It can be difficult on a personal level to watch a client, whom you may have known for years, begin to lose his mental capacity. But if that client is the settlor of a revocable trust of which you are a trustee, the settlor's incompetence can also put you in a precarious legal position.
In most states, so long as the settlor lives and is mentally competent, the trustee owes all duties solely to the settlor. But what if the settlor becomes mentally incompetent? In that situation, some states' laws require the trustee to exercise his duties for the benefit of the remainder beneficiaries as well. In many states, the law is as yet unsettled, so it's not clear to whom the trustee owes the primary duty as between the settlor and the remainder beneficiaries. The result can be a no-win situation in which the trustee faces potential liability claims whatever he does.
The trustee's dilemma of the incompetent settlor arises in part out of the tension between two forces fundamentally at odds with each other. The first is what we'll call “traditional” trust law, which tends to favor vesting rights in remainder beneficiaries — particularly once the trust has become functionally irrevocable due to the incompetence of the settlor. The second is the rise of the revocable trust as a will substitute. Persons named as beneficiaries in wills (for good reasons) have no rights while the testator lives, even if he should become incompetent. If revocable trusts are to function like wills, then treating the remainder beneficiaries in a similar fashion seems to make sense.
This issue is bound to arise with mounting frequency as the population ages and more people outlive their mental capacity. In light of the potential exposure of trustees who find themselves in this situation, it pays to investigate the law of the applicable jurisdiction and — if the settlor is still competent — consider taking proactive steps now to establish clear guidelines for proceeding if the settlor becomes incompetent.
First, let's raise awareness of the practical and legal problems that can arise when a settlor becomes incompetent. Next, let's review the historical development of the law of revocable trusts, culminating in the present state of the law relative to settlor incompetence. Then we'll offer some practical guidance that we hope will be of use to the trustee, before or after a settlor becomes incompetent.
When the settlor of a revocable trust becomes incompetent, the trustee can face some very difficult decisions. For example, assume that a settlor declares a revocable trust, with himself as sole beneficiary for his lifetime, himself and his longtime attorney as trustees and his children as the remainder beneficiaries. The settlor simultaneously establishes a pour-over will naming the trust as sole beneficiary. So far, so good. But let's suppose that the settlor, at age 70 and otherwise in good health, falls prey to Alzheimer's disease. Let's assume further that the settlor's doctors have declared him to be incompetent to manage his legal affairs.1 The trustee now has some difficult decisions to make.
Duty of Disclosure
One of the first decisions the trustee must make is whether he has a duty to disclose the details of the trust to the remainder beneficiaries. This judgment can be fraught with peril. For instance, must the trustee now divulge the full contents of the trust instrument to the remainder beneficiaries? In keeping with the increasing use of revocable trusts as will substitutes, it seems reasonable to assume that settlors sometimes will have intended that their beneficiaries be kept in the dark about their status until the settlor dies (even if no express intent has been stated). Doesn't the trustee owe the settlor some obligation to follow his wishes?
Settlors may have diverse motivations for keeping their trusts confidential until death. Suppose the trust agreement contains the dispositive provisions of the settlor's estate plan. Suppose further that the settlor never discussed his wishes with his children — in part because he has disinherited one child (but not the others). Even if disclosure is made only to those named as beneficiaries, frequently the excluded child will learn of his status, as well. A similar problem can result where the beneficiaries aren't treated equally — or where one or more perceive that they deserve more.
If the trustee elects to disclose the entire trust instrument, and one of the potential beneficiaries is disgruntled, the beneficiary can end up estranged from or abusive to the settlor. A dissatisfied potential beneficiary also might attempt to pressure the settlor to amend the dispositive provisions (notwithstanding the risk that the amendment might not be valid due to the settlor's mental state).
