Multi-participant trusts1 have become immensely popular. These trusts replace the single, all-powerful trustee with a host of independent decisionmakers, all deriving their authority directly from the trust instrument.
At first, we saw multi-trustee trusts whose co-trustees, instead of sharing all trustee powers as was traditional, were each assigned discrete roles. That approach quickly evolved into today's multi-participant trusts that have a directed trustee — plus: At a minimum, there's also a trust advisor or investment committee with sole power over all investment decisions or a particular asset, such as a closely held company. Sometimes, there's also another trust advisor to advise the trustee on issues concerning beneficiaries. Often, one or more trust protectors are added as watch-dogs over the trustee or trust advisors, or to amend the trust instrument, review accountings, change the governing law of the trust or remove and replace or consent to the actions of the trustee or another participant. A distributions committee might round out this assemblage of performers for a single trust.
Almost every recent major trust and wealth management trend has helped make multi-participant trusts popular: clients' misgivings about traditional trustees; settlors' and families' desires to assert greater control over trust functions; dramatic changes in trustee powers and investment standards; expanding sophistication and complexity of the investment world; surging use of dynasty trusts; federal tax laws limiting family involvement in distribution decisions; and competition among several states for trust business.
But despite the widespread use of multi-participant trusts, little public attention has been given to two major potential problem areas: Do they work as intended? And what rules do, and should, apply to each participant?
The problems arise out of the need to make an effective “trust organization” out of multiple participants with separate responsibilities, a problem that doesn't exist when there's a single trustee, co-trustees with shared responsibility or other typical trust structures. Often, insufficient attention is given to how participants will coordinate their activities and jointly pursue the shared objective of making a multi-participant trust succeed — leaving a coordination gap that threatens the proper functioning of these trusts.
Unfortunately, current law does little to fill this gap. The difficulty begins with common law fiduciary duties, still in full vigor in many states, that are incompatible with allocating responsibilities among a trustee and other participants. Also, new state laws legitimizing directed trustee and other roles in a multi-participant trust often are unclear or gap-ridden, especially about each participant's duties and liabilities. Indeed, most states still impose significant responsibilities on directed trustees that strike us as fundamentally inconsistent with the very concept of a directed trustee.
Rapidly evolving state laws address some of these issues constructively. But it's doubtful that statutes can ever resolve all the problems. Even if lawmakers provided adequate solutions for many trusts, it's unlikely grantors and their counsel would be satisfied with the legislative choices. The critical resource for addressing both challenges — making the trust function as intended and applying the right rules to participants' conduct — must be effective draftsmanship.
Wanted: Team Leader
The author of a multi-participant trust is faced with the question of how to create an effective trust organization out of multiple, independent players. The first step, we suggest, is to create the role of team leader, what we call a “managing directed trustee” (MDT), to help disparate players of a multi-participant trust cohere into an effective team (see “The MDT, Defined,” p. 36.) The kind of coordinator we envision is not created by common law, state statutes or the terms of the vast majority of directed trusts. But we think it could often prove indispensable for making these complex trusts work as intended.
The trust instrument dictates what decision-making responsibility belongs to each participant in a multi-participant trust. The MDT, as trust manager, is made responsible for setting and advancing the trust agenda — but not for trust decisions assigned to other participants. Therefore, a critical requirement is for the trust to make clear that the manager is not, we repeat, not liable for the results of other participants' actions or even for ensuring that other participants act on, or even respond to, the MDT's efforts to confirm that they made their trust-mandated decisions. Although the MDT has somewhat greater responsibility than a typical directed trustee under today's more progressive trust laws, all of the additional responsibilities are administrative only. The MDT has some responsibility for process — but none for outcomes.
An effective MDT should lower the risk that participants will (1) fail to act or record and communicate their actions, or (2) act without adequate information about the trust or its beneficiaries. Curtailing these common participant errors will lower the risk of breaches of trust. Settlors, beneficiaries, trust participants and anyone else with a stake in the quality of a trust's administration will appreciate having an MDT for its ability both to help avoid breaches of trust and to enhance the prospects that the trust will achieve its purposes, thereby furthering the beneficiaries' interests as intended by the grantors.
