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

1-Apr-19

Letters of Wishes

Take-Away:  We often ask settlors if they are willing to provide a letter of wishes to assist the trustee in the administration of an irrevocable trust, especially a trust that is expected to last for multiple generations. But that request begs several questions, including: What if that letter of wishes creates confusion since it is inconsistent with the terms of the trust? Is the letter of wishes valid and binding? Will a trustee be protected if it relies upon a settlor’s letter of wishes? Can a trust beneficiary obtain a copy of the settlor’s letter of wishes if the trustee actually refers to the letter in its administration of the trust or the exercise of its discretion? There is not much law available to answer these (and more) questions.

Background: As a broad generalization, when the terms used in a trust instrument are clear, a probate judge will look only at the language that is used in the trust instrument when the judge interprets the trust to give effect to the settlor’s intention. When there is evidence of an ambiguity in the trust’s terms with regard to the settlor’s intent, the probate judge may consider extrinsic evidence of that intent. A letter of wishes is a written communication from the settlor to the trustee of a discretionary trust that is designed to provide additional guidance to the trustee in the exercise of its discretion. Such a letter can be a helpful guide to the trustee in the exercise of its discretion under the trust, especially when the trust instrument itself is limited in the terms it uses, or if the trust instrument does not expressly address a particular circumstance.  The big question is whether a settlor’s letter of wishes is or can be viewed as a part of the trust instrument itself?

Legal Authority: There is very little legal authority for the use of, or a trustee’s reliance on, a settlor’s letter of wishes. [ See, Restatement (Third) of Trusts, Section 87.]

  • UTC: The Uniform Trust Code (UTC) Section 103(18) defines the terms of trust as “the manifestation of the grantor’s intent regarding a trust’s provisions as expressed in the trust instrument or as may be expressed by other evidence that would be admissible in a judicial proceeding.” The comments to UTC Section 103(18) note that while the trust instrument itself is always the most important determinant of the trust’s terms, the phrase terms of trust is not limited to just the trust instrument, and that oral statements with regard to the beneficiaries or the purposes of the trust, and the circumstances under which the trust is to be administrated, may all have a bearing on the trust’s meaning. [Restatement (Third) of Trusts, (2012)] all of which seems to expand what a judge might rely upon in the interpretation of a trust.
  • MTC: The Michigan Trust Code (MTC) does not directly incorporate the UTC’s definition terms of trust. The MTC defines “Trust instrument to mean a governing instrument that contains terms of the trust, including any amendments to a term of the trust.” [MCL 700.7103(m).] The phrase terms of trust is not separately defined in the MTC. The Reporter’s Commentary on this point notes: “The definition of ‘trust instrument’ is based on the definition found in UTC Section 103(19). However, it relies in part upon the term ‘governing instrument’, which is defined in MCL 700.1104(m). It does so because EPIC uses the term ‘governing instrument’ to cover a variety of devices that could establish a trust, including wills, trust agreements, beneficiary designations, court orders, and exercises of powers of appointment, and it was convenient to draw upon the term.” MCL 700.1104(m), which defines ‘governing instrument’ includes “…or dispositive, appointive, or nominative instrument of any similar type.” But neither EPIC nor the Michigan Trust Code expressly mentions expressed by other evidence the use of any ‘letters of wishes.’
  • Uncertainty: Since Michigan did not adopt the separate definition of terms of trust used in the UTC, it is questionable if a settlor’s letter of wishes would be considered by a probate judge has having a bearing on a trust instrument’s meaning.

Using Letters of Wishes:

  • Discoverable? One of the main arguments against the use of the settlor’s letter of wishes is that if the letter addresses [expands; refines; narrows] the trustee’s discretionary authority under the trust instrument, then in order to monitor and enforce his/her beneficial interest in the trust, the trust beneficiary must be able to review both the trust instrument and the settlor’s letter of wishes. [Restatement (Third) of Trusts, Section 28, comment a; Restatement (Third) of Trusts, Section 87 (2012.)] A contrary argument could be made against disclosure that the sole purpose of the settlor’s letter of wishes is to advise the trustee as to the settlor’s state of mind in connection with the trustee’s exercise of discretion in various hypothetical situations that the trustee may confront, and due to that limited purpose or use, the letter of wishes should not be discoverable by the trust beneficiary.
  • Ambiguous? What happens if the settlor’s letter of wishes itself is ambiguous, or worse yet, it directly contradicts the terms of the trust instrument? Will it be treated by a probate judge as a trust amendment? Should the trustee simply ignore the letter as contrary to the terms of the trust?
  • Taxes? A settlor’s letter of wishes may result in adverse transfer tax consequences, which might render the settlor’s transfer of assets to the irrevocable trust as being incomplete for federal gift tax reporting purposes, and thus expose the assets to inclusion in the settlor’s taxable estate for estate taxes as a form of retained control over the transferred assets or some prearrangement with the trustee as to how the assets will be distributed under the trust under IRC 2036 or 2038  (which could actually be a good thing these days with the large $11.4 million federal estate tax exemption and portability]  resulting in an income tax basis ‘step up’ of the trust’s assets on the settlor’s death.[Treas. Reg. 25.2511-2; IRC 2036(a)(2).]
  • Comprehensive?: Just like the trust instrument itself that warrants the use of a companion letter of wishes, the settlor’s letter of wishes cannot be all encompassing and address ever possible situation that the trustee may confront, such that its use may be very limited, or that the fact that it does not address a hypothetical situation means that the settlor intended the trust instrument to be literally interpreted with regard to the topic not covered in the letter of wishes.
  • Non-Binding?: If a letter of wishes is to be used by the settlor, it should clearly state that it is not binding on the trustee, so that the letter does not automatically become part of the trust’s “documents” and thus discoverable, or in a worst case scenario, enforceable by the trust beneficiaries (or their exception creditors) as conferring rights on the beneficiaries when the settlor intended only a discretionary trust.

Practice Tip: If the settlor intends to make use of a letter of wishes, the existence of that letter should be mentioned in the body of the trust instrument. That will become a helpful reminder, when the trust is later amended or restated, that there are outstanding letters of wishes that will probably needed to be updated as well. There would be nothing worse than for the trustee to have as part of its files ‘old’ letters of wishes that do not reflect either an updated trust and provisions for trust beneficiaries, or the evolving needs of those trust beneficiaries.

Conclusion: If the settlor, or the drafting attorney for that matter, is reluctant to draft a discretionary trust provision that could cover 3 or 4 pages of details and examples, many of which may never become relevant, a settlor should be encouraged to prepare a non-binding letter of wishes to be held by the trustee that is called upon to administer the trust. Such a letter would contain a fairly detailed statement of the settlor’s intentions with regard to discretionary distributions to be made from the trust, hopefully tied to the settlor’s material purposes that are identified in the instrument that led to establishment and use of the trust. The letter would contain examples, especially where the trust is established for a child, identifying typical ‘parental’ situations and explain what the settlor would likely decide in each particular case. While the trustee would obviously be left to make the final decision, the letter of wishes would provide to the trustee, and possibly a probate judge, helpful insight into the settlor’s intent from which they would not otherwise have benefited.

Further Reading: For a critical and honest assessment of the utility of a settlor’s letter of wishes, you may want to read: Bove and Langa, Distinguishing Discretion in Discretionary Trusts- the Letter of Wishes, Mass. Lawyers Weekly, Jan. 23, 2006; and Bove, The Letter of Wishes: Can We Influence Discretion in Discretionary Trusts, 35 ACTEC J. 38, 43 (2009).