How Typical Trust Agreement Clauses Can Get Turned Around in the Real World

“How Typical Trust Agreements Clauses Can Get Turned Around in the Real World,” that’s the subject of today’s ACTEC Trust and Estate Talk.

Transcript/Show Notes

This is ACTEC Fellow Connie Eyster of Boulder, Colorado.

The best laid schemes of mice and men isn’t supposed to be a reference to your client’s trust agreements, but sometimes the drafting goes awry. The competing interests of the settlor, the intended beneficiaries, and the trustee may someday give us grief instead of the promised joy.

ACTEC Fellows and litigators Meg Lodise of Los Angeles, Ray Prather of Chicago, and Eric Penzer of Uniondale, New York join us today to identify potential issues in the judicial interpretation of often desired trust provisions. Welcome. Meg, do you want to start us off?

Meg Lodise: Thanks, Connie. I’m going to just briefly introduce this. Eric, Ray, and I are going to go through a number of issues concerning distribution standards, competing beneficiaries, and, finally, trust situs and advisor issues which arise despite the attempts of drafters and advisors to create a well-functioning trust. And I think we’re going to start with Eric.

Enforceability of Conditional Bequest Provisions in a Trust

Eric Penzer: Yeah, well, an issue that has arisen from time to time over the years is the enforceability of provisions conditioning bequests on the beneficiary marrying within a particular religious faith. And while many of those cases are very old, the issue still exists. Indeed, the validity of such a provision was decided in a case by the Illinois Supreme Court, in the matter of Feinberg, as recently as 2009 (IN RE: Estate of Max Feinberg). So, this is still a relevant topic.

Those clauses involve more than a testator’s or grantor’s desire that their descendants continue to follow their religious traditions after they’re gone. The cases involve broader tension between competing values, the values of freedom of testation on the one hand and resistance to dead-hand control on the other. And the cases also reflect the difficulties the judiciary has had at times attempting to reconcile the public policy of freedom of testation, that a person should be able to leave their estate to whomever they want, and the policy favoring the right to marry and against inducing divorce.

Now, attempting to synthesize the case law on the subject, although there are no bright line rules, the law appears to be that one, conditioning of bequests on the beneficiary marrying within a particular religious faith doesn’t have constitutional freedom of religion implications because no state actor is involved. In provisions conditioning bequests on marriage within a faith are enforceable because they simply narrow the universe of persons the beneficiary can marry and still benefit from the bequest. However, to the extent the provision can be deemed to encourage divorce, it will be held unenforceable.

So if it induces marriage to a particular person, it’s enforceable; if it induces divorce, it’s unenforceable. And while those principles, while seemingly reconcilable, can lead to remarkable results. In a 1967 decision of the Pennsylvania Supreme Court, Keffalas Estate, the testator essentially conditioned bequests to his children and then marrying persons of true Greek blood and descent and of orthodox religion. The court held that the provision was valid and enforceable as against the testator’s unmarried sons because it merely encouraged them to marry within the faith. But the court held it invalid and unenforceable as against the testator’s daughter, who was married, because she would need to divorce her non-Greek orthodox husband and marry a Greek in order to receive the bequest. So in the end, she got to remain married to her non-Greek husband and still received her bequest. But if the sons married non-Greeks, they would forfeit their bequests, which brings to mind the age-old adage “who says the law is fair.” So that’s the lesson on those types of conditional bequests.

Ray Prather: My topic is beneficiary conflicts, and this can arise in a variety of ways, but I’ve found that most of these conflicts begin as a dispute over receiving information. That is, when one beneficiary wants to know how the trust is being used by another beneficiary. This can be a dispute between two current beneficiaries and a pot trust or between a current beneficiary and the presumptive remainder beneficiaries in other trusts. And I’ve often found that it becomes a highly contested issue when one of the beneficiaries is also the trustee of the trust.

What is a Trustee’s Duty to Report Trust Funds

Everyone knows the trustee must provide accountings or reports on the use of the trust funds. But who must they account to? In the pot trust situation with two current beneficiaries, it’s highly likely that both beneficiaries will receive all the information on how the trust funds are being used. So, for drafters who are worried about these issues and conflicting beneficiaries, it’s probably better to avoid the pot trust situation if you think that one person is going to be trying to look over the other person’s shoulder on how they’re using the funds.

