Fixing Broken Trusts with the Uniform Trust Act Tool Kit
Trusts can “go bad” for many reasons. Some may be unsuitable from the outset, perhaps being the product of a trust-mill or a generic form downloaded from the internet, with terms the settlor neither understood nor desired. Other trusts may have become defective over time as their stated purpose no longer matches the beneficiaries’ changing needs, or the trust assets may have dwindled to the point where the costs of maintaining the trust exceed its benefits.
Trustees can also cause a trust to “go bad,” whether by refusing to respond to the beneficiaries’ reasonable requests for information, or persistently failing to achieve a reasonable return on investments. Changes that have occurred to the trustee itself, such as a corporate takeover or an individual trustee’s declining health which have resulted in a substantial decline in service, may be the source of the problem.
What can be done to fix trusts that are broken? Traditionally it was very difficult under Pennsylvania law to terminate or modify trusts that were irrevocable, or to remove the trustee. However, the recently enacted Uniform Trust Act (referred to herein as the “UTA”), which is based on the model Uniform Trust Code, provides new opportunities for settlors (i.e., the persons who created and funded the trust), trustees, and/or beneficiaries to modify or even terminate an irrevocable trust, or to have the trustee removed. In several instances, the UTA allows this relief to be accomplished by the parties’ own action, without the necessity of seeking court approval.
This article will discuss generally how the UTA can be used to fix broken trusts, particularly with regard to how such trusts can be modified or terminated, and the grounds on which a trustee may be removed. (The gift, estate, GST, and income tax effects of trust modification or termination are beyond the scope of this article.) For specific advice regarding a trust that you may be personally involved with, please consult with an attorney of your choice.
TABLE OF CONTENTS
■ TERMINATING OR MODIFYING THE IRREVOCABLE TRUST
The UTA lays out several grounds on which a trust can be amended or terminated, even if by its terms it is non-amendable and irrevocable. The steps necessary in any specific case will depend on several factual settings:
A. When All the Beneficiaries Agree and the Settlor Consents
The trust’s beneficiaries acting together, when coupled with the settlor’s consent, have the power to modify or terminate an irrevocable trust, even if the modification or termination would be inconsistent with a material purpose of the trust. No court approval is necessary to accomplish this result, and the trustee has no role in the decision.
Example: Parent created an Irrevocable Life Insurance Trust back in 2003 for the purpose of reducing federal estate taxes. His spouse and children were named as the beneficiaries. Due to changes in federal tax law, estate taxes are no longer a concern. As a result, the spouse and children, as the beneficiaries, could agree to terminate the trust, notwithstanding that by its terms it is irrevocable, as long as the parent-settlor gives his consent.
B. Without Settlor’s Consent, Court Approval Required
If the settlor is unable or unwilling to consent, the beneficiaries’ ability to modify or terminate an irrevocable trust will require approval by the court, based on the following factors:
1. Unanimous Consent of Beneficiaries
Modification. An irrevocable trust may be modified upon the consent of all the beneficiaries, if the court concludes that the modification is not inconsistent with a material purpose of the trust.
Termination. An irrevocable trust may be terminated upon consent of all the beneficiaries if the court concludes that continuance of the trust is not necessary to achieve any material purpose of the trust.
2. Less Than Unanimous Consent of Beneficiaries
If not all the beneficiaries consent to a proposed modification or termination of an irrevocable trust, the modification or termination will be approved by the court only if the court is satisfied that:
● If all the beneficiaries had consented, the trust could have been modified or terminated under the UTA; and
● The interests of the beneficiaries who do not consent will be adequately protected.
One of the most innovative features of the UTA is its recognition of the Nonjudicial Settlement Agreement (herein “NJSA”) as a vehicle for resolving disputes between beneficiaries and trustees, without requiring court approval. All the beneficiaries (or their representatives) and the trustees may enter into a binding NJSA with respect to any matter involving the trust, including specifically its termination or modification.
Limitations on Use of NJSA
A NJSA will be valid only to the extent that it:
● Does not violate a material purpose of the trust; and
● Includes terms and conditions that could be properly approved by the court under the UTA or other applicable law.
