Estate Planning: A Critical Role for Financial Advisors

Tips From The Pros: Preventing Family Trust Disputes

Proper trust planning is essential for families looking to protect their wealth and prevent future family trust disputes. Roughly 58% of adults in the United States have either personally experienced or know someone who has faced family disputes without proper trust and estate planning.1 Some of these disputes are anticipated, and some aren’t. These disputes are generally among siblings, spouses, in-laws and former in-laws. Additionally, divorce rates for first-time marriages range between 40% and 50% in the United States.2 To avoid many of these conflicts, families are turning to modern trust states that provide privacy, asset protection and the assurance that family wishes are honored.Non-Judicial Validation StatuteParents frequently voice concern that there could be problems with their children regarding their inheritance when the parents pass away. Non-judicial validation statutes provide a great way to avoid this uncertainty and possible future disputes. Trust validation provides a powerful tool for settlors who live anywhere to create a trust in or move a trust to a modern trust state with a non-judicial validation statute (for example, Delaware or South Dakota).3 Settlors then follow the notice procedure associated with the non-judicial validation statute to avoid validity challenges. The notice can be directed to specific individuals (for example, those who pose the threat of a contest). The notice isn’t limited to beneficiaries—it can also target non-beneficiaries. The trust validation procedure is faster and far less expensive than litigation. This procedure simply uses a statute of limitations instead of adjudication. For example, the South Dakota statute4 states that anindividual may not commence a legal proceeding to contest the validity of a trust more than 60 days after the trustee, trust advisor, trust protector or settlor sends the individual a copy of the trust instrument and a notice informing the individual of the trust’s existence, the trustee’s name and address and the time allowed for commencing a proceeding. Most non-judicial validation statutes have either a 60-day or 90-day limitations period. Additionally, there’s case law to support many of the validation statutes.5It’s also important to note that the settlor has the power of disinheritance. To leverage this power, settlors can oversee the trust validation procedure while they’re alive and see how their relatives react. This leverage, combined with the power to disinherit, can certainly prevent disputes that might otherwise arise on the settlor’s death.In Terrorem/No-Contest ClauseMany of the modern trust states also allow for in terrorem (no-contest) clauses in a trust, which discourages a beneficiary (family member) from contesting a trust or risk forfeiting all or part of their inheritance.6 Such a clause can protect the settlor’s wishes and avoid the time, expense, uncertainty and stress of litigation.Discretionary Interest StatutesThe asset protection of trust discretionary interests varies by state.7 Many states have enacted the Restatement (Third) of Trusts (Restatement Third) for discretionary interests. Many advisors feel that the Restatement Third approach might allow for a fully discretionary trust to be attached by a beneficiary’s creditors as a property interest.8 To avoid this result, many of the modern trust states instead have codified the common law and the Restatement (Second) of Trusts (Restatement Second), which defines the types of interests a beneficiary has in a trust, and in essence, defines the rights of a beneficiary’s creditors.9 Consequently, a discretionary interest in one of these modern trust states isn’t a property interest or an entitlement and can’t be attached. This includes trusts with a “health, education, maintenance and support” distribution standard.10 Additionally, limited powers of appointment and remainder interests also aren’t property interests or entitlements.11 These classifications can become extremely advantageous from an asset protection standpoint and act as a major deterrent to family members who may want to dispute any interest they think they may have in the trust.Spendthrift ClausesGenerally, all trust jurisdictions offer some asset protection for both self-settled and third-party trusts through the incorporation of spendthrift provisions into the trust.12 A spendthrift clause prevents all but a few exception creditors from attaching a trust. Exception creditors fit within a specific type or class, generally defined by statute, that are allowed to potentially reach the trust’s assets. For example, alimony is a common spendthrift clause exception creditor in many states. As discussed above, some of the modern trust states have addressed these potential issues with the enactment of their discretionary support statutes following the Restatement Second and common law so that a discretionary interest in a trust isn’t a property right or an entitlement.13 This is especially relevant in light of a recent case in Florida14 in which the court pierced the spendthrift clause of a third-party trust set up by a father for his son, to garnish the trust’s discretionary interests for alimony payments by the divorced son (who was the trust beneficiary). The Massachusetts Supreme Court15 also has left the door open for the courts to consider future distributions from third-party discretionary trusts for purposes of property division in divorce.Additionally, in a California case16 involving a divorce, the wife was a primary beneficiary of two California irrevocable spendthrift trusts established by her father. During the divorce proceedings, the California court ordered the wife’s trusts to pay alimony. After the trusts began making payments pursuant to the California court order, the trusts changed situs to South Dakota. After the change of situs, the trusts stopped making alimony payments at the direction of the trust protector, who determined that the payments would violate the spendthrift clause of the trust as well as rapidly deplete the trust. The wife then petitioned South Dakota for court supervision to clarify whether the trust was prohibited from making the payments directly to the husband due to the spendthrift provision.17 The Supreme Court of South Dakota18 ultimately agreed with the wife and trial court and denied full faith and credit to the California judgment.Thus, the spendthrift provision alone may not be enough for asset