Indeed, reducing trust risk should make acting as an MDT attractive to any trustee of a multi-participant trust, even in the absence of explicit exculpatory trust language. After all, most institutional trustees today, when acting as co-trustees, insist on taking a coordinating role very much like the MDT position we're suggesting for multi-participant trusts. Few trusts and no state laws require a coordinating co-trustee, which is an added burden for institutional co-trustees. But trustees recognize that accepting this role is less risky than participating as a co-trustee in a trust that has no coordinator.
A Unique Need
Why is a coordinator needed in a multi-participant trust but not others?
In the classic multi-trustee structure, each co-trustee is charged by law (that is to say, common law and the Uniform Trust Code (UTC)) with significant responsibility for every discretionary and administrative trust action, whether or not performed by that particular co-trustee. This collective responsibility provides a powerful incentive for co-trustees to pay attention to what their fellow trustees are doing, to cooperate with them and to coordinate actions.
How about the now common trustee practice of delegating functions to multiple parties? Trustee-delegated roles simply don't create the same administrative problems. When trustees delegate responsibility and authority, they can, and almost invariably do, retain the power and authority to set standards for, supervise and remove the delegate.
But modern multi-participant trusts have no such supervisor for trust advisors and other power holders. In fact, a primary inducement to directed trustees (and a basis for their lower fees) is to eliminate their responsibility for overseeing other participants and the associated potential liability. Of course, none of the non-trustee participants are given any responsibility by the trust for other participants' conduct, either.
Most trustees and other participants in multi-participant trusts may not recognize the risk they are taking by participating in a trust in which no one is monitoring or coordinating participants' actions.
Some states' laws2 address directed trustees' and other participants' liability by making it clear that they have virtually no responsibility for trust functions outside of their spheres of activity. Unfortunately, the (perhaps unintended) consequence of these laws is that no one is given authority and responsibility for the effective operation of the whole trust. As a corollary, no one is responsible for monitoring, let alone assuring, that participants actually perform their assigned roles.
Yet as is true for any organization or joint endeavor involving several people or entities, a trust with multiple participants can be successful only if all participants know and perform their roles, and if they communicate and coordinate actions with the other participants. An effective team also requires each participant be clear about the others' duties, the standards applicable to all, and each participant's potential liability for his own and others' breaches. State law could supply at least some of this information. But when state law is silent, unclear or contrary to the purposes of the trust creator, the trust instrument should make it clear.
State laws do not specify participants' roles, responsibilities and authority for every or any particular trust — nor could they with any possibility of conforming to individual settlors' needs and desires. Even the most progressive statutes merely authorize a broad array of potential roles that may be performed by trust advisors or trust protectors.3 Consequently, it's always the draftsman's job to choose from that array the roles best suited to a particular trust, then to define the roles with precision and clarity.
Many modern trust laws are clear that each participant is a fiduciary to the extent of his assigned trust functions. But many trust instruments are written to relieve a participant of any liability, even for failing to perform the role that he alone has been given. This set-up begs the question: How can a trust succeed when participants with authority to perform vital roles have no responsibility for failing to do so?
Traditional State Law Liability
About half of the states now define participants' default duties, performance standards and liability for their own and others' breaches. By common law or statute, these states deem participants to be fiduciaries if they hold their powers for the benefit of beneficiaries.4 But many settlors don't want to hold their protectors and trust advisors to a full fiduciary standard and require draftsmen to carefully modify or even reverse state law policy choices.
It would surprise many practitioners, as it did us, to learn that most states, by common law or their adoption of standard UTC provisions codifying the common law,5 still impose residual responsibilities on directed trustees for the results of the actions of other participants — even when the trust instrument gives those other participants sole authority for the trust functions they perform. Rarely would a sophisticated directed trustee knowingly accept such responsibilities.
