Trusts, Estates & Tax Law NEWSLETTER

NOVEMBER 2008 PAGE 1 OF 4 Trust Act 2007 and Trust Act 2008 Changes to the fiduciary personally or to the fiduciary’s estate or credi- Title 12 of the Delaware Code tors or to the creditors of the fiduciary’s estate) that might, absent the , be treated as general powers of appointment Advisers and Further Recognition of Trust Protector for federal transfer tax purposes, may only be exercised by the fiduciary for the fiduciary’s health, education, support or elaware trust instruments have, for generations, routinely maintenance. The statute cuts such powers back, by operation Dbeen drafted to create a wide variety of offices and roles of law, to the extent necessary to prevent a fiduciary holding designed primarily to supervise or assist in the operation and any such power from being deemed to hold a general power administration of trusts. For example, trust instruments often of appointment over trust property sufficient to cause adverse name a “trust protector” who customarily is granted various estate or gift tax consequences. specified powers and rights by the terms of the trust instru- ment. In light of this longstanding and prevalent practice, Nature of ’s Interest in a Section 3313 of Title 12, often used to bifurcate fiduciary du- Described ties between a and a trust adviser (such as an invest- ment adviser or distribution adviser) has been revised by Trust rust Act 2008 also added new Subsection 3315(a) to Title Act 2008 to provide that trust protectors are “advisers” within T12, which provides that a trustee’s exercise of a discre- the meaning of the statute. This 2008 revision to Section 3313 tionary distribution power may not be overturned by a court marks the second express reference in the codified Delaware except on account of “abuse of discretion” within the meaning trust laws to the role of trust protector. See also 12 Del. C. of § 187 of the Restatement (Second) of Trusts. Section 187 § 3570(8)c.3 (flush language). of the Restatement provides, in relevant part, that if a power is conferred upon a trustee to distribute trust property to a partic- Section 3313 was also updated in 2007 to clarify existing law ular beneficiary in the trustee’s discretion, without reference concerning the scope and nature of a directed fiduciary’s du- to the needs of the beneficiary, the courts will not interpose if ties. New subsection (e) of Section 3313 generally provides the trustee acts honestly and from proper motives. See § 187 that unless otherwise provided in the governing instrument, (Illustrations 11 and 12; last sentence). a fiduciary acting at the direction of an adviser shall have no duty to (1) monitor the conduct of the adviser; (2) provide New Subsection 3315(b) provides that a creditor of a ben- advice to the adviser or consult with the adviser; or (3) com- eficiary eligible to receive discretionary distributions from a municate with, warn or apprise any beneficiary or third party trust may not directly or indirectly compel the distribution of a concerning instances in which the fiduciary would or might discretionary interest except to the extent such a right is grant- have exercised the fiduciary’s own discretion in a manner dif- ed to the creditor by the express terms of the . ferent from the manner directed by the adviser. The new sub- section (e) also creates a rebuttable presumption that actions Additional Limitations Period on Surcharge Actions of a directed fiduciary pertaining to matters within the scope rust Act 2008 amended Section 3585 of Title 12 to add of the adviser’s authority shall be presumed to be only ad- Ta new five-year statute of limitations for breach of trust ministrative actions taken to perform the fiduciary’s assigned actions. Under prior law, a beneficiary was required to bring duties and shall not constitute an undertaking by the fiduciary a claim for breach of trust within two years following the date to monitor the adviser. the beneficiary was sent a report that adequately disclosed the facts constituting the claim. In cases where the two-year limi- Disabling Statute for Inadvertent General Powers tation period does not apply, the new limitations period bars of Appointment Held in a Fiduciary Capacity breach of trust claims five years following the first to occur of (i) the removal, resignation or death of the trustee; (ii) the ew Section 3314 of Title 12, added by Trust Act 2008, termination of the beneficiary’s interest in the trust; or (iii) the Nis a so-called “disabling statute” patterned upon Section termination of the trust. 814 of the Uniform Trust Code. The new statute provides in general that various specified powers held solely in afidu- Morris Nichols partner Tom Pulsifer served as a member of the Estates and Trusts ciary capacity (such as the power to appoint trust property to Section’s drafting committee for Trust Acts 2007 and 2008.

