DELAWARE TRUSTS 2009

Transcription

1 DELAWARE TRUSTS 2009 Richard W. Nenno, Esq. Managing Director and Trust Counsel Wilmington Trust Company 1100 North Market Street Wilmington, Delaware

2 Reprinted with permission from Asset Protection: Domestic and International Law and Tactics, edited by Duncan E. Osborne and Elizabeth M. Schurig, published by Thomson Reuters/West, 610 Opperman Dr., Eagan, MN , (800) COPYRIGHT 2009 THOMSON REUTERS/WEST For authorization to photocopy, please contact the Copyright Clearance Center at 222 Rosewood Drive, Danvers, MA 01923, USA (978) ; fax (978) or West s Copyright Services at 610 Opperman Drive, Eagan, MN 55123, fax (651) Please outline the speci c material involved, the number of copies you wish to distribute and the purpose or format of the use. This publication was created to provide you with accurate and authoritative information concerning the subject matter covered; however, this publication was not necessarily prepared by persons licensed to practice law in a particular jurisdiction. The publisher is not engaged in rendering legal or other professional advice and this publication is not a substitute for the advice of an attorney. If you require legal or other expert advice, you should seek the services of a competent attorney or other professional. Nothing contained herein is intended or written to be used for the purposes of 1) avoiding penalties imposed under the federal Internal Revenue Code, or 2) promoting, marketing or recommending to another party any

3 Richard W. Nenno Wilmington Trust Company Richard W. Nenno, Esquire, is a Managing Director and Trust Counsel in Wealth Advisory Services at Wilmington Trust Company, Wilmington, Delaware. Mr. Nenno has over three decades of estate planning experience, is admitted to the practice of law in Delaware and Pennsylvania, and is a Distinguished Accredited Estate Planner. Prior to joining Wilmington Trust in 1982, he was an associate in the Estates Department of the Philadelphia law rm of Ballard, Spahr, Andrews & Ingersoll. Mr. Nenno is a cum laude graduate of Princeton University with an A.B. degree from the Woodrow Wilson School of Public and International A airs, and he earned his J.D. degree from Harvard Law School. Mr. Nenno is recognized as a national speaker and published authority on estate planning issues. He has spoken at the University of Miami Institute on Estate Planning, the ALI-ABA Planning Techniques for Large Estates Conference, the IBA/ABA International Wealth Transfer Practice Conference, the Notre Dame Tax and Estate Planning Institute, the AICPA Advanced Estate Planning Conference, the NYU Institute on Federal Taxation, and the Southern California Tax and Estate Planning Forum. He is a member of the Delaware State Bar Association (Past Chair: Estates and Trusts Section); Estate Planning Council of Delaware, Inc. (Past President); American Bar Association, Section of iii

4 Real Property, Trust & Estate Law (Chair: Non-Tax Estate Planning Considerations Group) and Section of Taxation; Philadelphia Bar Association. Mr. Nenno is the author or co-author of Asset Protection: Domestic & Int l Law & Tactics Ch. 14A; Terrors of the Deep: Tax Dangers When Exercising Powers Over Trusts The GST Regulations and the Delaware Tax Trap, 34 Tax Mgmt. Est., Gifts & Tr. J. 76 (Jan. 8, 2009); Planning to Minimize or Avoid State Income Tax on Trusts, 34 ACTEC J. 131 (Winter 2008); The Trust From Hell: Can It Be Moved to a Celestial Jurisdiction?, 22 Prob. & Prop. 60 (May/June 2008); The Power to Adjust and Total-Return Unitrust Statutes: State Developments and Tax Considerations, 42 Real Prop., Prob. & Tr. J. 657 (Winter 2008); Directed Trusts: Can Directed Trustees Limit Their Liability?, 21 Prob. & Prop. 45 (Nov./Dec. 2007); DAPT Lite: A Practitioner-Friendly Guide to the Delaware Asset Protection Trust, 32 Tax Mgmt. Est., Gifts & Tr. J. 227 (Sept. 13, 2007); Gerson v. Comr.: Donees of General Powers of Appointment Over Grandfathered Trusts Unite!, 32 Tax Mgmt. Est., Gifts & Tr. J. 130 (Mar. 8, 2007); Choosing and Rechoosing the Jurisdiction for a Trust, 40 U. Miami Inst. on Est. Plan. 400 (2006); Delaware Asset Protection Trusts Should Survive Bankruptcy, 33 Est. Plan. 31 (Jan. 2006); Delaware Asset Protection Trusts Create Obstacles for Creditors, 32 Est. Plan. 03 (Dec. 2005); Structuring CRTs as Delaware APTs to Provide Protection from Creditors and Surviving Spouses, 31 Tax Mgmt. Est., Gifts & Tr. J. 71 (Mar. 9, 2006); Delaware Asset Protection Trusts: Avoiding Fraudulent Transfers and Attorney Liability, 32 Est. Plan. 22 (Jan. 2005). iv

5 Delaware Trusts Richard W. Nenno* I. BENEFITS FOR TRUSTS GOVERNED BY DELAWARE LAW 1 Introduction 2 Trust infrastructure established 3 Carry out objectives 4 Statutory mechanisms 5 Perpetual trusts possible 6 No tax imposed on income accumulated or capital gains incurred for nonresidents 7 Prudent-investor rule followed 8 Division of responsibilities authorized 9 E ective third-party trusts available 10 Spendthrift trusts 11 Discretionary trusts 12 Accounts in banks 13 E ective self-settled trusts o ered 14 Power to adjust and total-return unitrust statutes available 15 Allocation rules exible 16 Court system superior 17 Planning option for NIMCRUTs exists 18 Charitable trust laws superior 19 Transfer to successor trustee facilitated 20 Decanting statute available 21 Surviving spouses' elective-share rights might be defeated 22 Trustee has insurable interest in insured's life *Richard W. Nenno, Esquire, is a Managing Director and Trust Counsel in Wealth Advisory Services, Wilmington Trust Company, Wilmington, Delaware. He is a cum laude graduate of Princeton University and earned his J.D. degree from Harvard Law School. Mr. Nenno writes and speaks nationally on estate planning topics. The author thanks W. Donald Sparks, II, Esquire, Richards, Layton & Finger, P.A., Wilmington, Delaware, for his contributions to early editions of this chapter. 1

