Trust law
In common law legal systems, a trust is a relationship in which a person or entity (the trustee) holds legal title to certain property (the trust property or trust corpus), but is bound by a fiduciary duty to exercise that legal control for the benefit of one or more individuals or organizations (the beneficiary), who hold "beneficial" or "equitable" title. The trust is governed by the terms of the (usually) written trust agreement and local law. The entity (one or more individuals, a partnership, or a corporation) that creates the trust is called the settlor, and in the United States, the trustor, grantor, donor, or creator, as well.
History
The trust developed in its original form (known as the use of land) at the time of the Crusades, when land ownership in England was still based on the feudal system.
When a landowner left his estate to fight the Crusades, he required a person to run the estate in his absence; to pay and receive the feudal dues, for example. To this end, he would convey his estate into the ownership of a friend on the understanding that it would be returned to him when he came back. However, the law of England did not recognise the claim of the returning crusader. As far as the common law courts were concerned, the only owner of the land was the friend with whom the land had been left and the original owner had no claim on it.
The only recourse of the disgruntled landowner was to petition the king, who retained a residuary power to do justice among his subjects. The king would routinely refer the matter to the Lord Chancellor, who would decide each case according to his conscience. Over time a system of precedent grew up around the Chancellor's decisions and it came to be recognised that the Chancellor's court (the court of Chancery) would recognise the claim of the returning landowner on the ground that it was unconscionable for the legal owner of the estate to deny the claim of the 'true' owner. The legal owner held the land only for the benefit of the original owner, and could be compelled to convey it to him if so requested.
The idea of the use of land developed over the centuries to become the modern trust. Today, property of any sort can be held 'on trust' for another person, and trusts can be used for a myriad of different purposes.
Basic Principles
The trust has been called the most innovative contribution of English legal thinking to the law.[1] Developed from the 11th century onwards, it plays an important role in all common law legal systems. Trusts developed out of the English law of equity which has no direct equivalent in civil law jurisdictions. However, since the use of the trust is so widespread, some civil law jurisdictions have incorporated trusts into their civil codes. Civil law systems also have analogous concepts like patrimony of affectation and the foundation that have similar independent patrimonies from their donors that trusts can have from their grantor. Roman law recognised a similar concept which it referred to as the fidei-commissa.[2]
A simple example of a trust which is common in real life is the situation where Joe Bloggs makes a will, including the clauses:
- I appoint John Smith to be my executor.
- I give my estate to my daughter Doris Bloggs if she attains 18.
Here, if Joe Bloggs dies while Doris Bloggs is still under 18, a trust comes into existence at that time, of which John Smith is the trustee and Doris Bloggs is the beneficiary.The Ownership of the trust's assets has become split:
- The trustee has legal ownership. In our example, John Smith's name will go onto any title deeds, and he will be the signatory on any bank account.
- The beneficiaries have equitable ownership. In our example, only Doris Bloggs has any right to enjoy the assets left by her deceased father. John Smith is not entitled to a penny from them. (In practice, of course, if John Smith is a professional trustee, there will certainly be another clause in the will which ensures that he is paid.) Notice, though, that Doris Bloggs is not entitled to this money outright - she only becomes entitled if she attains 18 - so her equitable ownership is not the same as outright ownership.
This dual title (legal versus equitable) is frequently called "split title." The "title split" of trust law may be generalized colloquially as follows: legal title involves control, management, and possession, while equitable (beneficial) title involves "benefit," "enjoyment," and "use."
Terminology
- Appointment. In trust law, "appointment" often has its everyday meaning. It is common to talk of "the appointment of a trustee", for example. However, "appointment" also has a technical trust law meaning, either:
- the act of appointing (i.e. giving) an asset from the trust to a beneficiary (usually where there is some choice in the matter - such as in a discretionary trust); or
- the name of the document which gives effect to the appointment.
- The trustee's right to do this, where it exists, is called a power of appointment. Sometimes, a power of appointment is given to someone other than the trustee, such as the settlor, the protector, or a beneficiary.
- Bare trust. Note that in the USA this term is instead used to mean a simple trust, see below. In other jurisdictions a bare trust means a trust where the beneficiary is absolutely entitled to the assets, and the trustee is obliged simply to pay them over to the beneficiary. Resulting and constructive trusts are usually bare trusts. Bare trusts generally do not continue for any length of time, unless they arise out of protracted litigation, or the beneficiaries are minors (in which case the bare trust must continue until they reach majority).
- Constructive trust. Unlike an express or implied trust, a constructive trust is not created by an agreement between a settlor and the trustee. A constructive trust is imposed by the law as an "equitable remedy." This generally occurs due to some wrongdoing, where the wrongdoer has acquired legal title to some property and cannot in good conscience be allowed to benefit from it. A constructive trust is, essentially, a legal fiction. For example, a court of equity recognizing a plaintiff's request for the equitable remedy of a constructive trust may decide that a constructive trust has been "raised" and simply order the person holding the assets to the person who rightfully should have them. The constructive trustee is not necessarily the person who is guilty of the wrongdoing, and in practice it is often a bank or similar organisation.