The intent of the UTC, and its common law roots, are made clear by its comment that directed trustees retain “overall responsibility for seeing that the terms of the trust are honored.”6 Clearly, such a wide-open role and its potential liability would be anathema to many directed trustees — especially when they're not compensated as full trustees. By retaining the common law duties of trustees to see that trust terms are fulfilled in the directed trust context, these states effectively impose a semblance of a coordinator role on directed trustees. But they do so in a way that also imposes on the directed trustee responsibility for the outcomes of actions taken by other participants and not just responsibility for the process of coordinating trust activities.
Case law on directed trustees is scant and hasn't been much help in clarifying or limiting directed trustees' burden of liability. To the extent courts have addressed the role under common law, they've determined that, if required by the trust instrument to follow the directions of a third party in performing specified functions, a trustee must do so — unless following the direction will result in a breach of the trust's terms or the directed trustee suspects a violation of the power holder's duties.7 Some existing case law suggests that a directed trustee also may have a duty to keep trust advisors, as well as beneficiaries, informed — based on any knowledge that the trustee has of potential breaches of trust and all facts material for the protection of the beneficiaries' interests, even if the trustee does not have any authority to act on this knowledge.8
In two high-profile cases involving the Employee Retirement Income Security Act and construing the common law of Texas and New York (Tittle v. Enron Corp. and In Re WorldCom, respectively), certain fiduciary duties of directed trustees regarding investments were held to be preserved even though their investment authority was restricted.9 In the Enron case, a directed trustee was found to retain a degree of discretionary authority and responsibility for matters about which it was directed. This responsibility stemmed from the trustee's common law fiduciary duties, which continued for a directed trustee, although this duty was “less than that of a ‘primary’ fiduciary.”10 The court ruled that determining what the directed trustee's precise obligations were and whether there was sufficient evidence to find the directed trustee retained a common law fiduciary duty to investigate the advisability of an investment-related decision were factual questions — the resolution of which depended, in part, on whether the directed trustee exercised control or authority.11
Thus, general fiduciary duties (to keep informed, investigate and warn beneficiaries, etc.) may linger, despite a trust instrument's limitations on a directed trustee's authority. And that leaves a directed trustee exposed, at least under the common law, for the outcomes of other participants' trust investments.
Traditional Liability Codified
The UTC, adopted in 21 states,12 has done much to clarify the role and liability of directed trustees. But standard UTC provisions can leave many directed trustees understandably nervous.
UTC Section 808 outlines the role of the modern directed trustee as well as its relationship to trust protectors, trust advisors and other power holders.13 So far so good. But one of the provisions (especially as elucidated by the related comment) imposes at least as much responsibility on directed trustees for the conduct of other trust participants as did the common law. That provision, adopted in 17 UTC states, says: “If the terms of a trust confer upon a person other than the settlor of a revocable trust power to direct certain actions of the trustee, the trustee shall act in accordance with an exercise of the power unless the attempted exercise is manifestly contrary to the terms of the trust or the trustee knows the attempted exercise would constitute a serious breach of a fiduciary duty that the person holding the power owes to the beneficiaries of the trust” (emphasis added).14
Recognizing whether a third party's direction is “manifestly contrary” to the terms of the trust or constitutes “a serious breach” by the person giving the direction, of course, requires the trustee to make potentially difficult judgment calls and to monitor the other participants. The prohibition in UTC Section 808(b) against a directed trustee following a direction he “knows” would constitute a serious breach also invokes a duty of inquiry under UTC Section 104(a), which states that a person's knowledge includes what he has reason to know “from all the facts and circumstances known to the person.”15 This subsection's comment asserts that it embraces what “the person would have discovered upon reasonable inquiry”16 and not just actual knowledge.