6 Special Supplement 23 Perpetual noncharitable purpose trusts respected 24 Virtual representation rules expansive 25 Rules for retention of counsel by trustees clear 26 Rules for obtaining Delaware law established II. DELAWARE DYNASTY TRUSTS 27 Introduction 28 Scope of dynasty trusts 29 The Exempt Dynasty Trust 30 The Grandfathered Dynasty Trust 31 The Nonexempt Dynasty Trust 32 Tax advantages of leaving nonexempt assets outright 33 Tax advantages of keeping nonexempt assets in trust 34 Choosing between the federal estate tax and the GST tax 35 Federal income-tax implications 36 Tax perils when exercising powers over trusts 37 The GST regulations 38 I.R.C. 2041(a)(3) and 2514(d) (the Delaware tax trap) 39 Analysis of the Delaware tax trap 40 Application of the Delaware tax trap to dynasty trusts 41 Why Delaware is the ideal jurisdiction for a dynasty trust 42 Trust infrastructure established 43 Carry out objectives 44 Perpetual trusts possible 45 No tax imposed on income accumulated or capital gains incurred for nonresidents 46 Rules for taxation of trusts 47 Determining whether imposition of tax is constitutional 48 Speci c state considerations 49 Planning, ethical, and other issues 50 Prudent-investor rule followed 51 Division of responsibilities authorized 52 E ective third-party trusts available 53 Spendthrift trusts 54 Discretionary trusts 55 E ective self-settled trusts o ered 56 Power to adjust and total-return unitrust statutes available 57 Allocation rules exible 58 Court system superior 59 Surviving spouses' elective-share rights might be defeated 2

7 Delaware Trusts 60 Trustee has insurable interest in insured's life 61 Perpetual noncharitable purpose trusts respected 62 Other features 63 Ethical and practical concerns 64 Moving trusts to Delaware 65 What law applies? 66 E ecting the move 67 To carry out client's objectives 68 To create a perpetual trust 69 To avoid state income tax 70 To provide more investment exibility 71 To provide greater protection from creditor claims 72 To avoid accounting requirements and administrative costs 73 To use the power to adjust or to convert to a total-return unitrust 74 Federal transfer-tax consequences 75 Delaware dynasty trusts for nonresident aliens 76 GST-tax rules 77 Property situs 78 U.S. as trust situs III. DELAWARE TOTAL-RETURN UNITRUSTS 79 Introduction 80 The problem 81 Traditional methods of distributing principal 82 Modi cation of governing instrument 83 New statutory solutions 84 Delaware's power to adjust statute 85 Delaware's total-return unitrust-conversion statute 86 Comments 87 Caveats 88 Delaware's statute recognizing new total-return unitrusts 89 Federal income-tax treatment of distributions 90 New unitrusts 91 GST-tax implications 92 Federal gift-tax implications 93 Federal income-tax implications 94 Implications of I.R.C. 643 regulations 95 Wilmington Trust Company's experience IV. DELAWARE ASSET-PROTECTION TRUSTS 96 Background 3

8 Special Supplement 97 Delaware Quali ed Dispositions in Trust Act 98 How to create a Delaware APT 99 Who may defeat a Delaware APT 100 Consequences if a Delaware APT is defeated 101 Moving trusts to Delaware 102 Infrastructure 103 Bene ts of Delaware APTs 104 Employ tax bene ts 105 Obtain asset protection 106 Protect CRTs and other estate-planning vehicles 107 Avoid state income tax 108 Provide options for NRAs 109 Provide protection for trusts moved from o shore or other domestic jurisdictions 110 Fraudulent-transfer rules 111 Defending Delaware APTs 112 Hurdle 1: Judgments against trustors are not enough 113 Hurdle 2: Non-Delaware court might lack jurisdiction 114 In rem jurisdiction 115 Personal jurisdiction 116 Hurdle 3: Non-Delaware court should/must decline jurisdiction 117 Hurdle 4: Venue might be bad 118 Hurdle 5: Delaware law should apply 119 Hurdle 6: Delaware court might not have to give full faith and credit to non-delaware court judgment 120 Hurdle 7: Delaware may and does limit remedies available for judgments given full faith and credit 121 Hurdle 8: Delaware APTs should survive bankruptcy U.S.C.A. 541's trust exclusion 123 BAPCPA and 11 U.S.C.A. 548(e)'s 10-year lookback rule 124 Post-petition distributions 125 Domestic APT cases 126 Concerns for attorneys 127 Ethical principles 128 Potential liability 129 Federal tax consequences 130 Income tax 131 Transfer taxes 132 Gift tax 133 Estate tax 134 GST tax 4

9 Delaware Trusts A comparison of Alaska and Delaware APTs 136 Advantages of Alaska APTs 137 Advantages of Delaware APTs 138 A comparison of Nevada and Delaware APTs 139 Advantages of Nevada APTs 140 Advantages of Delaware APTs 141 A comparison of foreign and Delaware APTs 142 Advantages of foreign APTs 143 Advantages of Delaware APTs 144 Establishing a Delaware APT 145 Proper design and administration of a Delaware APT Appendix A. Generation-skipping trust agreement Appendix B. Exempt dynasty trust illustrations Appendix C. Solvency letter Appendix D. Irrevocable trust agreement Appendix E. Additional resources I. BENEFITS FOR TRUSTS GOVERNED BY DELAWARE LAW 1 Introduction Delaware is renowned for its corporate laws. Less well known, perhaps, is that Delaware has been a trust-friendly jurisdiction for generations. Highlights in the development of Delaware trust law, which will be explored below, include: (1) Early in the 20th century, Delaware pioneered the bifurcation of trust duties between corporate trustees and investment advisers; (2) Delaware permitted perpetual trusts through the exercise of limited powers of appointment in 1933, it permitted 110-year trusts in 1986, and it authorized perpetual trusts of personal property in 1995; (3) Delaware has a decades-old practice of not taxing trust income (including capital gains) accumulated for nonresidents; (4) Delaware enacted the prudent-investor rule in 1986, long before the 1994 promulgation of the Uniform Prudent Investor Act ( UPIA ); (5) In 1997, Delaware became the second state to allow domestic asset-protection trusts ( APTs ); 5