Moreover, a settlor might wish for other reasons to keep his beneficiaries in the dark as to their potential beneficiary status or the financial circumstances of the trust, for example to preserve their motivation to find and sustain useful employment. Disclosing the trust's dispositive provisions also can lead to pre-death litigation over the validity of the trust — something that courts strongly disfavor in the will context.
In some cases, the trustee might actually prefer that there be a clear obligation to involve the remainder beneficiaries upon the incompetence of the settlor. By disclosing trust information to the remainder beneficiaries, the trustee might uncover any objections on their part while the trustee still has control of the trust assets (and thus the means to defend himself). It may allow the trustee to work cooperatively with the remainder beneficiaries and contemporaneously seek court direction if a dispute arises. If there's an obligation to keep the trust confidential, then obtaining this kind of guidance and establishing a working relationship with remainder beneficiaries will not be possible. Excluding them can foster mistrust and hard feelings that can be very difficult to overcome after the settlor passes.
Also, family strife isn't likely in every case. Not all settlors, while still competent, would prefer that their beneficiaries be kept in the dark until the settlor dies. Where hard feelings, estrangement or abuse of the settlor and litigation are unlikely, the benefits of involving remainder beneficiaries in the process can outweigh the risks.
Other questions follow from a decision to afford remainder beneficiaries rights when the settlor becomes incompetent. Must the trustee now consider the rights and interests of the remainder beneficiaries in the investment and management of the trust assets? How is the trustee to balance the potentially competing interests of the settlor and remainder beneficiaries? Does the trustee still owe primary allegiance and attention to the interests of the incompetent settlor? Considering the interests and desires of the remainder beneficiaries can lead to difficult conflicts. After all, the use of assets for the benefit and welfare of the incapacitated settlor necessarily will reduce the remainder beneficiaries' shares. Not all remainder beneficiaries can be counted upon to be as generous as the trustee might prefer when it comes to the care of the settlor.
If the remainder beneficiaries obtain their rights as beneficiaries upon the settlor's incompetence, are they entitled to require the trustee to account and to object to the account if they so desire? Do they thereby gain standing to petition to surcharge the trustee for alleged breaches of fiduciary duties (some of which might have allegedly occurred long ago)?
On the other hand, it's not entirely clear that making remainder beneficiaries wait to assert their rights until the settlor dies is appropriate in all instances. For example, if the settlor becomes incompetent and the remainder beneficiaries get no rights, there may not be anyone with capacity “minding the store.” No one, in other words, would be keeping the trustee honest and diligent and thus protecting the rights of the incompetent settlor-beneficiary.
In light of these competing considerations, the one thing that the trustee might hope for most is clear, predictable guidance in the applicable law. Alas, that clarity often is lacking. The result is that the trustee, if unprepared, can be in the unenviable position of accidentally doing the wrong thing or — even if he is prepared — facing a claim for liability regardless which route he chooses.
Tension Between Approaches
Why is the seemingly basic question of the remainder beneficiaries' rights when the settlor becomes incompetent still developing? To start with, the confusion in the context of an incompetent settlor in a sense parallels the lack of clarity in many states of the rights of beneficiaries of revocable trusts in general. We submit that the confusion in both contexts derives in part from tension between historical and progressive approaches to revocable trusts in general.
Historical trust law viewed revocable trusts with skepticism. Among other objections, courts and commentators questioned whether, in light of the powers retained by the settlor, the revocable trust was in fact a trust at all.2 After all, the revocable trust by definition could be amended or revoked at any time. Proponents of revocable trusts were thus at pains to make the case that interests had been conferred upon beneficiaries other than the settlor.3
The validity of revocable trusts is no longer seriously questioned. But this is a relatively recent phenomenon. As one commentator has observed, revocable trusts really only began to gain prevalence within recent decades.4 Revocable trusts now have come into vogue as will substitutes.5 Wealth holders increasingly have sought to keep confidential their net worth and assets, and to avoid the press and public attention that occasionally have accompanied probate proceedings.6 There also has been rising recognition that revocable trusts offer a convenient means to manage the assets of the settlor in the event of mental incapacity.7 Revocable trusts lend themselves to these purposes. One consequence of the rise of the revocable trust as a will substitute has been a more or less forthright acknowledgement under most states' laws that remainder beneficiaries have no real enforceable rights while the settlor lives.
