Equitable Deviation: The Settlor’s Intent (or the Beneficiary’s Benefit?)

Take-Away: A few of the states that have adopted the Uniform Trust Code (UTC) have created come confusion between the common law and that uniform law’s authorization to modify a trust to reflect changes in the beneficiary’s circumstances (or in some instances the beneficiary’s desires.)  Many trust beneficiaries simply want their trust terminated to be free of the trustee’s discretion and the restrictions imposed by the trust instrument. What ultimately controls: what the settlor intended with their trust instrument, or the beneficiary’s need (as described by the trust beneficiary, but which often is really their want?)

Background: The common law is replete with court cases that predictably tell courts and trustees that they must always carry out the settlor’s intent. This directive appears in the Michigan Trust Code’s periodic statutory reference to a probate judge and the trustee’s obligation to carry out the settlor’s material purposes for the trust. Hence, the lodestar to the interpretation of an irrevocable trust, or to answer the question whether it is permissible to make a modification to an irrevocable trust, or to terminate the trust, always starts out with the rhetorical question: What was the settlor’s intent or material purpose with respect to this trust?

Uniform Trust Code: Of some interest then is the Uniform Trust Code which provides: “Section 404: A trust and its terms must be for the benefit of its beneficiaries.”  This simple directive thus creates something of a tension in the administration of a trust. What prevails: the settlor’s intent, as gleaned from the trust instrument’s material purposes, or the beneficiary’s benefit, which perceived benefit may be inconsistent with the settlor’s intent or purpose?

Equitable Deviation-Termination of the Trust is Administrative?: The UTC’s reference to the benefit of the trust beneficiaries is an example of the UTC’s expansion of a concept called equitable deviation. It tends to creep into the dispositive provisions of a trust instrument which, in turn, finds support from the Restatement (Third) of Trusts, Section 66, which says that a probate court can order the trust’s termination and distribution of the trust assets to trust beneficiaries as an administrative, and not dispositive, action. This confusion, whether a trust’s termination is administrative or dispositive in nature, often sways a probate judge to conclude that the termination of an irrevocable trust, which obviously results in the distribution of its assets, is merely a change to an administrative, and not a dispositive, trust provision.

Example: A recent example of this judicial tendency to treat a trust’s termination as a modification to the trust’s administrative provision, per UTC 412(a) [which Michigan adopted with MCL 700.7412 (2)] is Matter of MacMackin Nominee Real Estate Trust, 95 Mass. App. Ct. 144 (2019). That UTC Section permits the modification or termination of a trust where the existence of circumstances not anticipated by the settlor create a situation in which modification or termination of the trust “will further the purposes of the trust.” This trust held two family cottages to be used by two children and grandchildren, along with a ‘side-fund’ to maintain the cottages in trust. Due to a trust funding mix-up, 6 vacant lots that were adjacent to the 2 cottages were not part of the cottage trust’s corpus; instead these vacant lots were transferred to a nominee trust. [No explanation was given why the lots could not be directly transferred to the cottage trust.] Consequently, the trust beneficiaries had to contribute their own funds to maintain the 6 vacant lots held in the nominee trust. The cottage trust was to terminate when the youngest grandchild attained age 30.

Due to family disagreements [not really a surprise when dealing with legacy cottages], one child trust beneficiary ultimately purchased the interests of other child trust beneficiary to resolve their disagreement over cottage usage and improvements. However, their dispute continued over the 6 vacant lots, which had been held in a nominee trust, i.e. only the lots, no income producing assets, were its corpus. Consequently, a petition was filed by the selling child to terminate the nominee trust that held the vacant lots. The beneficiary child who purchased the other’s interest in the trust and remained the beneficiary of the cottage trust objected to the termination of the nominee trust. The trial judge found that the material purpose of the nominee trust was to preserve the family compound, which was no longer viable, and thus the continuation of the nominee trust was no longer necessary: “ A critical purpose of the trust, therefore, was to give each child of the settlor and a child’s family equal use, enjoyment and control of the properties held in trust.” The trial judge thus ordered the sale of three of the vacant lots and the distribution of sales proceeds to the petitioners. The judge then ordered the remaining 3 vacant lots awarded to the child that owned the cottages. The appellate court concluded that the trust settlor could not have contemplated that one child and that child’s family would acquire sole ownership of the cottages, but not the vacant lots. Accordingly,  terminating the nominee trust now, when the family of the seller of the cottages has no interest in the cottages, and therefore derives no benefit from the nominee trust ”furthers equal treatment of the two children and their families.” To conclude, the appellate court found that terminating the nominee trust early was the modification of an administrative provision, and not a dispositive trust provision.

