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Trust Decanting: Flexibility and Danger

Crafting Trust Terms to Achieve Tax Benefits, Revise Fiduciary Powers, and Mitigate Beneficiary Liability

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Today’s faculty features: James P . S pica, Member, Dickinson Wright, Detroit Meryl G. Finkelstein, S

• r. Counsel, Fulbright & Jaworski, New Y
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Thomas R. Pulsifer, Partner, Morris Nichol Arsht & Tunnell, Wilmington, Del. Todd A. Flubacher, Partner, Morris Nichols Arsht & Tunnell, Wilmington, Del.

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STRAFFORD PUBLICATIONS WEBINAR

Trust Decanting: Flexibility and Danger

Thursday, October 6, 1:00-2:30 PM (EDT)

THE USES AND BENEFITS OF DECANTING AND DECANTING’S CONCEPTUAL BASIS IN THE COMMON LAW

James P. Spica Dickinson Wright PLLC Detroit 313-223-3090 j i @di ki i ht jspica@dickinsonwright.com

THE USE OF ‘DECANTING’: A LOOSE METAPHOR

FIDUCIARY AND NON FIDUCIARY POWERS OF APPOINTMENT

6

FIDUCIARY AND NON-FIDUCIARY POWERS OF APPOINTMENT

By ‘Trust Decanting,’ we generally mean the exercise of a fiduciary, special By Trust Decanting, we generally mean the exercise of a fiduciary, special power of appointment to distribute assets from one trust to another This use of the term is under-determined by the metaphor on which it’s based y p The analogy to pouring spirits from one vessel to another is apt enough, but there’s no analogue in the decanting of spirits to our narrow reference to fiduciary powers: oenophiles know that one doesn’t need a sommelier or a trained waiter to decant wine; and similarly, in the right circumstances, a beneficial, special power of appointment may be as good as a fiduciary one for moving assets from one trust to another for moving assets from one trust to another

THE USE OF ‘DECANTING’: A LOOSE METAPHOR

POWERS OF APPOINTMENT BY ANY OTHER NAME

7

POWERS OF APPOINTMENT BY ANY OTHER NAME

There are also powers of appointment we’re not in the habit of calling powers of There are also powers of appointment we re not in the habit of calling powers of appointment that can be used effectively to move assets from one trust to another, including:

• powers of substitution (of the kind regularly used to attract “grantor trust”

status),

• powers of amendment and
• powers of revocation or termination

THE USE OF ‘DECANTING’: A LOOSE METAPHOR

POWERS TO DO THINGS OTHER THAN APPOINT

8

POWERS TO DO THINGS OTHER THAN APPOINT

And there are means of effectively “moving” assets from one trust to another And there are means of effectively moving assets from one trust to another that have nothing to do with powers of appointment (nor, indeed, with the movement of assets), including:

• reformation or modification proceedings and
• trust mergers

THE USES OF DECANTING

TO DECANT (ASSUMING ONE CAN) OR NOT TO DECANT

9

TO DECANT (ASSUMING ONE CAN) OR NOT TO DECANT

Whether “decanting” (in its narrow, if metaphorically under-determined sense) Whether decanting (in its narrow, if metaphorically under determined sense) is a better means of “moving” trust assets than

• a beneficial, special power appointment,

p p pp

• a power of substitution,
• a power of amendment, revocation or termination,
• a reformation or modification proceeding or

p g

• a merger of trusts

will depend on one’s motivations, on why exactly one wishes that the trust p , y y terms governing the assets in question were different

THE USES OF DECANTING

COMMON MOTIVATIONS

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COMMON MOTIVATIONS

Common motivations for decanting include wishes: Common motivations for decanting include wishes:

• to correct drafting errors or revise accurately rendered, but ill-advised

provisions, e.g., a hobbling tax or perpetuities saving clause p g g p p g

• to enhance administration, e.g., by bifurcating fiduciary functions so as

to protect a less sophisticated, but integral trustee from investment responsibility

• to address unanticipated circumstances concerning a beneficiary’s

creditors, marital status, wealth or health, e.g., by creating a supplemental needs trust so as to allow a beneficiary to qualify for public assistance public assistance

• to change a trust’s vintage so as to put the beneficiaries’ interests in the

way of prospective legislative innovations, e.g., perpetuities reform

THE USES OF DECANTING

COMMON MOTIVATIONS (CONTINUED)

11

COMMON MOTIVATIONS (CONTINUED)

• to change situs or governing law

to change situs or governing law

• to supplement inadequate trustee provisions, e.g., by distinguishing the

administrative powers of interested and disinterested trustees

• to engineer income tax consequences, e.g., by granting the settlor a

g q g y g g power that‘ll trigger grantor trust status, or by spinning off capital loss assets for sale by a separate trust that can promptly be terminated in distributions to beneficiaries who have capital gains t i th l it f t f t d t b t i th

• to increase the longevity of transfer tax advantages, e.g., by tying the

termination of a trust “grandfathered” under Treasury’s GST tax effective date regulations to the durations of extraneous measuring lives