Example. The sole purpose of a grandparent’s education trust is to provide for the post-secondary education of grandchildren until the youngest reaches age 25. A NJSA could not be used to modify the trust to permit a distribution to help a grandchild purchase a residence, since that would clearly violate the trust’s material purpose.
Permissible Subject Matter
The UTA contains a nonexclusive list of 13 matters that may be resolved by use of a NJSA, including:
● The modification or termination of a trust
● The interpretation or construction of the trust’s provisions
● Direction to a trustee to perform or refrain from performing a particular act
● Transfer of a trust’s situs (i.e., its home jurisdiction)
● Granting to a trustee of any necessary or desirable power
● Exercising (or not) any power held by a trustee
Use of the NJSA
Because a NJSA can be used to resolve issues pertaining to the modification or termination of a trust, it can be used as an alternative to going to court to obtain relief.
Option to Seek Court Approval of NJSA
Given that the NJSA will not be valid if it contains terms that a court could not have approved or if it violates a material purpose of the trust, in some cases the beneficiaries and trustees will voluntarily ask the court to approve their agreement once it has been negotiated.
A. INABILITY TO EFFECTIVELY ADMINISTER TRUST
The court may order the modification of the administrative provisions of an irrevocable trust if it finds that adhering to the existing provisions would be impracticable or wasteful, or impair the trust’s administration. For example, this rule could be used to resolve problems caused by unreasonable restrictions the settlor placed on the use of the trust property. The statute’s policy is that the interests of the beneficiaries will trump any terms placed on the property’s use that are found to be unreasonable.
EXAMPLE: A father in his will created a family real estate trust and funded it with a prized vacation property that had been in his family for generations. With the intent of ensuring that the property would stay in the family for generations to come, the father fixed the term of the trust to last until the death of the last of his grandchildren who were alive at his death plus 21 years. The trust absolutely prohibits the trustees from selling, mortgaging, or otherwise alienating the property.
Several years have elapsed since the father’s death and his expectations for the property have not matched reality. Only one child uses the property, but pays no rent. Major repairs to the property are now needed, but the current cash on hand in the real estate bank account will barely cover the upcoming property taxes. The children, faced with college education bills for years to come, are urging the trustees to sell the property.
In this case, would a court rule that the trust’s prohibition on sale is impracticable and wasteful, and thus approve a modification of the trust’s terms?
B. TERMINATING THE “TOO SMALL” TRUST
Regardless of whether a trust is revocable or irrevocable, the UTA permits the trust to be terminated by the unilateral action of the trustee, or modified or terminated by the court.
Trustee’s Authority to Terminate Trust Without Court Approval
A trustee acting alone may terminate the trust if:
● The trustee concludes that the value of the trust property is insufficient to justify the cost of administration,
● The trustee has given written notice to the qualified beneficiaries at least 60 days before the proposed termination and
● No qualified beneficiary provides the trustee with a written objection to the proposed termination on or before the date specified in the notice.
Court’s Authority to Modify or Terminate Trust
The court may modify or terminate any noncharitable trust, or remove the trustee and appoint a different trustee, if it determines that the value of the trust property is insufficient to justify the cost of administration.
How Much Is Too Little?
The Pennsylvania statute does not give a specific dollar amount that will act as a simple dividing line where anything below it would automatically be deemed to be “too little.” (The model UTC also does not set a dollar amount, but in the commentary mentions the sum of $50,000.)
The test of what is “too little” in a particular case should be measured by a comparison between the fair market value of the trust property and the costs of its administration. The greater the costs, such as trustee commissions and property-related expenses, the higher the market value of the trust assets needs to be to justify such costs.
When considering whether to terminate a trust, the trustee or court should consider the purposes of the trust. Even if administrative costs may seem excessive in relation to the size of the trust, the need to protect the assets from beneficiary misspending may indicate that the trust be continued rather than terminated. The court may be able to reduce the costs of administering the trust by appointing a new trustee. The trustee may also be able to convert the assets from high-cost types of property, such as residential real estate or broker-managed investments accounts, to lower-cost forms such as no-load mutual funds.
