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NORTHERN TRUST PROFESSIONAL ADVISOR FORUM

Beware the Fine Print: Effectively Advising the Individual Trustee in Today's Changing Times1

January 31, 2012

Stacy E. Singer Senior Vice President

Midwest Fiduciary Practice Leader (312) 444-3826

ses7@ntrs.com

The Northern Trust Company 50 S. La Salle Street Chicago, IL 60603

1 The author wishes to express her deep gratitude to Laura G. Mandel , Senior Trust Administrator, for her assistance in the creation of these materials, which are based in part on materials previously developed by her.

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1. Introduction

The vast majority of trusts are handled by individual trustees, named to the

position because of the grantor’s confidence in their decision making skills. While

this may well reflect the best approach for managing the family situation, naming

an individual as the fiduciary presents its own unique challenges. Individuals are

oftentimes inexperienced and unaware of the proper processes and procedures

that should be followed in carrying out their fiduciary duties. As a result, the

advisors to such individuals face an additional burden of advising the fiduciary on

these issues to ensure that the trust is managed properly.

2. Fiduciary Duties of a Trustee

A. One of the most significant challenges for the individual fiduciary is

clarifying and understanding the role the individual trustee must play, and

how it differs from his or her role as an individual. Many individual

trustees believe that they can act as they think appropriate, without any

consideration of whether that is the proper fiduciary decision, or whether

there are other consideration that are required.

B. Key to advising an individual fiduciary is a thorough explanation of the

Trustee’s fiduciary duties, including:

1. Duty of Loyalty

2. Duty of Impartiality

3. Duty to Furnish Information

4. Duty to Exercise Reasonable Care and Skill

5. Duty to Keep Accounts

6. Duty to Take and Keep Control

7. Duty to Preserve Trust Property

C. Trustee’s Duty of Loyalty: “The trustee is under a duty to the beneficiaries

to administer the trust solely in the interests of the beneficiaries.” See

Restatement of Trusts (Third)2, Section 78 (2011). This duty is considered

2 In most situations, the terms of the trust document will control. If the document is silent or its provisions are contrary to applicable state law (and state law does not allow the instrument to override it), state law will apply. In general, the Restatement may be used as authority only where both the document and state law are silent.

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to be the most fundamental duty of a trustee. A trustee must not place

itself in a position where it would benefit at the expense of the

beneficiaries. Even if the transaction is fair to all parties, the transaction

may be set aside. See Scott, The Law of Trusts, Section 170 (1987). An

example of self-dealing would be a trustee’s purchase of assets from a

trust..

1. Actual economic loss to the beneficiary may not be required for a

lawsuit.

2. The transaction may be voidable by the beneficiary. The

beneficiary also may be entitled to disgorge the trustee’s profit on

the transaction.

3. The trustee may have a defense if the beneficiary has failed to

raise objections in a timely manner (“laches”), or if court approval

has been obtained.

4. The document may contain express language which waives the

duty of loyalty.

D. Trustee’s Duty of Impartiality: “A trustee has a duty to administer the trust

in a manner that is impartial with respect to the various beneficiaries of the

trust.” See Restatement of Trusts (Third), Section 79 (2011). The duty

applies to simultaneous (where several beneficiaries are entitled to share

in the income and principal) as well as successive interests. The typical

trust provides for successive enjoyment by different beneficiaries. The

trustee has a duty of fairness to all of the beneficiaries and of impartiality

among them. This duty requires a trustee to balance the competing

interests of differently situated beneficiaries in a fair and reasonable

manner. Ordinarily, the question of the duty of impartiality of the trustee

arises where there are successive beneficiaries, some being entitled to

income, others being ultimately entitled to the principal. A trustee’s duty to

deal impartially with beneficiaries is often challenged when the income

beneficiaries want the portfolio skewed towards income producing

investments as opposed to growth type investments. Absent contrary

provisions in the instrument, a trustee is under a duty to make investment

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decisions which produce income as well as increase the value of the

principal (including inflation). The Third Restatement adopts a “total

portfolio” approach to investing. Some commentators are encouraging

attorneys to counsel their clients on the “unitrust” or “total return trust”

alternative; legislation authorizing the conversion of an existing trust to a

unitrust or total return trust has now been passed in the majority of states.

In short, an income beneficiary receives a fixed percentage of the value of

the trust assets rather than the “net income.” The instrument also may

permit the trustee to favor one beneficiary over another. For example: “It

is my intention that the needs of my spouse shall take priority over the

needs of my children.

E. Trustee’s Duty to Furnish Information: The trustee has a duty “promptly to

respond to the request of any beneficiary for information concerning the

trust and its administration, and to permit beneficiaries on a reasonable

basis to inspect trust documents, records and property holdings.” See

Restatement of Trusts (Third), Section 173 (2011). (State law governs

what information beneficiaries are entitled to receive.) Where there are

several beneficiaries, each of them is entitled to information. Whether a

contingent remainderman is entitled to information varies from state to

state (see discussion on page 4, F). This duty is closely related to the

duty to keep accounts. Co-trustees are entitled to enough information

about the trust to fully participate in the administration of the trust, to carry

out the purposes and terms of the trust, and to prevent or redress a

breach of trust by a co-trustee. See Bogert, The Law of Trusts and

Trustees, Section 961 (1983). This duty may also include providing a

beneficiary with a copy of the trust instrument. See e.g. Fletcher v.

