Does Your Trust Need a Protector?

In the past decade or so states have responded to the trustee’s need to adapt trust provisions to evolving laws and beneficiary needs with the use of what is called a trust protector, although Michigan’s Trust Code refers to this role as a trust director.

A handful of the states that actively encourage the location of irrevocable trusts in their home states have adopted trust protector statutes that provide specific comprehensive trust protector powers that are available to be used regarding a trust, e.g., Delaware and South Dakota. Other states, like Michigan, have opted to permit the trust’s creator to expressly describe the trust director’s powers in the trust instrument. Usually trust directors are either assigned responsibilities over trust investments or specific trust assets e.g., an artwork collection that must be liquidated for a long period of time, or to make trust distribution decisions, e.g., one beneficiary might be a child who has unique medical expenses or special needs that the trust director is familiar with, or to oversee the trust’s day-to-day administration, e.g., asset protection, tax filing and meeting statutory reporting obligations. In short, specific duties regarding a trust’s administration can be assigned and delegated among several trust directors to collaborate with the trustee.

Michigan’s extensive trust director statute provides that the trust director must serve as a fiduciary, which is an important limitation and assures accountability, so the trust director must always act impartially, in good faith, and in the trust beneficiaries’ best interests. Other states do not always require that a trust protector serve as a fiduciary to the trust beneficiaries.

The trust director, as the name suggests, directs the trustee to either trust investments, trust distributions, or in some cases solely to handle the administrative decisions associated with an irrevocable trust. The trustee is required to comply with the exercise, or the non-exercise, of a power at the trust director’s direction. Since the trustee must follow the trust director’s directions, the directed trustee is not liable when it follows the trust director’s directions.

The exception where the trustee may still be liable for its acts or its failure to act is when the exercise or the non-exercise of a power is the result of the trust director’s fraud, or the trustee’s compliance with a direction would be its collusion to that fraud. Michigan’s statute also limits the trustee’s acquiescence to the trust director’s directions if it would result in a breach of the trust that involved the trustee’s or another trust director’s bad faith or reckless indifference to the purposes of the trust or the interests of the trust beneficiaries. Thus, the trust director directs the trustee in its administration of the trust which the trustee must follow, unless the trust director’s directions are contrary to the trust’s purposes or following those directions would perpetrate a fraud, which directions the trustee can then disregard. Other than these exceptions the trustee cannot be held liable when it follows the trust director’s directions.

Correspondingly, the trustee has a duty to provide information with respect to the trust to the trust director to the extent that such information is reasonably related to the powers and duties of the trust director or the powers and duties of the trustee or another trust director. As such, it is expected that information will flow back-and-forth between the trustee and the trust director.

Some of the common trust director powers that might be included in a trust instrument include the powers to:

• Make tax elections.
• Remove or replace the trustee.
• Make or block distributions from the trust.
• Manage, veto, or direct trust investments.
• Add or remove trust beneficiaries in limited situations.
• Change the state (situs) where the trust is administered.
• Change the governing law of the trust.
• Consent to a trust beneficiary’s exercise of a power of appointment.
• Amend the trust instrument as to its administrative, tax, or dispositive provisions.
• Grant powers of appointment to trust beneficiaries.
• Approve trust accountings or tax returns.
• Add a grantor (the trust creator) as a beneficiary from a class of trust beneficiaries.
• Terminate the trust.

The trustee’s exercise of some of these powers could expose the trustee to claims of a breach of fiduciary duty since any of these changes to the trust instrument might impair the interests of the trust beneficiaries in contravention of the trustee’s fundamental fiduciary duty to always administer the trust in the trust beneficiaries’ best interest consistent with the trust’s material purposes. Acting at the trust director’s direction will relieve the trustee from liability for claims of breach of fiduciary duty.

Adding a trust director to the trust instrument gives greater flexibility to the trust instrument. In the absence of the trust director holding any of these powers, the trustee would otherwise have to petition the local probate court to modify the trust, or terminate the trust, which entails time, expense, and publicity that most trust creators want to avoid. In some situations, rather than include an extensive list of trust director powers in the trust instrument, it might be easier to simply give the trustee the power to name a trust director later with a specific power(s).

Not every trust is a candidate to include a trust director. For example, a trust that provides that shortly after the trust creator’s death the trustee should as soon as practicable distribute all trust assets to the trust beneficiaries, there is no need to anticipate the need for additional flexibility to adjust the trust’s terms. In contrast, a trust that could exist for several years, or decades, after the trust creator’s death, like a so-called dynasty trust that is intended to continue for multiple generations to save transfer taxes, or a trust set to run for several years e.g., ‘distribute the remaining trust assets to my children when the youngest attains the age 50 years,’ might warrant the inclusion of the trust director in order to respond to changing laws or the beneficiary’s changing circumstances.

Laws continue to change, as do the needs of trust beneficiaries. Yet an irrevocable trust’s words are locked in on the date the trust becomes irrevocable. The trustee is charged with administering the trust, e.g., manage investments, make distributions, file reports and tax returns, based on those locked-in words. A so-called modern trust needs to be flexible to adapt to those changes without having to incur the expense to periodically visit the probate court to seek judicial permission to act, or not act, in each situation. It is time to consider adding a trust director, or trust directors, to your trust instrument.