A version of this article appeared in the March 2011 issue of Estate Planning, Volume 38, Number 3, © 2011, Thomson Reuters.
Joseph was a successful businessman during his lifetime and died owning a majority stake in a newspaper empire. Joseph provided for his estate to be held in trust for the benefit of his sons and then the remainder to be distributed among his descendants. Joseph's Will authorized the Trustees to sell any asset; however, the Trustees were expressly prohibited from selling the stock of one specific entity – the Press Publishing Company, publisher of The World and two other newspapers. In his Will, Joseph stated:
I particularly enjoin upon my sons and my descendants the duty of preserving, perfecting and perpetuating 'The World' newspaper (to the maintenance and upbuilding of which I have sacrificed my health and strength) in the same spirit in which I have striven to create and conduct it as a public institution, from motives higher than mere gain, it having been my desire that it should be at all times conducted in a spirit of independence and with a view to inculcating high standards and public spirit among the people and their official representatives, and it is my earnest wish that said newspaper shall hereafter be conducted upon the same principles.2
The newspaper empire continued to do well following Joseph's death; however, approximately fifteen years later, the newspapers started to decline. The newspapers were operating at a dramatically increasing loss over the seven years preceding the Trustees' action seeking construction of Joseph's Will to determine if it authorized them, despite the instrument's explicit language, to sell the Press Publishing Company. Although the Trustees demonstrated evidence in the instrument that Joseph contemplated the sale of Press Publishing Company's stock in certain emergencies, the Court opted to use its equitable powers to, in emergencies, "protect the beneficiaries from serious loss or total destruction of a substantial asset of the corpus."3 The Court held that in the event of a necessity, there is an implied power to sell despite express language prohibiting such sale, and therefore authorized the Trustees of Joseph's Trust to sell the stock of Press Publishing Company. The Court derived this "implied power to sell" on the law's assumption that "a testator had sufficient foresight to realize that securities bequeathed to a trustee may become so unproductive or so diminished in value as to authorize their sale where extraordinary circumstances develop, or crisis occurs."4 The Court concluded that Joseph's dominant purpose in establishing the Trust was to support his children and to preserve the trust corpus for his remaindermen, and not to retain the newspapers, out of pure vanity, under all circumstances, including the complete destruction of the trust corpus. Although Joseph may have hoped that the newspapers would continue to be successful, the Court determined that "he must have contemplated that they might become entirely unprofitable and their disposal would be required to avert a complete loss of the trust asset."5
The example of Joseph Pulitzer reminds us as estate planners that despite our attempted skillful memorialization of our clients' expressed intent, there remain forces outside our control, namely the Courts, the beneficiaries, the Trustees, and legislation, which may work against our clients' wishes. Such intervention is often appropriate, e.g., enabling flexibility when unanticipated circumstances arise. However, there remains the possibility that our client's intent, something that was so clearly expressed to us during our meetings with him, will be abandoned after he dies.
This article is intended to provide estate planning practitioners with a guide to best accomplishing our client's intent for the administration and disposition of his estate after his death. In particular, I will focus on planning and drafting for the client whose estate is mostly comprised of a business owned and operated by the client and his family. Because this business is the source of the client's wealth and success, often significantly changing the client's family's circumstances, the client may have specific objectives regarding the business's operation and management after his death. As planners, it is our responsibility to articulate and memorialize his intent in the documents we prepare and the estate planning we implement.
The article will first briefly highlight specific areas of the law, common and statutory, that currently exist to construe the instruments we draft, and therefore should be familiar to the estate planning practitioner. This universe is comprised of case law, the Uniform Prudent Investor Act and the Uniform Trust Code. Because these uniform laws are enacted in varying versions among the states, the model uniform laws, as promulgated by the National Conference of Commissioners on Uniform State laws, will be used unless specifically referenced otherwise. Following this overview, the article presents a fact pattern for a sample entrepreneurial client. The subsequent analysis will discuss the potential problems and proposed solutions for my sample client's planning.