The skepticism with which revocable trusts historically were viewed, combined with their rising popularity as will substitutes, has left them with an identity crisis of sorts — they are, in a sense, part way between irrevocable trust and will. It's perhaps unsurprising, therefore, that the various courts and state legislatures have not always been clear about remainder beneficiaries' rights (and a trustee's corresponding duties) under revocable trusts.8 And since revocable trusts' popularity is a relatively recent development, the law is still crystallizing.
State Laws Vary
The law of remainder beneficiaries' rights (and trustees' corresponding duties) is frequently not all that clear even in the case of a competent settlor. Some cases and other authorities suggest that all remainder beneficiaries of revocable trusts are entitled to at least some rights as beneficiaries.9 If this is the case, then presumably a trustee is obliged to exercise his duties as to all beneficiaries. Those duties would include the duty to inform beneficiaries, the duty to render accounts and the duty to impartially balance the interests of the remainder beneficiaries with those of the lifetime beneficiary.10 It might be argued that affording remainder beneficiaries immediate rights is appropriate because remainder beneficiaries immediately obtain a vested (though defeasible) right to the trust property.11
At least one court that has found that remainder beneficiaries in general have some rights reached that result through the application of common law principles.12 Another interpreted a provision based on Article 7 of the Uniform Probate Code of 1969 to a similar effect.13 Some of the secondary sources are occasionally cited to support this approach, as well.14
The modern trend, though, generally is to treat revocable trusts more like wills. This is the approach suggested, for instance, in the Uniform Trust Code (2000) (UTC), which expressly states that the intent behind it is to “treat the revocable trust as the functional equivalent of a will.”15 In the case of wills, beneficiaries have no rights until the testator dies. A will beneficiary doesn't even have the right to know he is a beneficiary, since dispositive provisions of wills are confidential — even privileged — until the testator dies.16
The Restatement (Third) of Trusts suggests a similar approach. It doesn't impose duties on the trustee vis-à-vis remainder beneficiaries while the settlor lives (and is competent).17
These authorities and the jurisdictions that follow them appear to have appreciated that the position of a remainder beneficiary is a highly uncertain one, since the settlor can, with the stroke of a pen, render the person a non-beneficiary.18 Thus, while the settlor lives, he represents the unification of all beneficial interests currently in existence.19 For instance, the Restatement (Third) of Trusts treats the power to revoke as “the equivalent of ownership of the trust property, even though the legal title to the property is held by the trustee.”20 It is thus the law in many states that remainder beneficiaries of revocable trusts don't acquire any of the rights of beneficiaries until the death of the settlor makes the trust irrevocable.21
That same tension between historical trust law and the use of revocable trusts as will substitutes is apparent in the law governing the effects of settlor incompetence — with one twist. As a matter of simple logic, once the settlor becomes incompetent, the trust becomes, practically if not legally, irrevocable, since any attempted revocation or amendment would be unenforceable.22 Even for some states that treat revocable trusts like wills while the settlor is competent, extending that approach to the situation of the incompetent settlor is stretching the analogy too far.23
But this doesn't mean that all states vest remainder beneficiaries with beneficiaries' rights when the settlor becomes incompetent. To the contrary, many states continue to treat revocable trusts like wills.24 Will beneficiaries obtain no rights until the testator dies — regardless of whether the testator becomes incompetent.25 Unfortunately, the law remains unsettled in a number of jurisdictions.
The case law offers little guidance as to the effect of the settlor's incapacity. The Restatement (Third), as previously noted, adopts the approach of extending a trustee's duties to remainder beneficiaries upon the incapacitation of the settlor.26 However, almost no cases have cited Section 74 of the Restatement (Third). There is, in fact, a general paucity of case law on the issue.
