Delaware Trust Act 2019 Legislative Update
Delaware Governor John C. Carney has signed House Bill 72 into law (“Trust Act 2019”). The legislation, signed on June 19, 2019, further improves and modernizes Delaware trust law, including the following highlights:
- adding Section 3343 to Title 12 of the Delaware Code, which empowers a fiduciary who has the power to appoint successor trustees to appoint multiple trustees and to allocate fiduciary duties among them;
- adding Section 3344 to Title 12 of the Delaware Code, which enables certain trustees to reimburse a trustor of a grantor trust for the trustor’s income tax liabilities attributable to such trust; and
- revising Section 3322 of Title 12 of the Delaware Code to provide, inter alia, that the standard of care applicable to a fiduciary when performing duties delegated to an agent shall apply to the fiduciary when selecting and monitoring the agent.
Section 3343 - Authority to Allocate Trustee Duties Among Multiple Trustees
Perhaps the most significant change to Delaware trust law found in Trust Act 2019 is the newly added Section 3343. Absent a contrary provision in the governing instrument, Section 3343(a) provides that any power to appoint a successor trustee shall be deemed to include the power to appoint multiple successor trustees and new additional trustees. Additionally, the power to appoint multiple successors and additional trustees is deemed to include the power to allocate various trustee powers exclusively to one or more of the trustees to the exclusion of others. A trustee to whom specific powers are allocated shall be a fiduciary only with respect to those powers and, in accordance with Section 3313A of Title 12, a trustee who is excluded from exercising powers shall have no liability for the actions of the other trustee and no duty to monitor or advise the other trustee or notify the beneficiaries. In sum, Section 3343 allows the person responsible for changing fiduciaries of a trust administered under Delaware law to divide responsibilities and allocate duties and fiduciary risk among multiple trustees.
Pursuant to Section 3343(b), the power under Section 3343 is subject to all of the provisions pertaining to the trustee of the trust, including qualifications for appointment, removal and resignation; standard of care and indemnification; and compensation. Applicable limitations on the appointment of a trustee, such as restrictions that prohibit the trustor or beneficiaries from serving, corporate fiduciary capital requirements, or related or subordinate party limitations, etc., will all apply to a power exercised under Section 3343.
Section 3343 should prove to be a very valuable tool in a variety of circumstances. For example, the statute may be used to appoint an “administrative trustee” with responsibility for administrative functions necessary to establish nexus for governing law and situs; to appoint a “tax trustee” to handle all tax-related matters; to appoint a “distribution trustee” to facilitate a decanting or a substantial distribution; or to appoint a “special holdings trustee” to be solely responsible for a portion of the trust’s portfolio such as a closely held-business.
Interestingly, Section 3343 can be used to either exclude co-trustees from certain actions altogether or to create a more traditional directed trust structure, all without needing to modify the trust instrument. Trust Act 2019 modifies the definition of “governing instrument” in Section 3301 of Title 12 to include an instrument that allocates trustee powers, duties and responsibilities among co-trustees under Section 3343 (a “Section 3343 Instrument”). Section 3313A(a) provides that if a governing instrument confers upon a cotrustee, to the exclusion of another cotrustee, the power to take certain actions, including the power to direct or prevent certain actions of the trustees, then the excluded trustee shall have no liability absent willful misconduct if acting at direction of the co-trustee, or no liability for action taken by the co-trustee. Consequently, Sections 3343, 3301 and 3313A are tied together in a way that supports the use of Section 3343 to create a directed trust structure.
For example, to create a directed co-trustee structure within the meaning of Section 3313A(a)(1), a Section 3343 Instrument could grant to Trustee A the exclusive authority to make all investment decisions and the exclusive power to direct Trustee B with respect to the exercise of all investment powers, and could grant to Trustee B the exclusive authority to exercise all investment powers but only upon the direction of Trustee A. Alternatively, to create an excluded co-trustee structure within the meaning of Section 3313A(a)(2), a Section 3343 Instrument could grant to Trustee A the exclusive authority to make all investment decisions and the exclusive authority to exercise all investment powers, and expressly exclude Trustee B from making investment decisions or exercising investment powers altogether.
