The following is not intended to be a comprehensive discussion of the law of trusts. Instead, it is intended to provide an overview of trusts and an explanation of the meaning of some of the terms that are commonly found in trusts.
Trusts are a common, and at times complex, planning tool utilized in a variety of contexts for a variety of purposes. The terms and complexity of a trust arrangement are generally dependent on the estate planning, business and succession planning, tax planning, and/or asset protection planning objectives of the client and commonly involve all of the foregoing objectives particularly for high net worth clients.
Clients may be motivated to utilize trusts for a variety of reasons. Their goals range from avoiding probate at death to reducing wealth transfer tax exposure, business succession planning and asset protection planning for heirs. Trusts can be valuable planning tools in appropriate circumstances. However, a trust’s usefulness is highly dependent on a series of factors including the timing of the trust’s creation; the identity and status of the settlor, trustee and beneficiaries; the terms of the trust, including its governing law; and the assets to be contributed to the trust. Trusts often contain certain key provisions, which are discussed below.
A trust is defined as “a fiduciary relationship with respect to property, subjecting the person for whom the property is held to equitable duties to deal with the property for the benefit of another person, which arises as a result of a manifestation of an intention to create it.” See, e.g., Sinclair v. Travis, 231 N.C. 345, 353, 57 S.E.2d 394, 400 (1950); Restatement (Third) of Trusts § 2 (2003). The relationship results from the separation of equitable and legal title to identifiable property. Sinclair v. Travis, 57 S.E.2d at 400. A trust cannot exist in the absence of any one of the following: (i) identified property, (ii) a person, commonly referred to as a “trustee,” with certain fiduciary duties relating to the identified property, and (iii) beneficiaries to whom the fiduciary’s duties are owed. See N.C.G.S. § 36C-4-401 (requiring the transfer of property to a trustee for the creation of a trust); N.C.G.S. § 36C-4-402 (requiring a trust to have a “definite beneficiary or be a charitable trust, trust for the care of an animal, or certain trusts for noncharitable purposes). Accordingly, it is important to understand the identity and scope of the primary parties to the trust relationship: the settlor, trustee and beneficiary.
A “settlor” is the statutory term used to describe any person who “creates” a trust or “contributes” property to a trust. N.C. Gen. Stat. §36C-1-103(17). Often trust agreements employ a series of terms when referring to the “settlor,” including the terms “trustmaker” and “grantor.” Those terms may usually be treated as synonymous with the term “settlor” for state law purposes. However, one must carefully evaluate the trust agreement to determine whether the designated individual falls within the functional definition of a “settlor” no matter the title (or lack thereof) provided in the trust agreement.
As one’s status as a “settlor” is dependent on the function he or she serves with respect to the trust, it is entirely possible for a person to contribute assets to a trust and therefore be properly designated a “settlor” of that trust for state law purposes without any formal mention of the individual in the trust agreement. What matters is the act of contributing property to the trust rather than the label provided to the individual in the trust document. If more than one person creates or contributes property to a trust, each person is a settlor of the portion of the trust property attributable to that person’s contribution except to the extent another person has the power to revoke or withdraw that portion of the trust property. Id.
The settlor of a trust relinquishes legal title to property conveyed to a trust to the “trustee.” Legal title to trust property is therefore vested in the trustee with equitable title vested in the beneficiaries of the trust. The settlor generally has no protectable interest in an asset once the asset is transferred to the trustee unless the settlor retains a separate status or relationship with the trust giving the settlor an enforceable or protectable interest in or over the trust property.
In most circumstances the identity of the trustee will be clear by express reference to a person as the “trustee” or a “trustee.” In the rare case where the role of a person as a trustee is unclear, the definition of a “trustee” provided by the North Carolina Uniform Trust Code is not generally helpful. N.C.G.S. § 36C-1-103(22) provides a circular definition of “trustee” in that a “trustee” includes “an original, additional, and successor trustee, and a cotrustee, whether or not appointed by a court.” Again, one must look past the presence or absence of a specific label provided to a person in the trust document and carefully evaluate the function that person is serving with respect to the trust property to determine if that person is properly categorized as a “trustee.”
