Practical Considerations in Drafting Silent Trusts
When a client asks her attorney to draft a trust, they likely will spend most of their time talking about who the client wants to benefit and who the client wants to serve as trustee. The attorney also should confer with the client about whether the client wants various administrative provisions to be included in the trust. One question the attorney should ask is “Do you want the beneficiaries to know about the trust right away?” If the answer is “no,” then the client wants what I will refer to in this article as a “silent trust.”
This article will not discuss the merits of silent trusts. I will assume that the client, after consulting with her attorney about the pros and cons of silent trusts, has requested her attorney to draft the trust as a silent trust. However, some states do not permit silent trusts or permit them only with strict limitations. Therefore, state law must be reviewed to determine whether and to what extent it permits silent trusts. If the law where the client resides does not allow silent trusts at all or not to the extent desired by the client, and the issue is important to the client, then the attorney should counsel the client about having another state’s law apply to the administration of the trust. Delaware, which allows silent trusts without strict limitations, may be an appropriate option for such a client.
SILENT TRUST VARIATIONS
There are two main variations of silent trusts: (1) those that prohibit the trustee from informing the beneficiaries about the trust and (2) those that negate the trustee’s duty
to inform the beneficiaries of the trust’s existence without prohibiting such disclosure. Accordingly, a threshold issue to be considered when drafting a silent trust is whether
silence is to be mandated or at the discretion of the trustee. Consider the following provision: “Until the Settlor’s death, the Trustee shall be under no duty to inform any person having a beneficial interest in any trust created hereunder of the existence of any such trust or the nature and extent of that person’s beneficial interest in, or rights with respect to, any such trust.” The foregoing provision does not mandate the trustee’s silence; rather, the trustee, though not required to notify beneficiaries prior to the Settlor’s death, may choose to do so. Perhaps the client prefers to give the trustee discretion in that regard, but perhaps not. This is an important decision for the client to make.
BENEFICIARIES
Another important decision for the client to make is whether just one beneficiary or only certain beneficiaries – as opposed to all of the beneficiaries – are to receive the silent treatment. The client may want her children to know about the trust, but may desire that her grandchildren and more remote descendants not know about the trust, at least not initially. Once the client has decided which beneficiaries should not be informed about the trust, the next question is: For how long does the client want the trust to be silent as to those beneficiaries? There are many possible options to consider.
For example, the client may want the silent treatment to continue until the death of the survivor of the client and her spouse. Alternatively, the client may want the trustee to delay notifying a beneficiary about the trust until that beneficiary reaches age 25 or some other age past the age of majority. A combination of the foregoing is possible, as are other possibilities, depending on applicable state law. For example, under Delaware law, a trust may restrict, eliminate, or otherwise vary the right of a beneficiary to be informed of the beneficiary’s interest in the trust for a period of time, including but not limited to a period of time related to (1) the age of the beneficiary; (2) the lifetime of the Settlor and/ or spouse of the Settlor; (3) a term of years or specific date; and/or (4) a specific event that is certain to occur. 12 Del. C. §3303(c). The client should consider granting a third party, such as the Protector, the authority to allow or require disclosure to beneficiaries earlier than otherwise permitted or required.
OTHER PARTIES TO THE TRUST
Thus far, we have considered how a trust may be drafted to eliminate or modify the trustee’s duty to notify beneficiaries of the trust’s existence. What about other parties to the trust, such as a Protector? Is the applicable state law clear regarding whether the Protector has an obligation under certain circumstances to notify beneficiaries, such as when the Protector knows or believes that the trustee has used trust funds for the trustee’s own benefit?
The client and her drafting attorney should consider specifying in the trust the obligations – or lack thereof – of all parties to the trust, not just the trustee, with respect to the silent nature of the trust. This drafting consideration extends to the beneficiaries themselves. In order to discourage disclosure by a beneficiary to another beneficiary, the client and her drafting attorney may want to include a provision in the trust that reduces or even eliminates the interest of any beneficiary who makes such a disclosure.
OTHER PROVISIONS
No matter how tightly drafted the provisions of the trust are regarding the silent nature of the trust, there is always the possibility that a beneficiary finds out about the trust before the intended time for disclosure.
This may happen due to an inadvertent disclosure by a careless trustee or when a beneficiary happens to notice a copy of the trust on his father’s desk. While it is not
possible to put the genie back in the bottle, what rights does that beneficiary now have to information about the trust? It would be helpful for there to be provisions in the trust that specify how the trustee is to handle that type of situation.
Without a doubt, it is crucial that the drafting attorney ensure that all other provisions in the trust are neither in conflict with nor inconsistent with the trust’s provisions that vary or eliminate a beneficiary’s right to be informed about the trust. What happens if the trust requires the trustee to notify a beneficiary of his or her Crummey power over the trust, but prohibits the trustee from notifying the beneficiary of the existence of the trust? That would put the trustee in the predicament of trying to determine which provision takes
precedence.
Not only Crummey powers, but all provisions that grant a beneficiary a withdrawal right (such as a right to withdraw property from the trust upon reaching a certain age) should be scrutinized to ensure that none of them conflicts with or is inconsistent with the silent provisions in the trust. In fact, all of the dispositive provisions of the trust should be reviewed for that purpose. If a trust requires or permits the trustee to make a discretionary distribution to a beneficiary, how does that mesh with a trust provision prohibiting the trustee from notifying that beneficiary of the existence of the trust?