Nearly all of the states that have expressly addressed the effect of the settlor's incompetence have done so by statutory enactment, through adoption of Section 603 of the UTC. The general approach of the UTC, as Section 603 reflects, is to analogize revocable trusts to wills. Thus, a trustee owes duties exclusively to the settlor until the settlor's death. As for the effect of settlor incompetence, the drafters gave adopting states a choice. They could adopt a limitation for the incompetence of the settlor (referred to as the settlor's “incapacity”), so that remainder beneficiaries would acquire their rights upon the incompetence of the settlor and the trustees would owe corresponding duties to the beneficiaries. Alternatively, they could choose to omit the limitation. If so, the trustee's duties would continue to be owed exclusively to the settlor until death, regardless of the settlor's competence.
Section 603 of the UTC in its current form provides as follows:
SECTION 603. SETTLOR'S POWERS; POWERS OF WITHDRAWAL.
While a trust is revocable [and the settlor has capacity to revoke the trust], rights of the beneficiaries are subject to the control of, and the duties of the trustee are owed exclusively to, the settlor.
During the period the power may be exercised, the holder of a power of withdrawal has the rights of a settlor of a revocable trust under this section to the extent of the property subject to the power.
The comments to Section 603 make clear the drafters' intent that states be free to adopt, or reject, the bracketed incapacity exception:
Concluding that uniformity among the states on this issue is not essential, the drafting committee has decided to place the reference to the settlor's incapacity in Section 603(a) in brackets. Enacting jurisdictions are free to strike the incapacity limitation or to provide a more precise definition of when a settlor is incapacitated.27
The drafters of Section 603 made the incompetence limitation optional to allow states to harmonize the law of revocable trusts with that of wills as concerns beneficiaries' rights. A slim majority of states that have adopted the UTC have omitted the incompetence limitation.28 Other states, however, have included it.29
Those trustees of trusts governed by the law of a UTC state thus will have the clearest guidance as to their duties when a settlor becomes incompetent. In most other states however, the effect of the settlor's incapacity is less certain. In such cases, the unfortunate trustee may be left trying to parse statutes, cases and secondary authorities that don't clearly answer the question.
The uncertainty surrounding a trustee's duties to remainder beneficiaries of a revocable trust in which the settlor is incompetent is a potential source of liability that should be proactively managed. We offer the following points for consideration by trustees:
- Trustees should, first, make an effort to understand the laws of the jurisdictions that currently apply to the revocable trusts they administer.
- In a sense, the real enemy is uncertainty. Thus, while the settlor is still competent, consider raising the issue of incompetence. Ascertain the settlor's wishes with regard to disclosure to remainder beneficiaries of dispositive provisions and information about the trust. Are there concerns about generating family squabbles or about remainder beneficiaries not considering the best interests of the settlor? Encourage the settlor to address these issues expressly in the language and structure of the revocable trust.
- If the settlor has concerns about the remainder beneficiaries and prefers to treat the trust like a will, the settlor may have to take more drastic steps to give the trustee the kind of clear guidance he might desire. In any case, the settlor should clearly express his intentions in the trust instrument. If the law that applies is that of a UTC jurisdiction that hasn't adopted the incompetence exception to Section 603, the settlor's intentions as expressed in the revocable trust should be enforceable.
- If the settlor isn't in such a jurisdiction, the settlor may be able to use a choice-of-law provision and select a trustee in a favorable jurisdiction to render his intentions enforceable. It may also be possible to mitigate the potential damage by limiting the trustee's duties to the remainder beneficiaries through piecemeal provisions. For example, the trust could make it clear that the trustee must administer the trust for the primary benefit of the settlor during his lifetime without regard to preservation of the corpus for the remainder beneficiaries. Similarly, the trust instrument could limit the amount of information that the trustee must disclose to beneficiaries, depending on the limitations that are allowable in irrevocable trusts in the settlor's jurisdiction.
