In an evolving landscape for modification of irrevocable trusts, Attorneys and Trustees should proceed with caution.
In a recent decision, Wright v. McDonald, 317-2020-EQ-00202, the 6th Circuit Probate Division invalidated a trust decanting and awarded damages in the amount of $3.225 Million against a Trustee for breach of fiduciary duty for engaging in the decanting. That award alone should give any estate planning attorney or trustee pause when it comes to decanting an irrevocable trust, but the underlying facts and legal analysis are worth examining further.
The petitioners in this case are brothers who were beneficiaries of a family trust established by their father (the “Grantor”) in 1998, prior to the enactment of New Hampshire’s current Trust code. At the time Grantor was married to his first wife and both were represented by the Respondent attorney. Respondent assisted the couple with their foundational and advanced estate planning and drafted the 1998 Trust as a Spousal Lifetime Access Trust (“SLAT”). The 1998 Trust permitted distributions to spouse and the issue of the Grantor. The preamble of the trust agreement specifically referred to the Grantor’s spouse or wife by name. The Respondent advised the couple that the Grantor would have indirect access to the trust assets if needed in the future so long as the wife was living. Importantly, the 1998 Trust included a provision that upon divorce the wife would be removed as a beneficiary and as a fiduciary. The Trust also permitted the Trustee to appoint the assets of the 1998 Trust to one or more trusts “for the benefit or one or more but not necessarily all” of the trust beneficiaries.
Three years after the Trust was established, the Grantor and wife separated and began divorce proceedings. Ultimately, Respondent continued to represent Grantor and ceased representing wife. The Respondent discussed the Grantor’s concern about lack of access to the 1998 Trust assets once the divorce was finalized. Respondent assumed the role of Trustee and decanted the 1998 Trust into a new, 2007 Trust which included language to define “Grantor’s Wife” as the person to whom the Grantor may be married at any time the reference is being interpreted and applied. At the time of the decanting, Grantor was in a relationship with a woman who would become his second wife two years later.
The controversy at the heart of the case is whether the decanting of the trust was unlawful. Respondent argued that it was not, asserting that use of the words “Grantor’s Wife” and “Grantor’s spouse” in the 1998 Trust signified any one of a class of persons to whom Grantor may be married to at a time a right or power was exercisable upon that spouse. Respondent primarily relied on the fact that the trust was designed as a SLAT which could provide access to the trust by spouse to benefit spouse and Grantor, and that there existed terms permitting modification by the trustee for tax purposes and “other reasons.” Petitioners argued that the terms specifically meant first wife, who at the time of the decanting was no longer a beneficiary. The Court agreed with Petitioners to invalidate the decanting and found the Respondent Trustee in violation of the duties of good faith and impartiality.
The Court found that the terms of the 1998 Trust were insufficient to establish a basis for implementing a “floating spouse” provision. Reading the express language of the 1998 Trust, the Court was not persuaded that the Grantor’s original intent was to provide for a class of wives or spouses particularly when the first wife was identified by name as spouse in the 1998 Trust.
Upon examining Respondent’s actions in advising his clients, and engaging in the decanting process, the Court held that Respondent in his capacity as Trustee breached the duty to act in good faith under RSA 536-B:8-801 and the duty of impartiality under RSA 536-B:8-803. The Court found that Respondent failed to act in good faith when he decanted the trust resulting in a dilution of the interests of the original beneficiaries and acted in a manner that put the interests of Grantor and his future spouse before those of the original beneficiaries. The Court observed that the ultimate result was the distribution of over $3 million of assets to the Grantor’s second spouse, away from the original beneficiaries even though the successor Trustee (not the Respondent) actually made the distributions. Regarding the duty of impartiality, even though the petitioners had no vested rights to distributions from the 1998 Trust, and despite language in the 1998 Trust that appeared to waive the duty of impartiality, the Court found a breach of this duty where the Trustee decanted the trust in a manner effectively reducing their respective beneficial interests, and sought a method of modification that did not inform the beneficiaries of the actions.
The conclusions are based in what many would consider “bad facts,” and it remains to be seen whether the matter will be appealed. Even so, there are a few takeaways for any practitioner assisting clients with establishing and modifying irrevocable trusts.
Address cash flow concerns and the possibility of divorce when making significant gifts to irrevocable trusts. A benefit of a “SLAT” is having a spouse continue to benefit from the trust. Ensuring that enough funds remain outside of the Trust and accessible to the Grantor can prevent “over gifting” and loss of access in event of divorce or death of the spouse beneficiary.
Discuss whether a floating spouse provision should be implemented. Consider having the parties acknowledge the provision in writing and having the spouse seek independent counsel. Carefully draft the floating provisions and any references to spouse to be clear in their meaning that it refers to any spouse, not just the spouse at the time of execution.
Finally, always proceed with caution in decanting a trust to remove or alter the beneficial interests of a trust beneficiary. Note that the modification in this case (adding a beneficiary) is not permitted under our decanting statute today. However, the Court continues to require Trustees to exercise appropriate due diligence in considering the beneficial interests of beneficiaries when making significant modifications that do or may affect those interests.