Presented by Richard Mayberry to lawyers nationwide by telephonic. CLE first presented in 2011. Determining the Need or Purpose for a Trust The use of trusts, particularly revocable trusts, originally from California, has drastically increased the past two decades. Revocable trusts are often the foundation of many estate plans. States that had burdensome probate procedures were the first to see the use of trusts. A revocable trust, also called a “living trust” or “revocable living trust,” is an inter vivos trust. The creator of the trust, called “grantor” or “settlor,” retains the power to revoke the trust and re-acquire the assets. In comparison to one of the probate procedures of the District of Columbia known as the unsupervised administration of an abbreviated estate, the Commonwealth of Virginia has a more burdensome probate procedure. The use of revocable trusts was a must in standard estate planning when there was no possibility to waive the requirement of an accounting for trusts created under a Will. Nowadays it is common practice to waive the requirement of trust accounting for any trusts created under a Will. The choice of incorporating a revocable trust in a standard estate plan now depends on the following criteria: 1. A Revocable Trust Can Never Replace a Will. If a revocable trust is created, it is always accompanied by a small Will called a “Pour-Over Will.” A Will is needed because the trustee does not have the statutory authority to stand in the decedent’s shoes with respect to marshaling the decedent’s assets, administering the decedent’s general estate, and distributing the decedent’s assets to the appropriate beneficiaries. The trustee has only those powers that are granted pursuant to the trust instrument and has authority only over those assets that are delivered to the trustee, meaning that are titled into the trust or for which the trust is a beneficiary. 2. More Expensive Planning. The cost of creating a revocable trust is more expensive and time consuming because the creator also will have to title all of the assets into the revocable trust. Some assets may be difficult to title under the trust. For instance, a mortgage company may have a clause due on transfer, meaning that the mortgage company does not allow the transfer of the real estate property into the trust. Sometimes, when a client wants to refinance his real estate property, the real estate property must be transferred into the client’s sole name so that the client can qualify for a mortgage. Often, the property can be re-titled immediately afterward into the trust, but not always. More often, the higher cost exists because real estate is titled into the trust, requiring the execution and recordation of a deed, and because there are many other assets to re-title, which is time consuming and expensive if the client wants his attorney to do it. In certain law firms, a full-time paralegal may be assigned to handle the re-titling of the assets into trusts. 3. Understanding the Trust. If your client does not understand how a trust works and will not have the discipline for keeping assets in the trust, a simple Will may be a better planning device. 4. Avoiding Probate Costs. Depending on the wealth of a client, probate costs may matter more, whereas for some small estates the cost of a revocable trust plan and its re-titling could be higher than the probate costs. Similar, less expensive re-titling of assets – such as joint property with right of survivorship, or TOD and POD accounts – permits a client to avoid probate. On the other hand, if the client has real estate in several states, the cost of probate can be substantially higher. In this case, a revocable trust is often recommended. 5. Court Supervision. A revocable trust will permit your client to avoid court supervision required under probate, which usually includes the filing of an inventory and yearly accountings. The filing of an accounting required in an estate administration is burdensome, particularly since the account needs to be balanced to the penny and certain paperwork is required such as providing a copy of all of the cashed checks. However, in certain circumstances, court supervision may be a blessing for the protection of the beneficiaries. In particular, when the trustee has no financial background, a review by a professional might be preferable. 6. Assuming that Nothing Needs to be Done at Death. When the clients do not understand the mechanics of the revocable trust, not only do they forget or not completely re-title their properties into the trust, but they often believe that nothing needs to be done at the death of the first spouse and won’t see an attorney after the death of the first spouse. 7. Assets Management. A revocable trust is a more complete document. A Will only provides instructions for the transfer of assets upon the death of the testator. A revocable trust provides an effective method for asset management and protection of resources in the event of illness or incapacity. Although a power of attorney authorizes the agent to reach the assets, it is usually only in a trust that you will find instructions on how to take care of the grantor/settlor in case of incapacity. Wishes regarding home care or acceptance to live in a nursing home can be included in the documents. Instructions to take care of a third person, such as a disabled child, can be incorporated into the trust instrument. 8. Privacy. When probated, a will becomes a public document. Anybody can request a copy. A revocable trust is a private document that permits keeping the transfer of assets private. 