TRUST ADVISORS

How and When to Use Trust Advisors Most Effectively

As this first part of a two-part article explains, a good course of action for clients establishing trusts is to appoint a corporate trustee plus a trust advisor who will provide necessary insight and meaningful oversight.

Author: SHELDON G. GILMAN, ATTORNEY

SHELDON G. GILMAN, of the Kentucky, Ohio, Indiana, Florida, District of Columbia, and Tennessee Bars, is a member of the law firm of Lynch, Cox, Gilman & Mahan, PSC, in Louisville, Kentucky. He is also a Fellow of the American College of Trust and Estate Counsel, and is a frequent author and lecturer on estate and employee benefit planning, and professional responsibility matters.

In many estate planning situations it is appropriate to create a trust for the benefit of the members of the client's family. Regardless of the number of years the trust will remain in existence, one of the more crucial issues facing clients is who will serve as trustee. The considerations that are used in selecting the person who will administer the client's estate are totally different from those involved in choosing a trustee because the objectives and responsibilities of these positions are so different. If a trust is created under a will, some states require that the fiduciary be a resident of the state or be related to the decedent by consanguinity or marriage. ¹ If the client executes an inter vivos trust, there are few legal restrictions on the choice of trustee other than the requirement that the trustee have capacity to contract.

The more important criteria in trustee selection are ability, durability, integrity, experience, judgment, understanding, and honesty. In this regard, a trustee could be a corporate institution; a family member; a professional person-that is, a lawyer or accountant who has special training; or a nonprofessionally trained individual, businessperson, or a combination thereof.

This first part of a two-part article analyzes the advantages and disadvantages of corporate and individual trustees, trustee conflicts of interest, the power to change trustees, the use of co-trustees and special trustees, and the use of trust advisors.

Corporate trustees

Advantages of corporate trustees. Assuming the trust is of sufficient size to interest a corporate trustee, such a trustee offers many advantages when compared to an individual.² The advantage of a corporate fiduciary in being permanent cannot be underestimated, even in an age when corporate organizations continue to pursue merger mania. The advertised and real positive features of a corporate trustee include the following:

• Greater economic resources at its disposal than an individual;
• Employment of specially trained persons to manage investments, especially as most corporate trust departments have investment committees to approve all trust investments and these committees monitor the trust department's investment recommendations;
• Employment of specially trained persons to advise beneficiaries regarding their personal needs;
• Employment of a combination of individuals who will administer the trust when a trust officer gets sick or goes on vacation; and
• Computerized record-keeping facilities that should be able to generate detailed reports of trust assets, distributions, amount of gains and losses, and to facilitate income tax reporting.

In those situations when a beneficiary contests the terms of the trust or is unusually aggressive, a corporate trustee is usually better prepared to demand conformity with the trust instrument and defend the grantor's wishes. ³ In addition, a corporate fiduciary is highly regulated and must comply with numerous regulatory requirements. Hence, the regulation of the corporate fiduciary, both internally and externally, has a great deal of appeal because in most cases, this more intense scrutiny results in a higher level of assurance of the trustee's independence and honesty.

A corporate fiduciary is a "professional" whose reputation and business standing in the community are judged by how well it carries out its fiduciary responsibilities. It is concerned about how well it manages its customers' trusts, and the corporate trustee tries to earn the business every day.

Disadvantages of corporate trustees. We have all heard our clients' complaints and the expression of their real fears regarding corporate trustees; i.e., they don't know me; they don't understand the family dynamics; they are too impersonal; their investment policies are too conservative; their investments have lost money; ⁴ they fail to keep pace with inflation; they are too expensive; truly effective employees get promoted or leave (creating high turnover); inexperienced persons handle accounts without proper supervision; etc.

In addition to the clients' expressed fears, there may be problems when the trust contains a closely held business, farms, or oil and gas or mineral interests, or a significant concentration of one security. ⁵ While most persons would have problems administering these kinds of assets, most corporate trust officers would readily agree that they do not possess the ability to manage a closely held business. Many corporate fiduciaries have guidelines that require the disposition of a closely held business and concentrated positions in one stock as soon as possible after the grantor's death, sometimes to the distinct economic disadvantage of the trust beneficiaries. Sometimes the corporate trustee will refuse to serve unless the client has established a plan for the liquidation of the closely held business before death. ⁶

Moreover, because many corporate trust departments have adopted strict policies and procedures, the corporate trust department lacks flexibility to deal quickly with unexpected but important trust administration issues. Every possible deviation of a trust procedure creates delay and a loss of beneficiary expectation, thereby increasing a beneficiary's stress and anger.

If the beneficiaries-as family members-have not gotten along, it is doubtful that a corporate trustee is going to be able to resolve years of family conflict. In some of these situations, the corporate trustee's structure and adherence to its policies will only exacerbate the problems for multiple sets of beneficiaries. It is the absence of flexibility and concern over legal exposure that sometimes will just freeze the corporate fiduciary.