- Discretionary trust. In contrast to a fixed trust, this is an arrangement where the trustee may choose, from time to time, who (if anyone) among the beneficiaries is to benefit from the trust, and to what extent, so long as the decision is made based on the beneficiaries' best interests. The purpose of such a trust is that no individual can claim to be entitled to any specific interest in the trust's assets, which often has tax advantages or asset protection advantages.
- Express trust. An express trust arises where a settlor deliberately and consciously decides to create a trust, over his or her assets, either now, or upon his or her later death. In these cases this will be achieved by signing a trust instrument, which will either be a will or a trust deed. Almost all trusts dealt with in the trust industry are of this type. They contrast with resulting and constructive trusts. The intention of the parties to create the trust must be shown clearly by their language or conduct. For an express trust to exist, there must be certainty to the objects of the trust and the trust property. In the USA Statute of Frauds provisions require express trusts to be evidenced in writing if the trust property is above a certain value, or is real estate.
- Fixed trust. In a fixed trust, the entitlement of the beneficiaries is fixed by the settlor. The trustee has little or no discretion. Common examples are:
- Hybrid trust. A hybrid trust combines elements of both fixed and discretionary trusts. In a hybrid trust, the trustee must pay a certain amount of the trust property to each beneficiary fixed by the settlor. But the trustee has discretion as to how any remaining trust property, once these fixed amounts have been paid out, is to be paid to the beneficiaries.
- Implied trust. An implied trust, as distinct from an express trust, is created where some of the legal requirements for an express trust are not met, but an intention on behalf of the parties to create a trust can be presumed to exist. A resulting trust may be deemed to be present where a trust instrument is not properly drafted and a portion of the equitable title has not been provided for. In such a case, the law may raise a resulting trust for the benefit of the grantor (the creator of the trust). In other words, the grantor may be deemed to be a beneficiary of the portion of the equitable title that was not properly provided for in the trust document.
- Inter vivos trust. A settlor who is living at the time the trust is established creates an inter vivos trust.
- Irrevocable trust. In contrast to a revocable trust, an irrevocable trust is one which will not come to an end until the terms of the trust have been fulfilled.
- Offshore trust. Strictly speaking, an offshore trust is a trust which is resident in any jurisdiction other than that in which the settlor is resident. However, the term is more commonly used to describe a trust in one of the jurisdictions known as offshore financial centers or, colloquially, as tax havens. By extension, "onshore trust" has come to mean any trust resident in a high-tax jurisdiction.
- Private and public trusts. A private trust has one or more particular individuals as its beneficiary. By contrast, a public trust (also called a charitable trust) has some charitable end as its beneficiary. In order to qualify as a charitable trust, the trust must have as its object certain purposes such as alleviating poverty, providing education, carrying out some religious purpose, etc. The permissible objects are generally set out in legislation, but objects not explicitly set out may also be an object of a charitable trust, by analogy. Charitable trusts are entitled to special treatment under the law of trusts and also the law of taxation.
- Protective trust. Here the terminology is different between the UK and the USA:
- In the UK, a protective trust is a life interest which terminates on the happening of a specified event such as the bankruptcy of the beneficiary or any attempt by him to dispose of his interest. They have become comparativeley rare.
- In the USA, a protective trust is a type of trust that was devised for use in estate planning. (In another jurisdiction this might be thought of as one type of asset protection trust.) Often a person, A, wishes to leave property to another person B. A however fears that the property might be claimed by creditors before A dies, and that therefore B would receive none of it. A could establish a trust with B as the beneficiary, but then A would not be entitled to use of the property before they died. Protective trusts were developed as a solution to this situation. A would establish a trust with both A and B as beneficiaries, with the trustee instructed to allow A use of the property until they died, and thereafter to allow its use to B. The property is then safe from being claimed by A's creditors, at least so long as the debt was entered into after the trust's establishment. This use of trusts is similar to life estates and remainders, and are frequently used as alternatives to them.
- Protector. A protector may be appointed in an express, inter vivos trust, as a person who has some control over the trustee - usually including a power to dismiss the trustee and appoint another. The legal status of a protector is the subject of some debate. No-one doubts that a trustee has fiduciary responsibilities. If a protector also has fiduciary responsibilities then the courts - if asked by beneficiaries - could order him or her to act in the way the court decrees. However, a protector is unnecessary to the nature of a trust - many trusts can and do operate without one. Also, protectors are comparatively new, while the nature of trusts has been established over hundreds of years. It is therefore thought by some that protectors have fiduciary duties, and by others that they do not. The case law has not yet established this point.