Three scenarios permitting a judicial override, or "equitable deviation,"6 of the Settlor's expressed intent are notable in case law – (1) an implied intent to sell in an emergency;7 (2) invalidity of the Settlor's expressed intent because it is contrary to (economic) public policy;8 and (3) modification because of unanticipated circumstances.9
As described above, the Pulitzer case was decided based on the Court's equity power to intervene when an emergency, i.e., the eminent failure of the enterprise funding the Trust, was posing a serious threat to the trust corpus. The Court took the position that it needed to "protect the beneficiaries" from such loss and held there was an implied power to sell because of the emergency, despite express language in the instrument to the contrary.10 The Court analyzed Pulitzer's intent and determined that his "dominant purpose" in establishing the Trust was to benefit his family, and language imploring his sons and more remote descendants to retain Press Publishing Company, and in particular, The World newspaper, was determined to be only a precatory direction to his descendants.
In Colonial Trust, another entrepreneur, Robert Brown, died owning real estate in Waterbury, Connecticut. In his Will, Brown made several specific directions regarding the management of real estate: (i) the Trustees were forbidden to sell either Brown's homestead or the "Exchange Place" property; (ii) no lease of any of Brown's real estate could exceed one-year; and (iii) no building constructed on any of Brown's land could exceed three stories.11 The Court agreed that it was Brown's intent to have the Trustees retain the Exchange Place property and his homestead; nonetheless, it held the prohibition from selling the properties invalid because it was an impermissible attempt to restrain alienation until the termination of the Trust, which may exceed the expiration of the lives in being plus twenty-one years.12 The Court also held invalid the restriction on leasing and constructing buildings greater than three stories. The Court concluded that these "imprudent and unwise" limitations were contrary to be interests of the beneficiaries.13 However, the Court based its invalidation of these restrictions on their negative effect to the neighborhood, stating such restrictions:
. . . make it impossible to obtain from [the properties] proper income return or to secure the most desirable and stable class of tenants, requires for the maintenance of the buildings a proportion of income greatly in excess of that usual in the case of such properties, and will be likely to preclude their proper development and natural use. The effect of such conditions cannot but react disadvantageously upon neighboring properties, and to continue them, as the testator intended, for perhaps seventy-five years or even more, would carry a serious threat against the proper growth and development of the parts of the city in which the lands in question are situated.14
Because of the harm these restrictions caused to the public welfare, namely the economic development of the neighborhood, they were held to be invalid violations of public policy.
The third case, Donnelly, did not involve a business owner, but a wealthy testator, D. I. Cornell, whose Will provided for an annual payment of $750 to be made to his grandson provided he was enrolled and in good-standing as a student in a degree-granting college, university or post-graduate school.15 The Will also provided for the payments to cease no later than December 31, 1945. While Cornell's grandson was pursuing his law degree, he was ordered to active duty as a U.S. Marine for the following three years. The Trustees refused to reinstate the grandson's payment following his return from WWII and to law school because the time limit of December 31, 1945 had passed. Sitting in Cornell's shoes, the Court stated that it must determine "what it conceives would have been done by the creator had he foreseen the situation of his beneficiary in a substitution of another course in order to the complete realization of the settlor's purposed bounty."16 The Court determined that Cornell's intent was to give his grandson $750 a year to complete his college and professional education, and that Cornell neither foresaw WWII nor his grandson being called to active duty during his post-graduate education.17 The Court concluded that because of this unforeseen circumstance, and despite the express language in the Will, the Trustees were to continue to make the annual payments to his grandson in order to fulfill Cornell's intent.18
The Court's willingness to intercede and deviate from the express terms of a Trust in the event of emergency, a violation of public policy, or unanticipated circumstances demonstrates that the Settlor's intent, as it is explicitly stated in our instruments, may not be enforced under all circumstances.
The Uniform Prudent Investor Act (the "Act") was intended to reform existing trust investment law and addressed, in part, the Trustee's (i) duty to diversify, (ii) determination of "risk and return" objectives for the Trust; and (iii) delegation of investment responsibilities.19 The Act specifically states that its rules are default rules that the Settlor can "alter or abrogate."20 Let us examine the Trustee's "duty to diversify" under the Act as it relates to the Settlor's expressed intent.