A trustee is a fiduciary with respect to the trust property vested in the trustee’s name. As a fiduciary, a trustee is generally subject to a series of duties with respect to the trust property and the beneficiaries. The following represent the common duties of a trustee. Importantly, the terms of trust may limit or even eliminate these duties generally or with respect to a specific matter or asset.
Upon acceptance of a trusteeship, a trustee is under a duty to “administer the trust in good faith, in accordance with its terms and purposes and the interests of the beneficiaries, and in accordance with [the North Carolina Uniform Trust Code].” N.C.G.S. § 36C-8-801. This general statement confirms the primary duty of the trustee is to follow the terms and purposes of the trust instrument and to do so in good faith. A trustee must administer the trust “as a prudent person would, by considering the purposes, terms, distributional requirements, and other circumstances of the trust” using “reasonable care, skill, and caution.” Id. § 36C-8-804. Accordingly, a trustee is under a duty to act in accordance with this “prudent trustee” standard of care unless the standard is modified by the terms of the trust.
The duty does not arise until the trustee accepts the trusteeship. A person accepts a trusteeship by either substantially complying with a method of acceptance provided in the terms of the trust or, if the terms of the trust do not provide a method or the method provided in the terms is not expressly made exclusive, by accepting delivery of the trust property, exercising powers or performing duties as trustee, or otherwise indicating acceptance of the trusteeship. N.C.G.S. § 36C-7-701. Taking actions to preserve the trust property is not considered an acceptance of the trusteeship if the person sends a rejection of the trusteeship to the settlor or, if the settlor lacks capacity, to a qualified beneficiary within a reasonable time after acting. Id. § 36C-7-701(c)(1). Likewise, merely inspecting or investigating trust property to determine potential liability under environmental or other law or for another purpose is not considered accepting the trusteeship. Id. § 36C-7-701(c)(2).
In addition to the duty to prudently administer the trust, the trustee is under a duty of loyalty. Specifically, the trustee must administer the trust “solely in the interests of the beneficiaries.” N.C.G.S. § 36C-8-802(a). This duty makes clear that a trustee may not place his or her interests or the interests of a third party over the interests of the beneficiaries. Conflicts of interest are not uncommon in situations where the trustee has another relationship with the trust, such as settlor, beneficiary, or holder of an investment in which the trustee has a personal investment. A transaction tainted by a personal conflict of interest with the trustee is voidable by a beneficiary affected by the transaction without regard to whether the transaction is fair to the beneficiary unless (i) the terms of the trust authorized the transaction, (ii) the court approved the transaction, (iii) the beneficiary did not commence a judicial proceeding within the time allowed by statute, (iv) the beneficiary consented to, ratified or released the trustee with respect to the transaction, or (v) the transaction involved a contract entered into, or a claim acquired by, the trustee before the person become or contemplated becoming trustee. N.C.G.S. § 36C-8-802(b).
Certain transactions, however, are only rebuttably presumed to be affected by a conflict of interest, meaning that the transaction may withstand scrutiny if the trustee can demonstrate it was fair to the affected beneficiaries. N.C.G.S. § 36C-8-802(c). Generally these transactions are made between the trust and certain persons with close ties to the trustee including (i) the trustee’s spouse or a parent of the trustee’s spouse, (ii) the trustee’s descendants, siblings, ancestors, or their spouses, (iii) an agent, attorney, employee, officer, director, member, manager, or partner of the trustee, or an entity that controls, is controlled by, or is under a common control with the trustee, or (iv) any other person or entity in which the trustee, or a person that owns a significant interest in the trust, has an interest or relationship that might affect the trustee’s best judgment. Id.