- Purpose trust. Or, more accurately, non-charitable purpose trust (all charitable trusts are purpose trusts). Generally, the law does not permit non-charitable purpose trusts outside of certain anomalous exceptions which arose under the eighteenth centry common law (and, arguable, Quistclose trusts). Certain jurisdictions (principally, offshore jurisdictions) have enacted legislation validating non-charitable purpose trusts generally.
- Resulting trust. A resulting trust is the form of implied trust which occurs where a trust fails, wholly or in part, as a result of which the settlor becomes entitled to the assets.
- Revocable trust. A trust of this kind can be "revoked" (cancelled) by its settlor at any time. Revocable trusts are common outside the USA, but (for tax reasons) they are usually only used in situations where the settlor or a major beneficiary has a USA connection.
- Simple trust. This term is only used in the USA, but in that jurisdiction has two distinct meanings:
- In a simple trust the trustee has no active duty beyond conveying the property to the beneficiary at some future time determined by the trust. This is also called a bare trust. All other trusts are special trusts where the trustee has active duties beyond this.
- A simple trust in Federal income tax law is one in which, under the terms of the trust document, all net income must be distributed on an annual basis.
- Special trust. In the USA, a special trust contrasts with a simple trust (see above).
- Testamentary trust or Will Trust. A trust created in an individual's will is called a testamentary trust. Because a will can become effective only upon death, a testamentary trust is generally created at or following the date of the settlor's death.
- Unit trust. A unit trust is a trust where the beneficiaries (called unitholders) each possess a certain share (called units) and can direct the trustee to pay money to them out of the trust property according to the number of units they possess. A unit trust is a vehicle for collective investment, rather than disposition, as the person who gives the property to the trustee is also the beneficiary. [3]
Creation
In general, a trust is not established until it is "constituted", meaning both that (1) the trust instrument -where one is required- is signed AND (2) money or something of value (e.g. farm land or a home) is transferred to the trustee. In legal parlance, there must be a res (Latin for "thing"; that is, there must be some property) that is the subject of the trust.
The trust instrument
Although there are other ways in which a trust may come into existence, typically a trust is created by one of the following:
- a written instrument (the trust document) signed by both the settlor (who may be the only beneficiary) and the trustee
- an oral declaration[4]
- the last will and testament of the settlor
- a court order (e.g. in family proceedings).
Some jurisdictions provide that certain types of assets cannot be made the subject of a trust without an instrument in writing.[5]
Trustee types
The trustee can be either a person or a legal entity. There can be multiple trustees, in which case the trust should provide a mechanism for the trustees to make decisions. A trust generally will not fail solely for want of a trustee; if there is no trustee, whoever has title to the trust property will be considered the trustee. If the interests of the trust require it, a court of competent jurisdiction may appoint a trustee to ensure the continuing viability of the trust.
Trust property
The trust property can be any form of property, be it real or personal, tangible or intangible. The beneficiary can be a single person, multiple persons, or a defined class or group of persons, including people not yet born at the time of the trust's creation. The trustee can be one of the beneficiaries, so long as the trustee is not the only beneficiary. A trust can also be created with some charitable purpose, as opposed to having a particular person or persons as its beneficiary.
Purposes
Any competent individual may create a trust for any legal purpose. See the jurisdictions sections, below, for purposes which are specific to a certain jurisdiction. The most common usages worldwide are:
- Privacy. Trusts may be created purely for privacy. The terms of a will are public and the terms of a trust are not. In some families this alone makes use of trusts ideal.
- Spendthrift Protection. Trusts may be used to protect one's self against one's own inability to handle money. It is not unusual for an individual to create an inter vivos trust with a corporate trustee who may then disburse funds only for causes articulated in the trust document. These are especially attractive for spendthrifts. In all cases known to this writer a family member or friend has prevailed upon the spendthrift/settlor to enter into such a relationship.
- Wills and Estate Planning. Trusts frequently appear in wills (indeed, technically, the administration of every deceased's estate is a form of trust). A fairly conventional will, even for a comparatively poor person, often leaves assets to the deceased's spouse (if any), and then to the children equally. If the children are under 18, or under some other age mentioned in the will (21 and 25 are common), a trust must come into existence until the contingency age is reached. The executor of the will is (usually) the trustee, and the children are the beneficiaries. The trustee will have powers to assist the beneficiaries during their minority.
- Charities. In some common law jurisdictions all charities must take the form of trusts. In others, corporations may be charities also, but even there a trust is the most usual form for a charity to take. In most jurisdictions, charities are tightly regulated for the public benefit (in the UK, for example, by the Charity Commission).
- Unit Trusts. The trust has proved to be such a flexible concept that it has proved capable of working as an investment vehicle: the unit trust.
- Pension Plans. Pension plans are typically set up as a trust, with the employer as settlor, and the employees and their dependents as beneficiaries.
- Corporate Structures. Complex business arrangements, most often in the finance and insurance sectors, sometimes use trusts among various other entities (e.g. corporations) in their structure.
