Applicable state law controls or influences innumerable characteristics of trusts. Among these characteristics are: whether the trust may continue indefinitely; to what extent trust property may be shielded from the claims of a beneficiary’s creditors (including a spouse or former spouse); whether or under what circumstances decanting or modification may be available; whether the benefits (and detriments) of the Uniform Trust Code will apply; whether a directed trustee or trust protector arrangement will be efficacious; whether certain types of property may be conveyed to and/or held in trust;1 and whether or to what extent the trust will be subject to state income taxes.2
Relevant Concepts
When evaluating what law applies to a given trust, a couple of separate and distinct concepts are relevant. First, one must determine the trust’s situs. Situs usually refers to the state where trust assets are physically located or where the trust is “grounded” or has its “foundation” or principal place of administration. The law of the situs generally governs trust administration matters (for example, trustee liability, trust accountings, characterizing of beneficial interests and compensation).3
Second, the trust’s governing law must be ascertained. As a general matter, a trust’s governing law is the particular legal system governing the validity, construction and effect of the trust instrument. Courts will often honor language in the trust instrument stating the governing law of the trust depending on the precise language used and the context.4 Consider, however, whether a trust instrument’s provision specifying that the trust’s validity and effect shall be determined under the laws of State X would be upheld if the settlor were domiciled in State Y and the trust had no or only nominal connections to State X.
Huber
In Huber,5 the settlor of a self-settled asset protection trust resided in the state of Washington. The trust was created in Alaska, and the governing instrument designated Alaska law to govern the trust. The trust held several assets having a substantial aggregate value. One asset of the trust, a $10,000 certificate of deposit, was held in Alaska. All other assets of the trust were held in Washington. One of three co-trustees of the trust was an Alaska-based corporate fiduciary. The corporate fiduciary engaged in virtually no trust administration activities.6
One of the main issues in Huber was whether the law of Alaska or the law of Washington would determine the validity of the trust. Alaska law recognizes self-settled asset protection trusts.7 Washington law doesn’t.8 In analyzing and resolving whether the trust was valid, the court referenced the general rule that an inter vivos trust of movables is valid if valid under the law of the state designated by the settlor to govern its validity.9 The court observed, however, that the general rule doesn’t apply unless: (1) the designated state has a “substantial relation” to the trust; and
(2) application of the designated state’s law doesn’t violate a strong public policy of the state where, as to the matter at issue, the trust has its most significant relationship.10
In granting partial summary judgment in favor of the plaintiff, the trustee for the bankruptcy estate of the settlor/debtor, the Huber court ruled that the provision of the trust instrument designating Alaska law as governing law wasn’t controlling. In so ruling, the court opined that Alaska didn’t have a substantial relation to the trust. The sole connections between Alaska and the trust were the $10,000 certificate of deposit and the inactive corporate fiduciary. All other connections between a state and the trust were with Washington.11 In addition, the court noted that Washington has a strong public policy against self-settled asset protection trusts, as evidenced by a statute that’s been in place for well over a century.12
Don’t Rely on Trust Instrument
It would be an estate planner’s dream if the law of a given state could be invoked by merely inserting a trust instrument provision, as if waiving a magic wand. As demonstrated by Huber, however, that’s often not possible. Accordingly, when designing a trust to accomplish a particular purpose, for example, long-term or perpetual existence or asset protection, the estate planner must not assume the trust will effectuate such purpose simply because state law under which such purpose is legally permissible is specifically referenced as “governing law” in the trust instrument. In addition to a trust instrument provision designating the trust’s governing law, it’s critical that as many other factors as possible relate the trust to the target state. Such factors include location of the trustee, location of the trust property and the trust’s principal place of administration. Even if those factors are favorable, though, if the settlor resides in a different state, and if the trust’s purpose violates a strong public policy of the settlor’s state of domicile, the purpose may not be achievable.13
Endnotes
1. For example, tenancy by the entireties property, community property.
2. For an overview of state income tax issues involving trusts, see Charles A. Redd, “State Tax Stew,” Trusts & Estates (July 2016), at p. 10.
3. See Bogert, et al., Bogert’s Trusts and Trustees (3d ed. 2009) Sections 291, 295, 296, 297); see also Uniform Trust Code (UTC) Sections 107 & Cmt., 108 & Cmt., 403 & Cmt.
4. Restatement (Second) of Conflict of Laws Sections 268-270, 277 (1971).
5. In re Huber, 201 B.R. 685 (Bankr. W.D. Wash., May 17, 2013).
6. The court stated the corporate fiduciary was “acting merely in the nature of a straw man.”
7. See AS 34.40.110.
8. See RCW 19.36.020.
9. Supra note 4, Section 270(a).
10. Ibid., Section 270(a) Cmt. B.
11. The state of Washington was the place of residence of the settlor, the situs of all trust property except the $10,000 certificate of deposit, the place from which all trust property except the $10,000 certificate of deposit was transferred to the trust, the location of the settlor’s creditors, the place of residence of all trust beneficiaries and the location of the lawyer who prepared the trust instrument and transferred assets into the trust.
12. Supra note 8.
13. As an example, it seems unlikely that a resident of State A, a state where determination of a surviving spouse’s elective share includes assets held in a predeceased spouse’s revocable trust, could avoid State A’s elective share rules by transferring substantially all his assets to a revocable trust in
State B, a state where revocable trust assets don’t count in arriving at a surviving spouse’s elective share.