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Trusts, Estates & Tax Law NEWSLETTER NOVEMBER 2008 PAGE 2 OF 4 Charitable Trusts and Noncharitable Purpose Trusts eficial interests in such trusts while enhancing the creditor protec- tion afforded by the legislation. elaware’s purpose trust legislation (12 Del. C. § 3555), Dwhich previously authorized the creation of trusts for any Trust Act 2008 included two changes to the Asset Protection declared purpose, including the care of animals, has been di- Trust Statute. Under the legislation in effect prior to the 2008 vided by Trust Act 2008 into two new . Revised Sec- amendments, the settlor of a Delaware asset protection trust tion 3555 provides that a trust for the care of animals is valid was permitted to retain the right to remove and advis- while new Section 3556 provides that a trust for any declared ers and to appoint successor trustees and advisers provided purpose is valid even if the purpose is not charitable and the that the settlor could not appoint a successor trustee or a suc- trust has no identifiable beneficiaries. Revised Section 3555 cessor adviser who was related or subordinate to the settlor limits the term of a trust for the care of animals to the lifetime within the meaning of Internal Revenue Code (“IRC”) Section of one or more animals living at the time of the settlor’s death 672(c). The 2008 revisions remove the IRC Section 672(c) and provides various rules concerning the enforcement and limitation meaning that the settlor may now retain the right administration of trusts for the care of animals. New Sec- to appoint successor trustees and advisers who are related or tion 3556 does not limit the duration of other non-charitable subordinate to the settlor within the meaning of IRC Section purpose trusts meaning that such trusts, in accordance with 672(c). In addition, Trust Act 2008 amended the Asset Pro- generally applicable Delaware , may continue in per- tection Trust Statute to permit a settlor to retain the right to be petuity. Moreover, Section 503(a) of Title 25 (which provides reimbursed from the trust for income tax liability incurred by generally that the rule against perpetuities does the settlor with respect to trust income by reason of the grantor not apply to trusts) was also revised to provide expressly that trust income tax rules. Under prior law, the settlor could only non-charitable purpose trusts are not subject to the common retain the right to be reimbursed for income taxes to the extent law rule against perpetuities. New Section 3556 also includes that the trustee, in the trustee’s discretion, determined. rules concerning the enforcement and administration of purpose trusts. The Asset Protection Trust Statute was also amended by Trust Section 3541 of Title 12 is Delaware’s cy pres statute. Added Act 2007. In 2007, the statute was amended to provide that if in 2005, Section 3303(b) of Title 12 generally provides settlors a creditor’s claim arises after a transfer to an asset protection of charitable trusts, and their designees serving during or after trust has been completed, the creditor will not be able to set the settlor’s lifetime, with a mechanism to enforce the pur- aside or bring an action against the transfer unless it can prove poses of charitable trusts. Trust Act 2007 harmonized the ap- that the transfer was made with actual intent to defraud the plication and standards of those two sections. Trust Acts 2007 creditor. Proof of intent to hinder or delay a creditor will no and 2008 expanded the cy pres statute and 3303(b) to cover longer be enough to set aside a transfer to an asset protection noncharitable purpose trusts within the meaning of Section trust under those circumstances. Trust Act 2007 also amended 3555 and 3556 of Title 12. the Asset Protection Trust Statute to make it clear that a trustee of an asset protection trust has the authority to pay debts, ex- Trust Act 2007 also reconciled the standards for court ordered penses and taxes of a decedent or the decedent’s estate, con- changes to the purposes of charitable and noncharitable pur- sistent with rules governing all spendthrift trusts. In addition, pose trusts in Sections 3303(b) and the cy pres statute. Under a new section 3574(e) was added to the Asset Protection Trust the old cy pres rule, departure from a trust’s purpose was per- Statute in 2007 to provide that a creditor shall have no rights missible only if the purpose had become unlawful, impracti- to the interest of a trust beneficiary solely because the ben- cable, impossible to achieve or wasteful. The new cy pres rule eficiary has the right to authorize or direct the trustee to pay is consistent with the standard under Section 3303(b), permit- estate taxes imposed upon the beneficiary’s estate, the debts of ting departure from a trust’s purpose only if the purpose has the beneficiary’s estate, or the expenses of administering the become unlawful under the U.S. or Delaware Constitution or beneficiary’s estate, unless such beneficiary actually directs if the trust would no longer serve any religious, charitable, the payment and then only to the extent of such direction. scientific, literary, educational or noncharitable purpose.

