The Capacity to Create a Testamentary Trust

• Author: Browne C. Lewis
• Pages: 1-45

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Chapter 1 - The Capacity to Create a

Testamentary Trust

This chapter is divided into two parts. Part I introduces students to the parties that

are involved in the creation of a trust. Further, that part discusses the function of each of the

parties. Most trusts are testamentary in nature, so they are created as a part of a will. In order

for a testamentary trust to be valid, the testator must be legally capable of executing the trust.

Thus, in Part II of the chapter, I discuss the mental capacity the testator must possess to be

deemed competent to create a trust. In addition, the students will be introduced to the other

legal theories that may be used to attack the testator’s ability to establish a trust.

The primary purpose of a trust is to provide a source of income for a person who is

not capable of managing his or her resources. For instance, Barbara’s son, John has a

gambling problem. Barbara wants to make sure that John always has a place to live. If

Barbara gives John a house outright, he would probably lose it in a card game. Barbara

cannot give John the house and forbid him from transferring it because a direct restraint on

alienation is invalid. Thus, the court would ignore the condition and give John the house

without the restriction. Barbara can give John a life estate in the property, so that he would

have a place to live until he died. Granting John a life estate may not be a good idea for

several reasons. A legal life tenant has a duty to pay taxes and to maintain the property in

good repair. However, that duty is limited because the life tenant only has to fulfill that

obligation to the extent the income from the property is sufficient to cover those expenses.

It is unlikely that the house will produce any income, so John would not be obligated to pay

the property taxes or to keep the house in good repair. Even if John has such a duty, he is

probably too irresponsible to do so. Thus, giving John a life estate in the house may cause

more problems than it cures. Moreover, if the life tenant accrues debt, that person’s creditor

can legally seize the life estate and sell it. The creditor would probably realize very little from

the sale. But, the sell of the life estate will defeat Barbara’s purpose of providing John with a

place to live. Barbara’s best option is to put the house in trust for John. This means that

Barbara would give the legal title of the house to a third party. That person would be

responsible for maintaining the house for John. As the beneficiary of the trust, John would

have equitable title of the house. Since John would not have legal title, he would be unable to

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sell or gamble away title to the house. Thus, the creation of a trust would enable Barbara to

achieve her objectives.

1.1. Parties Involved in a Trust Arrangement

Usually, at least three parties are involved in the creation of a trust. Those parties are

the settlor/trustor, the trustee, and one or more beneficiaries. In cases involving

testamentary trusts, the settlor is referred to as the testator. Three different individuals do

not have to be involved in the transaction in order for a valid trust to be established. For

example, one person can serve as the settlor and the trustee. If a self-settled trust is involved,

it is possible for one person to serve in all three capacities. However, for the trust to be

valid, the trustee must owe equitable duties to someone other than herself. Thus, if the

settlor is also the trustee, she cannot be the only trust beneficiary. The settlor/trustor is the

person who creates the trust. Since she is the person who established the trust, Barbara is the

settlor or trustor.

The third party who manages the trust is the trustee. The trustee may be an

individual or a corporation. The settlor may select one trustee or several trustees to manage

the trust. The trustee may be appointed by the trust instrument or by the court. The person

or entity appointed as trustee must affirmatively accept the role. Once the trustee accepts the

appointment as trustee, the person can be released of the obligation only with the consent of

the beneficiaries or by a court order. The trustee is entitled to receive reasonable

compensation. A trust will not fail for lack of a trustee. If the trustee dies and no successor

trustee is named in the trust instrument, the court will appoint a successor in trustee.

However, if the trust instrument or other facts indicate that the settlor chose the person to

act as trustee because of the nature of their relationship, the court may conclude that the

settlor would not want the trust to continue without that trustee. As a result, the court may

dissolve the trust on the death or resignation of the trustee. If the trust is created as a part of

a will, the executor can also serve as the trustee.

The trust instrument must give the trustee some active duties to perform. A settlor

who gives the trustee no managerial responsibilities creates a dry trust. As a result, the court

will not recognize the creation of the trust, and the beneficiary will receive legal title to the

trust property. The following example illustrates a dry trust:

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Example-Utilizing an instrument entitled “Trust For the Benefit of Roberto

and Marianna” Sophia placed one million dollars in an irrevocable trust for

her two children, Roberto and Marianna. She selected Vincent to serve as

trustee. Under the terms of the trust, $100,000 would be automatically paced

in the respective bank accounts of Roberto and Marianna each month.

Sophia never informed Vincent that he was to serve as trustee.

The above-referenced transaction did not result in a valid trust because the funds were

automatically dispensed to Roberto and Marianna. Vincent had no managerial duties. The

fact that the trust could function without Vincent’s knowledge further indicates that it was a

passive or dry trust. Consequently, the court would invalidate the trust and Roberto and

Marianna would have the right to split the million dollars and obtain it without restrictions.

The trustee has legal title to the trust property, and the beneficiary has equitable title.

Consequently, the trustee has the managerial authority over the property. Nevertheless, the

beneficiary is the one who suffers the consequences of the trustee’s good or bad decisions.

In the example put forth at the beginning of the chapter, the trustee has legal title to the

house and manages it for the benefit of John. Although the trustee has legal title to the

house, a personal creditor of the trustee has no recourse against the house. If the trustee

acquires an obligation on behalf of the trust, the creditor has recourse against the house, but

not against the trustee’s personal property.

Example 1-Keisha devises Purpleacre in trust to Robert to pay income to

Gary for life and the remainder to LaNitra on Gary’s death. Robert

accidentally hits April with his car. April files suit against Robert and receives

a judgment for $300,000. Although Robert has legal title to Purpleacre, April

cannot place a lien on Purpleacre to satisfy her judgment.

Example2-Gloria devises Blackacre in trust to Tamera to pay income to Ali

for life and the remainder to Patrick on Ali’s death. Tamera contracts with

Jason to make repairs to Blackacre. Jason submits a bill to Tamera for

$40,000. Tamera refuses to pay the bill. Jason can go to court and get a

mechanic’s lien on Blackacre. However, Jason cannot sue Tamera personally

for the debt.

The beneficiary of the trust is the person who receives the benefit of the trustee.

John is the beneficiary of the trust because it was created so he would have a place to live.