NORTHERN TRUST PROFESSIONAL ADVISOR FORUM

Transcription

1 NORTHERN TRUST PROFESSIONAL ADVISOR FORUM Delaware Trusts: Safeguarding Personal Wealth Laura G. Mandel President The Northern Trust Company of Delaware Joel Schoenmeyer Senior Legal Counsel The Northern Trust Company

2 I. Introduction: Key Milestones a. Delaware has long been the home for substantial personal wealth including long-term trusts funded by local residents with their assets tied to holdings in E.I. du Pont de Nemours & Co. and General Motors Corporation. i. Delaware began to attract wider attention as a trust jurisdiction in 1986 when its General Assembly completed a massive overhaul of its trust laws. 1. Although Delaware had earlier granted a deduction for trust income of trusts held for nonresident beneficiaries, the 1986 revision began the formal recognition of so-called administrative trusts or direction trusts. 2. Delaware has continued this tradition of revising its legislation every year to address trends in trust investment and administration. ii. The repeal of the Rule Against Perpetuities in 1995, the adoption of a selfsettled spendthrift trust statute, Qualified Dispositions in Trust Act, in 1997 and the enactment of the nation s first total return unitrust statute in 2000 firmly established Delaware s reputation as an innovative jurisdiction for safeguarding personal wealth. iii. In 2003 Delaware authorized trustees to decant assets from an existing trust into a new trust with modified dispositive or administrative terms. iv. In 2004 Delaware adopted legislation allowing non-charitable purpose trusts. v. In 2005, Delaware rejected the nearly universal common law rule that requires a trustee to notify discretionary beneficiaries of their interests in a trust. See III, Confidential Trusts. b. Delaware also allows for equitable adjustments to allow trustees to balance the needs of income beneficiaries and remaindermen. c. While the advances in trust law have been significant, an equally important factor is the exclusive jurisdiction of the Delaware Court of Chancery over matters of equity, which generally covers all fiduciary proceedings and disputes (and explicitly so in the case of actions under The Qualified Dispositions in Trust Act) other than the rare case involving a non-fiduciary claim for money damages against a trust or a trustee. i. With an established body of fiduciary law and a bench comprised of highly experienced jurists, the Court of Chancery offers lawyers and their clients the assurance that if a trust dispute should ever arise, Delaware has the judicial infrastructure to resolve it efficiently and fairly. ii. The recent Chancery Court decisions In Re The Ethel Peierls Charitable Lead Unitrust, In Re The Peierls Family Inter Vivos Trusts and In Re The Peierls Family Testamentary Trusts have raised some questions as to the migration of existing trusts into Delaware from other jurisdictions.

3 iii. These decisions do not impact new trusts established in Delaware. iv. These decisions are on appeal to the Delaware Supreme Court and oral arguments were heard on July 10, II. Delaware Directed Trusts a. Background on Delaware directed trusts i. With the adoption of the prudent investor rule in virtually every state, the more significant change in Delaware law in 1986 was the enactment of 12 Del. C. 3313(b) which, as codified, authorized trustees to take investment direction from authorized investment advisers named in a trust instrument, without liability for the advisers investment results (except in the event of the trustee s willful misconduct). 1. In the intervening years, 3313(b) has led to a substantial influx of administrative or direction trusts in which some party other than the trustee (and not necessarily a registered investment adviser under the Investment Advisers Act of 1940) has exclusive responsibility for the investment of the trust assets. 2. With the bifurcation of the trustee s traditional duties of administration and investment management, the designated investment adviser is treated as a fiduciary for the investment component (absent language in the trust agreement to the contrary). ii. A 2005 amendment to 3313 expanded its scope beyond investment actions so that it now applies to distribution decisions or other decisions of the fiduciary. 1. Section 3313(f) of the statute expressly provides that such other decisions of a fiduciary include the actions of a trust protector. 2. With the benefit of 3313(f), a directed trustee may follow a trust protector s directions without concern for vicarious liability stemming from the protector s actions. iii. The extent of an administrative trustee s protection from liability under 3313(b) was the subject of the dispute in Duemler v. Wilmington Trust Co., C.A. No NC (Del. Ch. 2004), in which the co-trustee and sole investment adviser brought an action against an administrative trustee for losses the trust incurred after the investment adviser elected not to tender a bond in an exchange offer and the bond issuer subsequently defaulted on its obligation. 1. The investment adviser claimed that the trustee wrongly failed to deliver to him a copy of the prospectus for the exchange offer. a. In concluding that 3313(b) insulated the administrative trustee from liability, the Vice Chancellor observed:

4 In connection with Plaintiff s decision not to tender the securities in the Exchange Offer, [the trustee] acted in accordance with Plaintiff s instructions, did not engage in willful misconduct by not forwarding the Exchange Offer materials to Plaintiff and had no duty to provide information or ascertain whether Plaintiff was fully informed of all relevant information concerning the Exchange Offer. (Id. at 2.) b. Given the plain language of the trust agreement defining the respective duties of the administrative trustee and the investment adviser, it is not surprising that the Vice Chancellor ruled against the plaintiff in open court immediately following the bench trial on the plaintiff s claim 2. The Duemler decision should give comfort to anyone who doubts whether a court would respect the bifurcation of a trustee s duties and exonerate a trustee for its co-fiduciary s conduct. See also, Rollins V. Branch Banking and Trust Company of Virginia 2001 W.L (Va. Cir. Ct.) (Court held in favor of corporate trustee noting that beneficiaries had sole authority to make investment decisions). iv. To bolster a directed trustee s protection from liability for the conduct of an adviser, 3313(e) explicitly absolves a directed trustee of a duty to monitor the conduct of the adviser, provide advice to the adviser or consult with the adviser, or communicate with or warn or apprise any beneficiary or third party concerning instances in which the trustee would have exercised its own discretion in a manner different from the manner directed by the adviser. b. Standards for advisers i. Advisers are fiduciaries by default under Delaware law, unless the governing instrument provides otherwise. ii. The instrument may exonerate and indemnify advisers, except for willful misconduct ( minimum standard required). iii. Each fiduciary (advisers, trustee, protectors) has a duty to keep each other reasonably informed regarding duty or function performed by that fiduciary but no fiduciary has a duty to monitor other fiduciaries adviser(12 Del. C. 3317). iv. Absent clear and convincing evidence to the contrary, the actions of the trustee that are taken within the scope of the adviser s authority (recording and reporting adviser s actions) shall be presumed to be administrative actions and shall not be deemed to constitute an undertaking by the fiduciary to monitor the adviser or otherwise participate in the scope of the adviser s authority. (12 Del. C (e))

5 c. Trustee liability for the adviser s actions i. Directed trustees are exonerated except for willful misconduct as long as they follow the direction of the adviser (12 Del. C. 3303(a), 3313(b)). ii. Trustees who act with the consent of an adviser are exonerated except for willful misconduct and gross negligence (12 Del. C (a), 3313 (c)). iii. Willful Misconduct is defined as intentional wrongdoing, not mere negligence, gross negligence, or recklessness (12 Del. C (a)). iv. Wrong doing is defined as intentionally malicious conduct or conduct intended to defraud or seek an unconscionable advantage. d. Settlors may act as investment or distribution advisers e. Examples: i. Settlors can act as investment or distribution advisers, but there are certain tax considerations, including: 1. Retention of voting authority for closely held stock 2. Distributions under HEMS standard 3. Discharge of legal obligation of support of settlor i. Clients who want to fund a trust with interests in closely-held entities and want to maintain control over the management of such entities. Be careful not to give settlor acting as adviser voting control over closely held business interests to avoid adverse tax consequences under IRC Section 2036 (b) ii. Trusts that contain a concentrated position that has historical value to the family ( legacy holdings ) iii. Clients who are interested in socially responsible investing iv. Allows for use of multiple managers including those not on trustee s approved investment platform v. Foreign Grantor Trusts established for US beneficiaries f. Definition of investment adviser s duties i. Investment Decision is defined as any investment, retention, purchase, sale, exchange, tender or other transaction affecting the ownership thereof or rights therein and with respect to non-publicly traded investments, the valuation thereof (12 Del. C (d)). ii. Northern Trust s preferred language clarifies and expands an investment adviser s duties (See Exhibit A).