Irrevocable trusts are regularly modified for the purpose of bifurcating responsibilities among multiple fiduciaries using techniques such as decanting, merger, non-judicial settlement agreements, and consent modification, but Section 3343 will eliminate the need to modify trusts in many such cases. When decantings and mergers are necessary, Section 3343 can also be helpful to assign merger or decanting powers to a new special purpose trustee.
Section 3343 is a powerful new tool available to trusts administered under Delaware law. Appointment instruments will require careful drafting, however, to clearly articulate the exclusive duties being assigned to the trustee, effectively limit the role of the excluded trustee, address all facets of the bifurcated relationship and avoid potential ambiguities, risks and pitfalls.
Section 3344 - Income Tax Reimbursement or Payment
Another important change in Trust Act 2019 is the addition of Section 3344, which provides certain trustees with a discretionary power to reimburse the trustor of a so-called “grantor trust” for any amount of the trustor’s personal federal or state income tax liability attributable to the trust. Specifically, Section 3344(a) provides that, unless the terms of the governing instrument expressly provide otherwise, if the trustor of a trust is treated under the Internal Revenue Code as the owner of all or part of the trust, the trustee (other than a trustee who is the trustor or a person who’s a “related or subordinate party” with respect to the trustor within the meaning of Internal Revenue Code Section 672(c)) may, in the trustee’s sole discretion, or at the direction or with the consent of an advisor (who’s not the trustor or a related or subordinate party with respect to the trustor), reimburse the trustor for any amount of the trustor’s personal federal or state income tax liability that is attributable to the inclusion of the trust’s income, capital gains, deductions and credits in the calculation of the trustor’s taxable income.
To avoid potential creditor issues, Section 3344(a) provides that the trustee may pay such amount directly to the trustor or to an appropriate taxing authority on the trustor’s behalf. Section 3344(a) further provides that neither the trustee’s reimbursement power nor the exercise of such power shall cause the trustor to be treated as a beneficiary of the trust for any purposes under Delaware law. While Delaware’s spendthrift statute, Section 3536 of Title 12, already included spendthrift protection when the terms of a governing instrument include a tax reimbursement provision, Trust Act 2019 updated the spendthrift statute to expressly include protection for the statutory reimbursement power under Section 3344.
Section 3344(a) also includes a provision that prohibits the use of income derived from a policy of insurance on the trustor’s life held in the trust, the cash value of any such policy and the proceeds of any loan secured by an interest in the policy from being used to reimburse the trustor or to pay an appropriate taxing authority on the trustor’s behalf. This provision of the statute should obviate an argument that the reimbursement power over a trust that owns life insurance on the life of the trustor might amount to an “incidence of ownership,” which could cause the property of the trust to be included in the trustor’s estate under Section 2042 of the Internal Revenue Code.
Finally, Section 3344(b) provides that the reimbursement power granted under subsection (a) shall not apply to a trust if the section’s application would reduce a charitable deduction otherwise available to any person for state or federal income, gift or estate tax purposes. This provision ensures that contributions to a trust that would otherwise qualify for a charitable deduction won’t fail to qualify for such a deduction due to the existence of the power to invade the principal of the trust.
Section 3322 - Fiduciary Agency Contracts; Delegation
Another notable change to Delaware trust law is the re-writing of Section 3322, which relates to a fiduciary’s delegation of trust powers to an agent. Prior to the enactment of Trust Act 2019, Section 3322 generally provided that a fiduciary could hire agents and delegate responsibility to such agents, that the agent(s) would be held to the same standard of care required of the fiduciary with respect to each responsibility so delegated, and that the fiduciary would be liable for abuse of discretion or negligence for the hiring of such agent(s) or for negligently continuing the agency relationship. In practice, however, an agent may not know what standard of care applies to the fiduciary under the trust’s governing instrument or applicable law and the agency agreement may purport to apply a different standard of care altogether. Additionally, the standard of care applicable to the Trustee’s action could be something other than negligence. This dynamic could lead to confusion and misunderstandings. Section 3322 has been re-written to provide greater certainty, to improve the efficiency of trust administration, and to tie the parties’ respective standard of liability to their roles and the governing instruments.
