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

18-Jan-19

Michigan Uniform Directed Trust Act- Drilling Down, Part 1

Take-Away: Michigan adopted, with a couple of modifications, the Uniform Directed Trust Act. It displaces the former Michigan trust protector provision, replacing it with a new section of the Michigan Trust Code. The Act permits a third party, also a fiduciary, to direct or otherwise control certain conduct of the trustee. The key point is that a directed trustee does not have to second-guess the directions provided by a trust director.  But as is often the case, the simplicity of that statement can also be deceiving.

Editorial Comment: This is the first of a couple of ‘overviews ‘of the new Michigan Uniform Directed Trust Act. It is culled from a 30+ page comprehensive article written by James P. Spica which appears in the Winter 2018 Michigan Probate and Estate Planning Journal on Michigan’s adoption of the Uniform Directed Trust Act. (I even read the article’s 337 endnotes!) Mr. Spica is a Commissioner on the Uniform Law Commission which is the source for the Uniform Directed Trust Act. In addition, Jim is the principal author of the Michigan Divided Trustee Act, which also became law in late December. Jim also sits on the Probate Council’s Divided and Directed Trusteeships ad Hoc Committee which proposed this legislation. As a result of Jim’s active involvement from the beginning with this legislation, his observations are critical to comprehend the purposes of the new law, identify what the law permits, and also identify what acts or omissions of a trustee it does not excuse. We owe Jim and other members of the Probate Council our gratitude for the time and effort that they expended over several years to help modernize Michigan’s trust laws.

Background: In late December, 2018 Michigan adopted its version of the Uniform Directed Trust Act. For simplicity, Michigan’s adopted version will be referred to as the Act, to be distinguished from the Uniform Directed Trust Act which will be referred to as the UDTA. The Act regulates the powers of another to direct the actions of a trustee, and it also adopts an even more radical elective scheme of fiduciary coordination which Mr. Spica has styled divided trusteeship- think of it as more than one trustee with regard to a single trust, each trustee assigned with a discrete set of responsibilities, and each trustee functions and carries out their respective duties in separate silos. The importance of these new laws is to reduce a trustee’s exposure to liability when if follows the direction of another as required by the terms of the trust, or when a trustee is totally relieved of specific responsibilities under the terms of the trust so that the trustee is not indirectly liable as it would be if the trustee functioned as a co-trustee with other co-trustees, for which there is an implied duty to monitor or second guess, and consequently be held liable for merely be acting as a co-trustee. To the point, divided trustees will not be treated as co-trustees.

Over-Arching Purpose: If the settlor of an irrevocable trust gives to another person, other than the trustee, some power or authority with regard to the trust, the settlor’s express division of administrative labor as reflected in the terms of the trust may be taken seriously by the trustee as the settlor’s intentional allocation of fiduciary risk in the administration of the settlor’s trust. The result is that a trustee that is subject to the directions of another should face fewer risks in the administration of the trust, if the trustee dutifully follows directions of another. As a consequence, the trustee’s standard fee may accordingly be adjusted downward to either reflect that reduced risk or reflect that less effort will have to be expended by the trustee if it does not have to use due diligence to confirm the purpose and effect of the direction that it is given, i.e. less work leads to a lower trustee fee. To achieve this objective, the trustee is relieved of the responsibility to second-guess the holder of the power to direct the trustee when the holder of that power acts within his/her authority under the trust instrument. In short, the directed trustee will not be held liable when it follows the directions of the trust director. Philosophically speaking, because the trust director is a fiduciary under the Act, the trustee beneficiaries will never be left without a fiduciary who will be accountable to them and who must always act consistent with the purposes of the trust and always act in the trust beneficiaries’ best interests.

Limits to the Trustee’s Protection: Despite the general statement that a directed trustee cannot be held liable for dutifully following the directions of the trust director, there are some obvious limitations, many of which will arise from how the trust instrument is written:

  • Narrow Scope of Trust Director’s Authority: The directed trustee still has the duty to confirm that the directions provided by the trust director are within the scope of authority or power that is given to the trust director under the trust instrument. Thus, the trustee cannot be exonerated from all liability by following any direction provided by the trust director; only for those directions that clearly have been assigned to the trust director under the instrument will the trustee have no liability. Example: A trust director is given the exclusive authority to manage and vote closely held stock that is held in the trust. The closely held business distributes a dividend to the trust. The trust director tells the trustee how the dividend distribution must be reinvested. The trustee is under no obligation to follow the directions of the trust director, as the trust director’s responsibilities are limited to managing the closely held business and voting its stock, not how its dividends are to be reinvested.
  • Who Takes the Initiative?: Another way to look at the limits to the possible exoneration of the directed trustee, is who, or what, initiated the action that is to be taken under the trust? An expressly delegated power to direct the trustee may, or may not, purport to shift the initiative from the trustee who is subject to direction to the trust director. Example: A trust director can be given the power to make all investments with regard to all of the trust’s assets. Thus, the settlor, under the trust instrument, delegates the initiative for all investment decision-making to the trust director. Alternatively, the trust instrument could simply give the trust director the power to veto trust investment suggestions made by the trustee, where the trustee articulates the plan of investments for the trust, subject to the trust director’s veto power. In this second situation, the initiative to make investment decisions originates or remains with the trustee, and thus the trustee is technically not a directed trustee.
  • Shared Responsibility Situations: It is possible that the trust instrument could be drafted such that both the trustee and the trust director may both hold a power, or where the trust director’s power is additive to the trustee’s power. Example: The trust instrument gives to the trust director the power to direct the trustee to make specific distributions to a trust beneficiary when it is requested by the beneficiary. The trust instrument also provides that the trustee may exercise its own discretion to make the same distribution to the same trust beneficiary without giving the trust director any veto over the trustee’s exercise of discretion. Thus, the Act may protect the trustee if the trust director directs the requested distribution and the trustee abides by that direction, so long as the trust director acts within the scope of his/her authority under the trust instrument. However, if the trust director merely acquiesces to a distribution request by the beneficiary which the trustee fulfills by exercising the trustee’s discretion, regardless of the existence of the trust director’s power to direct, the trustee may still be subject to claims by the trust beneficiary that the trustee abused its discretion in deciding to make or not to make the requested distribution.

