Modifying Irrevocable Trusts under the New Colorado Uniform Trust Decanting Act, 1116 COBJ, Vol. 45 No. 11 Pg. 55

• Author: Jessica L. Broderick, J.

45 Colo.Law. 55

Modifying Irrevocable Trusts under the New Colorado Uniform Trust Decanting Act

Vol. 45, No. 11 [Page 55]

The Colorado Lawyer

November, 2016

Jessica L. Broderick, J.

Trust and Estate Law

Colorado enacted the Uniform Trust Decanting Act in 2016. The Act provides a statutory framework for a trustee to modify an irrevocable trust based on the trustee’s discretionary power to make distributions.

Among estate planning lawyers and trustees, the concept of "decanting" a trust-pouring trust assets from one trust to a second trust, as wine is poured from one vessel to another-has changed over the years from mysterious, to intriguing, to worrisome, and now to generally accepted. New York enacted the first decanting statute in 1992. By the beginning of 2009, only seven states had enacted decanting statutes. By 2016, 23 states had enacted options for statutory decanting, each with its own structure and procedure.^[1]

In conjunction with this growth in state decanting laws, in 2015 the National Conference of Commissioners on Uniform State Laws (Uniform Law Commission) promulgated the Uniform Trust Decanting Act (UTDA)^[2] as a method for providing uniformity among state decanting laws. Uniformity could prevent choice of law questions for the trustee regarding which state’s decanting statute (if any) applies to a potential decanting, and it also could provide the Internal Revenue Service with a basis on which to promulgate tax guidelines relating to a decanting.^[3]

Colorado recently enacted its decanting statute. This process began in late 2014, when a subcommittee of the CBAs Trust & Estate Section (chaired by the author of this article) began studying drafts of what would become the UTDA, with the goal of determining whether to pursue enactment of the UTDA in Colorado. One year later, the subcommittee had drafted a bill of Colorado’s version of the UTDA, which was introduced in the Colorado Senate as Senate Bill 16-085, passed by the Colorado legislature in spring 2016, and signed by Governor John Hickenlooper on June 6, 2016. The Colorado Uniform Trust Decanting Act (Act) took effect on August 10, 2016.

This article (1) discusses when the Act may be useful to a trustee and the trustee’s advisor in administering a trust; (2) summarizes pertinent provisions of the Act, particularly the type of decanting that can be accomplished based on the structure of an existing trust, and the procedure for a decanting under the law; (3) describes limitations on decanting under the Act and special decanting situations; and (4) explains how a trust settlor can prevent the Act from applying to a particular irrevocable trust.

Decanting as Trust Modification Tool

The concept of decanting, by statute or under the common law, is based on the trustee’s discretion to make principal distributions to or for the benefit of the beneficiaries. If a trustee has discretion according to the terms of the trust agreement to determine when to make principal distributions and, among a class of beneficiaries, to whom to make such distributions, the trustee should have the power to exercise that discretion to distribute the trust assets into a different trust for the benefit of the beneficiaries, instead of outright.

Arguably, even without a decanting statute, a trustee can decant on the basis of the trustee’s discretion over distributions. At common law, the holder of a power of appointment can appoint property outright or in further trust.^[4] This concept was used historically as a basis for decanting, under the theory that a trustee’s power to make distributions to or for the benefit of a beneficiary is a power of appointment, ^[5] and so the trustee has the power to appoint property in further trust.

However, Colorado statutes define a power of appointment as one exercised in a nonfiduciary capacity.^[6] And a trustee with fiduciary duties and liability concerns may be hesitant to decant on a common law basis instead of according to the rules and procedures of a state statute.

