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 (UTA), which is based on the model Uniform Trust Code, provides new opportunities for settlors, trustees 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 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.
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:
- 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.
- 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.
Advantages of Using a Nonjudicial Settlement Agreement
One of the most innovative features of the UTA is its recognition of the nonjudicial settlement agreement (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.
The UTA contains a nonexclusive list of 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
Specific Grounds for Modification or Termination or Irrevocable Trusts
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.
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. A trustee acting alone may terminate the trust if it meets the proper requirements: 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.
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.
Reformation of Trust to Correct Mistakes
An analysis of the broken trust may reveal the problem does not require termination of the trust, or even a modification that might reflect on the settlor’s purposes, but a simpler 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 has retroactive effect.
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 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.
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.
Modification by Combining Trusts
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.
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.
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, 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 toward 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.
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.
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.
Decanting From Existing Trust to a New Trust
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.
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.
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 transfer or 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.
Grounds for Removal of Trustee
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.
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: if it contains a portability clause, and if the power is subject to any conditions.
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, if it finds by clear and convincing evidence that:
- Removal of the trustee best serves the interests of the beneficiaries,
- Removal is not inconsistent with a material purpose of the trust,
- A suitable co-trustee or successor trustee is available, and that at least one of the following events has occurred:
- The trustee has committed a serious breach of trust;
- Lack of cooperation among co-trustees substantially impairs the administration of the trust;
- The trustee has not effectively administered the trust because of the trustee’s unfitness, unwillingness or persistent failures; or
- 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.)
For more information on navigating how the UTA can be used to fix broken trusts, be sure to contact your legal representation. Above all, proper time and care should be taken to review the intricacies of this process before diving in.
Martin J. Hagan is a partner at Meyer, Unkovic & Scott. He has been serving clients in the areas of estate planning and administration, estate and gift taxation, special needs trusts, elder law, and estate and trust litigation for over 35 years. He can be reached at MJH@MUSLAW.com.