Individual trustees

The client selecting a nonprofessional individual as trustee will usually ask a family member, close friend, or business associate to serve because the client believes that these individuals possess a degree of intimacy with the client's family, or the client doesn't believe that the trust's assets will be of sufficient size to obtain the services of a corporate trustee. Sometimes the client may expect the trustee to serve without compensation and the appointment may be a way to save money. If this is the client's objective, then it may be difficult or impossible to change the client's mind.

However, if the prospective trustee is thoroughly familiar with the workings of the closely held business, and is respected by the family members, then it is possible that such person could successfully fulfill the duties of trustee.

Professional trustees. There are many times when the client who is establishing a trust will want a professional person to serve as trustee-for example, the client's accountant, attorney, financial planner, or investment advisor. The key element in this class of trustee is that the potential candidate is professionally trained, and is considered a specialist in a given field. The client selecting an individual from this group of professionals should determine whether the person has the needed experience and is truly qualified to handle the particular trust.

Usually the client who wants to appoint a professional to serve as trustee will have dealt with this person in the past, knows what to expect, and can assess the advisor's level of expertise. An attorney may be requested to serve as trustee because the attorney knows the family and has drafted the trust instrument. Further, the client may apply a reasonable amount of pressure for the lawyer to serve. When a lawyer agrees to serve in a fiduciary capacity, there are a number of professional responsibility issues for the lawyer to consider, including the following:

•Control over successor trustees. In Matter of Eisenhauer, ⁷ the trustee-lawyer was disciplined when the client's trust contained a provision giving the lawyer a veto power over any successor trustee. The Massachusetts court considered this provision "highly unusual" and "solely for the benefit" of the lawyer, especially as there was no evidence that the lawyer had disclosed the conflict of interest to the client or that the client had affirmatively consented to it.

•Requirement to consult with client regarding conflicts under Model Rule 1.8. In Missouri Informal Advisory Op. 970130 (1997), the Missouri Ethics Committee opined that if an attorney drafts a client's trust and the client requests that the attorney serve as trustee, the attorney may serve as trustee but must comply with all the requirements of MRPC 1.8, which include a requirement to give "the client...a reasonable opportunity to seek the advice of independent counsel in the transaction." It is submitted that most lawyers will not want to recommend to their clients that they seek the advice of another lawyer before the drafting lawyer serves as fiduciary.

•Exculpatory clauses. If a lawyer agrees to serve as trustee and would like the trust instrument to contain an exculpatory provision, the lawyer has an obligation to explain the meaning and effect of such provision to the client. The American College of Trust and Estate Counsel's ("ACTEC") Commentaries on the Model Rules, Fourth Edition, contain the following guidance for the lawyer who wants to insert an exculpatory provision into the trust.

Exculpatory Clauses. Under some circumstances and at the client's request, a lawyer may properly include an exculpatory provision in a document drafted by the lawyer for the client that appoints the lawyer to a fiduciary office. (An exculpatory provision is one that exonerates a fiduciary from liability for certain acts and omissions affecting the fiduciary estate.) The lawyer ordinarily should not include an exculpatory clause without the informed consent of an unrelated client. An exculpatory clause is often desired by a client who wishes to appoint an individual nonprofessional or family member as fiduciary. ⁸

With regard to exculpatory clauses, special consideration should be given to state law restrictions on their use. Some states have legislated specific provisions limiting the effect of exculpatory provisions. Therefore, before blindly inserting the provision, the drafter should consider the law of the jurisdiction where the trust will be administered to determine if an exculpatory clause will be given operative effect. ⁹

Because of the lawyer's need to explain various professional responsibility issues to the client, and because of the potential risks involved in serving as trustee, there are many lawyers who refuse to serve as trustee. Nevertheless, some lawyers feel comfortable explaining the professional responsibility issues and have established, within their own law firm, trust administration departments so as to generate an additional source of fee income.

Disadvantages of individual trustees. An individual nonprofessional trustee needs to possess knowledge of trust law, tax, and financial accounting, and the services of an attorney and accountant will still be required. Further, it is well known that competent tax and investment functions are time-consuming and expensive. As a result, the fees for competent accountants, attorneys, and investment counsel could wind up being more than the charges of a corporate fiduciary.

Whenever an individual serves as trustee, the biggest problem with the individual is that he or she is human. An individual trustee's illness, emotional characteristics, personal or business problems, and death can-and in many cases do-create havoc. When a client considers the selection of an individual trustee, the client must consider the age and physical condition of the person being chosen. Unfortunately, some believe that they are "honoring" the individual by choosing him or her as trustee. But, numerous articles have been written on how well-intentioned trustees have created significant amounts of mischief; examples galore appear in the daily newspapers.

Barring intentional disclosure, a certain loss of confidentiality occurs when an individual serves as trustee and the trustee has the same last name as the trust's grantor. For instance, while it may be possible for a trustee to operate a business under an assumed name, when the grantor and the trustee are high profile members of the community, then confidentiality of the family's personal business plans could be sacrificed.

This unintentional disclosure would not occur when the trustee is just one of many banks in the community, and the trustee buys a piece of property for one of its trust accounts. Further, when dealing with individuals, there can be increased difficulty in the title transfer of assets as some security transfer agents want certified copies of trust instruments and this slows down the transfer of assets and may make the process more costly.