9. Challenges. It may be more difficult to successfully challenge the validity of a trust funded during the lifetime of the grantor/settlor than to prevail in a Will contest. For instance, ongoing management of a trust makes it difficult to demonstrate incapacity or undue influence. It is also more difficult to discover the trust and institute legal action than it is to intervene in the probate process. 10. Contractual benefits. It is sometimes difficult or inconvenient to designate a testamentary trust as a beneficiary, while life insurance beneficiary designations and retirement plan benefits designations can easily be coordinated with a revocable trust. For instance, life insurance policy proceeds that are payable to the probate estate rather than the trustee of a trust would be subject to claims of creditors of the estate, probate tax, and the fees of the executor and commissioner of accounts. 11. Flexibility. A revocable trust offers more flexibility and ease of administration after the grantor’s death. There is no need to wait for the appointment of the executor and to receive the letters of qualification. Arrangements can be made for appointment of additional, substitute, and successor trustees without court intervention. By contrast, in a probate procedure, the appointment of a substitute executor is a burdensome process requiring a court petition. 12. Choice of Law and Situs. Because a revocable trust can be established somewhere other than the domicile of the grantor/settlor, jurisdictions with more favorable laws can be selected. III. Strategies for Effective Drafting A revocable trust may be drafted in the first person or the third person. The intake questionnaire is a must in order to efficiently draft a trust document. It is only by knowing what the client wants that you will be able to efficiently draft your document. Certain practitioners use assembly software such as HotDocs through WealthCounsel.com or software from other vendors. The advantage of such software is that the document generated does not carry any metadata. Metadata is defined as the data of data. It carries the history of the modifications of a document. So, if you have used a trust document drafted for John and you want to use this document to create a trust for Mary, and you send a draft electronically to Mary, Mary may be able to look at the Mega Tags of the document and find information about John. IV. Tips for Drafting Common Trusts 1. Declaration. The trust normally begins with an initial paragraph (preamble) that identifies the settlor and the trustee who are entering into the trust agreement. It can also be a statement that the trust is created as a declaration in which the settlor and the trustee are one and the same. This preamble also sets forth the date when the trust is created. 2. Purpose. It is important to state the purpose of the trust in case of any future challenge of the creation and purpose of the trust. 3. Family and Trustees. Although there is no need to identify the family of the settlor as needed in a Will, it is recommended to identify the family of the settlor for clarification purposes. Some documents have the designation of the trustees in the middle of the trust document; I prefer having this paragraph at the beginning of the trust instrument. 4. Provisions During the Life of the Settlor. I like to have two separate parts in the trust instrument, one providing general instructions during the life of the settlor and another part providing instructions in case of disability of the settlor. During the life of the settlor, you should have paragraphs regarding the following elements: (1) identification of the trust property or its funding; (2) the trust revocability and its amendments; (3) the disposition of income and principal; and (4) tax provisions (grantor trust status). Please note that for trusts created on or after July 1, 2006, there is a presumption that the trust is revocable. For a trust to be irrevocable, the trust instrument shall expressly state it. For trusts created before this date, the presumption is reversed. Thus, the settlor did not have the power to amend or revoke the trust on his/her own unless the power to revoke and amend was expressly reserved. In case of incapacity, you should have paragraphs regarding the following: (1) definition of incapacity and what is the procedure to declare the settlor incapacitated; (2) procedure in case of regain of capacity; (3) distribution of income and principal during the incapacity; (4) instructions for the management of certain assets such as the payment of life insurance premiums; and (5) instructions regarding the care of the settlor. 5. Provisions upon the death of the settlor. Usually you will have several provisions regarding the payment of expenses and debts, then provisions regarding the distribution of the balance of the trust. a) Payment of expenses. Provisions normally provide that the trustee is authorized (but not necessarily obligated) to pay funeral expenses, debts, administration and legacies contained in the Will, taxes and transfer taxes. This provision is of particular importance when the trust has been funded by the settlor and the assets in the settlor’s probate estate are insufficient to satisfy the expenses and bequests of the settlor’s Will. It is crucial that the tax clause in the settlor’s Will be coordinated with any direction in the trust instrument concerning the payment of taxes. b) Distribution of assets. It is recommended to have a separate paragraph about the distribution of tangible personal property from the residue of the trust. With a separate paragraph the tangibles are considered bequests that do not carry income distribution, whereas if they are included in the balance of the trust, any distribution of tangibles carries out income even though the tangibles are not generating income. 