Founded as an independent trust company in 1994, Houston Trust Company has a strong history of fiduciary culture. While Trust Administration does adapt and change to the times, the core tenets of trusteeship remain the same. “The essence of trusteeship is that the trustee shall serve the beneficiary with complete singleness of purpose … outside interests must be eliminated.”1 Trusteeship can be, and often is, a long-term proposition, extending down through multiple generations. It entails a careful adherence to governing documents through the prism of statutes, rules, regulations, and common law principles developed over centuries. With this issue of Viewpoints, we attempt to outline the principles of trust administration and the role of the Trustee, or “fiduciary”, who must balance the requirements and rigors of administration with the expectations and needs of the beneficiaries.
The term “trust” refers to any type of arrangement whereby a transferor, also referred to as a “grantor”, “settlor”, or “donor”, transfers property to another party, the “trustee”, with the intention that it be administered for the benefit of another, the “beneficiary”. Trusts are created and governed by a written document, usually either a trust agreement (“inter vivos” trust) or the grantor’s will (“testamentary” trust). A well-drafted trust will specify who the beneficiaries are, who may receive distributions, when, and for what purposes, how the trust estate is to be invested and accounted for, various powers and restrictions of the trustee, the line of succession of both the trustee and beneficiaries, the standards of trustee behavior and liability, and other relevant provisions.
Most professionally-drafted trust instruments are very well-written. However, the trustee may occasionally encounter an out-of-date or poorly-drafted instrument, which might contain vague or conflicting provisions. Or, the trust instrument may contain tortuously complex provisions. If the governing document is silent or unclear as to a particular item, the trustee must refer to applicable legal authorities to determine the proper interpretation of the item in question by consulting statutes, rules, regulations, case law, and/or other interpretive guidance. Sometimes, the trustee must retain legal counsel to get to an answer, both for the trustee’s and beneficiary’s protection, and in rare cases, the trustee even may have to petition the court for a ruling to provide further guidance. In all of these instances, the trustee must be able to use these tools effectively to discern the grantor’s intent, make a good faith effort to comply with that intent, and be prepared to defend the trustee’s decisions.
Trust administration begins with the initial funding of the trust estate. It is the moment the trustee is called into action. This event may occur at the time of creation of an inter vivos trust, but it also often occurs during estate administration. In contrast to estate administration, which typically lasts only a few years, trust administration can be a very long-term prospect and may continue for several generations.
There are two types of trustees—individual trustees and corporate trustees. Individual trustees are often family members or trusted family friends. A corporate trustee is an entity that has “trust powers”, meaning it is a corporation authorized to serve as a trustee under the probate and trust codes of a particular state or states. Corporate trustees may serve alone or together with one or more individual trustees. Although most any adult can be appointed to serve as a trustee, special expertise in the proper administration of a trust must be learned or hired. At a minimum, any individual serving as a trustee should possess strong organizational, analytical, and communication skills. Ideally, an individual trustee also should have access to bookkeeping infrastructure, investment, legal, and tax advice, and the ability to devote proper time and resources to the administration. A corporate trustee will have all of the forgoing, as well as capital backing, regulatory oversight, and proper insurance.
Assuming Trusteeship/Fiduciary Duties
To begin, a prospective trustee should carefully read and fully understand the provisions of the governing document (either the trust instrument or the will creating the trust) before acceptance of the appointment. There are certain duties that must be adhered to by a trustee, which are inherent in the Texas Trust Code, but made clear in case law. Among others, these duties include the duty of loyalty, the duty to retain control of and preserve trust property, and the duty to keep and render accounts. First and foremost, however, is a trustee’s duty to administer the trust in good faith according to its terms and applicable law.
To elaborate, a trustee must place beneficiaries’ interests before those of the trustee and avoid self-dealing. Although joint investments may be made, the trustee must keep assets held in trust separate from those of the trustee or of others for whom the trustee manages assets. A trustee also must deal impartially with trust beneficiaries.