Finally, the potential conflicts of interest-whether real or imaginary-must be considered. The family relative who serves as trustee could see his family relationship destroyed because of arguments over favoritism. If the individual trustee happens to be the family attorney, then serving as trustee has twice the exposure-once in the lawyer's fiduciary capacity and second, with his state bar's licensing authorities.

Conflicts of interest problems affecting trustees

A fiduciary is prohibited from taking part in a transaction in which he has a conflict of interest. A trustee may encounter such a situation if his personal interests could materially affect his or her judgment in carrying out fiduciary duties, or if he advances the interests of a third party in preference to those of the beneficiary. Specific examples of conflicts of interest problems that occur regardless of the type of trustee selected include the following:

• Trustee's purchase of property or any interest therein from the trust, whether the sale is public or private;
• Trustee's leasing of property from the trust;
• Trustee's sale of his own property to the trust;
• Trustee of one trust selling trust assets to himself as trustee of another trust;
• Trustee's lending trust funds to himself;
• Trustee's employing himself to do specialized work for the trust;
• Trustee ownership of a business held in a fiduciary capacity as a trust asset with another business that is competing with the trust's business;
• Trustee's accepting a gift from one with whom he conducts trust business;
• Trustee's securing incidental benefits for himself while engaged in trust business; or
• Trustee of corporate stock voting for election of himself as director or officer of the corporation.

Conflicts of interest-corporate trustee issues. Because of the nature of the interests involved, certain conflicts of interest may occur when a bank serves as trustee that would not likely arise if the trustee were an individual-for example, when a corporate trustee accepts a trust and the trust already contains shares of the corporate trustee; or, if the corporate trustee has to vote the shares of its corporation regarding various fundamental corporate issues that require shareholder approval. In these situations some states have enacted statutes indicating that the trustee has a conflict of interest in the exercise of a trust power and, therefore, the issue must be submitted to a court to authorize the exercise of the power.

Additional examples of possible conflicts of interest arise when the trustee serves as trustee of many accounts. The following situations should be considered.

• Collecting and retaining certain assets until a corporate decision can be made that it is appropriate to dispose of the asset;
• Acquiring an interest in a trust asset in which the trustee already owns an interest, either in its own right or for another trust account;
• Depositing trust funds in the bank's commercial department;
• Borrowing money from the bank's commercial department to finance various needs of a trust customer's account;
• Serving as trustee of multiple trusts created for some but not all of the same beneficiaries-for example, two or more trusts that have the same life income beneficiary but different remaindermen; ¹⁰ and
• Continuing or renewing a lending arrangement with the trustee's commercial lending department when a closely held business owned by the client's trust was already indebted to the corporate trustee before the client's death. ¹¹

Conflicts of interest when a beneficiary is trustee. When a beneficiary serves as trustee, there are significant issues that should be resolved-for example, will the trust's assets be includable in the trustee/beneficiary's taxable estate, and will a conflict of interest exist when the trustee/beneficiary has the authority to invade trust principal for his personal benefit? One of the fundamental duties that a trustee owes in connection with the administration of a trust is the duty of impartiality. Specifically, the trustee holds the trust estate for the benefit of all persons who are entitled to the remainder just as much as the trustee holds it for the persons who are entitled to the immediate beneficial enjoyment. This duty of impartiality is put to the test whenever an interested person, such as a surviving spouse, is named as trustee. ¹²

Possible exceptions to trustee conflicts. When a conflict exists, the merits of a particular transaction are not considered unless a recognized exception to the rule exists. Exceptions to a conflict of interest question that deserve a separate inquiry, especially as to whether the trustee truly acted in good faith, and whether the transaction was fair and reasonable, include the following:

• Did the grantor place the trustee in the position where the grantor knew that the trustee's personal interest would conflict with the beneficiaries' interests?
• Did the beneficiaries have knowledge of the transaction?
• Did the beneficiaries participate in the transaction?
• Did the beneficiaries either request or consent to the fiduciary's action?
• Did the beneficiaries request the action and agree to indemnify the trustee and waive the conflict?

The power to change trustees and tax considerations

While the initially appointed trustee may be acceptable, changes in circumstances may dictate that the original trustee be replaced. It is possible that the quality of service may deteriorate, or the trustee's fees are no longer competitive. Most people would not want to engage the services of an individual or a corporate trustee for an extended period of time without a right to change the trustee. Further, it is human nature for a provider of personal services to try a little harder to please the customer when the customer/beneficiaries or someone has the right to remove the service provider. Therefore, when considering giving beneficiaries a power to remove a trustee and appoint a successor trustee, consideration should be given to the tax aspects of such power.

