Trust structures are becoming so complex that clients are increasingly being advised to add a third participant to what is a traditional two-party arrangement: the trust protector.
While the use of a trust protector is not new, the marked increase in this use is a reaction to the evolving needs of trust administration. In general, a trust protector is appointed to act as a complement to traditional trustees under a variety of trust instruments, including trusts that are established during one’s lifetime or at death.
In essence, a trust protector is an individual or entity with the power to exercise some form of discretionary authority that supplements, complements or negates the discretionary powers of the traditional trustee. Moreover, the scope of a trust protector’s authority can be very specific, such as limiting it to evaluating a trustee’s decision regarding distribution needs of a particular beneficiary, or very expansive, such as managing the assets of a closely held business.
Historically, single trustees have been given comprehensive powers to administer trusts with broad discretion, provided they did not violate the terms of the trust agreement or their fiduciary duties. However, this typical “two-part” structure is proving inadequate to effectively manage modern trusts, which sometimes have increased durations, sophisticated dispositive schemes and varied types of assets.
The increased use of trust protectors has caused a number of states to revise their statutes to account for such a role. The Uniform Trust Code (UTC), which is currently adopted in some form by 30 states and the District of Columbia, has also ratified the use of trust protectors. The UTC provides that the terms of a trust may confer upon a person other than the settlor a power to direct certain actions of the trustee and that the terms of a trust may confer upon a person other than a trustee a power to direct the modification or termination of a trust.
Fiduciary Duties
The increased use of trust protectors has raised the issue of whether they are fiduciaries. There is, however, a dearth of case law relating to trust protectors in the U.S. and in particular to whether a trust protector acts in a fiduciary capacity. States that have specific statutes relating to trust protectors do not handle the issue uniformly: Some states specifically state they are fiduciaries; others state they are not acting in that capacity.
The UTC states that a person, other than a beneficiary, who has the power to direct an action is presumptively a fiduciary and can be held liable for breach of trust through action or inaction. However, most statutes, in addressing the trust protector’s role as fiduciary, first defer to the terms of the trust agreement. Accordingly, it is common and good practice to explicitly state in the trust agreement whether the trust protector is acting in a fiduciary capacity.
If trust protectors are considered to be acting in a fiduciary capacity, it should be noted that more difficult questions follow, such as to whom is the duty owed—the settlor, the trustee or beneficiaries? Also, what is the standard by which the trust protector is measured to ensure compliance and what is the appropriate remedy for a breach of duty? Should the standard of care be “due care,” negligence, gross negligence or bad faith? Is the appropriate remedy removal, money damages or compelling an act? The answers to these questions may depend on the nature of the role that the trust protectors are filling. Specifically, are they acting as if they were agents of the settlor, trustee or beneficiaries?
Traditional Trustee Powers
The most common powers granted to trust protectors are discretionary functions historically performed by the traditional trustee. These include exercising discretionary distribution decisions, controlling investment decisions and managing the trust assets. Increasingly, settlors prefer bifurcating the distribution powers and the investment powers between the trustee and the trust protector. This structure can provide checks and balances that avoid granting one party too much control over a trust. Also, as trust assets and investment options become increasingly complex, settlors may want a specific individual or institution to handle the investment decisions for some or all of the trust assets. For example, if the trustee is a family member whom the settlor trusts to make distribution decisions, but is not an individual who is financially or business savvy, the settlor may want an investment manager appointed as trust protector to deal with investment decisions. Such a scenario is common with trusts that involve closely held businesses.
Additionally, due to the increased complexity of trust distribution schemes, some settlors may prefer to grant the power to make distributions to someone who is familiar with the family’s dynamics. Or if the settlor prefers to have the trust protector oversee the trustee, the trust protector may be granted the power to veto distributions proposed by the trustee. In this case, the trust protector with veto power is acting more as an agent of the settlor in making sure that the trustee is carrying out the settlor’s wishes. Also note that if a trust protector is granted a power traditionally reserved to a trustee, it would be difficult to argue that the trust protector is not acting in a fiduciary capacity.
Trust protectors are sometimes given powers to ensure that the trustee is complying with the settlor’s desire to provide for the needs of the beneficiaries. In this role, the trust protector is arguably acting as an agent of the beneficiaries. A common power granted to trust protectors, for example, is the ability to add or remove the trustees, with broad or limited power to appoint a replacement.
Trust protectors may also be given the power to allocate trust receipts and/or expenses as between principal and income, usually to ensure that the beneficiaries are being treated fairly.
This issue regularly arises when there are separate income and remainder beneficiaries of a trust that have competing interests. An example of this would be when a surviving spouse is an income beneficiary of a marital trust established by the deceased spouse, but the remainder beneficiaries are the deceased spouse’s children from a prior marriage. In this situation, the trustee is placed in the difficult position of trying to keep all beneficiaries satisfied by generating enough income and providing for acceptable principal growth. Granting the trust protector the power to make equitable adjustments regarding the allocation of receipts and expenses between principal and income may relieve some of this tension and can help ensure that the interests of the beneficiaries remain balanced.
Changed Circumstances
When a settlor establishes a dynasty trust intended to last for multiple generations, the settlor must consider the possibility that changes in trust laws or tax laws may affect the trust’s administration. The longer a trust remains in existence, the higher the probability that some provisions could become outdated, ineffective or insufficient. To prepare for this possibility, a trust protector could be granted the power to alter or to add trust provisions. This would help ensure that the settlor’s intent continues to be met and that the trust remains compliant with the tax laws. One example would be giving a trust protector the authority to modify tax provisions to deal with the type of situation that settlors were hit with in 2010, when the federal estate tax was temporarily repealed.
A trust protector may also be granted the power to change the situs, or location, of a trust. State laws vary greatly with respect to trust administration provisions and are subject to revision, so there may be circumstances where a change in trust situs is necessary. An example would be changes in state income tax laws that may necessitate a change in the situs of a trust to avoid the imposition of such taxes on the trust or its beneficiaries.
Decanting of an irrevocable trust to another trust has become a popular technique. The theory behind decanting is that if a trustee has the discretionary power to make an outright distribution of the principal of a trust to a beneficiary, the trustee should be able to use that power to appoint the principal of the trust to another trust for the benefit of the same beneficiary. For various reasons, however, there may be instances where a trustee may be reluctant to decant. Accordingly, it may be preferable for a settlor to grant this decanting power to a trust protector who would not be so constrained.
A trust protector can also be appointed to arbitrate disputes or litigation among beneficiaries and trustees. Appointing a trust protector in the specific role as arbitrator or mediator can, in some instances, be a more efficient alternative to costly litigation.
Conclusion
The use of trust protectors will become more prevalent as the complexities of modern trusts continue to evolve and as more states enact domestic asset protection trust statutes. Trust protectors can serve a vital role in a trust to ensure that the settlor’s intent is being carried out or that the interests of the beneficiaries are being protected.
Professionals who incorporate the role of a trust protector into their trust documents must be cognizant of the powers granted to the trust protector and contemplate whether such a role is accepted in the jurisdiction where the trust will be administered.
Due to the unsettled nature of the trust protector role in U.S. trust law, the explicit terms of the trust document are of the utmost importance to ensure that the duties and obligations of the trust protector are clearly enumerated and the scope properly defined.
Daniel D. Mielnicki is a partner and Joshua N. Goldglantz is an associate in the wealth preservation and tax planning group of the Berger Singerman law firm in Florida.