6 iii. Examples of additional powers that investment advisers could hold: 1. Borrowing for investments including through entities held in trust including from trustee 2. Lending and guarantee of loans including to entities held in trust 3. Exercise of voting, conversion, subscription and similar rights 4. Creation of entities such as partnerships and limited liability companies 5. Duty to confirm value of nonmarketable assets at least annually 6. Direction on warranties and representations g. Common scenarios where distribution advisers are named in directed trusts i. A distribution adviser may be useful if settlor imposes productivity, lifestyle standards or other subjective criteria for a beneficiary s eligibility for distributions. ii. Distribution adviser can determine if beneficiary is substance free and thus eligible for distributions. iii. Distributions for supplemental special needs trusts iv. Distribution advisers can direct the trustee to decant the assets of the trust into a new trust. v. Distributions advisers can direct the trustee to distribute assets to a settlor of an overfunded asset protection trust. vi. See Northern s preferred language in Exhibit A which provides among other things: 1. Trustee has no obligation to review beneficiaries needs or requests 2. Trustee has no duty to make recommendations regarding distributions 3. Trustee has no duty to calculate impact of distributions on trust 4. Trustee has no duty to ensure impartiality or equality of distributions among beneficiaries h. Modification of trusts to name advisers to direct investments or distributions i. Depends upon the terms of the trust, the governing law of the trust and whether court approval is required. ii. Consider whether trustee or trust protector has authority to amend the trust. i. Role of Trust Protectors in directed trusts i. Delaware adviser statute expressly recognizes the role of Trust Protector (12 Del. C. 3313(f)) 1. A Trust Protector has all of the power and authority granted by the terms of the governing instrument which may include:

7 a. Power to amend the trust for tax reasons or to improve the trust s administration b. Power to modify a power of appointment or to grant a beneficiary a power of appointment c. Transfer situs and law governing administration d. Conversion of a trust from grantor trust to non-grantor trust e. To appoint and remove trustees and other advisers 2. Beneficiaries cannot be protectors. 3. A Trust Protector is presumed to be a fiduciary unless the governing instrument provides otherwise. j. Differences between delegating investment responsibility and accepting appointment as a directed trustee: i. When a trustee delegates its investment authority, the trustee must: 1. Exercise care, skill and caution in selecting the agent 2. Establish scope of agent s responsibility 3. Develop asset allocation guidelines for the agent 4. Periodically monitor the agent s performance 5. In some states notification to beneficiaries of a delegation is required ii. Even when a trustee delegates investment authority, it retains oversight responsibility for investments. iii. Ultimate liability for investments remains with the trustee. III. Confidential Trusts & Pre-Mortem Validation a. Confidential Trusts i. Delaware law recognizes that the intent of the settlor as expressed in the trust instrument is paramount. 1. Section 3303 (a) states: It is the policy of this section to give maximum effect to the principle of freedom of disposition and to the enforceability of governing instruments. In addition, Section 3303 (a) provides that the rule that statutes in derogation of the common law are to be strictly construed shall have no application to this section. 2. Delaware law permits a trust instrument to restrict the right of a beneficiary to be informed of an interest in a trust for a period of time if the instrument so directs. 12 Del. C (a) a. General statement in trust that no duty to inform exists is insufficient.

8 b. Set a trigger date for disclosure and do not define it as an event that may never occur (e.g. direction by trust protector, grantor or other third party). c. If a beneficiary is eligible for distributions do not preclude notification to the beneficiary. d. Create class of notice recipients during period of nondisclosure. 3. Northern has preferred language for confidential trusts (See Exhibit A, XVI). ii. Delaware trusts are not subject to any public registration or filing requirements unless specifically required by the trust or will or the trustee is compelled by court order to file an accounting. iii. In the event of litigation, the Court of Chancery may seal the record of trust proceedings upon request of a party and with a showing of good cause to preserve the confidentiality of the trust and the family s financial affairs. See Rule 5.1 of the Delaware Chancery Court. b. Delaware s pre-mortem validation statute i. In 2003, the General Assembly enacted a statute limiting a person s ability to contest the validity of a trust if certain requirements are met. 1. Under 12 Del. C. 3546(a), a trustee is permitted to give notice to a person of the existence of a trust. a. This notice starts a 120-day period for the person to contest the trust. b. The written notice must specify the trustee s name and address, whether the person is a beneficiary of the trust, and the time period the statute allows for bringing an action to contest the validity of the trust. 2. The effect of 3546 is to compel a dissenting person to mount a challenge to the validity of the trust while the settlor of the trust is still living and able to provide testimony negating lack of capacity or undue influence. 3. The statute also forces the dissenting person to make the claim with the realization that the settlor is well aware of the claim and may take action in response to the claim.

9 4. This statute may be very attractive to a client who wants to create a trust for the benefit of certain family members to the exclusion of other family members and also wants the comfort of knowing that the family members should be precluded from challenging the trust after the settlor passes away. c. Delaware s recognition of no-contest or in terrorem clauses i. For those settlors who may not feel comfortable taking the approach allowed by 3546, Delaware law also recognizes the validity of no-contest or in terrorem clauses in trusts and wills. See 12 Del. C ii. A no-contest provision will be enforceable, except in cases of an action in which: 1. the beneficiary substantially prevails in challenging the trust, 2. an action to determine whether the proceeding triggers the no-contest provision, 3. an action for construction or interpretation of the trust, or 4. an agreement in settlement of a dispute among the beneficiaries. IV. Income Tax Advantages a. Since 1971, Delaware has not imposed a fiduciary income tax on irrevocable trusts for non-resident beneficiaries. 30 Del. C. 1636(a). i. Absent a taxable connection to another state, capital gains and ordinary income can accumulate in irrevocable Delaware trusts for nonresidents, and the trust pays no Delaware State income tax. ii. Many non-resident trusts (including many from California, New York and New Jersey) have been moved to Delaware to avoid state income tax that would otherwise apply. iii. State income tax considerations 1. Residence of settlor at the time the trust was created 2. Residence of fiduciaries/advisers 3. Residence of trust beneficiaries 4. Source income of settlor s state of residence (e.g. operating business or real estate) 5. Trust Administration within the settlor s state of residence b. Delaware Incomplete (gift) Non-Grantor Trusts ( DING Trust ) i. Overview of a DING Trust 1. A grantor can contribute highly-appreciated assets to a DING Trust.

10 2. State income may be deferred or avoided as long as there is not a nexus with that other state such as residence of an adviser or noncontingent beneficiary in the state or administration within the state. In addition, source income of the state must be avoided. 3. Section 677(a)(1) of the Internal Revenue Code provides that a Grantor will be treated as the owner of a trust for income tax purposes if trust income, without the approval or consent of any adverse party, may be distributed to the grantor or the grantor s spouse. 4. Therefore, in order for the trust to be a non-grantor trust for income tax purposes, the consent of an adverse party must be obtained prior to distributing assets to the grantor or the grantor s spouse. ii. Structure of a DING Trust 1. The trust must be created in a jurisdiction which allows for self-settled asset protection trusts because if creditors of the grantor can reach the trust assets the trust will be a grantor trust for income tax purposes. Treas. Reg (a)-1(d). 2. The trust is structured as an incomplete gift for federal gift tax purposes through the grantor s retention of a testamentary limited power of appointment over the trust. Treas. Reg (b). 3. The trust must have a Distribution Committee composed of other beneficiaries -- with the authority to approve distributions to the grantor or the grantor s spouse ( adverse parties ). 4. Committee members should not be residents of grantor s home state. 5. Several Private Letter Rulings confirmed that under Delaware law a grantor can create a non-grantor trust, fund the trust with contributions that are not considered taxable gifts for federal gift tax purposes and still retain the right to receive discretionary distributions of trust income and principal from the trust. See PLR ; PLR ; PLR ; PLR ; and PLR iii. Potential adverse tax consequences of a DING Trust 1. In 2007, the IRS issued a notice calling into question the gift tax consequences to the members of the Distribution Committee. IR The Service opined in CCA that a testamentary power of appointment alone is insufficient to prevent a transfer to an irrevocable trust from being treated as a completed gift.

11 3. Some commentators argued that the CCA is distinguishable because its settlor retained no beneficial interest in the subject trust and had no veto power over distributions to other beneficiaries. 4. PLR was released by the Internal Revenue Service on March 8, 2013 a. Slightly different variation on the DING Trust structure and in fact a NING Trust i. Distribution Committee comprised of grantor and his four sons ii. Distributions could be made to grantor and his issue during grantor s lifetime: (1) pursuant to a direction by a majority of the Committee members with the consent of the grantor; (2) pursuant to a unanimous direction by all members of the Distribution Committee except the grantor; or (3) grantor could direct distributions to his issue under HEMS standard. iii. No automatic replacement of Distribution Committee members iv. Eligible committee members limited to adult issue of grantor, parent of minor issue of grantor or legal guardian of minor issue of the grantor v. If there were no eligible members, Committee ceased to exist vi. Distribution Committee ceased to exist at grantor s death vii. Neither grantor nor Committee members were treated as owners of trust for income tax purposes b. Combination of Grantor s consent power and limited testamentary power of appointment caused the transfer to be an incomplete gift for gift tax purposes. c. IRS held that members of Distribution Committee did not hold general powers of appointment as distributions required either consent of grantor or if they acted to distribute funds the decision was required to be unanimous among adverse parties. Finally, if a committee member ceased to serve there was no automatic replacement of the member. V. Asset Protection Trusts a. With its passage in 1997 of the Qualified Dispositions in Trust Act, 12 Del. C et seq. ( QDTA ), Delaware became the second state to enact legislation allowing domestic asset protection trusts.

