I 'trust' Your Discretion - Added Consideration When Drafting Discretionary Trusts With Interested Trustees in Light of Roenne v. Miller
| Citation | Vol. 90 No. 6 Pg. 32 |
| Pages | 32 |
| Publication year | 2021 |
November 2021.
Considerations of discretionary trusts
By Jake Holly.
Introduction
In an attempt to give interested trustees the most flexibility, many lawyers utilize words such as "sole" or "absolute" when describing the trustee's discretion in the trust instrument. But such broad language does little to guide the court when interpreting the trust terms in situations involving an interested trustee. In a recently published Kansas Court of Appeals decision, Roenne v. Miller, the court defined mandatory parameters limiting trustee discretion, which cannot be removed by the terms of the trust.[1] Inherent conflicts of interest exist if the trust terms permit an interested trustee to act beyond the limitations of her fiduciary duties. If push comes to shove, and a beneficiary brings a claim against an interested trustee for a breach of fiduciary duty, broad words used to describe the interested trustee's discretion will conflict with fiduciary obligations and not be interpreted literally.[2] This article will discuss this opinion, and how it changes the day-to-day practice of drafting discretionary trusts with an interested trustee. This article will also provide alternative arrangements which may alleviate risks and added considerations on how to draft better, enforceable trusts which are consistent with our client's intent and Kansas law.
A discretionary trust gives the trustee discretion to make distributions to the beneficiaries.[3] In turn, a hallmark of a discretionary trust is that a beneficiary has no legal right to force a distribution from the trustee.[4] Since the beneficiaries cannot compel distributions, a discretionary trust can be advantageous because it provides Medicaid advantages, tax advantages, and creditor protections. Usually, discretionary trusts will utilize adjectives such as "complete," "absolute," "uncontrolled," or "unfettered," when describing the trustees' discretion in making distributions.[5] However, notwithstanding this broad grant of authority, a beneficiary is not without any legal rights against the trustee.
The discretionary trusts described above are referred to as pure discretionary trusts because the trustee's discretion is not tied to any ascertainable standard when making distributions.[6] Alternatively, the trustee may be required to make distributions based on a particular standard, such as the health, education, maintenance, and support needs of the beneficiary, which must be considered when determining whether to make distributions. These trusts are referred to as support trusts.[7] There are also hybrid trusts, which lie somewhere in between because these trusts will give the trustee broad discretion in making distributions but tie the discretion to an ascertainable standard.[8] For example, "the trustee may make distributions to the beneficiary for such beneficiary's health and maintenance needs as determined by the trustee's sole and absolute discretion." Discretionary trusts, as used in this article, will generally include both pure discretionary trusts and hybrid trusts, unless indicated otherwise.
Settlors may establish a discretionary trust appointing a trustee who is also a beneficiary (an interested trustee). For example, many settlors establish discretionary family trusts, and appoint the most trusted child or children as trustees to administer and manage the trust for the benefit of themselves and for the other descendants. In addition to the typical advantages of discretionary trusts, this arrangement may also give settlors peace of mind, knowing that the trust will be administered by someone close, trusted, and familiar with the settlor's goals and wishes. Further, it allows the interested trustee greater flexibility in handling the assets, but still retains creditor protections and tax advantages. It can also be advantageous because an interested trustee will often not be provided compensation for her services, which leaves more of the trust income and assets for the beneficiaries. An interested trustee may also be utilized to control and manage a closely held family business. For these reasons, many lawyers will draft a discretionary trust with an interested trustee at some point in their practice.
