Powers of Appointment and Fiduciary Duties of a Beneficiary as Trustee – Complete Freedom or Asking for Trouble?
In trust planning, it is common that a trust beneficiary is appointed as trustee. A lot of confusion surrounds the consequences of appointing a beneficiary as his or her own trustee. On one hand, I have heard people say it is not allowed to have a beneficiary serve as trustee. On the other hand, I have heard people say it gives complete freedom to the beneficiary-trustee, especially when coupled with powers of appointment, to serve without being limited to fiduciary duties to other beneficiaries, current or future.
There can be many consequences to naming a beneficiary as trustee and granting a beneficiary a power of appointment including tax implications, creditors’ rights to trust assets, fiduciary duties, and rights of beneficiaries. I recently wrote an article regarding Mississippi’s adoption of Article 5 to the Uniform Trust Code dealing with creditors’ rights to trust assets.[1] That article deals with some of the consequences of granting certain powers to trust beneficiaries. The purpose of this writing is to discuss some recent cases involving fiduciary duties of a beneficiary-trustee, especially when that beneficiary-trustee is granted broad discretionary power and powers of appointment. These issues have been the subject of at least a few recent cases.
Recent Case Review
Peterson v. Peterson [2]
In the Peterson, case the Court of Appeals of Georgia ruled on fiduciary duties owed to remainder beneficiaries when the trustee-beneficiary was given a broad lifetime power of appointment. At issue was whether a trustee-beneficiary owed fiduciary duties in the exercise of her power of appointment.
The facts of the case are fairly straight-forward. Charles Hugh Peterson died in 1995. Under the terms of his Will, his assets were divided between a marital trust and a bypass trust, each for the benefit of his wife, Mary. Along with Charles and Mary’s three sons, Mary was appointed as co-trustee of both trusts. The trusts granted Mary “the power at any time and from time to time…to direct the Trustees to turn over any part of the property in this trust to my said wife or to or among such of my descendants or spouses of such descendants.” In default of exercise, the trusts would be divided among the Peterson’s three children, Calhoun, Alex, and David.
During the period of trust administration, a dispute arose between the co-trustees pitting Mary and Calhoun against Alex and David. During that dispute, Mary directed that all assets in the assets of the marital trust be distributed to her and all assets in the bypass trust be distributed to Calhoun. Alex and David refused to honor Mary’s directions given pursuant to her lifetime power of appointment to direct trust property be distributed to her, Charles’ descendants, or spouses of Charles’ descendants. Calhoun filed an action against Alex and David seeking to remove them as trustee or, alternatively, compel them to honor Mary’s directions. A critical issue in determining the prevailing party was whether the exercise of Mary’s power of appointment was subject to her fiduciary duties as trustee.
The Court of Appeals began its legal discussion citing to Connecticut Bank & Trust Co. v. Lyman[3], a case from the Connecticut Supreme Court of Errors decision. In Lyman, the court ruled on a request by a trustee that the court construe its fiduciary duties in honoring the exercise of a power of appointment. The trustee wanted to know whether it could honor that direction without regard to its fiduciary duties. The court held the trustee could honor that request notwithstanding its fiduciary duties to other beneficiaries. This is because the surviving spouse held the power to so direct under the terms of the trust. The Court of Appeals of Georgia, however, distinguished Lyman from Peterson, noting that the beneficiary in Lyman was not the trustee honoring the exercise a power of appointment. Rather, in Peterson, the trustee is the person actually exercising the power to distribute trust assets to one remainder beneficiary to the exclusion of others.
The court found a primary purpose of the trusts was for the support of Mary and, after her death, Charles’ children. In following that intent, a trustee is required to “administer the trust solely in the interests of the beneficiaries,” and subject to a “duty of impartiality.”[4] This requires a trustee to act “in good faith” and in consideration of “the purposes, provisions, distribution requirements, and other circumstances of the trust.”[5] Referencing the conflict of interests between Mary, Alex and David, along with the primary purpose of the trust to benefit Mary and Charles’ children, the court refused to require the co-trustees to make the distributions demanded by Mary. On June 29, 2020, the Supreme Court of Georgia refused to grant certiorari.[6]
Since this case took place during Mary’s lifetime, I question whether Mary could (or did) resign as trustee then renew her demand for distribution pursuant to her power of appointment. Presumably, no longer serving as trustee, she would be relieved from any fiduciary duties which caused the problem. From a review of obituary records, it appears that Mary died on April 10, 2020. Maybe she was able to achieve her goals prior to death.
