Trust Modification and Termination
A trust usually lasts a long time, and during that time, things change: the needs of beneficiaries may change, the law may change, particularly tax laws, investment opportunities may change, or there may have been a mistake in the construction of the trust or in its administration. Hence, the law has evolved various methods to modify or terminate a trust. In most cases, it is the beneficiaries who seek to change the trust, but the law cannot allow the beneficiaries to change the trust on their caprice—otherwise, there would be no incentive for a settlor to create the trust in the first place. Hence, the law generally considers the changes only in the light of the settlor's intent.
Another reason to allow the modification or termination of trusts is to improve the allocation of economic resources. Trusts own vast amounts of assets. After the settlor dies, he can no longer respond to changing events, and, thus, the economic resources of the trust could be wasted. It is equivalent to you starting a business that can only operate the way you said it should initially and that it cannot be changed. With certainty, the business will eventually become bankrupt, since no business can be operated profitably without being able either to respond to changes or to replace bad ideas with better ideas. While the trustee usually has some discretion to operate the trust, the discretion is usually limited because the settlor wants to maintain some control.
Because a trust must be funded, a trust naturally ends when all the trust property has been distributed or when the property has been withdrawn by the settlor. A trust may also terminate if it has achieved its purpose, or a court has determined that its purpose is unlawful, against public policy, or impossible to achieve.
A revocable trust is one where the settlor, as the creator of trust, can modify or terminate the trust either at will or by following the requirements to revoke the trust if they are set in the trust document. Neither the trustees nor the beneficiaries have standing to object.
Modifying or Terminating an Irrevocable Trust
An irrevocable trust cannot be modified or revoked without a court order, and usually requires the consent of the settlor, if still alive, and the beneficiaries. If the settlor and the beneficiaries agree to modify or terminate the trust, then the trustee has no standing to object.
A trust document governs both the administration of the trust and the distribution of the trust property. Courts are more apt to modify the trust's administration than its distribution scheme, since the trust is only administered to carry out the settlor's primary purpose: the distribution of its property to its beneficiaries.
In England, the beneficiaries can terminate the trust after the settlor has died if they all agree, because the trust property is considered the property of the beneficiaries. (What, then, is the point of creating a trust?)
In the United States, however, the law gives extensive consideration to the settlor's intent and so the beneficiaries cannot simply change it or terminate it by their agreement.
Consent of All Beneficiaries
Even when the court agrees to modify or terminate a trust, the consent of all beneficiaries may still be necessary—but some beneficiaries may not be born yet or may be too young to give consent. So where the consent of all beneficiaries is needed or desirable, the law has developed various methods to represent unborn and minor beneficiaries.
Traditionally, common law uses a guardian ad litem, who is someone appointed by the court, usually an attorney, to represent the unborn or minor child. However, there has been much criticism that guardians ad litem often consider only the economics of the trust when they should also consider the settlor's intent and the family. Another major drawback to the guardian ad litem is the cost of representation. Many jurisdictions are now allowing virtual representation by the adult beneficiaries, since their interests and the interests of the unborn and minor children are usually aligned.
To make it easier to modify trusts, many jurisdictions are now allowing the consent of most beneficiaries to suffice to change the trust, especially if the changes are not detrimental to the non-agreeing beneficiaries or if their benefits are protected. U.T.C. §411
Since the trust was created with certain objectives, there must be a reasonable basis for modifying the trust so that it can fulfill its objectives more efficiently. In modifying a trust, a court may modify either the terms of the trust or its administration. The administration of the trust may be modified if it has become impracticable or inefficient.
A trust may be modified if there is an unforeseen circumstance, such as changes in the law or a beneficiary develops serious health problems, that substantially impairs or defeats the settlor's intent, and all the beneficiaries agree to the modification. A court will more likely approve the modification if it improves compliance with the settlor's probable intent (aka equitable deviation), but will not necessarily approve of the change simply because it is better for the beneficiaries.
With clear and convincing evidence that a trust or its administration is inefficient in carrying out the intentions of the settlor because it was created based on a mistake in fact or in law, the court may correct the trust document to better reflect what the settlor intended at the time of the trust's execution (aka reformation). U.T.C. §415
The court may also modify a trust—and possibly make the modification retroactive—so that the settlor's tax objectives can be better achieved if the modification does not conflict with the settlor's probable intent. U.T.C. §416
Another means of modifying a trust is to terminate it and transfer the assets to another trust, possibly under another state's laws, with better terms or under a more permissive legal environment. Several states have enacted statutes that specifically allow decanting—pouring the assets of 1 trust into another—including Alaska, Delaware, Florida, New York, South Dakota, and Tennessee.
A settlor can agree with the beneficiaries to terminate an irrevocable trust, even if the trustee objects, but if the settlor is dead, then the court will try to determine if the trust has an unfulfilled material purpose [aka Claflin doctrine, after Claflin v. Claflin, 20 N.E. 454 (Mass. 1889)] or if the trustee is merely trying to extend the lifetime of the trust to earn more fees. In almost every case, however, the courts will not terminate the trust if it is a spendthrift or support trust or a discretionary trust, or if any beneficiaries are only to receive their benefit when they reach a certain age.
However, a court may still terminate a trust if it is in the best interest of the beneficiaries or if there was a probate settlement with the heirs of the settlor and the settlement included the termination of a testamentary trust.
A trust can also be revoked by the settlor's will. Under common law, the trust document must authorize it, but the modern trend is to allow revocation by will unless the trust document expresses otherwise.
A trust may also be terminated by the courts if it is uneconomical. Especially if the trust has less than $50,000 worth of property, its cost of administration may easily consume a large part of the trust. In these cases, the court will terminate the trust and distribute the property immediately to the beneficiaries. U.T.C. §414
Combination and division of Trusts
Sometimes, the settlor will create several trusts with different objectives and usually different beneficiaries. However, several trusts also incur more expenses, so if the trusts have basically the same objectives, they may be combined to achieve operating efficiency. Courts can, of course, combine several trusts or divide trust assets among several trusts if it is more expedient to carry out the settlor's intent or it is more beneficial to the beneficiaries. However, several states have passed statutes allowing division or combination of trusts without judicial intervention, and the trust document could also allow it.
Under common law, a trustee can only be removed for cause or because he committed a breach of trust. The Uniform Trust Code adds several other factors:
- lack of cooperation among co-trustees is undermining the performance of the trust;
- the best interests of the beneficiaries would be served because the trustee is unfit, unwilling, or persistently failing in the execution of his duties;
- or there has been a substantial change of circumstances and the trustee's removal is not inconsistent with a material purpose of the trust, and a suitable trustee is available to replace him.
If a trust is constructed to last a significant time, a trust protector (aka trust advisor) should be appointed who can modify the trust or appoint a new trustee. Sometimes the trust protector is given only has a veto power over a decision by the trustee. But a trust protector can modify the trust to respond to changing conditions and to oversee the trustee.
Trust protectors are often used in off-shore trusts that allow the settlor, as trust protector, to control the irrevocable discretionary trust indirectly without being the trustee. This may allow the settlor to protect assets from United States courts. If the settlor was the trustee, he could be ordered to turn over the assets even though they are located in a foreign jurisdiction since the settlor would be under the personal jurisdiction of the courts.