C. REFORMATION OF TRUST TO CORRECT MISTAKES
An analysis of the broken trust may reveal that the problem does not require termination of the trust, or even a modification that might reflect on the settlor’s purposes, but a more simple reformation to fix obvious mistakes, either of omission or commission, in the trust’s language. The court may reform a trust instrument, even if unambiguous on its face, to conform to the settlor’s probable intention, if it is proved by clear and convincing evidence that the settlor’s intent as expressed in the trust instrument was affected by a mistake of fact or law, whether in expression or inducement. The court may provide that the modification have retroactive effect.
● Mistake of Expression. A mistake of expression occurs when the terms of the trust misstate the settlor’s intention, fail to include a term that was intended to be included, or include a term that was not intended to be included. Mistakes of expression are frequently caused by scriveners’ errors.
● Mistake in the Inducement. A mistake in the inducement occurs when the terms of the trust accurately reflect what the settlor intended to be included or excluded but this intention was based on a mistake of fact or law. Mistakes of inducement often are traced to errors made by the settlor.
D. EQUITABLE DEVIATION
Apart from any action of the settlor or beneficiaries, the court can order an irrevocable trust to be modified or terminated, provided that certain circumstances are present:
If there are circumstances that apparently were not anticipated by the settlor, a court may:
● Modify the administrative or dispositive provisions of the trust,
● Make an allowance from the trust principal, or
● Terminate the trust
The purpose of equitable deviation is to modify any trust terms that have proved to be unsuitable, in order to better accomplish the settlor’s intent. Among other things, equitable deviation can be used to modify administrative or dispositive terms due to the settlor’s failure to anticipate economic change or problems that may have developed regarding a beneficiary. While it is necessary as a condition of the court granting relief that there be circumstances not anticipated by the settlor, the circumstances may have been in existence when the trust was created.
E. MODIFICATION TO ACHIEVE TAX OBJECTIVES
The court may modify a trust instrument in a manner not contrary to the settlor’s probable intention, if necessary to achieve the settlor’s tax objectives. Modification here is similar in concept to the cy-près doctrine applicable to charitable trusts and the deviation doctrine for unanticipated circumstances.)
NOTE: A modification made by the court will not necessarily be binding by the IRS or the Pennsylvania Department of Revenue. Absent specific statutory or regulatory authority, such binding recognition is normally given only to modifications made prior to the taxing event (for example, the death of the testator or settlor in the case of the federal estate tax).
F. MODIFICATION BY COMBINING TRUSTS
Clients may seek an attorney’s help in resolving problems caused by having several trusts being administered at the same time for the same beneficiaries and containing identical or at least similar terms. For example, one trust may have been created under an irrevocable life insurance trust for the benefit of the insured’s children, and a different trust containing the same terms may have been created under the insured’s will, with the only difference being the source of the trusts’ initial funding. The statute provides a solution in this case, depending on how similar the trusts provisions may be.
Trusts with Substantially Similar (But Not Identical) Provisions
The court for cause shown may authorize the combination of separate trusts whose provisions are substantially similar, upon such terms and conditions and with such notice as the court shall direct, notwithstanding that the trusts may have been created by separate instruments and by different persons. If necessary to protect possibly different future interests, the assets can be valued at the time of the combination and a record made of the proportionate interest of each separate trust in the combined fund.
Trusts with Identical Provisions, Tax Attributes and Trustees
A trustee is authorized, without court approval, to combine trusts that were created under the same or different instruments, provided that the trusts have identical provisions, tax attributes and trustees.
G. MODIFICATION BY DIVIDING A TRUST
Conversely, a single trust may have been created to benefit multiple beneficiaries when their needs for funds were substantially similar (e.g., support, maintenance, and education during their minority), but over time their financial needs may have grown widely disparate. As a result, one beneficiary may be pressuring the trustee to invest the trust property in a manner that will produce the greatest amount of income, while another beneficiary is pushing equally hard for investments geared to long-term growth and complains about the taxable income he or she has to report. Rather than continuing with one trust for beneficiaries with conflicting interests, the statute provides the parties with two alternatives.
