Trust Situs is Not Trust Governing Law

Take-Away: Merely because the trustee possesses the authority in a trust instrument to change the trust’s situs does not mean that the trustee can also change the trust’s governing law. These concepts are not the same.

Context: Much has been written about several states that now regularly compete for trust business. A month does not seem to go by without some state amending its trust laws to entice new trust business to that state. As a result, considerable estate planning literature now emphasizes the need to give to the trustee of an irrevocable trust the authority to change the situs of a trust in order to take advantage of these ever changing trust laws. Consequently, changing a trust’s situs is now part of conventional trust administration landscape the hallmark of which is flexibility. But the trustee’s ability to change a trust’s situs does not necessarily give to the trustee carte blanche with regard to the law that governs the trust that it administers.

Key Point: While a trust’s situs can be changed to a different state, there is no corresponding change to the governing law of the trust.

Definitions:

Governing law: Governing law is the unique legal system that governs or controls the validity, construction and legal effect of the trust instrument. If the trust instrument states its governing law, and most trusts do, that statement of the settlor’s intent will usually be honored by the probate court.
Situs: Situs refers to the state in which the trust assets are physically located or where the trust is ‘grounded,’ i.e. the principal place of the trust’s administration. Situs also can refer to the state in which the trust is deemed to exist, separate from where the trust assets are located or the domicile of the trustee or the trust’s beneficiaries.

Practicalities: The law of situs generally governs trust administration matters, such as trustee compensation or trust accountings and disclosures to trust beneficiaries. But a change in situs will not change a court’s interpretation or construction of the trust instrument and its terms which is controlled by the trust’s governing law. This distinction is often overlooked, premised on the assumption that the change in a trust’s situs will automatically expose the trust’s interpretation to the more favorable laws of the situs’ jurisdiction, which is not the case. While the situs of the trust might change by action initiated by the trustee, the trust’s governing law as specified in the trust instrument will remain the same. If the trust instrument specifies its governing law but it is silent on the trustee’s authority to change the governing law, the trustee will have to petition the probate court to change the trust’s governing law, and there is no assurance that a probate court will grant that petition.

A trust’s situs and governing law can affect many aspects of an irrevocable trust. Examples follow:

Asset Protection: Normally the laws of a state designated as its governing law, not its situs, determines if the beneficiary’s creditors can reach the beneficiary’s interest in the trust. [Restatement (Second) Conflicts of Laws, section 273.] Michigan’s favorable discretionary trust definition with its creditor protection features would be a good reason to retain Michigan as a trust’s governing law, even if situs is later changed. See MCL 700.7103(d), 700.7505, and 700.7815(1)
Privacy: A trustee must provide copies of the trust instrument and periodic accountings to the trust beneficiaries as a matter of conventional trust administration, a matter that is controlled by situs. While Michigan’s law requires a trustee to keep qualified beneficiaries informed about the administration of the trust and the material facts necessary for them to protect their interests, [MCL 700.7814], in contrast a trust that is sitused in South Dakota permits a trustee to petition a court to seal a trust instrument and related documents, effectively keeping the trust beneficiaries in the dark with regard to the existence of the trust or their rights as beneficiaries in the trust. [S.D.C.L. Section 21-22-28] A change in situs to South Dakota might be warranted if a silent trust is the settlor’s goal.
Perpetuities: With the recent interest in dynasty type trusts, it is important if a state has abolished the rule against perpetuities that govern long-term trusts, which is a trust validity question controlled by the trust’s governing law. While Michigan has extended its rule against perpetuities, there are still several ‘hoops to jump through’ to assure the dynastic nature of the trust. Delaware has abolished the rule against perpetuities. [See Delaware, 25 Del. C. Section 503] Merely changing the situs of a Michigan trust to Delaware will not expose the trust to Delaware’s more favorable dynasty trust laws. The state laws that govern the trust’s validity will control (Michigan), not its situs (Delaware). [Restatement (Second) Conflict of Laws, Section 269, comments d and f.]
Delegation: Some states have statutes that relieve a directed trustee from almost all liability while other states have far less comforting statutes that protect a directed trustee that follows a protector or advisor’s directions. It is not clear at this time whether a change in situs will provide further protection to the directed trustee who wants a greater degree of exoneration from liability if it follows a trust protector’s marching orders; is trustee exoneration a matter of trust administration controlled by situs, or is it affected by a trust’s governing law, since the trustee’s exoneration goes to the very nature of the fiduciary relationship with the trust’s beneficiaries? So far courts are uncertain whether to apply situs or governing law standards to a directed trustee’s exoneration from liability.

Conflict-of-Laws: When a trust is sitused in a state that is different from its governing laws, the answer to many questions will turn whether the issue is one that deals with trust validity, construction or the trust’s administration. This confusing potential conflict of laws may force a court to look at several different factors to decide which state’s laws to apply. Conflict of law disputes are very nebulous, and they often focus on many factors including: (i) is the trust inter vivos or testamentary?; (ii) is real estate held in the trust, which is normally controlled by the governing law of the trust, not its situs? ; (iii) what connections do the trustee and the trust beneficiaries each have with each state? In short, there is no easy answer when a conflicts of law question surfaces with settlors, trustees, trust beneficiaries, each of whom may be domiciled in a different state, with the trust estate being sitused in yet another.

Delaware: This might be reason enough for some clients to form trusts in Delaware, where Greenleaf Trust will soon have trust powers. As a generalization, Delaware has far more favorable laws than does Michigan, both as to the validity of a trust, e.g. if a dynasty trust is intended, and with regard to trust administration, e.g. it permits a form of silent trusts, unlike Michigan.

Conclusion: If the settlor’s intent is that the trustee should possess the power to change the trust’s situs, that should be clearly spelled out in the trust instrument. If the settlor believes that the authority conferred on the trustee to change situs should also include the authority to change the trust’s governing law, then the trust instrument should include a statement that the settlor’s intent is that the transferee state’s law will also apply to that change in trust situs. [Few trusts that I have seen over the years give the trustee the authority to change the trust’s governing law, just its situs.] At the same time, if the settlor has deliberately chosen a state’s governing law and situs in the trust instrument for specific reasons, it might also make sense that the settlor add additional language that prevents a future change in situs or governing law which is contrary to the settlor’s original objectives.