Fletcher, 480 S.E.2d 488 (Va. Sup. Ct. 1997) (wherein Virginia Supreme

Court compelled the trustee to produce the entire trust instrument and not

only relevant section.)

F. Trustee’s Duty to Exercise Reasonable Care and Skill: “The trustee is

under a duty to the beneficiary in administering the trust to exercise such

care and skill as a man of ordinary prudence would exercise in dealing

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with his own property; and if the trustee has or procures his appointment

as trustee by representing that he has greater skill than that of a man of

ordinary prudence, he is under a duty to exercise such skill.” See

Restatement of Trusts (Second), Section 184 (1959) and Restatement of

Trusts (Third), Section 227. The standard is objective. Some states

impose a higher standard on corporate trustees (e.g. California). The trust

instrument can, of course, alter this standard. For example: “The trustee

shall not be liable for any action taken in good faith, provided he has not

acted with gross negligence or willful default.”

G. Trustee’s Duty to Keep Accounts: “The trustee is under a duty to the

beneficiary to keep and render clear and accurate accounts with respect

to the administration of the trust.” See Restatement of Trusts (Second),

Section 172. Again, review applicable state statutes on who is entitled to

receive accountings. Some states require notice of the existence of a

trust to current beneficiaries and presumptive remaindermen (e.g. under

Florida Statutes 737.303, the trustee has a duty to inform all beneficiaries,

defined as current income or principal beneficiaries and all reasonably

ascertainable remainder beneficiaries, of the existence of the trust and the

address of the trustee and upon request provide a copy of the trust

instrument and annual accountings).

1. All co-fiduciaries and beneficiaries who are entitled to income or

principal may be entitled to accountings.

2. A trustee’s accounting should reflect all receipts, including all gains

and losses on investments, and disbursements. If costs are

incurred due to a trustee’s failure to keep clear accounts, such

costs are chargeable against the trustee and not the account. Not

only must a trustee keep accounts, but he must render an

accounting when called on to do so at reasonable times by the

beneficiaries. See Scott on Trusts, Section 172 (1970). “A

trustee’s refusal to produce an accounting is grounds for his

removal. The Comptroller of the Currency requires a corporate

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trustee to keep its fiduciary records separate from other records of

the bank.”

3. A trustee may require approval of accounts before distribution of

the assets. Typically, a trust instrument will provide that the

beneficiaries can approve the trustee’s accounts. For example,

“Upon written request, the trustee shall send a written account of all

trust receipts, disbursements, and transactions and the property

comprising the trust to each income beneficiary and, at the option

of the trustee, to the future beneficiaries of the trust. A ‘future

beneficiary’ of a trust is a person to whom the assets of the trust

would be distributed or distributable if the trust then terminated.

Unless court proceedings on the account are commenced within

three months after the account is sent, the account shall bind and

be deemed approved by all of the following beneficiaries who have

not filed written objections to the account with the trustee within

three months after the account is sent, and the trustee shall be

deemed released by all such beneficiaries from liability for all

matters covered by the account as though such account were

approved by a court of competent jurisdiction: (a) each beneficiary

to whom the account was sent and (b) if the account was sent to all

income and future beneficiaries of the trust, then all beneficiaries of

the trust who have any past, present, or future interest in the

matters covered by the account.”

H. Trustee’s Duty to Take and Keep Control: The trustee is under a duty to

the beneficiary to take reasonable steps to take and keep control of the

trust property. See Restatement of Trusts (Second), Section 175 (1959).

It is the duty of the trustee not only to take physical possession of the trust

property, but in appropriate cases to see that it is designated as trust

property. See Scott on Trusts, Section 175 (1987). Typically, if a

corporate trustee is acting, it has custody of the assets. In some

situations it is proper for the trustee to put the beneficiary in possession of

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the property; for example, a beneficiary may occupy a residence titled in

the name of the trust or have possession of tangible personal property.

I. Trustee’s Duty to Preserve Trust Property: “It is the duty of the trustee to

use care and skill to preserve the trust property,” See Scott on Trusts,

Section 176 (1987). The standard of care and skill is that of a person of

ordinary prudence. If the property is lost or destroyed or diminished in

value, the trustee is not subject to a surcharge unless the trustee failed to

exercise the required skill or care. Where, however, the loss to the trust

estate is the result of a trustee’s failure to use proper care or skill or where

the loss is due to negligence, a trustee is liable to the beneficiaries for loss

(depending on state law or the provisions of the trust instrument).

1. A trustee must not allow rights to subscribe to shares of stock or

subscription warrants to expire.

2. A trustee must pay taxes on real property held in the trust.

3. A trustee must keep property in good repair. If a trustee neglects to

make repairs and damage occurs, the trustee may be liable to the

trust estate for the loss. The duty to make repairs does not require

a trustee to make “improvements.” See Bogert, The Laws of Trusts

and Trustees, Section 600 (1981). (“Improvements” are changes,

extensions or additions to land or personal property, which alter or

increase its value and productivity.)

4. A trustee must protect the property from theft, i.e. obtain insurance.

3. Understanding the Terms of the Trust

A. Estate planning documents are filled with terms of art that make perfect

sense to advisers and no sense to individuals. In advising the individual

trustee, ensuring that the trustee thoroughly understands the terms of the

document is, in many ways, the most fundamental responsibility of the

advisers.