12 i. Currently, at least 15 states permit asset protection trusts in some fashion: Delaware, Alaska, Rhode Island, Nevada, Utah, Missouri, Oklahoma, South Dakota, Tennessee, Wyoming, New Hampshire, Hawaii, Virginia and Ohio. ii. A Delaware asset protection trust begins with a transfer of assets to an irrevocable trust with a Delaware trustee. The settlor may make a direct transfer to the trustee or may exercise a lifetime power of appointment under an existing trust. The Qualified Dispositions in Trust Act also recognizes transfers to a Delaware trustee from a trustee of an existing trust in another jurisdiction, to the extent that the original instrument is consistent with the requirements of the Qualified Dispositions in Trust Act. iii. A Delaware asset protection trust must have a Delaware-resident trustee that is either a regulated financial institution or an individual resident. In either case the Delaware trustee must materially participate in the administration of the trust through various administrative activities. iv. A trust subject to the Qualified Dispositions in Trust Act must expressly incorporate Delaware law to govern its validity, construction and administration unless the Delaware trust results from a trustee-to-trustee transfer from a trust existing in another jurisdiction. v. A spendthrift clause that bars the attachment or assignment of a beneficiary s interest in a trust is essential to the enforceability of a Delaware asset protection trust. b. Delaware trustees have seen settlors establish asset protection trusts for a variety of reasons. i. The popularity of these trusts has been driven, in part, by the occasional crisis in the availability of medical malpractice insurance and, in some cases, by the perceived increase in larger jury verdicts. 1. Not surprisingly, a substantial number of settlors of asset protection trusts are physicians, who are using the trusts to protect a portion of their wealth against excessive, uninsured liabilities. 2. Asset protection clients also include corporate directors who have concerns about their personal liability for uninsured claims arising out of shareholder litigation. ii. Some clients who wish to protect the surviving spouse from pressure or undue influence by family or friends where substantial funds are earmarked for charity at the survivor s death use asset protection trusts. c. With a properly structured Delaware asset protection trust, the settlor may be a beneficiary of the trust and retain certain powers over the trust.

13 i. As noted above, key administrative functions must be performed in Delaware (e.g. custody of assets within state, maintenance of trust records, preparation of fiduciary income tax returns) ii. Ability of creditors to reach the assets of a Delaware asset protection trust 1. Despite the settlor s continuing interest in potential distributions of income and principal from the trust, the settlor s creditors should not be able to reach the assets of the trust to satisfy their claims unless they can timely establish by clear and convincing evidence that the funding of the trust amounted to a fraudulent transfer. 2. Creditors of the settlor will not be able to reach the trust assets unless its claim is filed within a specified look back period. 3. Existing creditors must assert claims against the trust within a tail period which is the later of one year from the time the creditor could reasonably have discovered the existence of the trust and four years from the funding of the trust. 4. Future creditors can prevail only by showing, with clear and convincing evidence that the grantor actually intended to defraud that particular creditor by making a transfer of assets to the trust and claims must be brought within the four year tail period. 5. Each transfer to the same trust will have its own tail period. iii. Exceptions to creditors reaching an asset protection trust 1. Two classes of claims are not subject to the tail period or the need to prove a fraudulent transfer: a. A spouse or child with claims for alimony, support or a share of marital property. (A spouse does not include one who marries the grantor after the transfer). b. Tort claimants whose claims for death, personal injury or property damage precede the funding of the trust. iv. Powers a Settlor may retain 1. Veto power over distributions from the trust 2. Limited power of appointment effective on settlor s death 3. Potential or actual receipt of income 4. Potential or actual receipt of principal if distribution is result of trustee or distribution adviser acting in trustee s or distribution adviser s sole discretion, and 5. Pursuant to a standard that does not confer on the grantor a substantially unfettered right to principal 6. Potential or actual receipt of income from a charitable remainder annuity trust or unitrust

14 7. Potential or actual receipt of income from a grantor retained annuity trust or grantor retained unitrust 8. The right to remove a trustee or adviser and appoint a new trustee or adviser 9. The right to serve as the investment adviser for the trust 10. The ability to receive distributions to pay income tax liability associated with taxes generated by trust 11. The use of real property held under a qualified personal residence trust v. Powers a Settlor may not retain 1. Power to serve as trustee of the trust 2. Power to serve as a distribution adviser for the trust 3. Power to serve as the trust protector for the trust 4. Power to direct distributions from the trust 5. Power to demand a return of assets transferred to the trust 6. Evaluation of potential Delaware asset protection trusts vi. Client should have no known or anticipated creditor claims. 1. An asset protection trust should not be funded with a significant portion of a client s overall wealth. a. Many trustees recommend that a client fund an asset protection trust with no more than 40% of his or her financial assets. b. Clients should not expect to make requests for distributions from an asset protection trust. c. Accordingly, clients should retain sufficient liquidity to fund their lifestyle and family needs. d. It is inadvisable to fund an asset protection trust with a client s primary residence. 2. The Northern Trust Company of Delaware requires that every grantor of an asset protection trust execute: (1) Affidavit of Solvency; and (2) Grantor s Acknowledgement and Indemnity Agreement 3. See Northern s preferred language in Exhibit A, XIV for asset protection trusts a. Delaware law allows co-settlors to transfer tenancy by the entirety property into an asset protection trust and the property retains its character until the death of the first settlor. See 12 Del. C (f). b. Key Differences Between Delaware and Nevada Asset Protection Trusts

15 i. Nevada Statute of Limitations 1. If the person is a creditor when the transfer is made, action must commence within 2. Two years after the transfer is made; or 3. Six months after the person discovers or reasonably should have discovered the transfer, whichever is later. 4. If the person becomes a creditor after the transfer is made, action must commence within 2 years after the transfer is made. ii. Nevada has no creditor exceptions VI. Decanting a. 12 Del. C authorizes Delaware trustees with the power to discrete principal to establish a resulting trust for the benefit of one or more proper objects of the first trust and fund the new trust with the assets of the first trust. i. Decanting does not require notice to, or consent of, the beneficiaries of the first trust or court approval. ii. Most trustees as a matter of policy do, however, require notice to beneficiaries as well as consents, releases and indemnifications. b. Purposes for which decanting may be used: i. Conversion from non-grantor to grantor status or the reverse ii. Obtaining a tax-favored situs iii. Completing an incomplete gift in trust iv. Preserving net operating losses of a trust asset c. Modifying beneficial interests i. Granting or enlarging a beneficiary s power of appointment ii. Eliminating mandatory principal distributions iii. Excluding certain beneficiaries of first trust d. Changing administrative provisions i. Providing for removal and replacement of successor trustees/advisers ii. Addition of advisers for investments or distributions

16 iii. Changing situs for administration VII. Analysis of Trusts with a Foreign Grantor a. Why is this important? i. We need to be able to discuss how these trusts will work for the sake and benefit of our clients. ii. We also need to understand what the ramifications are for us as trustee, especially because we live in a new era of reporting requirements (discussed below). b. First question: Is the trust foreign or domestic? i. Note that a foreign grantor (by which I mean a non-u.s. citizen who is also not a resident of the U.S.) may create either a Foreign Trust or a Domestic Trust. 1. A non-u.s. citizen who is also a non-resident is sometimes known as a non-resident alien, or NRA. However, to avoid confusion, I ll use the terms foreign grantor or foreign person, so it doesn t sound like the National Rifle Association is setting up a trust. ii. A Domestic Trust for U.S. income tax purposes is a trust that meets both of two tests: the Court Test and the Control Test. These tests are addressed in Treas. Reg iii. Test #1: The Court Test. A trust satisfies the Court Test if it is subject to supervision by a U.S. court the safe harbors for the Court Test are as follows: 1. The trust instrument cannot direct that it be administered outside the U.S. 2. The trust must in fact be administered exclusively in the U.S. (administration here meaning the carrying out of duties under the trust instrument and applicable law). 3. The trust can t be subject to an automatic migration provision (that is, a provision requiring migration from the U.S. if a U.S. court attempts to assert jurisdiction). iv. Test #2: The Control Test. A trust satisfies the Control Test if only U.S. persons can control the substantial (non-ministerial) decisions regarding the trust. 1. Substantial non-ministerial decisions would include things like: whether or not to distribute income or corpus, whether or not to terminate the trust, and the selection of a beneficiary.

17 2. We have to look out for advisors if even one of them controls these types of decisions, then the trust fails the Control Test and is a Foreign Trust. 3. There is a 12-month grace period if an inadvertent change occurs that would cause a Domestic Trust to become a Foreign Trust or vice versa. (For example, if the U.S. trustee of a Domestic Trust dies and a non-u.s. trustee is named as successor, the trust would have 12 months to find another U.S. trustee to take over.) v. A Foreign Trust is any trust that is not a Domestic Trust (that is, any trust that does not satisfy both the Court Test and the Control Test). c. Second question: Is the trust a grantor or a non-grantor trust? i. A quick recap -- for income tax purposes, a trust is either a grantor trust or a non-grantor trust: 1. Under the grantor trust rules, the grantor is subject to U.S. income tax on the income of the trust. In other words, the grantor (or in some cases, another person) is treated as the owner of the trust, and the trust as an entity is basically ignored for U.S. income tax purposes. 2. In the case of a non-grantor trust, the trust itself and/or the trust beneficiaries will be subject to U.S. income tax on the income of the trust. 3. For our analysis, we begin by applying the grantor trust rules, per IRC , to determine if the grantor (or a non-adverse party) had one of the following powers: a. A reversionary interest greater than 5% (IRC 673) b. Power to dispose of the beneficial interest (IRC 674) c. Certain administrative powers, including the power to borrow without adequate interest or security or the power to reacquire trust property by substituting other property of equivalent value (IRC 675) d. Power to revoke (IRC 676) e. Situation where income can be used for the benefit of the grantor or his or her spouse (IRC 677) ii. But in a case where a foreign person is the grantor, we have to apply the grantor trust rules, and then turn to IRC 672(f). (See Treas. Reg (f)- 1.) This Section of the IRC treats a foreign grantor as a trust s owner for U.S. income tax purposes only if (a) the foreign grantor can revoke the trust without the approval or consent of any other person or (b) while the foreign grantor is living, distributions from the trust can only be made to the foreign grantor or

