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Drafting Do’s and Don’ts

Drafting Do’s and Don’ts explores why the language chosen in a particular situation was sub-optimal, hypothesizes about why mistakes were made, and offers suggestions for how that drafting could have been improved.

Inconsistent Drafting

The theme for this installment of Drafting Do’s and Don’ts is inconsistent drafting. To recognize inconsistent drafting, we generally need to look at two or more aspects of a trust. Each provision in isolation may be perfectly crafted, but when we step back and look at the trust agreement as a whole, we discover that there are parts that simply do not fit together.

In my experience, inconsistent drafting comes in two basic forms. Sometimes the inconsistency is caused by decisions that reflect an inconsistent drafting philosophy. In other cases, there is inconsistency in the technical aspects of a trust instrument.

By a drafting “philosophy” I mean the underlying conceptual framework for the trust, which drives the innumerable choices that must be made in trust drafting. For many of those choices there is no absolute right or wrong decision, but whatever choice is made should be applied consistently throughout the document. For example, some attorneys like providing the primary beneficiary of a trust with a 5% withdrawal power, while others prefer to avoid such provisions. Neither choice is inherently correct, but any particular attorney should have a perspective on this issue and make the opposite drafting choice only when there is a specific reason for doing so.

Philosophical Inconsistency

The most common place where I encounter a philosophical inconsistency is in the provisions governing trusts that benefit different generations. For example, one trust is primarily designed to benefit children, while another is intended primarily to benefit grandchildren. Broadly speaking there is no reason to have different provisions for those generations with regard to distribution standards, powers of appointment, and the ability to remove trustees. It’s not unusual, however, to see a trust that allows distributions for the health, education, maintenance, and support of a child, but grants the trustee absolute discretion to make distributions to grandchildren. One generation may be allowed to remove the current trustee and name a successor, while another generation is denied that authority. Sometimes these differences are customizations created after a meaningful discussion with a client, but more often they reflect the inconsistent default provisions of the attorney’s model trust.

Recently, I reviewed an irrevocable generation-skipping transfer (GST) tax exempt trust that provided: “The current and accumulated net income and principal may be distributed to or applied for the benefit of my daughter in such amounts and at such times as the trustees may determine reasonably necessary for her health, education, maintenance, and support.” Despite being GST exempt, this trust benefited only the daughter, and there was no mechanism for distributing assets to grandchildren. That’s an odd drafting choice, but the inconsistency is revealed by looking at what happens when the daughter dies.

Once the daughter dies, her trust will be divided equally among her children (the grandchildren) and held in trust. For grandchildren, the distribution standard is different. “The current and accumulated net income and principal may be distributed to or applied for the benefit of the Beneficiary . . . [or] for the benefit of any one or more of the Beneficiary’s issue.” (Emphasis added.) Why is the trustee allowed to make distributions only to the daughter while she is alive but allowed to make distributions to a grandchild’s issue while the grandchild is living? This should be consistent across the generations unless there is a specific reason for the difference, which there was not in this case. This is a philosophical inconsistency.

A second example of philosophical inconsistency relates to funding revocable trusts to avoid probate. Some clients and their attorneys want to avoid probate completely, and so they often sign something like a “Declaration of Trust Ownership of Personal Property” through which they assign all personal property now owned or later acquired to their revocable trusts. Even in those situations, however, I continue to see revocable trusts that distribute all tangible personal property to the surviving spouse, outright and free of trust. If the goal of the planning is probate avoidance, why distribute tangible property outright to the surviving spouse?

If the surviving spouse has assigned after-acquired personal property to his revocable trust, despite the explicit outright bequest, perhaps that property nevertheless transfers to the revocable trust of the surviving spouse. Even if that is correct, it would be better (and philosophically consistent) to have the revocable trust of the first spouse either (1) retain the personal property in a marital trust or (2) assign it to the revocable trust of the surviving spouse, which should still qualify for an estate tax marital deduction. That is, if the goal is to avoid probate, you should consistently draft with that goal in mind.

When I was in private practice, I rarely tried to avoid probate completely. That said, recently I have begun to question whether the default provision in a revocable trust should direct tangible personal property owned by the trust outright to the surviving spouse. Revocable trusts don’t take title to tangible property by accident, so perhaps the default provision should be to retain tangible property in a marital trust or to direct it to the revocable trust of the surviving spouse to minimize future probate. I have not reached a final conclusion on this, but I urge you to consider the issue and to reevaluate how your revocable trust handles tangible personal property.

Technical Inconsistency

The last issue of Drafting Do’s and Don’ts discussed mandatory income provisions. 32 Prob. & Prop., Jan./Feb. 2018, at 44. The following provision, which I could have included in that column, is a great example of technically inconsistent drafting. “The Co-Trustees shall invest and reinvest the principal of [this trust] and shall collect the income therefrom and shall pay or apply the net income therefrom, annually or at more frequent intervals, to or for the health, education, maintenance and support of [the beneficiary].” (Emphasis added.)

This is a mandatory income provision, so what does the last clause mean? If the income must be distributed at least annually, what is the relevance of the health, education, maintenance, and support (HEMS) of the beneficiary? If we unpack the last clause, two actions are authorized. First, the trustee can pay income to the beneficiary. Second, the trustee can apply income for the HEMS of the beneficiary. Each year the trustee must deploy all trust income in one of these two ways. Any income not applied for the beneficiary must be paid to him.

Given that the beneficiary will receive any income the trustee does not expend, why limit the trustee to a HEMS standard? It would be more consistent to simply say the trustee “shall pay or apply the net income therefrom, annually or at more frequent intervals, to or for the benefit of the beneficiary. . . .”

As a second example, consider the following language from a credit shelter trust: “(A). . . My trustees. . . shall pay the net income therefrom to my wife during her life.” The language is unambiguous and directs the distribution of all income annually to the surviving spouse. Unfortunately, paragraph B has a very different distribution standard. Paragraph B first authorizes the trustees to distribute principal to the surviving spouse or any descendant. It then provides: “I further authorize my trustees to withhold from my wife all or any part of the income payable to her under the provisions of Subdivision (A) of this Article, such provisions notwithstanding, and to pay the amount so withheld to any one or more of my descendants in equal or unequal shares or to accumulate it and add it to principal of such trust.” (Emphasis added.)

Said another way, while paragraph A requires that all income be distributed to the surviving spouse each year, paragraph B says the trustees can instead distribute income to descendants or simply accumulate income and add it to principal!

I would also point out that this complete reversal in the treatment of income is hidden in the final sentence of paragraph B, which otherwise deals with the disposition of trust principal. The last sentence of paragraph B should have been made a part of paragraph A, so that the trustees who are trying to determine how to treat income each year would have all the relevant provisions in a single paragraph.

Coming Up Next

I hope you will agree that drafting documents that are consistent, both philosophically and technically, is critical to crafting trusts that are accurate and easy to administer. In the next column I will review several trust provisions that were bad ideas, even though they were properly drafted. That will allow me to flesh out what I think good drafting accomplishes and what problems it avoids.

Did you find this column helpful? Disagree with something (or everything)? Have an example of drafting (good or bad) you would like to share? E-mail me at Stephen.Liss@ubs.com.