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Bench & Bar of Minnesota is the official publication of the Minnesota State Bar Association.

Finding Fiduciaries

Considerations in choosing and using trustees, directed trustees, and trust protectors

Too often the selection of an estate fiduciary is limited to a superficial consideration of which family members are disqualified from acting as trustee. This article discusses considerations relevant to the appointment of trustees, trust advisors, and trust protectors.

Counseling clients on the selection of trustees is an important part of an estate planner’s work. With the enactment of the Minnesota Trust Code, the selection of an appropriate fiduciary in a trust-based estate plan has become more involved, if not more complicated, due to the Code’s creation of the quasi-trustee positions of trust advisor and trust protector. Yet in many estate planning engagements, fiduciary selection is not given the depth of consideration the issue properly deserves.

Too often the analysis of the issue is limited to a superficial consideration of which family members are disqualified from acting as trustee. An attorney must help her client understand the fiduciary’s responsibilities and thoughtfully consider which person or entity is best suited to meet the client’s fiduciary needs. Moreover, the Rules of Professional Conduct (Rules 1.1, competence, and 1.4, communication with clients) require the estate planning attorney to be familiar with all the considerations involved in the selection of fiduciaries so that she may explain them to her client. This article will discuss considerations relevant to the appointment of trustees, trust advisors, and trust protectors.

Who should serve as trustee, trust protector, or other directing party?
General considerations

The minimum qualifications for an individual trustee are that the trustee be an adult and otherwise legally competent. Beyond those legal requirements, the fiduciary should be someone who is fair, honest, and of the utmost integrity. The would-be fiduciary should also be capable of understanding and fulfilling her fiduciary responsibilities, possess good judgment and financial skills, have good communication skills, and be familiar with the settlor’s views.

A number of other factors may influence the selection of a proper fiduciary: the size of the client’s trust; the nature of the trust assets; the sophistication of the prospective fiduciary; whether the prospective fiduciary has a special interest in any of the trust assets, thereby presenting him with a conflict of interest; whether the distribution provisions of the trust present a would-be trustee with a conflict of interest; and whether the identity of the trustee may have income or transfer tax consequences.

As a fiduciary, a trustee is a person (or institution) who manages property for another and who must exercise a standard of care imposed either by law or contract. In preparing a trust-based estate plan, the lawyer should explain to her client the duties and responsibilities imposed upon trustees so that the client may identify someone capable of fulfilling those duties. The Trust Code imposes seven duties upon trustees, and the attorney should familiarize the client with each. A trustee has a duty to administer the trust in good faith, in accordance with the terms and purposes of the trust, the interests of the beneficiaries, and applicable law. A trustee has a duty of loyalty; she may not place her own interests above those of the beneficiaries. If a trust has two or more beneficiaries, the trustee must administer the trust impartially, giving due regard to the beneficiaries’ respective interests. A trustee must administer the trust as a prudent person would, considering the purposes, terms, and distribution requirements of the trust and all the relevant circumstances, and in doing so must exercise reasonable care, skill, and caution. A trustee must take reasonable steps to take control of and protect the trust property. A trustee must not commingle trust property with the trustee’s own property and must keep adequate records of her administration of the trust. Finally, a trustee of an irrevocable trust has a duty to keep qualified beneficiaries reasonably informed about the administration of the trust and apprise them of material facts necessary to protect their interests.

The attorney should be familiar with the concept of a “directed trust” and the quasi-fiduciary positions of “directing party” and “directed trustee” created by the Trust Code. She must be able to determine whether the employment of any of those positions would help meet the objectives of the client’s estate plan. A directed trust is one in which the various administrative, investment, and distributive duties of the trustee are unbundled. With a directed trust a settlor may designate one or more directing parties, each of whom may give directions to the trustee. The trustee then, by definition, becomes an “excluded fiduciary.”

A directing party may be either a trust protector, an investment trust advisor, or a distribution trust advisor. A “trust protector” is a person given one or more of the dozen powers specified in Minnesota Statute section 501C.0808, including the power to modify beneficial interests in the trust, remove and replace trustees, and terminate the trust. An “investment trust advisor” is any person given authority to direct, consent to, or veto the exercise of the investment powers of the trust. A “distribution trust advisor” is a person given the authority to direct, consent to, veto, or otherwise exercise the distribution powers of the trust. Under the statutory default rule, a directing party is a fiduciary, subject to the same fiduciary duties applicable to a trustee. However, the settlor can provide the directing party should not be a fiduciary, in which case the directing party would have a duty to act in good faith and in a manner consistent with the terms and purposes of the trust and in the interests of the beneficiaries.

Single v. multiple fiduciaries

The nomination of co-trustees can be appropriate in certain circumstances. For example, the appointment of co-trustees could be advantageous where a surviving spouse will require assistance with the management of trust assets as she ages. Co-trustees might also be appropriate where the settlor wants to place checks and balances on the trustees. Such could be the case where a QTIP trust is established for the benefit of a second spouse and the settlor’s children from a prior marriage, or where the trust assets consist of business interests in which one trustee has an interest, but the other does not.

Clients often want to nominate more than one child as trustee for no reason other than that they do not want to exclude a child lest they hurt someone’s feelings. While consideration of family dynamics can be important in the selection of a trustee, clients should be warned against defaulting to the nomination of multiple trustees. The selection of multiple trustees can present certain challenges. Co-trustees may not be able to agree on a course of action, resulting in a deadlock. Under the Trust Code, where two co-trustees are serving they must act unanimously. If a client wants co-trustees, the potential for conflict and deadlock should be addressed.

