Winter 2010 Newsletter
After the Love is Gone: Reconciling with Your Virginia Irrevocable Trust
By: Lauren A. Jenkins
All long term relationships have their fair share of challenges. The administration of an irrevocable trust is no different. In the beginning, the client is excited about creating an irrevocable trust. The client visualizes the potential tax savings and is ambivalent to any negatives that could possibly result from entering into an irrevocable agreement. Although the attorney explains that the trust cannot be changed or revoked, the client insists that he would never want to modify or terminate his trust. Yet, with time, the irrevocable trust that once brought so much promise when originally executed no longer meets the client’s needs.
The change of heart can be attributed to a multitude of reasons. Maybe the dispositive terms of the trust no longer reflect the client’s intentions, or a change in law results in adverse tax treatment with respect to the trust assets. It could be the client wants the trustee to invest in different types of assets and such investment is not authorized by the trust. Perhaps the client’s best friend just created an irrevocable trust, and the client wishes his irrevocable trust was not so outdated. Whatever the reason, the client wants out of the agreement he happily entered into some time ago.
It is possible that the needed modifications may be accomplished by the terms of the trust. Many trusts now provide for limited amendments by the trustee, a trust protector who has the power to modify the terms of the trust, and/or the ability for the trustee to decant the assets from one trust to a new trust. However, such clauses rarely appear in irrevocable trusts that were drafted more than ten years ago. If the irrevocable trust does not provide relief within the four corners of the document, the client is generally required to petition the court for assistance.
The Commonwealth of Virginia understands that there may be instances when a client has fallen out of love with his irrevocable trust. Rather than forcing the settlor to live in misery with the irrevocable trust, the Virginia legislature offers an alternative through the Virginia Uniform Trust Code (“Virginia UTC”). The Virginia UTC provides the settlor, trustee, and beneficiaries with the ability to adequately address the problems in the irrevocable trust, many times even without court intervention.
The Virginia UTC became effective as of July 1, 2006 and applies to trusts created before, on, or after July 1, 2006.1 Prior to the enactment of the Virginia UTC, questions concerning Virginia trusts were answered by consulting statutes strewn throughout the Code of Virginia and case law. Many times, the statutes and case law were unable to reconcile the particular issue in contention, ultimately resulting in a petition to the court for resolution. The introduction of the Virginia UTC improves Virginia trust law by providing a comprehensive statutory scheme for the creation, administration, and termination of Virginia trusts.
Most of the statutes contained in the Virginia UTC are default rules: if the trust itself addresses the issue, the Virginia UTC will not apply.2 Therefore, a settlor can “opt out” of the majority of the Virginia UTC by specifically delineating the manner by which the trust will be administered. Trusts that fail to address a particular issue can rely on the default rules of the Virginia UTC for a resolution.
A note of caution: although it may be possible under Virginia law to modify or terminate an irrevocable trust, such actions could result in adverse income, gift, estate, and/or generation-skipping transfer (GST) tax implications. Therefore, it is imperative that the attorney determine the tax repercussions before advising a client to proceed with modifying or terminating an irrevocable trust.
II. Notice and Representation under the Virginia UTC
The options offered by the Virginia UTC frequently require notice to “qualified beneficiaries.” A qualified beneficiary is a beneficiary who:
(i) is a distributee or permissible distributee of trust income or principal;
(ii) would be a distributee or permissible distributee of trust income or principal if the interests of the distributees described in (i) terminated on that date, but the termination of those interests would not cause the trust to terminate;
(iii) would be a distributee or permissible distributee of trust income or principal if the trust terminated on that date.3
As an example, a client creates a trust providing for income to his spouse during her life. At the spouse’s death, the assets are held in trust for the benefit of the client’s child. The trust terminates upon the death of the child, and all remaining assets are distributed out-right and free of trust to the client’s grandchild. If the grandchild fails to survive the child, all remaining assets are distributed to a charity. The qualified beneficiaries of the trust would be the spouse, child, and grandchild. The charity is not considered a qualified beneficiary as the grandchild is the distributee upon trust termination.