Section 3 of the Act states, "A trustee shall diversify the investments of the trust unless the trustee reasonably determines that, because of special circumstances, the purposes of the trust are better served without diversifying."21 The Comment to Section Three of the Act continues by stating:
Circumstances can, however, overcome the duty to diversify. For example, if a tax-sensitive trust owns an underdiversified block of low-basis securities, the tax costs of recognizing the gain may outweigh the advantages of diversifying the holding. The wish to retain a family business is another situation in which the purposes of the trust sometimes override the conventional duty to diversify.22
For example, a Trustee, after determining that the sale of the Trust's high concentration of illiquid, low-basis stock in a closely-held business would not generate sufficient liquidity to produce an income equal to or in excess of the dividends being generated by such stock, and who decided not to diversify the trust's investments, was held not to have violated the New York Prudent Investor Act.23
The client's intention to opt-out of the Act is generally evidenced by trust language that supplants the Act's duty to diversify, such as authority for the Trustees to "retain any stock or other interest in any business, irrespective of the fact that such stock or other interest may constitute what otherwise might be regarded as an unduly large portion of the trust estate." Even without such language, the Trustee's retention of the client's business may be a "special circumstance" under which the Trustee is not required to diversify under the Act; however, it leaves uncertainty in the administration of the Trust after the client's death if the Settlor's intention to override the Act is not expressly stated.
Unlike the Act, the Uniform Trust Code (the "UTC") is not a purely "default rule" in the jurisdictions24 in which it has been enacted.25 Section 105 of the UTC sets out fifteen mandatory rules for Trusts,26 including provisions which may be inconsistent with the client's intent, such as (i)"the requirement that a trust and its terms be for the benefit of its beneficiaries, and that the trust have a purpose that is lawful, not contrary to public policy, and possible to achieve;"27 and (ii) "the power of the court to modify or terminate a trust under Sections 410 through 416 [of the UTC]."28
The first mandatory rule, the "benefit the beneficiary" rule, has been cited as setting "outer limits on the Settlor's power to abridge the default law."29 Other than provisions which are unlawful, contrary to public policy or impossible which Section 105(b)(3) lists, when would the Settlor's expressed intent not benefit the beneficiary? Most often, our clients' primary objective is to benefit their beneficiaries. Language governing the retention and operation of the client's business is usually a means to an end – the ultimate benefit of his beneficiaries. As the Court in Pulitzer concluded, it is rare to have a client so vain as to want, following his death, his failing business to continue despite the catastrophic detriment to his family.30 However, the continued ownership and operation of the client's successful business is also not per se for the "benefit of the beneficiary," especially if it is an objective "best economic interests of the beneficiary" test. For example, client's daughter requests Trustee to sell the family business because diversifying the investment of the net proceeds would produce more liquidity and less risk for the beneficiaries of the Trust. Is the client's expressed direction to retain the family business violative of the "benefit the beneficiary" rule because of the economic benefit a sale of the businesses may produce? Some, who are well versed in the "benefit the beneficiary" rule, say "yes."31 Assuming the answer is "yes," this is a noteworthy erosion of our client's ability to govern the ownership and operation of his business after the client's death.32 Nonetheless, this risk should not discourage the practitioner from expressing the Settlor's intent to retain the business throughout the instrument. Even in a state that has adopted the UTC, the Court reviewing the Trust may refuse to apply such a broad application of the "benefit the beneficiary" rule and instead enforce the Settlor's intent as expressed.