6. Trustee Provisions. The trustee should be granted adequate management powers, such as those specified in section 64.1-57 of the Virginia Code, which may be incorporated into a revocable trust by references. In addition, the trustee should be authorized to retain certain assets transferred to the trust by the settlor either during the settlor’s lifetime or acquired assets that do not meet the standard of Virginia’s prudent investor rule. The trustee should be allowed to resign with adequate notice, allowed to appoint a successor or co-trustee, and compensated as agreed upon. The trust should provide for the exercise of powers in the decision-making process when multiple trustees are involved. The trust instrument shall also provide for the exercise of powers in the decision-making process when multiple trustees are involved. Consideration should be given to naming an independent trustee or a trust advisor who would have the right to remove and replace any trustee, and possibly hold a limited power of amendment, upon the settlor’s death or disability. A new trend is to create a family committee for certain situations. 7. Spendthrift Provisions. A spendthrift provision is designed to protect the beneficiary’s interest in the trust. Certain states allow spendthrift provisions for a settlor. They are called Domestic Assets Protection Trusts (DAPT’s). The following states have adopted legislation to authorize DAPT’s: Alaska, Delaware, Hawaii, Nevada, New Hampshire, Rhode Island, South Dakota, Tennessee, Utah, and Wyoming. To be valid, the spendthrift provision must restrain both voluntary and involuntary transfers. Important exceptions to the creditor protection afforded by a spendthrift provision include the following: (i) The abilities of children to collect child support from the beneficiary of the trust. (ii) Creditors can seek and obtain court orders attaching distributions to or for the benefit of the beneficiary. In addition, creditors can reach a distribution of income or principal that a trustee was required to make to a beneficiary (a “mandatory distribution”) if the trustee fails to make the distribution within a reasonable time after the designated distribution date. (iii) Federal, state, and local governments cannot be prejudiced by the spendthrift provisions. 8. Survivorship Provision. The trust instrument can provide for survivorship presumptions and establish survivorship periods. It is essential that the trust provision be coordinated with the Will. 9. Rule Against Perpetuities Clause. Section 55-13.3 of the Virginia Code allows a grantor/settlor or testator to waive the rule against perpetuities as it applies to personal property held in trust. A clause waiving application of the rule may be desirable in some cases. The trust should contain a clause that requires the termination of any trust upon the expiration of the maximum period permitted under the rule against perpetuities. In addition, the trust shall direct the distribution of trust property upon such termination. 10. Division, Consolidation, and Termination of Trust. Even if the Virginia Code authorizes the trustee to divide, consolidate, or terminate trusts, it is recommended to give an express authority to the trustee to do so without having to petition the court. It could be very important for certain marital deductions or generation-skipping tax planning or to terminate small trusts where the continuation of such a trust would be uneconomical. 11. Governing Law. Because a trust is a private document, the governing law needs to be specified. In some situations, both the governing law and the choice of situs need to be carefully considered. Blocking the situs of the trust or its governing law may not always be a good choice because if the settlor moves to a different state, it may be preferable to have the trust adjusted to the new location. This may even be the case for a trustee. Finding competent local counsel is always important and sometimes the original situs of the trust may not be relevant. V. Executing the Trust 1. Execution Provisions. The trust should be signed by both the settlor/grantor and the trustee on the date the trust is created. Although there are no strict legal requirements, the signatures should be supported by either a notary or witness and in case of a bank or trust company, a corporate attestation. Because certain states require that a trust document be executed in front of a notary and two witnesses, certain practitioners prefer using this procedure requirement to ensure that the trust document will be recognized in all of the states of the United States. 2. Amendment of the Trust. As long as the trust is revocable it may be modified by amendments. In this age of word processing, it is frequently cleaner and more efficient to rerun the entire trust with the changes rather than to have multiple amendments. Because a trust is identified by the date of its creation, however, the common practice is to amend and restate the trust in its entirety so that the original date of the trust and taxpayer identification number can be preserved. VI. Provisions for Changes to the Trust Instrument Savings Clauses. Certain concepts such as generation-skipping tax or the preservation of the marital deduction are required to be defined. In addition, a savings clause may prevent any unintended and inadvertent disqualification that may occur, and limitations on the trustee’s powers should be included to prevent inadvertent tax consequences. 