10 1 Special Supplement (6) In 2001, Delaware became the rst state to enact a total-return unitrust-conversion statute; (7) In 2006, Delaware enacted a noncharitable purpose trust statute, and, following changes made in 2008, Delaware probably is the only state where such trusts may be perpetual; (8) Delaware's Court of Chancery and Supreme Court, famous for their corporate law decisions, have been rendering important trust decisions for many years; 1 Delaware's liability system consistently is ranked as the best in the country; 2 (9) Delaware judges have demonstrated a willingness to uphold Delaware trust laws in di cult cases; 3 (10) Other states use Delaware statutes as templates; (11) National commentators acknowledge the preeminence of Delaware trust law. As con rmation of Delaware's long-standing leadership in the trust eld, a 2006 empirical study, which analyzed pertinent data beginning in 1969, found that, Delaware was clearly attracting trust funds from out of state in the early 1970s, 4 and that, [i]n 1986 Delaware had a disproportionate share of the nation's trust funds. 5 Several of the provisions discussed below are not unique [Section 1] 1 See Wilmington Trust Co. v. Wilmington Trust Co., 26 Del. Ch. 397, 24 A.2d 309, 139 A.L.R (1942); Lewis v. Hanson, 36 Del. Ch. 235, 128 A.2d 819 (1957), judgment a 'd, 357 U.S. 235, 78 S. Ct. 1228, 2 L. Ed. 2d 1283 (1958). 2 See The State Liability Systems Ranking Study, dated April 15, 2008, conducted by Harris Interactive for the U.S. Chamber Institute for Legal Reform (a separately incorporated a liate of the U.S. Chamber of Commerce). The study was based on interviews with 957 practicing corporate attorneys and general counsels from December 18, 2007, to March 19, 2008, available at s/lawsuitclimate2008/index.cfm (last visited Jan. 12, 2009). 3 See Delaware Trust Co. v. Partial, 517 A.2d 259, 262 (Del. Ch. 1986); Gibson v. Speegle, 184 Del. Ch. LEXIS 475, at *6 7 (Del. Ch. 1984). 4 Schanzenbach and Sitko, Perpetuities or Taxes? Explaining the Rise of the Perpetual Trust, 27 Cardozo L. Rev. 2465, (Apr. 2006). 5 Schanzenbach and Sitko, Perpetuities or Taxes? Explaining the Rise of the Perpetual Trust, 27 Cardozo L. Rev. 2465, 2479 (Apr. 2006). See Sitko and Schanzenbach, Perpetuities, Taxes, and Asset Protection: 6

11 Delaware Trusts 3 to Delaware, but these bene ts and Delaware's ongoing efforts to maintain a salubrious trust climate continue to make it the best place for personal trusts. 2 Trust infrastructure established Starting early in the last century, Delaware began to establish a trust infrastructure. Thus, it has a well-thoughtout body of trust statutes; an ongoing commitment to update those statutes to respond to changing federal tax laws, nancial conditions, and other circumstances; an outstanding judiciary; a supportive legislature, executive branch, and legal and banking community; and numerous institutions that compete for trust business. Delaware updates its trust statutes almost every year, and 2008 was no exception as Governor Minner signed 2008 Delaware S.B. 247 on June 26, As discussed below, it made several important changes in Delaware law that took e ect on August 1, 2008, and that generally apply to new and existing trusts. According to commentators, Delaware... is achieving a reputation for being responsive to change. 1 3 Carry out objectives Delaware law traditionally has stressed the importance of carrying out the trustor's or testator's intent. Hence, in Delaware, the terms of a trust instrument will be carried out regardless of other statutes or laws. 1 Trust terms that will be respected include, but are not limited to, the following: (1) the right to be informed of the bene ciary's interest for a period of time; (2) the grounds for removal of a duciary; (3) the circumstances, if any, in which the duciary must An Empirical Assessment of the Jurisdictional Competition for Trust Funds, 42 U. Miami Inst. on Est. Plan (2008); Sitko and Schanzenbach, Jurisdictional Competition for Trust Funds: An Empirical Analysis of Perpetuities and Taxes, 115 Yale L.J. 356, 375 n.62, (Nov. 2005). [Section 2] 1 Covey and Hastings, Delaware 2005 Changes in Trust Statutes, Prac. Drafting 8275 (Oct. 2005). [Section 3] 1 Del. Code Ann. tit. 12, 3303(a). 7

