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

20-Jun-18

Terminating a Trust by Consent – Not so Fast

Take-Away: The Michigan Trust Code contains a couple of provisions that permit an irrevocable trust to be terminated. But just because the income beneficiary and remainder beneficiaries agree to commute the lifetime beneficiary’s interest under the trust will result in the termination of the trust.  A judge may have different thoughts on the termination when he/she looks to the purposes behind the trust.

Example: A trust is established for the settlor’s son. The son is to receive all of the trust’s income for life. Upon the son’s death, the assets held in the trust are to be distributed to three charities. The son and the charities agree that the trust should be terminated and the son’s income interest in the trust commuted (cashed out) with the balance of the trust assets then immediately paid to the charities. The son and the charities think this is a great idea, as each get their hands on the assets held in the trust now, and the son no longer has to deal with a trustee. No surprise, the trustee does not think the commutation of the son’s income interest in the trust is a good idea. What happens if the son and the charities decide to side-step the trustee and  petition the court to approve their commutation agreement, effectively terminating the trust over the trustee’s objection.

Background:  As has been covered in past summaries, the Michigan Trust Code permits the termination of a non-charitable trust under a variety of circumstances. [MCL 700.7411 (1); MCL 700.7412 (2).] The Trust Code provides that a trust may terminated in any of the following ways:

  • (a) By the probate court upon the consent of the trustee and the qualified trust beneficiaries, if the court concludes that the proposed termination of the trust is consistent with the material purposes of the trust or that the continuance of the trust is not necessary to achieve any material purpose of the trust; or
  • (b) Upon the consent of the qualified trust beneficiaries and a trust protector who is given the power under the trust instrument to grant, veto, or withhold approval of the termination of the trust; or
  • (c) By a trustee or trust protector to whom a power to direct the termination of the trust is given under the trust instrument.

A trust that is terminated in any manner just described will have its assets distributed as agreed upon by the qualified trust beneficiaries. [MCL 700.7411 (2).] However,  if the trustee refuses to consent, or not all of the qualified trust beneficiaries consent to the proposed termination of the trust, the trust’s termination can still be approved by the probate court if the judge is satisfied that: (i) if the trustee and all qualified trust beneficiaries had consented, the trust could have been terminated, and (ii) the interests of the qualified trust beneficiary who does not consent will be adequately protected. [MCL 700.7411 (5).]

How would the Michigan probate court react if the trustee refused to consent in the example provided, when the son and the charities filed their petition to commute the son’s interest in the trust, effectively transferring the balance of the assets to the charities now, not decades later when the son dies?

Effective Date: Michigan’s termination of trust by consent statute only applies to trusts that were created after April 1, 2010;  it does not apply to an irrevocable trust that was created before that date. [MCL 700.7411(2).]

Common Law: Prior to the Michigan Trust Code’s adoption Michigan’s common law was clear that the trustee and the trust beneficiaries could not terminate a trust by consent if to do so would violate a material purpose of the trust.  Rose v. Southern Michigan National Bank, 255 Mich. 275 (1931). But the same Michigan common law  permitted a judge to terminate an irrevocable trust if the trustee and the trust’s settlor agreed to its termination. Fredricks v. Near, 260 Mich 627 (1932).  Similarly, at common law, an irrevocable trust could be terminated if both the settlor and the trust beneficiaries all agreed as to its termination. Hein v Hein, 214 Mich. App 356 (1995.) Obviously the Trust Code departs from Michigan’s common law because it gives the trust settlor no voice in whether the trust can be terminated.

Inherent Material Purpose: The Trust Code does not define a trust’s material purpose. That presumably is left to the probate judge to find from reading the trust instrument. There is only one unpublished Michigan Court decision where the probate court refused the beneficiaries’ agreement, used to settle pending litigation, to terminate the trust. Apparently the beneficiaries overlooked mineral rights that were associated with the land that was held in the trust in their settlement agreement. The overlooked mineral interests became the subject of new litigation over the question of who owned the minerals (and the associated royalties.) The Court of Appeals found that the beneficiaries attempt to terminate the trust was ineffective, and thus the trust continued because a material purpose of the trust remained unfulfilled- the distribution of the mineral interests that were held in the trust with the real property. As a result of the judge’s finding, the trust continued, and the contingent remainder beneficiaries of the trust were entitled to receive the mineral interests upon the death of the life income beneficiary. In re Estate of Larry E. Hutchinson Living Trust, No. 326511, 2016 Mich. App LEXIS 1311 (July 7, 2016). Thus, the judge looked to one of the assets that the settlor had transferred to the trust to find a material purpose for that trust.