• r by evading perpetuities constraints all together for trust assets to

y g p p g which GST exemption has been allocated

THE BENEFITS OF DECANTING

COMPARING ALTERNATIVE MEANS

12

COMPARING ALTERNATIVE MEANS

As the common motivations we’ve described fairly suggest, one’s reasons for wishing that particular trust terms governing particular assets were different will often implicate possible alternative means of achieving preferable results The point is that in many cases, decanting may be superior to other means at h d d th t i h t th l t lt ti hand; and that, in any case, one has to compare the relevant alternatives

THE BENEFITS OF DECANTING

ILLUSTRATION 1: DECANTING VS. EXERCISE OF A BENEFICIAL POWER WHEN

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THE NEW TRUST WILL GRANT POWERS OF APPOINTMENT

As between the use of a fiduciary, special power of appointment (i.e., As between the use of a fiduciary, special power of appointment (i.e., “decanting”) and a nonfiduciary one, for example, one has always to reflect that the nonfiduciary power may implicate the so-called “Delaware tax trap,” IRC section 2041(a)(3) and its gift tax counterpart, IRC section 2514(d); h th l i l ti hi t f th ti i di t th t th “t ” whereas the legislative history of these sections indicates that the “trap” wasn’t intended to apply to purely fiduciary powers of appointment, such as a trustee’s discretionary power to invade principal See S. REP. No. 82-382, at 1 (1951), as reprinted in 1951 U.S.C.C.A.N. 1535, 1535

THE BENEFITS OF DECANTING

ILLUSTRATION 2: DECANTING VS. MERGER WHEN THE MERGER STATUTE

14

REQUIRES SEGREGATION

Another example is the case of longevity planning for tax advantaged trust assets when the goal is to subject beneficial interests in the assets to a g j more favorable perpetuities regime In that case, use of a special power of appointment, whether a fiduciary power (i.e., “decanting”) or a nonfiduciary one, may be superior to merger of the i ti t t t f th i ti t t f ll i t t i t t existing trust―or a part of the existing trust, following a strategic trust division―with a new trust that qualifies for the desiderated perpetuities treatment if the applicable merger statute requires post-merger segregation

• f distinct perpetuities parcels

p p p Under the Michigan Trust Code’s merger provision, for example, the merger of a trust that’s subject to the Michigan USRAP with a trust to which the Personal Property Trust Perpetuities Act applies may well not subject the t f th li t t t th f d t iti i assets of the earlier trust to the reformed perpetuities regime See MICH. COMP. LAWS ANN. § 700.7417(2) (“[i]f the rule against perpetuities speaks from different dates with reference to the trusts . . . .”)

THE BENEFITS OF DECANTING

ILLUSTRATION 3: DECANTING VS. CONSENSUAL MODIFICATION OF A TRUST

15

“GRANDFATHERED” FROM GST TAX

f f “ f ” Another example is the case of longevity planning for “grandfathered” status under the Treasury’s GST tax effective date regulations In this case, perpetuity isn’t in point, because the effective date regulations subject the tax advantage of grandfathered status to a RAP of their very subject the tax advantage of grandfathered status to a RAP of their very

• wn, one that’s completely independent of state law

See Treas. Reg. §§ 26.2601-1(b)(1)(v)(B) (nonfiduciary, special powers of See Treas. Reg. §§ 26.2601 1(b)(1)(v)(B) (nonfiduciary, special powers of appointment); 26.2601-1(b)(4)(i)(A) (fiduciary, special powers)

THE BENEFITS OF DECANTING

ILLUSTRATION 3 (CONTINUED): DECANTING VS. CONSENSUAL MODIFICATION

16

OF A TRUST “GRANDFATHERED” FROM GST TAX

But the regulations:

• contemplate that the exempt status of assets subject to a grandfathered

contemplate that the exempt status of assets subject to a grandfathered trust may survive the assets’ being appointed to a new trust, provided the appointment may not postpone or suspend the vesting (or absolute

• wnership or power of alienation) of an interest in the assets beyond the

R l t RAP i d ( T R § 26 2601 1(b)(1)( )(D)( 4) Regulatory RAP period (see Treas. Reg. § 26.2601-1(b)(1)(v)(D)(ex. 4) (especially the last sentence)) and

• permit the use of extraneous measuring lives with respect to the

exercise of exercise of – a nonfiduciary, special power of appointment (see id. § 26.2601- 1(b)(1)(v)(B)(2)) and – a fiduciary, special power (i.e., “decanting”) provided the terms of y, p p ( , g ) p the grandfathered trust or state law at the time the grandfathered trust became irrevocable authorized the distribution to a new trust without the consent or approval of any beneficiary or court (see id. § 26 2601 1(b)(4)(i)(A)) § 26.2601-1(b)(4)(i)(A))

THE BENEFITS OF DECANTING

ILLUSTRATION 3 (CONTINUED): DECANTING VS. CONSENSUAL MODIFICATION

17

( )

OF A TRUST “GRANDFATHERED” FROM GST TAX

The regulations also contemplate that the exempt status of assets subject to a The regulations also contemplate that the exempt status of assets subject to a grandfathered trust may survive the assets’ being distributed to a new trust,

• r retained in a trust that is modified, pursuant to a non-contested court
• rder or non-judicial settlement

But in that case, the distribution or modification must neither:

• shift a beneficial interest in the trust to any beneficiary who occupies a

lower generation (as defined in IRC section 2651) than the person or persons who held that beneficial interest beforehand nor

• extend the time for vesting of any beneficial interest in the trust

beyond the period provided for in the original trust beyond the period provided for in the original trust See Treas. Reg. § 26.2601-1(b)(4)(i)(D)

THE BENEFITS OF DECANTING

ILLUSTRATION 3 (CONTINUED): DECANTING VS. CONSENSUAL MODIFICATION

18

OF A TRUST “GRANDFATHERED” FROM GST TAX

The upshot is that: The upshot is that:

• whereas a special power of appointment whether a fiduciary power

(i.e., “decanting”) or a nonfiduciary one, may afford scope for longevity planning for a grandfathered trust―because the Treasury regulations allow an appointment to suspend vesting for a period determined by extraneous measuring lives;

• there’s no scope for such planning with respect to modifications or

distributions pursuant to non contested court orders or non judicial distributions pursuant to non-contested court orders or non-judicial settlements, for in these cases, the modification or distribution isn’t allowed to extend the period for vesting of interests in the grandfathered trust’s assets at all

DECANTING’S CONCEPTUAL BASIS IN COMMON LAW

THE VINTAGE OF POWER

19

THE VINTAGE OF POWER

This last illustration, the case of longevity planning for trusts “grandfathered” under the GST tax effective date regulations, emphasizes the potential, tax- g p p planning importance in every jurisdiction, regardless of the enactment of a decanting statute, of the common law authority, such as it is, for “decanting” For, as we’ve seen, the scope for longevity planning for a grandfathered trust d d th f t i li may depend on the use of extraneous measuring lives And the use of extraneous measuring lives may depend on the existence of a fiduciary, special power of appointment (if the trust in question doesn’t provide nonfiduciary special powers) provide nonfiduciary, special powers) And in that case, unless the trust instrument itself provides that the trustee may extend the life of the trust or make distributions in further trust, state law at the time the grandfathered trust became irrevocable must have authorized the distribution to a new trust without the consent or approval of any beneficiary or court See Treas. Reg. § 26.2601-1(b)(4)(i)(A) (supra Slide 12)

DECANTING’S CONCEPTUAL BASIS IN COMMON LAW

THE VINTAGE OF POWER (CONTINUED)

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THE VINTAGE OF POWER (CONTINUED)

Now, it won't be oversimplifying for our purposes to say that a “grandfathered” trust is one that was irrevocable on September 25, 1985 (see Treas. Reg. § 26.2601-1(b)(1)(i)) A d th ld t d ti t t t i th t N Y k’ t d i And the oldest decanting statute in the country, New York’s, was enacted in 1992 (see N.Y. EST. POWERS & TRUST LAW § 10-6.6 (McKinney 2002)) So the scope for the longevity planning we’ve described depends in every So, the scope for the longevity planning we ve described depends, in every jurisdiction, on the plausibility of the claim that given the terms of the grandfathered trust in question, the common law authorizes the trustee to make distributions in trust for the benefit of permissible distributees

DECANTING’S CONCEPTUAL BASIS IN COMMON LAW

THE RESTATEMENT (THIRD)’S TENTATIVE MUDDLE

21

THE RESTATEMENT (THIRD) S TENTATIVE MUDDLE

A trustee's discretionary power of distribution is a special power of appointment within the meaning of most states’ powers of appointment laws (see, e.g., g p pp ( g

• MICH. COMP. LAWS ANN. §§ 556.112(c); .112 (i))

This tracks the treatment of a trustee’s power to make discretionary distributions in the Restatement (Second) of Property: Donative Transfers ( RESTATEMENT (SECOND) OF PROP DONATIVE TRANSFERS § 11 1 (see RESTATEMENT (SECOND) OF PROP.: DONATIVE TRANSFERS § 11.1 (1986)) For reasons that won’t bear scrutiny, the authors of Tentative Draft No. 5 of the Restatement (Third) of Property: Wills and Other Donative Transfers have Restatement (Third) of Property: Wills and Other Donative Transfers have elected not to call a trustee’s power to make discretionary distributions a power of appointment, though the Restatement (Third)’s substantive analysis of such fiduciary powers doesn’t differ from that of the Restatement (S d) ( R (T ) P W & D (Second) (see RESTATEMENT (THIRD) OF PROP.: WILLS & OTHER DONATIVE TRANSFERS § 17.1 cmt. g (Tentative Draft No. 5, 2006)) In this, the authors of Tentative Draft No. 5 are ignoring what is (literally!) textbook knowledge on the classification of special powers of appointment textbook knowledge on the classification of special powers of appointment

DECANTING’S CONCEPTUAL BASIS IN COMMON LAW

THE RESTATEMENTS (SECOND) AND (THIRD)

22

THE RESTATEMENTS (SECOND) AND (THIRD)

(S ) f f In any case, the Restatement (Second) and Tentative Draft No. 5 of the Restatement (Third) both support the proposition that unless the trust instrument that created the discretionary power manifests a contrary intent, a trustee’s power to make discretionary distributions entails the powers: a trustee s power to make discretionary distributions entails the powers:

