Today’s topic on trusts law: Rights to distributions

1. Today’s topic on trusts law: Rights to distributions • Rights of the beneficiary to distributions • Rights of a beneficiary’s creditor to collect from the trust • Modification and termination of trusts

2. Rights of beneficiaries • Much clearer in mandatory trusts (e.g., all of the income of the trust is to be distributed to beneficiary A). • With discretionary trusts (e.g., trustee decides how to allocate income among beneficiaries, how much income to distribute, or whether to invade principal), the trustee is subject to principles of fiduciary obligation • It’s not a trust if the trustee has unlimited freedom to exercise the granted discretion

3. Marsman v. Nasca 573 N.E.2d 1025 (Mass. App. 1991), p. 598 Marsman v. Nasca (1) Sara Marsman Margaret Cappy Cappy One-third of residue, income payable quarterly, principal paid if trustees “deem it necessary or desirable,” in their sole discretion, for “his comfortable support and maintenance Sally Marlette Richard Marlette Image courtesy of Dana Hall Archives.

4. Marsman v. Nasca 573 N.E.2d 1025 (Mass. App. 1991) Marsman v. Nasca (2) Sara dies, leaving Cappy an income interest in trust, and discretion in trustee to pay principal. Cappy executes will leaving house and other property to Margaret. Sally and husband cover Cappy’s house expenses; Cappy deeds house to them, keeping a life estate. 1987 1972 1974 1971 1973 Nov. 1974 Cappy retires, takes out mortgage for $4,000 to pay bills; marries Margaret. Farr gives Cappy $300 from principal, asks for written explanation of need for more. Cappy dies. Margaret asked to leave house. She sues Farr. Cappy’s difficulty in meeting expenses intensifies. Image courtesy of Dana Hall Archives.

5. Did the trustee breach his fiduciary duties? • How could he breach his duties if he had “sole and uncontrolled discretion” to distribute principal? • The trustee was charged with providing “comfortable support and maintenance,” which means in accordance with the beneficiary’s accustomed standard of living • The trustee couldn’t prudently exercise his discretion if he did not inquire into Cappy’s needs • Trustees always have to act in good faith and with some degree of reasonableness (page 606) • If the trustee had sole discretion, it wouldn’t be a trust. The point of a trust is for the trustee to fulfill the settlor’s intent, not the trustee’s own intent.

6. Did the trustee breach his fiduciary duties? • The trustee did ask Cappy to explain his need for more money • The trustee’s letter “discouraged Cappy from making any requests for principal” (page 600) • The duty to investigate requires a more active role for the trustee. You can’t shift the burden of investigation so readily to the beneficiary • The trustee had notice of Cappy’s needs. He knew Cappy had taken out a mortgage on the house (which was used to pay bills) (page 600)

7. What’s the remedy? • Can Margaret get the house back? • No, Sara and Marlette were bona fide purchases without notice of the trustee’s breach of trust (pages 602-603) • What can Margaret get? • The funds from the trust that would have been given to Cappy (which go directly to his estate) (page 603)

8. Is the trustee liable personally for the breach of duty? • There was an exculpatory clause, and these protect trustees from liability in the absence of bad faith, or intentional or reckless misconduct (and the clause itself did not excuse “willful neglect or default”) • Does it matter that the trustee drafted the exculpatory clause? • Yes, if the trustee abused a confidential or fiduciary relationship • This court put the burden on Margaret to prove abuse, but the majority rule is to put the burden on the drafter to prove no abuse

9. Extended discretion; exculpation; and arbitration • Trustee discretion is “sole,” “absolute,” or “uncontrolled.” • In spite of extended discretion, trustee is still subject to judicial review. • Trustee must not act arbitrarily or capriciously, or abuse its discretion, and must act in good faith (UTC: purposes of trust and interests of beneficiaries). • Trustee is excused from liability or breach of trust. • If trustee is draftsman, trustee must show disclosure of clause and its meaning to settlor. • Cannot excuse liability for bad faith, reckless indifference, or intentional or willful neglect. • Claims for breach of trust must be resolved by arbitration. • Whether clause is enforceable, precluding judicial review, is unresolved. • Authority is scarce and contradictory.