Revenue Rulings and case law. In Rev. Rul. 73-21, ¹³ the grantor of a trust retained a contingent right to appoint himself successor trustee if the original trustee did not continue to serve. The IRS ruled that the power to determine whether to distribute or accumulate income was a power to designate who could possess or enjoy property within the meaning of Internal Revenue Code Section 2036. Therefore, because the grantor had the contingent right to appoint himself as successor trustee, he was considered to have retained a right to designate the beneficial enjoyment of the trust. It did not matter to the IRS that the power to determine the beneficial interest was exercisable by the grantor only if he had, in fact, appointed himself as trustee; the simple fact that he had the legal right to appoint himself was ruled sufficient to include all the trust property in the grantor's estate.

In Rev. Rul. 73-142, ¹⁴ the decedent retained the "unrestricted" power to remove the trustee and appoint a new trustee, with no express limitation on appointing himself. Trust distributions were not subject to an ascertainable standard, and the trustee had the power to withhold the distribution of income or principal and to apportion property between income and principal despite any rules to the contrary. The IRS, citing Section 2036(a)(2), concluded that the decedent had reserved the unrestricted power to remove the trustee and could appoint himself as trustee. Thus, the decedent possessed all the powers of the trustee, and the property was includable in his estate. Arguably, if the trustee's powers were limited by an ascertainable standard, the fact that the decedent possessed the power to remove the trustee and appoint himself as trustee should avoid the inclusion of the property in his estate.

In Rev. Rul. 79-353, ¹⁵ the trustee's power to distribute principal and income among the grantor's children was not limited by an ascertainable standard, and the grantor reserved the right to remove the trustee without cause and substitute another trustee, but he could not appoint himself. The IRS ruled that the trust property was includable in the grantor's estate under Sections 2036(a)(2) and 2038(a)(1), even though the grantor could not appoint himself as trustee. The IRS took the position that the removal power permits the grantor to continually change trustees until he could find a trustee who would follow his instructions, which is tantamount to retaining a power to serve as trustee himself.

The IRS's position was attacked because it failed to recognize the impact of the Byrum ¹⁶ case. The Sixth Circuit in that case considered the grantor's retained power to change trustees and stated: "That portion of the trust agreement that the government contends made the assets transferred into trust includable in the grantor's estate . . . relates to the grantor's retained power to: (1) vote the shares of the unlisted stock in the trust corpus; (2) veto transfer by the trustee of any of these shares of stock; and (3) to remove and appoint a successor corporate trustee at will . . ." (emphasis supplied).

The court held that the retained power to change trustees "at will" did not require inclusion in the grantor's estate. "Nor, for that matter, did the grantor's retaining of the power to replace the trustee by another corporate trustee make the value of the shares includable. . . ."

The Supreme Court, in Byrum, ¹⁷ discussed the retained power to change trustees but did not rule on this issue. Accordingly, for taxpayers in the Sixth Circuit, the Court of Appeals' opinion in Byrum should still be controlling in the taxpayer's favor. Further, if an ascertainable standard is coupled with the trust distribution provisions, the impact of Rev. Rul. 79-353 can be avoided because that Ruling applies only to discretionary distributions that are not limited by an ascertainable standard.

In Estate of Wall, ¹⁸ the decedent created an irrevocable trust giving an independent bank, as trustee, broad authority to control the beneficial enjoyment of the trust assets. The decedent retained the power to remove that bank and replace it with another corporate fiduciary, but the IRS still sought to include the trust assets in the decedent's estate under the reasoning of Rev. Rul. 79-353.

The Tax Court held that the decedent's estate did not include the value of the irrevocable trust because, although the decedent had the ability to remove the corporate trustee and appoint a successor corporate trustee, the decedent did not have an ascertainable and legally enforceable power to affect the beneficial enjoyment of the trust property or the income from it as the result of such power. The Tax Court came to this conclusion because of the established principle of trust law that a trustee has a duty of complete loyalty to the interests of the trust beneficiaries.

As a result of the decisions in Wall and Estate of Vak,¹⁹ the IRS announced in Rev. Rul. 95-58 ²⁰ that it was modifying Rev. Rul. 77-182 ²¹ to provide that a grantor's retention of the power to remove a trustee and appoint an individual or corporate successor trustee would not constitute the retention of control over the trust, as long as the successor trustee was not related or subordinate to the grantor within the meaning of Section 672(c) .

That section provides a definition which is used to determine whether a trust is treated as owned by the grantor for income tax purposes. Under Section 672(c), a related or subordinate party is any person (other than an "adverse party") who is the grantor's spouse, parent, issue, or sibling; an employee of the grantor; a corporation or an employee of a corporation in which stock holdings of the grantor and the trust are significant from the viewpoint of voting control; or a subordinate employee of a corporation in which the grantor is an executive. An "adverse party" is a person with a substantial beneficial interest in the trust which would be adversely affected by the exercise or nonexercise of the power.

Private letter rulings. The IRS extended its views concerning trustee removal and replacement powers held by a grantor to similar powers held by a beneficiary. For example, in Ltr. Rul. 9735023, the IRS determined that a beneficiary of a trust would not have the powers held by an independent trustee attributed to her where she had the power to remove and replace the trustee only with a successor trustee who was not related or subordinate to her within the meaning of Section 672(c). As a result, the beneficiary did not have a Section 2041 general power of appointment over the trust assets. The powers held by the independent trustee to make discretionary distributions of income to the beneficiary, if attributed to the beneficiary, would cause her to have a general power of appointment under Section 2041. ²²

Ltr. Rul. 200213013 is a favorable taxpayer ruling, and is worthy of review because it sets forth important facts and the tax law regarding the removal and appointment of successor trustees. In this ruling, the taxpayer transferred marketable securities to an irrevocable trust, and he and his spouse elected to take advantage of the "gift splitting" provisions of Section 2513. The taxpayer's spouse and an independent person were appointed as the initial trustees.

