The Role of the Fiduciary in the Estate and Trust Arena

Article previously appeared in The Legal Intelligencer (December 07, 2009)

An individual serving in the role of trustee has a variety of potential areas of responsibility, each of which can lead to potential legal and financial difficulties. Generally, a trustee will have a primary duty to the beneficiaries of the trust. In particular, such fiduciary’s difficulties can arise when the fiduciary has any potential conflict of interest or where multiple beneficiaries may have different interests.

In some cases, the design of the underlying trust may create conflicts that cannot be easily overcome by the trustee; in other cases, the actual operation or subsequent events — after the creation of the underlying documents — may create difficulties for and financial responsibility on the part of the trustee.

While far from inclusive, a trustee’s responsibility can include following directions from an incompetent settlor. Generally speaking, the trustee will be required to follow the directive of the settlor (grantor) of a trust as set forth on the instrument.

In many cases, the trustee has a responsibility to advise beneficiaries of issues regarding the operation of the trust or other instrument and the impact that any ongoing issues may have on the beneficiary’s current or future income or other rights.

To the extent that any significant issue impacts future opportunities for income or changes in corpus, the trustee may also have a responsibility to consider the beneficiary’s needs and desires. If these are not clearly spelled out in the underlying instrument, the trustee may need to either seek consent or authorization from the beneficiary and the settlor with regard to such issues, if he is still alive or competent, or seek jurisdictional guidance.

These will generally arise more often when there has been a lack of sufficient information in the original drafting or when the beneficiaries do not agree either to the competency of the settlor or the fiduciary’s determination of the settlor’s intent.

In addition, the trustee may have a duty not to delegate certain discretionary functions to other individuals, whether professional or otherwise. While the fiduciary may seek legal or tax counsel, unless it is specifically authorized under the underlying document, ultimate decision-making with regard to the trust and the interpretation will generally be the responsibility of the trustee.

Disputes often occur regarding the role of a trustee when multiple beneficiaries are involved. The trustee with multiple beneficiaries will need to clarify the responsibility to each individual or class of beneficiaries. The potential issue of different classes of beneficiaries may, in and of itself, give rise to the likelihood of a conflict.

In the circumstances where a trust is set up with an income beneficiary and a secondary corpus beneficiary, the determination of the type of investments that are made, and a distribution of “income” as opposed to items being added to corpus will have a significant impact on both beneficiaries, one potentially now and the other at the time of the demise of the income beneficiary. This is most common in the type of marital trust that is used regularly, especially where the beneficiaries are not blood relatives of the income beneficiary.

The income beneficiary may want to maximize the present return in the form of interest and dividends, while the residuary beneficiary may prefer to have capital gains or, perhaps more likely, to have stocks or securities remain in the trust for appreciation in value without any income tax impact.

While there is no single course of action that will guarantee legal harmony among the beneficiaries and therefore would provide complete insulation for the trustee, he or she should make certain that the underlying agreements are clear. If there is any ambiguity, it should be cleared up before the fiduciary relationship is accepted. In the drafting of the underlying documents, the attorney would need to take into account the recognition of multiple beneficiaries as noted, and should appropriately provide the “direction” to the fiduciary.

In an attempt to assist fiduciaries in balancing the equities between income beneficiaries and remainder beneficiaries, many states have adopted. in some form, the Uniform Principal and Income Act (UPIA) and the Uniform Trust Code (UTC).

The UPIA provides a fiduciary with the opportunity to make investment decisions based on current investment theory of total return and also to fulfill his/her fiduciary responsibility by allowing delegation of investment management to qualified third parties. Thus, the trustee need not be concerned with the poor performance of any one investment (assuming the trust does not direct otherwise) but with the overall return, both growth and income, that a given portfolio may provide.

Where the beneficiary and the remainderman are one in the same, the total return approach may not give rise to conflicting issues. But when they are different, such as where the surviving spouse is the income beneficiary, and the children (or stepchildren) are the remaindermen, conflicts may arise in that there may not be enough current income to satisfy the income beneficiary with sufficient current income. Thus to help the trustee with this dilemma, the UPIA has been promulgated and adopted in many states in some form.

