TRUST AND ESTATE LAW
BY JEFFREY B. KADAVY AND DYLAN H. METZNER
This article explains directed trusts and how they operate under the Colorado Uniform Directed Trust Act, It includes tips for drafting directed trusts and advising fiduciaries.
Estate planners are familiar with creating trusts to prudently manage and safeguard their clients' wealth. Clients generally understand the benefits of a trust as a tool for achieving a host of planning goals. But many clients are averse to the idea of hiring a professional, non-family member trustee to manage their wealth, even though a professional may better serve their needs. In addition, attorneys often fail to advise their clients about the risks of appointing a non-professional trustee. Such risks include a trustee who steals from the trust, a trustee who fails to exercise independent discretion (and thus subjects the trust to estate or generation skipping transfer tax inclusion), and litigation initiated by beneficiaries who simply don't like the family member trustee.
A directed trust allows trust settlors to involve family members in the administration of a trust when appropriate, but to use professionals to ensure compliance with fiduciary duties, provide professional investment management, deal with contentious beneficiary relationships, manage complex assets, and provide independent judgment with respect to discretionary distribution decisions.
This article explains directed trusts and discusses
■ how directed trusts differ from other common trust structures;
■ when to use a directed trust in an estate plan;
■ how directed trusts operate under the Colorado Uniform Directed Trust Act (CUDTA or the Act);
■ drafting and practical considerations; and
■ advising fiduciaries serving under a directed trust.
Distinguishing a Directed Trust
In a directed trust arrangement, the powers and fiduciary duties ordinarily vested in a trustee or equally among co-trustees are allocated to one or more "trust directors" and one or more "directed trustees." Under the Uniform Directed Trust Act (UDTA), a trust director has the power to direct a directed trustee in the performance of a specific function or functions, and the directed trustee must comply with such direction. The directed trustee either lacks or has diminished authority to act regarding the functions allocated to the trust director. Accordingly, the directed trustee's fiduciary duty and, therefore, potential liability are reduced.
The Delegated Trust
In a delegated trust arrangement, the trustee contracts with a third party to perform certain functions on behalf of the trustee. The third party acts as the trustee's agent, subject to the terms of the contractual relationship.1 The trustee must exercise due care in selecting the party to whom the functions are delegated and maintains an ongoing fiduciary duty to supervise that party and monitor his or her conduct.2 The trustee retains authority to act with respect to the functions delegated, so he or she cannot avoid fiduciary duty and the potential liability that follows it. This differs from a directed trust, in which the directed trustee does not exercise any powers regarding the trust director's functions, and thus the duties and liabilities shift from the trustee to the trust director.
In a co-trusteeship, the co-trustees' powers and duties are generally held jointly. Co-trustees are authorized to act in concert with respect to all trust functions, and therefore each must discharge all fiduciary duties. Thus, co-trustees generally remain fully liable for any breaches of trust, even if a breach resulted from the action of one co-trustee. Conversely, a directed trustee is generally not liable for complying with a trust director's direction or for a trust director's independent actions; a directed trustee simply complies with the trust director's instructions and, accordingly, is divested of power with respect to the trust director's functions.
History of Delegated Trusts
Historically, a trustee's authority to delegate functions was limited. In fact, a trustee had a duty not to delegate to others the doing of acts that the trustee could reasonably be required to perform personally.3 For example, in In re Will of Hartzell, a trustee delegated the power to hold the proceeds from the sale of trust property to the trustee's attorney, and the attorney absconded with the funds.4The court found that the trustee's delegation was improper and, therefore, the trustee breached its fiduciary duty and was liable for the loss to the trust estate.5 In so holding, the court relied on the general principle that while a trustee may delegate purely ministerial powers or duties, a trustee may not delegate powers and duties involving an exercise of judgment and discretion.6
The limits of a trustee's authority to delegate have been relaxed in recent years. For example, the Colorado Fiduciaries' Powers Act, CRS §§ 15-1-804 et seq., and the Uniform Prudent Investors Act, CRS §§ 15-1.1-109 et seq., specifically empower a trustee to delegate certain functions. However, both acts follow the Restatement (Third) of Trusts' approach, that a delegation is proper only if a prudent person of comparable skill would delegate the responsibilities to others.7 In addition, the delegating trustee has the duty to exercise fiduciary discretion in deciding whether, to whom, and in what manner to delegate fiduciary authority in the administration of a trust.
History of Directed Trusts
Common law recognizes directed trust arrangements but imposes on directed trustees the duty to monitor the actions of trust directors. For example, section 75 of the Restatement (Third) of Trusts provides:
[Generally], if the terms of a trust reserve to the settler or confer upon another a power to direct or otherwise control certain conduct of the trustee, the trustee has a duty to act in accordance with the requirements of the trust provision reserving or conferring the power and to comply with any exercise of that power, unless the attempted exercise is contrary to the terms of the trust or power or the trustee knows or has reason to believe that the attempted exercise violates a fiduciary duty that the power holder owes to the beneficiaries. (Emphasis added.) Thus, at common law, a directed trustee has a duty to comply with a trust director's direction, but the trustee retains a significant fiduciary duty: before complying, the trustee must interpose his or her own judgment to determine whether doing so would contradict the terms of the trust or violate any fiduciary duty that the trust director owes to the beneficiaries. A directed trustee cannot avoid a trustee's responsibilities, even with respect to functions specifically within the purview of a trust director. The CUDTA, like most modern directed trust statutes, alters this regime through a default rule that eliminates the trustee's duty to monitor the actions of a trust director.9
While case law interpreting such statutes is sparse, there are two seminal cases on the subject. The first case, Duemler v. Wilmington Trust Company, stands for the proposition that a directed trustee is not liable for the actions or inactions of a trust director if the trustee does not engage in willful misconduct.10 In Duemler, a sophisticated investment advisor was given the express power to direct the corporate trustee with respect to all trust investments. The trustee forwarded a prospectus relating to certain investments to the advisor while the advisor was on vacation, so the advisor did not receive the prospectus and thus took no action. Thereafter, the investments to which the prospectus related declined in value. The advisor sued the trustee, claiming that the trustee breached its fiduciary duty by not providing the advisor with timely financial information. The Court of Chancery of Delaware issued an unpublished order finding no willful misconduct and exonerating the directed trustee.11 This holding is consistent with the CUDTA’s willful misconduct standard.
The second case, Rollins v. Branch Banking & Trust Co. of Virginia,12 provides a cautionary tale for directed trustees who rely on a directed trust statute that is silent regarding a trustee’s duty to warn beneficiaries. In Rollins, a trust conferred the power to retain, sell, or purchase investments exclusively on the beneficiaries. The beneficiaries directed the trustee to hold concentrated positions in certain stocks. Twenty years later, at the beneficiaries’ direction, the directed trustee sold the stocks for a fraction of their original value. The...