Trust: What's in a word?

The word "trust" has several meanings but at the core of all its definitions is one concept - loyalty. And loyalty is very strong in the trust law setting. Historically, trust law in the United States has its roots in the Statute of Uses - an English law enacted in 1535 to end landholders' practice of being disloyal to their lords, who were allowing them to use their properties. Landholders were disloyal to their lords even though they were usually family members, related to their lords by blood or marriage. Today, the subject matter of trust law can be divided into two main areas: creation and administration. Creation essentially boils down to the legal definition of trust, i.e., what things must happen in order to have an instrument that will be legally recognized as a trust. It is not always necessary to write up a trust agreement but it is highly beneficial to do so since having a trust agreement can more clearly set out a settlor's (any individual who sets up a trust) intentions. There are several varieties of trust instruments from which people may choose, depending on for what/whom the trust is being created (a.k.a. the beneficiary of the trust) and, for what reason the trust is being formed.

Administration is primarily comprised of a series of duties owed by trustees - persons or entities capable of taking legal title to trusts – to the trust. The duty of loyalty is at the core of all trustees’ duties. Any adult individual, corporation (with trust powers) or governmental unit can be a trustee but, even so, not just anyone should be trustee because, like the English landholders mentioned above, a “bad trustee” can be disloyal, putting the trust at risk. To protect trusts from abusive trustee behavior, the law specifies five fundamental fiduciary duties for trustees. 

Duty1: The duty to act in a prudent manner

A trustee must act reasonably and competently in all manners of trust administration. If a trust has already been created, one of the first actions a trustee must take is to ensure that all of the trust investments are proper and to convert improperly invested assets into proper trust investments. Unless the trust agreement says otherwise, examples of improper investments are the investment of substantially all of the assets of the trust in a closely held business or in one or two securities, so, diversification is the key. Related to diversification, trust assets must be invested without favoring any class of beneficiary. The interests of one class of beneficiary should not be sacrificed for the benefit of the other. The trustee should, therefore, invest trust assets in a manner that produces a reasonable income stream while at the same time protecting the trust principal. Trust principal derives from the property given to the trust by the settlor and, income is the return in money or property for the use of the principal. 

Duty 2: The duty to carry out the terms of the trust

A trustee has a duty to carry out the intentions of the settlor as expressed in the trust instrument. The trustee is the agent of the settlor and not the beneficiaries of the trust, thus, trustees must carry out the terms of the trust as the settlor expresses. The beneficiaries’ wishes are subordinate to the desires of the settlor. 

Duty 3: The duty of loyalty to the trust

The duty of loyalty lies at the heart of trust law and is the epitome of a trustee’s duties. No person holding trust funds is allowed to derive any personal gain or advantage from the use of those funds but must manage them with solely the interests of the beneficiaries in mind. Trustees must act affirmatively to further the interests of the trust and, must defend the trust if it’s sued by a third party.

Duty 4: The duty to give personal attention to the business of the trust

Trustees are required to personally attend to the business of the trust. Thus, for the most part, administration of the trust cannot be delegated. Trustees’ administrative duties fall into the following categories: (a) provide safe custody of trust assets and collect the income generated by those assets; (b) determine current beneficiaries and provide for distributions from the trust as appropriate; (c) decide appropriate investment policy, periodically review investments and make suitable investment changes; (d) pay administrative expenses; (e) file federal and state income tax returns for trusts; (f) pay estimated and regular taxes, forwarding tax information to current trust beneficiaries and (g) keep separate income and principal accounts for each trust instrument (even if several trusts are contained in one trust document) rendering periodic summaries for each trust and each account separately.

Trustees, however, are not required to personally attend to ministerial tasks such as asset custody and record keeping; so these tasks can be assigned to others. In addition, if trustees require assistance to carry out their duties in a competent fashion, they can get help. For example, trustees are permitted to retain financial advisers and pay for the services out of the trust funds, as long as the trustee is prudent in selecting the advisors, sets the investment objectives, and monitors the advisers’ performance. In fact, given that the risk of self-dealing is greater where a trustee performs services that a separate, independent agent could perform, it might be better for trustees to get the help of other professionals in order to carry out their duties, thereby further upholding their loyalty to the trust. For trusts with two or more trustees, each can reasonably apportion their duties between them but one trustee must not be permitted to have exclusive management of the trust property.

Duty 5: The duty to account to the trust beneficiaries

Trustees must give beneficiaries all the information necessary to protect their interest in the trust. Trustees must prepare accounts that show how the trust is being administered. Specifically, the accounts must show the income received, the income paid and the income on hand; additions to principal, principal on hand and changes in investments.

Trustee fees and services

The trust agreement should set out a fee schedule. Trustees usually charge for each of the various functions which they perform. Set-up fees may be requested for initial services and distribution fees for disbursing the trust. Most fee schedules contain at least a minimal annual fee, with additional compensation for extra services like complicated sales of major trust assets, tax work or legal work. And where there are two or more trustees, it is common for the trust instrument to set their “reasonable compensation” as that of just one trustee, with fees for each trustee dependent upon the services each respectively performs.

Trustee liability and indemnity

In trust law, a “breach of trust” happens if trustees breach one or more of their duties. For the most part, trustees who breach their duties can be sued directly for damages in tort, i.e., a civil (not criminal) wrong. Trustees may be liable to the settlor, beneficiaries, or both. A “breach of trust” means that a trustee is personally liable, thus, unless the trust benefited from a trustee’s actions, money damages awarded for “breach of trust” cannot come from a trust’s assets. Even so, the onus is on the person bringing suit to prove that the trustee was personally at fault.

Conclusion

Many people may be tempted to choose a relative to administer their trust assets. Individuals primarily choose family because it may be free or less expensive to do so. But, rarely does a family member have the expertise to properly manage and dutifully administer a trust fund. To manage a trust properly one must not only possess investment and financial skills, but must devote a fair amount of time monitoring the investments, making distributions to beneficiaries and taking care of the necessary annual accountings and tax returns. More importantly, a family member trustee has a fiduciary responsibility to the settlor and trust beneficiaries. And like business and pleasure, sometimes fiduciary responsibilities and family members shouldn’t be mixed! The ideal trustee would have the legal skills to administer the trust, the investment expertise to manage the trust assets, and the ability to respond impartially and compassionately to the needs of the beneficiaries, while remaining loyal to the goals of the settlor throughout the life of the trust. Given these criteria, it is clear to see why people creating trusts should consider naming a lawyer1, a financial planner or other professional as trustee, and having the trust pay for their professional, administrative services. It is well worth the price to protect their interests and maybe more importantly, the future financial well-being of the trust’s beneficiaries - your family.

1 To avoid the appearance of impropriety, lawyers should probably not suggest themselves as trustees without also including a discussion of other possible choices and/or providing clients written disclosures about potential conflicts in providing trustee services as well as "traditional" legal assistance.