Trust Examination Manual
Section 4 - Compliance/Account Administration -
Personal and Charitable Accounts
Table of Contents
The services discussed below are commonly offered
by the majority of trust departments and the duties described are typical.
The duties associated with the various fiduciary capacities described vary
from state to state. For this reason,
they are described in general terms. In order to gain a more complete
understanding of the scope of the duties and responsibilities of a given
fiduciary capacity examiners should be familiar with applicable state
This section of the Manual is organized into the following parts:
A. General Overview
1. Policy Guidelines
2. Account Administration Considerations
Considerations/Applicable Law and Regulations
B. Types of product lines
C. Types of accounts and fiduciary
1. Court Supervised Accounts
2. Personal Trusts
a. Trustee Under Will
b. Trustee Under Agreement or by
c. Trustee by Order of The Court
3. Charitable Trusts
a. Internal Revenue Code
b. Charitable Lead Trust
c. Charitable Remainder
d. Pooled Income Fund
e. Charitable Contribution
"Clifford Trusts" for Banks
b. Escrow Agent
c. Trustee for Land Trusts or Real
Intermediary" for 1031 Exchange or "Like Kind Property Exchange"
e. Investment Advisory Agent
f. Managing Agent
g. Farm Management Agent
h. Attorney-in-Fact Pursuant to an
Executed Power of Attorney
i. Safekeeping Agent
D. Additional fiduciary capacities
2. Successor Trusteeships
E. Asset Protection Trusts
A. General Overview
The proper and efficient
administration of personal and charitable trust and agency accounts requires
the establishment and implementation of policies and procedures, a system to
monitor compliance therewith, and prompt correction of nonconformance.
The knowledge and
expertise of management and operational staff; active involvement by the
board of directors acting through a trust committee, and possibly through
subcommittees; and adequate policies and effective procedures, coupled with
systems for monitoring and ensuring compliance therewith; form the core of a
risk management system designed to monitor, measure, and manage the various
risks inherent in the administration of personal and charitable accounts.
Note: Unless specifically indicated
otherwise, the term "personal trust" refers to court supervised accounts,
personal trust accounts and personal agency accounts.
A.1. Policy Guidelines
The breath and depth found in an
institution's policies and procedures depend upon the types, size, and
complexity of accounts administered. Most policies, however, include the
Account Acceptance Guidelines -
Guidelines for the acceptance of accounts establishes limits on the type
of fiduciary accounts that will be accepted. In establishing these
should consider in establishing these guidelines are the level of
expertise and experience available, either in-house or through third-party
arrangements. It should also identify circumstances that may render the administration of
an account overly complex or risky, such as unique or difficult-to-administer assets or ambiguous or complex terms in the governing document.
As such, an
appropriate Account Acceptance Policy, coupled with an adequate
pre-acceptance review process, is a fundamental element in an institution's
risk management process. One of the most effective methods of limiting
the risk inherent in fiduciary operations is to decline appointments for
which the institution lacks appropriate qualifications or that present
heightened administration or compliance risks. For
example, a policy may, within given limits, permit the acceptance of
personal trust and investment agency accounts, but state that charitable
trusts and insurance trusts should not be accepted. The policy may,
however, provide for exception and establish a review process necessary to
accept an appointment that would otherwise be contrary to policy. All such
exceptions should be approved by the trust committee, or other duly
appointed subcommittee thereof.
Account Termination (or Closing)
Guidelines - These guidelines ensure that upon terminating an
account, the institution has adequately completed all of its
administrative duties and responsibilities. The guidelines should
identify all documentation required to close the account and include a
process whereby account administration will be reviewed so that no
outstanding administrative concerns remain unresolved. Often, an
institution will develop checklists to ensure that all necessary items
have been adequately addressed prior to closing the account. The
lack of, or flawed, account closing procedures could result in future
Fiduciary Appointments -
These guidelines describe the types of fiduciary appointments (e.g.
trusteeships, guardianships, successor trusteeships, co-fiduciary
appointments, etc.) that an institution will accept. The guidelines may
be included in account acceptance guidelines, if not addressed in a
Documentation Guidelines -
These guidelines identify the documentation required to be
maintained for each type of account accepted. For less complex
accounts, the guidelines may briefly refer to administrative issues and
approved checklists. Since a fiduciary must be able to
demonstrate the appropriateness and prudence of its account administration, an institution's documentation guidelines must require the
maintenance of original governing agreements, or working copies thereof,
documentation evidencing fiduciary appointment, synoptic records, legal
Account Review Guidelines -
These guidelines communicate the Board's evaluation of the risk
characteristics of various types of accounts by designating the depth and
level of review. Accounts having a greater degree of complexity or risk
may require an individual review performed at the trust committee level,
whereas homogeneous accounts posing a relatively lower level of risk may
be reviewed in groups at a lower management level. In any event, an
institution's account review guidelines should ensure that each account is
reviewed at least once during each calendar year. The FDIC's Statement of Principles of Trust
Department Management requires an annual review for all accounts, even
those that do not involve investment decisions.
