Wills, Trusts & Estates Prof Blog

Editor: Gerry W. Beyer
Texas Tech Univ. School of Law

Monday, November 21, 2005

The Standing of a Settlor

A comment by Michael R. Houston (J.D. 2005, Northwestern University School of Law) provides An Answer to the Problem of Settlor Standing in Trust Law? (Estate of Wall v. Commissioner, 101 T.C. 300 (1993)), 99 Nw. U. L. Rev. 1723 (2005).   Here is the conclusion to Mr. Houston's article:

[T]he tax code expresses a preference for outright inter vivos gifts as opposed to transfers that the settlor can control up until the time of death. To take advantage of this preference, settlors often convey gifts by means of an irrevocable trust. This method has the advantage of reducing taxes paid (which benefits settlors and beneficiaries alike), while giving the settlor the ability to specify the terms and conditions governing the trust and trustee. Unfortunately for settlors, the tax code provisions 2036 and 2038 are so far-reaching that even the slightest interference by the settlor after trust creation can negate the desired tax advantages. This, combined with the traditional rule that withholds settlor standing in suits against trustees of irrevocable trusts, leaves the settlor with little recourse in the face of misbehaving or poorly performing trustees.

While commentators have addressed the issue by calling for settlor standing, the courts have indirectly provided an alternate solution by embracing a trustee removal power vested in the settlor. Despite initial IRS objections, the courts are apparently satisfied that in preserving a trustee removal power, settlors retain insufficient control over the trust property to trigger the adverse tax treatment of 2036 or 2038. The decisions in Wall and Vak represent good news for settlors because a comparison of settlor standing and the trustee removal power shows that the latter is likely to be more useful to settlors than standing rights. Compared to settlor standing, retention and exercise of a right to remove the trustee is relatively straightforward.  Moreover, since exercising the right does not require any proof of trustee misconduct, the removal power, as compared with standing, favors the granting of greater trustee discretion, which is an increasingly important component in modern trust management.

Although the decisions in Wall and Vak downplayed the possibility for significant trustee influence by the settlor who retains a trustee replacement power, the opinions struck solid ground in pointing to the ever-present fiduciary duties owed by the trustee to the beneficiaries. These underlying rights give the beneficiaries the ability to enjoin detrimental behavior by the trustee, and their retention keeps the decisions in Wall and Vak well within the confines of traditional trust law. This protection remains even if the trustee were to act at the suggestion of a settlor engaged in active oversight of trust operations. In the end, beneficiaries are not harmed by a retained trustee removal power, and they may in fact benefit as a result of increased trustee monitoring. To the extent that settlor comfort levels rise with their confidence that trust administration will be carried out diligently and efficiently, including adherence to the settlor's specific wishes, beneficiaries should also profit from increased donations via the trust medium. Should settlors ever be found to be abusing their removal power, courts could always insist upon a joint grant of the removal power to both the settlor and the beneficiaries (at least while the settlor is alive). This added layer of protection should inhibit trustee replacements designed to achieve results adverse to the beneficiaries, regardless of whether the actions rise to the level of breaching fiduciary duties.

Given the settlor's desire to minimize taxes while simultaneously maintaining the ability to influence trustee decisions on an on-going basis, Wall and Vak could scarcely have turned out better for the settlor. In short, trustee replacement powers serve the functions that settlor standing would, without (1) adverse tax consequences, (2) the uncertainties and cost of trial, or (3) doing violence to traditional trust law. Welcome to settlor's nirvana.

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