Trust Directors – Naked-Nonfiduciary Powers of Appointment

Take-Away: As we learn more about trust directors and their promised utility, it is important to remember that a trust director in Michigan serves as a fiduciary, along with all of the duties that are normally associated with a fiduciary’s role. Other states leave it up to the trust’s settlor to decide if a trust director is to act as a fiduciary.

Background: With the advent of trust directors in Michigan (and nationwide), there can be some confusion when such a role player under a trust instrument must act as a fiduciary. Some states, South Dakota comes to mind, which are self-styled ‘trust-havens,’ have decided to not require a trust director to serve as a fiduciary. Other states, like Delaware, give the trust settlor the choice whether the trust director is to serve in a fiduciary capacity.

Definition of Trust Director:  A trust director is a person or entity that holds the power of direction to control the activities of a trustee, regardless of the name or title used in the trust instrument. This refers to the person who holds the power of direction, regardless of whether the person is a settlor or a trust beneficiary. [MCL 700.7703a(24)(f).] A trust director must either be a natural person or an organization that holds trust powers under Michigan’s statutes. A trust director, prior to the Michigan’s fairly recent amendment to the Michigan Trust Code (MTC), was often called a trust protector. Consequently, whether called a trust director or trust protector, they are the same for purposes of the Michigan Trust Code.

Trust Director as Fiduciary: Under the Michigan Trust Code a trust director must act as a fiduciary. The MTC provides: “A trust director has the same fiduciary duty and liability in the exercise or non-exercise of the power as a sole trustee in a like position and under similar circumstances if the power is held individually, or if the power is held jointly with a trustee or another trust director, as a co-trustee in a like position and under similar circumstances.” [MCL 700.7703a(5)(a).]

In addition, this trust director role as a fiduciary is one of the handful of MTC provisions that cannot be altered by the trust’s settlor in his/her trust instrument. [MCL 700.7703(a)(5)(b).] Consequently, the customary fiduciary duties that are faced by a trustee, e.g. loyalty, prudence, and disclosure, all equally apply to a trust director in Michigan.

Powers of Appointment:  At its most basic level, a power of appointment is a power of disposition. A power of appointment is defined in the Michigan Powers of Appointment Act. [MCL 556.112(c) as follows: “A power of appointment created or reserved by a person having a property interest that is subject to their disposition that enables the donee  [i.e. the powerholder]of  the power to designate, within any limits that may be prescribed, the transferees of the property or the shares or the interests in which shall be received.”  The Michigan Trust Code also adopts this formal definition of a power of appointment. [MCL 700. 7703a(24)(d).] This broad definition of a power of appointment thus includes a trustee’s power to make discretionary distributions, and as such,  it applies as well to powers delegated to a trust director under a trust instrument, i.e. the trust director holds a power of appointment.

Naked Power of Appointment: A naked power of appointment is a power of appointment that is not ‘coupled with an interest.’ ‘Coupled with an interest’ is shorthand for a larger legal principle with regard to the irrevocability of an agent’s power when the agent’s authority is ‘coupled with an interest.’ An agent’s power or authority in a principal-agent relationship terminates on the death of the principal. However,  if the agent’s authority is ‘coupled with an interest’, the agent’s authority is irrevocable, even upon the principal’s death. Accordingly, to constitute a power ‘coupled with an interest’ a property right in the thing which is the subject of the agency or power, must be vested in the person to whom the agency or power is given, so that he/she may deal with it in his/her own name; thus, in the event of the principal’s death, the authority could still be exercised in the name of the agent. Following this legal principle of a power of appointment that is ‘coupled with an interest’ a naked power of appointment over trust assets is one where the powerholder has no interest in the trust and no vested right in the trust for their own benefit, i.e. the powerholder is neither a trustee nor a beneficiary. In the estate planning context, a naked power of appointment, which is a power of appointment that is not ‘coupled with an interest, is one where the powerholder neither has nor acquires any estate in the interest in property  that is to be disposed of by the exercise of the power of appointment. Consequently, a trust instrument could give an ‘outsider’ a power to add a trust beneficiary, or to direct the distribution of trust assets, which thus is a  naked power. [Yep. Pretty mind-numbing.]

Nonfiduciary Powers of Appointment: Some power of appointments are intended by the trust’s settlor to be held in a nonfiduciary capacity. This means that they are not designated as trust directors as defined in the MTC and thus they are not subject to the fiduciary constraints imposed under MCL 700.7703a. A classic example of a nonfiduciary power of appointment is a trust beneficiary who is given a testamentary limited power of appointment to appoint the trust assets to alter the trust’s dispositive provisions on that powerholder’s death. That powerholder has no fiduciary duty to other trust beneficiaries with regard to the exercise, or the non-exercise, of that power of appointment that they hold.