B. Among the many terms and concepts that need to be explained are the

following:

1. Fiduciary duty in general

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2. Current v. remainder beneficiary

3. Vested v. contingent beneficiary

4. Power of appointment

5. Income and principal

6. Generation skipping tax—exempt v. non exempt

7. Mandatory v. discretionary

8. Discretionary distributions (see __ below)

9. Accounting

10. Estate tax and estate tax reimbursement

C. In addition, the actual terms of the document need to explained both

verbally and in writing, using language a lay person can understand (and

remember).

1. Who is entitled to income or principal?

2. Under what circumstances?

3. Who decides?

4. Are there any conditions?

5. Can anyone change the terms?

6. Are there timing issues?

7. Who decides on investments?

8. Are there any restrictions?

9. Are any responsibilities waived?

10. Is there a removal power? If so, under what conditions or

circumstances can it be excised and by whom?

D. Discretionary Distribution Terms

1. Usually, the instrument sets forth a standard of distribution, which

can range from very narrow to very broad. Sometimes the terms of

the trust express no standards or other clear guidance concerning

the purpose of a discretionary power, or about the relative priority

intended among the various beneficiaries. In effect, the specific

distribution standard set forth in the instrument limits the trustee’s

discretion. The case law of the state which governs the trust largely

defines the standard. As noted in the Restatement (Third)

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“presumed meanings yield to findings of actual contrary intention

[on the part of the grantor] and also may be affected by context and

the more general purposes of the trust and the estate plan of which

the trust is a part.” The following is a brief outline of the most

commonly encountered standards:

2. Support and maintenance. This is probably the most common

standard found in trust instruments. Support and maintenance

encompass distributions to beneficiaries for normal living expenses

such as housing, clothing, medical care, food, payment of taxes,

premiums on life and property insurance and interest on debt. This

standard may be construed to include routine vacations and

support of a beneficiary’s dependents. (See K, below). This

standard does allow for inflation adjustments and may for increased

distributions to meet increases in the beneficiaries’ needs. Courts

have tended to view these terms as synonymous even when this

results in the terms being treated as redundant. These terms are

usually accompanied by a reference to a beneficiary’s standard of

living. (See G, below.) These terms do not authorize distributions to

enlarge the beneficiary’s personal estate or to enable the making of

extraordinary gifts. See comment d (2) of Section 50 of the

Restatement (Third).

3. Health. This term includes routine items, such as annual physicals

and medications as well as unusual items such as surgery, nursing

care, hospitalization, psychoanalysis and rehabilitation. Arguably,

plastic surgery for cosmetic purposes or travel to spas and health

resorts would not be covered. See Butler, Franzen and Heisler,

Illinois Institute for Continuing Legal Education, Trust

Administration, Discretionary Distributions, Chapter 5 (2005).

“Health” is generally construed more broadly than “medical needs.”

If the intention is to assure the beneficiary special health care such

as in home care, additional language is advisable.

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4. Education. This would include not only tuition, room and board,

books and travel to school, but also other expenses such as tutors.

Bogert, The Law of Trusts and Trustees, Section 181 (2d ed. rev.

1981). The Restatement (Third) provides: “The term “education”

without elaboration is ordinarily construed as extending to payment

of living expenses as well as fees and costs of attending an

institution of higher education or a beneficiary’s pursuit of a

program of trade or technical training, and the like, as may be

reasonably suitable to the individual and to the trust funds available

for that purpose.” Courts have construed “education” to include

education through college, but unless there is explicit language in

the instrument it probably does not include professional or graduate

study. See Bogert, The Law of Trusts and Trustees, Section 182

(2d ed. rev. 1981). In general, courts have reasoned that if a settlor

intended to provide for a professional course of training beyond an

undergraduate degree, the settlor would have included an express

provision relating to distributions for graduate/ professional

education.

Definition of Education. The term “education” as used herein may

include, but shall not be limited to, (a) education at public or private

nursery, elementary or high schools, including boarding schools, (b)

undergraduate or graduate study in any and all fields whatsoever of

a professional character or otherwise, at public or private

universities, colleges or other institutions of higher learning and (c)

any other activity, including travel, which shall tend to develop fully

the talents and potentialities of the beneficiary of a trust. The

expenses of education shall be deemed to include, but shall not be

limited to, (a) tuition, books and incidental charges made by the

school attended by the beneficiary for whom payment is made, (b)

any travel costs to and from the institution attended by the

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beneficiary, (c) his or her room and board and (d) a reasonable

amount of spending money.

5. Best interests and welfare. This is a much broader and less

definite standard than maintenance and support. This standard

permits payments for luxuries or enjoyment. This standard does

not, however, permit a complete distribution of and termination of a

trust. See Scott on Trusts, Section 187.2 (4th ed. 1987). The

standard “best interests and welfare” is frequently used in larger

trusts to authorize the trustee to accumulate or to distribute income

among beneficiaries to achieve certain tax savings. The question

often arises whether a “best interests and welfare” standard is

broad enough to permit distributions to the beneficiary for the

purpose of making gifts for estate planning purposes. The answer

is unclear (See E, below). One Illinois Supreme Court case, Rock

Island Bank & Trust Co. v. Rhoads, 353 Ill. 131, 187 N.E. 139

(1933), held that distributions to a life tenant under a “comfort and

satisfaction in life” standard which enabled the beneficiary to make

charitable gifts were permissible. In the Rock Island case, the

Court focused on the settlor’s pattern of gift giving and the

beneficiary’s desire to continue the gift program. But see Kemp v.