10. Extent of discretion • “Trustee shall use the income and principal of the trust in the trustee’s full, absolute, and uncontrolled discretion for the educational expenses of my children.” • Trustee pays child number one’s bills to attend the state university, but refuses to pay child number two’s bills to attend an out-of-state private university.

11. Rights of the beneficiary’s creditors • Just as trusts can be designed to protect against mismanagement of wealth by beneficiaries, so their support will be secured, so can trusts be designed to protect against seizure of the wealth by the beneficiaries’ creditors • Discretionary trusts • Spendthrift trusts • If the settlor limits the beneficiary’s rights to the trust’s assets, creditors’ access can be limited

12. Evading creditors through discretionary trusts • Pure discretionary trusts • Trustee has absolute, sole or uncontrolled discretion over distributions to the beneficiaries • Support trust • Trustee is obligated to make distributions as necessary for the beneficiaries’ needs • Discretionary support trusts • Trustee has absolute, sole or uncontrolled discretion over distributions to the beneficiaries subject to a “standard of distribution” (e.g., for the comfortable support and maintenance of the beneficiaries, as in Marsden, or for the education or health care needs of the beneficiaries)

13. Discretionary trusts* and creditors Traditional law principles • Pure discretionary and discretionary support trusts • No right of creditors to compel payment from the trustee—but creditors can secure a Hamilton order to direct the trustee to pay the creditors before making any further distributions to the beneficiaries • Doesn’t guarantee payment, but allows for substantial leverage • Support trusts • Creditors generally cannot compel payment, except for suppliers of necessaries (e.g., food, clothing, shelter, medicine, medical care) and for child or spousal support * Creditors can intercept distributions from mandatory trusts that don’t have spendthrift clauses

14. Discretionary trusts: UTC §504 (2000, rev. 2004) • (b) …a creditor of a beneficiary may not compel a distribution that is subject to the trustee’s discretion, even if: • the discretion is expressed in the form of a standard of distribution; or • the trustee has abused the discretion. • (c) To the extent a trustee has not complied with a standard of distribution or has abused a discretion: • a distribution may be ordered by the court to satisfy a judgment or court order…forsupport or maintenance of the beneficiary’s child, spouse, or former spouse; Note that under the Restatement, creditors can reach any distributions that a trustee makes or is required to make

15. Problem, page 613 • What happens under traditional law? • B loses—not a supplier of necessaries or a spouse or child of A • What result under the UTC • B loses—not a spouse or child of A • What result under the Restatement? • The Restatement black letter language suggests B wins, but the comment on page 613 makes things unclear

16. Spendthrift trusts • Most trusts deal with the creditor problem through the spendthrift trust • If beneficiaries cannot alienate their interest (e.g., sell it to a sibling), the creditors cannot reach the interest • A few states assume trusts are spendthrift absent a provision permitting alienation • In other states, spendthrift provisions are typically included in trusts • Permitted per Ind. Code § 30-4-3-2

17. Spendthrift trusts • Theory is that the trust is a conditional gift; donors can impose conditions to protect their interests in determining the recipient of their gifts • Compare: • Living parent and child, where parent can provide for child  no recourse against parent for child’s creditors. • Deceased parent and child, where trust is to provide for child’s support  any recourse against trust for child’s creditors? • The modern debate is not over whether to have spendthrift trusts, but when to make exceptions. • Voluntary creditors (e.g., lenders) can investigate finances. • Involuntary creditors (e.g., tort victims) cannot investigate. • What of spouses and children?

18. Spendthrift trusts and tort victims • What were the facts in Scheffel, p. 616? • Kyle Krueger videotaped his sexual assault of a child and broadcast the videotape over the internet • Kyle was the beneficiary of a trust from his grandmother that paid him all of the net income (mandatory) • In addition, the trustee had sole discretion to pay out of principal when necessary for Kyle’s maintenance, support or education (discretionary support) • Kyle was convicted for the sexual assault, and the child’s mother won a default judgment in her tort suit against Kyle

19. Scheffel v. Krueger Scheffel v. Krueger 782 A.2d 410 (N.H. 2001), p. 616 Art. VII: No principal or income payable or to become payable under any of the trusts created by this instrument shall be subject to anticipation of assignment by any beneficiary thereof, or to the interference or control of any creditors of such beneficiary or to be taken or reached by any legal or equitable process in satisfaction of any debt or liability of such beneficiary prior to its receipt by the beneficiary. Should the court recognize an exception to spendthrift trusts for claims by tort victims?