- If the settlor has disinherited a beneficiary or for other reasons expects litigation, the settlor may want to consider alternatives to a revocable trust, such as use of a limited liability company to manage the settlor's assets when the settlor becomes incompetent.
- If you are informed that the settlor may be incompetent, confirm the settlor's condition and that it is consistent with the state law definition of incompetence that applies. (It may be advisable to have a limited Health Insurance Portability and Accountability Act release on file to enable you to confirm this information.) Obtain a legal opinion as to your duties, if any, to remainder beneficiaries based upon the applicable law and the specific language of the revocable trust. If legal counsel has meaningful doubt about your duties, consider seeking instructions from the appropriate court.
- If the settlor is declared incompetent, consider having a guardian appointed to protect the settlor's interests. Doing so might help insulate the trustee against subsequent claims of mismanagement.
The uncertainty surrounding a trustee's duties to remainder beneficiaries of a revocable trust when the settlor is incapacitated isn't likely to be fully resolved for some time. Trustees should be cognizant of the risks and advocate that the settlors they serve take steps to clarify their duties before incompetence occurs. If the trustee finds himself administering a trust for an incompetent settlor, the trustee should proceed with caution and promptly obtain legal advice. No trustee wants these issues resolved in a lawsuit captioned with the trustee's name after a “v.”
— The authors are indebted to Wendy Rusch, an associate in the firm's Milwaukee office, for her research assistance and valuable insight.
- An entire article could be devoted to the issues associated with determining whether the settlor has, in fact, become irretrievably incompetent and how the trustee should proceed when he suspects the settlor is declining — a process that most often occurs over months or even years. We wish to focus in this article, however, on the consequences once incompetence has been formally determined.
- Austin Wakeman Scott et al., Scott and Ascher on Trusts, Section 16.5, at p. 1049 (5th ed. 2007).
- Ibid., Section 16.5, at p. 1048.
- Alan Newman, “Revocable Trusts and the Law of Wills: An Imperfect Fit,” Real Prop. Tr.& Est. L.J. at pp. 532, 524 (Fall 2008).
- Frances H. Foster, “Privacy and the Elusive Quest for Uniformity in the Law of Trusts,” Ariz. St. L.J. at pp. 713, 714-27 (Fall 2006).
- Restatement (Third) of Trusts, Section 25, cmt. a (2003).
- It's beyond the scope of this article to summarize the law of all of the states regarding a trustee's duties to remainder beneficiaries of a revocable trust. An insightful and well-researched discussion is found in the article, Turney P. Berry et al., “Longmeyer Exposes (or Creates) Uncertainty About the Duty to Inform Remainder Beneficiaries of a Revocable Trust,” ACTEC Journal, Fall 2009 at p. 125.
- Johnson v. Johnson, 967 A.2d 274, 280-81 (Md. Ct. Spec. App. 2009), cert. granted, 972 A.2d 861 (Md. 2009) (holding that a beneficiary of a revocable trust subject to power of appointment is entitled to accounting), JP Morgan Chase Bank v. Longmeyer, 275 S.W.3d 697, 701-02 (Ky. 2009). This is also sometimes asserted to be the approach taken in the Restatement (Second) of Trusts, which does not explicitly distinguish between irrevocable and revocable trusts. See Restatement (Second) of Trusts, Sections 172, 173 (1959). Older treatise editions also appear to advocate this approach. See George Gleason Bogert and George Taylor Bogert, The Law of Trusts and Trustees, Section 970, at pp. 359-62 (Rev. 2d ed. 1983); Austin Wakeman Scott, The Law of Trusts, Section 172, at p. 455 (4th ed. 1987).
- See, e.g., Restatement (Second) of Trusts, Sections 172, 173, and 183 (1959).