Paterson, 4 A.D.2d 153, 163 N.Y.S.2d 245 (1967) (wherein the

court held that distributions to the income beneficiary under a “best

interests” standard for gifts to the “natural objects of her bounty” to

avoid estate taxes were unauthorized under the terms of the trust).

See also Dunkley v. Peoples Bank & Trust Co. 728 F. Supp. 547

(W.D. Ark. 1989) (surcharging trustee and requiring return of assets

that had been distributed to allow indirect gifts to be made by

discretionary beneficiary under “support, reasonable comfort and

best interests” standard).

6. Authority of Trustees to Make Gifts from Marital Trusts. Trustees

may be approached to make discretionary distributions from marital

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trusts to enable a spouse to make gifts. This, of course, results in

the marital trust being diminished and a lower estate tax at the

surviving spouse’s death. The rationale is that facilitation of the

spouse’s estate planning objectives is in the spouse’s “best

interest” or for the spouse’s “welfare.” There is limited law on this

issue.

In Matter of Mandel, 46 Misc.2d 850, 261 N.Y.2d 110 (1995), the

court refused to permit an invasion in a marital trust where the will

authorized invasions “for the spouse or for her use.” Similarly, in

another case the court denied an invasion to enable the wife to

make gifts to her children pursuant to a clause which authorized

invasions of principal “in the absolute discretion of my Trustee as

shall be appropriate and to the best interest of my wife …” In re

Estate of Howard, 236 S.E.2d 423 (1977).

In Estate of Hartzell v. Commissioner, T. C. Memo 1994-476

(1994), the IRS argued that the exercise of an invasion power over

property held in a general power of appointment marital trust was

invalid and the surviving spouse’s gifts of property should not be

recognized. The will authorized invasions of principal for the

comfort, maintenance, support and general well being of the

spouse, or to continue the standard of living to which she is

accustomed, or to aid her in living at a standard to which she is

accustomed, or to aid her in the event of any accident, injury,

illness or other emergency affecting her. The Tax Court ruled that

the property removed from the marital trust was not improperly

distributed to a third party and therefore not includable in the

surviving spouse’s gross estate.

In Technical Advice Memorandum 9337001, the IRS determined

that annual exclusion gifts made from a marital trust were improper

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because the marital trust was held for the spouse’s “exclusive

benefit” and distributions to facilitate estate planning objectives

were not for the spouse’s “comfort” (the applicable standard) and

exclusive benefit. Distributions for tax planning reasons may be

permissible if the trustee is given absolute discretion to make

discretionary payments, rather than having discretion to make

invasions for the “benefit” of or in the “best interest” of the spouse.

7. Comfort. The term “comfort” standing alone can encompass a

beneficiary’s enjoyment, happiness, pleasure or satisfaction in life.

The term authorizes distributions to a beneficiary beyond strict

support or maintenance, and could include travel and certain

luxuries. Frequently, however, the word “comfort” often

accompanies a support standard. Here the language adds nothing

to the usual meaning of support for a beneficiary whose lifestyle is

already at least reasonably comfortable. Such terms tend to elevate

the standard for a beneficiary whose accustomed lifestyle has been

more modest. See comment (d) (3) of Section 50 of Restatement

(Third).

8. Standard of living. Occasionally, standards will be expressed in

terms of the beneficiary’s standard of living or manner in which the

beneficiary is accustomed to living. This standard is ambiguous

unless the point in time to which the living standard relates is

clearly stated. The Restatement (Third) takes the position that the

term “accustomed manner of living” is ordinarily that enjoyed by the

beneficiary at the time of the settlor’s death or when the irrevocable

trust is created. In addition, the Restatement notes that if a

beneficiary becomes accustomed over time to a higher standard of

living, that standard may become the appropriate standard of

support if consistent with the trust’s level of productivity and not

inconsistent with an apparent priority among beneficiaries or other

purpose of the settlor. In the case of a surviving spouse, the

appropriate standard is likely to be that to which the beneficiary was

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accustomed while living with the settlor. See e.g. Barnett Banks

Trust Company v. Herr, 546 So. 2d 755 (Fla. App. 1989).

One Illinois case has held that the point in time at which the

standard of living is determined is the date of execution of the

instrument and not the settlor’s subsequent death or the standard

of living at the time of the request. See Hart v. Connors, 85 Ill.

App.2d 50, 228 N.E.2d 273 (1st Dist.1967). If there has been a

change in the standard of living from the date of execution of the

instrument until the settlor’s date of death, the beneficiary could be

locked into an unintended standard in some states. See also In re

Estate of McCart, 847 P 2d 184 (Colo. App. 1992) (Colorado court

of appeals found the “accustomed standard of living” distribution

standard to be “non-variable”, yet the court focused only on the last

three years of the settlor’s life in determining the applicable

“standard of living”).

9. Distributions to purchase a residence. Ordinarily, explicit language

should be in the trust instrument before distribution is made for

such a large expenditure. Such distributions are frequently treated

as advancements. (See V, below).