1. Marital Clause. The trustee shall have all of the powers to “hold, invest, reinvest, manage and administer the trust property and shall have all of the powers and discretion with respect thereto as are given to the Trustee of said trust.” But this clause should include the following limitation: “except such powers and discretion the possession or exercise of which would deprive my estate of the marital deduction under the federal estate tax law, rulings and regulations with respect thereto.” 2. Trustee Powers and Tax Clauses. To ensure that the trust exists as an irrevocable trust upon the death of the settlor/grantor, it is recommended to have the following limitation of the trustee powers: “No Trustee (other than the settlor) shall participate, directly or indirectly, in any exercise of discretion to make a distribution to or for its own benefit, except as expressly permitted herein and subject only to an "ascertainable standard" within the meaning of federal estate and gift tax rules. No Trustee (other than the settlor) shall participate, directly or indirectly, in the exercise of discretion to make a distribution to or for the benefit of any person in discharge of such Trustee's own obligation of legal support. Trustees who are beneficiaries of other Trust shares shall be prohibited from exercising reciprocal powers to make Trust distributions for the benefit of other Trustees who are beneficiaries of other Trust shares. If at any time all of the Trustees shall be precluded from exercising a discretion otherwise granted the Trustee, an "Independent Trustee" -- a person (including a corporation authorized to perform trust services) who is not a present or contingent beneficiary of any Trust share and who is neither related nor subordinate (within the meaning of section 672(c) of the Internal Revenue Code) to any beneficiary or any person appointing such Independent Trustee -- may be named by the acting Trustee(s) as an additional Trustee, and such Independent Trustee may be granted the sole authority to exercise such discretion.” 3. GST Tax Clauses. It is recommended to include a power of appointment to avoid GST tax. Below is a sample of such a clause: “An Independent Trustee may, in its discretion, grant to the income beneficiary of any Trust hereunder a testamentary general power of appointment, exercisable only by specific reference to the power in such beneficiary's Last Will; provided, however, that (1) the general power of appointment may only be granted in the discretion of an Independent Trustee and shall apply only to assets that are not exempt from Generation Skipping Transfer Tax (GST) and (2) the grant of the power of appointment shall be made only if in the discretion of the Independent Trustee such grant will tend to reduce the overall transfer taxes (estate and GST) that would otherwise be imposed on the assets subject to the power. The power may be exercisable in favor of the beneficiary's estate, the creditors of the beneficiary's estate, and any other person, outright or in Trust. The Independent Trustee may require that the exercise of the general power granted hereunder shall be subject to the condition subsequent that it shall be valid only if the Independent Trustee shall consent to the beneficiary's specific exercise, after it has been made. No person who is a beneficiary of any Trust hereunder and who is a Trustee of any Trust hereunder shall participate, directly or indirectly, in the exercise of any discretion relating to a grant of a power of appointment hereunder, including without limitation the discretion to grant a power of appointment and/or consent to any specific exercise, nor may any exercise of any power granted in this paragraph result in a benefit to any Independent Trustee participating in the exercise of such discretion. This power is entirely discretionary -- no Trustee shall be liable to any beneficiary for the exercise or non-exercise of this discretion.” . | Modern Approach to Standard Elements and Clauses Trust Code Act The Commonwealth of Virginia has adopted in 2005 the Uniform Trust Code (“VUTC”). Its effective date was July 1, 2006. The VUTC is located in Chapter 31 of Title 55 of the Virginia Code. The Virginia Code uses the word “settlor” rather than the word “grantor,” whereas the Internal Revenue Code uses the word “grantor.” The VUTC is divided into 11 articles. Article 9 is reserved for a future Uniform Prudent Investor Act. The VUTC is a default statute, but for Section 55.541.05 which sets forth the following mandatory provisions: 1) The requirements for creating a trust 2) The duty of a trustee to act in good faith and in accordance with the terms and purposes of the trust and the interest of the beneficiaries 3) The requirement that a trust and its terms be for the benefit of its beneficiaries, and that the trust have a purpose that is lawful, not contrary to public policy, and possible to achieve 4) The powers of the court to modify or terminate the trust 5) The effect of a spendthrift provision and the rights of certain creditors and assignees to reach a trust as provided in Article 5 of the VUTC 6) The power of the court under Section 55-547.02 to require, dispense with, modify or terminate a bond 7) The power of the court to adjust a trustee’s compensation specified in the terms of the trust which is unreasonably low or high 8) The effect of an exculpatory term 9) The rights under Sections 55-550.10 through 55-5500.3 of a person other than a trustee or beneficiary 10) Period of limitation for commencing a judicial proceeding 11) The power of the court to take such action