18 his or her spouse. iii. In the above case, the trust is deemed not to exist for income tax purposes instead, the grantor is taxed on it. iv. Two related notes: 1. A foreign person s interest in a grantor trust may be subject to U.S. transfer taxation. 2. A trust s status can change (for instance, upon the foreign grantor s death, or if the foreign grantor renounces his or her power to revoke). v. If the trust is a non-grantor trust, the first question we asked (Foreign Trust or Domestic Trust?) is important for determining upon what income the trust is taxed. A Domestic Non-Grantor Trust generally pays tax on all of its U.S. income. A Foreign Non-Grantor Trust generally pays tax only on its U.S. source income, since it is treated as a foreign person (see IRC 641(b)). VIII. Beneficiary Issues and the Foreign Non-Grantor Trust a. In many cases, a trust created by a foreign grantor will be considered a Foreign Non- Grantor Trust. b. This means that the trust s income has to be allocated between the trust and its beneficiaries, using the same concepts we employ for any other non-grantor trust (DNI, simple vs. complex trusts, etc.). c. Foreign beneficiaries are subject to U.S. income taxes, but only on the trust s U.S. source income. A foreign beneficiary is not normally subject to U.S. income taxes on a trust s foreign source income because there is no U.S. nexus for U.S. income taxation. d. U.S. beneficiaries typically are subject to U.S. income taxes on their share of the trust s DNI, regardless of whether the source of the income was the U.S. or not. U.S. beneficiaries are also subject to the throwback rules regarding accumulation distributions, and these rules can create major problems (see below): i. These rules begin by distinguishing whether the distribution is characterized as a distribution of DNI, a distribution of an accumulation, or a distribution of principal. ii. Distributions are first treated as DNI. If a Foreign Non-Grantor Trust does not distribute all of its DNI to a beneficiary in a given year, the excess is deemed an accumulation and called UNI ( Undistributed Net Income ). See IRC 665(a). UNI carries over, so if distributions in a future year exceed DNI, the excess is treated as an accumulation distribution to the extent of the UNI of prior years.

19 iii. There are two unfavorable aspects of receiving an accumulation distribution: such distributions are taxed as ordinary income (they lose their character), and the U.S. beneficiary must pay an interest charge as per IRC 668. e. Potential reporting requirements for Foreign Non-Grantor Trusts and their beneficiaries: i. Form 1040, Schedule B, part III ( Foreign Accounts and Trusts ); ii. Form 1040R (as opposed to Form 1041), to be filed for the trust; iii. Form 3520 see Part III ( Distributions to a U.S. Person From a Foreign Trust During the Current Tax Year ). In addition, a U.S. beneficiary receiving an accumulation distribution see above would attach Form 4970 (Tax on Accumulation Distribution of Trusts) to Form 3520; iv. Foreign Non-Grantor Trust Beneficiary Statement (found on page 4 of Form 3520-A); v. In some cases, trust beneficiaries must file an FBAR (Form TD F ); and vi. Form 8938, relating to The Foreign Account Tax Compliance Act (aka FATCA ), under IRC 6038D. IX. Bringing a Foreign Trust to Delaware a. This typically involves converting a foreign trust to a domestic trust. b. We will work with the client and his or her advisors regarding the best way to do this. However, we will not opine on the tax ramifications of such a move. c. Common methods: i. Changing situs and governing law of the trust as allowed under its provisions. ii. If a change of situs and governing law is not allowed, then the question is whether the trust can be amended (with or without court involvement) or decanted to allow such a change.

20 Exhibit A Suggested Language for Delaware Trusts I. APPOINTMENT OF INVESTMENT ADVISER; EXONERATION OF TRUSTEE AND INVESTMENT ADVISER. In reliance on the provisions of 12 Del. C. 3313(a), the Grantor appoints (the Investment Adviser ) as Investment Adviser, with full power to manage the investments of the trust, including the power to purchase, sell and retain all of the trust assets, and power to exercise voting, subscription, conversion, option and similar rights with respect to such property and to participate in or consent to any voting trust, reorganization, merger, dissolution or other action affecting any such property. The Investment Adviser shall serve in a fiduciary capacity and conform to the purposes of this Agreement. The Trustee shall follow the directions of the Investment Adviser with respect to all matters relating to the management and investment of trust assets. Without in any way limiting the broad powers conferred upon the Investment Adviser pursuant to this agreement, the Investment Adviser shall have the specific authority to direct the Trustee to borrow and lend money and to guarantee the repayment of any indebtedness, for such periods of time and upon such terms and conditions as to rates, maturities, renewals and securities as the Investment Adviser deems advisable, including the power to borrow from the Trustee itself or one of its affiliates and to mortgage, pledge or encumber such portion of the trust property as may be required to secure any loans or indebtedness and as makers, endorsers or guarantors to renew existing loans or guarantees. The power to direct the Trustee to guarantee loans shall include the power to direct the Trustee to guarantee the loans of any partnership, limited liability company, corporation, business trust or other business entity (owned in whole or in part by the Trust) in proportion to the trust s ownership interest in such business entity. The Investment Adviser shall also have the specific authority to direct the Trustee to create partnerships, limited liability companies, corporations, business trusts or other business entities, to direct the Trustee with respect to the Trust s responsibilities regarding its ownership of any such entity, and to direct the Trustee to transfer any portion of the Trust estate to any such entity. Further, the Investment Adviser shall have the authority to direct the Trustee to open accounts in the name of the Trust or any such entity for the purpose of fulfilling its ownership responsibilities and facilitating the transfer of the Trust estate to any such entity. As long as an Investment Adviser is acting, the Investment Adviser shall have sole responsibility (and the Trustee shall have no responsibility) for the investment, voting and management of the assets of the trust. The Trustee shall make only such sales and investments as the Investment Adviser directs. The Trustee shall be under no obligation to review the trust assets, make any investment recommendation with respect to them, solicit any direction from the Investment Adviser, value the assets if they are non-marketable, or insure the assets. The Trustee need not review whether the Investment Adviser is satisfying its responsibilities hereunder. As specified in 12 Del. C. 3313(b), the Trustee shall incur no liability for any act or failure to act by the Investment Adviser, or for acting on or implementing any direction of the Investment Adviser, and it shall not be liable for any loss resulting from any action taken by the Investment Adviser, or taken by it in accordance with a direction of the Investment Adviser. As provided in 12 Del. C. 3313(e), the Trustee shall have no duty to monitor the conduct of the Investment Adviser, provide advice to the Investment Adviser or consult with the Investment Adviser or communicate with or warn or apprise any beneficiary or third party concerning instances in which the Trustee would or might have

21 exercised the Trustee s own discretion in a manner different from the manner directed by the Investment Adviser. Furthermore, in accordance with 12 Del. C. 3302(e) and 3586, the Trustee shall have no liability under this trust to any trust beneficiary or any other person whose interest arises under this trust for the Trustee s good faith reliance on this provision or any other provision of this Agreement concerning investment decisions (unless the Trustee has acted with willful misconduct proven by clear and convincing evidence in the court then having primary jurisdiction over the Trust, which court shall be the Delaware Court of Chancery for so long as Delaware remains the situs of the Trust). With regard to trust assets over which the Investment Adviser has investment responsibility and in addition to the Investment Adviser's duties herein, the Investment Adviser shall have the duty (a) to confirm to the Trustee, in writing, the value of trust assets at least annually and upon the request by the Trustee, (b) to direct the Trustee with respect to making any representation, warranty or covenant required to be made in order to maintain any investment, (c) to direct and instruct the Trustee on future actions, if any, to be taken with respect to such representations, warrantees and covenants and (d) to direct the Trustee to sign agreements and any other documentation required in connection with the purchase of any investment and the maintenance of any such investment. Notwithstanding the foregoing, the Trustee has no duty to monitor whether the Investment Adviser is abiding by its duty to provide valuation of non-marketable assets and shall not be liable for failing to request a valuation or for the Investment Adviser's failure to give the Trustee a valuation. II. APPOINTMENT OF DISTRIBUTION ADVISER; EXONERATION OF TRUSTEE AND DISTRIBUTION ADVISER. In reliance on the provisions of 12 Del. C. 3313(a), the Grantor appoints (the Distribution Adviser ) as Distribution Adviser. The Distribution Adviser shall hold and exercise the full power to direct the Trustee to distribute income and principal of the trust pursuant to the standards established under this Agreement. The Trustee shall follow the direction of the Distribution Adviser with respect to all matters concerning the distribution of income or principal of the Trust. Notwithstanding the foregoing or any other provision of this Agreement, if at any time a beneficiary of a trust created by or pursuant to this Agreement is serving as Distribution Adviser, such beneficiary may only exercise the authority conferred pursuant to the terms of this Agreement to direct the Trustee to distribute income and/or principal of the Trust to such beneficiary and his or her descendants for his, her or their health, education, maintenance or support. In addition, such beneficiary may not direct the Trustee to distribute income or principal to his or her descendants if doing so would discharge a legal obligation of such beneficiary. The Distribution Adviser shall serve in a fiduciary capacity and conform to the purposes of this Agreement. As long as a Distribution Adviser is acting, the Distribution Adviser shall have sole responsibility (and the Trustee shall have no responsibility) for all discretionary actions involving any distribution of income or principal of the Trust. The Trustee shall make only such distributions of income or principal as the Distribution Adviser directs, or distributions that are non-discretionary and mandated by the terms of the Trust. The Trustee shall be under no obligation to review the beneficiaries needs or requests for income or principal distributions, make any recommendation with respect to such distributions, solicit any direction from the Distribution Adviser, calculate the impact of any distribution on the likely duration of the Trust, or ensure the equality of distributions among the beneficiaries. The Trustee need not review whether the Distribution Adviser is satisfying its responsibilities hereunder.

