loss.  It was the trust director’s responsibility to protect the trust and invest its assets, and his failure to do so was not the fault of the directed trustee.

New York: While this state has not (yet) adopted a form of the Uniform Directed Trustee Act, it did address directed trusts in its Mens Rea Remus decision. The New York Court held that despite clear trust language that absolved the directed trustee from liability for carrying out the written duties of the trust’s investment committee, accountability was nonetheless “essential element of all fiduciary relationships that cannot be waived by the trust instrument.’ In effect,  the Court found that if a trustee’s concern that following the directions of an advisory committee, or that trust director actions might result in a breach of fiduciary duty, the directed trustee was required to come to the court for instructions. In short, like situations where there are co-trustees who disagree on how to administer the trust, it is incumbent on the directed trustee to petition the probate court for direction. In this case, the Court found that it was proper for the directed trustee to have come to the probate court to ask if it was reasonable to follow the directions of the investment advisory committee,  and more importantly, that the trustee would have been liable for breach of fiduciary duty had it not done so. A trust instrument might include provisions that encourage the directed trustee, at the trust’s expense, to seek a probate court’s direction if there is any question whatsoever, about the trustee’s accountability for following the trust directors directions. This would address the Michigan statute’s exception from exoneration if the trustee is view (always with hindsight) has having acted, or not acted, with reckless indifference.

Conclusion: It is reasonable to expect that as time passes more frequently Greenleaf Trust will be asked to serve in a directed trustee capacity. While there is some ‘comfort’ from the exoneration provisions contained the Michigan Trust Code, there is no reason why Greenleaf cannot ask for additional provisions to be included in that directed trust instrument, especially when it comes to describing the scope of the trust director’s powers. As mentioned above, the narrower those trust director powers are described in the trust instrument, the easier it will be for Greenleaf to comfortably follow directions, or to understand when it remains accountable to the trust beneficiaries for decisions that it makes. And when in doubt, it needs to be comfortable being empowered to petition the probate court seeking directions.