In a recent case, but not in Michigan, the court was confronted with facts similar to those set forth in the Example. Horgan v. Cosden, Florida District Court of Appeals, Second District, Case 2D17-1354 (May 25, 2018). Upon the settlor’s death the trust became irrevocable. The settlor’s son was the lifetime income beneficiary. The remainder interest in the trust passed to three educational institutions (charities) on the son’s death. The son and the charities entered into an agreement to terminate the trust to divide the $3.0 million in assets then held in the trust; the division of the trust assets was based on their respective actuarial interests in the trust. The trustee did not agree to the early termination of the trust. The son then filed a complaint against the trustee to terminate the trust in accordance with Florida’s trust code, which permits a judicial modification (or termination) of an irrevocable trust  on the petition of either the trustee or a qualified trust beneficiary if, among other reasons, a material purpose of the trust no longer exists. This Florida statute is almost the same as Michigan’s MCL 700.7412 (2). The Florida trial court permitted the trust to be terminated. The appellate court reversed the trial judge and entered an order that barred the termination of the trust. The appellate court looked more to commonplace reasons for the use a trust as opposed to the assets held in the trust (which the Michigan Court of Appeals looked to.). Some observations of the Florida appellate court are interesting in how it disposed of the son’s arguments why the trust should be permitted to be terminated, in effect imputing a material purpose to the trust simply by reason of the trust’s mere existence:

  • The settlor’s intent is the polestar of trust interpretation, and an early termination of a trust based on common circumstances [that the son wanted to avoid having to deal with a trustee and eliminate the expense associated with holding assets in trust] applicable to many trust administrations would thwart that settlor intent;
  • Settlors generally retain assets in trust for beneficiaries to avoid vesting of significant assets in the hands of the beneficiary, to protect the beneficiary from creditor claims, to have third-party professional asset management, and to achieve the other benefits of trust ownership that could be easily thwarted when courts are lenient in applying those statutory provisions that authorize a trust’s termination by beneficiary consent.
  • The trustee’s fees were customary, there were no unusual administrative expenses incurred, and there had been no invasion of trust principal, which the court felt addressed the son’s claims that continuance of the trust would be ‘wasteful;’
  • That there were market fluctuations did not create a real risk that the settlor’s intent would be frustrated, the Court noting: If we were to affirm the trial court’s ruling, beneficiaries could have trusts terminated simply by stating that they did not want to pay trustees’ fees, administrative expenses, or be concerned about market fluctuations.’
  • Thus, mere savings on future administrative expenses and the risk of market fluctuations of the assets held in the trust was not a good reason to terminate an existing trust.

Unanticipated Circumstances: The Michigan Trust Code also permits a probate court to terminate a trust because of circumstances not anticipated by the settlor, and that termination of the trust will further the settlor’s state purpose, or if there is no stated purpose in the trust instrument, the settlor’s probable intention. [MCL 700.7412(2).] Again, a change in circumstances is something that the probate judge gets to decide. Only two cases  have been reported in Michigan as to what constitutes a change in circumstances that warrant a modification or termination of an irrevocable trust. In one case a purported change in the estate tax laws was not deemed by the court to be a sufficient change in circumstances to warrant a modification of an irrevocable trust to permit amendments to the trust (which amendments on their face seemed to be unrelated to the estate tax law changes that were the claimed change-in-circumstances basis for the trust’s modification.) In re Otto William and Margaret Anne Meyer Revocable Trust, No. 326894 2016 Mich. App LEXIS 573 (March 17, 2016). The other case seemed to be much more lenient to find a change of circumstances. The probate court found that unanticipated conflict among the settlor’s children constituted a ‘substantial change in circumstances’ that warranted the removal of one child of the settlor as the then acting trustee,  while it ignored the settlor’s named successor trustee (another child to the conflict) in the trust instrument. In re Mlynarczyk Living Trust, No 302877, 2011 Mich App LEXIS 1575 (September 15, 2011.)

Conclusion: While multiple provisions in the Michigan Trust Code contemplate the modification or termination of an irrevocable trust [consent if material purpose is achieved; change in tax laws; uneconomic; change in circumstances] it may not be as easy as some beneficiaries think, especially if the material purposes for the trust are spelled out in the instrument and thus easily located by the probate judge which must approve the modification or termination.