As trust laws continue to evolve and modernize, trustees and beneficiaries sometimes face a challenging dilemma. Situations arise where, over time, the terms of an irrevocable trust no longer fit a family's needs. Families are often advised that they have few options, but some jurisdictions, including South Dakota, allow reformation or decanting to improve problematic or outdated trusts. (1) This article provides an overxiew of what is involved in reforming or decanting an irrevocable trust. (2)
Sometimes an irrevocable trust needs modification to improve the trust's administrative provisions. These modifications can include: replacing a trustee; clarifying or streamlining trustee succession; allowing a beneficiary to serve as trustee; moving the trust's situs to or from another jurisdiction; or terminating a small trust. This article is intended to provide an overview of what South Dakota law permits in circumstances where a trust instrument does not provide a mechanism for reformation.
Commonly, trustees or beneficiaries wish to: change the governing law if the trust does not allow such a change; take advantage of another state's favorable trust laws; change dispositive provisions allowing for a trustee to make a distribution not clearly within the standards set forth in the trust; adjust trustee powers; adjust restrictions on beneficiaries; benefit new, unanticipated beneficiaries; modernize or update a trust; divide a trust to separate generation-skipping transfer (GST) tax-exempt property from other property; divide the trust into separate trusts; consolidate trusts; adjust trustee compensation provisions; adjust outdated distribution caps or formulas to account for inflation and cost-of-living increases; or adjust against antiquated social conventions (example: allowing for beneficiaries to be adopted children or children born out of wedlock). Sometimes trust modification becomes necessary to achieve tax goals, such as to qualify for the marital deduction, obtain a charitable deduction, meet qualified domestic trust (QDOT) requirements, or correct ambiguous or poorly drafted documents.
MODIFICATION, REFORMATION, OR TERMINATION
Modification or amendment of an irrevocable trust is often referred to as either modification or reformation, depending upon the rationale for the change needed. (3) How and when reformation is permitted is a matter of state law. (4) Trusts are often governed by either a choice of law provision in the trust instrument or if the trust instrument is silent as to governing law, the law where the trust is being administered. (5) If the trust being modified is governed by substantive law in one jurisdiction but is being administered in another jurisdiction, the procedural laws of the state of administration will typically apply. (6)
Accordingly, for trusts administered in states with difficult trust laws or slow court systems, it is often desirable to transfer the trust situs to a jurisdiction where reformation is available and expedient under state procedural laws. (7) In most cases, transferring a trust's situs can be done either by the trust instrument's terms or under the governing state law. (8)
Once the trust is sitused in a jurisdiction with flexible and favorable trust laws, it is typically easier to achieve the desired result. Along with certain other states, South Dakota law allows an irrevocable trust to be modified or terminated upon the consent of all the beneficiaries if the trust's continuance on its existing terms is not necessary to carry out a material purpose. (9) An irrevocable trust may also be modified or terminated upon the consent of the grantor and all of the beneficiaries, regardless of the necessity of its material purpose. (10) Furthermore, South Dakota courts may reform trusts to "conform to the trustor's intention if the failure to conform was due to a mistake of fact or law and the trustor's intent can be established." (11)
The process is simple. Beneficiaries may consent to modification and termination...