and exercise such jurisdiction as may be necessary in the interest of justice The VTUC sets trustees’ duties among which are certain duties toward beneficiaries and qualified beneficiaries. Most of the duties can be waived. One often will find that these obligations are waived during the life of the grantor and the grantor’s spouse and start to be implemented afterward. It is very important for the trustee to check the trust document regarding these obligations and under which circumstances they are waived. Since the default rules may apply to trusts drafted prior to the effective date of the VUTC, a lot of trusts will fall under the default rules. Therefore, one needs to be familiar will all of the default rules of notices, obligations to report, and obligations to file inventories and accountings with the Commissioner of Accounts. VUTC sets new Trustee duties for beneficiaries and qualified beneficiaries 1. Duty to Inform. Section 55.548.13(A) of the Virginia Code provides that “A trustee shall keep the qualified beneficiaries of the trust reasonably informed about the administration of the trust and of the material facts necessary for them to protect their interest. Unless unreasonable under the circumstances, a trustee shall promptly respond to a beneficiary’s request for information related to the administration of the trust.” By providing a copy of the annual trust report, the trustee will satisfy this obligation. However, additional information should be submitted by the trust for special circumstances, for instance the sale of a closely held business interest or other hard-to-value asset. 2. Duty to Provide Notice. Section 55-548.13 (B) of the Virginia Code requires the trustee to provide notice upon the occurrence of certain events: (1) Within 60 days after accepting a trusteeship, the trustee shall notify the qualified beneficiaries of the acceptance and of the trustee’s name, address and telephone number. (2) Within 60 days after the date the trustee acquires knowledge of the creation of an irrevocable trust, or the date the trustee acquires knowledge that a formerly revocable trust has become irrevocable, whether by the death of the settlor or otherwise, the trustee shall notify the qualified beneficiaries of the trust’s existence, of the identity of the settlor or settlors, of the right to request a copy of the trust instrument, and of the right to a trustee’s report. (3) The trustee shall notify in advance the qualified beneficiaries of any change in the method or rate of the trustee’s compensation. Notices shall be sent via first-class mail, personal delivery, delivery to the person’s last known place of residence or place of business, or a properly directed electronic message[2]. 3. Duty to Provide a Copy of the Trust Instrument. In addition, Section 55-548.13 (B) of the Virginia Code provides that upon request of a beneficiary, the trustee shall promptly furnish to the beneficiary a copy of the trust instrument. You will notice that in the sample form mentioned in the paragraph immediately above, I usually automatically include a copy of the trust. I believe in open communication with the beneficiaries. The more they are informed from the beginning, the less they can complain afterward since they have been provided notice of the actions and powers of the trustee. 4. Duty to Report. It may seem redundant to have an additional paragraph regarding the duties of the trustee to report while we already have a paragraph which sets duties to inform. However, Section 55-548.13(C) provides specific instructions on how a trustee may provide reports not to the beneficiaries but to the distributees. A trustee shall send to the distributees or permissible distributees of trust income or principal, and to other qualified or nonqualified beneficiaries who request it, at least annually and at the termination of the trust a report of the trust property, liabilities, receipts, and disbursements, including the source and amount of the trustee’s compensation, a listing of the trust assets and, if feasible, their respective market values. Upon a vacancy in a trusteeship, unless a co-trustee remains in office, a report shall be sent to the qualified beneficiaries by the former trustee. A personal representative, conservator, or guardian may send the qualified beneficiaries a report on behalf of a deceased or incapacitated trustee. The VUTC authorizes the beneficiaries to waive the right to a trustee's report or other information otherwise required to be furnished under Section 55-548.13 of the Virginia Code. However, a beneficiary, with respect to future reports and other information, may withdraw a waiver previously given. Since the duties of the Trustee vary toward Qualified Beneficiaries and Beneficiaries, and Distributees and Permissible Distributees, it is important to know the distinctions. distinctions Qualified and Permissible 1. Beneficiary. Section 55-541.03 of the Virginia Code defines a beneficiary as a person who has a present or future beneficial interest in a trust, vested or contingent; or as a person who holds a power of appointment over trust property in another capacity than a trustee. 