Independent Trustees: How Much Is Enough Discretion?

May 31, 2012 | Trusts & Estates

When a Testator creates a Qualified Terminable Interest Property (QTIP) Trust or a Credit Shelter Trust under his or her Will, the Testator’s spouse is always a beneficiary of the QTIP Trust and frequently a beneficiary of the Credit Shelter Trust. The Testator will often appoint his or her spouse and another individual – usually a friend, relative, accountant, or lawyer – as Co-Trustees of the Trusts. The Co-Trustees are responsible for receiving the assets bequeathed to the Trusts, investing such assets, paying Trust expenses, and making distributions to the beneficiaries of the Trusts.

With respect to this last responsibility – distributing Trust assets to the beneficiaries – the Testator often creates an important distinction between the spouse trustee and the non-spouse trustee: only the non-spouse or “independent” trustee has the power to make discretionary distributions of principal from the Trusts to the surviving spouse.

Since the Independent Trustee alone has the power to distribute principal to the surviving spouse, he or she will likely be placed in a position after the Testator’s death where the surviving spouse approaches him or her for a distribution of principal from the trust. In response to this request, the Independent Trustee may tell the spouse to take whatever he or she needs from the trust and the Independent Trustee will consent to the distribution.

This, however, is not the appropriate way to reply to the surviving spouse’s request. In a recent New York State Surrogate’s Court case, attorneys from our practice group successfully challenged distributions from a trust that were made in this manner. In its decision, the Court ruled that such deference by the independent trustee to the surviving spouse did not qualify as a proper exercise of discretion by the independent trustee. As a result, the Court directed that the principal distributed to the surviving spouse be returned to the trust.

To avoid similar challenges, Independent Trustees must do what their title implies: exercise independent discretion when making a distribution of principal to a surviving spouse and never be a “rubber stamp.” If a surviving spouse asks for a distribution of principal from a trust under which he or she is a beneficiary, we recommend that the Independent Trustee:

  1. Ask questions about the distribution – What is the purpose of the distribution? How urgently is it needed? Are there alternatives?
  2. Put the response to the request in writing and within the response provide reasons for the approval (or rejection) of the request.
  3. Always, always sign the check for the distribution him/herself.

Of course, those are just a few of the ways an Independent Trustee can protect him/herself from potential future challenges when making a discretionary distribution of principal to a beneficiary of a Trust. Please feel free to contact our firm if you have any questions about this subject.

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