Tubbs v. Berkowitz [7]
The basic facts of Tubbs are not significantly different than Peterson. Here, Harry Berkowitz and his wife established a joint revocable trust that, after the first death, divided trust assets between a marital trust and a survivor’s trust. Harry’s wife died and Harry was appointed as trustee over both trusts. The survivor’s trust was revocable by the survivor. The survivor held a power of appointment over the marital trust to direct assets be appointed to “such one or more persons and entities, including the surviving spouse or the surviving spouse’s estate…as the surviving spouse shall request.” As part of the administration of his wife’s estate, Berkowitz became involved in a dispute with his daughter, Janice Tubbs. After these disputes arose, Harry exercised his power of appointment to appoint the assets of the marital trust to himself. Tubbs filed a petition seeking to declare that Harry could not exercise his power of appointment to appoint trust property to himself.
As in Peterson, a primary issue in the case was whether Harry’s fiduciary duties as trustee prevented him from exercising his power of appointment to effectively divest a remainder beneficiary (Janice) of their interests in the trust. The trial court noted that “the powers of appointment at issue [were] not given to the Trustee, but to the surviving settlor” going on to say “if faced with the exercise of a power of appointment by Harry-as-Settlor…, Harry-as-Trustee has no discretion but to follow those directions.”
In these statements, the trial court noted what I believe to be two important distinctions: (a) powers held in a fiduciary versus non-fiduciary capacity and (b) duties of a trustee in the exercise of discretion versus the obligation of a trustee to follow the requirements of the trust agreement. Here, the court recognizes that the power of appointment was held in a non-fiduciary capacity. It was granted to the surviving settlor, not the trustee. While they may be the same person, the capacity in which each is grated is distinguished in the trust agreement. Further, the trustee would have no discretion over the exercise of, or distributions in satisfying, the surviving settlor’s power of appointment. Without any discretion, a trustee cannot be said to have improperly exercised its discretionary powers. The trustee is compelled to make distributions pursuant to the surviving spouse’s exercise of the power of appointment.
Following the court’s apparent recognition of those distinctions, the court cited terms of the martial trust stating the trustee “shall distribute” to the surviving spouse “all or any part of the trust…to such one or more persons…including the surviving spouse… as the surviving spouse shall request.” Tubbs was unable to cite to any authority, and the court’s research could not find, any limitation on the donee of a power of appointment’s right to exercise the power even if that donee is also trustee. Tubbs argued that the ability of a beneficiary-trustee to demand all trust assets be distributed to themselves without regard to any fiduciary duty rendered the trust essentially meaningless. The trustee in that situation effectively owes no fiduciary duties. The court disagreed by recognizing that, until the power of appointment is exercised, the trustee-beneficiary still must recognize and respect the rights of the remainder beneficiaries.
Ultimately, the court ruled that duties of a trustee do not impose restrictions on the trustee’s separate role of a donee of a power of appointment. A power of appointment of the type granted Harry is held in a non-fiduciary capacity.[8] Harry has authority to exercise this non-fiduciary capacity granted to him as beneficiary without regard to his duties as trustee. As such, the court affirmed the granting of summary judgment in Harry’s favor.
Ferguson v. Ferguson [9]
Yet again, in Ferguson, a court is forced to deal with a surviving spouse’s exercise of a power of appointment. Here, Roger and Sybil Ferguson created a joint revocable trust in 1994. Under that document, they disinherited their son, Michael. After Roger’s death in 2012, the trust assets divided into shares, a marital trust, a family trust, and a survivor’s trust. Sybil served as trustee of each of the trusts. Around eighteen months after Roger’s death, Sybil had a change of heart and decided to exercise a power of appointment granted to her under the survivor’s trust to add Michael as a beneficiary of the survivor’s trust.
None of the other beneficiaries, the Ferguson’s other children, challenged Sybil’s exercise of her power of appointment. However, a number of other issues arose regarding fiduciary duties owed to Michael, Michael’s access to information regarding trust administration, and the enforceability of a “no contest” provision. These issues were brought before the court after Michael’s petition seeking information relating to the original funding of subtrusts after Roger’s death as well as other information relating to trust administration, all well before the death of Sybil.
After Sybil’s death, prior to distribution of assets from the survivor’s trust, Michael sought financial information regarding original funding of the marital trust, family trust, and survivor’s trust. He also sought other financial information from Roger’s date of death until final distribution of the survivor’s trust. Michael’s counsel argued that to “know what comes out at the bottom of the hopper…we have to know what went in at the top[.]” Therefore, notwithstanding when Michael became a beneficiary of the survivor’s trust, he is entitled to the information requested to determine his current beneficial interest in the survivor’s trust.
The trial court determined that Michael did not become a beneficiary of the survivor’s trust until after Sybil’s death. As a result, he was not entitled to any information regarding the trust until that time. An intermediate appellate court affirmed in part and reversed in part the trial court’s ruling, including finding the trial court in error for holding Sybil did not owe Michael fiduciary duties and for failing to enforce the “no contest” provision to exclude Michael as a beneficiary. This placed the matter before the Supreme Court of Idaho.