Even a trust that permits the trustee to make distributions for the benefit of a beneficiary (rather than directly to the beneficiary) may be problematic with respect to silent provisions in the trust. Consider a distribution for the benefit of a beneficiary, such as the trust’s payment of that beneficiary’s college tuition. It may be possible, if the trust is a grantor trust for income tax purposes, for the trustee to make that payment from the trust in a confidential manner. However, if the trust is not a grantor trust for income tax purposes, the trustee will be required by federal tax law to send the beneficiary a Schedule K-1, which will alert that beneficiary to the existence of the trust.
Certain administrative provisions of the trust are potential landmines vis-a-vis silent trust provisions. Provisions requiring or permitting accountings or statements to be sent to beneficiaries present the potential for a conflict or inconsistency with silent trust provisions. Similarly, provisions that give a beneficiary a power to appoint or remove a trustee or other fiduciary of the trust create the potential for conflict or inconsistency with silent trust provisions. One common trust structure is to have co-trustees, one of which is the “Administrative Trustee” who has responsibility to communicate with the beneficiaries. If the trust is drafted such that the “Trustee” is prohibited from notifying beneficiaries of the trust’s existence, but the “Administrative Trustee” is specifically carved out of the definition of “Trustee” in the trust instrument, then the Administrative Trustee is put in a thorny position.
The drafting attorney also should be aware of and take into account the client’s other estate planning documents. For example, if the beneficiary of the trust is appointed as the executor of the client’s estate, will that beneficiary need to know about the trust in order to perform his or her functions as executor? Given that the executor will have the authority to review the gift tax returns filed by the client, will the executor discover the existence of the trust in that way?
POTENTIAL PROBLEMS WITH TRUSTS
Silent trusts, by their very nature, give rise to two potential problems. The first problem is the potential lack of oversight and accountability. If beneficiaries are unaware of the trust, how will appropriate oversight of the trustee be achieved and how will the trustee be held accountable for the trustee’s mistakes or misconduct? Second, from the trustee’s viewpoint, certain risk management options may not be available if the beneficiaries are unaware of the trust. How will the trustee be able to benefit from those risk management options that require beneficiary participation or notice? For example, when a trustee is uncertain about taking a particular action, the trustee may desire to secure the consent of the beneficiaries before taking that action. With a silent trust, that is not possible. Or is it?
A solution to both of the potential problems identified in the preceding paragraph is a “designated representative” for those beneficiaries who are unaware of the trust. In certain states, such as Delaware, such a position may be created in the trust. For example, under Delaware law, during any period of time that a governing instrument restricts or eliminates the right of a beneficiary to be informed of the beneficiary’s interest in a trust, unless otherwise provided in the trust instrument, any designated representative then serving shall represent and bind such beneficiary for purposes of any judicial proceeding and for purposes of any nonjudicial matter, and shall have the authority to, and is a proper party to, initiate a proceeding relating to the trust before a court or administrative tribunal on behalf of any such beneficiary. 12 Del. C. §3303(d).
The designated representative’s role can encompass being a “watchdog” for the designated beneficiaries and making claims against the trustee and/or other fiduciaries of the trust on behalf of those beneficiaries, even to the point of bringing a lawsuit to pursue such a claim. Having a designated representative also opens up the possibility of having a valid, binding nonjudicial settlement agreement concerning the trust, as well as the trustee being able to obtain a consent or release that binds all of the beneficiaries. If the designated representative role is created in the trust, then there are numerous drafting considerations. The drafting issues to consider include the following:
• Is the representative to be considered a fiduciary or non-fiduciary?
• What is the representative’s standard of care? For example, should the representative be liable only for his or her gross negligence?
• Is the representative entitled to compensation, and if so, how is the amount of compensation determined?
• Financially, how will the representative be able to bring a claim against the trustee? For example, will the attorney’s fees of the representative be an expense that is
payable directly from the trust?
TRUSTEE SELECTION
One last drafting consideration concerns the selection of the trustee. Will the client’s preferred choice for trustee agree to serve as trustee of a silent trust? Before starting to draft the trust, the attorney may want to ask the preferred trustee about his, her or its willingness to serve as trustee of a silent trust. Some corporate trustees may not be willing to accept trusteeship of silent trusts.
Drafting a silent trust requires careful consideration of many issues. Before starting to draft a silent trust, one must understand the limits, if any, imposed on such trusts by applicable state law. It also is a good idea to ascertain the willingness of the client’s preferred choice for trustee to serve as trustee of a silent trust, particularly if the client’s preferred choice is a bank or trust company. Next, one must choose between the two main variations of silent trusts described in the third paragraph of this article; however, it is possible to have one variation apply to certain beneficiaries and the other variation to apply to other beneficiaries. There are many obvious matters to consider, such as for how long the silence should last. Other, less obvious considerations, such not be ignored. For example, one should consider whether to include provisions in the trust to address the possibility that a beneficiary finds out about the trust before the intended time for disclosure. Certainly, one should consider including a provision appointing a designated representative for the beneficiaries who are unaware of the trust. Finally, before sending the draft trust for the client’s review, the drafting attorney should take one last look to make sure that there are no other provisions in the trust that are incompatible with silent trust provisions.
Commonwealth Trust Company is pleased to provide this article as a guide. Commonwealth Trust Company is not engaged in the practice of law and is not providing legal advice by the provision of these materials. Commonwealth Trust Company recommends that clients seek the opinion of their attorney regarding the specific legal and tax issues addressed in this article.