The trust instrument provided that the Family Trustee could pay or apply trust income and principal to or for the benefit of the settlor's descendants, in such amounts and proportions as the "Family Trustee deems necessary or desirable for a descendant's health, education (including post-graduate), support and maintenance in reasonable comfort and in the manner to which the descendant has become accustomed, and shall add any unpaid net income to principal. The trust estate shall not be used to pay any support obligation of Settlor or Spouse." The trust instrument also provided that at all times there was to be one independent trustee who was not a related or subordinate party to the settlor or the spouse within Section 672 and one Family Trustee who could be any person other than the settlor. The independent trustee also had the power to amend the trust in any manner required to meet the trust's tax objectives.

The taxpayer asked the IRS if the spouse's right to appoint a successor independent trustee or Family Trustee would result in the trust assets being included in her taxable estate. The IRS provided a favorable response, and stated that the Family Trustee's power to distribute trust income and corpus among the trust beneficiaries was limited by an ascertainable standard. Hence, the powers reserved to the settlor would not cause the trust corpus to be included in the settlor's gross estate. With regard to the includability of the trust corpus in the spouse's estate, the letter ruling found that although the spouse will consent to treat the gift to the trust made by the settlor as if made one-half by the spouse, Section 2035(a), and Section 2036 through Section 2038 do not apply to property interests that the decedent did not actually own and thus did not transfer.

Use of co-trustees and special trustees

As a result of the problems, both perceived and real, that arise when a trustee has unfettered control and the beneficiaries do not have any effective influence with the trustee, and in those situations where the trustee is also a beneficiary, some clients prefer to designate a co-trustee or a special trustee when the trust contains special assets.

Co-trustees: Individual and corporate. Because of the absence of a "perfect" answer (that is, whether a client should select an individual or a corporation as trustee), the client may believe that the ideal arrangement would be to have co-trustees-an individual and a corporate institution. Presumably, the individual would supply the personal touch and would possess the desired insight into the family's needs and knowledge of any special assets, and the corporate institution could provide the fiduciary expertise.

If co-trustees are going to work, the client and the targeted co-trustees should carefully consider the mechanics of the proposed working relationship. Will both trustees need to agree on all investment decisions, on authorizing discretionary distributions, and on basic trust administration issues like signing checks and tax returns? Will both co-trustees be responsible for the acts of one co-trustee? Will both co-trustees be responsible for an adverse result when that result is caused by the actions of one trustee and not the other? How will a co-trustee protect himself or itself from the actions of the other co-trustee? Many of these issues are resolved by state statute. For example, Florida's new Trust Code, Florida Statute 736.0703, which appears to be typical of the type of guidance provided to co-trustees, provides the following specific guidance:

• Co-trustees who are unable to reach a unanimous decision may act by majority decision.
• A co-trustee must participate in the performance of a trustee's function unless the co-trustee is unavailable to perform the function because of absence, illness, etc., and in that situation if prompt action is necessary, the remaining co-trustee or a majority of the remaining co-trustees may act for the trust.
• A co-trustee may not delegate to another co-trustee the performance of a function the grantor reasonably expected the co-trustees to perform jointly.
• A co-trustee who does not join in an action of another co-trustee is not liable for the action.
• Each co-trustee must exercise reasonable care to prevent a co-trustee from committing a breach of trust, and compel a co-trustee to redress a breach of trust.
• A dissenting co-trustee who joins in an action at the direction of the majority of the co-trustees and who notifies any co-trustee of the dissent at or before the time of the action is not liable for the action.

As most states have adopted a statutory solution to the administration of trusts with multiple trustees, it is important for the practitioner to check the client's legal residence and the statutory provisions of that state (or of the state of residency of the trust or the state whose law governs the trust). After considering the specific provisions of the laws of the relevant state, it may still be best to have the trust document respond to many of the potential trust administration issues. For example, give consideration to the following:

• Provide that the decision of one of the co-trustees be final and binding on the trust.
• Provide that one trustee's decision with regard to investments be final, while giving the other trustee final decision-making power over a special asset or discretionary distributions.
• Provide that a third party resolve any differences of opinion and provide a process for resolution.

Special trustees. Instead of selecting a co-trustee, some clients may want to consider the appointment of a special trustee to make decisions concerning a specific trust matter. A special trustee may be designated to control the trust's ownership of a closely held business, but this trustee would not have responsibility for general trust investments or for making discretionary distributions to the trust beneficiaries. The typical example is a client who would prefer to have his partner run the business, be in full control, and operate it in the same way that it has been operated during the client's life. The special trustee would run the business and would be authorized to determine the terms and conditions for the disposition of the trust's ownership interest.