First, the Idaho Supreme Court handled the question of whether Sybil as trustee-beneficiary owed fiduciary duties to Michael. The court noted that trustees of discretionary interests may have broad discretion, but must satisfy their basic fiduciary duties and may not abuse their discretion.[10] When a trustee holds broad discretionary authority (“absolute,” “unlimited,” or “sole,” for example), they are not absolved from their basic fiduciary duties. These duties go beyond what is expressly stated in the trust agreement, but also what is required under state law.[11] Under these obligations are the duty of loyalty (act in the interests of the beneficiary, not the trustee’s own interests) and the duty to keep trust beneficiaries reasonably informed about trust administration.
With that framework, the court addressed the time at which those duties became owing to Michael. Sybil executed her Will on October 3, 2013 appointing assets of the survivor’s trust to Michael at her death. During the eighteen months between the execution of that Will and Sybil’s death, the court determined that Sybil owed Michael fiduciary duties.
In litigation prior to reaching the Idaho Supreme Court, this was an important issue as the courts used this to determine the point at which Michael became entitled to trust financial records. However, the Idaho Supreme Court cited the relevant state statute as requiring a trustee to provide a beneficiary “with relevant information about the assets of the trust and particulars relating to the administration.”[12] Based on this statutory language, regardless of when Michael became a beneficiary, the court held he was entitled to the information he requested as such was “relevant information” required to determine whether the survivor’s trust received its full allocation of divided assets after Roger’s death. When such information is relevant, it may be required to be disclosed to a beneficiary even if it relates to periods of time before the beneficiary’s interest in the trust arose. In holding that Michael’s action was based on “probable cause,” the court refused to enforce the trust’s “no contest” provision.[13]
I find it somewhat strange the Idaho Supreme Court discussed the issue of when fiduciary duties became owing to Michael. Given the court’s ruling that he was entitled to information from before his beneficial interest in the trust existed, it seems this was rendered irrelevant. However, the court specifically found he became a beneficiary and was owed fiduciary duties once Sybil signed a Will appointing him as beneficiary. This seems contrary to the ambulatory nature of a Will not becoming effective to grant rights to anyone until the death of the testator. In its holding, the Idaho Supreme Court appears to have rendered an opinion which violates that basic legal premise, and at a time when the issue was rendered moot by the court’s opinion on another issue.
Discussion
Trusts are drafted very often which appoint a beneficiary as trustee or co-trustee, grant the trustee broad discretion, and grant a beneficiary-trustee powers of appointment. A common scenario is where spouses pass assets in trust for each other at a first death, reserving significant powers for the survivor. Typically, the intent is to mimic outright ownership while still obtaining benefits of a trust which could be created for tax planning reasons, protection of assets from creditors, protection from subsequent marriages, Medicaid planning, and any number of other reasons. One of the structural choices which can give a beneficiary significant control over a trust is to name the beneficiary as trustee. As mentioned in the introduction of this writing, opinions seem to vary about the consequences of this choice.
It seems relatively clear that one can grant a power of appointment in a fiduciary capacity (really, any trustee’s right to make distributions is a fiduciary power of appointment) or in a non-fiduciary capacity.[14] When the power is granted in a non-fiduciary capacity and the trustee, whomever that may be, is mandated to honor an exercise of the power, it would seem an inefficient exercise to require the powerholder to resign as trustee merely to exercise the power. Likewise, it would seem to be contrary to many, if not most, settlors’ intentions. The law does not appear to strongly support holding the holder of a non-fiduciary power to fiduciary duties when exercising their power of appointment.[15]
In my view, the Peterson court outright got it wrong. There is no explanation for their opinion. The closest I can get is to read the case as turning on the settlor’s intent. The court may have believed Charles did not intend for his wife to exercise the power to cut out certain descendants (although, if not, why not simply limit the terms of the power of appointment) and felt compelled to require that intent be fulfilled. The Tubbs court, facing essentially the same question, reached the opposite result. In doing so, the court recognized fiduciary versus non-fiduciary powers as well as discretionary powers of a trustee versus mandatory trustee actions. When the trustee would be required to honor the exercise of the non-fiduciary power, then the trustee cannot be said to have breached their duty merely because the powerholder is requiring the trustee to make a distribution which, if made under the trustee’s discretion, would be a breach of duty. Of course, this is the correct answer.