2. Qualified Beneficiary. The term “qualified beneficiary” is defined under Section 55-541.03 of the Virginia Code as follows: "Qualified beneficiary" means a living or then existing beneficiary who, on the date the beneficiary's qualification is determined, (i) is a distributee or permissible distributee of trust income or principal; (ii) would be a distributee or permissible distributee of trust income or principal if the interests of the distributees described in (i) terminated on that date, but the termination of those interests would not cause the trust to terminate; or (iii) would be a distributee or permissible distributee of trust income or principal if the trust terminated on that date. In addition, Section 55-541.10 of the Virginia Code expands the list of qualified beneficiaries to the following: (i) Whenever notice to qualified beneficiaries of a trust is required under this chapter, the trustee shall also give notice to any other beneficiary who has sent the trustee a request for notice. (ii) A charitable organization expressly designated to receive distribution under the terms of a charitable trust has the rights of a qualified beneficiary under this chapter if the charitable organization, on the date the charitable organization’s qualification is being determined: 1. Is a distributee or permissible distributee of trust income or principal; 2. Would be a distributee or permissible distributee of trust income or principal upon the termination of the interests of other distributees or permissible distributees then receiving or eligible to receive distributions; or 3. Would be a distributee or permissible distributee of trust income or principal if the trust terminated on that date. (iii) A person appointed to enforce a trust created for the care of an animal or another noncharitable purpose as provided in § 55-544.08 or 55-544.09 has the rights of a qualified beneficiary under this chapter. (iv) The attorney of the Commonwealth has the rights of a qualified beneficiary with respect to a charitable trust having its principal place of administration in the Commonwealth but need not be given notices or information required under §§ 55-547.05 and 55-548.13 unless otherwise requested. 3. Distributee v. Permissible Distributee. These words are not defined in the VUTC or most legal dictionaries. A distributee is a person who is entitled to receive a share from the trust. A permissible distributee would be a person that would be allowed or permitted to receive a share from the trust. Trustee’s Investment Powers Another important element to concentrate on is the trustee’s powers toward investments. The standard of investment has drastically changed in the past few decades. 1.) Standard of an Ordinary Prudent Man The standard of an ordinary prudent man who will be dealing with his own property applies to the trustee. However, the trustee will be personally liable for all losses resulting to the trust estate in case of negligence or willful misconduct. In addition, the Courts apply a higher standard of care for trustees who have special financial skills. The historical rule governing the investment of trust property was known as the “Prudent Man Rule.” This Rule mandated that a trustee preserve the trust property and make it productive. Ultimately, the Prudent Man Rule was replaced by the more flexible “Prudent Investor Rule,” which allows a trustee greater flexibility in investments. In essence, the Prudent Investor Rule requires a trustee to preserve the trust property and to make it productive, while acting with reasonable care, skill, caution, and undivided loyalty to the beneficiaries. Trustees should be aware that fiduciary litigation is on the rise. The Center of Fiduciary Analysis reports a 22% compound annual increase in fiduciary litigation.[3] With the development of technology, beneficiaries can find a lot of information online and become more knowledgeable about their rights and fiduciaries’ duties. For instance, the American College of Trust and Estate Counsel (ACTEC) has published a guide titled “What It Means to Be a Trustee: A Guide for Clients.”[4] The guide provides an excellent summary of a trustee’s duties that is accessible and understandable for a layperson, who might be a beneficiary or considering to accept a trustee position. Trustees are subject to liability by not investing following the Prudent Investor Rule or by lack of diversification of the trust portfolio. List of Securities Sections 26-40 and 26-40.01 of the Virginia Code provide a list of securities into which fiduciaries can invest that are considered prudent investments. The list includes bonds, notes, obligations issued by governmental entities or political subdivisions of the Commonwealth of Virginia, other states, and the United States. So long as the trustee invests in one of the securities listed in the statute, the trustee will suffer no penalties or potential liability for mismanagement of trust assets. Scott v. United States, 86 F. Supp. 2d 664, 2002 U.S. dist. LEXIS 4074 (E.D. Va. 2002), aff’d. 328 F. 3d 132 94th Cir. Va. 2003). Waiving the Prudent Man Rule The Commonwealth of Virginia has adopted the Prudent Investment Act. The Prudent Man Standard was developed in Harvard College v. Amory.[5] The theory is that being prudent meant investing enough of the trust assets in high-quality bonds to produce adequate income and investing the rest in conservative stocks to preserve the value of the trust corpus for the remainder beneficiaries. The goal was to select the right securities. Such securities could be identified either by studying market trends or by studying economic data about companies and industries. It was the trustee’s responsibility to take the time to analyze the relevant data or consult an expert who had done so to ensure that the asset purchased represented the best possible value for the money invested. Changes in economic conditions and the growing acceptance of Modern Portfolio Theory caused many to question the continued viability of the income rule and the model for picking trusts and securities. When the trust document