The Trust Code also requires each co-trustee to participate in the performance of the trustee’s duties, unless the trustee is unable to do so for some reason. This requirement can present logistical impediments to the day-to-day management of the trust. Some of those types of difficulties may be overcome by a proper delegation of a trustee’s duties or powers. The Trust Code authorizes one trustee to delegate duties and powers to another trustee, if prudent under the circumstances. However, even when there has been a proper delegation, a co-trustee is always under a duty to exercise reasonable care to prevent another co-trustee from committing a serious breach of trust and to compel a co-trustee to redress a serious breach of trust. Accordingly, the client should be advised that each trustee will be severally responsible for the proper management of the trust (and could be held liable for another trustee’s breach of the trust).

Individual v. corporate trustee

Any fiduciary appointment involves a choice between an individual or a corporate fiduciary. Each has its advantages and disadvantages. An individual trustee may possess unique insights into the settlor’s value system and beliefs and the circumstances of the beneficiaries, making her uniquely qualified to understand the goals and objectives of the trust. An individual typically also has the advantage of being a lower cost alternative. On the other hand, an individual may not understand her fiduciary duties, may not be capable of properly managing the trust assets, or may fail to obtain adequate professional assistance. In some cases, an individual trustee’s discretionary authority to make or withhold distributions can strain family relationships. Corporate trustees have the advantage of being professionals capable of providing professional asset management and tax advice and possessing experience in dealing with a broad range of beneficiary issues and behaviors. The disadvantages of selecting a corporate trustee may include lack of familiarity with the settlor’s objectives and the beneficiaries, as well as higher fees.

The attorney as fiduciary

Occasionally a client will ask her attorney to serve as trustee. Any attorney considering acceptance of a fiduciary appointment must be mindful of several practical and ethical considerations. First, the attorney should determine whether her professional liability insurance covers acting as a fiduciary. Then the attorney should consider the following ethical obligations.

Rule 1.1 of the Minnesota Rules of Professional Conduct requires a lawyer to provide competent representation. A lawyer should not accept a fiduciary appointment unless she can perform her fiduciary duties (e.g. make investment decisions) competently.

Rule 1.2 requires an attorney to consult with the client about the means by which the objectives of the representation are to be carried out. If an attorney is going to serve as fiduciary and simultaneously provide legal services, she should explain the costs of, and alternatives to, such dual service. Having accepted a fiduciary appointment, the lawyer should ameliorate any disadvantages that may come from such dual service.

Under Rule 1.4 a lawyer is required to explain a matter to the extent reasonably necessary to permit the client to make an informed decision regarding the representation. In the context of the attorney serving as fiduciary, this rule requires the lawyer to reasonably explain: (1) the implications of the lawyer serving as fiduciary, including the fiduciary duties and powers the attorney would have; (2) alternative choices of fiduciary available to the client and the relative abilities, competence, and fee structure of each; and (3) the attorney’s potential pecuniary interest in the arrangement. Because of the potential for conflict with the attorney’s self-interest, the client should be advised to consult with independent counsel.

Rule 1.5 prohibits a lawyer from charging an unreasonable fee. When a lawyer will serve as fiduciary, the question arises of what fee the lawyer should charge for actions performed as fiduciary. Should he charge his regular hourly rate? Or a reduced rate under the theory that many fiduciary actions do not require the same level of knowledge or training as actions performed in the lawyer’s professional capacity? While a lawyer may serve as fiduciary and as attorney for the fiduciary and be compensated in both capacities, the lawyer should not receive double compensation for the same work.

Rule 1.7 prohibits a lawyer from representing a client absent informed consent, confirmed in writing, if the representation
of that client will be materially limited by the personal interest of the lawyer. A client is permitted to appoint her attorney as fiduciary so long as the client is properly informed, the appointment does not violate the conflict of interest rules of Rule 1.7, and the appointment is not the product of undue influence or improper solicitation by the lawyer. The client’s informed consent to the appointment must be in writing.

Using trust protectors and directed trustees

Directing parties are not necessary for all trusts. A garden-variety revocable trust intended to serve as a will substitute is unlikely to require a directing party. Situations where a directing party may be appropriate include: (1) where the settlor wants to provide flexibility in a long-term trust; (2) where the trust holds special assets that might be better managed by an investment trust advisor or trust protector than the trustee; (3) where privacy in the administration of the trust is particularly important; or (4) where the settlor, beneficiaries, or trustee cannot possess certain powers for tax reasons.

Once it is determined that use of a directing party would be appropriate, a number of issues should be addressed, including: (1) whether the directing party should be subject to fiduciary duties or required to act in accordance with the lower good faith standard (generally, if the powers conferred upon a directing party are those that would otherwise be exercised by a trustee, a fiduciary duty is probably appropriate; conversely, if the powers are of a sort that would typically be exercised by the settlor, the beneficiaries, or a non-trust actor such as a court, the lower good faith standard may be sufficient); (2) the scope of the directing party’s authority; (3) the succession plan for the directing party; (4) the mechanism for ensuring the directing party will have access to necessary information; and (5) the directing party’s compensation.

Conclusion

The proper process for selecting fiduciaries involves more than quizzing clients about family members and relationships. The estate planning attorney will do her client a service, and fulfill her ethical obligations, if she clearly identifies the client’s needs for fiduciary services and explains to the client how the different offices now existing under Minnesota trust law may be used to meet those needs. Only then may the attorney properly assist her client in the selection of the persons or entities best suited to serve as fiduciary.

JAMES T. MCNARY is the principal of McNary Law Office, P.A. in Red Wing, where he practices in the areas of estate planning, business succession planning, and trust and estate administration.

 

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