A.2. Account Administration Considerations
It is the fundamental duty of a
fiduciary to administer an account solely in the interest of the
beneficiaries without permitting the interests of the trustee, or any
third parties, to conflict in any manner. The duty of loyalty
is of paramount importance, and is the cornerstone of all fiduciary
appointments. The successful administration of an account must meet the
needs of the beneficiaries in a safe and productive manner and equitably
balance the interests of each beneficiary. This is true for any account
administered. Therefore, a satisfactory account administration program ensures that accounts
comply with applicable laws and the governing agreement.
Such a program follows fundamental concepts of management and includes the
Assignment of accounts to a
specific officer. In larger departments two officers may be assigned: an
administrative officer and an investment officer. This allows for the
assignment of accountability for the various aspects of account
The intent of the testator,
settlor, or principal must be clearly understood by the account officer(s).
This ensures the identification and fulfillment of the purposes and
objections of an account.
Identification of any restrictive
language, such as
exculpatory language, provisions governing the invasion of principal,
Adherence to the investment
provisions, including restrictions, contained in the governing agreement.
This affords the
income beneficiary and the
remainderman or principal beneficiary, respectively, of an level of
income or capital appreciation consistent with the intent of the creator
of the trust.
Considerations/Applicable Law and Regulations
Both common law and civil law
(Federal, state and local statutes and regulations) govern trust activities.
There are laws that apply to fiduciary activity in general, to specific
fiduciary functions (trustee, conservator, guardian, agencies, etc.), and to
the specific type of property under administration (securities, real estate,
A.3.a. Common Law/Fiduciary
The body of common law is much more
voluminous and detailed than civil law. Therefore, management should have at
least a general familiarity with some of the more widely known common law
authorities such as Scott, Bogert, and the Restatement of the Law of Trusts.
Each of these sources provides insight into the general fiduciary principles
that should be followed in the administration of personal and charitable
trusts. The following are some of the more important duties of a trustee
that originated out of common law:
A trustee owes a duty of
loyalty to administer trust affairs solely for the benefit of the
beneficiaries. The thrust of this duty is to avoid conflicts of interest
that would enrich or provide an advantage to the trust administrator at
the expense of the beneficiary.
A trustee must exercise the skill and
prudence, as a person of ordinary prudence would exercise in managing his
own property. Trust managers who represent themselves as having expertise will be held to that level of expertise.
A trustee may not delegate the
administration of the trust or the performance of acts that the trustee
should personally perform. It should be noted that the trust
agreement or state law may permit certain delegations. However, the
determination of whether a delegation is appropriate is contingent upon
whether the act requires professional skills or abilities not possessed by
the trustee. For example, trustees can employ accountants,
attorneys, and other professionals, when those qualifications or abilities
are lacking in the trust department. Furthermore, a breach of trust
for not delegating duties may occur when certain qualifications are
necessary, but are not possessed or obtained through other sources.
Refer to the Prudent Man Rule in Appendix C for additional information.
A trustee must keep and render
accurate accounts. The accountings
should reflect receipts and disbursements, gains and losses on
investments, and other transactions affecting the account. Such
records are also necessary for completion of tax returns. Usually,
the state law requirements apply to testamentary trusts or
court-appointments and call for
accountings to the court at specific intervals. If the trustee fails
to keep accurate records, the court may take actions, up to and including
removal of the trustee. Also, a beneficiary may request an account
statement from the trustee, as deemed necessary. Most trust
departments provide at least quarterly statements to accountholders, but
The trustee must provide information to the beneficiary that will protect his rights or
that would be viewed as important by the beneficiary.
A trustee has a duty to keep
trust property separate from his own property and should not commingle
trust property with that of other trust accounts. Trust property
should be clearly
earmarked. The purpose behind this duty is to provide an audit
trail, to prevent the trust's assets from being attached by the trustee's
creditors, and to prevent fraudulent use. This duty does not preclude a trust manager from using mutual
funds or other pooled investment vehicles.
A trustee must take title to all
titled or certificated assets and secure documents representing intangible
assets upon becoming trustee.
A trustee must make the trust
productive and must invest the trust assets for income or
increase in market value.
Uninvested cash (other than held for distribution or reinvestment) held
for periods of time, may be evidence of
negligence by the trustee.