12 3 Special Supplement diversify investments; and (4) a duciary's powers, duties, standard of care, rights of indemni cation and liability to persons whose interests arise from that instrument. 2 4 Carry out objectives Statutory mechanisms Delaware has statutory mechanisms to ensure that a client's wishes will be implemented. First, a bene ciary may not bring a judicial proceeding to contest whether a trust was validly created more than 120 days after the trustee provides such bene ciary with speci- ed written information. 1 Delaware attorneys nd this procedure to be e ective in forestalling litigation if it is initiated upon the creation of an inter vivos trust because a disgruntled bene ciary must come forward while the trust's creator still is available to testify. If the trustee does not follow the foregoing procedure, a bene ciary is barred from bringing such a judicial proceeding at the rst to occur of: (1) two years after the client's death; (2) the expiration of the period in which a petition for review of a will could be led if the trust was revocable at the client's death and if the trust was speci cally referred to in the client's will; or (3) the date the bene ciary's right to contest was precluded by adjudication, consent, or other limitation. 2 Second, consistent with the policies of honoring a testator's or trustor's intent and discouraging litigation relating to it, a no-contest or in terrorem or penalty clause is valid in Delaware. Thus, a provision of a will or trust that reduces or eliminates the interest of a bene ciary who contests such will or trust is enforceable. 3 Recognizing that such clauses must be applied judiciously, though, the statute provides that a no-contest clause does not apply to: (1) an action brought by a trustee or personal representative; (2) an action in which a court determines that a bene ciary prevailed substantially; (3) a settlement agreement among bene ciaries of a will or trust; (4) an action to determine whether a 2 Del. Code Ann. tit. 12, 3303(a). [Section 4] 1 Del. Code Ann. tit. 12, 3546(a)(1). 2 Del. Code Ann. tit. 12, 3546(a)(2) to (4). 3 Del. Code Ann. tit. 12, 3329(a). 8

13 Delaware Trusts 5 proceeding constitutes a contest; or (5) a construction proceeding brought by a bene ciary of a will or trust. 4 Third, absent fraud or misrepresentation, a bene ciary may not bring a surcharge action against a trustee later than two years after the trustee provides a report that contains speci ed information. 5 Thus, if a trustee discloses activity to a bene ciary that is consistent with the testator's or trustor's intent but that is objectionable to the bene ciary, the bene ciary must act within a relatively short period of time. In 2008, the statute was amended to bar a claim arising from activity that a trustee does not disclose in the foregoing manner within ve years after the rst to occur of the removal, resignation, or death of the trustee; the termination of the bene ciary's interest in the trust; or the termination of the trust. 6 5 Perpetual trusts possible Delaware has permitted perpetual trusts since In that year, it enacted a statute 1 that provides that the exercise of a limited or general power of appointment begins a new perpetuities period. 2 Thus, if a bene ciary exercised a limited power of appointment to extend a trust in each generation, the trust could last forever free of federal transfer tax. Congress's response to this strategy is discussed below. 3 In 1986, Delaware abolished the common-law rule against perpetuities and replaced it with a requirement that all trust interests in real and personal property had to end within 110 years. 4 In 1995, though, Delaware eliminated the 110-year limitation for personal property so that stocks, bonds, and other 4 Del. Code Ann. tit. 12, 3329(b). 5 Del. Code Ann. tit. 12, 3585(a). 6 Del. Code Ann. tit. 12, 3585(d). [Section 5] 1 38 Del. Laws, c. 198 (1933). 2 Del. Code Ann. tit. 25, 503(c). 3 See 38 to Del. Laws, c. 422 (1986). 9

14 5 Special Supplement personal property may remain in trust forever. 5 Real property held in trust continues to be governed by the 110-year limitation that was enacted in 1986, 6 but this limitation can be avoided by placing real property in a limited liability company ( LLC ) or family limited partnership ( FLP ) because an interest in such an entity is personal property under Delaware law. 7 Thus, Delaware is one of several states that permit the creation of a perpetual trust for other than charitable or similar purposes. Delaware abolished the rule against accumulations when it abolished the common-law rule against perpetuities in No tax imposed on income accumulated or capital gains incurred for nonresidents A nongrantor trust is subject to income tax in Delaware if it was created by the will of a Delaware resident or by an inter vivos instrument created by such a resident or if the trust has a resident trustee. 1 In 2008, the top rate was 5.95% on income over $60, The trustee of a Delaware trust may deduct income (including capital gains) set aside for future distribution to nonresident bene caries. 3 Therefore, an irrevocable nongrantor trust without a Delaware remainder bene ciary will not be subject to Delaware income tax because all income either will be distributed (which will result in a distributions deduction) or will be accumulated (which will result in a deduction for Delaware purposes). Delaware determines the residence of unknown or unascertained bene ciaries in a way that minimizes the application of its income tax based on the current residence of their 5 Del. Code Ann. tit. 25, Del. Code Ann. tit. 25, 503(b). 7 Del. Code Ann. tit. 25, 503(e). 8 Del. Code Ann. tit. 25, 506. See Equitable Trust Co. v. Ward, 29 Del. Ch. 206, 224, 48 A.2d 519, (1946) (direction to accumulate income from Pennsylvania real estate by Delaware trustee of testamentary trust did not violate Pennsylvania rule against accumulations). [Section 6] 1 Del. Code Ann. tit. 30, 1601(8). 2 Del. Code Ann. tit. 30, 1102(a)(11). 3 Del. Code Ann. tit. 30,

15 Delaware Trusts 7 known or putative parents or other identifying persons. 4 Given that Delaware has a small population, few Delaware trusts pay Delaware income tax. 7 Prudent-investor rule followed In 1986, Delaware enacted the prudent-investor rule that permits a trustee to acquire virtually any type of investment and that assesses investment performance on the whole portfolio rather than on an asset-by-asset basis. 1 Nevertheless, because the express terms of the governing instrument are paramount, a client may direct a more liberal or a more restrictive investment policy than that authorized by the prudent-investor statute. 2 Delaware law permits a trustee to consider bene ciaries' other trust interests and resources in establishing the investment policy for a trust and no longer requires it to determine such a policy for each trust without regard to other factors. 3 Delaware law also relieves a trustee from liability for a life insurance policy held in a trust, provided that the insured is noti ed of such limitation of the trustee's responsibilities in the governing instrument or a separate writing. 4 Two Delaware cases have interpreted the prudent-investor rule to protect trustees from claims of breach of duciary duty for failing to diversify trust investments. In one case, the Delaware Supreme Court held that individual trustees did not breach their duciary duty or violate the prudentinvestor rule by investing the principal of a trust solely in tax-exempt bonds. 5 In the other case, the Delaware Court of Chancery rejected a bene ciary's complaints about the trust's lack of diversi cation because the individual trustee's failure to diversify resulted primarily from the bene ciary's refusal, 4 Del. Code Ann. tit. 30, 1636(b). [Section 7] 1 Del. Code Ann. tit. 12, Del. Code Ann. tit. 12, 3302(e), 3303(a). 3 Del. Code Ann. tit. 12, 3302(c). 4 Del. Code Ann. tit. 12, 3302(d). 5 Law v. Law, 753 A.2d 443 (Del. 2000) (prior cases found at: Law v. Law, 1999 WL (Del. Ch. 1999), a 'd in part, rev'd in part, 753 A.2d 443 (Del. 2000); and Law v. Law, 1997 WL (Del. Ch. 1997), a 'd in part, rev'd in part, 753 A.2d 443 (Del. 2000)). 11