A trustee’s investment decisions are excepted out of these general conflict of interest provisions under certain circumstances. If the trustee invests in an investment company, investment trust, or pooled investment vehicle in which the trustee or its affiliate has an investment, to which the trustee, or its affiliate, provides services for compensation, the relationship is not presumed to be affected by a conflict between the trustee’s personal and fiduciary interests if the investment otherwise complies with the prudent investor rule discussed below. N.C.G.S. § 36C-8-802(f)(1). However, a trustee must vote shares of stock or exercise other similar powers of control over business enterprises in a manner that is in the best interest of the beneficiaries. Id. § 36-8-802(g). This includes appointing directors or other managers who will manage the corporation or enterprises in the best interests of the beneficiaries. Id. The duty to vote business interests in the best interests of the trust beneficiaries may prove particularly difficult in situations where the primary asset of the trust is a closely-held family business in which the trustee has personal interests.
A particularly thorny duty is the trustee’s duty of impartiality among the beneficiaries. “If a trust has two or more beneficiaries, the trustee shall act impartially in investing, managing, and distributing the trust property, giving due regard to the beneficiaries’ respective interests.” N.C.G.S. § 36C-8-803. Beneficial interests, as discussed more fully below, come in a plethora of complex and often conflicting varieties. A beneficiary may be one of many for which discretionary distributions can be made or may hold only a current income interest. The other members of the class of potential distributees or a beneficiary of the principal interest may well favor a different distributional scheme or investment portfolio than another beneficiary. Absent some overriding guidance from the trust document, the statutory default is that the trustee must act impartially in the trustee’s decision-making, most commonly in the area of investments, distributions and the allocation of receipts between income and principal. In the area of investment decisions, compliance with certain default rules under the North Carolina Uniform Prudent Investor Act may be required to strike the proper impartiality. While a comprehensive discussion of the duty of impartiality is beyond the scope of this manuscript, what is clear is that the trustee must act reasonably in light of the purposes and terms of the trust giving due regard to any beneficiary relationship that may appear tainted by a conflict of interest.
Unless the terms of a trust expressly provide otherwise, a trustee must comply with the North Carolina Uniform Principal and Income Act (“NCUPIA”). N.C.G.S. § 37A-1-103(a). NCUPIA provides a series of rules regarding the allocation of receipts to income and principal. A comprehensive discussion of NCUPIA is beyond the scope of this manuscript. However, one should be aware that the concept of taxable income and trust “income” are separate concepts that produce substantially different results for beneficiaries entitled to income or principal respectively. NCUPIA contains significant provisions governing the charging of expenses to income or principal, the presumed portion of income of certain receipts, the timing and appropriateness of distributions from income or principal, and certain discretion given to a trustee regarding the ability to adjust the allocation of a receipt between income and principal.
An implicit duty that arises within a trustee’s duty to act prudently with regard to trust administration is the trustee’s duty to keep adequate records. Id. § 36C-8-810(a). A question, however, is to what degree and extent a trustee has a duty to inform and report to the beneficiaries. In North Carolina, a trustee is under a duty to provide reasonably complete and accurate information as to the nature and amount of the trust property, at reasonable intervals, to any qualified beneficiary who is a distribute or permissible distributee of trust income or principal. N.C.G.S. § 36C-8-813(a)(1). In addition, a trustee must provide a copy of the trust instrument, reasonably complete and accurate information as to the nature and amount of the trust property, and allow reasonable inspections of the subject matter of the trust and the accounts and other documents relating to the trust upon a reasonable request of any qualified beneficiary. Id. § 36C-8-813(a)(2). As a result, a trustee must, without prompting, provide certain information at regular intervals to qualified beneficiaries who may be distributed income or principal, but is only require to respond to requests for information from other qualified beneficiaries.
A trustee is presumed to have discharged the trustee’s duty to inform and report to a qualified beneficiary for matters disclosed by a report sent at least annually and at termination of the trust to the beneficiary that describes the trust property, liabilities, receipts, and disbursements, including the source and amount of the trustee’s compensation, and lists the trust assets and their respective market values, including estimated values of assets with uncertain values. Id. § 36C-8-813(b).