• to make distributions in trust for permissible distributees and
• to create powers of appointment over trust assets

See RESTATEMENT (SECOND) OF PROP.: DONATIVE TRANSFERS § 19.3 cmt. a

• illus. 2 (1986); RESTATEMENT (THIRD) OF PROP.: WILLS & OTHER DONATIVE

TRANSFERS § 17.1 (Tentative Draft No. 5, 2006)

DECANTING’S CONCEPTUAL BASIS IN COMMON LAW

CASE LAW

23

CASE LAW

There may or may not be any case authority in a given jurisdiction for the proposition thus supported by the Restatements viz that at common law a proposition thus supported by the Restatements, viz., that at common law, a discretionary power to distribute trust property presumptively implies the power to “decant” There is, for example, as far as the author knows, no decided case binding as precedent on Michigan or Ohio judges that clearly stands for that proposition But the absence of local precedent hasn’t prevented states considering decanting legislation from asserting that their decanting statutes are at least decanting legislation from asserting that their decanting statutes are at least partly declaratory of common law applicable prior to enactment (see, e.g., WILLIAM J. MCGRAW III, OHIO STATE BAR ASSOCIATION, REPORT OF THE ESTATE PLANNING, TRUST AND PROBATE LAW SECTION 66-67 (n.d.), http://www.ohiobar.org/General%20Resources/pubs/councilfiles/EstPlanCo mReport.pdf (explaining a proposal to enact new section 5808.18 of the Ohio Trust Code authorizing decanting))

DECANTING’S CONCEPTUAL BASIS IN COMMON LAW

SEGUE TO STATE STATUTES

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SEGUE TO STATE STATUTES

And, indeed, a legislative decanting regime for Michigan, which the author has drafted on behalf of Greenleaf Trust and which is currently before committees of the Michigan Bankers Association and the Michigan State Bar, purports to be partly declarative But now it’s time for us to turn to decanting statutes that have already been enacted and to Meryl Finkelstein

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A decanting statute permits a trustee who has the discretionary authority to invade the principal

INTRODUCTION

A decanting statute permits a trustee who has the discretionary authority to invade the principal

• f a trust (and in some cases income) for the benefit of one or more trust beneficiaries to exercise

that authority by transferring some or all of the assets of the trust in further trust. The rationale underlying a decanting is that a trustee who has the discretion to distribute trust property to or for the benefit of one or more current beneficiaries of the trust has a special power property to or for the benefit of one or more current beneficiaries of the trust has a special power

• f appointment over the trust property that allows the trustee to distribute the property to another

trust for the benefit of one or more beneficiaries. To date, eleven states have enacted specific decanting legislation:

• Alaska (1998)
• Arizona (2009)
• Delaware (2003)
• Florida (2007)
• Indiana (2010)
• Nevada (2009)
• New Hampshire (2008)
• New York (1992 but substantially amended in August 2011)
• North Carolina (2009)

North Carolina (2009)

• South Dakota (2007)
• Tennessee (2004)
• Missouri (2011)

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* The author gratefully acknowledges the assistance of Fulbright Associate Brian Smith in the preparation of these materials

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THRESHOLD CONSIDERATIONS FOR THE TRUSTEE

1. Is the proposed decanting consistent with the trustee’s fiduciary duties? 2. Has the trustee thoroughly reviewed the trust instrument? a. Does the trust instrument prohibit the trustee from decanting the trust? b. Does the trust instrument give the trustee specific power to decant the trust? 3. If the trust instrument authorizes the trustee to decant the trust, will the trustee’s power be exercised in a manner that is consistent with the provisions of the trust instrument? 4. If the trust instrument is silent, does the trustee have the requisite power under the applicable state decanting statute? 5 Which state’s law applies? 5. Which state s law applies? 6. Does the trustee’s exercise of the decanting power comply with all statutory requirements?

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STATUTORY DIFFERENCES

All of the state decanting statutes are intended to achieve the same result – to allow the trustee to appoint the assets of an existing trust to a second trust – but their substantive provisions differ in a variety of ways, including:

• The level of discretion that the trustee must hold with respect to the power to invade the trust (i.e.,

absolute discretion versus trusts with distribution standards);

• Whether a decanting may be based on a power to invade trust income;
• The persons for whose benefit the power to invade the first trust may be exercised and the

persons who are permissible beneficiaries of the second trust; persons who are permissible beneficiaries of the second trust;

• Limitations on the trustee’s exercise of the power that are intended to preserve certain tax benefits
• f the first trust (i.e., marital and charitable deductions, gift tax annual exclusions);
• Limitations on the ability of a beneficiary-trustee to decant;
• Whether powers of appointment not granted under the first trust may be granted to a beneficiary of

the second trust; and

• The procedural aspects of the trustee’s exercise of the decanting power, including:

1 Method of exercise 1. Method of exercise 2. Notice to beneficiaries/waivers of notice 3. Consent 4. Court filing requirements

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SCOPE OF THE TRUSTEE’S INVASION POWER UNDER STATE LAW

1, Must the trustee have absolute discretion to distribute trust principal?