waives the Prudent Man Rule, beneficiaries have no recourse against the trustee for poor investment performance. In Hoffman v. First Virginia Bank of Tidewater[6], the court held that when the Prudent Man Rule has been waived, the trustee could only be liable for fraud, dishonesty or bad faith. Under the Will, the trustee was given power to invest in any type of property “regardless of diversification or State laws.” The trustee invested more than one-third of the trust assets in REIT securities which became “substantially worthless.” The court decided that the trustee was not liable. Diversification of the Trust Portfolio Although in the Commonwealth of Virginia the trustee may be protected by investing in the list of securities mentioned above, the trustee may want to follow the general trend of recommended methods of investment. The trustee needs first to review carefully the trust document and look for specific directions. In most states, the trustee has a duty to the beneficiaries to diversify the trust portfolio. It has been proven that diversification reduces risk without reducing returns. This is because volatility reduces returns, and diversifying a portfolio reduces volatility. Although this duty is not absolute and varies among jurisdictions, most courts justify the imposition of the duty to diversify on the theory that diversification spreads the risk of investments, with the ultimate goal of protecting the trust assets. In the late 1960s, views on fiduciary investment practices and the use of available investment products evolved considerably. Investments once believed to be risky, such as options, futures, and foreign investments, suddenly became accepted parts of a diversified investment portfolio. Because the law regarding the duty to diversify has changed with the evolution of the investment markets, it may not be unusual to find in a given state (1) older cases that reject the duty to diversify and (2) more recent cases that adopt this generally accepted duty of a trustee. It is important to remember that while a trustee must observe both the prudent investor rule and the duty of impartiality when making investment decisions, the trustee's conduct will be reviewed in the context of the portfolio as a whole, rather than investment-by-investment. Thus, it may be permissible for a particular investment to be underproductive if the trust estate as a whole is productive. The trustee has a duty to the income beneficiary to invest in assets that will produce reasonable income. At the same time, the trustee must diligently guard the safety of the trust principal. If the income beneficiary and the remainderman are different individuals, the duty of impartiality mandates that the trustee balance the income beneficiary's desire for income with the remainderman's desire for growth in principal. I recommend that the trustee have a meeting with the income beneficiaries and the remaindermen where the investment strategy plan is reviewed and market risks and tax treatments of investments are addressed. I have everybody sign the investment strategy plan or I send a memorandum after the meeting. A proper balancing of interests will vary, depending on the circumstances of the particular trust. To determine how the interests should be balanced, the trustee must consider, at a minimum, the purposes of the trust, the terms of the trust instrument, and distribution requirements outlined in the trust. In addition, the trustee must take into account other circumstances (such as the unique interests and situations of all beneficiaries) in determining how the beneficiaries' interests should be balanced. The trustee should attempt to develop creative structures within the confines of the trustee's defined duties that balance the different positions of all the beneficiaries, when making investment decisions. Investment Advisors The trust instrument may authorize the trustee to use the services of the investment advisor and even require the assistance of an investment advisor. Virginia laws do not require the trustee to consult with a financial advisor.[7] Certain trust companies accept to be a “directed trustee” meaning that the investment power is delegated to an investment advisor. The trustee, particularly if it is a professional trustee, will make due diligence on the selection of the advisor. The investment advisor will have to provide information on his or her qualifications and certifications, length of time of experience, amount of assets under management, and proven records. In addition, the trustee and the investment advisor shall execute an investment management agreement with a schedule listing the assets under management. The trustee should ensure that the agreement provides only a delegation of power, that the trustee has final authority, and that the trustee is not liable for the investment advisor’s actions. ------------------ II. A Modern Approach to Standard Elements and Clauses A. Trust Code Act The Commonwealth of Virginia has adopted in 2005 the Uniform Trust Code (“VUTC”). Its effective date was July 1, 2006. The VUTC is located in Chapter 31 of Title 55 of the Virginia Code. The Virginia Code uses the word “settlor” rather than the word “grantor,” whereas the Internal Revenue Code uses the word “grantor.” The VUTC is divided into 11 articles. Article 9 is reserved for a future Uniform Prudent Investor Act. The VUTC is a default statute, but for Section 55.541.05 which sets forth the following mandatory provisions: 1) The requirements for creating a trust 2) The duty of a trustee to act in good faith and in accordance with the terms and purposes of the trust and