Unless expanded, restricted, eliminated, or otherwise altered by the terms of the trust, a trustee who invests and manages trust assets owes a duty to the beneficiaries of the trust to comply with the prudent investor rule set forth in North Carolina Uniform Prudent Investor Act. N.C.G.S. § 36C-9-901. A trustee must “invest and manage trust assets as a prudent investor would, by considering the purposes, terms, distribution requirements, and other circumstances of the trust” while exercising reasonable care, skill and caution. N.C.G.S. § 36C-9-902(a). This standard of care requires a trustee to evaluate investment and management decisions not in isolation but in the context of the trust portfolio as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the trust. Id. § 36C-9-902(b). The circumstances that a trustee should consider include general economic conditions, the possible effect of inflation or deflation, the expected tax consequences of investment decisions or strategies, the role that each investment plays within the overall trust portfolio, the excepted total return from and income and the appreciation of capital, other resources of the beneficiaries known to the trustee, needs for liquidity, regularity of income, and preservation or appreciation of capital, and an asset’s special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries. Id. § 36C-9-902(c). No particular investment type is prohibited so long as it complies with the standards of the rule.
Significantly, a trustee is required to diversify the investments of the trust unless the trustee reasonably determines that, because of special circumstances, the purposes of the trust are better served without diversifying. Id. § 36C-9-903. This duty can be particularly problematic if the trust does not alter the prudent investor rule with regard to diversification if the trust assets are comprised of closely-held business interests.
A trustee has a “reasonable time” after accepting the trusteeship or receiving trust assets to review the trust assets and make and implement decisions regarding investments to bring the trust portfolio into compliance with the purposes, terms, distributions requirements, and other circumstances of the trust, and with the requirements of the North Carolina Uniform Prudent Investor Act. § 36C-9-904.
A trustee’s foregoing duties may be, and often are, modified by the terms of the applicable trust. The terms of a trust prevail over any default provision under the NCUTC, NCUPIA, or NCPIA except: (i) the requirements for creating a trust; (ii) the duty of a trustee to act in good faith and in accordance with the terms and purposes of the trust and the interests of the beneficiaries; (iii) the requirement that a trust and its terms be for the benefit of its beneficiaries, and that a trust have a purpose that is lawful, not contrary to public policy, and possible to achieve; (iv) the power of a court to modify or terminate a trust; (v) the effect of a spendthrift provision and the rights of certain creditors and assignees to reach a trust, (vi) the effect of an exculpatory term relating to the Trustee, (vii) the rights of certain persons other than a trustee or beneficiary, (viii) the period of limitation for commencing a judicial proceeding, (ix) the power of the court to take any action and exercise any jurisdiction as may be necessary in the interests of justice, (x) the subject-matter jurisdiction of the court and venue for trust proceedings, and (xi) certain powers to alter beneficiaries or renounce an interest over property. N.C.G.S. § 36C-1-105(b).
Trusts commonly modify a trustee’s duties, particularly with regard to the duty of impartiality, duty of loyalty, duty to comply with the prudent investor standard, and duty to inform and report to the beneficiaries. In most cases, such modifications will be respected, but one will want to examine the trust document carefully to determine the scope and degree of the modified duty, the trustee’s compliance with the duty, and the modification’s compliance with G.S. § 36C-1-105(b).
A “beneficiary” is any person, whether born or unborn, who has a present or future beneficial interest in a trust, vested or contingent, including the owner of an interest by assignment or transfer, but exclusive of a permissible appointee of a power of appointment. A beneficiary also includes anyone, other than the trustee, who holds a power of appointment over trust property. N.C.G.S. § 36C-1-103(3). Accordingly, anyone with the right or potential right to enjoy or appoint the trust property, in whole or in part, is a beneficiary except if that person’s ability to receive or enjoy the trust property is part of a class of potential beneficiaries under a power of appointment held by another person. The “interests of the beneficiaries” are defined as the “beneficial interests provided in the terms of the trust.” Id. § 36C-1-103(9). Accordingly, the terms of the trust dictate who are the beneficiaries and the extent of their interests.
Practitioners will encounter a variety of beneficial interests in trusts ranging from the common to the extraordinary. Often, the scope and extent of beneficial interests are carefully crafted by planning attorneys through thoughtful balancing of the settlor’s intentions and objectives, administrative efficiency, tax savings and compliance, and flexibility in the event of future changes in relationships or circumstances of the beneficiaries.