- Asset Protection. The principle of "asset protection" is for a person to divorce himself or herself personally from the assets he or she would otherwise own, with the intention that future creditors will not be able to attack that money, even though they may be able to bankrupt him or her personally. One method of asset protection is the creation of a discretionary trust, of which the settlor may be the protector and a beneficiary, but not the trustee and not the sole beneficiary. In such an arrangement the settlor may be in a position to benefit from the trust assets, without owning them, and therefore without them being available to his creditors. Such a trust will usually preserve anonymity with a completely unconnected name (e.g. "The Teddy Bear Trust"). The above is a considerable simplification of the scope of asset protection. It is a subject which straddles ethical boundaries. Some asset protection is legal and (arguably) moral, while some asset protection is illegal and/or (arguably) immoral.
- Tax Planning. The tax consequences of doing anything using a trust are usually different from the tax consequences of achieving the same effect by another route (if, indeed, it would possible to do so). In many cases the tax consequences of using the trust are better than the alternative, and trusts are therefore frequently used for tax avoidance. For an example see the "nil-band discretionary trust", explained at Inheritance Tax (United Kingdom).
- Tax Evasion. In contrast to tax avoidance, tax evasion is the illegal concealment of income from the tax authorities. Trusts have proved a useful vehicle to the tax evader, as they tend to preserve anonymity, and they divorce the settlor and individual beneficiaries from ownership of the assets. This use is particularly common across borders - a trustee in one country is not necessarily bound to report income to the tax authorities of another. This issue has been addressed by various initiatives of the OECD.
- Money Laundering. The same attributes of trusts which attract legitimate asset protectors also attract money launderers. Many of the techniques of asset protection, particularly layering, are techniques of money-laundering also, and innocent trustees such as bank trust companies can become involved in money-laundering in the belief that they are furthering a legitimate asset protection exercise, often without raising suspicion. See also Anti Money Laundering and Financial Action Task Force on Money Laundering.
Society of Trust and Estate Practitioners
The international professional association for the trust industry is STEP, the Society of Trust and Estate Practitioners. Its members place the letters TEP after their names.
Jurisdictions
The United States
The Trust Industry
Most trust law in the United States is now statutory at the state level. Fiduciary tax law is both federal (see the Internal Revenue Code) and state.
Trustees may be (1) competent individuals or (2) state or federally chartered corporations with trust powers (usually banks). Typically bank trustees will have integrated their fiduciary organization into their investment management or private banking groups.
It is not unusual for an individual to serve as trustee alongside a bank trustee: they are typically called "co-trustees." Both individual and corporate trustees may charge fees for their services, although individual trustees typically serve gratis when part of the settlor's family or the settlor him/herself. The term "co-trustee" may and typically will fool either the bank trust officer or the individual co-trustee into thinking their roles are identical. Both should read the document carefully. If the roles are not further defined in the document, then their roles are legally the same. As a practical matter however the corporate trustee will nearly always do the custody work and keep the books. But many documents will give the individual co-trustee powers that differ from the corporate trustees. For example, the individual co-trustee's rights and duties may be limited to dealing with discretionary distributions of principal and income, sale of a personal residence held in the trust, or sales of a heartstring asset.
Note: in the context of bank trust organizations, references to the "co-trustee" are nearly always to the individual trustee.
Ever fewer American banks serve as trustee, as litigation costs rise. For most banks trust services are not profitable. For large and effective trust organizations a trust organization properly integrated into private banking and investment division can be quite profitable.
Trust laws
The fifty states harbor rich differences in fiduciary law despite on-going efforts to reduce disparities through the Uniform Principal and Income Act and other uniform act efforts. It has been a common practice of American lawyers for the past 150 years or so to choose the law of Massachusetts to govern the disposition of property conveyed in trust. In the absence of a nationally uniform law, their justification was that the courts of Massachusetts ruled on trust questions with far greater experience and authority than any other State (much like choosing corporate law in Delaware for your new firm). Nevertheless, unless the terms of the trust document are incompatible with public policy (creating a trust to advance a criminal enterprise, for example), the governing local law generally allows most trust agreements to be enforced according to their terms.
For example, some states require all trustee fees to be charged equally to principal cash and income cash. If the trust document directs otherwise, however, the law allows document language to prevail. Where a document contains obnoxious, unworkable, impractical, or outdated language, the beneficiaries and trustees have recourse to local courts having general jurisdiction in equity -- most commonly for a declaration or judicial construction or for reformation of the trust to bring it into compliance with the original intent of the settlor, or to deal with circumstances not imaginable by the settlor at the time the trust was created to make the trust cy pres or as close as possible to the original intent.
When the trustee or beneficiary needs interpretation of the trust document (often but not necessarily incident to a dispute) the local probate court judge is the place to get an answer. In the trust business one speaks of "docketing" a trust, i.e. taking it to the judge. When the judge is finished, the trust is then "undocketed."
