Serving elders and families in Cuyahoga, Lake, Geauga, and Lorain, Ohio Counties

Phone: (216)481-0020
Offices in Euclid and Lakewood
 

Trusts

 

handshakeIn common law legal systems, a trust is an arrangement whereby money or property is managed by one person (or persons, or organizations) for the benefit of another but is owned by the ‘Trust’. A trust is created by a settlor, who entrusts some or all of his or her property to people of his choice (the trustees). The trustees are the legal owners of the trust property (or trust corpus), but they are obliged to hold the property for the benefit of one or more individuals or organizations (the beneficiary, a.k.a. cestui que use or cestui que trust), usually specified by the settlor. The trustees owe a fiduciary duty to the beneficiaries, who are the “beneficial” owners of the trust property.

The trust is governed by the terms of the trust document, which is usually written and in deed form. It is also governed by local law.

In the United States, the settlor is also called the trustor, grantor, donor, or creator.

Significance

The trust is widely considered to be the most innovative contribution to the English legal system. Today, trusts play a significant role in all common law systems, and their success has led some civil law jurisdictions to incorporate trusts into their civil codes. Trusts are recognized internationally under the Hague Convention on the Law Applicable to Trusts and on their Recognition which also regulates conflict of trusts.

Basic principles

Property of any sort can be held on trust. The uses of trusts are many and varied. Trusts can be created during a person’s life (usually by a trust instrument) or after death in a Will.

Creation

Trusts can be created by written document (express trusts) or they can be created by implication (implied trusts).

Typically a trust is created by one of the following:

  • a written trust document created by the settlor and signed by both the settlor and the trustees (often referred to as an inter vivos or “living trust”);
  • an oral declaration;
  • the will of a decedent, usually called a testamentary trust; or
  • a court order (for example in family proceedings).

In some jurisdictions certain types of assets cannot be the subject of a trust without a written document.

Formalities

Generally, a trust requires three certainties, as determined in Knight v Knight:

  • Intention. There must be a clear intention to create a trust (Re Adams and the Kensington Vestry)
  • Subject Matter. The property subject to the trust must be clearly identified (Palmer v Simmonds). One cannot, for example, settle “the majority of my estate”, as the precise extent cannot be ascertained. Trust property can be any form of specific property, be it real or personal, tangible or intangible. It is often, for example, real estate, shares or cash.
  • Objects. The beneficiaries of the trust must be clearly identified, or at least be ascertainable (Re Hain’s Settlement). In the case of discretionary trusts, where the trustees have power to decide who the beneficiaries will be, the settlor must have described a clear class of beneficiaries (McPhail v Doulton). Beneficiaries can include people not born at the date of the trust (for example, “my future grandchildren”). Alternatively, the object of a trust could be a charitable purpose rather than specific beneficiaries.

Trustees

The trustee can be either a person or a legal entity such as a company. There can be multiple trustees, (there must be a minimum of two for a trust in relation to land, so that they can provide a receipt in the event of a sale). A trustee has many rights and responsibilities, these vary from trust to trust depending on the type of the trust. A trust generally will not fail solely for want of a trustee; if there is no trustee, whoever has title to the trust property will be considered the trustee. Otherwise, a court may appoint a trustee, or in Ireland the trustee may be any administrator of a charity which the trust is related to. Trustees are nearly always appointed in the document (instrument) which creates the trust.

It is very important to remember a trustee has a huge responsibility. He may be held personally liable for any issues which arise with the trust. For example, if a trustee doesn’t properly invest trust monies in order to fully expand the trust fund, he may be liable for the difference. There are two main types of trustees, professional and non-professional. Liability is different for the two types.

The trustees are the legal owners of the trust’s property. The trustees administer all of the affairs attendant to the trust. This includes investing the assets of the trust, insuring trust property is preserved and productive for the beneficiaries, accounting for and reporting periodically to the beneficiaries concerning all transactions associated with trust property, filing any required tax returns on behalf of the trust, and many other administrative duties. In some cases, the trustees must make decisions as to whether beneficiaries should receive trust assets for their benefit. The circumstances in which this discretionary authority is exercised by trustees is usually provided for under the terms of the trust instrument. It is then the trustees’ duty to determine in the specific instance of a beneficiary request whether to provide any funds and in what manner.

By default, being a trustee is an unpaid job. However, in modern times trustees are often lawyers or other professionals who cannot afford to work for free. Therefore, often a trust document will state specifically that trustees are entitled to reasonable payment for their work.

A trust can be created without the trustees having any knowledge of its existence. However, it is usual for the settlor to make arrangements with potential trustees (for example, friends or a professional) before creating the trust.

Beneficiaries

The beneficiaries are beneficial (or equitable) owners of the trust property. Either immediately or eventually, they will receive income from the trust property or they will receive the property itself. The extent of an individual beneficiary’s interest depends on the wording of the trust document. One beneficiary may be entitled to income (for example, interest from a bank account), whereas another may be entitled to the entirety of the trust property when he turns 25. The settlor has much discretion when creating the trust, subject to limitations imposed by law.