- Restatement (Third) of Trusts, Section 25, reporter's notes on cmt. b (2003) (quoting David Hayton, “When is a Trust Not a Trust?,” J. of Int'l Tr. Corp. Planning at p. 3 (1992)).
- See, e.g., Johnson, supra note 9 at pp. 280-81.
- See Longmeyer, supra note 9 at pp. 701-02 (applying Kentucky's enactment of Section 7-303 of the Uniform Probate Code to hold that all beneficiaries, including remainder beneficiaries, are entitled to information about a trust, and holding the trustee subject to a duty to disclose).
- See supra note 9. A word of caution is in order here. The older restatements and treatises (like the cases they cite) don't explicitly distinguish between irrevocable and revocable trusts, including when it comes to the rights of beneficiaries. For example, as noted in the fifth edition of Scott on Trusts, prior editions simply did not consider what rules should apply to revocable trusts. Austin Wakeman Scott, Scott and Ascher on Trusts, supra note 2, Section 16.5. Thus, although these resources are cited by some to support the position that trustees owe their duties to all beneficiaries, including remainder beneficiaries, it can be doubted whether that result is intentional. The result is a great deal of potential confusion when one reads these cases or commentary.
- Uniform Trust Code (UTC) Art. 6, gen'l cmt., 7C Uniform Laws Annotated (U.L.A.) 368 (2006).
- UTC Section 603, 7C U.L.A. 554, 2004 amendment cmt.; Tim A. Thomas, “Annotation, Involuntary Disclosure or Surrender of Will Prior to Testator's Death,” 75 A.L.R. 4th 1144, 1146 (1990 and Supp. 2005).
- Restatement (Third) of Trusts, Section 74 (2007).
- Ibid., Section 74 cmt. a (“A power of this type allows the trust property to be taken by and vested personally in the settlor . . ., thereby eliminating all interests of other beneficiaries.”)
- Ibid., Section 74.
- Ibid., Section 74 cmt. a.
- In re Malasky, 736 N.Y.S.2d 151, 153 (App. Div. 2002); In re Estate of West, 948 P.2d 351, 355-56 (Utah 1997) (during the lifetime of the donor, the trustee owes his duties solely to the donor; rights of any remainder beneficiaries vest only upon the death of the donor).
- Restatement (Third) of Trusts, Section 74.
- See, e.g., infra note 29 and accompanying text.
- See infra note 28.
- See Foster, supra note 6 at p. 754.
- Restatement (Third) of Trusts, Section 74.
- 7C U.L.A. 5003 and 2004 amend. cmt. at p. 554.
- Ala. Code Section 19-3B-603; Ariz. Rev. Stat. Ann. 14-10603; Fla. Stat. Section 736.0603; Me. Rev. Stat. Ann. Tit. 18-B, Section 603; Neb. Rev. Stat. Section 30-3855; N.C. Gen. Stat. Section 36C-6-603; N.D. Cent. Code Section 59-14-03; Ohio Rev. Code. Ann. Section 5806.03; Or. Rev. Stat. Section 130.510; 20 Pa. Cons. Stat. Ann. Section 7753; S.C. Code Ann. Section 62-7-603; Va. Code Ann. Section 55-546.03.
- Ark. Code Ann. Section 28-73-603; D.C. Code Section 19-1306.03; Kan. Stat. Ann. Section 58a-603; Mich. Comp. Laws. Section 700.7603; Mo. Rev. Stat. Section 456.6-603; N.H. Rev. Stat. Ann. Section 564-B:6-603; N.M. Stat. Section 46A-6-603; Tenn. Code Ann. Section 35-15-603; Utah Code Ann. Section 75-7-606; Wyo. Stat. Ann. Section 4-10-603.
Eric L. Maassen, far left, is a partner with Foley & Lardner LLP in its Milwaukee office, and Gregory M. Monday is a partner in its Madison, Wis. office