22 As specified in 12 Del. C. 3313(b), the Trustee shall incur no liability for any act or failure to act by the Distribution Adviser, or for acting on a direction of the Distribution Adviser and it shall not be liable for any loss to the Trust or any claim of inequality, partiality or unreasonableness resulting from any action taken at the direction of the Distribution Adviser, or taken by the Trustee in accordance with the direction of the Distribution Adviser. As provided in 12 Del. C. 3313(e), the Trustee shall have no duty to monitor the conduct of the Distribution Adviser, provide advice to the Distribution Adviser or consult with the Distribution Adviser or communicate with or warn or apprise any beneficiary or third party concerning instances in which the Trustee would or might have exercised the Trustee s own discretion in a manner different from the manner directed by the Distribution Adviser. Furthermore, in accordance with 12 Del. C. 3302(e) and 3586, the Trustee shall have no liability under this Trust to any Trust beneficiary or any other person whose interest arises under this Trust for the Trustee s good faith reliance on the provisions of this Article or any other provision of this Agreement concerning distribution decisions (unless the Trustee has acted with willful misconduct proven by clear and convincing evidence in the court then having primary jurisdiction over the Trust, which court shall be the Delaware Court of Chancery for so long as Delaware remains the situs of the Trust). The Distribution Adviser shall be protected to the fullest extent permitted by law, and specifically as permitted by 12 Del. C The Distribution Adviser shall not be held liable to any beneficiary for any distribution decision made hereunder, unless it results from actions taken in bad faith or through willful misconduct proven by clear and convincing evidence in the court then having primary jurisdiction over the Trust, which court shall be the Delaware Court of Chancery for so long as Delaware remains the situs of the Trust. III. THE TRUSTEE AND THE ADVISERS - GENERAL PROVISIONS The Trustee shall have no obligation to investigate or confirm the authenticity of any investment direction, distribution direction or other direction it receives from any Adviser, or the authority of the person or persons conveying such direction. The Trustee and each Adviser shall be deemed to have acted within the scope of its respective authority and not to have participated in actions outside the scope of such authority, to have exercised reasonable care, diligence and prudence, and to have acted impartially as to all interested persons, unless the contrary be proved by clear and convincing evidence in the court then having primary jurisdiction over the Trust, which court shall be the Delaware Court of Chancery for so long as Delaware remains the situs of the Trust. Neither the Trustee nor any Adviser shall be liable for the acts or defaults of each other. To the extent that more than two persons are serving concurrently as an Adviser in the same capacity, an affirmative vote of a majority of such Advisers must be reached with respect to any decision, action taken or direction given. Otherwise, such Advisers must act unanimously. Notwithstanding the foregoing, to the extent that more than one Adviser is serving in the same capacity, the Advisers may designate one such Adviser to communicate all their directions to the Trustee. No successor Trustee shall be required to examine the acts of any prior Trustee, and any successor Trustee shall be responsible only for those assets which are actually delivered to such Trustee. No successor Adviser shall be required to examine the acts of any prior Adviser, and any successor Adviser shall be responsible only for actions it takes and directions it gives subsequent to its appointment.

23 Unless the Trustee or an Adviser has written notice of an event affecting the beneficial interests in the trust, neither the Trustee nor the Adviser shall incur any liability for acting as though such event had not occurred. IV. RESIGNATION AND REMOVAL OF TRUSTEE AND APPOINTMENT OF SUCCESSOR The Trustee may resign by a separate acknowledged instrument delivered to the Grantor or, after the Grantor s death or incapacity, to each adult beneficiary to whom the Trustee is then authorized to distribute income, such resignation to be effective upon the appointment of a successor Trustee. If there are no adult beneficiaries, the instrument of resignation shall be delivered to the parent or legal guardian of each minor beneficiary to whom the Trustee is then authorized to distribute income. If, upon the resignation of the Trustee, no successor Trustee designated by this trust instrument qualifies to act, a majority in number of the adult beneficiaries to whom the Trustee is then authorized to distribute income or, if none, a majority in number of the minor beneficiaries (each such beneficiary acting through his parent or legal guardian) to whom the Trustee is then authorized to distribute income, may appoint a successor Trustee (other than the Grantor). Any Trustee may be removed, with or without cause, by the Grantor or, if the Grantor is incapable of acting, by a majority in number of the adult beneficiaries to whom the Trustee is then authorized to distribute income or, if none, by a majority in number of the minor beneficiaries (each such beneficiary acting through his parent or legal guardian) to whom the Trustee is then authorized to distribute income. If, upon the removal of the Trustee, no successor Trustee designated by this trust instrument qualifies to act, the individuals who remove such Trustee shall appoint a successor Trustee (other than the Grantor), provided, however, that such successor Trustee may not be related or subordinate to the person or persons making such appointment, within the meaning of 672(c) of the Internal Revenue Code. If no successor Trustee has qualified within 60 days after the resignation or removal of the Trustee, the resigned or removed Trustee may appoint such a successor, or may bring an appropriate action in court for the appointment of such a successor. The costs and expenses of any such action, including but not limited to the compensation and expenses of attorneys and guardians, shall be paid from principal or income, or both, of the trust, as the Trustee in its sole discretion shall determine. Notwithstanding the foregoing, a Trustee, for its administrative convenience, may appoint an affiliated corporation or successor of an affiliated corporation as successor Trustee. The Trustee shall effect any such appointment with a written instrument delivered to the party or parties who would receive notice of the Trustee s resignation. Any appointment of a successor Trustee pursuant to this trust instrument shall be made by a separate acknowledged instrument delivered to the Trustee so appointed, shall be effective at such time as may be specified in such instrument, and shall be revocable until such time. A successor Trustee shall qualify by filing its consent to act with the trust records. V. REMOVAL OF ADVISERS AND APPOINTMENT OF SUCCESSORS The Grantor or, if the Grantor is deceased or incapable of acting, a majority in number of the adult beneficiaries to whom the Trustee is then authorized to distribute income or, if none, a majority in number of the minor beneficiaries to whom the Trustee is then authorized to distribute income, may

24 remove an Adviser and appoint a successor Adviser to act upon such terms and conditions as the appointing individuals may determine. For purposes of the preceding sentence, action taken on behalf of a minor may be taken by the minor s legal guardian or a parent of the minor or, if none, by any individual whom the Trustee deems appropriate. VI. GOVERNING LAW AND SELECTION OF FORUM This trust instrument shall be construed under, and the trusts created shall be governed by, the laws of the State of Delaware. As long as the Trustee of this trust has its principal place of business in the State of Delaware, any action or proceeding relating to this trust shall be brought and enforced in the Court of Chancery of the State of Delaware. VII. FEES OF THE TRUST COMPANY AND THE ADVISERS The Trustee shall be entitled to receive compensation for its services under this trust instrument in accordance with an agreement between the Trustee and the [Trust Protector/Grantor/Primary Beneficiary]. In the absence of such an agreement, the Trustee shall be entitled to receive compensation for its services under this trust instrument in accordance with its schedule of rates published from time to time and in effect at the time the compensation is paid, including minimum fees and additional compensation as stated therein, and except as required by law, such compensation shall not be reduced by any compensation received by the Trustee or its affiliates for providing any of the additional services authorized herein. The Grantor recognizes that such compensation may exceed the compensation for such services in effect from time to time under the laws of the State of Delaware. The Trustee shall pay out of the income or principal or both, as it in its sole discretion determines, the charges and expenses of each of the Advisers and shall have no obligation to inquire into the reasonableness of any such charges or expenses. VIII. WAIVER OF ACCOUNTS; APPROVAL OF ACCOUNTS The Trustee shall not be required to render annual or other periodic accounts to any court, whether or not required by statute. The Trustee will have the right, at the expense of the Trust, to prepare an accounting in accordance with applicable court requirements and rules and to apply at any time to a court of competent jurisdiction for judicial settlement of any account of the Trustee whether or not previously settled as herein provided or for the determination of any question of construction or for instructions. In any such action or proceeding it will be necessary to join as parties solely the Trustee and the Grantor, or, if the Grantor is then deceased, the then living adult beneficiaries of the Trust (although the Trustee may also join such other parties as the Trustee may deem appropriate), and any judgment or decree entered herein will be conclusive and binding on all persons at any time interested in the Trust. No less frequently than annually, the Trustee shall provide the trust s income beneficiaries, or their designated representatives, with a written account of the trust s transactions for the immediately preceding reporting period. Unless within 60 days after the mailing of a written account a beneficiary asserts an objection to a transaction disclosed in such account, the account shall be deemed to be as conclusive and fully binding, and the Trustee shall be fully relieved and discharged in all respects, as if the account had been approved in a judicial proceeding in which all persons interested in the trust had appeared, either individually or by a representative under 12 Del. C