10. Comfortable maintenance, health, education and welfare. The

inclusion of the words “comfortable” and “welfare” authorizes

distributions that go beyond the mere maintenance and support of

the beneficiary. As discussed above, the use of the terms “comfort”

or “comfortable” imply distributions not solely for the necessities of

life, but may include things that bring ease, contentment or

enjoyment. Several courts have interpreted the term “comfort”

(which is different than “comfortable support and maintenance) as

the equivalent to “station in life”.

11. Distributions in the trustee’s sole discretion. Many trust instruments

attempt to grant unlimited discretion to the trustee either by omitting

a standard of distribution or by granting the trustee “sole, absolute

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and uncontrolled discretion.” Both case law and commentary state

that where there is no standard, courts will not interfere with a

trustee’s discretion if the exercise is made in good faith and

consistent with the purposes of the trust. See Restatement of

Trusts (Third), Section 50, comment c states: “Once it is

determined that the authority over trust distributions is held in the

role of trustee, words such as “absolute or “unlimited” or “sole and

uncontrolled” are not interpreted literally. Even under the broadest

grant of fiduciary discretion, a trustee must act honestly and in a

state of mind contemplated by the settlor.” Where a trustee is given

sole and absolute discretion, the court will intervene only if the

trustee acts arbitrarily or dishonestly. See Scott on Trusts, Section

187 (4th ed. 1987). Similarly, under the Uniform Trust Code the

use of terms such as absolute, sole, or uncontrolled require a

trustee to act in good faith and in accordance with the terms and

purposes of the trust and the interests of the beneficiaries. In

Matter of Stillman, 107 Misc.2d 102, 433 N.Y.2d 701 (1980), the

trustees refused to invade principal to support the grandsons of the

grantor. The grandsons sued for abuse of discretion, and the court

ordered the trustees to make discretionary distributions for support

despite the instrument’s grant of “absolute and uncontrolled”

discretion to the trustees. See also PLR 9625031 (distinguishing

“discretion” from “sole discretion”).

12. Discretion for support of dependents. If the discretionary trust is for

the benefit of, for instance, the grantor’s daughter, there is a split of

authority as to whether that discretion also extends to the support

of anybody who is legally dependent upon the beneficiary, such as

a spouse or minor child. Section 50 of the Restatement (Third)

provides that a support standard generally includes support of a

spouse and minor children including suitable education of a

beneficiary’s children. Again the terms of the trust instrument and

state law would be determinative. See Edward C. Halbach,

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“Problems of Discretion in Discretionary Trusts,” 51 Columbia Law

Review 1425, 1436 (1961). The term “dependents” should be

defined in the instrument. If distribution may be made to a

beneficiary “and those dependent upon him” and if no definition is

given, it is unclear whether payments be made (a) to those persons

to whom the beneficiary has a legal obligation of support; (b) to

those persons considered the dependents of the beneficiary for

income tax purposes; or (c) to those persons who are, in fact,

dependent upon the beneficiary.

13. Distributions upon Fulfillment of Specified Conditions. Often the

instrument will provide that a beneficiary is entitled to a distribution

if he/she maintains sobriety or remains drug free. Such conditions

are permissible provided they do not violate public policy. An

example of a condition that violates public policy is to condition

distributions upon a beneficiary’s divorcing a particular individual.

See Restatement of Trusts (Third), Section 76 (2003) (“a trust or a

provision in the terms of a trust is invalid if enforcement of the trust

or provisions would be against public policy, even though its

performance does not involve the commission of a criminal or

tortious act by the trustees”).

4. Fees (aka The Elephant in the Room)

A. Many individual trustees are uncertain whether or how much to charge for

serving as trustee. If the individual as agreed to act out of loyalty or a

sense of duty to the grantor, she may be uncomfortable with the idea of

charging a fee; however, the amount of time and energy involved in

meeting her obligations may cause a change of heart.

1. Restatement (Third) of Trusts, Section 38, states: “A trustee is

entitled to reasonable compensation out of the trust estate for

services as trustee, unless the terms of the trust provide otherwise

or the trustee agrees to forgo compensation.”

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2. Of course, this definition begs the real question—what is

reasonable? The Restatement (Third) states “The trustee's

experience, skill, and facilities, however, are factors in determining

the reasonableness of compensation. … Local custom is a factor

to be considered in determining compensation. Other relevant

factors are: the trustee's skill, experience and facilities, and the time

devoted to trust duties; the amount and character of the trust

property; the degree of difficulty, responsibility, and risk assumed in

administering the trust, including in making discretionary

distributions; the nature and costs of services rendered by others;

and the quality of the trustee's performance.”

3. In some states, state law provides for a percentage fee, subject to a

reasonableness standard. In all states, the amount of

compensation can be reviewed by a court to ensure it is

reasonable.

4. If the trustee has special skills or experience, a higher fee may be

appropriate. For example, an attorney, accountant or investment

professional likely will be entitled to a higher fee than an individual

who has no experience in these areas. However, the appropriate

fee may still be lower than the hourly fee such individual charges

third party clients.

B. As in most cases, the terms of the trust may provide for specific

compensation terms—either more or less than would otherwise be

permitted. If the terms in the document are not unreasonable, they will be

honored by the courts. (State law may also provide for compensation.)