(see Florida and Indiana)

2. What constitutes absolute discretion under the applicable statute?

(see Florida and Indiana)

3. Can the trustee exercise a decanting power with respect to the first trust if the trustee’s discretion is limited by a standard?

(see Alaska Arizona Delaware Missouri Nevada New Hampshire New York North Carolina South Dakota (see Alaska, Arizona, Delaware, Missouri, Nevada, New Hampshire, New York, North Carolina, South Dakota, Tennessee)

4. If the trustee’s discretion under the first trust is limited by a standard, must the same standard (or as restrictive a standard) be included in the second trust?

(see Alaska, Arizona, Missouri, New York, North Carolina)

5. Can a decanting be based on a trustee’s discretionary power to distribute trust income?

(see Arizona, Missouri, Nevada, New Hampshire, North Carolina, South Dakota)

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PERMISSIBLE BENEFICIARIES OF THE SECOND TRUST

1. To what extent can the beneficiary provisions of the second trust vary from the beneficiary provisions of the first trust? a. Can the second trust eliminate persons who are current beneficiaries under the first trust? b Can remainder beneficiaries be eliminated? b. Can remainder beneficiaries be eliminated? c. Can the second trust add as beneficiaries persons who are not beneficiaries of the first trust? 2. Can the interests of remainder beneficiaries of the first trust be accelerated to present interests in the 2. Can the interests of remainder beneficiaries of the first trust be accelerated to present interests in the second trust?

see South Dakota and Missouri (specifically allowed) see North Carolina (specifically prohibited)

3. Can the trustee grant a power of appointment not provided for under the first trust to a beneficiary of the second trust?

(see Delaware, Nevada, New York, North Carolina)

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STATUTORY LIMITATIONS ON EXERCISE OF TRUSTEE’S INVASION POWER

1. Provisions prohibiting the reduction of: a. Fixed income interests

(see Alaska, Arizona, Delaware (marital trusts), Florida, Indiana, Missouri (marital trusts), Nevada, N H hi N Y k N th C li S th D k t ( it l t t ) T ) New Hampshire, New York, North Carolina, South Dakota (marital trusts), Tennessee)

b. Annuity and unitrust interests

(see Arizona, Delaware (marital trusts), Florida, Indiana, Missouri (CRTs/GRATs), Nevada, New Hampshire, New York, North Carolina, South Dakota (CRTs/GRATs) )

2 P i i i t i t b fit f th fi t t t 2. Provisions preserving certain tax benefits of the first trust: a. Marital deduction (see Florida, Indiana, Nevada, New Hampshire, New York, North Carolina) b. Charitable deduction (see Florida, Indiana, Nevada, New Hampshire, New York, North Carolina) c Gift tax annual exclusion (

N d N H hi N Y k)

c. Gift tax annual exclusion (see Nevada, New Hampshire, New York) d. Contributions to 2503(c) trusts (see Delaware, Missouri, North Carolina, South Dakota) e. Changes in grantor trust status (see New York) 3 Can property subject to a presently exercisable power of withdrawal be decanted? 3. Can property subject to a presently exercisable power of withdrawal be decanted?

(see Delaware, Missouri, Nevada, New Hampshire, North Carolina, South Dakota)

4. Provisions prohibiting extension of the permissible period of the rule against perpetuities applicable to the first trust.

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(see Alaska, Arizona, Florida, Indiana, New York, North Carolina, South Dakota, Tennessee)

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ADDITIONAL LIMITATIONS WHERE TRUSTEE IS A BENEFICIARY OR WHERE BENEFICIARIES POSSESS CERTAIN POWERS

1. May a beneficiary-trustee of the first trust exercise a decanting power?

(see Arizona, Missouri, Nevada, New Hampshire, New York, North Carolina, South Dakota)

2. May a beneficiary-trustee act if discretion under the first trust is limited by an ascertainable standard?

(see Arizona, Missouri, Nevada, New Hampshire, South Dakota)

3. Are there restrictions on decanting where beneficiaries of the first trust have the right to remove and l t t ? replace trustees?

(see Missouri, Nevada, New Hampshire, South Dakota)

4. Are there restrictions relating to the possible discharge of a support obligation of the beneficiary-trustee.

( N d d N H hi ) (see Nevada and New Hampshire)

5. If the decanting statute is silent, do other state law provisions bar a beneficiary-trustee from acting?

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MECHANICS OF THE TRUSTEE’S EXERCISE OF THE POWER TO APPOINT IN FURTHER TRUST

1. Does the statute set forth a specific manner of exercise?

(Yes – Delaware, Florida, Indiana, Nevada, New York, North Carolina, South Dakota, Tennessee) (No – Alaska, Arizona, Missouri, New Hampshire)

2. May the second trust be established under the first trust instrument or is a new trust instrument required?

(South Dakota specifically requires a new trust) (Specific authority to establish 2nd trust under 1st trust: Arizona, Florida, Indiana, Missouri, Tennessee)

3. Is notice to beneficiaries (or any other party) required and if yes, what constitutes notice?

(see Florida, Indiana, Missouri, New Hampshire, New York, North Carolina, South Dakota)

4 May a beneficiary waive notice? 4. May a beneficiary waive notice?

(see Florida, Indiana, Missouri, Nevada, North Carolina, South Dakota)