25 IX. INVESTMENT IN AND RETENTION OF SECURITIES MANAGED, ISSUED UNDERWRITTEN OR DISTRIBUTED BY TRUSTEE OR AFFILIATE; OTHER DEALINGS AND TRANSACTIONS WITH AFFILIATES The Trustee, at the direction of the Investment Adviser, if one is serving, is authorized to invest in, retain or otherwise deal in any securities managed, issued, underwritten or distributed by the Trustee or by any of its affiliates, any participation in any investment company registered under the Investment Company Act of 1940, any investment fund exempt from registration under the Investment Company of Act of 1940, for which the Trustee or its affiliate is an Adviser or agent, and any other affiliated investment within the meaning of 12 Del. C. 3312, and is authorized to otherwise deal with or transact business with any of its affiliates, notwithstanding the fact that such Trustee or affiliate may receive separate fees, commissions or other costs directly from such security, fund, affiliated investment, dealing or transaction. X. EMPLOYMENT OF AND DEALINGS WITH AFFILIATED AGENTS, INCLUDING BROKER- DEALERS AND OTHER AFFILIATED CORPORATIONS The Trustee is authorized to employ or otherwise deal with such agents, Advisers and other counsel, including but not limited to entities affiliated with the Trustee, and to pay out of income or principal or both the reasonable charges and fees of such agents, Advisers and counsel, as it shall in its sole discretion determine; provided, however, that the Investment Adviser, if one is serving, shall have the sole power to select brokers and dealers for the sale or purchase of any securities or other investment property in the trust. XI. AMENDMENT OF ADMINISTRATIVE PROVISIONS The Trustee shall have the power, by a separate acknowledged instrument filed with the trust records, to amend the administrative provisions of this trust instrument (including the provisions relating to the Trustee). The determination by the Trustee as to the provisions subject to amendment shall be conclusive upon all persons interested in the trust. The Trustee may exercise this power from time to time, and may release this power in whole or in part, provided that the Trustee shall not amend the trust in a manner that would alter any beneficial interest under the trust. XII. CHANGE OF TRUST SITUS The Trustee shall have the power to remove all or part of the trust property or to change the situs of administration of the trust from one jurisdiction to another and to elect, by a separate acknowledged instrument filed with the trust records, that the law of such other jurisdiction shall govern the administration of the trust, provided that the Trustee shall not make such an election if it would alter any beneficial interest under the trust. The Trustee's authority to change the situs of administration of the trust and elect that the laws of another jurisdiction shall thereafter govern the administration of the trust does not impose a duty on the Trustee to monitor the laws of any jurisdiction other than the jurisdiction in which the trust is then administered. XIII. AUTHORIZATION TO TERMINATE SMALL TRUSTS The Trustee may terminate the trust if in its sole discretion the trust is so small as to make continuation inadvisable, and shall distribute the principal to the income beneficiary of the trust or to the committee, conservator, guardian or other person responsible for such beneficiary.

26 XIV. CLAIMS AGAINST TRUST ASSETS [ASSET PROTECTION TRUSTS ONLY] To the extent that any of the creditors of the Grantor or other beneficiary asserts a claim that it is entitled, through the exercise of the judicial process or otherwise, to reach the assets of the trust in satisfaction of its claim, the Trustee shall have no obligation to defend the trust or its assets against any such claim or to initiate or intervene in any litigation, arbitration proceeding or mediation proceeding for the purpose of resisting any such claim, unless the Trustee is reasonably satisfied that it will be fully indemnified from the assets of the trust for all of its liabilities and expenses (including professional fees and expenses of counsel, accountants and expert witnesses) arising from or attributable to the Trustee s participation therein. If the Trustee reasonably determines that the readily marketable assets of the trust are, or have become, insufficient for such purposes, the Trustee may request that the Grantor provide the Trustee with comparable indemnity, supported with such security as may be satisfactory to the Trustee in its sole discretion, and in the absence of such additional indemnity or security, the Trustee may refuse to participate in any such proceeding or may withdraw from an ongoing proceeding, even if such refusal or withdrawal may result in the granting or awarding of relief against the trust (including a distribution of trust assets in satisfaction of a claim). The Trustee shall incur no liability to anyone whomsoever in connection with any such refusal or withdrawal pursuant to this Section. XV. SPECIAL POWERS WITH RESPECT TO INSURANCE The Trustee shall have the following powers and responsibilities with respect to any insurance policies owned by the trust, subject to the direction of an Investment Adviser if one is acting: A. Exercise of Rights. To exercise all or any of the options, benefits, rights, privileges, and interests under the policies; and any receipts releases and other instruments executed by the Trustee in connection with the policies shall be binding and conclusive as to all persons entitled to any proceeds hereunder. B. Conversion of Privileges. If the Trustee is the owner of any group term life insurance policy and the policy is terminated either because the person insured is no longer eligible for coverage under the policy or because of termination of the group policy, the Trustee may convert such group term policy to any other policy of insurance authorized by law or the provisions of the group term insurance policy. The decision of the Trustee with regard to conversion of the group term policy shall be made in its sole discretion and shall be conclusive and binding on all persons having an interest in this trust. C. Payment of Premiums. Unless the premium on the life insurance policy is paid by the employer of the Grantor, and except as otherwise provided in this section, the Trustee may, in its sole discretion, pay the premiums on the policies. If funds are insufficient for reasons beyond the control of the Trustee, the Trustee may exercise the options available to it under the life insurance contract, including, but not limited to, surrender of the policy, accepting a paid-up policy or exercise of a waiver of premium provisions in the event of disability of the Grantor. The Trustee may pay the premiums from funds received from the Grantor, or from other persons. The Trustee shall not, without the consent of an adverse party, as defined in IRC 672(a), use any trust income for the payment of premiums on insurance on the life of the Grantor. D. Collection of Proceeds. The policies of insurance transferred to the trust, and all additional policies which may later be so transferred, shall be made payable to the Trustee on behalf of the trust. For the purpose of collecting monies due under such policies, the Trustee shall have the power to make proper proofs and releases to enable it to receive the proceeds thereof, to institute

27 any suit or proceeding and to perform any and all other acts necessary or appropriate for accomplishing such purpose. The Trustee shall not, however, be obligated to institute or maintain any litigation to enforce payment of any policy until the Trustee shall have been indemnified to its satisfaction. The receipt of the Trustee shall be in full acquittance and discharge of the companies issuing the policies and upon payment of the proceeds thereof to the Trustee, the insurance companies shall be exempted from all liability as to the proper application of the trust estate. Expenses incurred in making such collections shall be a proper charge against the trust. E. Limitation of Duties of Trustee. With respect to any policies of insurance acquired by, or transferred to, the trust, and all additional policies which may later be so acquired or transferred, the Trustee shall have no duty (a) to determine whether the contract is or remains a proper investment, (b) to investigate the financial strength or changes in the financial strength of the life insurance company, (c) to make a determination of whether to exercise any policy option available under the contract, (d) to make a determination of whether to diversify such contracts relative to one another or to other assets, if any, administered by the Trustee, or (e) to inquire about changes in the health or financial condition of the insured or insureds relative to any such contract. The Grantor acknowledges that the Trustee has disclosed the application of 12 Del. C. 3302(d), and the limitation of the Trustee s duties thereunder, to the trust created hereunder. The Trustee shall not be liable to the beneficiaries or to any other party for any loss resulting from the absence of those duties upon the Trustee. XVI. CONFIDENTIALITY OF TRUST [FOR CONFIDENTIAL TRUSTS ONLY] "No less frequently than annually, the Trustee shall provide the Investment Adviser, if any, the Distribution Adviser, if any, the Trust Protector and the Notice Recipients with a written account of the trust s transactions for the immediately preceding reporting period. Unless within 60 days after the mailing of a written account a Notice Recipient asserts an objection to a transaction disclosed in such account, the account shall be deemed to be as conclusive and fully binding, and the Trustee shall be fully relieved and discharged in all respects, as if the account had been approved in a judicial proceeding in which all persons interested in the trust had appeared, either individually or by a representative under 12 Del. C Notwithstanding any other provision of this Agreement and in accordance with 12 Del. C. 3303(a), none of the Trustee, the Investment Adviser, the Distribution Adviser or the Trust Protector, if any, shall furnish any account statement or other account information to any beneficiary of the Trust (other than the Notice Recipients), or provide any such beneficiary with notice of the existence of the Trust, unless directed in writing to do so by the Trust Protector. For purposes of this agreement, any beneficiary who is prohibited from receiving notice of the existence of the Trust, whether by virtue of the confidentiality provisions of this agreement or otherwise, shall for all purposes of this agreement (including any judicial proceeding and all nonjudicial matters, such as granting releases pursuant to 12 Del. C and measuring the limitation period in 12 Del. C. 3585) be represented and bound by the Notice Recipients and any other Adviser/Fiduciary/person then receiving statements. Wherever the term Notice Recipients appears in this Agreement, it shall mean the following individuals in the indicated order of priority: (1) The Grantor, while living and competent; (2)Each adult beneficiary to whom the Trustee is then authorized to distribute income (or their custodial parents or legal guardians if there is no adult beneficiary).".

