Trusts

Don't try this at Home. We're about to discuss creation of trusts. The purpose of this discussion is to provide basic consumer information. It is not designed to help you create your own trusts. Creating a trust has significant consequences. You should not attempt to create trusts on your own.

What is a trust. A trust is a method of managing and holding property in which a fiduciary (trustee) holds property according to specific instructions. A trust is created by a settlor. The settlor is the person who transfers property into the trust, who instructs the lawyer on the terms which will govern the drafting of the trust.

The fiduciary who holds the property and who manages or disposes of that property according to the terms of the trust is called the trustee. A trustee may be a bank related trust department, licensed bonded and regulated by the state. Or it may be Uncle Jim, a trusted relative. Or, it may be the settlor herself.

Example: Mary wants Zapp National Bank's trust department to hold her life savings and manage her money. She doesn't want the money to go through probate. Instead, she wants it to be transferred directly to her children when she dies. She has her lawyer draw a trust document naming the trust department as trustee. Mary is the creator of the trust. She is the settlor. Zapp Trust is the trustee.

The persons who ultimately get the benefit from the trust are called beneficiaries. Beneficiaries have legally enforceable rights in the trust. The rights are determined by the trust document and by the law of trusts. Sometimes the trust document is irrevocable.That means that the settlor, the creator of the trust, loses control over the property at the time is created. She loses the power to amend the trust. She cannot cancel the trust. Any property transferred into the trust is beyond her control. Disposition and management of the trust is now under the control of the trustee, who is governed by the trust document. Sometimes the trust is revocable. That means that the settlor, the creator of the trust, can cancel the trust, can amend the trust instrument, can remove property from the trust, can change the beneficiaries or trustee. This absolute control comes from the right to cancel and revoke. The decision to make a trust revocable or irrevocable has tax and estate planning consequences, and should be made in consultation with an attorney.

Special Trust terms:

• Charitable Trust: A trust established for a charitable purpose. Here, the beneficiaries are either particular charitable entities, or a particular charitable purpose. In many states, the Attorney General supervises the public's interest in the trust to some extent.

• Inter-vivos trust. A trust created during the settlor's lifetime to receive property transferred prior to death.

• Testamentary Trust. A trust which takes effect at the time of death, typically created in a will. A previously established inter-vivos trust, of course, can receive property at death via the will.

Distinguish between creating a trust and putting property into that trust. A trust is like an urn. It holds water, but only if you pour water into the urn. A trust only applies to property which has been transferred to the trustee. Sometimes we run across persons who have established trusts, but who have failed to move their property into the trust. Sometimes people don't leave clear indications as to whether they intended a particular item of property to be included in the trust. After a trust is created, the settlor should take great care in making his intentions clear. If the property is stock, or real estate, the transfer formalities should be observed. If you acquire property later outside the trust, you will want to make it clear whether the property is to be governed by the trust.

Interpretation of trust documents. In several places in this series, we have discussed interpretation of written documents. Many of the same rules apply to trusts. See for example, Contract Meaning and Wills II. The interpretation of trust documents arises primarily in connection with irrevocable trusts, or in connection with administration after the death of the settlor.

The Trustee. We have said a trustee is a fiduciary. What does that mean? As we consider this question, we focus primarily upon an irrevocable trust, actively managed in the interest of beneficiaries. For example, suppose Maude Frick has an ice cream making business. In addition, she has one-million dollars in outside investments. Maude believes that her son, Morton, is unreliable. She wants her empire to be managed by her trusted friend Theodore Trumpe, until Morton's daughter Mabel Maude Frick is old enough (age 31) to take over the business. Theodore Trumpe is a trustee subject to fiduciary duties. What can we say about those obligations.

Duty of Loyalty. The trustee must administer the trust solely in the interest of the trust and its beneficiaries. The trustee may not engage in self-dealing, that is, using the assets or opportunities of the trust for the benefit of the trustee. Here are some examples of self-dealing which may be prohibited by the duty of loyalty:

• Sale of trustee's property to the trust: If Theodore Trump sells his land to Maude's ice cream business so that it can build a new Maude's Ice Cream store, that is prohibited self-dealing.
• Sale of trust property to the trustee: If Theodore Trump decides that the business should be sold, he cannot purchase it himself.
• Deposit to own institution. If a bank trustee acquires certificates of deposit on its own bank, that may be self dealing. Sometimes a trust will specifically authorize such deposits.
• Competition with the trust. If Theodore Trump starts his own ice cream business, of course, this would be inconsistent with his duty to maximize the profits of Maud's Ice Cream. A trustee should not be competing with the trust for land sales or development opportunities, or for the acquisition of an investment.
• Hiring ones own services. A trustee should not ordinarily serve as the attorney or real estate broker, or other service provider for the trust. A trustee can sell trust property. And a trustee can receive compensation for performing those services. But a trustee could not sell real estate for the trust as a commissioned sales person.
• Pay from third parties for trust duties. A trustee should not receive outside compensation from others for the performance of his duties. Mabel Maude Frick cannot pay Theodore Trump extra money to provide intensified investment management services, for example.

Other Duties. Here are some other duties. To some extent a trust document may exempt the trustee from these obligations, or provide specific instructions on how those obligations should be met.

• Reasonable Care.A trustee must use reasonable care in managing the property. How do we know what that means? We will discuss this in a succeeding panel. A trustee does not serve as a guarantor that the assets will increase in value. Its duty is to make reasonable decisions when viewed at the time those decisions were made, not when viewed with hindsight. The trustee must pay trust obligations, such as taxes, prudently manage trust property, enforce claims of the trust against others (even beneficiaries), and prudently defend claims against the trust estate.

• Segregate Property. The trustee must not co-mingle trust property with his own property or the property of others.

• Duty to account. A trustee must keep regular accounts; must render accounts to the beneficiaries; and must allow the beneficiaries to inspect trust records.

• Distribute in accordance with trust. Of course, the trustee must make distributions in accordance with the trust instrument. If the trustee has discretion, the trustee will have wide latitude to exercise that discretion, subject to judicial review.

This is the beginning of our discussion of trusts. There will be much more. Please be patient. We will be adding panels from time to time.