16 7 Special Supplement as consent investment adviser, to approve the trustee's recommendations. 6 8 Division of responsibilities authorized Delaware law permits the testator or trustor to allocate distribution, investment, and administrative decisions among cotrustees, advisers, and/or protectors. For over a century, Delaware has recognized the directed trust a trust in which the trust instrument instructs the trustee to make investment decisions as directed by a person named in the trust instrument. This practice was codi ed in 1986, 1 and the statute speci es that a trustee will be liable for following the instructions of a direction adviser named in the governing instrument only if it engages in willful misconduct. 2 To recognize this diminished responsibility, Delaware corporate trustees customarily charge less to administer directed trusts than trusts over which they have investment duties. Upholding this statute, an unreported 2004 decision of the Delaware Court of Chancery held that a corporate trustee was not liable for a loss that resulted from the direction investment adviser's failure to instruct it to tender securities in an exchange o er. 3 Although the statute originally dealt only with investment matters, it was extended a few years ago to cover distribution and other decisions. Based on a 2001 Virginia decision, 4 the statute was amended to relieve a directed trustee from the duty to: (1) monitor the adviser's conduct; (2) provide advice to or consult with the adviser; and (3) warn the bene- ciaries in instances in which the trustee would have exercised discretion di erently. 5 That amendment also speci- ed that administrative actions taken by the trustee (e.g., 6 In re Couch Trust, 723 A.2d 376 (Del. Ch. 1998). [Section 8] 1 65 Del. Laws, c. 422 (1986). 2 Del. Code Ann. tit. 12, 3313(b). 3 Duemler v. Wilmington Trust Co., Del. Ch., C.A. No NC, 2004, Strine, V.C. (Nov. 24, 2004). 4 Rollins v. Branch Banking, Trust Co. of Va., 56 Va. Cir. 147, 2001 WL (2001). 5 Del. Code Ann. tit. 12, 3313(e). 12

17 Delaware Trusts 9 con rming the receipt of directions) will not be deemed an undertaking to assume a more active role in the trust. 6 The statute was amended in 2008 to recognize that a protector may be an adviser and to specify that an adviserprotector's duties may include the powers to: (1) remove and appoint trustees, advisers, trust committee members, and other protectors; (2) modify or amend the governing instrument to achieve favorable tax status or facilitate the e cient administration of the trust; and (3) modify, expand, or restrict the terms of a power of appointment. 7 A 2008 article observes that: 8 If the settlor wishes to have a true directed trust in which the trustee will follow the direction of an advisor, who may or may not be a co-trustee, without the trustee being required independently to evaluate the prudence of those directions, then the Delaware approach under which the trustee is liable for losses only in the event of wilful misconduct would appear optimal. Delaware also recognizes the delegated trust a trust in which the trustee hires an agent to advise it concerning trust investments. 9 Given that the trustee is responsible for the agent's performance, however, Delaware corporate trustees do not charge less to administer delegated trusts. 9 E ective third-party trusts available In the past, the creator of a third-party trust (i.e., a trust that the creator creates for bene ciaries other than the creator) could provide protection for a bene ciary from claims by his or her creditors by making the bene ciary's interest discretionary or by subjecting it to a spendthrift clause. The issuance of the Third Restatement of Trusts has called into question the e ectiveness of discretionary trusts and spend- 6 Del. Code Ann. tit. 12, 3313(e). 7 Del. Code Ann. tit. 12, 3313(f). 8 Clarke and Zeydel, Directed Trusts: The Statutory Approaches to Authority and Liability, 35 Est. Plan. 14, 22 (Sept. 2008). 9 Del. Code Ann. tit. 12,

18 9 Special Supplement thrift trusts in states that have not codi ed the traditional rules. 1 Delaware's statutes o er the needed protection. 10 E ective third-party trusts available Spendthrift trusts In 2008, Delaware's third-party spendthrift trust statute was restated to provide that: 1 (1) The creditors of a trust bene ciary generally have only such rights against the bene ciary's interest in the trust or the property of the trust that are expressly granted to them by the governing instrument and Delaware law; (2) The provision's protections apply regardless of the nature or extent of the bene ciary's interest or regardless of any action that the bene ciary takes or might take; (3) The protection is not limited in amount or subject to claims for willful torts; 2 (4) A bene ciary's interest that is not subject to the rights of his or her creditors is exempt from all legal or equitable process instituted by such creditors; (5) A bene ciary's creditor may not bring an action against the trustee or the bene ciary to: (a) compel the trustee or the bene ciary to notify the creditor of a distribution, (b) compel the trustee or the bene ciary to make a distribution, (c) prohibit the trustee from making a distribution to or for the bene t of the bene ciary, or (d) compel the bene ciary to exercise a power of appointment or revocation; (6) A bene ciary's voluntary, involuntary, direct, or indirect assignment of an interest that the governing instrument prohibits him or her from assigning is void; (7) A bene ciary may not waive a spendthrift clause's protections; [Section 9] 1 See 52 to 54. [Section 10] 1 Del. Code Ann. tit. 12, Parsons v. Mumford, 1989 WL (Del. Ch. 1989); Gibson v. Speegle, 184 Del. Ch. LEXIS 475, at *6 7 (Del. Ch. 1984). 14