Notice must also be given to any beneficiary who has requested the trustee provide such beneficiary with notice.4 Thus, if the charity in the example above requested that it be provided notice, the trustee would be required to send such notice to the charity even though it is not a qualified beneficiary under Virginia Code Section 55-541.10.
In addition to notice, some Virginia UTC provisions also require the consent of qualified beneficiaries. Consent can become problematic if a qualified beneficiary is a minor or has yet to be born. The Virginia UTC solves these complications by providing that a person can consent to an action on behalf of a qualified beneficiary, and such consent is binding.5 As long as there is not a conflict of interest, a parent can bind the parent’s minor or unborn child.6 If the parent is unable to consent, a grandparent or more remote ancestor can bind such minor or unborn child.7 These representation rules are incredibly useful, especially if the parents are unable to represent the minor or unborn child due to a conflict of interest (e.g., one parent is the settlor and the other parent is serving as trustee). As a result, the Virginia UTC offers an efficient resolution to issues arising during the trust administration while protecting interested parties.
III. Reconciliation under the Virginia UTC
The Virginia UTC covers a myriad of topics with respect to the administration of a trust. For purposes of this article, we will focus on the statutes in the Virginia UTC that allow a settlor, trustee, and/or beneficiary to effectively address common issues that arise with the irrevocable trust administration. Those issues include: (i) combining and dividing trusts; (ii) removing and/or appointing a trustee; (iii) transferring the principal place of administration; (iv) modifying the trust; and (v) terminating the trust.
A. Combination and Division of Trusts
Many trusts grant a trustee the power to combine separate trusts or divide a trust into separate trusts. However, depending upon the age of the irrevocable trust or the expertise of the attorney drafting the irrevocable trust, it is possible that such authority is not granted within the instrument itself. Reasons for combining two or more trusts can include (i) preventing a trust from becoming uneconomical; (ii) reducing administration expenses; (iii) leveraging liquidity among trusts; and (iv) simplifying the administration of multiple trusts with similar terms. Trusts are commonly divided due to (i) GST tax issues; (ii) income tax implications; and (iii) investment strategies.
Under Virginia Code Section 55-544.17, a trustee can combine two or more trusts into a single trust or divide a trust into two or more separate trusts as long as such action “does not materially impair rights of any beneficiary or adversely affect achievement of the purpose of the trust.” The trustee is able to combine trusts or divide a trust after he has notified the qualified beneficiaries. 8 It is important to note that the qualified beneficiaries are not required to consent, nor does the proposed action require court approval.9 Moreover, it is not necessary for the terms of the trusts to be identical. However, a trustee should be wary before combining trusts with substantially different terms. As an alternative to Virginia Code Section 55-544.17, experts have advised trustees to obtain the consent of qualified beneficiaries or court approval before combining trusts with substantially different terms.10 Such consent and/or approval will offer protection to the trustee against claims by disgruntled beneficiaries if the combining of trusts or division of a trust results in a substantial decrease in value to trust assets or adverse tax implications.
B. Removing and/or Appointing a Trustee
It is not uncommon for beneficiaries to be unhappy with a trustee. Although there may always be tension between a beneficiary and trustee—after all, the trust is not the beneficiary’s checkbook—there are certain circumstances which require the trustee’s removal. The settlor may also be dissatisfied with a trustee’s performance. Frequently, clients name friends and family members as trustees of their trusts without truly appreciating the significance of such appointment. The trustee may not understand his fiduciary duties, and as a result, cause unnecessary depletion of trust assets. If the trust itself does not set forth a procedure for removing the trustee, the Virginia UTC offers settlors, co-trustees, and beneficiaries the ability to remove a trustee.