5. Is beneficiary consent required?

(see Nevada in limited circumstance) (see Nevada in limited circumstance)

6. Is court approval required? Are there any court filing requirements?

(see New York – court filing requirement for testamentary trusts and certain inter vivos trusts)

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ADDITIONAL STATUTORY PROVISIONS

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State Decanting Statute Reference Guide & Outlines

State Statute Name Alaska Alaska Stat §13 36 157 Alaska Alaska Stat. §13.36.157 Arizona

• Ariz. Rev. Stat. Ann. §14-10819

Delaware 12 Del. C. §3528 Florida

• Fla. Stat. §736.04117

Indiana

• Ind. Code §30-4-3-36

Missouri Missouri Uniform Trust Code §456.4-419 Nevada 13 Nev. Rev. Stat. §163.556 New Hampshire N.H. Rev. Stat. Ann. §564-B: 4-418 New York N.Y. Est. Powers & Trusts Law §10-6.6(b) North Carolina N.C. Gen. Stat. §36C-8-816.1 South Dakota S D Codified Laws §§55-2-15 to 5-2-21 South Dakota S.D. Codified Laws §§55-2-15 to 5-2-21 Tennessee

• Tenn. Code Ann. §35-15-816(b)(27)

NOTE: The author is admitted to practice in the State of New York. The state-specific material presented herein, including the following outlines, were prepared

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based upon a review of the relevant statutes. As the author is not admitted to practice in the other states which have enacted decanting statutes, each person utilizing these materials is advised to consult with local counsel in each jurisdiction other than New York regarding the application and interpretation of each state’s respective statute.

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NEW YORK

(continued on next page)

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NEW YORK

(continued)

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Strafford Publications Webinar October 6, 2011 TRUST DECANTING: TRUST DECANTING: FLEXIBILITY AND DANGER COMMON PITFALLS

Thomas R. Pulsifer Morris, Nichols, Arsht & Tunnell LLP 1201 N. Market Street P.O. Box 1347 Wilmington, DE 19899‐1347 Telephone: (302) 351‐9226 Facsimile: (302) 425‐4682 tpulsifer@mnat.com www.mnat.com

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Trust Decanting: Flexibility and Danger C Pitf ll Common Pitfalls

• I.

Introduction

A. At least ten states permit decanting by statute (Alaska; Arizona; Delaware; Florida; Nevada; New Hampshire; New York; North p Carolina; South Dakota; and Tennessee) B. Superficial similarities in the statutes disguise important and sometimes subtle differences C. Rules regarding availability; circumstances in which decanting is permitted; permissible terms of recipient trust; formal requisites

• f decanting; and many other aspects of the decanting

transaction vary from State to State transaction vary from State to State D. The statutes offer many valuable options and opportunities but inevitably entail significant risks E. “Forewarned is forearmed” E. Forewarned is forearmed

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fl f l b l f h

• II.

Conflicts of Law; Availability of the Statue

A. The proper conflicts of law analysis applicable to statutory d ti t ti i ffi i tl l t b l i decanting transactions is sufficiently novel so as to be unclear in its detail B. Typical fact patterns create many superficial issues amenable to easy resolution 1. Trusts governed in part by the laws of multiple jurisdictions 2. Trusts have co‐fiduciaries in multiple jurisdictions C. Some outlier cases may create true traps for the unwary 1. Administration governed by laws other than the laws of the trust’s situs 2. Trusts having no clear situs D Proper analysis probably follows Wilmington Trust Company v D. Proper analysis probably follows Wilmington Trust Company v. Wilmington Trust Company, 26 Del. C. 397, 1942) but this is not necessarily so. See 12 Del. C. § 3528(f); compare AS 13.36.157; A.R.S. 14‐10819(B) E C ld f ll i t t t b k th l ? E. Could following a statute break the law?

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III St t t R i it C diti Li it ti

• III. Statutory Requisites; Conditions; Limitations

A Identifying the nature of the trustee’s principal

• A. Identifying the nature of the trustee s principal

distribution power; absolute discretion v. ascertainable standard

• B. Statutory safeguards; express and implied limitations
• C. Compliance with ascertainable standard

ddi b fi i i d i l i b fi i l

• D. Adding beneficiaries; reordering or altering beneficial

interests of non‐current beneficiaries

• E. Reduction in fixed income interest and other
• E. Reduction in fixed income interest and other

anomalies

• F. Cures: Releases and virtual representation
• G. Perhaps incurable powers deficiency problem

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IV T t Li bilit d P ti i ti

• IV. Trustee Liability and Participation
• A. Issues encountered in obtaining trustee acquiescence

to a proposed decanting

• B. Protecting the trustee from liability
• C. Law governing releases and consents; virtual

representation; fiduciary liability and standard of care

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V M h i l I

• V. Mechanical Issues
• A. Filing requirements

B N i i

• B. Notice requirements

C Other statutory formalities

• C. Other statutory formalities

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VI G ti Ski i T f T

• VI. Generation‐Skipping Transfer Tax

Considerations

• A. Treasury Reg. § 26.2601‐1(b)(4)(i)(D)
• 1. Modification v. exercise of a power
• B. Grandfathered trusts v. other exempt trusts