For the current beneficiary, who is also a trustee and the presumptive remainder beneficiaries wanting to know how the funds are being used for that current beneficiary, this is an issue that came up in the case, Schwalm v. Schwalm out of Massachusetts. In that case, the decedent’s children wanted to know how their stepmother- the current beneficiary and trustee of the trust- was using the trust that they were eventually going to receive. And in that case, the Massachusetts court held the decedent’s children were not entitled to any accountings while they were presumptive remainder beneficiaries.

Now, the law on this topic is highly variable among states, even among states that have adopted the Uniform Trust Code. For example, Illinois and Massachusetts are both Uniform Trust Code states, but I believe the result in Schwalm v. Schwalm would have been very different had it been litigated in Illinois. So I think the takeaway from the Schwalm case is estate planners should always have this discussion with their clients and how much information should the presumptive remainder beneficiaries receive about trust, while the current beneficiary is another person, perhaps a parent or a stepparent? So, having those discussions, they would be able to build into the drafts of their documents just exactly how much information and how often presumptive remainder beneficiaries would receive that information. With that, I’m going to hand it over to Meg, who I believe is going to talk about situs.

Meg Lodise: Thanks, Ray. Yes, I’m going to talk about situs, which is a particularly prevalent issue. Trustors frequently draft trust with the situs selection clause along with the governing law clause to attempt to have the law of a particular jurisdiction govern the administration of trust. And although sometimes those situs selection clauses may be governed by UTC or UPC provisions, I’m just dealing here with situations where it’s in the trust itself.

An interesting case on this issue is the IMO Daniel Kloiber Dynasty Trust out of Delaware in 2014. It gives an excellent illustration of how situs selection may go awry. In that case, the trustor established a Delaware trust with various provisions to protect his family, including a Delaware corporate trustee, a special trustee to direct investments, and with the power of trustee removal, as well as a holder who had the power to direct distributions to the beneficiaries. The trust also included various exculpatory provisions to protect the corporate trustee and the ability of the beneficiaries through the various advisors to change the law and situs of the trust.

Several years after the trust was established, the primary beneficiary’s son became involved in a divorce proceeding in the state of Kentucky. The Kentucky court attempted to assert jurisdiction over the Delaware trust, and the son and his son attempted to wrest control back to Delaware through removal of the special trustee and appointment of a new one, also notably not a resident of Delaware. The Delaware court found that it did not have exclusive jurisdiction despite the situs selection provisions of the trust. Notably, the Delaware court pointed to all the provisions of the trust that discouraged court involvement, such as waivers of accounting and the ability to move situs if the beneficiary chose. According to the Delaware court, this made the choice of Delaware law and situs, quote, “impermanent and potentially temporary.”

I think the lesson from Kloiber is that despite the best drafting attempts, the facts may outrun them, and the courts will look to equitable factors. I don’t think it’s completely irrelevant that the issues here were what assets would be available to the complaining wife in the Kentucky divorce proceedings. But as a practice pointer, if there is a concern about whether or not the desired court will assume jurisdiction, it may make sense to try to bring some sort of proceeding in the desired court to establish jurisdiction there. Although, even that strategy may not work if the court sees it as merely an advisory proceeding and not truly dealing with the matter and controversy.

The Delaware case of In re: Trust Under Will of (Wallace B.) Flint for the Benefit of (Katherine F.) Shadek, which is a 2015 case, addresses this very point. In the court’s opinion at page 186, it notes, “A petition seeking consensual declarations that do not require judicial implementation does not give rise to an actual controversy supporting declaratory relief.” So even if you try to bring the case in front of the court to acquire jurisdiction, the court may refuse you.

The bottom line is that no matter what your best attempts at drafting are, the courts and the beneficiaries may very well turn those attempts on their head. Thanks.

Connie Eyster: Thank you, Meg, Ray, and Eric, for sharing your knowledge and wisdom on how trust provisions can have unintended consequences or unexpected applications. We really appreciate your time today.

Additional Resources:

• Caution for Divorcing Spouses Who Are Trust Beneficiaries (Oct 2024)
• The Intersection of Well-Being and Trust Planning (Sept 2023)

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