UTC Section 808's comment places the directed trustee's obligations squarely within a context of broad trustee responsibility: “Powers to direct are most effective when the trustee is not deterred from exercising the power by fear of possible liability. On the other hand, the trustee does have overall responsibility for seeing that the terms of the trust are honored” (emphasis added).17 This view of a directed trustee's duties can only be understood to include a duty not just to coordinate but also to supervise participants and their actions if necessary to discharge the trustee's “overall responsibility for seeing that the terms of the trust are honored.”18 But what's unclear is: from whence does a directed trustee derive the authority to cause any other participant to do what is necessary to ensure that the terms of the trust are honored? And what can the directed trustee do when a participant refuses or fails to perform its responsibility?
Fortunately, the comment to Section 808 acknowledges that the terms of a trust may alter the directed trustee's responsibilities by providing, for example, that the “trustee must accept the decision of the power holder without question.”19 The power to alter this duty is present in the UTC of all adopting states.20 But, obviously, it's up to the draftsman of a multi-participant trust to investigate precisely what fiduciary duties a state's law imposes on a directed trustee and, if alteration by trust instrument is permitted, alter them as necessary to accomplish the settlor's purposes.
Progressive State Laws
So-called “progressive” state laws lean the other way, but may go too far.
Several states have limited the common law duties that apply to directed trustees and other participants for each other's performance. These include the UTC states of Arizona, Tennessee and New Hampshire21 as well as the non-UTC states of Delaware and South Dakota.22 Generally, they allow a directed trustee to follow a direction essentially without inquiry (although a Delaware directed trustee remains liable for its “willful misconduct”23).
New Hampshire's provision is typical of these states in substance, stating: “Whenever, pursuant to the terms of a trust, an agreement of the qualified beneficiaries, or a court order, an excluded fiduciary is to follow the direction of a trustee, trust advisor, or trust protector with respect to investment decisions, distribution decisions, or other decisions of the non-excluded fiduciary, then, except to the extent that the terms of the trust [etc.] provide otherwise, the excluded fiduciary shall have no duty to:
monitor the conduct of the trustee, trust advisor, or trust protector;
provide advice to the [other participants]; or
communicate with or warn or apprise any beneficiary or third party concerning instances in which the excluded fiduciary would or might have exercised the excluded fiduciary's own discretion in a manner different from the manner directed by the [other participant].”24
States with similar provisions are considered particularly progressive and friendly to multi-participant trusts because of their strong protection for directed trustees. Unsurprisingly, trustees seem more willing to accept directed trusts in these jurisdictions.
By clarifying that directed trustees and other participants are responsible only for their own roles and not for other participants' actions, these states have eliminated nearly all of the residual responsibility and liability of a directed trustee for the actions of other trust participants. While good for directed trustees from a liability perspective, there is a downside to this approach: No one is charged with ensuring that the trust will operate as intended by the settlor or as desired by the beneficiaries. No one has management responsibility. When everything goes well in trust administration, this gap may not be observable. It's when action or inaction of a participant have the potential to cripple the trust that the limits of this approach appear.
No Mandated Coordinators
No state's laws, to our knowledge, actually require cooperation or expressly empower the trustee or another participant to act as a coordinator or hold them responsible for the processes of the trust. Of course, common law and standard UTC states do, in effect, require the directed trustee to police other participants' actions to ensure they're not “manifestly contrary” to the trust and do not constitute a “serious breach of fiduciary duty.” But as noted, these provisions create responsibility for results, not process, and therefore create an unacceptable risk for most sophisticated trustees.
No state strikes the appropriate balance between, on the one side, protecting the directed trustee from liability for bad results arising from the failings of participants over whom the trustee has no control (and, importantly, over whom the settlor does not wish the trustee to have control) and, on the other side, encouraging and empowering the directed trustee to perform a coordinator role and manage trust processes.