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Strafford Publications Webinar October 6, 2011 TRUST DECANTING: FLEXIBILITY AND DANGER STRATEGIES

dd l b h Todd A. Flubacher Morris, Nichols, Arsht & Tunnell LLP 1201 N. Market Street P.O. Box 1347 l Wilmington, DE 19899‐1347 Telephone: (302) 351‐9226 Facsimile: (302) 425‐4682 tflubacher@mnat.com www.mnat.com

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STRATEGY OVERVIEW STRATEGY OVERVIEW

• Evaluate trustee’s power to decant

Evaluate trustee s power to decant

• Evaluate trustee’s duties in connection with

decanting decanting

• Determining the applicable law
• Address trustee’s risk
• Implementation

p

• Plan ahead

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BEFORE DECANTING, THERE ARE TWO TRESHHOLD ISSUES TRESHHOLD ISSUES

• First, you must determine whether the trustee has the power to decant.

In other words, is it possible to decant from the current trust to a new trust with the desired terms under the applicable statute and the trust instrument?

• Second, the decanting must be consistent with the trustee’s applicable

fiduciary duties for making a distribution. In other words, are the changes that the trustee will be making to the governing instrument consistent i h h ’ d i f l l i i li d d i with the trustee’s duties of loyalty, impartiality and care, and consistent with the standards for a distribution of principal?

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THE TRUSTEE’S POWER VS. DUTIES THE TRUSTEE S POWER VS. DUTIES

• If the trustee doesn’t have the power to decant under the

p specific circumstances, then decanting is simply not possible.

– The Trustee must have the power to distribute principal. The differences between the original trust and the new trust must be – The differences between the original trust and the new trust must be permitted under the applicable statute.

• However, the issue of whether decanting is consistent with

fiduciary duties can often be overcome be releases and/or consents from the beneficiaries.

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TRUSTEE’S POWER TO DECANT TRUSTEE S POWER TO DECANT

• The trustee must have the power to distribute principal.

A i h h h di ib ll f h i i l f h

• Assuming the trustee has the power to distribute all of the principal of the

trust, one must then look at the original instrument and the new instrument, identify the differences between them, and assess whether the proposed changes are permissible under the applicable statute.

It i ll d i bl t t l l l t k thi t d li bl l – It is generally advisable to get local counsel to make this assessment under applicable law.

• Typically, administrative provisions can be modified in almost any way that is

desired.

– If the only differences between the original instrument and the new instrument are administrative in nature and the beneficial interests will remain the same then the analysis is administrative in nature, and the beneficial interests will remain the same, then the analysis is generally quite simple.

• However, if the decanting alters the beneficiaries’ interests, then close scrutiny

is necessary to ensure that the new instrument does not run afoul of the applicable statute. applicable statute.

– Generally, you cannot add beneficiaries or change or eliminate the interests of beneficiaries who are currently not proper objects of an exercise of the power to distribute principal. – Different statutes may also have other specific limitations (such as the inability to change the income interest under a marital trust or change the vesting of an interest under a 2503(c) trust) trust).

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THE TRUSTEE’S FIDUCIARY DUTIES

• When a trustee decants, it is making a distribution of the trust assets pursuant

to the terms of the original instrument and in accordance with the trustee’s to the terms of the original instrument, and in accordance with the trustee s applicable fiduciary duties.

• In exercising its discretion, the trustee must uphold its duties of impartiality,

care and loyalty to all of the trust beneficiaries. f h i d d f ki i i l di ib i i h i i l

• If there is a standard for making principal distributions in the original

instrument, such as an ascertainable standard, then the decanting may still be performed, however, the decanting must comply with the applicable standard. h h h d h l f f

• Where a trustee has the power to invade the principal of a trust for a

beneficiary that is subject to a standard, the trustee owes the other beneficiaries of the trust the duty of care to make some investigation to learn whether the condition precedent to the right to the principal exists and justifies the distribution justifies the distribution.

• If the trustee simply abdicates its duties and acts solely upon the request of

the beneficiaries, then this potential failure to exercise any discretion concerning the distribution could result in an abuse of discretion.

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STANDARD OF REVIEW FOR TRUSTEE’S EXERCISE OF DISCRETION OF DISCRETION

• If the trustee has discretion to make distributions under the
• riginal instrument, then the decision to make the

distribution would typically be reviewed by a court under an abuse of discretion standard abuse of discretion standard.

• The trustee should process the decision through its usual

procedures for making a discretionary distribution.

– The trustee should make the decision through its discretionary distribution committee. – The trustee should investigate the facts and circumstances. g – It may be advisable to get advice from legal counsel. – The process should be documented.

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WHAT LAW APPLIES? WHAT LAW APPLIES?

• The decanting is not possible if the laws of a jurisdiction with a common law or

statutory power to decant does not apply You must effectively avail yourself statutory power to decant does not apply. You must effectively avail yourself

• f the enabling law.
• Many statutes provide that the decanting shall be viewed as an exercise of a

power of appointment. Under Delaware law, the validity of the exercise of a power of appointment is governed by the laws of the jurisdiction in which the power of appointment is governed by the laws of the jurisdiction in which the trust is administered. The Delaware decanting statute provides that the statute shall apply to any trust administered in Delaware.