20. Did the NH statute waive the spendthrift clause? • No. The clause was inapplicable only if the settlor was the beneficiary or the assets were fraudulently transferred to the trust • But other states have allowed tort victims to reach trusts with spendthrift clauses • In those cases, the spendthrift law was created by common law. Here we have a statute that has expressly addressed the issue (page 617) • Does this mean child support orders can’t pierce a spendthrift clause in NH? • No. N.H. has amended its statute.

21. Spendthrift trusts, alimony and child support • What were the facts in Shelley, p. 618? • Grant was the beneficiary of a trust that entitled him to income and also to discretionary payments of principal for purposes of investing and when emergency needs arose (page 618). • The emergency needs clause included his children as beneficiaries • The trust had a spendthrift clause as well (page 618) • The case arose because Grant failed to make child support payments from two previous marriages and alimony payments from one of the marriages

22. Shelley v. Shelley Shelley v. Shelley354 P.2d 282 (Or. 1960), 618 Testator • Trust Income (mandatory) • Exception for spouse or children? • Yes • Trust Principal • (discretionary) • Exception for spouse or children? • No • Children Beneficiaries • Does “emergency” include the desertion by father? • Yes Patricia Betty Grant

23. Exceptions to spendthrift provision: UTC §503 (2000, rev. 2005) … (b) A spendthrift provision is unenforceable against: (1) a beneficiary’s child, spouse, or former spouse who has a judgment or court order against the beneficiary for support or maintenance; (2) a judgment creditor who has provided services for the protection of a beneficiary’s interest in the trust; and (3) a claim of this State or the United States to the extent a statute of this State or federal law so provides. (c) A claimant against which a spendthrift provision cannot be enforced may obtain from a court an order attaching present or future distributions to or for the benefit of the beneficiary. The court may limit the award to such relief as is appropriate ... .

24. Spendthrift trusts and providers of necessities • Can creditors who provided necessary goods or services reach spendthrift trusts? • Yes, according to traditional law, the Restatement (note 2.c, page 622) and Indiana law, but not under the UTC.

25. Spendthrift clause • The interests of the beneficiaries of any trust created by this instrument shall not be subject to or liable for any anticipations, assignments, sales, pledges, debts, contracts, or liabilities of said beneficiaries, including but not limited to alimony claims and claims of any federal, state, or local governmental agency, and said interest shall not be seized by creditors of said beneficiaries, or by anyone, by attachment, garnishment, execution or otherwise. • See also Scheffel spendthrift clause

26. WA ME MT ND VT MN OR NH MA ID WI NY SD RI WY MI CT PA NJ IA NE NV OH DE IN IL UT MD CO WV VA KS MO CA KY NC TN AZ OK AR SC NM GA AL MS TX LA FL AK HI Asset Protection Trust States (2008) Rhode Island Delaware

27. Self-settled asset protection trusts, p. 624 • Can settlor’s shield assets from creditors by placing them in trust for the settlor’s own benefit? • Not under traditional law, the Restatement or the Uniform Trust Code • However, some states have created statutory authorization for asset protection trusts • Will they work for out-of-state residents? • Clear that you can’t assist a client to shield assets when liability is looming, but you may have an obligation to apprise other clients about this option

28. Modification and termination • There is no problem modifying or terminating an irrevocable trust if the settlor and all of the beneficiaries agree to do so. • But what if the settlor is dead or does not consent? • When can the beneficiaries agree to modify or terminate the trust? • When can the trustee seek a modification or termination?