Purposes

Common purposes for trusts include:

  • Privacy. Trusts may be created purely for privacy. The terms of a will are public and the terms of a trust are not. In some families this alone makes use of trusts ideal.
  • Spendthrift Protection. Trusts may be used to protect one’s self against one’s own inability to handle money. It is not unusual for an individual to create an inter vivos trust with a corporate trustee who may then disburse funds only for causes articulated in the trust document. These are especially attractive for spendthrifts. In many cases a family member or friend has prevailed upon the spendthrift/settlor to enter into such a relationship.
  • Wills and Estate Planning. Trusts frequently appear in wills (indeed, technically, the administration of every deceased’s estate is a form of trust). A fairly conventional will, even for a comparatively poor person, often leaves assets to the deceased’s spouse (if any), and then to the children equally. If the children are under 18, or under some other age mentioned in the will (21 and 25 are common), a trust must come into existence until the contingency age is reached. The executor of the will is (usually) the trustee, and the children are the beneficiaries. The trustee will have powers to assist the beneficiaries during their minority.
  • Charities. In some common law jurisdictions all charities must take the form of trusts. In others, corporations may be charities also, but even there a trust is the most usual form for a charity to take. In most jurisdictions, charities are tightly regulated for the public benefit (in the UK, for example, by the Charity Commission).
  • Unit Trusts. The trust has proved to be such a flexible concept that it has proved capable of working as an investment vehicle: the unit trust.
  • Pension Plans. Pension plans are typically set up as a trust, with the employer as settlor, and the employees and their dependents as beneficiaries.
  • Corporate Structures. Complex business arrangements, most often in the finance and insurance sectors, sometimes use trusts among various other entities (e.g. corporations) in their structure.
  • Asset Protection. The principle of “asset protection” is for a person to divorce himself or herself personally from the assets he or she would otherwise own, with the intention that future creditors will not be able to attack that money, even though they may be able to bankrupt him or her personally. One method of asset protection is the creation of a discretionary trust, of which the settlor may be the protector and a beneficiary, but not the trustee and not the sole beneficiary. In such an arrangement the settlor may be in a position to benefit from the trust assets, without owning them, and therefore without them being available to his creditors. Such a trust will usually preserve anonymity with a completely unconnected name (e.g. “The Teddy Bear Trust”). The above is a considerable simplification of the scope of asset protection. It is a subject which straddles ethical boundaries. Some asset protection is legal and (arguably) moral, while some asset protection is illegal and/or (arguably) immoral.
  • Tax Planning. The tax consequences of doing anything using a trust are usually different from the tax consequences of achieving the same effect by another route (if, indeed, it would be possible to do so). In many cases the tax consequences of using the trust are better than the alternative, and trusts are therefore frequently used for tax avoidance. For an example see the “nil-band discretionary trust”, explained at Inheritance Tax (United Kingdom).
  • Tax Evasion. In contrast to tax avoidance, tax evasion is the illegal concealment of income from the tax authorities. Trusts have proved a useful vehicle to the tax evader, as they tend to preserve anonymity, and they divorce the settlor and individual beneficiaries from ownership of the assets. This use is particularly common across borders � a trustee in one country is not necessarily bound to report income to the tax authorities of another. This issue has been addressed by various initiatives of the OECD.
  • Money Laundering. The same attributes of trusts which attract legitimate asset protectors also attract money launderers. Many of the techniques of asset protection, particularly layering, are techniques of money-laundering also, and innocent trustees such as bank trust companies can become involved in money-laundering in the belief that they are furthering a legitimate asset protection exercise, often without raising suspicion. See also Anti Money Laundering and Financial Action Task Force on Money Laundering.
  • Co-ownership. Ownership of property by more than one person is facilitated by a trust. In particular, ownership of a matrimonial home is commonly effected by a trust with both partners as beneficiaries and one, or both, owning the legal title as trustee.

Revocable trust. A trust of this kind can be amended, altered or revoked by its settlor at any time, provided the settlor is not mentally incapacitated. Revocable trusts are becoming increasingly common in the United States as a substitute for a will to minimize administrative costs associated with probate and to provide centralized administration of a person’s final affairs after death.

Irrevocable trust. In contrast to a revocable trust, an irrevocable trust is one in which the terms of the trust cannot be amended or revised until the terms or purposes of the trust have been completed. Although in rare cases, a court may change the terms of the trust due to unexpected changes in circumstances that make the trust uneconomical or unwieldy to administer, under normal circumstances an irrevocable trust cannot be changed by the trustee or the beneficiaries of the trust.

Linda Rich is a licensed attorney practicing in the greater Cleveland area with law offices in Euclid and Lakewood. Contact her for assistance with your Trusts or other elder law related issues.