the interest of the beneficiaries 3) The requirement that a trust and its terms be for the benefit of its beneficiaries, and that the trust have a purpose that is lawful, not contrary to public policy, and possible to achieve 4) The powers of the court to modify or terminate the trust 5) The effect of a spendthrift provision and the rights of certain creditors and assignees to reach a trust as provided in Article 5 of the VUTC 6) The power of the court under Section 55-547.02 to require, dispense with, modify or terminate a bond 7) The power of the court to adjust a trustee’s compensation specified in the terms of the trust which is unreasonably low or high 8) The effect of an exculpatory term 9) The rights under Sections 55-550.10 through 55-5500.3 of a person other than a trustee or beneficiary 10) Period of limitation for commencing a judicial proceeding 11) The power of the court to take such action and exercise such jurisdiction as may be necessary in the interest of justice The VTUC sets trustees’ duties among which are certain duties toward beneficiaries and qualified beneficiaries. Most of the duties can be waived. One often will find that these obligations are waived during the life of the grantor and the grantor’s spouse and start to be implemented afterward. It is very important for the trustee to check the trust document regarding these obligations and under which circumstances they are waived. Since the default rules may apply to trusts drafted prior to the effective date of the VUTC, a lot of trusts will fall under the default rules. Therefore, one needs to be familiar will all of the default rules of notices, obligations to report, and obligations to file inventories and accountings with the Commissioner of Accounts. The VUTC sets new Trustee duties for beneficiaries and qualified beneficiaries as follows: 1. Duty to Inform. Section 55.548.13(A) of the Virginia Code provides that “A trustee shall keep the qualified beneficiaries of the trust reasonably informed about the administration of the trust and of the material facts necessary for them to protect their interest. Unless unreasonable under the circumstances, a trustee shall promptly respond to a beneficiary’s request for information related to the administration of the trust.” By providing a copy of the annual trust report, the trustee will satisfy this obligation. However, additional information should be submitted by the trust for special circumstances, for instance the sale of a closely held business interest or other hard-to-value asset. 2. Duty to Provide Notice. Section 55-548.13 (B) of the Virginia Code requires the trustee to provide notice upon the occurrence of certain events: (1) Within 60 days after accepting a trusteeship, the trustee shall notify the qualified beneficiaries of the acceptance and of the trustee’s name, address and telephone number. (2) Within 60 days after the date the trustee acquires knowledge of the creation of an irrevocable trust, or the date the trustee acquires knowledge that a formerly revocable trust has become irrevocable, whether by the death of the settlor or otherwise, the trustee shall notify the qualified beneficiaries of the trust’s existence, of the identity of the settlor or settlors, of the right to request a copy of the trust instrument, and of the right to a trustee’s report. (3) The trustee shall notify in advance the qualified beneficiaries of any change in the method or rate of the trustee’s compensation. Notices shall be sent via first-class mail, personal delivery, delivery to the person’s last known place of residence or place of business, or a properly directed electronic message[2]. 3. Duty to Provide a Copy of the Trust Instrument. In addition, Section 55-548.13 (B) of the Virginia Code provides that upon request of a beneficiary, the trustee shall promptly furnish to the beneficiary a copy of the trust instrument. You will notice that in the sample form mentioned in the paragraph immediately above, I usually automatically include a copy of the trust. I believe in open communication with the beneficiaries. The more they are informed from the beginning, the less they can complain afterward since they have been provided notice of the actions and powers of the trustee. 4. Duty to Report. It may seem redundant to have an additional paragraph regarding the duties of the trustee to report while we already have a paragraph which sets duties to inform. However, Section 55-548.13(C) provides specific instructions on how a trustee may provide reports not to the beneficiaries but to the distributees. A trustee shall send to the distributees or permissible distributees of trust income or principal, and to other qualified or nonqualified beneficiaries who request it, at least annually and at the termination of the trust a report of the trust property, liabilities, receipts, and disbursements, including the source and amount of the trustee’s compensation, a listing of the trust assets and, if feasible, their respective market values. Upon a vacancy in a trusteeship, unless a co-trustee remains in office, a report shall be sent to the qualified beneficiaries by the former trustee. A personal representative, conservator, or guardian may send the qualified beneficiaries a report on behalf of a deceased or incapacitated trustee. The VUTC authorizes the beneficiaries to waive the right to a trustee's report or other information otherwise required to be furnished under Section 55-548.13 of the Virginia Code. However, a beneficiary, with respect to future reports and other information, may withdraw a waive |
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