New Hampshire comes closest to the ideal balance, requiring the least augmentation of state law by the trust instrument. New Hampshire alone requires participants to communicate material information to each other.25 It also permits participants to monitor each others' performance without assuming a duty to monitor or a duty to perform another's job. New Hampshire law provides that when a directed trustee (or other fiduciary) “confirm[s] that [another's] directions have been carried out and record[s] and report[s] actions taken at [the other's] direction,” its actions shall be presumed to be administrative actions taken “solely to allow the [fiduciary] to perform those duties assigned to [it] under the terms of the trust … and such administrative actions shall not . . . constitute an undertaking … to monitor [another participant] or otherwise participate in actions within the scope of the [other participant's] authority.”26
Delaware has a similar provision but it imposes liability on the directed trustee if his following of a participant's direction can be deemed “willful misconduct.”27 Delaware also fails to establish a duty to communicate among participants.
Multi-participant trusts often give sole authority for critical trust decisions to a non-trustee participant, but seldom give the trustee or anyone else back-up authority to act if a participant fails to act or if there's a vacancy in a key participant role. To assure the functioning of a multi-participant trust despite a vacancy among participants, New Hampshire alone allows a trustee, without liability, to step temporarily into the vacant role, during which time it may petition a court to fill the vacancy.28
While progressive states permit a trustee to perform a monitoring and coordinating role and largely protect it in doing so, none of them actually require a trustee or any other participant to perform that role (apart from New Hampshire's limited duty to communicate). Laws that free trustees from responsibility for results without imposing on anyone the responsibility for trust processes pose as much of a challenge for the draftsman as state laws that conversely impose on trustees responsibility for “seeing the terms of the trust are honored.” The first set fails to protect the settlor and the beneficiaries by failing to ensure the trust will work as intended. In each case, the draftsman must supply the missing elements. The second set of state laws fails to protect the trustee.
In every state, therefore, the draftsman must protect each participant from responsibility for results over which it has no control while assuring that the coordination gap is closed by giving someone authority and responsibility for the trust processes of monitoring and coordinating all participants.
Ideally, participants of a multi-participant trust would spontaneously and voluntarily get together and work out how the trust should operate. Certainly, this often happens in the co-trustee context. Undoubtedly many settlors expect their multi-participant trust participants to just work it out. And, in fact, this, too, sometimes occurs. But why leave it to chance and state law? Why risk ending up in court and having a judge decide how coordination in a multi-participant trust should be managed (or should have been managed)?
Under the current (or any foreseeable future) state of the law, anyone drafting a trust with multiple trust participants must meet the challenge of achieving greater certainty as to the responsibilities and potential liability of trust participants and, ultimately, for making sure the trust will work as intended. These challenges can be met, but require a meticulous, three-step analytical and creative process.
Analyze the state law. Draftsmen first must consider carefully the effect that the laws applicable to the trust will have on the performance of all participants and even on their willingness to act. Such consideration must include embracing the possibility of siting the trust in a jurisdiction with relatively clear and well-developed laws in this area. Arguably, re-siting is mandatory if the settlor's home state does not at least have a strong directed trustee statute and clear support for trust language that overrides state law.
Fill state law gaps. Second, practitioners must take pains to draft trust provisions that fill any state law gaps in setting standards of conduct and liability of a participant for its own or others' acts and omissions. The drafting must overturn any state law standards, duties and liabilities that may be inconsistent with the settlor's objectives and substitute clarity for any ambiguities. Again, it is vital that the draftsman ascertain that under the governing law of the trust, these trust provisions will control over conflicting common law and statutes. This may require considering reciting the trust.
Ensure coordination and cooperation. Trust lawyers are very familiar with the task of setting standards and duties as well as expanding or contracting powers in trust instruments. Less familiar is drafting to assure the necessary coordination and cooperative activity for a smoothly functioning trust organization.
Clearly, multi-participant trusts are qualitatively different from other trusts — and those differences have not been adequately addressed by state laws. A few states have shown some leadership in this regard. Unsurprisingly, they are the states that have demonstrated broad-ranging trust law leadership in recent years, including Delaware, New Hampshire, South Dakota and Tennessee. These states have provided needed clarity as to directed trustees' and other participants' permitted roles and the limited responsibility they have, if any, for other participants' actions. New Hampshire, at least, has started to close the coordination gap that can undermine the effective management of trusts with multiple independent actors.