Creation
The rule that a trust is not established until it has res, discussed above, creates a problem where there is a "self-declared" trust, i.e. one in which the settlor acts as his own trustee, nothing is accomplished by signing trust documents without assets being retitled in the name of the self-declared trust. Failure to follow through on retitling is one of the great bugaboos of self-declared trusts.
This rule sometimes gives rise to "one-dollar trusts" - trusts holding just one dollar yet still posted to the books of bank trust organizations, awaiting more significant funding from life insurance proceeds or the settlor's decision to fund inter vivos. The bank normally will charge nothing to hold the document and the one dollar until the trust is funded with more than the one dollar. Note: banks typically will not collect the one dollar: Usually one dollar is posted on and off the books to establish the trust's existence.
Many trusts specifically allow for additional deposits (cash, securities, real estate, etc.) at the direction of the settlor or others, provided the trustee is willing to accept those assets. This can be problematical in the case of real estate, where entry into the chain of title will make the trustee liable for the acts of all others in the change of title. Corporate trustees will often not accept certain real assets, especially where real property is compromised by unremediated environmental issues or where the trustee is unable to make a thorough inspection. A corporate trustee without real property expertise will sometimes avoid accepting any real estate.
Purposes
- This section lists purposes which are specific to the USA. See also the "Purposes" section above, which lists the generic purposes for which trusts are used.
- As an investment account with the added advantages of a full-service trustee. Typically, the individual will be older and wanting a strong relationship with his/her trust advisor. The trust document often then becomes the platform for the settlor's estate planning when combined with a pour-over will provision, i.e., all probate assets (assets in the name of the decedent) going to the trust post mortem. In such trusts there is typically a large component of services including bill payings, insurance claim filings, working with the settlor's attorney, accountant, and children, and financial planning. The personality and devotion of trust officer will be crucial to such a trust's success.
- Trusts are often created pursuant to an estate plan. The most common example by far is a credit shelter trustee wherein the settlor (by will or as dispositive provisions of a trust created inter vivos) leaves an amount in trust for benefit of a surviving spouse not in excess of the current federal exemption equivalent to the Federal Estate Tax. In 2006 this figure is $2 million. Thus an individual would leave, say, $2 million in trust for his wife (keep the $2 million out of her estate), give his widow the net income and the corpus to his children at her death.
- Trusts are often created as a way to contribute to a charity and retain certain benefits for oneself. A common ploy is to create a charitable remainder unitrust ("CRUT") with, say, $5 million with a percentage of the value at the end of each year coming back to the settlor, 5% say, and the remainder going to the charity at the death of the annuitant/settlor.
- Trusts may be created to protect an individual's welfare or other state benefits. These are typically called "special needs trusts." Typically, an individual has Medicaid and Social Security Supplemental Security Income (SSI) coming in. For such individual to then be given access to funds in excess of, usually, $2,000 ("countable" assets), risks immediate termination of his government benefits. To assure the individual a life of some ease beyond what he can afford from Social Security checks, a family member will place several hundred thousand dollars into a special needs trust for the little extras in life: dinner out, a birthday party, some new clothes, et alia. Such trusts require the expertize of a member of the "elder law" bar and must be administered with great care. It is best to have a family member as a co- or sole trustee. Given the small size of these trusts, they are typically not profitable for a corporate trustee.
- Trusts may be created to get funds to the next generation where there is significant wealth and federal exclusionary gifts have already been used up. The most typical of such vehicle is the grantor retained annuity trust (GRAT). Federal tax law specifically allows for this vehicle. Here the grantor places an asset in the trust -- one he expects will grow rapidly during the term of the trust. The document then requires the trustee to pay to the settlor a specific sum of money (the annuity) at certain intervals during the life of the trust. If there are assets in the trust at the end of the term, those assets go without estate or gift tax to the remaindermen. Here's a typical case: settlor owns large block of low cost basis stock in a publicly traded company. He does not wish to sell the stock and pay capital gains tax. He also has estate tax problems since his net worth when he dies is likely to be $10 million or more. His attorney drafts a GRAT in which he places $2 million of the single company's stock. The document calls for the smallest legal interest rate (published monthly by the Federal Government), which is then paid through the term of the trust. Upon the termination of the trust, the annuity has been paid back to the grantor and the remaining corpus is delivered to the remaindermen (typically children) without tax. Money has now passed from the grantor to his/her children without gift or estate tax. There has been no capital gains tax.
- Some create trusts to protect family members from themselves. It is not unusual to see a will in which four children get funds free of trust or any other encumbrances from their father but a fifth child's funds are all or mostly placed in trust. This is usually for good cause -- drug abuse, demonstrated inability to hold onto money, fear or divorce, criminal activity, a wish to see the funds go to grandchildren rather than one's own children.