5. Potential Conflicts of Interest

A. In general, the most likely conflict of interest for an individual trustee arises

where the individual is also a beneficiary. The Restatement (Third)

illustrates the issue clearly: “It is virtually inherent in the nature of trusts

and trustees' responsibilities that, in many matters of trust administration,

personal interests of a beneficiary-trustee will come into conflict with the

interests of other beneficiaries, to whom the trustee owes fiduciary duties.

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Illustrative are matters ranging from the exercise of discretion regarding

distributions to the trustee's selection of investments.”

B. Explaining this conflict to the individual trustee is often the most

challenging job of the attorney or other adviser. The individual trustee

may not understand the risks involved, or see that the actions taken may

not meet the fiduciary standards required—especially the duties of loyalty

and impartiality.

C. In some cases, the individual trustee may even need separate counsel for

each role—one for her role as trustee, another for her role as beneficiary.

In fact, it may be beneficial (and is common in many documents) to allow

the individual trustee to appoint an independent trustee to make certain

tax and other decisions. This will avoid the conflict, as well as the

potential adverse tax consequences.

6. The Importance of Process and Documentation

A. The courts have repeatedly advised that the Trustee does not have an

obligation to always be correct in making decisions; however, the fiduciary

does have a duty to follow a process for evaluating issues and to

document that process. See, for example, In re Will of Dumont, 791

N.Y.S.2d 869 (2004), reversed on other grounds, 809 N.Y.S.2d 360

(2006).

B. Corporate fiduciaries create and maintain various investment, oversight,

compliance and discretionary committees that reflect a clear process,

together with documentation standards associated with each committee.

If the process is reasonable based on the available knowledge and if the

process if followed, the fiduciary may escape liability for otherwise faulty

decisions, especially of the problems are only clear in retrospect.

C. Documenting discretionary decisions

1. Written Request

a. Generally, a request for a discretionary distribution must be

made in writing (or confirmed in writing) by the beneficiary if

he or she is capable of doing so. This would include

electronic mail or facsimile. If the beneficiary is a minor, the

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parent or guardian should make the request. The request

should state the reason for the request and should be as

detailed as possible. Any oral request for a discretionary

distribution should be confirmed in writing by the beneficiary

or the trustee. The trustee should receive as much

information as is possible as to the reason for the request,

together with adequate information about the beneficiary’s

own financial resources where the governing instrument

requires that they be considered (See IX, below). For

instance, if the request relates to education, it should be

itemized in terms of tuition, room and board, books, and

incidental expenses. If the beneficiary has already incurred

an expense, a copy of the receipt should be attached. In

addition to the above information, the trustee should

consider the scope of the power provided in the governing

instrument and the size of the trust.

b. As a rule, prior to making discretionary distributions, the

Trustee should make appropriate inquiries into the

circumstances and needs of the particular beneficiaries or

classes of beneficiaries. In addition, the Trustee should

review the past history of requests and payments. The

trustee has a duty to inquire into the needs of beneficiaries

and to respond to those needs independent of a

beneficiary’s request. It is then the duty of the trustee to

take the initiative; and, on a regular basis, obtain adequate

information as to the resources and needs of beneficiaries

so that appropriate recommendations can be made or

updated and the trustee’s discretion can be exercised

properly. A trustee is under a duty to the beneficiary to give

him such information as is reasonably necessary to enable

him to enforce his rights under the trust. See Restatement of

Trusts (Third), Section 82 (2003).

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2. Nonexercise of power. Abuse of trustee discretion can occur

through nonexercise of a discretionary power. See Marsman v.

Nasca, 573 N.E.2d 1025 (Mass. App. Ct. 1991) (court found that

trustee had a fiduciary duty to inquire into a beneficiary’s resources

to recognize his needs where trustee had power to invade principal

for beneficiary’s “comfortable support and maintenance”); Kolodney

v. Kolodney, 6 Conn. App. 118, 503 A.2d 625 (1986) (trustee’s

failure to inquire into beneficiary’s needs was an abuse of

discretion). See also, Feibelman v. Worthern National Bank, 20

F.3d 835 ( Ala. App. Ct. 1994) (trustee abused its discretion in

failing to evaluate beneficiary’s lifestyle before making discretionary

distributions of principal where trust permitted distributions as

necessary to maintain beneficiary’s standard of living at date of

grantor’s death).

3. It is advisable to review the asset allocation for the trust in

conjunction with the discussion of potential distributions to the

beneficiary. Charts that illustrate the impact of various levels of

distributions (3-4% per year) on the trust over the long term are

advisable. See attachment titled “How Much Can I Spend ” In

some cases, the distinction between income and principal is no

longer relevant in determining whether discretionary distributions

should be made. Other factors such as investment concentrations

may impact the asset allocation and ultimately the ability of the

trustee to make discretionary distributions.

4. Trustee Recordkeeping/Discretionary File

a. It is the trustee’s obligation to keep full and accurate records

of trust administration, including its reasons for making

discretionary distributions. See Restatement of Trusts

(Third), Section 83 (2003).

b. In addition, records of distributions are necessary for income

tax and accounting purposes and to enable the trustee to

provide the beneficiaries with accurate information. The

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Restatement (Third) specifically notes that the trustee may

contribute to the common expenses of the guardian of a

minor child without itemization of the expenses or direct

application of trust funds. It is advisable, however, to

request a budget from the guardian of the minor child.

