Designing Trust Protectors and Their Powers
By Craig C. Reaves, CELA
More attorneys are utilizing trust protectors in trusts they are drafting. This is especially true with special needs trusts. Whether called trust advisors, personal agents, or trust protectors, the concept is the same: someone other than the settlor, trustee, or beneficiary is empowered to direct, oversee, or consent to something relating to a trust. If this sounds vague, that’s because it is. There are many options available when deciding who should serve as a trust protector and what authority they are granted.
This article provides an overview of the myriad of options available to the drafting attorney when designing a trust protector. For more comprehensive information, refer to the materials the author presented at the NAELA 2012 Annual meeting in Seattle.
There is no universal definition of a trust protector. However, one of the better definitions was proposed by Stewart Sterk in an excellent law review article analyzing the liabilities of a trust protector.1 He defined a trust protector as a “person selected by the settlor to represent the settlor’s interests in making specific trust decisions that the settlor will be unable to make.”
In other words, according to Sterk, a trust protector’s job is to extend the influence and oversight of the settlor by making decisions and changes to the trust that the settlor would most likely have made if the settlor was living and capable.
Why Use a Trust Protector
There are essentially three reasons a person would consider using a trust protector. One is to police the trustee. Although traditionally the beneficiary is tasked with the responsibility to keep a trustee in check, the settlor may not want or trust the beneficiary to hold this power. Also, enforcing this power through a beneficiary can lead to costly and time-consuming litigation.
A second reason is to guide the trustee regarding trust distributions (especially in the special needs context) and/or regarding investment decisions. A third reason is to empower someone to change the trust in order to adapt to future changed circumstances, such as changes in the law, the beneficiaries, or the trust assets.
Once the decision is made to use a trust protector, then the settlor and attorney need to decide the basic structure. There are four that should be considered.
- The first consideration is who should be the trust protector. A trust protector can be a person acting alone, a group of people, or a legal entity, such as a microboard or law firm. When utilizing people, whether alone or in a group, the settlor can choose specific people, such as a relative or friend, or a person who fits into a certain class or category, such as the current guardian of the beneficiary, an accountant, or an attorney.
- If possible, there should also be successor trust protectors named, and a process for choosing a successor trust protector in case all of those named are unable or unwilling to serve. Authority can be granted to an existing trust protector to name his or her successor, or to someone else, such as the trustee, beneficiary, or another trust protector whose sole job is to appoint successor trust protectors. If there is a group of people serving as a trust protector, the remaining members or the group can be given this authority.
- There should be a mechanism to remove a trust protector, either for good cause or any reason. This authority can be held by other trust protectors (either other members of the trust protector committee or another trust protector appointed to act only for this purpose), the beneficiary, the trustee, or a court.
Lastly, reimbursement of reasonable expenses incurred by the trust protector should be authorized. In addition, compensation of a fixed stipend or hourly rate can be paid.
Powers That Can Be Granted to a Trust Protector
There are various ways powers granted to a trust protector can be organized. No one way is better than others as long as all of the powers are appropriately identified.
Classes of Powers: Potential trust protector powers can be divided into two classes: those relating to trust management issues, and those relating to the distribution of trust assets.
Examples of management powers that can be granted to a trust protector are the power to review and/or approve accountings prepared by the trustee, review and approve proposed investments, veto an investment decision made by the trustee, direct an investment decision, remove the trustee (for good cause or any reason), replace the trustee (with a corporate trustee, non-profit trustee, or person), add a co-trustee, appoint a successor trustee, change the situs or governing law of the trust, amend the trust (to comply with tax or other law changes, obtain favorable tax status, make technical corrections, or correct scrivener’s errors), terminate the trust, determine whether an event has occurred, settle disputes (between trustees, trustee and beneficiary and/or between beneficiaries), and authorize litigation by the trustee against third parties.
Examples of distribution powers that can be granted to a trust protector are requiring that the trust protector be consulted by the trustee about all distribution decisions, requiring the trustee to obtain the trust protector’s consent in order to make distributions, giving the trust protector power to veto a distribution decision, direct the trustee when/how to distribute, advise the trustee about distribution decisions if asked by the trustee, amend the distribution provisions of the trust, change the beneficiary, act as an advocate for the beneficiary with the trustee, consent to the exercise of a power of appointment, and modify the terms of a power of appointment.
Types of Powers: Each power granted to a trust protector, whether management or distribution power, can be further organized into five different types:
1.Authorizing or directing the trust protector to monitor something relating to the trust;
2.Requiring the trustee to secure the consent of the trust protector in order to take action;
3.Empowering the trust protector to veto an action taken by the trustee;
4.Empowering the trust protector to initiate action unilaterally; and
5.Empowering the trust protector to direct the trustee to take a certain action.
Who Initiates the Power: Each trust protector power must be initiated by someone. This can be the trust protector (the holder of the power), trustee, beneficiary, or someone else, such as an interested family member. The following questions should be answered for each power so the drafter can appropriately design the powers.
If the trust protector can initiate the power: Can the trust protector direct the trustee to take a certain action? For example, make a distribution, invest in a certain asset, provide a financial accounting, etc. Must the trustee do what the trust protector directs, or can the trustee ignore the direction from the trust protector and do what the trustee believes is correct? Can the trust protector unilaterally take action without involving the trustee or beneficiary? For example, amend the trust, change the trust situs, remove the trustee, and terminate the trust.
If the trustee can initiate the power: Must the trust protector be consulted in order for the trustee to act? Must the trust protector consent before the trustee can act? Can the trust protector veto an action taken by a trustee? Must the trust protector be advised of the trustee’s actions?