Naming Conventions
While practitioners (bank trustees and fellow traveler trust and estate attorneys) persist in titling trusts as "Tr. u/a" (trusts under agreement a/k/a inter vivos trusts) or "Tr. u/w" (trusts under will), there is little practical difference between the two; it matters little whether a trust was created while the settlor is alive or following his death per terms of his will.
Industry convention is for the settlor's name to appear in the title. In the USA, the name follows a shorthand for the type of instrument. Consider "Tr. u/a John Smith" ("Tr. u/a" stands for "trustee under agreement"). This title indicates that during his lifetime John Smith created a trust. This title conveys no information about revocability and might better be titled "Tr. u/a John Smith Revocable" or "Tr. u/a John Smith Irrevocable". Conventional titles may further indicate the names of one or more beneficiaries in cases where the beneficiary is not the same as the settlor. Hence: "Tr. u/a John Smith FBO Alma Smith" or, if appropriate, "Tr. u/a John Smith FBO Alma Smith irrevocable". Titles also frequently include more information such as the existence of more than one trustee ("Co-tr. u/a John Smith": "co-tr" means co-trustee) or that one or more of the trustees are not the original trustee (Successor Co-Tr. u/a John Smith).
As a practical matter the typical corporate trustee's computer system will have room for a short title (with a limited number of characters: 32 in this writer's experience) and a long title with an unlimited character field. Typically, compromises are made in the short title and serve primarily as a reminder to the trust advisor which account he/she is viewing on the computer screen. Thus a complicated situation might be resolved as follows:
- SHORT TITLE: John Smith IRREV for Alma
- LONG TITLE: Successor Co-trustee under the will of John Q. Smith for the benefit of Alma Smith et alia irrevocable dated 5/1/1982 restated 4/11/2003.
In this example the bank trustee is the successor trustee, i.e. not the original trustee. John Q. Smith is the settlor (the creator of the trust). Alma Smith and others are the beneficiaries. The original document was executed on May 1, 1982. That document was completely rewritten, i.e. a new document was substituted for the original, on April 11, 2003.
Because each trust document is potentially different from each other document, a seasoned and capable practitioner will carefully consult actual document language before making any important decisions.
Some settlors insist on trust names that defy industry convention. Thus, aggrieved parents who create a scholarship trust for a deceased daughter may put the following language in their document: "This trust shall be called the Sally Sue Smith Education Trust." Some bank trustees might ignore the legal name of the trust, and refer to the trust, in bank records, as the "John & Jill Smith Education Trust" where John and Jill Smith are the grantors.
Inadvertent termination of trust
The trustee is said to hold legal title to the corpus, while the beneficiary holds equitable or beneficial title. Generally, a trust cannot exist unless there is at least some "title split" -- that is, the same person cannot generally hold all legal and all equitable title at the same time. If the legal and equitable title merge in the same person, the trust is considered nonexistent. This can happen when a sole trustee becomes the sole beneficiary (see Merger doctrine).
It is common practice for an individual to name himself trustee as well as being settlor and sole beneficiary. In such case the trust exists provided there is also at least one other trustee, but the settlor signs the trust document first as SETTLOR and second as TRUSTEE. In such cases the settlor/trustee/beneficiary files income tax returns to report income from trust property under his own taxpayer ID number -- usually his Social Security number. In such cases the settlor/trustee/beneficiary must be careful during trust administration to sign documents with the correct hat on. For example: The settlor/trustee/beneficiary hires an investment firm (often the purely investment part of a bank). Communication with the bank must be from "John Smith, Trustee" rather than "John Smith, settlor" or "John Smith, beneficiary." In the not unusual event that the self-declared trustee decides to resign in favor of a corporate trustee, he does so as "John Smith, trustee" with the concurrence of "John Smith, beneficiary/settlor." It happens....
Personal versus institutional
Practitioners typically distinguish personal trusts from institutional trusts: the former being established as a part of one or more individuals' estate and personal financial planning and/or investment needs, and the latter typically by or on behalf of foundations, endowments, and defined benefit and other qualifed pension plans. Most fiduciaries manage these two types of business separately, although it is not uncommon for small institutional accounts to be handled by the personal trust group.
Terminology
The various names listed above for the creator of a trust are interchangeable -- with "settlor" preferred by the legal community and "grantor" by trust officers and related practitioners. Typically, a trust created by a single individual, in which the settlor retains the ability to remove funds at any time, is called a grantor trust. Such trusts are often created as an investment management vehicle -- at least during the life of the settlor.
The term "grantor trust" also has a special meaning in tax law: a trust in which the Federal income tax consequences of the trust's investment activities are entirely the responsibility of the settlor or another individual who has unfettered power to take out all the assets. Therefore, where "grantor trust" is used, one must inquire which meaning is called for.