The UTC also prohibits a Trust from limiting the Court's power to modify or terminate as provided by Sections 410 through 416.33 Section 411 of the UTC provides:
A noncharitable irrevocable trust may be terminated upon consent of all of the beneficiaries if the court concludes that continuance of the trust is not necessary to achieve any material purpose of the trust. A noncharitable irrevocable trust may be modified upon consent of all of the beneficiaries if the court concludes that modification is not inconsistent with a material purpose of the trust.34
Both judicial proceedings require the Court to determine the "material purpose" of the Trust. This standard is derived from the holding in Claflin, in which the Court refused to accelerate a young beneficiary's inheritance because it was not the testator's intent for his son to receive the entirety of his share at age twenty-one, but in three installments at ages twenty-one, twenty-five and thirty as his Will specified.35 The Court determined that the "purposes of the trust" would not be accomplished if it permitted a modification to the trust instrument contrary to the Settlor's intent.36
A procedure to modify or terminate the Trust often allows for some desired flexibility in the administration of the Trust, such as in the event the needs of a beneficiary unexpectedly change because of a disability. To maintain this flexibility, but still to protect the client's intent, the practitioner would be wise to expressly state the "material purpose" of the Trust in the instrument. Alternatively, a client may be concerned by this perceived "easy" avenue to override his choices regarding the administration and dispositive provisions of his Trust, including its premature termination. To protect the client's intent, the practitioner may want to include language expressly stating that a termination or modification would be contrary to the Trust's "material purpose."37
Planning Strategies for Sample Client
Mr. Client, a seventy-five year old widower, is a successful entrepreneur. During his lifetime, he has amassed a large commercial real estate empire. Despite his age, Mr. Client is still very active in the management of the enterprise, Family Co., which purchases, sells, develops and leases commercial properties. Mr. Client has four adult children, but his sole daughter is the only offspring involved in the family business. The success of Family Co. has provided a very comfortable lifestyle for Mr. Client's family. Mr. Client's three sons receive a generous salary from Family Co. for their 'consulting" services, which supports their respective families. Mr. Client has an existing estate plan, drafted prior to his wife's death and the accumulation of the majority of his wealth, which provides for his estate to be divided into equal shares for his children. Each child's trust share will continue in trust for his or her lifetime and will then be distributed to the deceased child's children upon his or her death. Mr. Client's brother, seventy-two years old, is currently named as successor Trustee to serve upon Mr. Client's death or incapacity. There are no specific directions in Mr. Client's estate plan to provide for the retention and management of Family Co.; however, there is a general provision that authorizes the Trustee to retain the stock in any business owned by Mr. Client at his death, irrespective of the portion such stock comprises of the entire trust corpus.
Mr. Client is aware of the void in his estate plan to provide for the succession of Family Co., but is paralyzed to make any changes because a solution is not obvious to him. Mr. Client simply wants the status quo – the operation of the business and the support of his family – to continue after his death. During an initial meeting with Mr. Client, he expressed the following un-prioritized goals: (1) provide for the continued financial support of his sons and their families so they can maintain their current standard of living; (2) provide for his daughter to succeed him in managing Family Co. and authorize her to make all decisions, without any limitation, regarding its operation and management; and (3) provide for the continued operation and ownership of Family Co. by the Trust for the ultimate benefit of his children and future descendants.
There are a number of apparent problems in Mr. Client's current estate plan: (1) selection of successor Trustee; (2) silence as to intent for continued ownership and operation of Family Co.; (3) silence as to delegation of decision-making concerning Family Co. to Mr. Client's daughter; and (4) silence as to intent to provide for sons and their families. If Mr. Client died tomorrow without updating his estate plan, his brother, as successor Trustee, may not be aware of Mr. Client's objectives. The Trustee would likely, with the advice of counsel, analyze if diversification of the trust investments was necessary, and may consider and pursue a sale of Family Co. to generate liquidity to provide for the needs of Mr. Client's children and grandchildren. Until the sale of Family Co., or if Family Co. is retained, Mr. Client's daughter would not have any express authority under the trust instrument to operate the business. Mr. Client's brother, as Trustee, will likely rely on his niece's advice and expertise concerning the operation of the enterprise; however, he will have to balance the needs of the business with the needs of all of his beneficiaries and may decide, against his niece's advice, to declare a large dividend to provide liquidity for the Trust. Mr. Client's brother is also not aware of Mr. Client's concern to support his sons and may decide not to made distributions necessary to continue their lavish lifestyle, especially when his niece protests to the extraordinary large distributions made to them and the smaller distributions made to her. The silence in Mr. Client's estate plan as to his intent will lead in an unpredictable mess to be sorted out by his Trustee and his children. The death or resignation of an elderly Trustee, possible pre-existing resentment among his family, and turbulence with Family Co. after Mr. Client's death may exacerbate the problem and lead to costly litigation.
Although every client is different, the following is a list of considerations and possible solutions for Mr. Client's estate planning attorney:
1. Clearly express Mr. Client's intent for the Trust to own and operate Family Co., including his wishes for the business during his children's lifetimes and after they are all deceased.
