During the Covid-19 crisis, many family business owners are updating their estate planning to make sure that it reflects their current wishes regarding fiduciary appointments and the disposition of their property (just in case). When they do so, they should consider the advantages of creating a lifetime trust for each of their beneficiaries.
What IS a “trust”?
A trust is a property arrangement under which a person (the “settlor”) transfers property, during lifetime or at death, to another person (the “trustee) who agrees to manage and use the property for the benefit of a third person (the “beneficiary”). The trustee serves as a fiduciary, which is a “person or party that has an obligation to act in good faith, trust, honesty and best interests of another.” https://dictionary.thelaw.com/fiduciary/.
Usually, the specific terms of a trust are set forth in a trust agreement or in the settlor’s will. The terms of a trust may be brief and general or they may be detailed and bespoke. If there is an omission or ambiguity in the terms of a trust, then usually it is resolved by reference to the statutory and common law of the state whose law governs the trust’s construction or administration. Traditionally, and academically, a trust has been considered to be a property arrangement, not an entity, but these days it is common to see a trust treated as an entity or a “person” in practice and under the law.
How is a trust administered?
Under a conventional estate plan, a beneficiary’s share of the estate is held in trust (i.e., managed by a trustee) while the beneficiary is a minor, because a minor does not have the knowledge and experience (or the legal right) to manage his or her own property. Then the trust terminates when the beneficiary reaches the age of majority, or perhaps a later age, when it is thought that the beneficiary will be able to manage the property prudently, without the assistance of a trustee.
While the property is held in trust, the trust terms may permit the trustee to use trust income or trust principal for the beneficiary’s benefit, such as for payment of costs of health care, education, or living expenses. If the trust continues after the beneficiary has reached the age of majority, the trust terms may permit the trustee to distribute trust income or trust principal to the beneficiary for specific purposes, or otherwise as the trustee deems appropriate. When the trust terminates, the trust property is transferred to the beneficiary and the trustee is discharged.
In the past decade, many states have updated their trust statutes to allow trust administration to be better tailored to the specific circumstances of each trust. Under traditional trust law, the trustee was the sole fiduciary and, as such, was responsible for managing how the trust property was invested, deciding how the trust income and principal would be used for the beneficiary, and keeping all of the trust’s accounts. Under current law, a trust’s terms can separate and allocate the traditional responsibilities and powers of a trustee, and some additional new powers, to a “directing party” or a “trust protector”. (These new roles are sometimes given other names, depending on the relevant state law.)
● A directing party, generally, can be given authority to make decisions about a) managing trust property and/or b) distributing trust income and principal to or for the benefit of the beneficiary.
● A trust protector, generally, can be given authority to a) approve trust accounts, b) remove and replace trustees and directing parties, and/or c) amend the trust terms.
Application of these new roles can be especially helpful for administration of a trust that holds family business interests.
Generally, corporate fiduciaries do a much better job than individuals with respect protecting trust assets, maintaining and reporting accurate trust accountings, and complying with tax filing requirements. Some corporate fiduciaries, however, prefer not to take responsibility for family business interests. (This is not universally true. For example, see the National Trust Closely Held Business Association at https://ntchba.org/, which educates and supports personnel at corporate fiduciaries that manage family business interests.) To properly manage family business interests in a trust may require the trustee to engage in a high level of ongoing due diligence that can be cumbersome for some corporate fiduciaries and that can seem intrusive and unnecessary to the business’s managers.
In such cases, a settlor can appoint a corporate fiduciary to serve as trustee, to provide general trust administration services, and then appoint an individual who is already familiar with the family business (such as a family member or a trusted advisor) to serve as the trust’s directing party, who will take full responsibility for decisions regarding the family business interests.
This is just one example of how current trust law offers a broad range of design features that allow family business interests to be held in trust in a way that does not disrupt business operations or succession planning. Part two of this blog post (next Monday) will discuss the advantages of a lifetime trust and will make the case that design features available under current trust law eliminate most or all of the potential disadvantages of a lifetime trust.