With regards to trust property, a trustee must take control of all trust property, protect it, and invest it as a prudent investor would. If the trustee possesses special skills, he or she must put those skills to use both in relation to beneficiaries and the trust property. Should any claims be made against a trust, the trustee must defend it, or alternatively, enforce claims should the need arise.
A trustee must keep complete and accurate records of trust activities and should render periodic statements to beneficiaries. It also should be noted that proper trust administration utilizes trust accounting, which is a specialized system of accounting that tracks principal and income somewhat differently from GAAP accounting or Quick Books. The differentiation between principal and income is paramount to trust transactions. For example, the trust instrument may require periodic distribution of “net income” —income received less expenses of the trust. As trust accounting does not always follow financial or income tax accounting rules, some receipts and disbursements may be allocable partly to income and partly to principal. In order to properly calculate the necessary distributions, a trustee must have knowledge of these distinctions and administer the trust accordingly.
A trustee must keep beneficiaries reasonably informed of material facts regarding the trust and should communicate regularly with beneficiaries. The trustee may employ agents and advisors to assist with certain trust functions; however, some functions cannot be delegated, and the trustee must exercise care in the selection and supervision of such agents. In any case, expenses incurred in trust administration must be reasonable.
Finally, perhaps the most important duty of a trustee is to communicate. A trustee should correspond with beneficiaries regularly and meet with beneficiaries as needed. Doing so will help mitigate the consequences of any misunderstanding.
While a trust’s governing document may modify a trustee’s fiduciary duties to some extent, a conscientious trustee will follow the common law duties to the best of his or her ability. And while a trustee must be flexible in its thinking to find workable solutions, the trustee should be consistent in the discharge of these duties.
Who Should Serve As Trustee
Turning to the appointment of a trustee, it is common for an individual to name their spouse or one or more of their children—typically the oldest—to serve. Although these arrangements can and do work for some families, we have observed how they also can turn ugly, destroying family relationships and consuming the family’s wealth.
Courthouse case records are replete with stories of family fiduciary appointments gone wrong, resulting in diminishment or even total loss of the estate or trust. Sometimes these losses are caused by the family-member fiduciary’s inexperience, while outright fraud or theft of estate or trust assets may have occurred in others.
A surviving spouse trustee, though genuinely well-intentioned, may be vulnerable and fall prey to the influences of one or more descendant factions or the wants of an opportunistic new spouse and their progeny. In any case, these individuals frequently do not have prior experience in serving as a trustee and often are not aware of the duties, tasks, and responsibilities required, much less of their own personal liability for breach of trust.
The trust creator may wish to name one or more descendants, typically the children, to serve as trustee for the family. The difficult task of “choosing the right trustee” may be complicated by the fact that children and other descendants will hide intra-family hostilities while the parent trust creator remains alive. However, once this individual has passed, long-simmering rivalries among siblings and other family members can re-surface, causing at minimum intra-family strife, and possibly full-blown feuds.
One way to avoid such an event is the appointment of a corporate trustee. Corporate trustees usually have no immediate ties to the beneficiaries, and therefore, are able to remain impartial and help navigate difficult family relationships. Corporate trustees also are subject to state and federal regulations and are held to a very high standard of care.
A trust estate may be comprised of virtually any type of property. Among the asset types trusts may hold are cash, investment securities, private investment funds, commodities contracts, real estate, mineral and royalty interests, timber and farming/ranching interests, tangible property, rare collections, precious metals, notes and mortgages, and the like. A trustee is responsible for the proper handling and management of everything held in trust. Proper asset allocations and investment plans are necessary and must be governed by the boundaries of the trust instrument (and the law). At the same time, they need to be aligned with the interests of the beneficiaries.