• However, other states may have a different conflicts of laws approach to the

applicability of a decanting statute applicability of a decanting statute.

• The issues of situs, governing law and place of administration can become

complicated, particularly if a trust is being moved to a jurisdiction in order to utilize a decanting statute.

• If these issues are not addressed, there can be risk that the decanting was not

proper, or that the trustee cannot effectively obtain releases.

– It may be necessary to get legal counsel in one or more jurisdictions to address these multi‐ jurisdictional issues.

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TRUSTEE LIABILITY CONCERNS TRUSTEE LIABILITY CONCERNS

• A trustee will generally be concerned about the potential liability to

b fi i i f b h f fid i d i i d i h i i f beneficiaries for breach of fiduciary duties associated with its exercise of discretion to appoint the trust assets to the new trust, unless the reasons for the decanting are so ministerial and innocuous that it poses little or no risk to the trustee.

• The risk could be limited, or eliminated, if all of the beneficiaries consent to

the decanting and release the trustee for all liability in connection with it.

• Of course, it is not always the case that all of the beneficiaries are living adults

d th ft ti t i d b fi i i h i ht t ti ll and there are often contingent remainder beneficiaries who might potentially complain in the future.

• Fortunately, many jurisdictions, like Delaware, have virtual representation

statutes that can effectively bind all present and future beneficiaries of the y p trust if all of the adult beneficiaries release the trustee, and there is no conflict

• f interest between those beneficiaries and the parties represented (this is

more easily accomplished when the changes caused by the decanting are administrative in nature and are not changes to beneficial interests) administrative in nature and are not changes to beneficial interests).

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TRUSTEE LIABILITY CONCERNS TWO LINES OF DEFENSE TWO LINES OF DEFENSE

• A trustee should have two lines of defense in connection with a decanting,

if the trustee has the power to make principal distributions in its discretion.

• First, the trustee can get release and indemnification agreements from the

beneficiaries with virtual representation binding the minors and unborns.

• Second, even if there is some issue with the release and indemnification,

the trustee’s actions will be judged under the abuse of discretion standard.

• This provides that the trustee’s exercise of discretion will only be
• verturned if it’s actions were arbitrary or capricious, not merely

unreasonable.

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DECANTING CAN BE VIEWED AS BOTH A TERMINATION OF THE OLD TRUST AND A REMOVAL OF THE TRUSTEE OF THE OLD TRUST AND A REMOVAL OF THE TRUSTEE

DECANTING AS A TERMINATION OF THE OLD TRUST Wh i d d h f h fi fl i h d d h

• When a trust is decanted, the assets of the first trust flow over into the second trust, and the

first trust is terminated. Not only will the trustee typically seek releases in connection with its exercise of discretion to decant, but it will likely seek releases and an accounting, and any

• ther typical procedure that a trustee in its particular jurisdiction will seek when a trust is

terminated and its service as trustee ends. terminated and its service as trustee ends. DECANTING AS A REMOVAL OF THE TRUSTEE

• Since the assets have been transferred to a new trust, which may or may not have the same

trustee as the original trust, a decanting can also be viewed from the trustee’s perspective as a removal of the trustee of the first trust and an appointment of a successor trustee. a removal of the trustee of the first trust and an appointment of a successor trustee. consequently, it is advisable to include an indemnification provision in the new, second trust instrument that runs to the trustee of the original trust, even if the individual or corporate identity of the trustee is the same for both trusts (such individual or entity will still be serving in two different capacities).

• Thus, the outgoing trustee knows that if claims, taxes, fees, liabilities, etc. from the original

trust arise in the future, which would have been properly payable from the trust, the trustee

• f the original, now defunct trust can still have some recourse against the new trust to be

reimbursed.

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IMPLEMENTATION IMPLEMENTATION

• Some statutes may permit the trustee to provide notice to beneficiaries or

f l h h file a notice with the court.

• Generally, a decanting requires a written instrument, signed by the trustee

and notarized. D di th b f h i ht i l d ft

• Depending upon the number of changes, you might simply draft a

decanting instrument that provides that the new trust shall be held in accordance with all of the terms and conditions of the original trust subject to some enumerated changes and additions. j g

• Alternatively, you might draft an entirely new trust agreement and also

draft a decanting instrument that memorializes the trustee’s exercise of its power to decant the assets of the original trust to the new trust.

– The new trust could be a declaration of trust, or have the trustee of the original trust as the grantor, or it could have some other person as the grantor.

• Trustee Release, indemnification and approval of account.

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PLANNING AHEAD FOR DECANTING PLANNING AHEAD FOR DECANTING

• By far, the biggest hurdle in accomplishing a decanting is the trustee’s

reluctance to take on the risk associated with the exercise of discretion.

• When drafting new trust agreements, it is advisable to draft enabling

provisions in the agreements which limit a trustee’s liability and provides indemnification in connection with a decanting.

• This kind of advanced planning might provide the flexibility and protection

for a trustee to enable the trustee to perform a decanting in the future, if it is desired by the beneficiaries, without the delay and expense of releases, accountings, indemnifications, etc.

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