19 Delaware Trusts 10 (8) The provision's protection extends to claims for forced heirship, legitime, marital elective share, or similar rights; (9) The provision's protection applies to a trust bene ciary's interest until trust property actually is distributed; (10) A trustee may make direct payment of a bene ciary's expenses even if the bene ciary has outstanding creditors; (11) A trustee is not liable to a bene ciary's creditors for paying the bene ciary's expenses; (12) Unless a trust meets the requirements of Delaware's Quali ed Dispositions in Trust Act, a spendthrift clause in a self-settled trust does not prevent the trustor's creditors from satisfying claims from the trustor's interest in the trust to the extent that such interest is attributable to the trustor's contributions; 3 (13) A trust may include a provision authorizing the trustee to reimburse the trustor for income taxes attributable to the trust on a discretionary basis without causing the trust to become self-settled; 4 (14) The possessor of a non-hanging Crummey power is not treated as the trustor due to the lapse, waiver, or release of the power; (15) A creditor of a trust bene ciary has no right against the bene ciary's interest solely because the bene ciary has a limited inter vivos or testamentary power of appointment over the trust; (16) A creditor of a trust bene ciary has no right against the bene ciary's interest solely because the bene ciary has a general inter vivos or testamentary power of appointment over the trust unless and to the extent that the bene ciary actually exercises the power; (17) A creditor of a trust bene ciary may reach the assets of a trust if and to the extent that the bene ciary may revoke the trust in his or her own favor; (18) A bene ciary receiving payments from a charitableremainder trust ( CRT ) may release his or her inter- 3 See Part IV below. 4 Rev. Rul , C.B

20 10 Special Supplement est in favor of a succeeding charitable bene ciary even if the CRT has a spendthrift clause. Although the Supreme Court of Delaware held that a wife could reach her husband's income interest in a third-party spendthrift trust to pay her claim for separate maintenance, 5 the court emphasized that: 6 We... consider that, for the purposes of the appeals before us, the record discloses solely that the individual parties are still husband and wife. The court concluded its opinion as follows: 7 It... remains to be seen, if the husband appears generally in this litigation and subjects himself to the jurisdiction of the Court of Chancery, whether, on nal hearing, his contentions with regard to his Mexican divorce will be ultimately upheld, in which event we assume that the wife would lose her status as wife, and there may be an entirely di erent situation then facing the Chancellor. This question, however, is not before us, and we make no ruling upon the future outcome of the course of the litigation. 11 E ective third-party trusts available Discretionary trusts Black's Law Dictionary de nes a discretionary trust as [a] trust in which the settlor has delegated nearly complete or limited discretion to the trustee to decide when and how much income or property is distributed to a bene ciary. 1 Historically, Delaware did not have a statute that covered the ability of creditors to reach a bene ciary's interest in such a trust. However, given the uncertainty that now exists on this issue, Delaware adopted legislation in 2007, which was revised in 2008, to provide that: (1) A bene ciary eligible to receive distributions from a trust in the trustee's discretion has a discretionary interest; 2 (2) A creditor may not directly or indirectly compel the 5 Garretson v. Garretson, 306 A.2d 737 (Del. 1973). 6 Garretson v. Garretson, 306 A.2d 737, 739 (Del. 1973). 7 Garretson v. Garretson, 306 A.2d 737, 742 (Del. 1973). [Section 11] 1 Black's Law Dictionary at 1548 (8th ed. 2004). 2 Del. Code Ann. tit. 12, 3315(b). 16

21 Delaware Trusts 12 distribution of a discretionary interest except to the extent expressly granted by the terms of a governing instrument in accordance with Delaware's third-party spendthrift trust statute; 3 (3) A court may overturn a trustee's decision regarding a discretionary interest only if it nds that the trustee abused its discretion within the meaning of Restatement Second, Trusts 187 not Restatement Third, Trusts 50 and E ective third-party trusts available Accounts in banks Creditors of non-delaware residents as well as Delaware residents may not reach assets of accounts in Delaware banks. The current statute provides as follows: 1 Banks, trust companies, savings institutions and loan associations... shall not be subject to the operations of the attachment laws of this State. This protection is not new. In fact, the earliest predecessor of the statute was enacted in Over the years, Delaware courts have read the protection broadly as follows: (1) Sterling v. Tantum (1915) 3 Funds in trust department of corporation having banking powers are exempt from attachment even though trust department is distinct from banking business; (2) Provident Trust Co. v. Banks (1939) 4 Filing of creditor bill in equity court does not enable creditors to reach assets of self-settled trust at Delaware trust company; (3) Bank of Delaware v. Wilmington Housing Authority 3 Del. Code Ann. tit. 12, Del. Code Ann. tit. 12, 3315(a). [Section 12] 1 Del. Code Ann. tit. 10, 3502(b) Del. Laws, c. 90 (1871). 3 Sterling v. Tantum, 28 Del. 409, 5 Boyce 409, 94 A. 176 (Super. Ct. 1915). 4 Provident Trust Co. v. Banks, 24 Del. Ch. 254, 9 A.2d 260 (1939). 17