Note: It is likely that Title 30 of the Delaware Code (concerning state taxes) will Spendthrift Trusts and Creditor Protection Generally be amended in 2009 to exempt non-charitable purpose trusts (but not animal care trusts) from state income taxation. ection 3536 of Title 12 is the Delaware Code section pertaining Asset Protection Trusts Sprimarily to third-party spendthrift trusts. he 2007 and 2008 revisions to the Delaware Qualified Section 3536(a) has been revised and reorganized by Trust TDispositions in Trust Act (the “Asset Protection Trust Act 2008 in order to provide even greater protection against Statute”) are in keeping with the recent trend to permit trust claims made by creditors of trust beneficiaries. As revised, the settlors to retain greater control over such trusts and greater ben- statute now provides that a creditor of a beneficiary has only

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Trusts, Estates & Tax Law NEWSLETTER NOVEMBER 2008 PAGE 3 OF 4 such rights against the beneficiary’s interest as are expressly Bypassing Funding of Trusts for granted to the creditor by the terms of the trust instrument or Delaware law. Direct Distribution to Beneficiaries

Section 3536(a) was also amended by both Trust Acts 2007 he amended Section 3543 of Title 12 permits a party in and 2008: (i) to provide that a trustee may directly pay any Tpossession of property to make direct distribution of the expense on behalf of a beneficiary to the extent permitted by property to the beneficiaries rather than to the trustee intended the trust instrument and may exhaust the income and principal to receive it, if the trustee would have been required to make of the trust for the benefit of such beneficiary, regardless of immediate distribution to the beneficiaries upon receiving the whether he or she has any outstanding creditors and without property. Trust Act 2007 expanded the rule to make it useful risk of liability to any creditor of the beneficiary for paying the for trustees in possession of such property, whereas the old beneficiary’s expenses; and (ii) to clarify that every assign- rule only gave the power to executors. ment by a beneficiary of an interest in a trust with an anti-as- signment provisions by a beneficiary is invalid, including di- Virtual Representation rect, indirect, voluntary and involuntary assignments (subject, ection 3547 of Title 12, Delaware’s virtual representation however, to specific exceptions set forth in Section 3536). Sstatute, became a more useful tool with respect to trust Prior to Trust Act 2007, Section 3536(c) of Title 12 made it matters after the enactment of Trust Act 2007. The old vir- clear that a beneficial interest of a trustor in an irrevocable tual representation statute became subsection (a) of Section that he or she created is subject to the claims 3547. Section 3547(a) permits a minor, incapacitated, unborn of his or her creditors to the extent of his or her contribu- or unascertainable person to be represented and bound for any tions to the trust, unless the Asset Protection Trust Statute pro- purpose by another who has a substantially identical interest vides otherwise. Trust Acts 2007 and 2008 amended Section with respect to the particular question or dispute, to the extent 3536(c) to add another exception to the general rule. The new that there is no conflict of interest between them with respect Section 3536(c) provides that a trustor’s retained right to re- to the particular question or dispute. The heart of the changes ceive discretionary distributions as reimbursement for income to the virtual representation statute is the addition of a new taxes paid that are attributable to trust assets will not in and of subsection (b) and a new subsection (c) to cover additional itself subject the trustor’s transferred property to the claims of circumstances. The new subsection (b) permits presumptive his or her creditors. The new Section 3536(c) accommodates remainder beneficiaries to represent and bind contingent suc- a common provision in grantor trust instruments permitting cessor remainder beneficiaries, including adults and charities, a trustee to reimburse the grantor for the payment of income for the same purposes, in the same circumstances and to the taxes attributable to the trust. same extent that minor and unborn beneficiaries could be bound under the old statute. The new subsection (c) permits Trust Act 2008 also clarifies the relationship between Section the parents or guardians of a minor or incapacitated trust ben- 3536 and Delaware’s asset protection trust legislation (12 Del. eficiary to bind such beneficiary (and in some cases, his or her C. § 3570 et seq.) by excluding self-settled trusts from the unborn descendants) for purposes of trust matters, provided scope of the creditor protection afforded by Section 3536. As that there is no one else to virtually represent the beneficiary a result, self-settled trusts are subject to claims made by the and provided that there is no material conflict of interest be- settlor’s creditors unless such claims are barred by the Asset tween the beneficiary and the beneficiary’s parents. Subsec- Protection Trust Statute. tion (c) eliminates the need for a court appointed guardian to represent minor beneficiaries in trust matters under circum- Effect of Provisions in Governing Documents: stances where they could not have been represented under the Duty of Diversification old statute. The additions to the virtual represent statute sim- plify the process of obtaining consents for purposes of filing enerally, Section 3303(a) of Title 12 of the Delaware consented trust petitions. GCode enforces any express provision in a governing in- strument, other than the exculpation of a fiduciary for willful Saving the Marital Deduction Gift in misconduct and the preclusion of a court ordered removal of a Improperly Drafted Instruments fiduciary for willful misconduct. As a response to case law in other jurisdictions, Trust Act 2007 amended Section 3303(a) he new Section 3549 of Title 12, added by Trust Act 2007, to specifically provide that the language in a governing instru- Tis intended to fix improperly drafted instruments that are ment may provide that a trustee does not have to diversify the intended to qualify for the marital deduction. Section 3549(a), assets of a trust. provides a rule of construction in favor of compliance with