28 XVII. CONFLICT OF INTEREST "From time to time, one or more of the trust, the settlor, the settlor's spouse, the individual acting as trustee and/or one or more entities the interests in which are held directly or indirectly by the Trust, may have or wish to enter into a loan ( Loan ) with the Corporate Trustee in its individual capacity (the Lender ). Having the Corporate Trustee acting as both trustee and Lender poses a conflict of interest because as trustee, the Corporate Trustee has a fiduciary duty to preserve the trust property for the beneficiaries, while as Lender, the Corporate Trustee will be a direct or indirect creditor of the trust and in the position of seeking repayment on favorable terms of the Loan from the trust and therefore from the trust property. These competing interests as Lender and as trustee shall be referred to as the Conflict of Interest. The settlor specifically (a) waives the Corporate Trustee s Conflict of Interest, and (b) authorizes the Corporate Trustee as trustee to take any action or omit to take any action in good faith related to the Loan, including but not limited to any participation as trustee in any decision as to when and whether to enter into and repay the Loan or to deal with the collateral and any security interest therein, as though the Conflict of Interest did not exist. The Corporate Trustee shall not be liable for any action or omission taken by the Corporate Trustee as trustee in good faith with respect to the Loan, or any action or omission taken by the Lender pursuant to the Loan or any security interest related thereto while the Loan is outstanding, including but not limited to any decision to pursue the Lender s rights as a security interest holder in the event of any default." XVIII. DETERMINATION OF EQUIVALENT VALUE FOR GRANTOR TRUSTS The Grantor or Trust Protector may exercise the Power to Substitute by an instrument in writing signed by such Grantor or Trust Protector and delivered to the Trustee, provided that such Grantor or Trust Protector must certify to the Trustee in such instrument that the substituted property and the Trust property for which it is substituted are of equivalent value. The Trustee shall give notice of the proposed substitution to the Investment Direction Adviser and shall send a copy of the instrument exercising the Power to Substitute with such notice. The Investment Direction Adviser shall notify the Trustee in writing, within 30 days of receiving notice from the Trustee, that the property proposed to be substituted by such Grantor is or is not of equivalent value with the Trust property for which it will be substituted. If the Investment Direction Adviser does not give such notice to the Trustee within the 30 days set forth above, the Investment Direction Adviser shall be deemed to approve the values of the properties being substituted as being of equivalent value. If the Investment Direction Adviser does not agree that the assets or property proposed to be substituted are of equivalent value with the property to be acquired by such Grantor or Trust Protector, the Trustee may seek a judicial determination by a Court of competent jurisdiction that the requirement of equivalent value is satisfied. The reasonable expenses of such independent determination, including any judicial determination, shall be borne by the Grantor exercising each power. XIX. WAIVER OF PRUDENT INVESTOR RULE, RULE AGAINST SELF-DEALING AND DUTY OF LOYALTY With the written consent of the Grantor, if living, otherwise the Primary Beneficiary, or, if the Primary Beneficiary is not competent, a majority of the Notice Recipients, the Investment Direction Adviser and/or the Trustee, depending on who then holds the investment power (for purposes of this Article Investment Fiduciary ) is authorized (but not directed), with respect to any trust power or authority that the Investment Fiduciary may exercise to acquire and retain investments not regarded as traditional for trusts including investments that would be forbidden or would be regarded

29 as imprudent, improper or unlawful by the prudent person rule, prudent investor rule, 12 Del. C. 3302, any rule or law concerning the duty of loyalty, any rule or law limiting, prescribing, or voiding or making voidable any interested party or self-dealing transaction, or any other rule or law which restricts a fiduciary s capacity to invest. The Investment Fiduciary may invest in any type of property, wherever located, including, but not limited to, any type of security or option, improved or unimproved real property, and tangible or intangible personal property, and in any manner, including direct purchase, joint ventures, partnerships, limited partnerships, limited liability companies, corporations, mutual funds, business trusts or any other form or participation or ownership whatsoever. Furthermore, the Investment Fiduciary may acquire property from, transfer property to, obtain services from, provide services to, and otherwise enter into contracts, understandings, arrangements, and other dealings, of any kind or nature, with any person or entity (each such person or entity hereinafter referred to as a Third Party ) whether or not the Third Party is in any manner related to, or affiliated with, the Investment Fiduciary or any other person or entity related to, or affiliated with, the Investment Fiduciary and without regard to whether the Investment Fiduciary, acting in its corporate or personal capacity or in any other capacity, or any person related to, or affiliated with, the Investment Fiduciary has other contracts, understandings, arrangements or dealings, whether or not for remuneration with the Third Party. In making investments the Investment Fiduciary may disregard any or all of the following factors: (a) Whether a particular investment, or the Trust investments collectively, will produce a reasonable rate of return or result in the preservation of principal. (b) Whether the acquisition or retention of a particular investment or Trust investments collectively are consistent with any duty of impartiality as to the different beneficiaries. No such duties shall exist. (c) Whether the acquisition or retention of a particular investment or any aspect of the administration of the investment violates any duty of loyalty or rule against self-dealing. No duty of loyalty shall exist to the extent such duty would limit or preclude self-dealing transactions. (d) Whether the Trust is diversified. No duty to diversify shall exist. (e) Whether any or all of the Trust investments would traditionally be classified as too risky or speculative for trusts. The entire Trust may be so invested. The Investment Fiduciary shall have sole and absolute discretion in determining what constitutes acceptable risk and what constitutes proper investment strategy. The purpose in granting the foregoing authority is to modify the prudent person rule, prudent investor rule, the application of 12 Del. C. 3302, the duty of loyalty, the rule against self-dealing, or any rule or law which restricts a fiduciary s ability to invest insofar as any such rule or law would prohibit an investment or investments because of one or more factors listed above, or any other factor relating to the nature of the investment itself.

30 LEGAL, INVESTMENT AND TAX NOTICE: This information is not intended to be and should not be treated as legal advice, investment advice or tax advice. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal or tax advice from their own counsel. IRS CIRCULAR 230 NOTICE: To the extent that this message or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law. For more information about this notice, see The Northern Trust Company of Delaware revises its preferred language periodically. Although the language is the product of much thought and effort, no form language is a substitute for informed legal judgment. The attorney must make an independent determination as to whether the particular language is generally appropriate for a client and, further, how it must be modified meet any special circumstances and objectives of the client. The Northern Trust Company of Delaware does not guarantee that the language effectively accomplishes their purpose, and it assumes no responsibility for the language or its use. Laura G. Mandel, 2013 Joel S. Schoenmeyer, 2013

31 EXPERIENCE THE RIGHT PARTNERSHIP July 16, 2013 Professional Advisor Forum 2013 Northern Trust Corporation northerntrust.com 0 EXPERIENCE THE RIGHT PARTNERSHIP

32 Delaware Trusts: Safeguarding Personal Wealth Laura G. Mandel President, The Northern Trust Company of Delaware Joel Schoenmeyer, Senior Legal Counsel, The Northern Trust Company 1 EXPERIENCE THE RIGHT PARTNERSHIP

33 Today s Agenda Click here A C C E S S. E X P E R T I S E. S E R V I C E. Key Milestones Delaware Directed Trusts Confidential Trusts & Pre-Mortem Validation Income Tax Advantages Asset Protection Trusts Decanting Analysis of Trusts with a Foreign Grantor Beneficiary Issues and the Foreign Non-Grantor Trust Bringing a Foreign Trust to Delaware 2 EXPERIENCE THE RIGHT PARTNERSHIP EXPERIENCE THE RIGHT PARTNERSHIP

34 Click here Key Milestones of Delaware Law A C C E S S. E X P E R T I S E. S E R V I C E Delaware enacts deduction for trust income accumulated in irrevocable trusts for future distribution to nonresident beneficiaries 1986 Formal Recognition of administrative trusts or direction trusts 1995 Repeal of the Rule Against Perpetuities 1997 Adoption of a self-settled spendthrift trust statute 2000 Enactment of the nation s first total return unitrust statute 2003 Delaware authorizes trustees to decant assets from an existing trust into a new trust 2004 Delaware adopts legislation allowing a non-charitable purpose trust 2005 Amendment to Delaware law allows a settlor by express direction in the trust instrument to maintain confidentiality for a designated period of time Heightened flexibility and protections for directed trusts, asset protection trusts, spendthrift and purpose trusts, along with broader virtual representation and decanting statutes. 3 EXPERIENCE THE RIGHT PARTNERSHIP EXPERIENCE THE RIGHT PARTNERSHIP

35 Click here Delaware Trusts: Preservation Through Innovation A C C E S S. E X P E R T I S E. S E R V I C E. The State of Delaware is a trust-friendly jurisdiction that promotes innovative trust laws and attractive income tax advantages. Explore Delaware s unique advantages. At The Northern Trust Company of Delaware, we help advisor and clients employ several strategic advantages that may not be available in other states. Important Delaware Advantages: Wealth Enhancement State Income Tax Savings Investment Flexibility Administrative Flexibility Pre-Mortem Validation High Level of Confidentiality 4 EXPERIENCE THE RIGHT PARTNERSHIP EXPERIENCE THE RIGHT PARTNERSHIP

