As trust decanting becomes increasingly popular, we can expect to see more disputes and litigation regarding trust decanting. This blog post examines some of the main issues that will likely arise in those disputes.
First, what is trust decanting? The Uniform Law Commission states: “’Decanting’ is the term used to describe the distribution of assets from one trust into a second trust, like wine is decanted from the bottle to another vessel. Decanting can be a useful strategy for changing the outdated terms of an otherwise irrevocable trust, but can also be abused to defeat the settlor’s intent.”
Essentially, decanting is designed to address a dilemma posed by irrevocable trusts. Unlike revocable trusts that can be revoked by the trust settlor (the person enacting the trust), an irrevocable trust by its terms can’t be revoked by the settlor. That poses an issue as to what should happen if, due to changing circumstances, the settlor would otherwise be (or has been) inclined to amend or revoke it. Decanting is designed to address this problem. In general, and with some caveats, trust decanting entails creating a new trust (often referred to as the “second trust”), into which the assets of the irrevocable trust (the “first trust”) are conveyed. The second trust will contain certain different terms from the first trust, thereby effectively changing the terms governing the administration of the trust assets.
Trust decanting is becoming increasingly popular as more state legislatures authorize the practice. Virginia has permitted the practice for several years, and recently the Virginia General Assembly adopted the Uniform Trust Decanting Act, which is effective on July 1, 2017.
There are potential problems and risks relating to the practice of trust decanting, namely that the terms of the second trust will differ so significantly from the terms of the first trust, that the intent of the settlor will be defeated, or certain beneficiaries will be unduly disadvantaged. To prevent that, the Uniform Trust Decanting Act details what actions may and may not be taken with respect to decanting.
Decanting is a complex area, and the scope of potential disputes is large. This is especially so because the case law in the area is sparse, given the relatively recent adoption of state statutes authorizing the practice. The following are some of the most common disputes that I anticipate arising:
Claims for Breach of Fiduciary Duty
The Uniform Trust Decanting Act provides that “in exercising the decanting power, an authorized fiduciary shall act in accordance with its fiduciary duties, including the duty to act in accordance with the purposes of the first trust.” Va. Code § 64.2-779.2. This obligation raises a host of issues that could lead to litigation by a beneficiary against a trustee exercising the decanting power.
If a beneficiary doesn’t believe that the terms of the second trust are as favorable to that beneficiary, or if the terms are designed to improperly benefit the trustee, the beneficiary could attempt to assert a claim for breach of fiduciary duty. Beneficiaries should recall that the Virginia Uniform Trust Code spells out a lengthy statutory list of fiduciary duties, all of which bind trustees in addition to the trustee’s common law fiduciary duties. Such duties include (in general, and with some caveats): to administer the trust in good faith, to act loyally, to act impartially, to act prudently, to protect the trust property, to inform and report to certain beneficiaries and qualified beneficiaries, etc.
Moreover, a beneficiary could claim that the terms of the second trust are not in accord “with the purposes of the first trust,” a potentially fact-specific claim that could turn on the circumstances surrounding the language and adoption of the first trust and the settlor’s intent.
Reduction of Fiduciary Liability
The Uniform Trust Decanting Act specifies an array of actions that a trustee cannot take to try to benefit his own standing as trustee. For example, the second trust may not “reduce fiduciary liability in the aggregate.” Va. Code § 64.2-779.14(C). However, it may “divide and reallocate fiduciary powers among fiduciaries.” These provisions raise many interesting questions, including whether an array of protective provisions in the second trust would reduce fiduciary liability “in the aggregate.” Moreover, when would a purported “reallocation” of fiduciary powers in fact operate to effectively reduce fiduciary liability in the aggregate? What about a scenario with co-fiduciaries (one of whom is a corporate trustee, the other of whom is merely an individual), and liability is reallocated to shift liability from the deep-pocketed corporate trustee to the potentially judgment-proof individual?
Trustee Removal Claims
The Uniform Trust Decanting Act provides that a trustee can’t use the decanting power to modify a provision in the first trust that grants another person power to remove or replace the trustee, unless (i) that person who holds the power “consents to the modification in a signed record and the modification applies only to the person,” or (ii) the person holding the power and the qualified beneficiaries of the second trust “consent to the modification in a signed record and the modification grants substantially similar power to another person,” or (iii) the court approves the modification and the modification grants substantially similar power to another person. Va. Code § 64.2-779.15.
Trustee removal provisions are fairly common in comprehensively-drafted trust instruments, and they traditionally grant some or all of the beneficiaries, or a trust protector, the right to remove the trustee (I wrote a separate blog post on trustee removal actions, which can be accessed here. While the Act’s prohibition on using the decanting power to modify provisions of this nature is fairly strong, beneficiaries should remain on guard to ensure that in any trust decanting, such a provision is not buried down in the details by an unscrupulous trustee seeking to evade detection.