5. Routine Payments. If routine payments are being made the trustee

should monitor the payments and obtain supporting documentation

to justify continued payments. For example, if payments are being

made for education, the trustee should obtain certification

confirming the beneficiary’s enrollment at the educational

institution. In National Academy of Sciences v. Cambridge Trust

Co., 370 Mass. 303, 346 N.E.2d 879 (1976), a testator left money

in trust for his wife with the proviso that if she remarried, her income

interest was to cease and the principal was to be paid to the

National Academy of Sciences. The wife remarried, did not inform

the trustee of her remarriage, and endorsed all the checks using

her first husband’s surname. The court surcharged the bank for the

amount of those payments because, although there was a limitation

on payment of income, the bank made “absolutely no effort” to

determine whether or not the beneficiary had remarried. A factor in

determining whether it is equitable to allow the trustee to recoup

overpayment to a beneficiary is “the nature of the mistake by the

trustee whether he is negligent or not.” Even where a trustee has

made an overpayment in good faith, a change in the position of the

beneficiary may be sufficient to prevent the trustee from recovering

the overpayment. See Restatement of Trusts (Second), Section

254, comment d (1959).

a. In addition, the governing instrument may require further

investigation of the beneficiaries’ financial status, behavior,

employment, family situations or other matters. It may, for

example, be advisable to secure a budget, financial

statements or income tax returns from a beneficiary or a

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written statement from the beneficiary as to his needs or

wishes. Depending on the standard and considerations

imposed, it may also be wise to analyze the comparative

financial standing of a class of beneficiaries, including the

beneficiaries’ income tax situations and projected estate tax

situations. Many trust instruments now require that a

beneficiary be “gainfully employed” or a “productive citizen”

(so called “incentive trusts”). See, Butler, Franzen and

Heisler, Illinois Institute for Continuing Legal Education,

Trust Administration, Discretionary Distributions, Chapter 5

(2005).

6. Co-trustees

a. If there are one or more co-trustees, written approval from

the co-trustees is necessary before a distribution can be

made. See Restatement of Trusts (Second), Section 194

(1959). At common law, trustees of a private trust must act

unanimously. If there are three or more trustees, a majority

vote of the trustees may be controlling depending upon the

trust instrument and state law. See e.g. Illinois Trusts and

Trustees Act, 760 ILCS, 5/10 (2010). The Illinois statute,

however, does not say how issues are to be resolved if the

trustees are evenly divided on an issue. In some cases, the

instrument will state that, in the event of a disagreement,

either the decision of the individual or corporate trustee will

control.

7. Controlling Decisions. Any action or inaction of the majority of the

trustees having joint powers shall be as effective as if taken by all

trustees. If the trustees are evenly divided, the individual trustee

shall decide. A nonconcurring trustee shall not be liable for any

action or inaction of any other trustee.

7. Investment Decisions -- Prudent Investment Rules

A. Background

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1. The historical rule governing investment of trust property was

known as the “Prudent Man Rule.”

a. The Rule mandated that a trustee preserve the trust property

and make it productive.

b. Ultimately, the Prudent Man Rule was replaced by the more

flexible “Prudent Investor Rule,” which allows a trustee

greater flexibility in investments.

2. 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.

B. Legislatures in many states have formally adopted the Prudent Investor

Rule, while courts in other jurisdictions have referred to the Rule as

articulated in the Restatement of Trusts in their decisions.

1. Those trustees in jurisdictions that have adopted the Restatement’s

version of the Prudent Investor Rule are given the benefit of

consideration of the performance of the investment portfolio as a

whole.

2. The Restatement approach also judges a trustee’s investment

choices at the time the choices are made, not later in time based

purely on the result of an investment portfolio3

3. Section 227 of the Restatement (Third) of Trusts suggests a list of

characteristics a trustee should consider in examining a

contemplated investment, and a trustee may wish to consider

incorporating the suggested elements into an investment review

checklist as part of the trustee’s risk management plan.

3 RESTATEMENT (THIRD) OF TRUSTS § 227 cmt. b. (“The trustee is not a guarantor of the trust’s investment performance.”). However, inevitably, performance may be a key factor persuasive to the decision-maker in a court proceeding.

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Characteristics A Trustee Should Consider

In Examining A Contemplated Investment4

1. Expectations concerning the investment’s total return, and also the

amount and regularity of the income element of that return whenever the

beneficial interests or purposes supported by the trust are affected by

distinctions between trust accounting income and principal.

2. The degree and nature of risks associated with the investment and the

relationship of its volatility and characteristics to the diversification need of

the portfolio as a whole.

3. The marketability of the investment, and the relation between its

liquidity and volatility characteristics and the amount, timing, and certainty

of the trust’s cash flow or distribution requirements.

4. Transaction costs (including tax costs) and special skills associated

with the acquisition, holding, management, and later disposition of the

particular investment.

5. Any special characteristics of the investment that affect its risk-reward

tradeoffs and effective return, such as exposure to unlimited tort liability,

the presence and utility of tax advantages, and the maturity dates and

possible redemption provisions of debt instruments.

C. In the absence of binding authority, some courts have looked to the rules

set forth in the Uniform Prudent Investor Act (UPIA) as persuasive

authority to offer guidance in a case involving allegations of breach of the

duty to invest prudently.

1. Like the Restatement, the UPIA establishes that fiduciaries be

evaluated on the basis of the portfolio as a whole, rather than on

their individual investments.