Generally, a Texas trustee is under a duty to comply with the Texas Prudent Investor Act. This act allows the trustee to make a wide range of investments, but also requires diversification of trust assets by default— unless special circumstances exist such that the trust estate would be better off by not diversifying. Two examples of special circumstances include if a trust would suffer an extraordinary tax impact as a result of full diversification of a concentrated holding, or, if a trust held a highly illiquid asset that could not be sold or liquidated without great expense or loss to the trust estate. The inclusion of a non-diversification clause in the trust agreement might offer some comfort, but the extent to which the trustee is protected from failing to diversify can be contested.
The assets and liabilities held by a trust estate figure prominently into its overall investment, risk, and income tax profiles. As such, the trustee must have a working understanding not only of the potential value the assets and liabilities may contribute, but also of their relative risks and tax attributes. In some cases, the individual trustee will possess no specialized understanding or knowledge of these matters. In others, the trustee may have a background in law, tax, investments, or general business. However, rarely is an individual adequately equipped to handle all aspects of a complex portfolio holding multiple asset classes. In such cases, the value proposition for engaging a corporate fiduciary is particularly strong, as the entity’s professional staff can provide a broader spectrum of skill sets and experience and also will have quick access to highly-specialized outside expertise when needed.
A trustee may also borrow funds, issue notes, and pledge or mortgage trust-owned property. In doing so, the trustee should carefully consider all of the relevant facts and circumstances. Why is it necessary to borrow? What is the purpose of the loan? What are the terms? Who is the lender?
Ultimately, a trustee is responsible for all trust property while it is under administration and must have the resources and wherewithal to manage and protect that property.
And now, we come to trust distributions, where everything discussed above comes into play—the trust document, fiduciary duties, income and principal accounting, impartiality, and the proper governance of trust assets. Invariably, a trust’s governing document will contain provisions addressing distributions to beneficiaries. It may specify to whom distributions may be made (if at all), how much can (or must) be distributed, when distributions may (or must) be made, and the reasons for which distributions may be made. Depending on the language used in the governing document, this piece of trust administration can be among the simplest—or the most challenging— aspects of the trustee’s day-to-day duties.
Standard trust distribution language is often known as “HEMS” whereby a trustee can distribute income and/or principal for a beneficiary’s health, education, maintenance and support. This so-called “ascertainable” standard may be further qualified (or limited) by allowing or requiring a trustee to consider the beneficiary’s “resources outside of trust” or to take into consideration a beneficiary’s “happiness” or “well-being”. Requests for distributions to pay college tuition are relatively straightforward and easy to approve. Requests for funds to purchase a car can be more complicated. In general, a car would be necessary for a beneficiary’s maintenance and support, but what if the car is a Porsche convertible?
Although many trust instruments contain “standardized” distribution standards, such as “HEMS”, or “best interests”, or mandatory net income distributions, the drafting possibilities are virtually endless. The one constant, however, is that the trustee is duty-bound to adhere to the standard expressed in the trust instrument. A trustee runs the risk of breaching the trust either by making an unauthorized distribution or failing to make a required distribution. Worse yet, improper distributions could open the integrity of the trust estate to challenge by the beneficiary’s creditors.
Serving as trustee can be a long-term commitment; one that spans multiple generations. As outlined in this issue of Viewpoints, trusteeship requires careful adherence to the governing document and a comprehensive knowledge and understanding of statues, rules, regulations, and common law principles. A conscientious fiduciary must keep well-informed of these variables in order to navigate the requirements and rigors of administration while managing the expectations and needs of the beneficiaries.
We have observed that individuals often find themselves frustrated by the complexity of the issues presented during trust administration and typically are not in a position to devote the time or expertise required to do the job correctly over a sustained period time. In other cases, mishandling of trust assets can create interpersonal problems and even result in litigation. As such, a corporate fiduciary, whether serving alone, as a co-fiduciary, or as an agent for the appointed individual, can provide the desired objectivity, continuity, and professionalism, to ease the burden of all interested parties. Although the corporate fiduciary must be compensated for its services, such compensation usually results in efficiencies to the trust estate, the long-term benefits of which outweigh the costs.