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Trusts, Estates & Tax Law NEWSLETTER NOVEMBER 2008 PAGE 4 OF 4 the marital deduction provisions of the IRC, if the governing with any claim that has been or might be asserted against instrument contains a marital deduction gift. Subsection (b) the fiduciary, and the payment of counsel fees and related of Section 3549 further provides that any fiduciary operating expenses from the fund with respect to which the fiduciary under a governing instrument that contains a marital deduc- acts shall not cause the fiduciary to waive or be deemed to tion gift has all the powers, duties, and discretionary authority have waived any right or privilege including the attorney- necessary to comply with the marital deduction provisions of client privilege. However, if the fiduciary has found to have the IRC. A federal district court located within the State of breached some fiduciary duty, Section 3333 provides that the Washington relied on a similar state statute there to save the Court may, in its discretion, deny the fiduciary the right to marital deduction for an improperly drafted trust. have some part or all of such fees and expenses paid from the fund and may require the fiduciary to reimburse any such Decanting Trusts fees and expenses that have already been paid from the fund.

ection 3528 of Title 12, Delaware’s so-called “decanting Conclusion Sstatute,” was updated in 2007 to clarify existing law that a trustee, who has authority under the decanting statute to make overnor Ruth Ann Minner signed into law Trust Act 2007 distributions in further trust, may exercise such authority to Gon July 5, 2007 and Trust Act 2008 on June 26, 2008. grant a general or limited to a trust These pieces of legislation were drafted by committees of the beneficiary to whom the trustee could have made an outright Estates and Trusts Section of the Delaware State Bar Associa- distribution. tion (“DSBA”) and were sponsored by the DSBA. Trust Acts 2007 and 2008 provide advancements in Delaware Trust Law Income Interests of Trust Beneficiaries that will give settlors, beneficiaries and fiduciaries of trusts ection 6104 of Title 12 sets forth rules concerning when more tools and greater flexibility to accomplish their objec- San income interest of a trust beneficiary arises. Trust Act tives. 2007 amended that Section to provide a clear rule concerning when an income beneficiary first becomes entitled to trust -in come from a trust created upon the distribution or division of This newsletter addresses only some of the more material pro- another trust. The new rule provides that if an asset becomes visions of Trust Acts 2007 and 2008. For a more complete or subject to a new trust by reason of a distribution from or divi- detailed discussion, please contact any member of our Trusts, sion of another trust, it becomes subject to the new trust as of Estates and Tax Group. the date of the event requiring the distribution or division. Thomas R. Pulsifer Failure of an Inter Vivos Trust to Dispose of Assets (302) 351-9226 [email protected] ection 3592 of Title 12 is intended to address circumstances Sin which the terms of an inter vivos trust do not effectively Todd A. Flubacher dispose of a portion or all of the trust property. Section 3592 (302) 351-9374 was amended in 2007 to clarify the application of that Sec- [email protected] tion when a trustor has died leaving a will and a disposition fails immediately upon the death of the trustor. The new rule Kimberly M. Gill generally provides that if the failure of an inter vivos trust to (302) 351-9102 effectively dispose of property occurs simultaneously with the [email protected] death of the trustor, the trust principal not effectively disposed of shall be treated as though it were an additional part of the Scott D. Goodwin trustor’s estate, and shall be disposed of in accordance with (302) 351-9462 the trustor’s will, or if he or she leaves none, then in accor- [email protected] dance with the laws of the State of Delaware.

Fiduciary’s Right to Retain Counsel Morris, Nichols, Arsht & Tunnell LLP combines a broad national practice of corporate, intellectual property, business reorganization rust Act 2007 added new Section 3333 to Title 12, which and restructuring and commercial law and litigation with a general codifies a fiduciary’s right to retain counsel. Thenew business, tax, and real estate practice within the State of T Delaware. The firm’s clients include Fortune 500 companies, smaller Section 3333 provides that except as provided in the govern- firms and partnerships, financial institutions, government agencies, ing instrument, a fiduciary may retain counsel in connection commercial law and litigation firms and not-for-profit organizations.

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