A trustee must comply with all
provisions of the trust
instrument, including those regarding distributions to or for
beneficiaries. The trustee must exercise care to ensure that
distributions are made in an accurate and timely manner.
A trustee must deal impartially
with beneficiaries. An equitable balance must be made between the income
beneficiaries and principal beneficiaries (remaindermen).
The trustee must work with
persons holding power and control, such as state
courts, local taxing authorities, property managers, etc. One task
related to this duty is the voting of proxies.
A trustee has an obligation to
work with and exercise skill in communicating with co-trustees. A co-trustee must be
especially wary of acting unilaterally, or conversely, being indifferent
toward the actions of the other trustee.
A trustee has a duty to defend against claims
involving trust assets or the validity of the
trust. It is imperative that fiduciaries
have access to legal advice as
questions arise and whenever
a claim is made.
The trustee must preserve and
protect the property of the trust. In practice, this means obtaining and
maintaining insurance, ensuring that deeds, mortgages and titles are
properly recorded, and depositing funds within the FDIC deposit insurance
limitations. Trustees must maintain
buildings, vehicles, and equipment in good condition to prevent
Examiners should not cite
"violations" of common law (equity). Noncompliance with certain principles
of equity would normally be treated as another criticism with reference to
"generally accepted trust practices", rather than a statutory violation.
Noncompliance with common law may involve a substantial exposure to
liability and loss.
Trust companies will attempt to
limit exposure to liability and loss by inserting exculpatory clauses
into the trust instrument. These clauses usually seek to limit liability to
severe breaches of trust, such as negligence, bad faith, or willful
misconduct, and not for every failure to use ordinary skill and ability.
The courts have afforded fiduciaries only limited protection from lawsuits
against fiduciaries employing these clauses. Since a trustee purports to
have specialized fiduciary skills, courts do not appreciate a defense
claiming only ordinary care and skill was utilized. Additionally, the fact
that the trustee often demands the insertion of this clause could be
construed as conflicting with the fiduciary's duty of loyalty to his
client. Clauses which limit losses resulting from a co-trustee's own
actions or property under his control, exclusive of the other
co-trustee, usually have similar limited effectiveness.
Civil courts have provided several
remedies for failure of fiduciaries to properly exercise their obligations.
These remedies include setting aside inappropriate transactions, enjoining a
disloyal act, monetary damages, forfeiture of fees or interest or nullifying
a sale and ordering a re-sale of property. Courts have removed trustees
where there were egregious instances of improper administration of trust
agreements. Examples of circumstances where a trust could be found liable
In the event of an improper
transaction, such as a sale of assets from a trustee to a trust, or an
inter-account transaction, a beneficiary will often be given a choice of
either affirming the transaction, setting aside the sale, or taking the
profit resulting from the sale. It is the burden of the trustee to prove
that any transaction is fair to all parties.
The failure to adequately defend
the trust from attack could result in financial liability. Such attacks may
derive from creditors seeking to attach the assets of the trust, a lawsuit
challenging the validity of the trust, or attempts to prematurely terminate
the trust. Fiduciaries have been found liable for failure to appeal a court
case where the trust was held liable. Expenses from a successful court
challenge can be paid from the trust; frequently, an unsuccessful challenge
can be defended using trust assets if the defense was encouraged by the
A failure by a trustee to act
promptly and competently in receiving and maintaining trust assets could
result in whatever loss ensues. For example, failure to ensure trust
property could result in the trust being held liable in the event of storm
damage or theft. Additionally, unwarranted delays by a successor trustee in
obtaining financial assets could result in liability if these assets
declined in value during the delays.
Co-mingling the assets of the trust
with the assets of the trustee or another trust could result in significant
liability. Should a trustee be unable to trace the source of assets, the
trustee may be held liable for damages or a court may conclude that all the
co-mingled assets are those of the trust.
The failure to make trust assets
productive also produces liability exposure. A trustee that does not
promptly invest cash, that deposits funds in excess of FDIC insurance
coverage, or that does not
make necessary changes in investments received, could
cause significant liability.
Examiners are not expected to
render a legal opinion as to equity matters involved in the administration
of personal trusts. However, the examiner should discuss the facts of an
apparent violation of a common law principle or of the trust instrument
itself, and extend contingent liabilities as necessary. In complex and
significant matters, the bank's legal counsel may provide a legal opinion
concerning the matter.