Under Virginia Code Section 55-547.06, a settlor, co-trustee, or beneficiary is able to seek removal of a trustee by petitioning the court. The court may remove the trustee if:
(i) the trustee has committed a serious breach of trust;
(ii) the lack of cooperation among the co-trustees impairs the administration of the trust;
(iii) the court determines that the removal of the trustee best serves the interest of the beneficiaries due to the unfitness, unwillingness, or persistent failure of the trustee to administer the trust effectively; or
(iv) there has been a substantial change of circumstances.11
The court may also remove the trustee if it determines that:
(i) the removal of the trustee is in the best interests of the beneficiaries (all of whom must request the trustee be removed);
(ii) the removal of the trustee is not inconsistent with a material purpose of the trust; and
(iii) a suitable co-trustee or successor trustee is available.12
Removal of the trustee is often the first part of a two part problem: once the trustee is removed, a successor trustee will need to serve in his place. Most irrevocable trusts provide a list of successor trustees or delineate a process for appointing successor trustees if there is a vacancy. However, situations do occur, especially in older trusts, where the list of successor trustees has been exhausted and the instrument does not provide for the appointment of additional successor trustees. The Virginia UTC solves this problem by allowing a successor trustee to be appointed by the unanimous consent of the qualified beneficiaries.13 If the qualified beneficiaries are unable to agree on a successor trustee, the court will appoint the successor trustee.14 As a result, the Virginia UTC streamlines the fiduciary removal and appointment process if the trust fails to address such issues.
C. Transferring the Principal Place of Administration
There are many reasons a trustee may wish to transfer a trust’s principal place of administration outside of Virginia. These reasons could include more favorable tax treatment, better creditor protection for beneficiaries, or directed trusteeship. More frequently, trustees seek to move the principal place of administration to take advantage of decanting statutes.
Decanting a trust is a term used to describe transferring assets from one trust to another trust. The power to decant the trust assets to a different trust is generally given to the trustee. Often, decanting is used (when available) as an option for dealing with a defunct irrevocable trust. Currently, there are ten states that have enacted decanting statutes: (i) Alaska; (ii) Arizona; (iii) Delaware; (iv) Florida; (v) Nevada; (vi) New Hampshire; (vii) New York; (viii) North Carolina; (ix) South Dakota; and (x) Tennessee. Virginia has not enacted a decanting statute; however, attorneys should consider drafting a decanting provision in their clients’ trusts to ensure maximum flexibility—especially if the trust is dynastic in nature. For Virginia irrevocable trusts that do not contain decanting provisions, the ability to transfer the principal place of administration to a different state allows the trustee to benefit from the decanting statutes in other jurisdictions.
Under Virginia Code Section 55-543.01, a trustee can change the principal place of administration of a trust to a different jurisdiction by notifying the qualified beneficiaries of the proposed transfer at least sixty days before initiating the transfer. The notice to the beneficiaries must include:
(i) the name of the jurisdiction to which the principal place of administration is to be transferred;
(ii) the address and telephone number at the new location at which the trustee can be contacted;
(iii) an explanation of the reasons for the proposed transfer;
(iv) the date on which the proposed transfer is anticipated to occur; and
(v) the date, not less than sixty days after the giving of the notice, by which the qualified beneficiary shall notify the trustee of an objection to the proposed transfer.15
As long as a beneficiary does not object to the proposed transfer during the stated objection period, the trustee has the authority to transfer the principal place of administration. It is important to note that court approval is not required. Changing a trust’s principal place of administration can dramatically transform the trust administration—especially if the trust is decanted to a new trust. The Virginia UTC allows the trustee to ultimately make significant changes to the trust administration with only the consent of the qualified beneficiaries.
D. Modifying the Trust
It is difficult for an irrevocable trust to adequately address every potential issue that will occur during the trust administration. One of the most powerful tools offered under the Virginia UTC is the ability to modify an irrevocable trust with court approval.
One of the most frequent problems found in an irrevocable trust is that the dispositive provisions (while satisfactory when the trust was originally executed) no longer reflect the settlor’s intentions. For example, the trust may direct the trustee to make substantial mandatory distributions to the beneficiary upon the occurrence of certain events (e.g., reaching a specific age, a term of years, or completion of an educational program). However, as time progresses, the settlor may decide that such mandatory distributions are not in the best interest of the beneficiary. The beneficiary may have creditor issues (including a potential ex-spouse), substance abuse problems, or special needs. In such instances, the best approach to protect the beneficiary from others (and himself) may call for such assets to remain in trust—which requires a modification of the trust provisions.