Key Points Under the Act:

  • Trust Director: The terminology trust protector under the Michigan Trust Code is now dropped (as defined in MCL 700.7809) and is replaced with term trust director under the Act. Unlike the old trust protector statute, a settlor of the trust can function as a trust director.
  • Powers:  The Act does not specify a particular form that a power to direct must take or its scope. Example: The trust instrument could grant a power to make all trust investments to the trust director, e. a plenary power, or the trust instrument could grant a power of direction to a trust director only with regard to an art collection that his held in the name of the trust.
  • Subject to Power of Direction: The Act uses the terminology a trustee subject to a power of direction. Unfortunately, this can be a slippery concept. Examples: #1. The removal of a trustee with the exercise of that express authority or power that is granted to another person under the trust instrument is not treated as a power of direction, and thus the trustee that is subject to the removal by another will not be treated for liability purposes as a directed trustee. #2.  A person may be given a power to substitute assets of equivalent value with the trust under IRC 675(4) which is not, normally, a power of appointment; it, too, would not be treated as a power of direction. In sum, some powers with regard to a trust may, or may not, fall within the definition power of direction.
  • Powers of Appointment: An understanding of how the Act functions, and what powers may result in a directed trustee, will often turn on what constitutes a power of appointment under Michigan’s Powers of Appointment Act. Some powers of appointment are non-fiduciary in nature, while other powers of appointment are fiduciary in nature, thus making it difficult at times to ascertain if a trustee that is directed by a trust director will be free from liability or not, i.e. if the power is held in a non-fiduciary capacity. A sample list of powers that can be delegated to a trust director that will usually trigger fiduciary obligations by the trust director to trust beneficiaries, and thus relieve the directed trustee from liability, include the power:
    • To vote proxies for securities held in trust;
    • To make or take loans;
    • To adopt a particular valuation of trust property or determine the frequency or methodology of valuations;
    • To manage or select managers for a trust owned business;
    • To select a custodian for trust owned assets;
    • To direct the delegation of a trustee’s or a non-trustee trust actor’s powers to the extent the powers to be delegated are non-dispositive;
    • To change the trust’s principal place of administration or tax situs or the law that governs the meaning and effect of the trust’s terms;
    • To ascertain the happening of an event that affects the administration of the trust if the power holder is not a health-care professional who acts in that ascertaining the happening of that event, e.g. a diagnosis of the beneficiary’s Alzheimer’s;
    • To determine the compensation to be paid to a trustee or a non-trustee trust actor;
    • To prosecute, defend, or join an action, claim or judicial proceeding with regard to the trust;
    • To veto a trustee’s or a non-trustee trust actor’s exercise of a given power of the given power is non-dispositive; and
    • To release a trustee or non-trustee trust actor from liability for an action proposed or previously taken by the trustee or non-trustee trust actor.

Conclusion: As noted above, there is some belief that if a trustee faces less risk when it is simply follows the direction of a trust director, the trustee will charge a reduced fee. That may well be the case. But the fees a directed trustee charges will no doubt turn on the scope of the powers that are delegated to the trust director. Following an earlier example, if the trust director’s power is limited to managing the art collection held in the trust, with all other duties of investment and trust administration remaining with the trustee, it is hard to imagine a dramatic adjustment in the trustee’s standard fee, if the only direction that it must take is with regard to the art collection. Similarly, while a trust might start out with the trust director holding substantial powers over a trust’s investment portfolio, but at a future date the trust director himself could be removed from the trust, and not be replaced, that will leave the trustee with more responsibilities, and risk, than when the trust first commenced. Or, a closely held business held in the trust and managed by the trust director would probably result in a reduced standard trustee fee- until the closely held business is sold and no longer is held in the trust. Accordingly, there easily could be occasions where the trustee’s fees increase with future changes in events or circumstances. Consequently, focusing solely on the probable reduction of a trustee’s standard fee might at best be illusory if the terms of the trust are always changing.