Trust Act 2017 Legislative Update
On August 30, 2017, Delaware Governor John Carney signed House Bill 169 into law (“Trust Act 2017”), which provides settlors, beneficiaries and fiduciaries of Delaware trusts with more tools and greater flexibility to confidently accomplish their various objectives.
Section 3313A – Excluded cotrustee.
New Section 3313A of Title 12 of the Delaware Code addresses the duties and liability of a trustee when a trust instrument grants a cotrustee exclusive authority to take specified actions on behalf of the trust, including the power to direct or prevent certain actions of the excluded trustee. Section 3313A is patterned after Delaware’s frequently utilized direction adviser statute, Section 3313 of Title 12, but provides settlors and fiduciaries with a greater level of certainty regarding the risks and responsibilities associated with trusts that divide trustee powers and duties among various cotrustees such as distribution trustees, independent trustees, investment trustees, administrative trustees, and the like.
In a typical directed trust arrangement, a directed trustee exercises certain powers – frequently investment or distribution powers – only at the direction of an adviser. The directed trustee retains the trust powers but may only exercise one or more of those powers as directed by an adviser. Although this arrangement can be very effective in many circumstances, fiduciaries may find themselves in difficult situations when acting at the direction of an adviser. For example, a trustee might be directed to exercise a power in a manner that they do not believe to be in the best interest of a beneficiary, or it may be unclear as to whether or not a direction falls within the scope of an adviser’s authority, or the trustee might have difficulty determining whether and how to communicate with beneficiaries regarding an adviser’s directions. These problems increase exponentially when a trustee is operating under a poorly drafted governing instrument. New Section 3313A, however, codifies a viable alternative to the directed trust regime that provides certainty to fiduciaries serving as cotrustees and may alleviate some of the anxiety and uncertainties associated with the most common problems faced by directed trustees.
First, new Section 3313A addresses circumstances in which a cotrustee has the power to direct an excluded trustee in an arrangement that is similar to a typical directed trust under Section 3313. Specifically, Section 3313A(a)(1) provides that, when the terms of the governing instrument confer upon a cotrustee the power to direct certain actions of another cotrustee, the directed cotrustee must act in accordance with the direction and shall have no duty to act in the absence of such direction. Similar to the direction adviser statute, Section 3313A(a)(1) provides that when acting at the direction of the cotrustee, the directed cotrustee is not liable, individually or as a fiduciary, for any loss resulting directly or indirectly from compliance with the direction absent wilful misconduct on the part of the directed cotrustee.
New Section 3313A varies significantly from the direction adviser statute in Subsection (a)(2), which provides that, if the terms of the governing instrument confer upon the cotrustee exclusive authority to exercise any power, the excluded trustee is not liable, individually or as a fiduciary, for any loss resulting directly or indirectly from the action taken by the cotrustee in the exercise of the power. This provision provides certainty under Delaware law that a cotrustee who is entirely excluded from holding a particular trustee power or authority is completely exonerated with respect to the actions taken by a cotrustee having sole power and authority for the matter. Although a directed trustee or cotrustee is nearly as protected under Delaware law, a directed trustee is still subject to a wilful misconduct standard when exercising powers at the direction of another.
Section 3313A(a)(3) provides that all excluded trustees (including cotrustees acting at the direction of other cotrustees and those completely excluded from holding a particular power or authority) have no duty to monitor the conduct of the cotrustee, to provide advice to the cotrustee, to consult with or request directions from the cotrustee or to notify a beneficiary of any action taken or not taken by the cotrustee. Excluded trustees are also provided with protections under Section 3313A(b), which provides that, when a cotrustee exercises its exclusive power to take a certain action with respect to the trust, only that cotrustee shall be liable to the beneficiaries with respect to the exercise of the power as if the excluded trustee were not in office. Moreover, that cotrustee shall also have the exclusive obligation to account to the beneficiaries and to defend any action brought by the beneficiaries with respect to the exercise of the power.