29. Modification and termination under traditional law • Termination by beneficiaries • Claflin doctrine allows termination except when continuation is necessary to carry out a material purpose of the settlor • Modification or termination by trustees • Doctrine of equitable deviation permits modification or termination of administrative terms on account of unanticipated circumstances • When necessary to accomplish the purposes of the trust, but not merely to benefit the beneficiaries

30. In re Trust of Stuchell 801 P.2d 852 (Or. App. 1990), p.643 In re Trust of Stuchell What were the facts? J.W. Stuchell Stuchell died. Will created trust for family: • When Edna dies, principal to be distributed to her children or their descendants per stirpes. • John Harrell, Edna’s son, is unable to live independently. Can the trust be modified under equitable deviation to provide for continuation as special needs trust and not count as income for by Medicaid? Other life income beneficiaries Edna Harrell John Harrell No. Modification not permitted merely because it is more advantageous to the beneficiaries

31. Modern modification due to unanticipated circumstances Restatement (Third) of Trusts§ 66(1) (2003) The court may modify an administrative or distributive provision of a trust … if because of circumstances not anticipated by the settlor the modification or deviation will further the purposes of the trust. Uniform Trust Code§ 412(a) (2000) The court may modify the administrative or dispositive terms of a trust or terminate the trust if, because of circumstances not anticipated by the settlor, modification or termination will further the purposes of the trust. To the extent practicable, the modification must be made in accordance with the settlor’s probable intention.

32. In re Riddell In re Riddell157 P.3d 888 (Wash. App. 2007), p.645 Irene George What were the facts? George and Irene died. Wills created trusts for family: • When Ralph and Beverly die, principal to be distributed to their children • Nancy is unable to live independently because of psychiatric disease. Beverly Ralph Can trust be modified to provide for continuation as special needs trust for Nancy’s benefit? Donald Nancy

33. What result in Riddell? • Under traditional law principles • No. The modification was merely for the benefit of the beneficiaries (in this case avoiding payment to the State) (page 646) • Under Third Restatement • Yes. Nancy’s mental illness was not anticipated, and modification would further the purposes of the trust by preserving the trust’s assets for Nancy’s care (both because Nancy cannot manage them, and the State likely would seize them) (page 648)

34. What result in Riddell? • But why is it legitimate for Nancy’s father/trustee to shield the trust assets from the state (page 648)? After all, the funds would be going to pay for her basic needs. • Because Congress specifically authorized special needs trusts for families like the Riddells. Modification is appropriate in this case.

35. Question 1, p.649 • Did Nancy’s father have a duty to request a modification of her trust? • No. The duty to petition applies to administrative terms, and this case involved a distributive term (Restatement § 66(2), page 645) • But one of the comments to § 66 suggests that there might be some duty if the trustee has actual knowledge that a purpose of the settlor would be jeopardized by adherence to existing provisions governing distribution.

36. Question 2, p.649 • What result under traditional law? • Petition fails. It’s not clear we have a qualifying change in circumstances (the examples in the Restatement involve situations with a decline in value), and even if we do, they haven’t changed to the extent that compliance would substantially impair achieving the purposes of the trust. • Moreover, the change would affect a dispositive rather than administrative term of the trust. • What about termination by beneficiaries? • It was a spendthrift trust

37. Question 2, p.649 • What result under UTC § 412, page 645? • Case for termination is stronger since the UTC only requires that the termination further the purposes of the trust rather than being necessary to avoid frustrating the purposes of the trust (page 642) • The Somers court allowed for the distribution to the charity but not to the individuals

38. Anticipating unanticipated circumstances:Trust Protectors, p. 651 Trust Protector Settlor Trustee • Examples of Protector Powers • replace trustee; • approve modifications to trust provisions; • terminate trust; or • select a successor trust protector. Beneficiaries Other options: trustee power to modify the trust, with a co-trustee rather than trust protector; powers of appointment in beneficiaries; decanting power

39. Claflin and material purpose • Traditional Claflindoctrine: • If continuance of the trust without termination is necessary to carry out a material purpose of the settlor, the beneficiaries cannot compel termination. • Examples of material purpose (traditional law): • Spendthrift trust • Discretionary trust (pure or support) • Support trust • Postponed enjoyment (e.g., principal distributed when beneficiary reaches age 30) • What about terminating a trust with successive beneficiaries?