protection purposes due to possible exception creditors and lack of a discretionary interest statute that follows the Restatement Second. The South Dakota Supreme Court case described above is unique in that it highlights an initial successful attack of the traditionally protected third-party discretionary trust spendthrift provision in a state such as California, juxtaposed with a jurisdiction like South Dakota that follows the Restatement Second and common law as its historical interpretation of a discretionary interest and spendthrift provision.19In-LawsFamilies may also want to name in-laws as beneficiaries. If so, it might be best to name an in-law spouse in the trust document as a “floating spouse” beneficiary20 who’s defined as the spouse with whom the beneficiary is living with and married to at the time of the distribution. Such clauses are particularly important if in-law beneficiaries aren’t even born and, thus, are unknown; this is frequently the case with long-term or perpetual dynasty trusts. Consequently, protecting against future divorce is very important.A trust may also require that beneficiaries sign prenuptial agreements21 to be eligible for trust distributions. Moreover, many modern directed trusts purchase homes with trust funds instead of giving cash outright to children and/or grandchildren to purchase the home.22 In such a case, the trust owns the home, and the children and/or grandchildren are trust beneficiaries who can use the home tax-free. The home owned by the trust is also protected in the event of a future divorce.Beneficiary Quiet TrustsMany families believe that a beneficiary’s knowledge of a trust and trust information can result in family disputes. Consequently, these families look to use beneficiary quiet statutes enacted by many of the modern trust states.23 These statutes allow the grantor to modify the notice requirements and waive notice to one or more beneficiaries of any trust-related information. Some statutes allow a grantor to exempt the trustee from the notice requirements but only for the life of the grantor or until the grantor’s incapacity, whichever is shorter.24 Other statutes,however, allow for beneficiary waiver of notice, while also providing that the grantor, trust advisor or trust protector, by the terms of the governing instrument, may expand, restrict, eliminate or otherwise modify the rights of beneficiaries to acquire trust information. Consequently, the beneficiary quiet status can extend beyond the grantor’s death or incapacity with discretion given to the trust protector, which is an important advantage.25 Beneficiary quiet status can apply to any one or more of the trust beneficiaries. Generally, the trust protector watches over the beneficiary’s interest while the trust is in beneficiary quiet status. Thus, the ability to keep trust information quiet from one or more family member beneficiaries provides another planning option to prevent unnecessary family disputes involving a trust.Purpose TrustsGenerally, a purpose trust is created for a purpose (something) rather than for a beneficiary (someone).26 Non-purpose trusts are generally established with family and/or charitable beneficiaries. A purpose trust doesn’t have beneficiaries; a trust enforcer is generally appointed to make sure the purpose is enforced. The purpose trust also usually has a trust protector and an administrative directed trustee. The trust protector and enforcer can be the same individual or a committee. Once the purpose has ended, a purpose trust can convert to a beneficiary trust if desired, or the assets of the purpose trust can be distributed to a charity.Broad purpose trusts may not be established in every state,27 but all jurisdictions allow for pet trusts (a form of purpose trust to care for a pet), which are more limited in scope. Additionally, many states also allow for honorary trusts (trusts with the limited purpose to take care of a gravesite). Some of the modern trust states allow for broad purpose trusts to be established for any lawful purpose, not just for pets or honoraries. These broad purpose trusts can also be established as long-term or perpetual (dynasty trusts).28Some of the broad purposes for a purpose trust are maintenance and protection of family property (for example, antiques, cars, jewelry or art memorabilia); family homes (residence and vacation); and buildings, property or land.29 Family members aren’t trust beneficiaries, because a purpose trust doesn’t have beneficiaries, but the purpose trust can allow family members to “use” the family property owned by the purpose trust. The trust enforcer enforces the oversight, use and maintenance of the property. Because the family members aren’t trust beneficiaries or fiduciaries, their ability to bring court action is extremely limited. This is the responsibility of the trust enforcer.30 As such, the purpose trust can also minimize family disputes over family property.Legal Fees Involving Trust LitigationSome of the modern trust state statutes provide that the court may award attorney’s fees and costs to any prevailing party.31 Consequently, if someone sues the trust and is unsuccessful, they must reimburse the trustee for its legal fees. The reimbursement of legal fees to the trustee, combined with an in terrorem/no-contest clause, discretionary interest statutes and purpose trust statutes, can all provide powerful impediments to family members desiring to go to court over trust matters.PrivacyInformation regarding wills and testamentary trusts is generally public as part of the probate process. But many families don’t like court matters because they can frequently expose a family’s confidential information to the public. This aversion to publicity results in many clients establishing and funding trusts during their lifetimes to avoid probate. But once funded, any future court matters and records involving trusts are generally open to the public, and most states keep court matters involving trusts public.32 However, certain modern trust states allow court records involving trusts to be sealed either automatically or on a case-by-case basis for a period of years or in perpetuity.33In addition, certain modern trust states allow for non-judicial reformations/modifications and trust decantings, which can be used when possible to reform/modify or modernize a trust, without involving the court, thus keeping matters private.34 Consequently, many families elect to use these mechanisms to keep trust matters private, which may result in fewer future family trust disputes.