Presumed Nonfiduciary Powers: Whether a power over a trust is held in a fiduciary capacity, or not, is an important distinction. As noted earlier, a trust director is subject to fiduciary duties under the MTC. Yet the MTC also identifies some powers held by a non-trustee that are presumed to be held in a non-fiduciary capacity. So who acts as a fiduciary and who does not becomes important to identify. Recall that a person or entity may be classified as a trust director under the MTC even though that title is not used in the trust instrument. [MCL 700.7703a(1)(a-f).]

Statutory Rules of Construction: The MTC also contains an extensive set of rules of construction for certain powers (or presumptions) used in a trust instrument. [MCL 700.7703a(2)(a)-(c).]

1. Identified Statutory Exceptions (Sort of): The MTC exempts certain described powers of appointment in a trust instrument as powers held by a trust director– so what might look like a trust director will not be treated as  a trust director (nor, apparently as a fiduciary.)  These ‘excluded’ powers include a power of appointment which is in the form of a power to do any of the following acts: (i) adjust between principal and income; (ii) convert to, or from, a unitrust; (iii) modify, reform, or terminate a trust; and (iv) distribute trust assets in ‘further’ trust.  But…
2. Presumed Fiduciaries: The same statute then creates a contrary presumption, i.e. the individual will be treated as  a trust director with respect to these same four powers (described in 1 immediately above) if they are held by a non-trustee who does not have a beneficial interest in the trust. These four powers are nevertheless presumed to be held and exercised in a fiduciary capacity. (Head spinning yet?) Why this contrary statutory presumption of acting as a fiduciary exists is because it is assumed that a settlor likely expects a non-beneficiary who holds  any of these 4 powers to act for the benefit of all of the trust beneficiaries. (You be the judge if you agree with the reasoning for this presumption.)
3. Settlor’s Intent of Nonfiduciary Power: A power of appointment that is intended (express or implied?) by the settlor in the trust instrument to be held by the powerholder in a non-fiduciary capacity will be respected: unless, of course, the power is held by a trust director which is always a fiduciary under the MTC and which cannot be altered by the settlor;
4. Power to Create a Power of Appointment: A power that is (i) intended by the settlor to be held in a non-fiduciary capacity that (ii) enables the holder to create a power of appointment, regardless of whether the created power is intended to be held by the donee [ i.e. a powerholder] of the created power in a fiduciary or non-fiduciary capacity;
5. Power to Remove and Appoint Trustees: Powers to remove and appoint trustees and trust directors: Powers to remove and appoint trustees and trust directors are not fiduciary powers because such powers are claimed to be common and thus deemed to be viewed differently than other powers of direction; it is possible, however, that the settlor could expressly subject the power to remove and appoint trustees and trust directors to fiduciary duties;
6. Settlor’s Power to Revoke the Trust: Powers to direct held by the settlor with a power to revoke the trust: A power to direct that is retained by the settlor with a power to revoke the trust is an extension of the other MTC principles that the duties of a trustee run only to the settlor while the trust is revocable [See MCL 700.7603(1);]
7. Beneficiaries’ Power for Themselves: Power held solely by a trust beneficiary of the trust: this exception follows the principle that a power that is for the sole benefit of the person who holds the power is not a fiduciary power, e.g.  the beneficiary’s power of withdrawal. However, if the power held by a trust beneficiary could affect another’s beneficial interest in the trust then that power will be subject to fiduciary duties imposed under MCL 700.7703a;  and
8. Tax Objectives: Powers over a trust that, under the terms of the trust, are expressly held in a nonfiduciary capacity in order to achieve a settlor’s tax objectives.

Conclusion: I have to say that the MTC’s provisions with regard to trust directors is one of the most confusing provisions to follow or implement. Clearly the Legislature’s intent is that a trust director will be subject to fiduciary duties, a role that cannot be altered by the settlor. Moreover, the term trust director does not actually have to be used for an individual or entity to be treated as a trust director; even without that title, a power holder might still be treated as a trust director who is subject to fiduciary duties. But then you encounter a series of powers identified in the statute that are excepted from the definition of trust director, even though those powers are in fact powers of appointment. Under some definitions, such excluded powers could be viewed a naked powers of appointment held by someone that is not coupled with an interest in the trust. There is a lot to consider if one is asked to hold a power over a trust without having an interest in the trust. Just a lot to digest as we become more familiar with  trust directors.