If the beneficiary (or someone else) can initiate the power: Must the trust protector be consulted before the beneficiary can act? Can the trust protector veto an action taken by the beneficiary? Can the beneficiary direct the trustee to take a certain action? If so, can the trustee ignore the beneficiary? Or must the trustee do what the beneficiary directs? Can the trustee appeal to the trust protector for authority to ignore the beneficiary?
If the trust protector is responsible for monitoring something relating to the trust, what must be monitored? The trustee? The beneficiary? The trust investments? The trust distributions? The applicable laws? Something else? All of these? Some of these? If the trust protector does not have a duty to monitor, but must be notified by someone before the trust protector must take action, who has standing (or responsibility) to notify the trust protector? The trustee? The beneficiary? Anyone?
Trust Protector Powers are Held in Fiduciary or Non-Fiduciary Capacity
No matter what powers are granted to a trust protector, the trust protector will hold the powers in either a non-fiduciary (often personal) capacity or a fiduciary capacity. The liability of the trust protector, and the liability of the trustee for following or not following the directions of the trust protector, will vary depending on whether or not the trust protector is deemed to be a fiduciary for the particular power in question.
Non-Fiduciary Powers. If a beneficiary is appointed as a trust protector, then, at least as to powers that affect the beneficiary, he or she will usually be deemed to be holding the powers in a personal capacity rather than a fiduciary capacity. There may be an applicable statute, but so far only Alaska has a statute that specifically states a trust protector does not hold powers in a fiduciary capacity. 2 Other states have statutes that declare a trust protector to be a fiduciary.
A trust protector who is not a beneficiary may hold some powers in a non-fiduciary capacity, especially when the trust protector does not have the duty to monitor something relating to the trust and someone else has the responsibility to initiate the involvement of the trust protector.
Fiduciary Powers: Usually a trust protector will hold powers as a fiduciary. Most state statutes dealing with trust protectors take this position, as does the Uniform Trust Code and Restatement (Third) of Trusts. The trust protector may owe fiduciary duties to the beneficiary, trust, settlor, or a combination of all three. A properly drafted trust will clarify this.
There are currently 11 states that have statutes specifically dealing with trust protectors. 3 Some of these consist of multiple, detailed sections. Others are quite vague. Most of the state statutes specifically state that the trust protector is a fiduciary. 4
Alaska is the only clear exception, 5 although Arizona is also an exception unless the trust protector holds a power to direct. 6
Also, many of the state statutes set forth the types of powers that a settlor can give to a trust protector.7
As of the date these materials were prepared, 23 states and the District of Columbia have adopted a version of the Uniform Trust Code (UTC).8
Section 808 of the Uniform Trust Code recognizes the concept of a trust protector without using the title. Subsection (d) says, “A person, other than a beneficiary, who holds a power to direct is presumptively a fiduciary who, as such, is required to act in good faith with regard to the purposes of the trust and the interests of the beneficiaries. The holder of a power to direct is liable for any loss that results from breach of a fiduciary duty.”
Steps to Follow
When considering the use of a trust protector, the starting place is the applicable state law, if there is any. There should be a thoughtful discussion with the settlor about the settlor’s purpose for establishing the trust, and his or her vision, concerns and desires relating to the trust, the beneficiary and the various powers to be granted to the trustee and a trust protector. If a trust protector is to be utilized, the structure of the trust protector should be carefully thought out. Each power to be granted to the trust protector needs to be designed so it is clear who is to initiate the power and exactly what are the trust protector’s powers, duties, and responsibilities. Lastly, each clause needs to be carefully drafted and coordinated with the other provisions of the trust so there are no gaps or conflicting provisions.
1 Stewart E. Sterk, Trust Protectors, Agency Costs, and Fiduciary Duty, 27 Cardozo L.Rev. 2761, 2763 (2006).
2 Alaska Stat. §13.36.370(d).
3 The first trust protector statute was enacted in South Dakota in 1997. This was followed by Idaho, Alaska, Wyoming, New Hampshire, Tennessee, Delaware, Arizona, Michigan, Nevada, and Vermont. Connecticut’s statute dealing with the creation of a trust to provide for the care of animals contains the concept of a trust protector, but otherwise there is not a specific trust protector statute.
4 Mich. Comp. Laws §700.7809; N.H. Rev. Stat. Ann. §564-B:12-1202; S.D. Codified Laws §55-1B-1(4) and §55-1B-4; Vt. Stat. Ann. §1102; and Wyo. Stat. §4-10-711.
5 Alaska Stat. §13.36.370(d).
6 Ariz. Rev. Stat. Ann. §14-10818.D. However, a somewhat contradictory statute concerning a holder of a power to direct is §14-10808.D. This statute says, “Unless the trust instrument provides otherwise, a person, other than a beneficiary, who holds a power to direct is presumptively a fiduciary who, as such, is required to act in good faith with regard to the purposes of the trust and the interests of the beneficiaries. The holder of a power to direct is liable for any loss that results from breach of a fiduciary duty.”
7 Alaska Stat. §13.36.370; Ariz. Rev. Stat. Ann. §14.10818; 12 Del. C. §3570(8)c; Idaho Code Ann. §15-7-501; Nev. Rev. Stat. §163.5553; N.H. Rev. Stat. Ann. §564-B:12-1201(a); S.D. Codified Laws §55-1B-6; Vt. Stat. Ann. §1101(a); and Wyo. Stat. §4-10-710(a).
8 Alabama, Arizona, Arkansas, District of Columbia, Florida, Kansas, Maine, Michigan, Missouri, Nebraska, New Hampshire, New Mexico, North Carolina, North Dakota, Ohio, Oregon, Pennsylvania, South Carolina, Tennessee, Utah, Vermont, Virginia, West Virginia. and Wyoming. Six of these states also have a specific trust protector statute. These states are: Wyoming, Tennessee, New Hampshire, Arizona, Michigan, and Vermont.