40. In re Estate of Brown In re Estate of Brown 528 A.2d 752 (Vt. 1987), p.653 (3) The … trust … shall be used to provide an education … for the children of my nephew … . Said trust to continue for said purpose … until … accomplished. At such time as this purpose has been accomplished … [the trust shall continue] for the care, maintenance and welfare of [my nephew and wife] for and during the remainder of their natural lives. What were the facts? • Has the educational purpose been satisfied? • If so, is there any other material purpose preventing termination of the trust and distribution of the assets to nephew and wife?

41. Brown and material purpose • The trust cannot be terminated if it is a support trust. Is it? • No. The trust provides for the nephew and his wife all of the income and such principal as is necessary to maintain them in the style to which they are accustomed rather than to use income or principal only to the extent necessary to support them (page 654) • Is it non-terminable as a spendthrift trust? • No. The terms of the trust do not indicate that it is a spendthrift trust. • Was there another material purpose preventing termination? • Yes. The trust was designed to assure a life-long income to the nephew and his wife (“to live in the style and manner to which they are accustomed, for and during the remainder of their natural lives”) • As the court observed, when the trust merely provides for successive gifts, life and remainder beneficiaries can agree to termination.

42. Modification or termination of noncharitable trust by consent • Weakens material purpose • Authorizes termination if reason outweighs material purpose • Preserves requirement of beneficiaries’ unanimity • Preserves material purpose • Weakens requirement of beneficiaries’ unanimity • Authorizes termination if interests of absent beneficiary will be adequately protected

43. Removal of a trustee • Rules draw a balance between the need to protect the settlor’s interests against beneficiaries who might want to find a trustee more sympathetic to their requests and the need to protect the settlor against an irresponsible trustee • Traditionally, removal has been allowed only for cause—serious breach of duty, but not a minor breach. • UTC allows beneficiaries greater power to seek a new trustee (§ 706(b)(2)-(4), page 660) • Of course, the trust document can override the law’s default rules (e.g., by giving the power of removal to a trust protector or to the beneficiaries)

44. Modification due to unanticipated circumstances Restatement (Third) of Trusts § 66(1) (2003) • The court may modify an administrative or distributive provision of a trust … if because of circumstances not anticipated by the settlor the modification or deviation will further the purposes of the trust. • If a trustee knows or should know of circumstances that justify judicial action under Subsection (1) with respect to an administrative provision, and of the potential of those circumstances to cause substantial harm to the trust or its beneficiaries, the trustee has a duty to petition the court for appropriate modification of or deviation from the terms of the trust.

45. Modification and termination under traditional law • Termination by beneficiaries • Claflin doctrine prohibits termination when doing so would be contrary to a material purpose of the settlor • Modification or termination by trustees • Doctrine of equitable deviation permits modification or termination of administrative terms on account of unanticipated circumstances • When necessary to accomplish the purposes of the trust, but not merely to benefit the beneficiaries

46. Trust protectors • The trust instrument should make clear whether the protector is subject to fiduciary duties • If the answer is no, perhaps there also should be an exculpatory clause to deal with the possibility that a court might hold that the protector’s fiduciary status cannot be waived, though this too might not be enforced.

47. Decanting clause example • The independent trustee of any trust hereunder (the “original trust”) shall have the power at any time and from time to time, in such trustee’s sole and absolute discretion, to appoint any portion or all of the principal of any trust held hereunder to the trustee of another trust under any other instrument, by whomever created, provided that the exercise of such power (a) does not reduce any fixed income interest of any beneficiary of the original trust; (b) is in favor of the beneficiaries of the original trust; and (c) does not violate any applicable rule against perpetuities.

48. Removal of a trustee • Any trustee may be removed at any time by the Settlor during his competent lifetime upon delivery of written notice to the Trustee being removed; and following the Settlor’s incapacity or death, any corporate Trustee may be removed by the individual Trustee(s), or if no individual Trustee(s) is/are serving, by a majority of the then permissible income beneficiaries of the Trust (with the custodial parent, guardian or other legal representative acting on behalf of a minor or otherwise incapacitated beneficiary).