Trustee Division Without Court Approval
First, the trustee is authorized, without court approval, to divide the one trust into separate trusts and to allocate to each trust either:
● A fractional share of each asset and each liability held by the original trust, or
● Assets having an appropriate aggregate fair market value and fairly representing the appreciation or depreciation in the assets of the original trust as a whole.
The beneficiaries of the separate trusts may be different, as long as their rights are not impaired. If the division reflects disclaimers or different tax elections, the division will relate back to the same date to which the disclaimer or tax election relates.
Division by Court
Second, the court for cause shown may authorize the division of a trust into two separate trusts upon such terms and conditions and with such notice as the court directs. In this case, the beneficiaries could be more flexible in the division of the assets.
A possible alternative to the division of assets under the UTA as discussed above is for the trustee, acting alone, to distribute or appoint the trust property from an existing trust to a new (transferee) trust. “Decanting” is the popular name given to this technique, as in wine being poured from one bottle into another. Pennsylvania does not have a statute authorizing the decanting technique; as a result, decanting is not much used with Pennsylvania-sited trusts, especially since the division of trusts as authorized by the UTA may provide an adequate solution.
By What Authority Can the Trustee Decant?
The authority of the trustee to decant assets from an existing trust into a new trust can come from three different sources: common law, state statute, or the trust instrument itself. (By the same token, the trust instrument at issue may prohibit decanting.)
Common Law. The trustee’s authority to decant has been based on his or her ability to distribute trust principal, in that the ability to make distributions from principal gives the trustee a form of special or limited power of appointment, which in turn authorizes the trustee to create a new trust, subject to certain limitations arising from the transferor trust. The Restatement (Second) of Property adopts the principle that a trustee with the discretionary power to distribute trust property should be authorized to create a new trust for the same beneficiaries. The Restatement also supports the theory that the power to transfer property to a new trust is analogous to exercising a special power of appointment. In the absence of a Pennsylvania statute authorizing decanting, the common law would appear to be the source most applicable to a Pennsylvania trust.
State Statutory Authority. New York in 1992 was the first state to enact legislation authorizing the decanting technique. Other states adjoining Pennsylvania with some type of decanting statute include Delaware, New Jersey, and Ohio.
Authority (or Lack Thereof) in Trust Instrument. The trust instrument should be reviewed to determine if it includes any decanting-related language, including any provisions that specifically prohibit decanting.
NOTE: A new Uniform Trust Decanting Act, which attempts to combine parts of several states’ decanting statutes and current case law, was approved by the National Conference of Commissioners on Uniform State Laws in July 2015. Whether it will be adopted by Pennsylvania remains to be seen.
Another major change in Pennsylvania law effected by the UTA is the expansion of the grounds on which a trustee may be involuntarily removed. Under prior law, some breach of fiduciary duty by the trustee was a necessary element of any petition for trustee removal. Now the law allows for a type of “no fault” removal if certain other elements are present.
Does the Trust Contain a Portability Clause?
Trustee removal is not a mandatory provision under the UTA. Thus, any analysis of a possible removal action must start with a review of the given trust instrument to determine: (1) if it contains a portability clause, i.e., a provision giving the beneficiaries, the settlor, or a co-trustee the power to remove a trustee, and (2) if the power is subject to any conditions.
Court Approval Required
In the absence of a portability clause, the settlor, a co-trustee, or a beneficiary may request the court to remove a trustee. A trustee may also be removed by the court on its own initiative.
Grounds for Removal
The court may order a trustee removed if it finds by clear and convincing evidence that:
1. Removal of the trustee best serves the interests of the beneficiaries,
2. Removal is not inconsistent with a material purpose of the trust,
3. A suitable cotrustee or successor trustee is available, and that at least one of the following events has occurred:
4.A. The trustee has committed a serious breach of trust;
4.B. Lack of cooperation among co-trustees substantially impairs the administration of the trust;
4.C. The trustee has not effectively administered the trust because of the trustee’s unfitness, unwillingness or persistent failures; or
4.D. There has been a substantial change of circumstances. (A corporate reorganization of an institutional trustee, including a plan of merger or consolidation, is not by itself a substantial change of circumstances.)
What Does “Substantial Change of Circumstances” Mean?