36 Click here Investment Flexibility with Directed Trusts A C C E S S. E X P E R T I S E. S E R V I C E. Delaware law gives you the freedom to appoint investment advisers to manage trust assets and to limit the trustee s liability for the management of those assets. Delaware law permits trustees to take direction from authorized investment advisers. The benefits of the bifurcation of investment responsibility between the trustee and the authorized adviser include: The ability to hold interests in closely-held investment entities or operating businesses where you may not want the trustee to be involved with the management of those assets Since you are acting as an investment adviser, the trustee will not interfere with your investment and business management decisions In addition, should you have a concentrated holding in your portfolio, as the investment adviser you will be able to direct the trustee to retain the holding Investment Flexibility 5 EXPERIENCE THE RIGHT PARTNERSHIP EXPERIENCE THE RIGHT PARTNERSHIP

37 Distribution Flexibility Click here A C C E S S. E X P E R T I S E. S E R V I C E. In addition to affording greater investment flexibility, Delaware law also provides you the option of appointing an adviser who determines if and when your beneficiaries receive distributions. Unlike other states, Delaware law affords the opportunity to name advisers to direct distributions to beneficiaries. Examples of situations where distribution advisers can be useful: If you wish to impose subjective criteria for a beneficiary s eligibility for distributions, such as lifestyle or productivity standards If you wish to impose mandatory testing for substances prior to a beneficiary receiving a distribution Where you prefer family members and/or friends with greater knowledge of your beneficiaries needs to assume responsibility for those decisions Administrative Flexibility 6 EXPERIENCE THE RIGHT PARTNERSHIP EXPERIENCE THE RIGHT PARTNERSHIP

38 Confidentiality Click here A C C E S S. E X P E R T I S E. S E R V I C E. Delaware law also provides you a high level of confidentiality regarding your wealth transfer plans. Withholding of Information: Avoidance of public filings Allows trustees to withhold information about trusts from beneficiaries for a designated period of time as long as your trust specifies nondisclosure Does not require a trustee to file trust agreements in court or to register trusts with a public agency, nor does it mandate court accountings for living trusts or testamentary trusts unless the instrument so directs Limited court supervision The Delaware Court of Chancery does not exercise continuing jurisdiction over trusts, acting only in response to petitions brought by interested parties High Level of Confidentiality 7 EXPERIENCE THE RIGHT PARTNERSHIP EXPERIENCE THE RIGHT PARTNERSHIP

39 Pre-Mortem Validation Click here A C C E S S. E X P E R T I S E. S E R V I C E. Delaware law additionally allows for challenges to the validity of trusts before your death, compelling dissenting parties to raise any objections while you are still living. How It Works: The trustee gives written notice to a person of the existence of the trust, starting a 120-day period for the person to challenge the trust The dissenting person must file a challenge during this period while you are still living and able to provide testimony negating the lack of capacity or undue influence After this 120-day period, the person is currently precluded from challenging the trust after your death, offering finality and certainty that your wishes will be honored In the event you are not comfortable with this approach, Delaware law also recognizes the validity of no-contest clauses in trusts, with certain exceptions. Pre-Mortem Validation 8 EXPERIENCE THE RIGHT PARTNERSHIP EXPERIENCE THE RIGHT PARTNERSHIP

40 Click here State Income Tax Savings A C C E S S. E X P E R T I S E. S E R V I C E. While the burden of state income taxes can be a significant drag on the growth in value of an irrevocable trust in other states, Delaware offers an appealing alternative venue for your irrevocable trusts. Delaware does not impose any state income tax on the federal taxable income of irrevocable trusts that is accumulated for distribution in future years to nonresident beneficiaries Absent a taxable connection or nexus with another state, capital gains and ordinary income can accumulate in irrevocable Delaware trusts without incurring a state income tax Example: Two trusts (one in California and one in Delaware) to sell a zero-basis asset for net proceeds of $5 million Sale in Delaware Trust Sale in California Trust Sale Proceeds $5,000,000 $5,000,000 Tax Cost $0 $0 Gain on Sale $5,000,000 $5,000,000 State Tax $0 $0 Federal Tax $1,000,000 $1,000,000 Proceeds Net Tax $4,000,000 $3,335,000 Delaware Benefit $665,000 Assumptions: Federal capital gains rate 20%; California state income tax rate 13.3% (maximum rate of 12.3% plus a mental health services tax of 1% for taxable income over $1,000,000) State Income Tax Savings 9 EXPERIENCE THE RIGHT PARTNERSHIP EXPERIENCE THE RIGHT PARTNERSHIP

41 Click here Delaware Incomplete Non-Grantor Trusts (DING) A C C E S S. E X P E R T I S E. S E R V I C E. A Delaware DING Trust, affords the ability to contribute highlyappreciated assets and defer or avoid state income tax as long as there is not a nexus with another state. The trust must be created in a state allowing for self-settled asset protection trusts because if creditors can reach the trust assets the individual will be taxed on all income and capital gains The trust must be structured as an incomplete gift for federal gift tax purposes by retention of powers, such as a veto power over distributions and the power to appoint assets at death DING Strategy CLIENT Contribution Prerequisites: Non Grantor Trust (for income tax purposes), Incomplete Gift (for gift tax purposes) Distribution Committee (members with adverse interests ) DELAWARE ASSET PROTECTION TRUST BENEFICIARIES The trust must have a Distribution Committee composed of other beneficiaries with the authority to direct or approve distributions to the grantor and/or grantor s spouse For illustrative purposes only. Not legal or tax advice. State Income Tax Savings 10 EXPERIENCE THE RIGHT PARTNERSHIP EXPERIENCE THE RIGHT PARTNERSHIP

42 Click here Delaware Asset Protection Trusts A C C E S S. E X P E R T I S E. S E R V I C E. With a properly structured Delaware Asset Protection Trust, a client can be a beneficiary of a self-settled trust and, importantly, retain certain powers over the trust, such as the power to manage the trust assets. Prerequisites: A transfer to an Irrevocable Trust A Delaware Trustee Delaware law governs the Trust Expressed spendthrift language Permissible powers, include: Serve as investment adviser Hold veto power over distributions Retain limited power of appointment effective at death Receipt of income and principal under certain circumstances Removal and replacement of trustee or adviser Prohibited powers, include: Serve as trustee, distribution adviser, or trust protector Direct distributions or demand a return of assets Delaware Asset Protection Trust Strategy CLIENT Contribution DELAWARE ASSET PROTECTION TRUST Income and/or principal to client, but generally not reachable by certain creditors BENEFICIARIES For illustrative purposes only. Not legal or tax advice. Wealth Enhancement 11 EXPERIENCE THE RIGHT PARTNERSHIP EXPERIENCE THE RIGHT PARTNERSHIP

43 Click here Analysis of Trusts with a Foreign Grantor A C C E S S. E X P E R T I S E. S E R V I C E. Why is this important? What questions do we need to ask? Is the trust Foreign or Domestic? Court Test Control Test 12 EXPERIENCE THE RIGHT PARTNERSHIP EXPERIENCE THE RIGHT PARTNERSHIP

44 Income Tax Analysis Click here A C C E S S. E X P E R T I S E. S E R V I C E. Income tax analysis of trusts with a foreign grantor Is the trust a Grantor or Non-Grantor Trust? Key provision: IRC 672(f) Grantor Trusts 13 EXPERIENCE THE RIGHT PARTNERSHIP EXPERIENCE THE RIGHT PARTNERSHIP

45 Click here Foreign Non-Grantor Trusts A C C E S S. E X P E R T I S E. S E R V I C E. Foreign Non-Grantor Trusts Foreign Beneficiaries U.S. Beneficiaries Throwback rules 14 EXPERIENCE THE RIGHT PARTNERSHIP EXPERIENCE THE RIGHT PARTNERSHIP

46 Click here Reporting Requirements for Foreign Trusts A C C E S S. E X P E R T I S E. S E R V I C E. Reporting Requirements Trust Beneficiary 15 EXPERIENCE THE RIGHT PARTNERSHIP EXPERIENCE THE RIGHT PARTNERSHIP

47 Click here Bringing a Foreign Trust to Delaware A C C E S S. E X P E R T I S E. S E R V I C E. Converting a foreign trust to a domestic trust Change situs Can the trust be amended or decanted? 16 EXPERIENCE THE RIGHT PARTNERSHIP EXPERIENCE THE RIGHT PARTNERSHIP

48 Click here The Northern Trust Company of Delaware A C C E S S. E X P E R T I S E. S E R V I C E. Established in September 2004 as a trust office of Northern Trust Bank, FSB, Northern Trust obtained a Delaware limited purpose trust company charter on January 1, 2006, and today offers specialized wealth management services. The Northern Trust Company of Delaware is a direct subsidiary of Northern Trust Corporation, with its own Board of Directors It is supervised by the Delaware State Bank Commissioner and the Federal Reserve Bank of Chicago Assets Under Management* Assets Under Custody* $8.45 Billion $14.7 Billion *Financials as of 12/31/ EXPERIENCE THE RIGHT PARTNERSHIP EXPERIENCE THE RIGHT PARTNERSHIP