If a special trustee is desired, it is necessary to determine how the responsibilities of the primary trustee and the special trustee are to be divided. Not only must the division be clearly understood, there must be a practical aspect to it. The client must determine the scope of each trustee's power, and, probably most important, the extent of each party's liability for his or its own acts or for the acts of the other trustee.

The problems of appointing a special trustee are probably not any more difficult than appointing a co-trustee. The client should consider the special problems of compensation of the primary trustee and the special trustee. It may be appropriate for the primary trustee's fees to be reduced when its responsibilities have been lessened. One approach would be to exclude the assets that are under the control of the special trustee from the total value of the assets on which the corporate trustee's fees are based.

The recommended solution: The trust advisor

After the client has analyzed all the problems of trustee selection, including the appointment of co-trustees and/or special trustees, many clients will conclude that the best approach is to appoint a single trustee, the corporate fiduciary, who will be responsible for all trust administration issues, and then appoint an advisor, or a committee of advisors who will provide the corporate fiduciary with the necessary insight as to the beneficiaries' needs and oversight of the trustee's administrative services.

It is believed that this course of action makes the most sense because the competent corporate fiduciary is a full-time professional with the advantages described earlier, while the advisory committee serves on a consulting basis. While the use of an advisor or advisory committee might not solve all problems, the recommended action of using an independent corporate fiduciary in combination with the personal touch of an involved advisory committee has substantial merit.

Because the practice of appointing persons-whether a beneficiary or a nonbeneficiary-to serve as an advisor to a corporate fiduciary is a relatively recent development, there are not a significant number of cases where the courts have been called upon to resolve controversies between a trust advisor, a trustee, and the beneficiaries. For those courts that have considered trust advisor issues, they seem to have concluded that the appointment of a trust advisor, and the granting to such advisor powers of control over designated areas of trust administration is a valid, legitimate, and appropriate means by which a person may secure not only the services of a competent trustee, but also the knowledge, advice, and expertise of a trusted friend, business associate, family advisor, or other uniquely qualified individual.

The general nature and extent of the powers and duties of an advisor, as well as the relationships and responsibilities between the advisor and the fiduciary and the beneficiaries are governed by the provisions of the client's trust instrument. If the trust provisions are ambiguous, it should be argued that such provisions should be interpreted in accordance with the rules of construction applicable generally to wills and trusts.

Although an advisor may be given extensive powers of control over the administration of a trust, it is widely recognized that the advisor is not the executor or trustee. The principal distinction between the advisor and the appointed fiduciary is that the advisor does not have title to, or right of possession over, the trust assets. Moreover, the fiduciary's powers are provided by state law and the trust instrument, whereas the advisor's powers are limited to those stated in the trust instrument.

Powers over special assets. When a substantial portion of a trust's assets consist of special assets (for example, a majority ownership interest in a closely held business), and it is desired that control of the company be retained and exercised by existing owners or other persons having special knowledge of the business, the advisor should be given specific powers over the business-e.g., the right to vote the shares and direct or consent to the sale of the business interest. If the client's intent is that the advisor will assume control over the trust's interests in the company, but not with respect to other trust investments, the trust document should make it clear that the advisor will have no powers over general trust administration issues. The separate powers of the trustee and the advisor should be made clear.

When the client wants to have an advisor for a special asset, it may be appropriate to have two advisors-one advisor to make all decisions regarding the special asset, and another advisor for general trust administration issues.

Requirement to follow directions-`Abusive direction issues.' When the advisor has the power to direct the trust's investments, the trustee's duties are different because, as a general rule, the trustee must follow the advisor's directions. To protect the trustee from losses that may result because of the trustee's compliance with the advisor's direction, some states have statutes specifying that a trustee will be protected when following the advisor's directions. ²³ However, just as co-trustees have an obligation to check on each other's actions, a trustee may have a duty to check on the propriety of the advisor's directions. Professor Scott says: ²⁴

[T]he trustee is not justified in complying with his directions if the trustee knows or ought to know that the holder of the power is violating his duty to the beneficiaries as fiduciary in giving the directions. The trustee cannot properly take the position that the responsibility is wholly that of the holder of the power.

Thus, requiring the trustee to refuse to follow the advisor's directions when he "ought to know" that the advisor is abusing his duty may obligate the trustee to investigate the advisor's proposed actions. If the advisor's action appears to be an abuse of the advisor's discretion, the trustee should raise the issue with the advisor, and if the advisor persists in directing an action that is considered inappropriate, the trustee should consider conferring with the trust's beneficiaries. If that action fails to produce a satisfactory result, the trustee may be forced to seek court instructions.

While the court proceeding would be designed to protect the interests of the trust beneficiaries, the action is also necessary to protect the trustee because the failure to seek instructions could result in the fiduciary being surcharged. If the trustee finds the advisor's actions so inappropriate and such actions continue for a period of time, the trustee should resign.