22 12 Special Supplement (1976) 5 Wages of employee of Delaware bank are not subject to garnishment; (4) Delaware Trust Co. v. Partial (1986) 6 Request for temporary restraining order to enjoin withdrawal of funds from bank denied. However, Garretson v. Garretson held that the seizure by sequestration of spendthrift trust income in the hands of a bank as Trustee at the suit of a wife seeking maintenance from a husband is not an attachment within the meaning of Nevertheless, in the nonmarital context, a Delaware or non-delaware resident may obtain substantial protection from creditors by placing funds in a checking, savings, trust, or other account at a Delaware institution. Even in the marital context, an individual will be no worse o by so doing than he or she would have been by holding funds elsewhere and might be better o because, in Delaware Trust Co. v. Partial, the Delaware Court of Chancery indicated that Garretson has limited application: 8 It has been held that Section 3502 does not directly exempt Delaware banks from the operation of our sequestration process. The statute authorizing sequestration, however, and the Garretson case construing it is limited to the seizure of property to compel appearance and thus has no application to the case at bar. In addition, mandatory or discretionary distributions from a marital-deduction trust, a CRT, a revocable trust, an assetprotection trust, etc., into an account in a Delaware bank or trust company will insulate the funds from creditor claims. Although the statute prohibits attachment of assets in a non-bankruptcy context, it will not apply upon the ling of a petition under the United States Bankruptcy Code ( Bankruptcy Code ) unless the account ts within one of the limited exemptions or exclusions provided by the Bankruptcy Code. 5 Bank of Delaware v. Wilmington Housing Authority, 352 A.2d 420 (Del. Super. Ct. 1976). 6 Delaware Trust Co. v. Partial, 517 A.2d 259 (Del. Ch. 1986). 7 Garretson v. Garretson, 306 A.2d 737, 742 (Del. 1973). 8 Delaware Trust Co. v. Partial, 517 A.2d 259, 261 (Del. Ch. 1986) (internal citations omitted). 18

23 Delaware Trusts E ective self-settled trusts o ered Traditionally, the creator of a self-settled trust (i.e., a trust that the creator creates for bene ciaries including the creator) could not provide protection for the creatorbene ciary from claims by his or her creditors either by making the interest discretionary or by subjecting it to a spendthrift clause. Under Delaware's Quali ed Dispositions in Trust Act (e ective July 1, 1997), 1 a person may create an irrevocable Delaware trust: (1) which should not be reachable by creditors; and (2) from which he or she still may bene t. It appears that the trust also may be structured to be a completed gift for federal gift-tax purposes and to be excludable from the trustor's gross estate for federal estate-tax purposes Power to adjust and total-return unitrust statutes available On June 21, 2001, Delaware became the rst state to enact a total-return unitrust-conversion statute. 1 When the statute is available, the trustee may convert an income trust to a total-return unitrust with or without court approval. The trustee may select a unitrust percentage of not less than 3% nor more than 5%; decide how to account for and value illiquid assets; select the number of prior periods, if any, to use in calculating the unitrust amount; and determine whether the current bene ciary or the trust will pay income taxes attributable to capital gains incurred to make unitrust distributions. 2 In 2004, Delaware amended its total-return unitrustconversion statute to take account of three years of experience and the nal regulations that the Internal Revenue Service ( Service ) issued under 643 of the Internal Reve- [Section 13] 1 Del. Code Ann. tit. 12, 3570 to See Part IV below. [Section 14] 1 Del. Code Ann. tit. 12, Del. Code Ann. tit. 12,

24 14 Special Supplement nue Code of 1986 ( I.R.C. ) early that year. 3 The 2004 amendments also added a provision to Delaware law that recognizes newly created total-return unitrusts. 4 E ective August 1, 2005, Delaware adopted the power to adjust receipts and disbursements between income and principal under 104 of the 1997 Uniform Principal and Income Act ( UPAIA ) 5 as well as 105 of the UPAIA, 6 which governs judicial proceedings involving the power to adjust. Delaware's power to adjust speci cally authorizes the trustee to require the bene ciary to pay income taxes on capital gains adjusted to income. 7 Delaware's unitrust-conversion statute 8 and its power to adjust statute 9 provide that action taken under the statute is a matter of trust administration and that the statute is available to any trust administered in Delaware under Delaware law or to any trust, regardless of its place of administration, whose governing instrument provides that Delaware law governs matters of construction or administration. Thus, if moving a trust changes the law that governs its administration, the trust will be able to take advantage of these statutes. 15 Allocation rules exible Delaware law gives a trustee complete discretion to allocate receipts from royalties, copyrights, and patents between income and principal. 1 In addition, a Delaware trustee is authorized to cause a bene ciary who receives a distribution of income and principal to be taxed on capital gains. 2 3 See Part III below. 4 Del. Code Ann. tit. 12, 3527A. 5 Del. Code Ann. tit. 12, Del. Code Ann. tit. 12, Del. Code Ann. tit. 12, 6113(h). 8 Del. Code Ann. tit. 12, 3527(l). 9 Del. Code Ann. tit. 12, 6113(g). [Section 15] 1 Del. Code Ann. tit. 12, 6102, Del. Code Ann. tit. 12, 3325(30). 20

25 Delaware Trusts Court system superior A Delaware court will not become involved in the administration of a trust unless an interested party seeks relief. When judicial involvement is needed (e.g., when the proper interpretation of the governing instrument is uncertain or a duciary is believed to be acting in breach of duty), prompt and e cient relief is available in the Delaware Court of Chancery and, if necessary, the Delaware Supreme Court. The Chancellor and the Vice-Chancellors of the Delaware Court of Chancery and the Justices of the Delaware Supreme Court (the courts that handle corporate as well as duciary matters in Delaware) are not elected. Instead, the Delaware Constitution requires that they be appointed by the Governor with the consent of a majority of the members of the Senate and that all Delaware judges come as equally as possible from the two major political parties. 1 For this and other reasons, Delaware's liability system is ranked as the best in the country in a 2008 study conducted for the U.S. Chamber Institute for Legal Reform (a separately incorporated a liate of the U.S. Chamber of Commerce). 2 Delaware's merit-based appointive judicial selection process and its political-party balance requirement and the Delaware Supreme Court's custom of rendering unanimous decisions, the mandatory nature of its jurisdiction, and its internal operating procedures have made that court the preeminent state appellate court in the country. 3 Trust administration ordinarily is not supervised by the Delaware courts, and this practice can produce substantial savings in accounting and other court costs over the duration of a trust. Unless ordered by the court, a trustee is not required to le an inventory or reports with the Court of [Section 16] 1 Del. Const. Art. IV, 3. 2 The State Liability Systems Ranking Study, dated April 15, 2008, conducted by Harris Interactive for the U.S. Chamber Institute for Legal Reform (a separately incorporated a liate of the U.S. Chamber of Commerce). The study was based on interviews with 957 practicing corporate attorneys and general counsels from December 18, 2007, to March 19, 2008, available at mate2008/index.cfm (last visited Jan. 12, 2009). 3 See Holland and Skeel, Jr., Deciding Cases Without Controversy, 5 Del. L. Rev. 115, (2002). 21

