Trust Review Question John Drake was a high income earning taxpayer that was always looking for ways to lower his tax liability. He had seven adult children and thought of distributing some of his income to them to minimize his overall income tax bill. In 2006, he announced to his wife and children that henceforth all of the income of his stock portfolio would be part of an irrevocable, inter-vivos trust for the use and benefit of his seven children. He further stated that his business partner Tom Jones had accepted the position of Trustee of the Drake Family Trust. Drake had substantial stock and bond holdings. He set up a bank account titled the Drake Family Trust Account to receive income and dividends from the various assets. Deposits in the amount of $300,000 were deposited into the bank account in 2007 representing the income from the portfolio. However, he never changed the ownership of the portfolio with his stockbroker. John Drake continued to be listed as the owner. The Drake Family Trust provided in pertinent part: “The Trustee, Tom Jones shall have sole and absolute discretion to distribute so much of the income and principal to one or more of the children as he, in his sole and absolute discretion, shall determine for their lives. It is my hope that my children will use their money wisely and put it to good use like giving it to the American Red Cross, then upon the death of all of my children to my grandchildren, free from trust.” Shortly after the establishment of the trust John Drake and Tom Jones had a falling out. They dissolved their business relationship each one starting their own business. In spite of the falling out, John knew Tom Jones to be a very honorable and honest person. As part of the management of the trust assets, Tom Jones quickly liquidated all of the stocks and bonds and reduced the holdings to cash which at that time had grown to $800,000. He invested the entire proceeds in a new start-up company that Tom Jones and his wife owned completely. The investment was very safe. Indeed, through the course of time the return provided from Tom’s company was superior to the return on investment of the earlier portfolio. AS TO QUESTIONS 1 THROUGH 5 – IGNORE ANY IMPACT OF THE RULE AGAINST PERPETUITIES 1. Is the Drake Family Trust a valid trust? Why or why not. Discuss the elements that must be present before a trust is considered valid. If you conclude that the trust is valid, when did it become valid? Answer: Inter Vivos Irrevocable Turst, which deals with personal property. Elements of trust are: settler with intent, declaration, ascertained beneficiaries and trust property (res). Trustee not required, court will appoint one. Here the ‘res’ is missing on 2006. This is the speilman pascal case. Trust for future profits. In 2006 there is not trust because lack of res. In 2007 there were deposits made into the account so there is a trust. For tax purposes, the trust would be invalid for the assignment of income because of the fruit of the tree doctrine. 2. If the trust is determined to not be valid, who owns the assets? If the attempted Drake Family Trust had been a failed Testamentary Trust, who gets the assets? Answer: (1) If the trust is determined to not be valid the settler owns the assets or it is an inter vivos gift. Gift requires intent + delivery and acceptance. John didn’t do everything within his power to perfect and effectuate a gift, but he didn’t because he didn’t change the title on the account out of his name. So John as settler owns the property. (2) If failed Testamentary Trust, who gets the assets. Testamentary Trust created in a Will by definition. The residuary takers would take the property. If the Testamentary Trust failed and the will failed, then it would go to intestacy. 3. Assume for the purposes of this question only that the trust is valid under private trust law rules but the Internal Revenue Service correctly challenged the income tax effect of the trust under the Grantor Trust Rules in the Internal Revenue Code. Could John Drake terminate the Drake Family Trust since there is no tax benefit inuring to John? In your answer discuss the elements that need to be in place for the termination of a trust. Answer: Elements Required for the Termination of a Trust: (1) In facts says intends to be irrevocable. Language says not irrevocable though. In CA then would assume it is revocable. (2) Clapton (Clafflin??) Doctrine: A Trust may be terminated if everyone agrees, principally the settler if his purpose has been frustrated. However, the doctrine makes it difficult to terminate a trust if there are existing beneficiaries. The existing beneficiaries would have to agree to the trust termination. Under US law very difficult to have a trust terminated if it violates the purposes of the Settlor. If the Settlor died, it would be very difficult to get a termination because his intent to get a tax break was not in the docs so courts wouldn’t know that his intent had been frustrated. 4. What interests have been created in the children of John Drake? Has a Power of Appointment been created? Why or why not? Answer: Beneficiaries with a fee simple absolute life estate. (2) The language about the red cross: If there is a power of appointment it would be a special power of appointment. But it is not, it is only precatory language that does not rise to the level of a power of appointment. No intent manifest. 5. Has Tom Jones violated any fiduciary duties by liquidating and re-investing the trust assets in the manner that he did? In your answer explain the fiduciary duty that a trustee owes a trust. Answer: Violations of Fiduciary Duties: (1) Loyalty: Self Dealing: and conflicts of interest (2) Prudence: Diversity (3) Duty of Loyalty: is associated with self dealing. Trustee can act solely for the benefit of the beneficiary. Undevided loyalty. No further inquiry rule: If trustee engages in self dealing the court does not have to look any further, there will be liability on the trustee, UNLESS the trustee is a bank or there is advance judicial approval. Damages: the gain the company made on account of the self dealed investment (disgorging profits). Duty of Prudence: Relates to the diversification. All of the trust assets were invested in the company owned by the trustee. However since the return was good there probably aren’t damages. Although could argue that it wasn’t prudent to diversify because it was ‘a very safe investment’. Stay away from being conclusory. 6. Assume for purposes of this question only that the Drake Family Trust is a valid testamentary trust in all respects. The only question is whether it is valid as it relates to the rule against perpetuities. Assume further that John Drake had no grandchildren at the time of his death. What is the interest created in the grandchildren? Does it violate the rule against perpetuities? Answer: Know Common Law Application of the rule. Here we have a contingent remainder in the grandchildren. i.e. if there are any grandchildren. Rule: All interests must vest or die not more than 21 years from some life in being at the creation of the interest. What is the life in being? The life in being can be any person if you can prove the interest will vest or fail within that life or 21 years after its expiration. How do we determine what the measuring life is? Look for a life that works in making the proof required. This person if found is known as the measuring and validating life. Here the children are the measuring life, and they must have grandchildren while alive, so when they die the contingent remainder will vest or die because no more children can be had. LIVES IN BEING + 21. lives in being are the current children. Since this is a testamentary instrument John cannot have any more kids, so there is no issue of an after born child (not a life in being at the creation of the trust) as the class has closed.