Newly enacted Section 3313A will serve as a valuable gap filler for existing governing instruments that do not clearly address the duties or liability of an excluded cotrustee and provides certainty to settlors, fiduciaries and their advisers regarding how such relationships will be governed under Delaware law. A properly drafted trust agreement can effectively bifurcate trust powers among more than one trustee and insulate the excluded trustee from liability for the acts of its cotrustee with respect to the exercise of powers from which it is excluded. As confirmed by the express statutory language, an excluded trustee should take comfort from the fact that it has no duty to act in any respect with regard to the powers from which it is excluded.
Section 3338 – Nonjudicial settlement agreements.
Trust Act 2017 also amends 12 Del. C. § 3338 to make nonjudicial settlement agreements available to charitable trusts and noncharitable purpose trusts, provided that the statute may not be used to change the trust’s purposes unless the trust has become unlawful under the constitution or no longer serves any religious, charitable, scientific, literary, educational or noncharitable purpose or the trustor is a party to the agreement.
Section 3341 – Consequences of trust merger and similar transactions.
Trust Act 2017 adds new Subsections (4) and (5) to 12 Del. C. § 3341 to address the effect of trust mergers, certain decantings and similar transactions.
First, with respect to cases where the transferee trust receives its initial funding as a result of the merger or other transaction, new Section 3341(4) of Title 12 confirms that, absent a contrary provision in the governing trust instrument of the transferee trust, (i) any power of appointment exercisable over property of the transferor trust remains exercisable over the property of the transferee trust, and (ii) an instrument purporting to exercise a power of appointment over property of the transferor trust that predates the merger or other transaction remains effective with respect to the transferee trust, but only to the same extent that such instrument would have been a valid exercise of the power of appointment over property of the transferor trust. These provisions essentially ensure that powers of appointment may not be merged or decanted out of existence and that the exercise of a power of appointment over a trust that was signed before a merger or decanting need not be re-executed following the merger or decanting, in cases where the trust is merged with or decanted into a previously unfunded trust. However, if a power of appointment is intended to be excluded or narrowed by a decanting transaction, it is advisable to specifically state as much in the governing instrument of the new trust.
The issue is more complicated in cases where a trust is merged with or decanted into another trust that has previously been funded. To address this issue, new Section 3341(5) of Title 12 provides that any power of appointment exercisable over property of either trust participating in the merger or other transaction shall, following the transaction, be exercisable over property of the transferee trust only to the extent expressly provided by the terms of the written documents effective the merger or other transaction. This provision prevents an inadvertent expansion of a pre-existing power of appointment over property that such power was never intended to cover.
Section 3342 – Modification of trust by consent while trustor is living.
A year after its enactment, the Delaware trust modification statute, 12 Del. C. § 3342, has been modified to provide that a trustor’s power to participate in a trust’s modification may be exercised by an agent under a power of attorney, but only to the extent that the agent is expressly authorized under the power of attorney or the terms of the trust’s governing instrument, or if the agent is not so authorized, by the guardian of the trustor’s property or similar court-appointed representative with the approval of the court supervising the guardian or similar representative. This change expressly addresses how the modification statute may be utilized to modify a Delaware trust when the trustor is incompetent. Section 3342 was also modified to clarify that a modification under the section requires the participation of all trustors.
While the modified statute is useful, trustors should be educated about the broad range of modifications that could be accomplished by their agents under the statute. Moreover, trustors and their advisers are cautioned to expressly grant agents the power to modify trusts under Section 3342 in a durable personal power of attorney document or the trust’s governing instrument if it is intended that such a power be granted to the agent.
Section 3528 – Trustee’s authority to invade principal in trust.
Prior to Trust Act 2017, decanting under the Delaware decanting statute, 12 Del. C. §3528, required that the property of the existing trust be decanted into a new separate trust. As a result of Trust Act 2017, Delaware now permits trustees to effect a trust decanting into the same trust, without the need to create a new separate trust.