The UPIA provides a fiduciary with two powers to fix this dilemma. The first is granting the trustee the “power to adjust,” which thereby gives the trustee the power to allocate in any year principal to income or vice versa. In this way, the income beneficiary can be provided a reliable income stream from a given investment portfolio notwithstanding the actual return earned on the portfolio in the form of interest or dividends. Another power given to the trustee is to have him/her treat the trust as a unitrust. In this way, the trustee can establish a fixed annual percentage of the trust’s value and effectively convert the trust to a unitrust.

This change is allowed under the Internal Revenue Code. Under Treasury Reg. 1.643(b)(3)-1, the trustee may use the power to adjust the unitrust election concept and make allocations between principal and income provided the allocation is reasonable. In using the unitrust election, the regulations provide a safe harbor of no less than 3 percent and no more than 5 percent. Generally, each state will set the rate to be used for trusts subject to their laws. In Pennsylvania, the unitrust amount is currently set at 4 percent, with the trustee having the ability to modify it within the IRS guidelines.

The opportunity for the trustee to have a conflict of interest can arise in a number of circumstances. These can be obvious, where the fiduciary is going to receive fees that are not in accord with the underlying document and/or are not properly disclosed. It also can occur when the fiduciary is utilizing a third party for some aspect of service or professional advice and the terms are not “arms-length” and/or there is an additional relationship between the fiduciary and the provider of services.

This may occur in something as simple as the purchase of a life insurance policy from a related entity, to the use of the CPA for tax return preparation services who is the brother/son/brother-in-law of the fiduciary. In this case, simple disclosure may be adequate, with an acknowledgement by the grantor and/or beneficiaries. In other cases, it may be more appropriate to use the services of a completely disinterested and unrelated third party.

In the case of trustees fees for inter vivos trusts, the general rule is that absent any amount set forth in the trust document, the trustee is entitled to compensation that is reasonable for the duties performed. This results in most cases of having a court determine the amounts to be paid, especially in situations where there are one or more beneficiaries under a legal disability, such as minority or mental incompetence. In most cases where judicial determination is needed, a full and complete accounting by the trustee will be required. It is therefore preferable for the trust document to set forth the trustee’s commission.

In the case of trustees fees for trusts created in a will, the trustees are generally paid commission in accordance with statutory schedules. This does not mean that the testator could not fix a fee different from the statutory rate, but in doing so, the testator runs the risk, if such commission is lesser than the statutory rate, of the trustee not accepting his or her appointment. If there is going to be a commission different than the statutory rate, it is best for the parties to agree in advance of what they will be.

Many trust documents give the trustee “absolute discretion” to act in his/her fiduciary responsibility. An initial reading of such powers may lead one to believe that, as trustee, any action can be taken or power exercised without the use of any reasonable judgment. The general rule is that this is not the case. No court has ever authorized unlimited discretion that would take such action beyond judicial review. Any trustee decision must still be taken with some standard of reasonableness or based on the settlor’s wishes and desires.

An additional area of potential exposure relates to insurance trusts. While many refer to the type of insurance policy containing the correct provisions as a “Crummey” trust, the issue is whether the fiduciary is following the performance of the underlying policy in a fashion that meets the “prudent man” standards. Policy illustration should be reviewed on a regular basis, and where applicable, reviewed with outside insurance professionals for alternate policy consideration. Maintaining a dialogue with the owner and/or beneficiary — even if in the simple form of sending copies of monthly, quarterly and/or annual statements as they are received by the fiduciary — can go a long way toward obviating an allegation of lack of information. The discussion of alternate insurance instruments can also be helpful in this regard.

In summary, acting as a trustee requires that one understand his/her duties to clients and potential third parties to avoid unwanted litigation and liability. Consultation with professionals experienced in the area of fiduciary responsibility should be considered by anyone who decides to take on the responsibilities of becoming a trustee.

David H. Glusman is the partner-in-charge of Marcum LLP’s Philadelphia office. He also heads its advisory services group and co-chairs its health services group. He provides various consulting services in the areas of forensic accounting, litigation support, auditing and tax.

Stephen D. Lassar is a partner in the firm’s New York City office, where he helps clients plan their current and future trust and estate needs. In addition to his role with the firm, Lassar serves as the managing partner of Goldfinger & Lassar, a law firm focused on estate planning and corporate law.