For purposes of the NCUTA, there is at times a significant distinction between a “beneficiary” generally and a “qualified beneficiary.” Status as a “qualified beneficiary” may entitle the beneficiary to receive certain notices regarding decanting, changes of situs or governing law, or even trust modifications. A qualified beneficiary may also be entitled to reports and information about the trust assets and administration whereas a beneficiary more generally may not be. In still other cases, the consent of a qualified beneficiary may be required or desired in order for the trustee to take certain needed or desired action. Accordingly, a beneficiary’s status as a “qualified beneficiary” may be very important under certain circumstances.
A “qualified beneficiary” is a living beneficiary whom, on the date of the beneficiary’s qualification is determined, any of the following apply: (i) is a distributee or permissible distributee of trust income or principal; (ii) would be a distributee or permissible distributee of trust income or principal if the interests of the distributees described in (i) terminated on that date without causing the trust to terminate; or (iii) would be a distributee or permissible distributee of trust income or principal if the trust terminated on that date. N.C.G.S. § 36C-1-103(15).
The identity and role of a beneficiary, trustee and settlor should be distinguished from other persons who may have certain rights or responsibilities with respect to a trust, but who do not necessarily possess beneficial interests in the trust, have no fiduciary relationship with respect to the trust or trust property, or who have not created or made a contribution to the trust. Trusts commonly provide that one or more persons other than a trustee may take certain actions with respect to the trust and often may do so in a nonfiduciary capacity. These “power holders” may be third parties with no relationship with the settlor, beneficiaries or trustee. However, a power holder may also possess the dual status as a settlor, trustee and/or beneficiary of the trust.
In North Carolina, a “power holder” includes anyone who under the terms of the trust has the power to take certain actions with respect to a trust and is not a trustee or a settlor. N.C.G.S. § 36C-8A-1. A power holder may be given a power to direct or consent to a number of actions by the trustee, including power over investment decisions, discretionary distributions, trust administration matters, or the removal or appointment of a trustee. Id. § 36C-8A-2. A power holder may even have the ability to grant a power of appointment to a beneficiary, increase or decrease the interests of a beneficiary, or modify or amend the trust to take advantage of better tax treatment or assets protection laws. Notably, the recently added provisions of the NCUTA pertaining to power holders are default provisions that may be changed by the terms of the trust. Therefore, settlors have great flexibility for including and planning with power holders, including allowing the settlor to retain certain powers over the trust. Id. § 36C-8A-3(a); N.C.G.S. § 36C-1-105.
A significant advantage to naming a power holder rather than a trustee to exercise certain powers is that the power holder does not necessarily have to exercise the power in a fiduciary capacity, meaning that in some statutory instances or when the trust expressly provides that the power can be exercised in a nonfiduciary capacity the power can be exercised based on the power holder’s personal whim and not based on the interests of the beneficiaries or other fiduciary standard of care. A trustee is not generally liable for following the directions of a power holder unless such compliance would constitute intentional misconduct on the part of the trustee. Id. § 36C-8A-4. As a result, a settlor could grant a trusted third party the right to significantly alter the interests in the trust over time and the third party could exercise the power in a nonfiduciary capacity, leaving a beneficiary little or no recourse against the power holder. Planners are increasingly utilizing power holders to provide flexibility in trust arrangements. Practitioners are cautioned to carefully evaluate the scope and duties of a power holder when encountering such provisions in a trust document as the power holder could, as a practical matter, have more power and influence over a beneficiary’s interest than the trustee.
 For purposes of the North Carolina Uniform Trust Code, the term “Trustee” does not include trustees in mortgages or deeds of trusts. N.C.G.S. § 36C-1-103(22).
 A “qualified beneficiary” is a living beneficiary to whom, on the date the beneficiary’s qualification is determined, any of the following apply: (a) is a distributee or permissible distributee of trust income or principal; (b) would be a distributee or permissible distributee of trust income and principal if the interests of the distributees described in (a) terminated on that date without causing the trust to terminate; or (c) would be a distributee or permissible distributee of trust income or principal if the trust terminated on that date.