Trust agreements can terminate for any number of reasons. Following are several explanations of why a trust might end, come to its conclusion, and be terminated…
Natural Trust Termination
Upon the settlor’s death. Upon the death of the settlor (or within a reasonable time after death) a standard liquidating trust may terminate. Upon a designated age or date. Upon a specific date or the beneficiary turning a specific age, the provisions of a trust may call for complete distribution and termination of the trust.
Upon another stated event. Upon the occurrence of some other event (i.e., graduation from college, marriage, the birth of a child), the terms of a trust may require termination.
Upon conclusion of maximum legal term. Upon the expiration of the governing perpetuities period a trust must terminate. In most states, the rule against perpetuities (“RAP”) requires that a trust terminate following the death of all those lives in being as determined at the time the interest in trust vests, plus 21 years. In some states (small minority) the RAP has either been revoked entirely or statutorily extended so far out that the maximum trust term allows an interest to continue in trust for a really, really long time. In Nevada an interest in property “must vest or terminate within 365 years after its creation.” See NRS 111.1031. An important note on planning trends: The dispositive provisions of trusts are trending towards the more frequent use of “continuing trusts” and away from “liquidating trusts”. Some of the reasons are as follows:
(a) Transfer tax planning. Desire to defer the payment of transfer taxes (i.e., estate, gift and generation skipping transfer taxes).
(b) Asset protection. The spendthrift provisions of a trust can protect trust assets from a beneficiary’s personal creditors (even in the event of divorce, bankruptcy or other legal challenges).
(c) Incentivizing responsible behavior. Some parents may desire to provide for their children’s needs, but not every want. So as not to remove the motivation for beneficiaries to work hard, meaningfully contribute to society, and otherwise be productive, trust provisions requiring outright distribution and termination may be passed by in favor of trust provisions simply providing for specific needs. As trusts become more commonplace, folks seem to be more comfortable administering and transacting with continuing trusts.
Powers of appointment. Many trusts will provide a power of appointment to a beneficiary, the trustee, or some other party. Upon appointment of all of a trust’s assets, pursuant to a power of appointment, a trust will terminate. Trustees should understand whether a power of appointment is a general power or a limited power since each type could potentially carry different transfer tax consequences.
Other termination triggers: Reasons for terminating a trust early
The following are reasons why it may be necessary or desirable to terminate a trust early, before it has run its course as set forth in the trust indenture:
Diminished value of trust assets. Where the assets of the trust have diminished greatly in value since its creation, the trust may be terminated. Following are some ways to bring about a trust termination because of diminished value.
(a) Small trust statutes. These statutes, found in many states, allow a trustee or a trust’s beneficiary to change or terminate a trust that has become too small to administer effectively. They are as follows: (1) A trust can become too small to administer where the trust pays out more than it earns from investments over time; and/or (2) A trust may become too small when the assets of the trust decrease significantly in value. The inability to pay a trust beneficiary may frustrate the trust’s original stated purpose. Some statutes may allow a trustee to modify or terminate a trust without a court or beneficiary approval, while others may allow modification or termination only with the approval of a beneficiary or a court. Still others may allow termination only if the trust is under a certain value. That value is usually written into the statute. Nevada’s small trust statute states that “Upon such terms and conditions as are just and proper, the court may order termination and distribution of a trust before the time provided in the trust instrument, if administration or continued administration of the trust is no longer feasible or economical. A petition for such an order may be filed by an interested person under NRS 164.010 and 164.015.”
(b) Pursuant to a specific provision of a trust agreement. If a trust instrument provides for a distribution of a “small trust”, then court approval may not be necessary. Make sure the term “small” is clearly defined and determinable, and make sure the trustee (or someone else) has broad enough discretion to determine whether the requirements of the “small” definition have been met. Here is an example of a “small trust” provision: “If the trustee, in the trustee’s absolute discretion, determines that the amount held in trust is not large enough to be administered in trust on an economical basis, then the trustee may distribute the trust fund free of trust to those persons then entitled to receive the same.”
Divorce. A divorcing/divorced couple may need to terminate or modify trust agreements that were entered into during marriage. Follow terms of the divorce decree and property separation agreements even if divorce is not finalized grantors can generally revoke the provisions of a revocable trust as to their separate property and their one half of the community property. Note: the exact asset split is not necessarily needed to perform the revocation—just need a general description of all “separate property and any interest in the community property” and an expression of intent to revoke.
Following are a few planning points to consider when a client is going through a divorce: (1) Get involved early. Trust attorneys should be involved in counseling their clients (and the client’s divorce lawyer) as to the duties, rights, and opportunities belonging to the client with respect to any interests in trust. Trust attorneys should not wait to get involved until divorce is finalized. In fact, much can be gained by having the trust attorney involved pre-divorce. (2) Disinheritance. Consider disinheriting spouse even before divorce is finalized. (3) Understand conflicts of interest. Where a trust attorney represents or represented both spouses who are parties to a divorce, such representation must be undertaken very carefully. While it is not necessarily impossible to continue representing either or both parties with regard to their trust and estate plans, the attorney should be very clear as to the scope of their new engagement and as to whom they represent. Mutual written waivers of the conflict should surely be obtained.
Death and other changes in circumstances. Where a beneficiary has died, or is no longer part of the group of beneficiaries entitled to take under the trust, it may necessary to terminate the trust.
Disclaimer or relinquishment. Where a beneficiary wishes to be removed or replaced by another beneficiary, such as an institution or nonprofit organization, it may then be necessary to terminate the trust.
Mutual agreement of beneficiaries. Under the “Claflin Doctrine,” (See Claflin v. Claflin, 20 N.E. 454 (Mass. 1889)), which is followed in the majority of jurisdictions today, the beneficiaries can compel termination or modification of a trust if and only if: (1) all beneficiaries join in the request to the trustee or in the suit petitioning the court to modify or terminate the trust; and (2) the proposed modification or termination will not defeat a material purpose of the settlor in creating the trust.
The first requirement of getting the consent of all beneficiaries, may be difficult to obtain because “all beneficiaries” consists of not only all existing but also all potential beneficiaries, some of which may not be born yet or otherwise ascertainable. Note on virtual representation: Virtual representation may be used to bind persons who are minors, incapacitated, unborn, or whose identity or location is unknown or not reasonably ascertainable. The virtual representative must also have a substantially identical interest with respect to the particular matter or dispute. Usually the interests of the representative and the person represented are identical, such as membership in the same beneficiary class. Also, virtual representation is available only to the extent there is no conflict of interest between the virtual representative and the person represented. In 2009 Nevada joined a very small minority of states and added a virtual representation statute to its laws, which may help in effectively binding someone who is otherwise not represented. See NRS 164.038.
The second requirement of not defeating the settlor’s “material purpose” in setting up the trust turns on the wording of the trust instrument and the circumstances around its execution. Additionally, courts allow parole evidence to evaluate the settlor’s statements before and after the creation of the trust to flush out the settlor’s original purpose behind the trust. In Nevada we don’t necessarily follow the Claflin Doctrine. See Ambrose v. First National Bank 482 P. 2d 828, 87 Nev. 114, 1971.