26 16 Special Supplement Chancery for an inter vivos trust whenever created or for a testamentary trust created or moved to Delaware after July 31, In Delaware, a bene ciary may not hold a trustee liable for a breach of trust if the bene ciary, with or without consideration, released the trustee from liability for the breach or consented to or rati ed the transaction. 5 This statute facilitates exercises of decanting powers and other nonjudicial modi cations of Delaware trusts. There is little reason to have judicial accountings in Delaware because they do not have res judicata e ect other than for matters to which exceptions have been taken and that have been determined by the court. 6 Indeed, a trustee that les a judicial accounting simply to obtain exculpation might have to pay the cost of the accounting itself. 7 Unlike courts in many other states, the Delaware courts welcome requests for declaratory judgments. Hence, a Delaware statute provides that: 8 Any person interested as or through an executor, administrator, trustee, guardian or duciary, creditor, devisee, legatee, heir, next-of-kin or cestui que trust, in the administration of a trust, or of the estate of a decedent, an infant, a person mentally ill or insolvent, may have a declaration of rights or legal relations in respect thereto: (1) To ascertain any class of creditors, devisees, legatees, heirs, next-of-kin or others; or (2) To direct the executors, administrators or trustees to do or abstain from doing any particular act in their duciary capacity; or (3) To determine any question arising in the administration of the estate or trust, including questions of construction of wills and other writings. A petition for declaratory judgment might be led, for example, to resolve ambiguity regarding the identity of bene ciaries of a trust. 4 Del. Code Ann. tit. 12, Del. Code Ann. tit. 12, Del. Ct. Ch. R In re Corcoran Trusts, 282 A.2d 653 (Del. Ch. 1971), order a 'd, 295 A.2d 725 (Del. 1972). 8 Del. Code Ann. tit. 10,

27 Delaware Trusts 17 E ective December 3, 2007, 9 all miscellaneous petitions involving trusts in Delaware (e.g., to reform a trust) must be led electronically. 10 Such petitions may request that the record be sealed and do not require the ling of a court accounting. Delaware attorneys report that if a petition to reform a trust is accompanied by all requisite consents, the petition may be carefully reviewed and approved by the Court of Chancery within a few days. No other jurisdiction can match the quality, timeliness, and tradition of Delaware's judicial system. 17 Planning option for NIMCRUTs exists Under a section of Delaware's Principal and Income Act, if a charitable-remainder unitrust ( CRUT ) adopts the provisions of that section by reference, an increase in the value of a zero coupon bond, an annuity contract before annuitization, a life insurance contract before the death of the insured, an interest in a common trust fund, a partnership interest, or any other obligation for the payment of money that is payable at a future time in accordance with a xed, variable, or discretionary schedule of appreciation in excess of the price at which it was issued is not distributable until it becomes available for distribution (i.e., when the trustee receives cash on account of the obligation). 1 This provision is designed to permit persons who do not need signi cant income in the early years of a net income with makeup charitable-remainder unitrust ( NIMCRUT ) to defer the receipt of income until later years when they are presumably in a lower income-tax bracket and in need of supplemental retirement income, with the NIMCRUT e ectively functioning as a deferred-compensation arrangement. Private letter rulings approved CRUTs that contained provisions based on similar state statutes. 2 9 Administrative Directive of the Chancellor of the Court of Chancery of the State of Delaware No efile Administrative Procedures (Oct. 15, 2007). 10 Del. Ct. Ch. R [Section 17] 1 Del. Code Ann. tit. 12, 6112(a). 2 See Priv. Ltr. Ruls ,

28 18 Special Supplement 18 Charitable trust laws superior The trustor, or a person or persons whom he or she designates, may maintain an action to enforce a charitable trust in Delaware. 1 Commentators observe that Delaware's provision is superior to 405(c) of the Uniform Trust Code ( UTC ) because it authorizes the trustor to designate someone to enforce his or her wishes after he or she cannot do so. 2 Previously, Delaware's cy pres statute permitted a court to intervene if a charitable trust's purposes become unlawful, impracticable, impossible to achieve or wasteful. 3 In 2007, Delaware legislation narrowed the cy pres statute so that a court may become involved only if a particular charitable purpose becomes unlawful under the Constitution of this State or the United States or the trust would otherwise no longer serve any religious, charitable, scienti c, literary, educational, or noncharitable purpose Transfer to successor trustee facilitated According to regulations under I.R.C. 2601, a trust that is grandfathered for purposes of the federal generationskipping transfer tax ( GST tax ) because it was irrevocable on September 25, 1985, will lose its tax-favored status if it is modi ed in a way that lengthens its duration. 1 Delaware law speci es that the duration of a trust will not change merely because its place of administration is moved to Delaware. 2 Another Delaware statute stipulates that the administration of a trust will be governed by Delaware law while the trust is administered in Delaware unless the governing instrument or a court order provides otherwise. 3 In certain circumstances, this statute will permit a trust, which previ- [Section 18] 1 Del. Code Ann. tit. 12, 3303(b). 2 Covey and Hastings, Delaware 2005 Changes in Trust Statutes, Prac. Drafting 8275 (Oct. 2005). 3 Del. Code Ann. tit. 12, 3541, 72 Del. Laws, c. 388 (2000). 4 Del. Code Ann. tit. 12, 3541(a). [Section 19] 1 Treas. Reg (b)(4)(i)(E), Example 4. 2 Del. Code Ann. tit. 12, 3332(a). 3 Del. Code Ann. tit. 12, 3332(b). 24