A trustee may also decant where an existing trust agreement includes a provision permitting decanting. But a conservative trustee may prefer to follow the procedures in a decanting statute instead of relying solely on a provision in a trust instrument granting the trustee power to distribute principal to another trust.^[7]

Where a modification to a Colorado trust or a division or consolidation of Colorado trusts is desirable for trust administration, but the trust terms do not expressly permit such an action, trustees have often relied on a court-ordered reformation, modification, division, or consolidation, rather than decanting. But petitioning for these remedies may be an expense the trustee is unwilling to incur, even if such action is uncontested. In addition, the legal basis for a court-ordered trust reformation, modification, division, or consolidation may be uncertain if the proposed changes do not fit one of the existing statutory or trust provisions for such actions.^[8]

The Act offers trustees of a Colorado trust another method to modify the terms of a trust or effect a division or consolidation of trusts. Decanting does not require court approval, and the provisions of the statute define the trust terms and beneficial interests that may be changed by decanting particular trusts, giving trustees more certainty.

Decanting may be useful to trust administrators to

• fix outdated administrative provisions;

• name successor trustees, if the trust agreement does not provide for them;

• divide a trust for multiple beneficiaries into separate trusts for individual beneficiaries;

• include more favorable tax provisions;

• merge trusts to simplify administration;

• change a trust situs; and

• convert a trust into a special needs trust for a beneficiary with a disability.

Availability of and Procedure for Decanting

Trustees of Colorado trusts and their advisors should consider whether decanting particular trusts may be useful and in the best interests of the trust beneficiaries. If so, the Act should be examined in conjunction with the trust agreement to determine whether decanting is available and the procedure for doing so.

Prerequisites to Decanting

The Act applies to a trust that has its principal place of administration in Colorado or that provides in its agreement that it is governed by the laws of Colorado for the purpose of administering the trust or constructing or determining the meaning or effect of the trust terms.^[9] The trust must be irrevocable (or revocable by the settlor only with the consent of the trustee or a person holding an adverse interest),^[10] and the trust may not be held solely for charitable purposes.^[11] A trustee’s exercise of the decanting power is subject to the trustee’s fiduciary duties, including the duty to act in accordance with the purposes of the "first trust" (the Act’s term for the original trust over which the trustee is exercising the decanting power).^[12] Therefore, a trustee should consider whether a proposed decanting would be consistent with the purposes of the first trust and the settlor’s intent. The Act does not create a duty to exercise the decanting power or inform beneficiaries of its existence.^[13]

Standards for Decanting

The trustee’s level of discretion over distributions of trust principal determines the types of changes the trustee may make to a trust’s structure and terms through a decanting. A trustee must first determine whether the trustee has "limited distributive discretion" or "expanded distributive discretion."^[14] (If the trustee has no discretion over principal distributions, the trustee cannot decant under the Act, except in the case of a special needs trust, as described below.)

Limited distributive discretion.

Limited distributive discretion is arguably the easier standard to identify and apply. If a trustee’s discretionary power over principal distributions is limited to an ascertainable standard or a reasonably definite standard, the trustee has limited distributive discretion.^[15] An ascertainable standard is one permitting distributions for a beneficiary’s health, education, maintenance, and support.^[16] A reasonably definite standard is a "clearly measurable standard" under which the trustee is "legally accountable."^[17]

If a trustee has limited distributive discretion, the trustee has the power to decant, but the beneficiaries must receive, under the second trusts^[18] in the aggregate, beneficial interests that are substantially similar to the beneficial interests of the beneficiaries under the first trust.^[19] This means that the trustee can decant to update administrative and trustee provisions but cannot make significant changes to the dispositive structure of the trust.

A trustee with limited distributive discretion can divide trusts if the beneficial interests under the second trusts, in the aggregate, are substantially similar to the interests under the first trust. This may be a useful tool to divide trusts without obtaining court permission for the division under CRS § 15-16-401.

Expanded distributive discretion. A trustee with expanded distributive discretion has discretionary powers that are not limited to an ascertainable standard or a reasonably definite standard.^[20] A trustee who has absolute discretion, or who can make distributions for a beneficiary’s happiness, comfort, or welfare, or in some other manner that is broader than limited distributive discretion, has expanded distributive discretion.^[21]

A decanting by a trustee who has expanded distributive discretion is not subject to the requirement that the beneficial interests remain substantially similar in the second trust. Therefore, a trustee with expanded distributive...