Advisors are fiduciaries. Courts will generally consider a trust advisor as a fiduciary because the trust advisor has been entrusted with discretionary powers and courts have acted to protect beneficiaries from inappropriate self-dealing. In addition, the power to direct trust investments carries with it duties of loyalty, impartiality among beneficiaries, and responsibility to follow a prudent investment policy. Therefore, no less care should be expected of an advisor with such powers than of the trustee. However, the author has found no case in which a trust advisor has been surcharged for an error in investment judgment.

As to the trust advisor who does not have a power to direct investments, but has only the power to approve the trustee's proposed course of action, it would appear that there would be a lower standard of responsibility because the trustee is responsible for initiating investment proposals, and the advisor's duty is limited to using prudence in approving or disapproving the trustee's recommended investments. Accordingly, the burden of consenting to a recommended investment as a prudent man would appear to be less onerous than an obligation to direct investments.

Assuming that you would conclude that the advisor has fiduciary responsibilities, you then need to consider whether the client should or could reduce or eliminate the advisor's fiduciary obligations by specifying in the trust instrument that the advisor is not to have any responsibility for the advisor's decisions or is to be responsible only for actions constituting willful wanton misconduct, etc. Notwithstanding the provisions of the trust instrument, courts may reject, out of hand, this type of limiting language in a case where the court finds a severe breach of a fiduciary duty. Further, if the advisor happens to be a lawyer, the lawyer must be prepared to explain to the court that he or she met all the professional responsibility requirements of Rule 1.8 of the Model Rules of Professional Conduct. ²⁵

Finally, it is probable that few grantors who impose investment responsibilities upon business associates or family friends are aware of the advisor's potential liability, and such advisors are even less likely to be aware of the assumed risks. The fact that the advisor receives no compensation, is being a "nice guy," is not going to protect the advisor as trustees who receive no compensation are held to the same fiduciary standards as other trustees. ²⁶ It would be reasonable to presume that advisors will not escape liability merely because they are not compensated for their time and trouble.

Trustee coordination with advisors. The interaction of trust advisors with the trustee can be effectuated in different ways: (1) the trustee could be required to keep the advisors informed about its actions-whether before or after the fact of the trustee's actions; (2) the trustee could be required to consult with the advisors before making investment or distribution decisions; or (3) the trust advisors could have the power to direct the trustee, in which case the advisors would initiate the action.

The trust instrument should give the trustee guidance for those situations when the advisors fail to respond to the trustee's request for guidance or refuse to approve a trustee recommended action, or when the advisors fail to agree (the advisors are deadlocked). In those situations where the advisor consistently refuses to respond or responds negatively, the trustee could seek court authorization, but in most situations, this is not a practical solution because of the cost, delay and the general refusal of courts to intervene prospectively with trust administration issues. As a last resort, the trustee could elect to resign.

Criticism of trust advisors. The strongest criticism of trust advisors is that their involvement complicates trust administration, causes delay, and makes trust administration more expensive. Moreover, when there are two or more advisors, and it becomes necessary for the trustee to educate, confer and obtain approval from a group of people, the problems become even more difficult. Nevertheless, it is argued that the complications and expense involved in using a trust advisor can be reduced by the inclusion of a well thought-out and carefully drafted trust provision which makes clear (1) the advisor's rights and responsibilities in dealing with the trustee and the beneficiaries, and (2) the trustee's rights and responsibilities in dealing with the advisors, and (3) the rights of the beneficiaries in dealing with both.

Part 2 of this article, which will appear in the next issue of Estate Planning, will cover significant case law, the selection of trust advisors, the role of the committee of advisors, and drafting suggestions.

PRACTICE NOTES

While the use of an advisor or advisory committee might not solve all problems, the recommended action of using an independent corporate fiduciary in combination with the personal touch of an involved advisory committee has substantial merit.
¹

For example, Florida requires that the decedent's personal representative be a Florida domiciliary or be (1) a legally adopted child or adoptive parent of the decedent; (2) related by lineal consanguinity to the decedent; (3) a spouse or a sibling, uncle, aunt, nephew, or niece of the decedent, or someone related by lineal consanguinity to any such person; or (4) the spouse of a person "otherwise qualified under this section" in order to serve. See Fla. Stat. 733.304, and In re Estate of Greenberg, 390 So.2d 20 (Fla., 1980). Also, Kentucky requires that a fiduciary be a Kentucky domiciliary or "related by consanguinity, marriage, adoption or the spouse of such person so related" in order to serve. See KRS 395.005.
²

An example of this point recently arose in the author's practice. The decedent's trust was to be funded with $750,000, and had two beneficiaries, ages 21 and 18. The trust was to continue as one trust until the younger beneficiary attained age 22, at which time two separate trusts were to be created with mandatory distributions of principal at ages 25 and 30. The designated corporate trustee declined to serve because the one trust was soon to be divided into two relatively small trusts, the significant economic needs of the beneficiaries who required special attention, and because the maximum term of the trusts would be 12 years.
³

