Trust and Estate Law: Trusts as Entities Under Restatement (Third), 0716 COBJ, Vol. 45 No. 7 Pg. 73
| Author | Georgine Kryda, J. |
Georgine Kryda, J.
Trust and Estate Law articles are sponsored by the CBA Trust and Estate Section. Topics include trust and estate planning and administration, probate litigation, guardianships and conservatorships, and tax planning.
Coordinating Editors
David W. Kirch, Aurora, of David W. Kirch, P.C.—(303) 671-7726, dkirch@dwkpc.net; Constance D. Smith, Denver, of Fairfield and Woods P.C.—(303) 894-4474, csmith@fwlaw.com
Restatement (Third) of Trusts reflects the practice of referring to the trust res and the fiduciary relationship as a legal entity (i.e., “the trust”). This article develops the conceptual framework based on transaction cost theory introduced in Part 1, published in the April issue of The Colorado Lawyer, for drafting trust agreements under Restatement (Third) when clients and courts look at trusts as entities rather than exclusively as fiduciary relationships.
Restatement (Third) of Trusts1 (Restatement (Third)) sparked the latest debate regarding trusts as fiduciary relationships versus trusts as entities. Part 1 of this article, published in the April issue, compared the definitions of “trust” in Restatement (Second) of Trusts2 (Restatement (Second)) (trust as fiduciary relationship) and Restatement (Third) (trust as entity); reviewed the origins of trust concepts from purely fiduciary relationship to entity; and introduced the search, bargain, and enforcement aspects of transaction cost theory as a framework for drafting trust agreements under Restatement (Third).
Part 2 develops the conceptual framework based on transaction cost theory for drafting a trust agreement under Restatement (Third), summarizes Colorado court decisions regarding trusts as entities, and revisits the question of “what is a trust?” by posing a hypothetical based on a computer-trustee that virtually eliminates agency costs.
Conceptual Framework for Drafting
The challenges for the drafter of a trust agreement today include: (1) evaluating the appropriateness of the trust for the transfer of the settlor’s property; (2) assessing the costs associated with the organization and implementation of the settlor’s intentions via the trust; and (3) anticipating the potential vulnerability of the trust arrangement to opportunistic actions by the settlor, trustee, beneficiary, or a third party, such as a creditor. Transaction cost theory—with its consideration of search, bargain, and enforcement costs—can be used to analyze the trust-making process from inception through enforcement, and works well with other theories such as contract, agency, and property rights. Thus, transaction cost theory offers a viable framework for the drafter under Restatement (Third).
Evaluating the Appropriateness of the Trust
The starting point for the attorney is to understand the potential settlor’s goals, the nature of the property with which the settlor intends to fund the trust, the complexity of managing the proposed trust, and the identification of intended beneficiaries. If a trust is appropriate, the next question concerns the type of trust to create, which could be, for example, private, donative, charitable, business, or public.3
To illustrate the use of the transaction cost framework, assume that clients who inquire about a trust want to follow either a “lock box” or a “black box” approach to managing their property. Conceptually, a lock box is like a safe deposit box into which property is deposited for safekeeping by the trustee who distributes the same property pursuant to the settlor’s instructions; alternatively, a black box masks its internal operations so parties see only the input and the output, and may not know how the trustee transforms inputs into outputs.
The objectives of the lock box approach are to preserve and convey property in its present form; for example, this arrangement is used when the settlor wishes to convey cash, investment accounts, personal property, the family farm or ranch, or business property in its present form to subsequent generations or to charity. In a lock box arrangement, one anticipates clear instructions and a narrow scope of authority for the fiduciary because the trust res is not expected to change form.
On the other hand, the objectives of the black box approach are to accumulate and convey wealth. Under this approach, for example, the settlor may wish to convey property to a trust that will then generate returns to be distributed to subsequent generations or to charity. In a black box, the settlor does not see, know, or control the precise transformation process; the settlor sees only the input and the output. If the settlor transfers $100,000 in cash to a trust in the black box approach, the settlor does not necessarily require cash as the output. The settlor may specify that the cash be spent exclusively on insurance policies, but there are limits to how much control the settlor may retain and still have an effective estate plan after the settlor dies. Thus, one anticipates general guidance and a relatively broad scope of authority for the fiduciary to seek the highest rate of return for a prescribed or prudent rate of return.
The client’s preference influences the structure of the trust and the functioning of the fiduciary relationship. The settlor may view the trust agreement as a contract for testamentary disposition and request that the drafter address the limitation of creditors’ rights, the scope of the trustee’s duties, and the operation of in terrorem clauses. With a lock box approach, the client typically wants extensive control and issues directives to be followed, analogous to the client managing the client’s own firm. With a black box approach, the client typically is more flexible and amenable to permitting the trustee to follow whichever investment strategy yields the highest rate of return for a given level of risk tolerance, analogous to the client having a more entrepreneurial and market-based outlook. Under either approach, the drafter must consider the settlor’s capacity and any evidence of undue influence.
Once the decision is made to choose either a lock box or black box approach, the next step for the drafter is to assess the costs of the trust arrangement.
Assessing the Costs of the Trust Arrangement
Transaction cost theory can be used to analyze both the lock box and the black box approaches to trusts. The drafter must address the nature of the trust res, determine what access the trustee and the beneficiary will have to the trust res,and define the amount of flexibility afforded the trustee and the beneficiary. Any arrangement will have three types of transaction costs—search, bargain, and enforcement—which will guide the drafter’s inquiries and written product.
Search. Search costs are incurred when the settlor seeks and identifies a suitable trustee and desired beneficiary.
Regarding the trustee, the first question is who—individual or institution—is (1) qualified to serve for the likely duration of the trust (the temporal component) and (2) possesses the knowledge to manage and shepherd the trust property to the beneficiary (the skill component).
• Under the lock box approach, the settlor will search for a trustee who is likely to follow orders and not alter the property, and the beneficiaries are most likely ascertainable.
• Under the black box approach, the settlor will search for a trustee with the entrepreneurial mindset and capabilities to adapt to changing market conditions to secure the highest rate of return on the initial trust property, given a prescribed risk tolerance. The settlor may have only a general idea of who the beneficiaries will be, such as future generations.
Bargain. The settlor negotiates arrangements for the structure and operation of the trust with consideration of the trustee, who accepts the duties as prescribed in the trust agreement or, where the trust...
To continue reading
Request your trial