Trustee Fiduciary Duties - A Broad Overview
Trustees must function in a fiduciary capacity. There are
"The duty of impartiality is most relevant when a trust is created for lifetime and successive beneficiaries. In this instance, there is an inherent conflict because distributions for the life tenant by their nature affect the interests of the successive beneficiaries.
several broad fundamental duties a trustee must generally abide by. First, a trustee has a duty of prudence which requires the trustee to exercise reasonable care, skill, and caution in managing and administering the trust.[9] Whether a breach of the duty of prudence occurs is a question of fact, based upon the circumstances, the terms of the trust, the value of the trust, the needs and resources of the beneficiaries, and any other relevant factors.[10] A subset of the duty of prudence is the "prudent investor rule" which generally requires trustees to diversify their investments.[11] Additionally, the duty of prudence imposes, as a matter of reasonable care in some circumstances, a duty to seek expert advice in carrying out responsibilities.[12]
Second, a trustee has a duty of loyalty, and must generally administer the trust solely in the interest of the beneficiaries and deal with the beneficiaries fairly.[13] Unless the trust expressly provides otherwise, a trustee has a strict duty against self-dealing and may not engage in transactions with the trust, regardless whether the deal is fair or made in good faith.[14] Another subset of this duty is the duty of impartiality, which requires the trustee to act impartial with respect to multiple beneficiaries under a single trust.[15] But the duty of impartiality does not mean that the trustee must treat the beneficiaries equally. Instead, it means the trustee must treat them equally in light of the purpose and terms of the trust.[16] The duty of impartiality is most relevant when a trust is created for lifetime and successive beneficiaries. In this instance, there is an inherent conflict because distributions for the life tenant by their nature affect the interests of the successive beneficiaries. Under these circumstances, the trustee has a duty to act with due regard to both the current and successive beneficiaries under the trust.[17]
Lastly, a trustee has a duty to administer the trust in accordance with its terms and applicable law.[18] A trustee must act in a state of mind contemplated by the settlor, which is generally inferred from the trust instrument.[19]The interpretation of the trust instrument is a question of law within the discretion of the court.[20] Because of the combination of default fiduciary obligations at law, and the duty to administer a trust in accordance with its terms, fiduciary obligations may be modified by the terms of the trust.[21] This is especially true in discretionary trusts with an interested trustee where certain fiduciary obligations, such as the duty against self-dealing, may be altered by the trust terms.
In fact, most fiduciary obligations are default rules and may be altered or removed by the trust terms. Kansas, along with a majority of states, has largely adopted the Uniform Trust Code ("UTC").[22] The UTC is mostly compromised of default rules as stated in K.S.A. 58a-105, which provides (emphasis added):
(a) Except as otherwise provided in the terms of the trust, this code governs the duties and powers of a trustee, relations among trustees and the rights and interests of a beneficiary.
(b) The terms of a trust prevail over any provision of this code except:
(1) The requirements for creating a trust;
(2) the duty of a trustee to act in good faith and administer the trust in accordance with K.S.A. 58a-801, and amendments thereto;
(3) the requirement that a trust and its terms be for the benefit of its beneficiaries, and that the trust have a purpose that is lawful, not contrary to public policy and possible to achieve;...[23]
K.S.A. 58a-801 largely contains the broad fiduciary duties of prudence, loyalty, and to administer the trust in accordance with its terms.[24] Given the interplay between subsection (a), (b)(2), and (b)(3), the trustee's authority is governed not only by the terms of the trust but also by statute.[25]
Additionally, K.S.A. 58a-814 provides:
[notwithstanding the breadth of discretion granted to a trustee in the terms of the trust, including the use of such terms "absolute," "sole" or "uncontrolled," the trustee shall exercise a discretionary power in good faith in accordance with the terms and purposes of the trust and the interests of the beneficiaries.
Thus, reading these statutes in tandem, there is always a requirement that a trustee must act in good faith and for the benefit of the beneficiaries. "Good faith" is not defined within the Kansas Uniform Trust Code ("KUTC") but is generally understood as a requirement that the trustee act honestly and
"When the settlor intends, and does create a discretionary trust, courts may generally only interfere in cases where the trustee abuses the discretion.
with proper motives.[26] Also, the "trust and its terms [must] be for the benefit of its beneficiaries."[27] Accordingly, courts will generally interpret trust terms in a manner which is consistent with the beneficiaries' interests. Trust terms cannot remove these minimum fiduciary duties.
When a trust has an interested trustee there is an inherent tension among the default...
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