A Letter to a Brother
On being a good trustee
Imagine this scenario: You are a successful business owner with two young children. Your business is increasingly profitable; the value is growing rapidly. You decide to set assets aside in trust both for estate planning purposes and to provide your children and future grandchildren with rainy-day funds. You plan to ask your brother to be the trustee of a trust for your family, but you wonder how his career in medieval French literature will be applicable to his role as trustee.
In some states, it is possible to be a trustee with limited responsibility. Your brother could select an “investment trustee” to help with investment-related decisions or a “management trustee” to help with decisions relating to the business interests, but let us assume you want your trusted sibling to take care of your family affairs.
We see this dilemma often. Many clients have asked whether an individual — even one with little or no specialized knowledge – can be a good trustee. Our answer is yes — if certain fundamentals are kept in mind. For purposes of illustration we’ve drafted a letter to the brother.
Dear Brother: Please read the trust instrument. The trust instrument is your instruction manual. It names you as trustee and explains your authority. My attorney, who drafted the trust instrument, will provide an outline of significant provisions. In addition, be aware that state law underlies the trust instrument. Where a trust instrument is silent – by failing to mention whether you can sell trust property, for example – state laws provide lists of trust powers to round out those granted under the instrument.
Dear Brother: Please understand who owns the trust property. I have placed shares of my family business in the trust. I want them to be managed wisely, but I no longer own those shares and therefore have no official say. My children are too young to know about the trust, but they will likely become interested when they are seeking distributions. My grandchildren don’t exist yet but are mentioned in the trust instrument as the recipients of any trust property remaining upon my children’s death.
None of these individuals actually owns the shares. You are the trust property’s legal owner. I, the owner-operator of this business, can no longer direct the management or distribution of the property. You need not worry about business decisions, but you still have important duties with respect to the trust property. I have done my best to advise you through a “side letter” and “precatory” language in the trust agreement, and my intent in creating the trust governs your decisions. My children, even when they are in their 40s and running their own family businesses, cannot direct the management or distribution of the trust property; you alone are responsible for these in accordance with the trust’s terms.
You may not be a despot, however. My children — and their future children — also have an ownership role: They are “beneficial owners,” which is a bit like being a company shareholder. Although someone else is in charge of running things for their benefit, they still have some rights. In the trust context, beneficiary rights are protected by state law and the courts. The greatest protection is the high standard to which a trustee is held in carrying out his duties, which reminds me …
Dear Brother: Please understand your duties. Under every state’s laws, trustees are expected to fulfill certain duties. Failing to do so is to be subject to lawsuit and personal liability. I have given you some guidance in the side letter and the trust as to the extent of your duties, but be wary of any general release from responsibility, as courts resist dilution of the trustee role. The following are considered a trustee’s fundamental duties, which should underlie your actions. This is a guide – not an exhaustive list.
- You have a duty to administer the trust by its terms. You must understand the trust instrument and avoid inadvertently deviating from its terms. There is a difference between “shall” and “may.” If the trust instrument says that “the trustee shall pay all the net income to my child annually,” you must establish regular remittances. You also must know what “net income” means. The trust instrument may use the terms “income” and “principal” without any definition. State law provides default allocation rules for trust earnings and expenses between income and principal, so you would be wise to turn to an attorney for guidance.
- You have a duty of loyalty to the beneficiaries. Your job as trustee is to act in the beneficiaries’ best interests. In relation to the trust, you must not put your own interests or those of anyone else first. Courts have interpreted this standard strictly.
- You have a duty of impartiality among the beneficiaries. Loyalty to beneficiaries raises a question: What if beneficiaries’ interests conflict? One of the trustee’s most difficult duties is the duty to be impartial to all beneficiaries. It underlies decisions as to both investment (growth vs. income) and distribution (equal or unequal, now or later). Here, courts tend to be a bit more understanding: If you act in good faith to balance all beneficiaries’ interests and have good reasons for your decisions, you will have fulfilled the duty of impartiality.