Settlors, trustees, and beneficiaries may also seek to have the administrative provisions of an irrevocable trust modified. Common administrative modifications include revising the order of successor trustees, relaxing the investment powers of the trustee, appointing a trust protector, and adjusting fiduciary compensation.
A Virginia irrevocable trust can be modified pursuant the Virginia UTC in a number of different ways, all of which may be commenced by a trustee or a beneficiary.16
• Consent by Settlor and All Beneficiaries. Under Virginia Code Section 55-544.11(A), a court shall modify an irrevocable trust if the settlor and all beneficiaries consent to the modification, even if the modification is inconsistent with a material purpose of the trust.
• Consent by All Beneficiaries. A court may modify an irrevocable trust if all beneficiaries consent to the modification as long as the modification is not inconsistent with a material purpose of the trust.17 This allows an irrevocable trust to be modified without the consent of the settlor—which will most likely arise in situations where the settlor is no longer alive or is incapacitated.18
• Modification without Consent of All Beneficiaries. A court is also able to modify an irrevocable trust even without the consent of all beneficiaries if the court determines that the interests of the non-consenting beneficiaries will be adequately protected.19
• Unanticipated Circumstances. A court may modify the administrative or dispositive terms of an irrevocable trust to further the purposes of the trust due to circumstances not anticipated by the settlor.20
• Impractical Administration. A court has the power to modify the administrative terms of an irrevocable trust if the continued administration of the trust on its existing terms would be impractical or wasteful or impair the trust’s administration.21
• Uneconomical Trust. An irrevocable trust may be modified by the court if it determines that the value of the trust assets is insufficient to justify the cost of administration.22
• Mistake. A trust may be modified by the court to conform the terms of the trust to reflect the settlor’s intent “if it is proved by clear and convincing evidence that both the settlor’s intent and the terms of the trust were affected by a mistake of fact or law, whether in expression or inducement.”23
• Tax Purposes. A court may modify an irrevocable trust to achieve the settlor’s tax objectives as long as the modification does not conflict with the settlor’s probable intent.24
The modification options offered under the Virginia UTC have the ability to breathe new life into an irrevocable trust. As a result, the administration of an irrevocable trust can continue as originally intended by the settlor.
E. Termination the Trust
Despite a settlor’s best intentions, there are instances where the only reasonable alternative is to terminate the irrevocable trust. The Virginia UTC provides different options depending upon the situation presented, many of which are similar to the requirements discussed above for the modification of an irrevocable trust
.• Consent by Settlor and All Beneficiaries. Under Virginia Code Section 55-544.11(A), a court shall terminate an irrevocable trust if the settlor and all beneficiaries consent to the modification, even if the termination is inconsistent with a material purpose of the trust.
• Consent by all Beneficiaries. The irrevocable trust may be terminated by the consent of all beneficiaries and the court finds the termination is not inconsistent with a material purpose of the trust.25 Once the termination is approved by the court, the trustee is required to distribute the remaining assets as agreed by the beneficiaries.26
• Termination without Consent of all Beneficiaries. A court is able to terminate an irrevocable trust even without the consent of all beneficiaries if the court determines that the interests of the non-consenting beneficiaries will be adequately protected.27
• Unanticipated Circumstances. A court may termi-nate an irrevocable trust to further the purposes of the trust due to circumstances not anticipated by the settlor.28 If the trust is terminated, the trustee distributes the remaining property in a manner consistent with the trust.29
• Uneconomical Trust. Virginia allows for termination of uneconomical trusts without court approval if the total value of the trust is (i) under $100,000, and (ii) the trustee determines that the value of the trust property is insufficient to justify the cost of administration.30 In such instances, the trustee can terminate the trust after he provides notice to the qualified beneficiaries.31 Once the trust has been terminated, the trustee is required to distribute the remaining property in a “manner consistent with the purpose of the trust,” which usually means the assets are distributed among the qualified beneficiaries according to their interest in the trust.32 Even if the trust assets are $100,000 or more, an interested party still has recourse with respect to an uneconomical trust. Under this same statute, a court has the power to (i) modify a trust; (ii) terminate a trust; or (iii) remove a trustee and appoint a successor trustee if the court determines that the trust assets are insufficient to justify the cost of administration.33 In such instances, the interested party would petition the court for relief pursuant to Virginia Code Section 55-544.14.