This modification to the decanting statute will resolve several of the concerns that are regularly expressed by fiduciaries when considering whether or not to decant a trust. With a properly designed transaction, fiduciaries should no longer be concerned about the potential need to open new trust accounts, obtain a new EIN or retitle trust property as the result of a decanting. Moreover, the new provision will allow fiduciaries to avoid several of the questions that frequently arise as part of a decanting transaction, such as whether the governing instrument of a new trust should take the form of a trust agreement or a declaration of trust and who should execute such governing instrument. This addition to the statute may also resolve fiduciaries’ concerns about the tax-related implications of creating one or more new trusts in a decanting transaction.
Section 3570 – Definitions applicable to Subchapter VI (Qualified Dispositions in Trust)
Trust Act 2017 clarifies law related to Delaware asset protection trusts by expressly confirming that a sale or exchange for full and adequate consideration is not a “disposition” for purposes of Delaware’s Qualified Dispositions in Trust legislation meaning that (i) a person engaging in such a transaction does not become a settlor of the trust by reason of the sale or exchange, and (ii) such a transaction may not be voided by a creditor.
Section 3585 – Limitation of action against trustee following trustee’s report.
Trust Act 2017 also adds a new limitations period for actions against a trustee following the trustee’s departure from office. Prior to Trust Act 2017, the default statutory period for a beneficiary to initiate an action for breach of trust against any trustee under Section 3585 of Title 12 of the Delaware Code was two years after being sent a report that adequately disclosed the facts constituting a claim, unless otherwise precluded by adjudication, release, consent or limitation. Following the enactment of Trust Act 2017, Section 3585 now provides that, in the case of a trustee who ceases to serve as trustee for any reason (including, but not limited to, on account of the termination of the trust by reason of liquidation or by reason of a merger, a decanting, or a similar transaction described in Section 3341 of Title 12 of the Delaware Code), a beneficiary shall have one hundred twenty days (120) from the date the beneficiary was sent a report that (i) notifies the beneficiary that the trustee has ceased to serve; (ii) adequately discloses the facts constituting a claim; and (iii) adequately discloses the statutory time allowed under the section for initiating proceedings against the former trustee for breach of trust. Revised Section 3585 now also provides that, in the case of a beneficiary who is represented and bound by a designated representative under Section 3303(d) of Title 12 of the Delaware Code, a trustee’s report that is sent to the designated representative is sufficient to commence the running of the applicable limitations period under Section 3585.
25 Del. C. § 501 – Powers of appointment; effect of rule against perpetuities.
Section 501 of Title 25 of the Delaware Code provides that every interest in property created through a power of appointment is deemed to be created at the time of the exercise of such power of appointment, as opposed to the time of the creation of such power of appointment. This provision creates an opportunity to spring the so-called “Delaware tax trap”, in order to obtain a basis step up or minimize transfer taxes, by creating a second power of appointment that could be exercised so as to postpone the vesting of any estate or interest in the property subject to the power for a period ascertainable without regard to the date of the creation of the first power thereby causing the property subject to the power to be includable in the gross estate of the powerholder pursuant to Section 2041(a)(3) of the Internal Revenue Code. For many years, powerholders have avoided springing the Delaware tax trap by exercising their powers of appointment in a manner that expressly prohibits a second power that is created by the first power from being exercised in a manner that could postpone the vesting of any estate or interest in the property subject to the power for a period ascertainable without regard to the date of the creation of the first power. Notably, Section 504 of Title 25 of the Delaware Code protects unsuspecting powerholders from inadvertently springing the Delaware tax trap with regard to generation-skipping transfer tax exempt trusts.
Trust Act 2017 adds a new Subsection (b) to Section 501, which provides that, upon an express indication in an instrument exercising a power of appointment that Subsection (b) shall apply, an estate or interest in property created through the exercise of a power of appointment shall be deemed to have been created at the time of the creation, and not at the time of the exercise, of such power of appointment. As a result of this enactment, Delaware has created another method of avoiding the Delaware tax trap by providing a statutory opt out pursuant to which the donee of a power of appointment over trust property may avoid the application of the general default rule of Section 501(a).
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