Federal income tax implications
For Federal income tax purposes in the United States, there are several kinds of trusts: grantor trusts whose tax consequences flow directly to the settlor's Form 1040 (U.S. Individual Income Tax Return) and state return, simple trusts in which all the income created must be distributed to one of more beneficiaries and is therefore taxed to the non-settlor beneficiary (e.g. the widow of a trust created by the late husband), whether or not the income is actually distributed (it happens), and complex trusts, which are, in general, all trusts that aren't grantor trusts or simple trusts. Some trusts may alternate between simple and complex under certain conditions. Many but not all trust organizations do their own tax work. This can be highly specialized work.
All simple and complex trusts are irrevocable and in both cases any capital gains realized in the portfolios are taxed to the trust corpus or principal.
Civil Law Jurisdictions
Most jurisdictions that have the trust concept do so because their legal systems are based on the English legal system, (a common law system), where the trust was developed. As such, trusts tend to be most prevalent in Commonwealth jurisdictions.
However, at least two jurisdictions, Switzerland and Liechtenstein, are civil law jurisdictions which have "imported" the trust concept into their laws by means of statute. The basic principles of trust law in those jurisdictions are very much as set out in this article, with some variations, but the legal and intellectual underpinning of that law is entirely different.
Australia
In Australia, trust law is under the jurisdiction of the federal government, and the legislation often interacts with Corporations law and Family tax law. Equity still regulates trust law to a significant extent, and Australian law has often followed English developments.
There are a variety of trusts recognised and used in Australia, including Unit trusts, Discretionary trusts and Hybrid trusts. Testamentary trust are also sometimes used.
A discretionary trust is often known as a "family trust" in Australia.
United Kingdom
Creation
Generally, equity requires that three certainties are demonstrated and that all relevant formalities are completed before constituting a trust.
The Three Certainties
The certainties are certainty of intention, certainty of subject matter and certainty of object. In the case of certainty of intention, there must have been manifested an intention to create a trust (Re Adams and the Kensington Vestry). Certainty of subject matter is concerned with whether or not the trust property can be clearly identified. If not, the purported trust is void (Palmer v Simmonds). Certainty of objects is concerned with whether or not the beneficiaries of the trust are ascertainable. Where discretionary trusts are concerned, the test for certainty is whether it can be said with certainty if any given individual is or is not a member of the class and the trust does not fail simply because it is not possible to ascertain every member of a class (McPhail v Doulton). As regards fixed trusts, the trust will fail unless it is possible to ascertain every beneficiary at the time the trust came into existence (Re Hain's Settlement).
Formalities
There are several formality requirements that have been imposed on express trusts by, inter alia, section 9 of the Wills Act 1837 and section 53 of the Law of Property Act 1925 (LPA) .
Testamentary Trusts
S.9 Wills Act 1837 provides that all testamentary trusts must be in writing, signed by the testator or by someone in his presence and by his direction, and be attested by two witnesses.
Land
s.53(1)(b) provides that: ‘a declaration of trust respecting any land or any interest therein must be manifested and proved by some writing signed by some person who is able to declare such trust or by his will.’The declaration itself need not be in writing. The writing required is that of evidence of the declaration and failure to comply with this requirement will render the declaration of trust unenforceable (Leroux v Brown ).
Dispositions of Equitable Interests
Dispositions of equitable interests are void unless they are in writing signed by the person disposing of the interests or by an agent authorised by that person (s.53(1)(c) LPA 1925). By contrast to s.53(1)(b), the requirement here is that the disposition itself must be in writing. The requirement here also applies to dispositions of equitable interests in both land and personalty (Grey v IRC ).
Exceptions
As regards formalities, the courts have made it clear that it will not allow a statute to be used as an instrument of fraud (Rochefoucauld v Boustead ). In this case, the claimant sold land to the defendant who had orally agreed to hold the land on trust for the claimant. The defendant later argued that because the purported trust was not evidenced in writing, according to the Statute of Frauds there was no valid trust . The court of appeal refused to allow the statute to be used as an instrument of fraud and held that it is a fraud for a person who have knowingly had land conveyed to him as trustee to later deny the trust and claim the land for himself. In such cases, oral evidence will be allowed to establish a trust.
Prima facie, the courts appear to be allowing something expressly not allowed under the statute. This would appear to be at odds with the principle of parliamentary sovereignty. One argument against that conclusion is that if the purpose of the statute is to prevent fraud, then surely the court, in not allowing people to rely on the statute fraudulently, is merely giving effect to the statute? On this basis, some like Watt claim that the courts have actually upheld the integrity of the statute rather than undermine it .
Constitution of the Trust
In Milroy v Lord , Turner LJ stated that:
‘in order to render a voluntary settlement valid and effectual, the settlor must have done everything which, according to the nature of the property comprised in the settlement, was necessary to be done in order to transfer the property, and render the settlement binding upon himself’
He went on to say that the settlor may constitute an express trust by either transferring the property to the trustee or by a self-declaration of trust. In the latter case, no transfer is needed.
