Volume 18, Number 2
Estate and Financial Planning
Drafting to Avoid Conflicts
By Stephanie E. Donaho
This article is intended to act as a catalyst for careful reflection by drafters on how the drafting decisions in tax-dominated estate planning documents can in fact either increase or decrease the likelihood of conflict among those with an economic stake in the property. It addresses only drafting decisions for structure and substantive provisions, and not decisions for administrative provisions.Structure of trusts—spray trusts. While testators are alive, they sometimes wish to create trusts in their wills in which all children are beneficiaries and each can receive distributions in accordance with need without regard to equality of distribution. Unfortunately, a family seldom operates as a unit after the death of the patriarch and matriarch, and unequal distributions can generate conflict. As a result, this author recommends using a single spray for siblings only when estates are relatively small and the primary use of the funds will be to house, clothe, and educate the children. Even then, the spray trust concept should be used for the shortest period.Tiered beneficiaries. A variation of a spray trust involves the creation of separate trusts for each beneficiary, which permits distributions to be made not only to that child but also to his or her descendants. If a primary beneficiary has little or no need for the funds, the trust assets can be diverted to younger generation beneficiaries without making them wait until their parent dies.
If tiered beneficiaries are being considered, the following are possible ways to reduce the likelihood of conflict:
• Prioritization of beneficiaries.
• Access limits.
• Distribution standard (permits trustees to impose equality of distribution among younger generation beneficiaries).
• Inter vivos power of appointment.
• Veto power.
• Separate trusts.
• Equitable adjustments.
• Exclude remote descendants.
Distributions standards. The income only model is frequently problematic in situations in which the primary beneficiary of the funds is not related to and/or aligned with the remainderman. Planners should use income only trusts in situations in which the trust is to be of fairly short duration or in which the income beneficiary’s need for income is fairly insignificant and is unlikely to result in conflict.
The HEMS standard allows the beneficiary to serve as a trustee or co-trustee. However, it can produce controversy when remainder beneficiaries believe that the current beneficiary receiving HEMS distributions has adequate resources of his or her own.
A broad discretion standard, which permits distributions to be made at the trustee’s complete discretion, at the trustee’s discretion for the "best interests" of a beneficiary, or for the "comfort and welfare" of the beneficiary, is the one most likely to permit distributions to be made (or withheld) without fear of liability. It requires careful consideration of the identity of trustees and the methods for removing and replacing trustees and selecting successor trustees.
The primary motivation of a unitrust concept is to align the current beneficiary and the remaindermen by removing the incentive of the current beneficiary to seek high income at the expense of growth. The financial interests of both the current beneficiary and the remaindermen are in the growth of the overall trust fund, and their investment objectives are more likely to be aligned.
One way to reduce conflict between a current beneficiary and remaindermen over distributions is with 5-and-5 withdrawal rights, which give a current beneficiary the right to withdraw a certain percentage of the trust each year, irrespective of whether the beneficiary meets a standard for distribution. This can be done without significant adverse tax consequences if the beneficiary is given a "5-and-5" distribution right, which is an exception to a taxable power of appointment.Second marriages. One family situation with the greatest potential for conflict is the estate of a testator who has children from a first marriage and a second wife or husband. Instead of automatic use of a marital trust, consideration should be given to separating the interests of the spouse and the children. This can be handled in one of several ways.
• Probate assets to children.
• Probate assets to spouse.
• Division of assets.
Blended families. The situation becomes more complex in a second marriage when there are children from both spouses’ previous marriages. In many instances, these children grew up together, and the testators want to treat all children as being children of both of them. Although this approach appears to be fair and inclusive on its surface, there is a significant potential for conflict. It is more common than not for events after the first spouse’s death to lead the second spouse to change his or her will to include only his or her own children, or otherwise to exclude some or all of the first spouse’s children. A "cutback clause" in the will of each spouse may avoid this problem. If he or she is the first to die, the remaindermen under his or her will change to the extent that the second spouse does not follow the original estate plan.Powers of appointment. Testamentary powers of appointment ensure that the use of trusts does not give too many rights to the putative remainder beneficiaries. The fact that a parent who is a beneficiary of a trust can disinherit any one or more of his or her children is an effective tool to reduce conflict. Most powers of appointment are drafted to be broad. A beneficiary is usually given the right to change any and all provisions on how the remainder of the trust will pass at his or her death, so long as the appointees are within one or more designated classes. However, a very broad power of appointment can also be a tool to permit unfairness and conflict by pitting siblings against each other in vying for a parent’s favor and by taking away from putative remaindermen something to which they feel entitled, as opposed to failing to leave them something to which they had no legal entitlement (e.g., not including them in a will).Specific bequests and special assets. Drafters should be careful that their form language is clear on gifts of personal effects. In addition, a will should specifically address whether or not purchase money indebtedness should follow a specifically bequeathed asset. It is also a good idea to clarify that the executor has the power to specify the method of division, to liquidate and distribute items that the executor believes are subject to dispute, and to divide the proceeds.
Testators should carefully consider any estate plan whereby they are leaving expensive assets to their children that the children may not be able to afford to maintain. Where it is unlikely that children can afford the assets, the testator must face the need for liquidation. Generally, an estate is less likely to have controversy if there are ample liquid assets.
Closely held businesses are a likely source of conflict, particularly if one or more children are active in the business while others are not. A buy-sell agreement can be of great assistance. When this agreement is used and is funded with life insurance, a testator must understand that the child who receives the business (and usually gets his or her pro rata share of the estate as well) may be receiving a much greater share of the estate than is fair in some circumstances, particularly where the new business owner can turn around and sell the business and take it public.
Estate planners should identify where there might be conflict regarding separate versus community property. In the event that commingling may have occurred, to avoid conflict the parties should consider a postnuptial agreement to the effect that certain assets are separate property. Another alternative is to give one-half of the testator’s separate property to the spouse, to eliminate any incentive to dispute the executor’s decision. If this route is selected, drafting care needs to be taken to consider not only assets, but debt as well.
Stephanie E. Donaho is a partner with Locke Liddell & Sapp LLP in Houston, Texas.
- This article is an abridged and edited version of one that originally appeared on page 32 of Probate and Property, July/August 2000 (14:4).