Understanding and correctly expressing Mr. Client's intent is not as easy as it sounds. As discovered during the initial meeting, Mr. Client is paralyzed from making a decision because he doesn't know how his goal of "maintaining the status quo" can be effected after his death. The practitioner should continue the conversation with Mr. Client to help him identify and prioritize his goals. As mentioned above, generally the client's primary goal is to provide for his family, which will need to be refined depending on the varying circumstances of the beneficiaries. However, the practitioner will not discover these nuances unless she has an in-depth discussion with Mr. Client. In the trust instrument, the practitioner should state whether Mr. Client wants a complete prohibition of the sale of Family Co., or if Mr. Client wants the ownership of Family Co. to continue only under certain circumstances. The practitioner should review with Mr. Client whether there are any "do's" or "don't's" regarding the retention of the business, and whether these rules vary depending on which children, if any, are alive. The practitioner should identify which directions are appropriate for the trust instrument versus a "side letter" (discussed below). Mandatory directions generally fall into the former category, while discretionary, albeit important, directions generally fall into the latter category. The practitioner should also discuss the stark reality that Family Co. may not succeed after Mr. Client's death and memorialize Mr. Client's intent for Family Co. under those circumstances.
2. Establish an Investment Advisor or Committee to made decisions regarding Family Co. and clearly identify how the responsibilities of this investment fiduciary are to interact with the duties of the Trustee.
Mr. Client would like his daughter to handle all matters relating to Family Co. after his death. However, having her serve as Trustee and also make decisions regarding trust distributions to her siblings, nieces and nephews may not be appropriate. The bifurcated delegation of these two roles to an Investment Advisor and a Trustee may meet Mr. Client's goals. However, a problem may arise concerning the overlap and inconsistencies between the duties of each fiduciary. For example, the following issues should be anticipated and dealt with in the trust instrument: (i) if the Trustee determines that there is a need for liquidity, can he compel the Investment Advisor to liquidate Family Co. or declare a dividend; (ii) can the Investment Advisor appoint herself as a director or officer of Family Co., and are any related conflicts of interests waived; (iii) does the Investment Advisor have to consider the needs of the beneficiaries when making a decision to liquidate or pay a divided; (iv) can any of the Investment Advisor's decisions regarding the retention or sale of Family Co. be challenged; and (v) should the Trustees have a "put" on Family Co. stock to force the redemption of such stock to create liquidity.
As an alternative to establishing a separate office to manage Family Co., the Trustee can delegate this responsibility to Mr. Client's daughter. Section 9 of the Act permits the Trustee to delegate his investment and management responsibilities provided the Trustee exercises "reasonable care, skill and caution" in (i) selecting the agent; (ii) establishing the terms and scope of the delegation; and (iii) periodically reviewing the agent's actions to monitor the agent's performance and compliance with the delegation.38 If the Trustee's delegation meets these requirements, he is not liable for his agent's actions.39
3. Clearly express what provisions of the Act and the UTC will not apply, especially as to the Trustee's duty to diversify, as well as the "material purpose" of the Trust to address possible judicial actions to modify or terminate the Trust.
As discussed above, the Act serves as the default law for trust investments unless the Settlor provides otherwise.40 In particular, to ensure that the duty to diversify under Section 3 of the Act will not apply, the practitioner should include specific language authorizing the retention of Family Co. notwithstanding it may comprise a large percentage of the Trust.41 In addition, if consistent with Mr. Client's intent, language relieving the Trustee (or Investment Advisor) of liability for any loss resulting from a decision to retain Family Co. would be appropriate. To address the provisions of the UTC which are mandatory, the practitioner should consider articulating the "material purposes" of the Trust, such as "to protect trust property from the future creditors of Mr. Client's descendants and to continue the Trust for as long as permitted by law," and "to continue the ownership and operation of Family Co., provided it is operating at a minimal profit necessary to support the needs of Mr. Client's descendants, whatever those needs are, as determined in the sole discretion of the Trustee." Drafting to discourage modification or termination under all circumstances is not recommended because of the inevitable need for flexibility in the event of unanticipated circumstances that may arise with a long-term Trust.42