In those instances where a beneficiary attacks the fiduciary, it is important to determine the beneficiary's real intent; that is, is there a legal basis for such attack or is the beneficiary plotting to remove the trustee based on the alleged existence of hostility between the beneficiary and the designated trustee? For an excellent discussion of this subject, see "Hostility Between Trustee and Beneficiary as Ground for Removal," 63 A.L.R.2d 523; and Becker, "Control of Trust-Held Companies by Trustees," 19 J. Corp. L. 41 (1993).
⁴

Another recent experience from the author's practice is illustrative. Five years ago, a widow, age 85, created a charitable remainder unitrust with $100,000 of appreciated stock. The corporate trustee sold all the stock, reinvested all the proceeds into one aggressive growth mutual fund, and in a short time the trust grew to almost $200,000, but the value of the CRUT today is $70,000. The corporate trustee denied a claim based on lack of diversification.
⁵

See Gilman, "Fiduciary Management of the Closely Held Business," ABA Real Property, Probate and Trust Law Section, 11th Annual Spring Symposia (3/22-24/00), South Beach, Fla.
⁶

In a recent posting on the American Bar Association's Estate Planning List Serve, an attorney commented on the ongoing dialogue concerning individual vs. corporate trustees, and then described the following problem in trying to obtain the services of a corporate trustee. "Husband is 70 years old, wife is 65. They have no children and no charitable intent, they want to leave their entire estate in equal shares to two separate families. The problem is they have about 75 LLCs all with separate residential properties with a total value of $50 million. Properties generate about $500,000 a year of net cash flow, and they have their own construction company and crews. All holdings are debt free. No one in extended family is capable and/or willing to step in (a) in case of disability, or (b) death of the surviving spouse. I thought the situation was perfect for a corporate trustee to sell properties off piecemeal, but three banks so far said they can't or won't do it until/unless the assets were reduced to cash! Wondering if anyone has ever used an institution who was willing to serve in similar circumstances?"
⁷

689 NE2d 783 (Mass., 1998).
⁸

See ACTEC Commentary on MRPC 1.8.
⁹

See, e.g., Fla. Stat. 736.1011, Exculpation of trustee.
¹⁰

For example, in Wiggins v. PNC Bank, Kentucky, Inc., 988 SW2d 498 (Ky. App., 1998), the court held that when a trustee (a corporate trustee in this case) serves as trustee of two trusts with the same life income beneficiary but different remaindermen, the trustee had a conflict of interest when faced with having to choose between the trusts to provide for the income beneficiary. The court held that the trustee's distribution from one of the trusts for the income beneficiary constituted a breach of trust. The court ruled that the trustee should have sought court authorization before exercising the power of encroachment, even though the trust instrument gave the trustee broad discretion to invade principal for the income beneficiary. The result of this case has been legislatively overruled for corporate trustees by KRS 287.220.
¹¹

In another example from the author's private practice, when reviewing a corporate fiduciary's trust account, this author noted that the financial statements of a decedent's family-held business disclosed that the business owed the corporate fiduciary approximately $3 million for the business's operating needs. However, the financial statements also indicated that the family business had a depository relationship with the corporate fiduciary and that the cash on deposit was substantially more than what would be needed for the business's reasonable operating needs. Furthermore, the interest being paid to the corporate fiduciary's commercial department was greater than the market rate, and the interest being paid on the business's deposits was below market rate.
¹²

Some state statutes require that a trustee/beneficiary obtain court approval before exercising a power of distribution. For example, Florida, see Fla. Stat. 737.402(4)(a); Indiana, see Ind. Code 30-4-3-5; and Kentucky, see KRS 386.820 require that court approval be obtained before a trustee exercises a trust power for the trustee's own benefit.
¹³

1973-1 CB 405.
¹⁴

1973-1 CB 405.
¹⁵

1979-2 CB 325.
¹⁶

27 AFTR 2d 71-1744, 440 F2d 949, 71-1 USTC ¶12763 (CA-6, 1971).
¹⁷

30 AFTR 2d 72-5811, 408 US 125, 33 L Ed 2d 238, 72-2 USTC ¶12859, 1972-2 CB 518 (S.Ct., 1972).
¹⁸

101 TC 300 (1993).
¹⁹

70 AFTR 2d 92-6239, 973 F2d 1409, 92-2 USTC ¶60110 (CA-8, 1992), rev'g TC Memo 1991-503, 62 CCH TCM 942, TCM ¶91503 At issue in Vak was whether a trust grantor had made a completed gift to the trust when he retained the right to replace the trustees. The Eighth Circuit held that he had.
²⁰

1995-2 CB 191.
²¹

1977-1 CB 273.
²²

See also Ltr. Ruls. 9746007, 9735025, and 9607008.
²³

For example, in Kentucky, KRS 287.275 protects a bank from liability, but not an individual trustee, when a bank fiduciary acts at the direction of a trust advisor. Further, a bank fiduciary is relieved from any obligation to perform investment reviews and make recommendations with respect to any investments when an advisor has the authority to direct trust investments.
²⁴

2A Scott, Trusts §185, at 574 (4th ed. 1987).
²⁵

See the earlier discussion regarding exculpatory clauses when the lawyer serves as trustee.
²⁶

See 2A Scott, Trusts, supra note 24, at §169.

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