2. The UPIA also varies the investment standard depending on the

particular skill level of the trustee with respect to investments, which

is a concept often expressed in case law.

4 The list of considerations is taken verbatim from the RESTATEMENT (THIRD) OF TRUSTS § 227.

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3. The UPIA, like the Restatement, sets forth a checklist of

considerations that a trustee must take into account when

determining a proper investment portfolio for the trust.

Circumstances A Trustee Should Consider

In Investing and Managing Trust Assets5

1. General economic conditions

2. The possible effect of inflation or deflation

3. The expected tax consequences of investment decisions or strategies

4. The role that each investment or course of action plays within the

overall trust portfolio, which may include financial assets, interests in

closely held enterprises, tangible and intangible personal property, and

real property

5. The expected total return from income and the appreciation of capital

6. Other resources of the beneficiaries

7. Needs for liquidity, regularity of income, and preservation or

appreciation of capital

8. An asset’s special relationship or special value, if any, to the purposes

of the trust or to one or more of the beneficiaries

D. Diversification of the Trust Portfolio

1. Subject to modification by specific directions provided in the trust

instrument, the trustee generally has a duty to the beneficiaries to

diversify the trust portfolio.

2. This duty is not absolute and varies among jurisdictions.

E. Balancing the Investment Portfolio

1. The trustee must be aware of the duty of impartiality and properly

balance growth and income where the trust creates these

distinctions.

2. Consider the ability to adjust income and principal or to convert to a

unitrust.

5 The list of considerations is taken verbatim from the UNIFORM PRUDENT INVESTOR ACT § 2(c) (1995).

26

8. Communication Dos and Don’ts

A. Outline the trust administration process, including anticipated frequency of

communication

1. Consider whether to communicate the “rules of administration” in

person, with a letter, or both

a. Provide the beneficiaries with the fiduciary’s preferred

contact information

b. Give alternates to accommodate different communication

styles

c. Phone, e-mail, letter

d. Set expectations regarding response times for phone calls,

e-mails and letters

2. Remember that the duty of impartiality requires a fiduciary to be fair

in communicating with beneficiaries

3. Even the difficult beneficiaries are entitled to information

4. Before denying a request just because he or she can, the fiduciary

should consider what is achieved by saying “no”

5. Beware of the “spokesperson” beneficiary, as well as the “squeaky

wheel” beneficiary

B. Consent or Ratification

1. Generally, a beneficiary must be competent and of legal age in

order to provide valid consent or ratification.

2. The fiduciary also must fully disclose the material aspects of the

transaction for which it seeks consent or ratification.

a. To obtain the full benefits of this protection, a trustee should

insist that the beneficiaries obtain independent counsel to

advise regarding any transactions at issue.

b. If a beneficiary does not wish to retain independent counsel,

the fiduciary should be certain that the relevant facts and

circumstances surrounding the transaction are set forth in a

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written document through which the beneficiary gives its

consent or ratifies the actions of the fiduciary.

c. Documenting that a transaction is fair and reasonable also is

a recommended practice.

C. Handling the Flow of Information, Making Decisions and Implementing

Decisions

1. Communication with the beneficiaries on a regular basis can

prevent many disagreements between beneficiaries and trustees.

2. Keep personal feelings for a particular beneficiary out of the trust

administration, as emotional decision-making may lead to lawsuits

for breach of duty.

3. Use of Advisors and Agents

a. Individual Trustees are unlikely to understand when to look

to their advisors for guidance. Part of what an adviser needs

to do is explain to the trustee when an adviser is needed, as

well as when a specialized adviser may be necessary.

b. Consider the case of Vento v. Colorado National Bank, 907

P.2d 642 (1995). There, Colorado National Bank served as

Trustee of four separate trusts that owned coal mining

property. Seven years after an initial lease of the mine, the

Trustee was approached by the lessee, requesting changes

to the lease and approval to assign the lease to another coal

company that planned to purchase the lessee’s assets. The

plaintiff objected to the changes and assignment; the trustee

ultimately agreed. Plaintiff then sued alleging, among other

things, a breach of fiduciary duty because the trustee failed

to consult independent mining experts and attorneys with

experience in mining leases prior to agreeing to the changes

and assignment. On that issue, the Appellate Court affirmed

the trial court finding in favor of the plaintiff, ruling that the

trustee failed to exercise judgment and care “when it failed to

seek the advice of independent mining experts…” and also

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should have “hired outside legal counsel to assist…” Id at

646.

c. A trustee can and will be held liable for failing to hire the

appropriate advisers with the needed expertise to advise in

the administration of the trust.

9. Conclusion:

Working with an individual trustee can be both rewarding and challenging.

Understanding what information needs to be provided, how to explain and advise

someone without any technical background or framework, and ensuring that

proper processes and procedures are implemented and followed is never easy.

However, when successful, it is one of the most important ways an adviser can

ensure that his client’s wishes are carried out.

LEGAL, INVESTMENT AND TAX NOTICE: This information is not intended to be and should not be treated as legal advice, investment advice or tax advice. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal or tax advice from their own counsel. IRS CIRCULAR 230 NOTICE: To the extent that this message or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law. For more information about this notice, see http://www.northerntrust.com/circular230. © 2012 by Stacy E. Singer All rights reserved