Depending on what type of property is involved, certain formalities need to be satisfied before the property is validly transferred, and the general principle is that equity will not perfect an imperfect gift . Thus, in the case of land, there needs to be a deed , and in the case of shares, sections 182 and 183 of the Companies Act 1985 provides that in general, a share transfer form must be executed and delivered with the share certificates followed by entry of the name of the new owner in the company books.
Types of trust
Types of trust include
- a bare trust;
- an accumulation and maintenance trust;
- an interest in possession trust;
- a reversionary interest trust;
- an express trust;
- an asset-protection trust;
- a protective trust;
- a spendthrift trust;
- a life insurance trust;
- a life interest trust;
- a remainder trust;
- a charitable trust;
- an honorary trust;
- a resulting trust; and
- a constructive trust.
Duties of trustees
Duties of trustees include:
- a duty to consider the proper investment of the trust assets
- a duty to prepare annual accounts except where the assets are held in specie
- a duty to keep adult beneficiaries informed at least annually
Trustees must be unanimous in their decisions and are personally responsible to the beneficiaries for those decisions. In the event of dispute can apply to the Court of Chancery for directions as to the correct course of action.
Rights of beneficiaries
Beneficiaries who feel the trustees are not (properly) fulfilling their obligations have the right to take the trustees to the Court of Chancery for a declaration concerning the proper actions of the trustees.
Exceptions
As mentioned above, in order that a trust be constituted, there usually needs to be a transfer of trust assets to the trustees and in the course of doing so, there might be certain formalities that have to be complied with. Otherwise, because equity will not perfect an imperfect gift, the trust will not be constituted .
However, since Milroy v Lord , the court have at times appeared to have added the qualification that although legal title to trust property remains vested in the settlor, an attempted transfer by the settlor to the trustee might be effective in equity even though not all the formalities required for a valid transfer have been complied with. This might be the case where the settlor has done everything in his power to divest himself of trust property. In such cases, it is therefore possible for a trust to be constituted even though certain formalities have not been complied with.
An illustration of this principle is seen in Re Rose . Here, the settlor had by voluntary deed transferred shares in a private company to be held on certain trusts. Under the company constitution, however, the directors of the company have the right to refuse to register transfers. Accordingly, they delayed registration by some two months after the deed had been executed. The question faced by the court was when were the shares transferred? S.182 and s.183 of the Companies Act 1985 would suggest that the shares were only transferred when the directors registered the transfer. However, the court held that the shares were transferred when then the settlor executed the deed and the trust was constituted on that date. This is because the settlor had done everything in his power to divest himself of the shares.
Re Rose was applied subsequently in a number of cases including Mascall v Mascall which concerned the transfer of registered land. More importantly, the Re Rose principle was reviewed in Pennington v Waine . Here the donor intended for her nephew to take up directorship in a private company. In order for him to do so, he needed to own shares in the company. Therefore, she executed a share transfer form concerning shares in the company in favour of her nephew. In contravention of the companies act, she had not delivered the share transfer form to her nephew. Neither had he been registered as a shareholder. The donor had sent the forms to her agent, the company auditor, who then told the nephew the he need not take further steps as regards the shares. The nephew then took up directorship of the company. The court held that the shares did not from part of the donor’s estate on her death as there was an equitable assignment of those shares. This was so despite the fact that the donor had not done everything in her power to transfer the shares. The court reached its decision partly on the basis that clearly the donor intended the transfer to have immediate effect and it would have been unconscionable for the donor to retract. Unconscionability would depend on the circumstances in each particular case but in this case, the court felt that it was because the Donor had told the nephew of her intentions and he, in taking up directorship, had acted detrimentally.
The problem with the concept of unconscionability, however, is that it is a very vague concept. What exactly does the court mean by unconscionability? Even in the context of the case, it seems doubtful that it can be said to be unconscionable for the donor to change her mind. The court mentioned some detrimental reliance on the part of the nephew in becoming a director, but how exactly is that detrimental? It was not suggested that the nephew had incurred expenditure or had been detrimentally affected by becoming a director. The court provided no great elaboration on how it decided unconscionability here. This is therefore somewhat of a grey area.
References
- ^ Roy Goode, Commercial Law (2nd ed.)
- ^ Although this was a bequest in a law. Roman law never employed a concept equivalent of the inter vivos trust later seen in common law jurisdictions.
- ^ Kam Fan Sin, The Legal Nature of the Unit Trust, Clarendon Press, 1998.
- ^ See for example T Choithram International SA and others v Pagarani and others [2001] 2 All ER 492
- ^ For example, in England, trusts over land must be evidenced in writing under s.56 of the Law of Property Act 1925
See also
- Blind trust
- Charitable trust
- Foundation (charity)
- Inter vivos trust
- Rabbi trust
- Settlor
- Testamentary trust
- Trusts and estates
- Barnes Foundation case
Categories
Articles lacking sources from June 2006 | All articles lacking sources | Common law | Wills and trusts | Equity