Aside from the effect of fiduciary duties on the right of a beneficiary-trustee to exercise the power, questions can arise about the effect of an exercise on duties owed to the beneficiaries. As discussed in Ferguson, exercise of the power may create fiduciary duties to a new beneficiary or beneficiaries. If so, does it relieve the trustee from duties to those who may be removed as a beneficiary through the exercise? What about if the exercise is revocable (such as in a Will)? Does that allow a powerholder beneficiary-trustee to shift fiduciary duties to be owed to a favorable group of beneficiaries while leaving open the right to bring those cut out back into the fold?
It is true that courts have recognized that one cannot ever take off their hat as fiduciary.[16] When serving as a trustee, one cannot act in other capacities and avoid fiduciary duties. However, when one holds fiduciary and non-fiduciary powers, it would seem appropriate to allow the non-fiduciary powers to be exercised free from fiduciary duties.[17] To require otherwise could, in Peterson and Tubbs, for example, require the spouse to resign as trustee prior to exercising their power of appointment. Certainly, when one spouse appoints the other as trustee-beneficiary with a power of appointment, he or she does not intend for the survivor to be faced with the choice of serving as trustee or exercising their power of appointment. Anecdotally, the intent is usually the opposite. As mentioned previously, spouses often want to grant each other as much power as possible, with as little accountability as possible, while still obtaining benefits of passing assets into trust for the survivor.
Conclusion
Given the clear recent litigation involving exercise of powers of appointment by a beneficiary-trustee, especially a surviving spouse, planners should carefully consider how to structure trust arrangements to clearly effectuate the intent of settlors. To the extent a power is intended to be held in a non-fiduciary capacity, perhaps the trust document should expressly state this intention rather than relying on general legal principals to reach that conclusion. Additionally, the timing of exercise may be an issue for planners to consider. Given the findings in Ferguson, the timing of exercise may affect the timing of when fiduciary duties are owed.
In any event, planning for a beneficiary-trustee holding a power of appointment clearly is not as straight-forward as many would like to think. Planners should carefully consider the multitude of consequences that can come from this planning structure. While many clients will want to give a beneficiary these roles (trustee and holder of a power of appointment), it is important to think through the ancillary consequences of that arrangement and determine how best to accomplish the settlor’s intent without opening up the beneficiary-trustee, and the intended structure, to disruption.
[1] Edmondson, Gray, “Creditors Rights to Trust Assets – Mississippi Law Update,” July 16, 2020, https://esapllc.com/2020msutcarticle5/.
[2] Peterson v. Peterson, 835 S.E.2d 651 (Oct. 29, 2019).
[3] Connecticut Bank & Trust Co. v. Lyman, 170 A.2d 130 (Conn. 1961).
[4] Citing Rollins v. Rollins, 790 S.E.2d 157 (2016).
[5] Id.
[6] https://www.gasupreme.us/granted-denied-petitions/2020-denied/
[7] Tubbs v. Berkowitz, 47 Cal.App.5th 548 (April 7, 2020).
[8] Citing Restatement (Second) Property, Donative Transfers, § 11.4, cmt. a., p 18.
[9] Ferguson v. Ferguson, 2020 WL 3989092.
[10] Citing Restatement (Third) of Trusts, § 50.
[11] Citing Restatement (Third) of Trusts, § 76.
[12] Idaho Code § 15-7-303(b).
[13] Citing Idaho Code § 15-3-905 and Restatement (Third) Property, Wills and Donative Transfers, § 8.5, cmt. C.
[14] See Restatement (Second) of Property, Donative Transfers § 11.1; Uniform Powers of Appointment Act, comments to § 102; and Uniform Trust Code, comments to § 103.
[15] See, e.g.., comments Uniform Trust Code § 814 indicating that requiring good faith exercise of discretionary powers by a trustee, even if granted in the absolute, sole, or uncontrolled, discretion of the trustee, applies only to powers held in a fiduciary capacity as opposed to a non-fiduciary capacity.
[16] See, e.g., Frank Aragona Trust v. Commissioner, 142 T.C. 9 (2014), where the Tax Court recognized that Michigan law would not allow a trustee to take off their hat as trustee when acting in different capacities. Fiduciary duties, including the duty of loyalty, are owed to the beneficiaries at all times regardless of the capacity in which the trustee is acting.
[17] In line with this thinking, that powerholders are intended to have rights superior to those subject to exercise of their power, Uniform Trust Code § 302 allows the holder of a general power of appointment to bind those subject to their power absent a conflict of interest between the two. Miss. Code Ann. § 91-8-302 extends this to all holders of a power of appointment, not just holders of a general power of appointment. The Mississippi also requires a “material” conflict of interest to take away the right of the powerholder to bind others. For other examples, see also Tenn. Code Ann. § 35-15-302, Ala. Code § 19-3B-302, and Ga. Code Ann. § 53-12-8(e).
