Take-Away: Just because a trust instrument expressly names the trust’s governing law, that choice of law may not be binding on future courts. There needs to be more than just a choice or preference expressed for a court to apply the laws of another state to the trust.

Background: We live in an era when states adopt aggressive trust codes and unique provisions with regard to trust in order to attract trust business to their jurisdictions. As such this results in disparate trust law provisions that settlors may wish to choose from for a variety of reasons. These differing trust provisions can deal with the duration of a trust (the repeal of the rule against perpetuities in some jurisdictions), asset protection trusts (to shield assets from creditor claims or the claims of former spouses), the ability to decant the terms of the trust (in some states without a prior notice to the trust beneficiaries) or the ability to appoint a trust protector or directed trustee (to control or overcome the discretion of the named trustee.) Consequently, some trusts may be drafted to adopt the perceived ‘favorable’ laws of another jurisdiction. The question is whether that choice of law as expressed by the trust settlor (or trust protector) in the trust instrument will be respected.

  • Situs: A trust’s situs refers to the state where the trust assets are physically located or where the trust is ‘grounded’ or has its ‘foundation’ or its ‘principal place of business.’ Accordingly, the law of situs generally governs trust administration matters, such as trustee liability, trust accountings, trustee compensation, or the characterization of the beneficial interests of the trust. MCL 700.7107, 700.7108, and 700.7403.
  • Governing Law: A trust’s governing law is the particular legal system that governs the validity, construction and legal effect of the trust instrument. A probate court will usually honor language in the trust instrument that states its governing law, subject to the language used or the context. Restatement (Second) of Conflict of Laws, Sections 268-270, 277 (1991).

Question: Consider whether a trust instrument’s provision specifying that the trust’s validity and effect shall be determined under the laws of Nevada (with very favorable creditor protection laws) would be upheld if the settlor was  domiciled in Michigan and who had only nominal connections with Nevada. Would a Michigan probate court apply Nevada law to the trust?

Example:  An example where a court refused to follow the ‘governing law’ direction in a trust instrument was the fairly notorious 2013 In re Huber Bankruptcy Court decision- its notoriety resulting because the settlor unsuccessfully tried to hide behind Alaska’s established asset protection statute. The facts were pretty straightforward. Mr. Huber resided in Washington. He set up an asset protection trust naming Alaska as its ‘governing law.’ The trust held assets of substantial value, all of which were located in Washington, but for one $10,000 CD held in Alaska. An Alaskan Bank was named as one of three co-trustees, but according to the court, the Alaska Bank ‘engaged in virtually no trust administration activities.’ The legal question was whether Washington or Alaska governed the validity of the trust. Alaska adopted a strong asset protection legislation. Washington had a strong public policy against self-settled asset protection trusts.

Thus the battle lines were drawn as to which state law would apply to the trust. Since the settlor had filed for bankruptcy protection, the self-settled trust was being challenged by the bankruptcy trustee as invalid under Washington’s law.

The court in analyzing this conflict of laws noted that the general rule is that an inter vivos trust of ‘movables’ is valid if valid under the law of the state designated by the settlor to govern its validity. But the court then noted that this ‘general rule’ does not apply unless: (i) the designated state has a substantial relation to the trust; and (ii) the application of the designated state’s law does not violate a strong public policy of the state where, as to the matter at issue, the trust has its most significant relationship. Applying this analysis, the court refused to enforce the trust provision that specified that Alaska was the trust’s governing law. It stressed in its finding that Alaska did not have a substantial relationship with the trust. The sole connection between the trust  and Alaska was the $10,000 CD and an ‘inactive corporate trustee.’ Finally the court noted Washington’s strong public policy against self-settled trusts.

Conclusion:  When we are presented with a trust instrument that seeks to be governed by the law of another state, there is no guarantee that such a provision will be enforceable, even when there are ‘some’ connections with the other state. Consider a state like Florida that has adopted a statute that permits a surviving spouse to pursue his/her elective rights against the assets held in the decedent spouse’s trust, unlike Michigan’s statute which only permits an election against the deceased spouse’s probate estate. Could a client who resides in Florida most of the year create a trust naming Michigan as its governing law, in order to foreclose a surviving spouse’s elective rights? There may be sufficient public policy of  a state, as reflected in its statutes, that might cause the selected governing law in the trust instrument to be ignored by a court.  Whenever possible it is critical that as many other factors as possible relate to the trust to the targeted state, e.g. location of trustee, location of trust property, principal place of trust administration. Even then, there is no guaranty that a court will follow the trust instrument’s ‘governing law’ directive.