Similar to the beginning of any relationship, it is not the settlor’s intent to have his irrevocable trust pre-maturely terminated. However, there are circumstances under which terminating the irrevocable trust is the only viable option. The Virginia UTC understands that such situations do occur and offers settlors, beneficiaries, and trustees the ability to terminate an irrevocable trust.
Commitment can be a terrifying experience—especially when problems arise in a relationship that is intended to last forever (or a very long time). It is impossible to predict every potential issue that will affect the irrevocable trust administration—people change, the law changes, and mistakes do happen. Despite the irrevocable nature of the trust, settlors, ben-eficiaries, and trustees have the power to make adjustments (sometimes without court approval) that will result in substantial improvements to the trust administration. If such modifications will not revive the irrevocable trust, the Virginia UTC provides a process for terminating the trust. The Virginia UTC offers hope to settlors, beneficiaries, and trustees who find themselves in such untenable situations.
Lauren A. Jenkins is an associate at the McLean, Virginia office of Holland & Knight LLP where she is a member of the Private Wealth Services Section. Ms. Jenkins focuses her practice in the areas of estate and tax planning, estate and trust administration, and beneficiary representation. She assists clients with the creation of sophisticated estate plans, as well as advising fiduciaries with respect to the administration of trusts and estates, including the modification and termination of irrevocable trusts. Ms. Jenkins also represents beneficiaries who desire separate counsel to protect their interests.
1 Va. Code Ann. § 55-551.06.
2 Va. Code Ann. § 55-541.05.
3 Va. Code Ann. § 55-541.03.
4 Va. Code Ann. § 55-541.10(A).
5 Va. Code Ann. § 55-543.01.
6 Va. Code Ann. § 55-543.03(6).
7 Va. Code Ann. § 55-543.03(7).
8 Va. Code Ann. § 55-544.17.
9 John E. Donaldson & Robert T. Danforth, The Virginia Uniform Trust Code, 40 U. Rich. L. Rev. 325, 350 (2005-2006).
10 Id. at 351. The authors advise the trustee to obtain the consent of the qualified beneficiaries under Va. Code Ann. § 55-550.09 or petition the court for approval under Va. Code Ann. § 55-544.10.
11 Va. Code Ann. § 55-547.06(B).
12 Va. Code Ann. § 55-547.06(B)(4).
13 Va. Code Ann. § 55-547.04(C)(2).
14 Va. Code Ann. § 55-547.04(C)(3).
15 Va. Code Ann. § 55-541.08.
16 Va. Code Ann. § 55-544.10.
17 Va. Code Ann. § 55-544.11(B).
18 It is important to note that the holder of a grantor’s power of attorney can consent to the modification of an irrevocable trust on behalf of the grantor (under Va. Code Ann. § 55-544.11(A)) if permitted under the power of attorney or the trust itself.
19 Va. Code Ann. § 55-544.11(D).
20 Va. Code Ann. § 55-544.12(A).
21 Va. Code Ann. § 55-544.12(B).
22 Va. Code Ann. § 55-544.14(B).
23 Va. Code Ann. § 55-544.15.
24 Va. Code Ann. § 55-544.16.
25 Va. Code Ann. § 55-544.11(B).
26 Va. Code Ann. § 55-544.11(C).
27 Va. Code Ann. § 55-544.11(D).
28 Va. Code Ann. § 55-544.12(A).
29 Va. Code Ann. § 55-544.12(C).
30 Va. Code Ann. § 55-544.14.
32 Donaldson at 350.
33 Va. Code Ann. § 55-544.14.