Fiduciary

By E. Deane Kanaly 

In the years of the Crusades, the Crusaders often left their property to be used and protected by somebody while they were off fighting in the Crusades.  This situation was often referred to as the “use.”  Later, the word “trust” came into being because, after all, the question arose as to whom you would trust to maintain and protect your property during your absence.  Trust, therefore, developed as a noun and later became a legal form.

An early trust provided that no property could ever be sold, no income would ever be distributed, and that the trust would last forever.  Someone figured out that the trusts would, in the course of several hundred years, own a good portion of the planet.  Therefore, three compelling rules came into effect that are still in effect in most states today.  One is the rule against perpetuities, which means that a trust can last no longer than 21 years and 9 months after the death of the last named beneficiary.  The trust must then terminate and be distributed to the beneficiary. 

Second, is the rule against accumulation of income.  This rule says you have to distribute income at some point during the life of the trust to prevent untoward accumulation.

Third, is the rule against alienation of title, which said that you cannot take property out of commerce by provisions in the trust agreement.  This would be against the public interest and would eliminate progressive development of properties, both real and personal.

A trust, as you will recall, involves the trustor or grantor, the creator of the trust; the trustee, the one to whom the trust is entrusted for execution of its terms and conditions; and the beneficiary, the recipient of the benefits of the trust. 

Property in a trust is divided into two classes:  legal ownership and beneficial ownership.  The trustee is the legal owner of the property; the beneficiary is the recipient of the benefits of the property.  The trustee has fiduciary responsibility to honorably discharge the responsibilities and provisions of the trust without conflicts of interest and self-dealing.  The fiduciary’s responsibility is a high form of responsibility that goes far beyond what any individual might do in the way of risk-taking and personal actions.

As the trust evolved over the years (basically, in England), as it came to the United States, the trustee was only authorized to sell property if they bought government bonds, as a protective measure against loss.  Later it was determined that certain types of investments, such as common stocks, could be included but only on a “legal list” of companies in whose stocks the trustee could invest.  This soon became a political football in that companies were lobbying state legislatures for approval to get on the legal list of investments.  After much consternation and litigation, the “prudent man rule” evolved which is still basically in force today.  It goes something like this:  “a trustee may buy, lease, mortgage, encumber and exchange any item of property – real, personal or mixed – which a prudent person would use for their own use, for investment, not speculation.”  This means that the trustee can really invest in almost any type of property, so long as it can be shown that it is prudent, protected and in the best interests of the beneficiary.  It should be noted that a trustee’s responsibility is to the grantor, testator or trustor – and not to the beneficiaries.  The law states simply that if the trustor, testator or grantor wanted the beneficiary to determine the investments and/or the other trust provisions, they would have left the property outright to the beneficiary.

The trust, as it has evolved, oftentimes produces both an income beneficiary and a remainder beneficiary.  In other words, the trustee is to provide the income from the trust for “X” and the “Y” gets the remainder.  This places the trustee in the unenviable position of difficult investment decisions because income, of course, is important to the income beneficiary and, later, the type of income – taxable versus non-taxable – whereas, the remainderman is more interested in capital appreciation or growth over the life of the trust which will, of course, inure to his or her benefit.

As the trust evolved over a period of time, it further encompassed broader discretionary powers given to the trustee.  First, it was deemed that if the income from the trust was not sufficient for the needs of the life beneficiary, the trustee could invade principal for the income beneficiary.  This provision contemplates that the trustee exercise due diligence in evaluating the needs of the income beneficiary in whatever standards, such as health, education, maintenance of standard of living provisions which might be the guiding light to the trustee.  Later when it was deemed that the income may be more than the income beneficiary needs, the trustee, in exercising its discretion, could distribute income to the prime beneficiary but also, for example, to a widow’s three children and retain some of the income in a trust.  Therefore, there would be five income tax payers:  the widow, the three children and the trust itself.  This would break up the income and the resulting income tax for the benefit of all concerned.

Even later, provisions have been included to allow the trustee, at its sole discretion, to terminate the trust if the trustee deems the trust to be no longer economically or practicably feasible. 

The modern-day trust is a flexible and viable instrument that requires objective judgment and empathetic understanding of all factors and individuals involved.  You should consider the responsibilities of the trustee in creating a trust and empowering the trustee with discretion on distributions of principal and/or income.  It is not an easy task.  It requires objectivity, experience and intent to be fair to all concerned.