Section 3322(a) now simply provides the foundational rule that a fiduciary may appoint agents to assist in the performance of a fiduciary’s duties, pay such agents from the fiduciary fund and delegate investment, management, or other fiduciary duties to any such agent, including an agent who is a co-fiduciary.
Section 3322(b) now provides that, when a fiduciary exercises its discretion to appoint an agent to assist in the performance of the fiduciary’s duties, the standard of care applicable to the fiduciary when personally performing such duties shall apply to the fiduciary with respect to selecting and hiring the agent, paying the agent from the fiduciary fund, establishing the scope and specific terms of the agency relationship, and overseeing the agent’s actions and continuing the agency relationship, but that the fiduciary shall not otherwise be liable for the conduct of such agent. Section 3322(b) further provides that this rule shall apply even if the aggregate amount paid to the agent and the fiduciary from the fiduciary fund exceeds the amount that would have otherwise been payable from the fiduciary fund to the fiduciary or the standard of care applicable to the agent is a lower standard than the standard applicable to the fiduciary when personally performing duties to be performed by the agent. Consequently, Section 3322 both ensures that a fiduciary will be held to a consistent standard of care whether it is performing a duty or selecting an agent to whom such duty will be delegated, and provides certainty to agents that the otherwise enforceable terms of their agency agreement with the trust’s fiduciary will be honored.
Section 3325 - Specific Powers of Trustee; Power to Sever
Subsection (28) of Section 3325, which already permits a division of a trust for any reason, was modified to clarify that the trustee’s power to sever a trust includes the power to divide a trust “along family lines.” Although this is simply a clarification of existing law, this clarification should provide fiduciaries with greater certainty when exercising this power. Fiduciaries must be cautious, however, to ensure that the remaining requirements of the statute are met in connection with any trust severance.
Section 3544 - Waiver of Trustee Duty to Investigate Prior Modifications
Section 3544 has long provided that, in the absence of actual knowledge of a breach of trust or information that would cause a reasonable person to inquire, a successor trustee is under no duty to examine the accounts and records of its predecessor trustee or to inquire into the acts or omission of its predecessor. Trust Act 2019 revised Section 3544 to clarify that a trustee also has no duty to inquire into or confirm the validity of a governing instrument or actions by a predecessor trustee altering or modifying a governing instrument. Consequently, in most circumstances a successor trustee will have no duty to review trust modifications, decantings, mergers, and similar transactions that occurred prior to their taking office and should be entitled to rely upon the validity of the underlying documents for those transactions.
Section 3547 - Representation by Persons with Substantially Identical Interests
Delaware’s virtual representation statute, Section 3547, was modified last year to add a new subsection (c), which provides that the holder of a general testamentary or inter vivos power of appointment, or a nongeneral testamentary or inter vivos power of appointment that is expressly exercisable in favor of any person or persons, except for the holder of the power, his or her estate, his or her creditors, or the creditors of his or her estate (commonly referred to as a “broad limited power of appointment”), may represent and bind persons whose interests, as takers in default, are subject to the power, but only to the extent that there is no material conflict of interest between the holder and the persons represented with respect to the particular question or dispute. Trust Act 2019 modifies Section 3547(c) in two ways. First, Section 3547(c) now requires that any person who must consent to the exercise of a power of appointment must also consent to any such virtual representation by the holder of the power. Second, Section 3547(c) clarifies that the “material conflict of interest limitation” applies only to holders of a broad limited power of appointment. Consequently, the holder of a general power of appointment may represent and bind takers in default whose interests are subject to such power even if the holder of the power has a material conflict of interest with such takers in default with respect to a particular question or dispute.
Section 3570 - Qualified Dispositions in Trust; Definitions
Subsection (b) of Section 3570 was modified to confirm that a transferor’s ability to appoint and/or serve as “designated representative” will not cause a trust instrument to be deemed to be revocable for purposes of Delaware’s Qualified Dispositions in Trust Act. This modification provides greater certainty surrounding the roles and powers that a settlor may exercise over a Delaware self-settled asset protection trust.
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