4-Nov-19
Trust Modification: Practical ‘Traps’
Take-Away: Last week we covered nonjudicial settlement agreements to change how a trust is administered. In the past, we have covered the various provisions of the Michigan Trust Code that authorize the modification, or in some cases termination, of an irrevocable trust. We have also reviewed Michigan’s two decanting statutes, where the trustee creates a ‘new’ trust to receive the ‘old’ trust’s assets. Obviously, there are many opportunities to modify trusts to adapt them to the changing needs to beneficiaries, trustees, or simply to respond to ever-changing tax laws. How a trust instrument is drafted can either facilitate, or impede, many of these trust modification options.
Background: There are many reasons why trusts are modified these days. Some examples include: (i) updating trust administrative provisions; (ii) adding trust directors; (iii) adding general powers of appointment to exploit ‘free-basing’ opportunities; (iv) giving the trustee the authority to loan trust assets to beneficiaries; (v) changing a trust’s situs to avoid state income taxation of accumulated trust income; (vi) removing a contingent general power of appointment to remove assets from the reach of the beneficiary’s creditors. To accomplish these changes there now exist the Uniform Trust Code, the Uniform Trust Decanting Act, and the Uniform Directed Trust Act.
As mentioned above, the Michigan Trust Code has multiple provisions to modify a trust instrument, based on the Uniform Trust Code. Michigan has two separate statutes that permit the trustee to decant trust assets to a ‘new’ trust with different trust provisions. Last year Michigan adopted the Michigan Directed Trustee Act. The Michigan Trust Code also permits nonjudicial settlement agreements among the trustee and trust beneficiaries to alter how the trust is administered without probate court involvement. While these are all mechanisms to modify the terms of an existing trust, some trust provisions may make it more challenging to take advantage of these trust modification opportunities.
Trustee Removal Powers: A beneficiary’s authority to remove and replace trustees could preclude a trustee from exercising his/her power to decant the trust. The beneficiary’s power to remove and replace a trustee, even if limited to an individual who is neither related nor subordinate to the beneficiary [IRC 672(c)], might be construed so broadly as not to comply with the Uniform Trust Decanting Act’s definition of an authorized fiduciary. [Section 2(3).] Some states require that a trustee is not an authorized trustee if a trust beneficiary possesses the authority to remove and replace an acting trustee, if the new trustee so appointed could be related or subordinate to the trustee possessing the removal/replacement power. If decanting the trust’s assets is the goal, a solution might be for the beneficiary to release their power to remove and replace trustees prior to the trustee’s action to decant the trust’s assets.
Charities as Specific Remainder Beneficiaries: If a specific charity is named as a contingent remainder beneficiary of the trust that could lead to the unwanted involvement of that charity in any trust modification proceeding, no matter how remote that charitable residuary bequest might be. One possible solution to avoid having to ‘invite the charity to the party’ is for the trust instrument to give the trustee discretion to distribute trust assets where there are no more living descendants of the settlor to ‘one or more charity to which the settlor made charitable contributions during the settlor’s lifetime.’ Consequently, that type of charitable residuary bequest does not specifically identify a specific charity in the trust instrument. The settlor could also rely upon a ‘letter of wishes’ to provide further guidance to the trustee to implement this residuary bequest, without having to name the charity in the trust instrument.
Trustee Cannot Change Some Administrative Provisions in a Decanting: While under the statutory decanting powers a trustee can decant the trust’s asset to a ‘new’ trust without the consent of the trust beneficiaries, just a 63-day advance notice is required, and some administrative provision changes still require the consent of some trust beneficiaries. [MCL 700.7820a (2).] For example, if the goal is to remove a trustee removal power from an individual trust beneficiary [MCL 700.7820a (2) (d)] that cannot be accomplished in a straightforward decanting. Similarly, if the trustee wants to decant the trust assets to a trust where a trust director is used, which indirectly limits the trustee’s potential liability, decanting to achieve that objective cannot be accomplished due to statutory limitations. Under the Michigan decanting statute, the trustee cannot use the statutory decanting power if the result would be either a reduction in the trustee’s standard of care or an expansion of the trustee’s exoneration. [MCL 700.78201(2) (c).] A solution to this limitation might be to include in the trust instrument its own trustee decanting power provision to not rely on the Michigan statutory power to decant with its inherent limitations.
Trustee Requests for Releases: A trustee that is involved in a trust modification will usually require releases from both current and remainder trust beneficiaries. That will entail chasing down many individuals to obtain their releases. A trust instrument might be drafted to include a provision that specifically addresses future trust modification proceedings, where the number of consents and releases is limited to a specific number, e.g. “no more than 10 beneficiaries’ consent shall be required to modify this trust or release the trustee from any liability associated with any trust modification under the Michigan Trust Code.” Alternatively, some states, like Delaware, permit the appointment of a designated representative to act on behalf of Notice Recipients, to receive notices and sign documents on behalf of the a beneficiary, both adult and minor beneficiaries. [See 12 Del. C. Section 3339, which authorizes the use of a designated representative to receive notices, sign consents, and give releases.]
Parents Act as Co-Trustees of their Children’s Crummey Trust: Grandparents who create crummey trusts for their grandchildren often name the parents of those grandchildren as the co-trustees of the trust. Both parents acting as co-trustees will limit the trustee’s ability to rely on virtual representation to provide notice, and obtain consents or waivers on behalf of the minor trust beneficiaries. A simple solution might be to have one of the parents resign as co-trustee, and then permit the remaining parent to reappoint their spouse as co-trustee once the trust modification is completed. Obviously, the trust instrument should contemplate both the co-trustee resigning, and the mechanism to re-appoint a co-trustee who has resigned.
Conclusion: Building flexibility into an irrevocable trust is now expected these days. Possessing the option to change a trust instrument will preserve options for future trust modifications due to altered family circumstances, tax law changes, and to refine and implement the settlor’s intent. While multiple Michigan statutes now exist to modify the terms of a trust instrument, or decant the trust’s assets to a ‘new and improved’ trust, those options all have their own limitations and restrictions. As such, some thought should go into the possibility of future trust modifications when the trust is drafted, and how those modifications might be addressed in an expedited and efficient manner. This might include specific provisions in the trust instrument that expressly contemplate a future trust modification or adding trust specific decanting procedures without relying on default procedures and requirements contained in the Michigan Trust Code.