- You have the duties of skill, care and prudence. Ignorance is no defense, but prudence is. The trustee role requires a certain amount of knowledge and common sense. While you are not expected to be a combination of attorney, accountant, business mogul and investment professional, you are expected to know when to hire such professionals. A complicated trust agreement or an unexpected situation will require an attorney’s advice. This trust will, at least for a period, own interests in an operating business. You are brilliant but do not know much about owning a business, especially partial interests in one owned by a trust. You should therefore hire an accountant experienced with fiduciary income tax returns, at minimum in order to act in the beneficiaries’ best interests.
- You have a duty to give personal attention to the trust fund. You were named as trustee for a reason, and your role is not to hand over management to your attorney, accountant or investment adviser and get on with your life. A happy medium may be to delegate some decisions to a professional co-trustee. However, delegation does not mean abdication; you are expected to monitor the person or firm you engage.
- You have a duty to disclose the trust to beneficiaries. My children are babies now, but soon they will be old enough to be responsible for their own finances and care. I plan to explain this trust when they are older and if I cannot, you must. The extent of the disclosure can depend on the nature of a beneficiary’s interest. State laws vary, so you should consult with counsel to determine how much, what and when to tell my family about this trust.
- You have a duty to communicate with beneficiaries. Complementing your disclosure to the beneficiary is your willingness to communicate. I have directed you, through language in the trust instrument, to distribute trust property as needed to provide for my children’s health, education, maintenance and support. In the future, you will need to know what is going on in their lives. This is not an invitation to be nosy; it is a duty to actively “keep the lines of communication open” so that my children, and their children, provide enough information about themselves to guide you in investing and distributing the trust for their best interests.
- You have a duty of confidentiality. The converse of disclosure and communication with respect to beneficiaries is to maintain confidentiality, both as to information they have provided you about themselves and information about the trust.
- You have a duty to consider the specialized assets. There are some things unique to a trust with business interests to keep in mind. Part of a trustee’s duty is to value trust assets at a regular interval. For marketable securities, this job is easy, but for a private family business like mine, it is more difficult. You may be able to work with my office, but you may need more detailed information than our books hold. You may hire an appraiser specializing in valuing closely held businesses. Another administrative factor to consider is the distribution process. If, after careful deliberation, you’ve determined it is in my children’s best interests to make a distribution, what do you give them? Hopefully I’ve funded the trust with cash in addition to company shares, but if I haven’t, what do you do? Transferring shares may not be practical, especially without a market for my kids to turn their shares into cash. You may sell some shares back to the company, but in some cases, that could lead to unintended tax results. My side letter and the professionals you’ve hired will be your guides through these nuanced issues.
Dear Brother: Please work with your co-trustee. I have considered naming a co-trustee to act with you, possibly a corporate trustee or my attorney, as professional knowledge could be an added benefit. If I do, does this mean you can relax and let your co-trustee do all the work? Yes and no. You can certainly expect your corporate co-trustee to perform administrative duties, hold and protect assets, manage investments and bring any legal or other technical issues to your attention. However, the fundamentals discussed still apply to you; you must understand the trust terms and purposes, participate in decision making and oversee your co-trustee’s actions.
Co-trusteeship is a team effort and requires communication. Suppose my daughter informs you that she has the opportunity to take a semester abroad. Let your co-trustee know, as this may justify a distribution of accumulated income. Likewise, if your co-trustee needs your approval on something, consider it carefully and respond promptly.
Finally, expect your co-trustee, whether professional or not, to do a good job. If you are unfortunate enough to have a co-trustee who behaves badly, it is your duty to do something about it. You may need only to point out an error for it to be corrected, or you may need to fire and replace your co-trustee.
Dear Brother: Thank you for accepting this important role. Serving as trustee for family members can be both valuable to them and rewarding to you. But understanding the full scope and legal responsibilities (and liabilities) of your role and all that it entails is important in avoiding unnecessary difficulties.
Alison Hutchinson is managing director and senior wealth planner and Melineh Ounanian is senior vice president and chief fiduciary officer at Brown Brothers Harriman (www.bbh.com).
Someone with little or no specialized knowledge can be a good trustee — if certain fundamentals are kept in mind.