Aside: The nominee trust held only vacant lots and no income producing assets to sustain the vacant lots in trust. The court had to find that the change in circumstances was not anticipated by the settlor, to enable the court to terminate the trust. In doing so, the court had to find that the ‘early’ termination of the nominee trust was a change to an administrative, not dispositive, provision, even though the end result was a change in the trust’s distribution provision. It is a bit surprising that the trial court, or the appellate court, did not take an easier route to terminate the trust, and they made no mention of yet another provision of the UTC, which permits the termination of an uneconomic trust. [See MCL 700.7414.] Perhaps this easier path was not pursued because that UTC section requires the distribution from the terminated trust in a manner provided for in the terms of the trust, which the court apparently did not want to do. [See MCL 700.7414(3) for a comparison under Michigan’s Trust Code.]

Equitable Deviation: Under the doctrine of equitable deviation, a probate court may effect a change in the express administrative provisions of a trust instrument in order to accomplish the trust’s express purpose. Restatement (Second) of Trusts, Section 381. As a generalization, a probate court will require both an unforeseen and unforeseeable change in circumstances and a frustration of the settlor’s main objective, i.e. material purposes, if the trust’s conditions are strictly followed. The ‘test’ in order to apply the equitable deviation doctrine is not the best interests of the beneficiaries; rather, the petitioners must establish that the settlor’s presumed intent is incapable of fulfillment. Example: A trust instrument directs that stock be held and not sold by the trustee. Yet the stock significantly drops in value and the trustee feels compelled to sell the stock to avoid any further loss and  to better diversify the trust’s corpus. The trustee may sell the stock and  equitably deviate from the trust’s directive to hold and not sell the stock may occur, notwithstanding the clear language of the trust instrument to the contrary.

Administrative, Not Dispositive Provisions: However, as noted, an equitable deviation is only supposed to occur with regard to a trust’s administrative directives or prohibitions, not dispositive directives. The problem, from time to time, is that a probate judge who is called upon to modify trust instrument under the UTC tends to confuse administrative and dispositive directions, especially when it decides to terminate a trust with the ‘early’ distribution of assets to the trust’s beneficiaries- a distribution that benefits the beneficiary.

Dueling Restatements: This is one of the frequent occasions where we find a stark departure between the Restatement (Second) of Trusts  and the Restatement (Third) of Trusts. The Second version is considered to be a comprehensive summary of traditional trust law as formulated under the common law over the years and focuses upon the settlor’s intent as the controlling concept. The Third version was written principally by law professors which summarizes their view of what the law of trusts ought to be, which places more emphasis on the needs (aka wants) of the trust beneficiaries. These are admittedly gross generalizations, but you can get the picture of why petitioning lawyers tend to cite the Third version when they seek to modify or terminate a trust.

Trustee’s Affirmative Duty: The Restatement (Third) of Trusts, Section 66(2) actually imposes an affirmative duty on a trustee to initiate a trust modification or equitable deviation court action when circumstances warrant invocation of the doctrine of equitable deviation. Comment (c) to Section 66(2) notes: “This duty [to invoke the doctrine of equitable deviation]…is not generally extended to distributive provisions…because of concern that to do so might create unfair risks and burdens for trustees, and also might in some situations, present impartiality problems.” The use of the word generally in this comment implies, however, that on occasions a dispositive trust provision can also be deviated from, e.g. the trust’s termination is accelerated. The circumstances that trigger this affirmative duty are supposed to have the potential to cause substantial harm to the trust or its beneficiaries. The trustee’s affirmative duty arises only if the trustee knows about the circumstances or should have known about them.  Comment (e) to Section 66(2) notes that if the trustee is actually aware that a purpose of the settlor would be jeopardized by adhering to existing provisions governing “distributions, the trustee would have a duty to petition the court for instructions or for appropriate deviation or modification.”

Aside: Normally a trustee is not supposed to take sides in a judicial proceeding that could shift equitable or beneficial interests among trust beneficiaries as a result of  its fiduciary duty of impartiality. Yet here we have the Restatement (Third) of Trusts telling the trustee that it has an affirmative obligation to pursue court proceedings to permit a deviation from the trust instrument’s dispositive provisions.

Michigan Trust Code: While Michigan adopted much of the Uniform Trust Code, it did not adopt, wholesale, Section 404 of the UTC. Instead, Michigan’s MCL 700.7404 provides: “A trust may be created only to the extent its purposes are lawful, not contrary to public policy, and possible to achieve.” Consequently,  there is no mention of the trust being for the benefit of the trust’s beneficiaries. This is also one of the rare provisions of the Michigan Trust Code that cannot be trumped by the express provisions of the trust instrument.[MCL 7105(2)(c).]

Conclusion: I confess I have a bit of trouble seeing the judicial termination of a trust as affecting only an administrative trust provision, and not a dispositive trust provision if the result is that the trust beneficiaries receive assets ‘early’ and free from other restrictions. It appears that the doctrine of equitable deviation is beginning to creep into trust dispositive provisions, and that the wishes of the beneficiaries may ultimately be accorded more respect than the wishes of the settlor. But what do I know!