Practitioners need to seek out those states that support the purposes of the trusts they are drafting. But even when trusts are sited in the states with the best multi-participant trust laws, draftsmen still must respond with appropriate trust language to state laws that undermine their purposes as well as supply any missing elements, such as the specifics of each participant's role and responsibility, the precise duties and liabilities of all participants and a skillfully crafted “managing directed trustee” to act as coordinator, process manager and overall team leader.
— The information presented within this article is provided for educational purposes only and is not a solicitation for any product or service provided by JPMorgan Chase & Co. and its subsidiaries.
See generally Anita M. Sarafa and John P.C. Duncan, “The Coordination Gap: Coordinating Relationships Among Co-Trustees, Directed Trustees, Protectors and Advisors,” Section 31, 2007 Notre Dame Tax and Estate Planning Institute, for the concepts and research underlying this article.
12 Del. Code Ann. Section 3313 (2008); N.H. RSA 564-B:7-711 (effective Sept. 9, 2008); S.D. Codified Laws Section 55-18-2 (2008); Wy. Stat. Ann. Statutes 4-10-715, 4-10-717, 4-10-718 (2008).
See generally Sarafa and Duncan, supra note 1, Part IV, “Contributions of State Law to the Functioning of Multi-Participant Trusts.”
Uniform Trust Code (UTC) Section 808 (2005).
UTC Section 808, Comment (2005).
Restatement (Second) Of Trusts, Section 185 (1992), Commente.
Rollins v. Branch Banking and Trust Company of Virginia, 56 Va. Cir. 147 (Va. Cir. Ct. 2002).
Tittle v. Enron Corp., 284 F. Supp. 2d 511 (S.D. Tex 2003). See also In Re WorldCom, Inc. ERISA Litigation, 263 F. Supp. 2d 745 (S.D.N.Y. 2003).
Enron, supra note 9 at p. 601.
The UTC has been adopted in Ala., Ariz., Ark., Fla., Kan., Maine, Miss., Neb., N.H., N.M., N.C., N.D., Ohio, Ore., Pa., S.C., Tenn., Utah, Va. ,Wyo. and the District of Columbia.
UTC Section 808 (2005).
UTC Section 808(b) (2005).
UTC Section 104(a) (2005).
UTC Section 808, Comment (2005).
See UTC Section 105(b) (2005).
Ariz. Rev. Stat Section 14-10808 (effective Dec. 31, 2008) replaces UTC Section 808(b) with a new provision providing in relevant part that in a directed trustee situation, “the trustee has no duty to review the directions it is directed to make or to notify the beneficiaries regarding any investment action taken pursuant to the direction … [and] is not subject to liability if [it] acts pursuant to the direction, even if the actions constitute a breach of fiduciary duty, unless the trustee acts in bad faith or with reckless indifference.” Tenn. Code Ann. Section 35-15-808, deletes from subsection (b) “unless the attempted exercise is manifestly contrary to the terms of the trust or the trustee knows the attempted exercise would constitute a serious breach of a fiduciary duty that the person holding the power owes to the beneficiaries of the trust.” See also note 24 infra and accompanying text for New Hampshire's provision.
Supra note 2.
12 Del. Code Ann. Section 3313(b) (2008).
N.H. RSA 564-B:12-1204(a) (2008).
N.H. RSA 564-B:8-813(k) (2008).
N.H. RSA 564-B:12-1204(b) (effective Sept. 9, 2008).
12 Del. Code Ann. Section 3313(b) and (e) (2008).
N.H. RSA. Section 564-B:7-712 (2008).
John P.C. Duncan is the founder of Chicago-based Duncan Associates Attorneys & Counselors, P.C. Anita M. Sarafa is a managing director in the Chicago office of JP Morgan Private Bank