The addition of “substantial change of circumstances” to the statute represents a major expansion of the grounds for removing a trustee. Prior to the UTA, getting the court to remove a trustee required proof of some act of misfeasance or breach of fiduciary duty on the trustee’s part. Including “substantial change of circumstances” as a ground for removal introduces the idea of “no fault” removal.
The Comments to the model UTC make it clear that the term “substantial change of circumstances” addresses changes that have occurred with respect to the trustee, not the beneficiaries, although in practice the lines between the trustee’s and beneficiaries’ changed circumstances tend to be interrelated.
The question of how “substantial change of circumstances” would be interpreted by the courts was answered emphatically by the Pennsylvania Superior Court in a 2013 case, which dealt with the beneficiaries of two trusts being administered by a Pennsylvania corporate trustee seeking to have that trustee removed in favor of a corporate trustee in Virginia, where several of the beneficiaries lived. The two salient facts mentioned by the Superior Court in that case were that:
(1) the existing corporate trustee was not chosen by the settlor, but had succeeded to that role as the result of multiple bank mergers that had occurred over the years; these mergers in turn had resulted in the loss of trusted bank personnel and the trusts being administered by different bank officers, and
(2) the proposed successor trustee was offering the beneficiaries more personalized service, greater convenience due to its location in the other state, more efficient service due to its administration of several other family trusts, and greater personal knowledge of the overall financial service needs of the beneficiaries.
The Superior Court concluded that the existing trustee should be removed, finding that under the circumstances of that case — a string of mergers over several years resulting in the loss of trusted bank personnel, coupled with the movement of a family from Pennsylvania to Virginia, constituted a substantial change in circumstances.
The term “material purpose” appears in several sections of the UTA dealing with the modification or termination of a trust or the removal of a trustee. These sections generally state that any such proposed change will be permitted only if it is “not inconsistent with a material purpose of the trust.” Likewise, a nonjudicial settlement agreement will be deemed valid only to the extent it does not violate a material purpose of the trust.
Identifying what, if any, material purpose a trust may have will thus be a necessary step in determining the extent to which a trust may be modified or terminated, or a trustee removed, since any proposed change must be tested to ensure it will be in accord with such purpose.
Given the importance the UTA places on “material purpose,” it is unfortunate that it does not itself offer a definition of the term, other than to state that a “spendthrift provision in a trust instrument is presumed to constitute a material purpose of the trust.” So, is “material purpose” the same as the settlor’s “intent” in creating the trust? If not, how do they differ? Does a material purpose have to be expressly stated in the document, or can it be inferred from the facts and circumstances pertaining to the beneficiaries that are outside the document? And what is the meaning of “material”? Where does one draw a line between purposes that are deemed “material” and those that are not?
Thankfully, court decisions interpreting the term “material purpose” can provide some answers to these questions. Those decisions make clear that the courts require evidence of a particular concern or objective of the settlor, such as concerns about the beneficiary’s ability to manage finances, or lack of judgment or level of maturity, before they will find that a trust has a “material purpose.”
Sometimes the very nature or design of a trust will suggest such purpose, such as a trust for minor children or an incapacitated adult beneficiary with special needs. By contrast, a trust being administered for adult beneficiaries that gives the trustee no duties other than to hold the trust property and pay it out as the beneficiaries request would lack a material purpose. In such cases, courts have approved the trust’s termination, notwithstanding the protests of the trustee.
Presumption that a Spendthrift Provisions is a Material Purpose
As mentioned above, the UTA states that a spendthrift provision, i.e., language in a trust that restrains both voluntary and involuntary transfers of a beneficiary’s interest, will be presumed to constitute a material purpose of the trust. As such, it can be rebutted by sufficient evidence to the contrary.
Distribution Provisions of the Trust Are Key
Examining the underlying distribution provisions of the trust instrument should resolve the issue of whether spendthrift protection was meant to be a material purpose, or if it was added to the document simply as boilerplate. As with the example described above, if the trust gives the beneficiaries open-ended access to the trust property, it would be hard to argue that protecting the trust property from the claims of the beneficiaries’ creditors or their own voluntary transfers was a material purpose of the settlor in creating the trust.