Trust Reformations

Take-Away: A trust reformation, not a trust modification, is required if the goal is to achieve a tax benefit under the trust, as a trust reformation is retroactive to the date the trust was created. Not so with a trust modification.

Background: A trust reformation is not the same thing as a trust modification. While there are a variety of provisions in the Michigan Trust Code that authorize the modification of the terms of an irrevocable trust, there is only one provision that deals with trust reformations. [MCL 700.7415- Reformation to Correct Mistakes.]

MTC: The Michigan Trust Code’s (MTC) reformation authorization is deceptively simple: “The court may reform the terms of a trust, even if unambiguous, to conform the terms to the settlor’s intention if it is proved by clear and convincing evidence that both the settlor’s intent and the terms of the trust were affected by mistake of fact or law, whether in expression or inducement.”

Ambiguity: It is important to keep in mind, however, that trust reformation is not the same thing as resolving an ambiguity of the trust through its interpretation. A probate court’s power to interpret ambiguity in a trust through interpretation is authorized under another MTC provision. [MCL 700.1302(b)(v)(vi).] Restated, resolving an ambiguity in a trust involves interpretation of language that is already in the trust instrument. A trust reformation may involve the addition of language not originally in the trust instrument, or the deletion of language originally included in the trust instrument by mistake, if necessary, to conform the language in the trust instrument to the settlor’s intent.

Expression or Inducement: A mistake in expression occurs when the terms of the trust misstate the settlor’s intention, fail to include a term that was intended to be included, or include a term that was not intended to be included. A mistake in inducement occurs when the terms of the trust accurately reflect what the settlor intended to be included or excluded, but this intention was based on a mistake of fact or law.

Not a Default Provision: This statutory power given to a probate court to reform the terms of a trust cannot be eliminated by the terms of the trust, i.e. it is not a default provision of the MTC. [MCL 700.7105(2)(d).]

Retroactive Effect of Reformation: The biggest difference from a trust modification is that with a trust reformation the reformed trust has retroactive effect to the date that the trust was executed and became irrevocable. This is critically important if tax considerations are driving the need to change the terms of the trust. With a trust modification, the change takes effect whenever the action is complete and when the trust’s modification occurs. A trust’s reformation is retroactive to the date that it was created.

Example: An irrevocable trust was created that gave a consent power to the settlor to override the trustee’s decision to make any trust distribution- the settlor’s required consent being a condition of any distribution from the trust. That retained power to control the ultimate enjoyment of the transferred property to the trust would cause the trust’s assets to be included in the settlor’s estate under IRC 2036(a)(2) or IRC 2038. A modification to eliminate the requirement of the settlor’s consent to the distribution would only be effective at the time of the trust’s modification. A trust reformation would have retroactive effect to eliminate the settlor’s retained power of consent to the date the trust was created. A trust reformation would be required if the settlor has died.

Example: A QTIP trust is created for the settlor’s spouse. The trust instrument provides that income may be distributed to the spouse or among her descendants. Thus, the spouse is not entitled to receive all of the trust income as a matter or right which is required for the unlimited marital deduction. If the settlor’s goal is to cause the trust to be protected by the unlimited marital deduction, there is the need to remove language ‘or among her descendants’ from the trust instrument to qualify for that intended tax benefit, i.e. the marital deduction. A trust reformation will be required to have the settlor’s transfers into the trust qualify, from the beginning, as a QTIP trust..

Other situations where a trust reformation would be required is where the residuary clause was mistakenly left out of the trust [it does actually happen from time to time!] or the wrong person is identified as a recipient of a bequest or devise, or a class of beneficiaries was omitted from the trust’s distribution provisions.

Proof: All these possible reformation changes hinge on whether there is evidence of a mistake made by the trust’s settlor, such as the settlor was mistaken about a particular fact or mistaken about the law, or more commonly, there was a mistake made by the attorney who drafted the trust, usually referred to as a scrivener’s error. However, this has to be proved by extrinsic evidence, i.e. information outside the four corners of the trust instrument. The proof could be through testimony, affidavit, or documents. However, the evidentiary standard for such proof is high: clear and convincing evidence. In a fairly recent Michigan Court of Appeals decision, the probate court correctly refused to hold an evidentiary hearing with regard to claims of a scrivener’s drafting error when the party that had alleged mistake of fact or law had failed to offer any evidence showing that clear and convincing evidence that the settlor’s intent and the terms of the trust had been affected by mistake of fact or law. In re Soloman Gaston Miller Trust, Michigan Court of Appeals, No. 341502, November 29, 2018.

How Far Back Can a Trust Reformation Go?: A recent Michigan Court of Appeals decision, with mixed result, addressed the question of how far back in time can a trust reformation go and still become effective.

Case: In re December 23, 2002 Restatement of the Vivian Stolaruk Living Trust, Michigan Court of Appeals, No. 352064, April 22, 2021

Facts: The children’s mother died in 2003. Their mother left her assets in a trust for the lifetime benefit of the children’s father. The children receive a copy of their mother’s trust sometime after her death, however the children were unaware of the scope of the limited power of appointment conferred on their father under the trust. Rather, the children relied upon a flowchart prepared by their parents’ estate planning attorney, which flowchart did not fully describe the scope of the testamentary limited power of appointment held by their father. The father on his subsequent death in 2018 exercised the testamentary limited power of appointment in favor of a charity, effectively disinheriting the children from their mother’s trust.

Dispute: In 2019, the children brought an action to reform their mother’s 2003 trust to narrow the scope of the limited testamentary power of appointment held by their father, i.e. eliminating any potential charitable appointees, as suggested by the attorney’s flow chart. The trustee filed a motion for summary disposition of the children’s reformation petition, asserting that laches, i.e. it is inequitable to wait so long to bring the claim, barred the children from seeking to reform a trust that was more than a decade after the settlor died and more than a year after their father’s death.

Probate Court: The probate court granted the trustee’s motion to dismiss the children’s petition to reform their mother’s 2003 trust.

Court of Appeals: In a split decision, two appellate judges agreed to reverse the probate judge’s grant of summary disposition of the petition to reform the trust. The case was sent back to the probate court for an evidentiary hearing to determine if a drafting mistake had been made with regard to the scope of the testamentary limited power of appointment the trust instrument conferred on the surviving spouse. One appeals judge believed that laches should have precluded any reformation of the irrevocable trust.

Conclusion: Apparently, from Stolaruk Trust decision, an irrevocable trust over 16 years ‘old’ might still be reformed, so long as the clear and convincing evidentiary standard can be met. Most often a trust is reformed due to scrivener’s error, and usually to achieve some intended tax benefit, e.g. marital deduction; charitable deduction; non-grantor trust status. However, as indicated by the Michigan case cited, a reformation action might also be used to alter the distribution of assets, long after the settlor has died.