A.3.b. Federal Statutes
The administration of personal
trusts, including charitable trusts, is subject to federal statutes. A fiduciary is subject to
Federal laws in the same manner as any individual or business owning or
dealing with property. The violation of Federal statute is typically
described in the report of examination. Examples of Federal laws and
regulations with which a fiduciary must comply include: Federal securities
laws; consumer protection laws; the Federal Reserve Act and implementing
regulations; fair credit laws; U.S. Treasury regulations; the Internal
Revenue Code, etc. Violations may result from the activities of a trustee or
other fiduciary or apply by reason of the type of property held and/or
administered by the fiduciary.
A.3.c. State Statutes
State financial or banking codes
include laws governing banks, trust companies, and similar institutions. A
growing number of states have adopted various uniform statutes that apply
directly or indirectly to the conduct of trust activities. States
adopting uniform statutes often modify them. Therefore, management should be
familiar with the text of their respective state law. Below are some of
the more common uniform codes.
Uniform Prudent Investor Act
Uniform Prudent Investor Act establishes "modern portfolio theory" as the standard for the
management of trust assets, rather than focusing on the prudence of
individual investments, as is the case with the Prudent Man Rule.
Uniform Prudent Investor Act
permits the delegation of investment and management functions, subject to
The text of the Uniform Prudent Investor Act and comments is found in
Uniform Trust Code - The act
comprises a comprehensive codification of trust law. However, many
states have modified major portions relating to the rule of perpetuities,
and asset protection trusts. See Asset Protection Trusts
in this chapter.
Uniform Probate Code - The act
simplifies and clarifies the law concerning the affairs of decedents,
missing persons, protected persons, minors, and incapacitated persons. The
code is designed to promote a speedy and efficient system for liquidating
the estate of a decedent and distributing estate assets to the
designated heirs, facilitating the use and enforcing certain trusts,
and providing a uniform law among various jurisdictions.
Uniform Principal and Income Act
(UPIA) - The UPIA provides guidance to fiduciaries regarding the allocation
of assets between principal and income. This allocation is very important
when the trustee must consider the interests of both an income beneficiary
and a remainderman in administrating a trust or estate. The UPIA is a
default statute that only operates when the governing instrument is
silent. The UPIA provides guidance to the fiduciary when the settlor grants
discretion to the trustee or when the trust agreement is silent as to the
allocation. Therefore, a settlor may direct the allocation of principal
and income in any manner in a revocable trust. The UPIA was originally
written in 1931 and was revised in 1962. Another revision, endorsed by the
American Bar Association, was drafted in 1997. It is now being recommended
for enactment in all states. The recent revision has two main purposes.
First, a general revision was necessary to bring the act up to date.
Second, the rules for allocating income and principal was updated to
address the principles of modern portfolio theory. The 1997 UPIA amends
existing rules (it expands the definition of receipts from an entity,
provides for uniform treatment of corporate distributions and when an
investment in an entity is liquidated, and modifies the treatment of
receipts from the exploitation of natural resources, etc.) and establishes
rules for asset types (derivatives, asset-based securities, etc.) not
mentioned in the prior UPIA. A copy of the
1962 UPIA and
1997 UPIA are found in Appendix C. Please refer to the discussion
in Section 3.
Transfer Act (UFTA) - The UFTA is designed to prevent fraudulent
transfers which occur when a debtor intends to hinder, delay, or defraud a
creditor, or transfers proceeds under certain conditions to another person
without receiving reasonable equivalent value in return. Included within
the law are the "Badges of Fraud", which aid in determining whether the
debtor had actual intent to defraud. See
Uniform Gifts to Minors Act (UGMA)
- The UGMA allows an adult to contribute to a
custodial account in a minor's name without having to establish a
trust or name a legal guardian for the transfer of property to a minor.
Uniform Simultaneous Death Act
(USDA) - The purpose of the USDA is to establish priority of death in the
case of simultaneous deaths. The priority affects the distribution of a
The text of
these and other uniform acts is also available at the Internet site of the
National Conference of Commissioners of Uniform State Laws
State laws that apply to classes of
property also are relevant. For example, real property held as an asset of a
trust or estate would be subject to state real property laws, while some
states have intangible taxes on monetary assets.
B. Types of Product Lines
The volume and type of personal
trust accounts can be
segregated into three broad product lines; trusts, estates (including
guardianships), and agencies. An important distinction is made between those
accounts for which the institution has investment discretion, and those for
which it does not. The relationships may be further categorized by the
specific capacity in which the institution serves, the purpose of a
particular type of account, and/or other unique features of an account.
Personal trust accounts can also be segregated into those accounts subject
to supervision by a court and those that are not.
C. Types of Accounts and Fiduciary
C.1. Court Supervised Accounts
The administration of estates and
guardianships is supervised by an appropriate court, referred to in various
jurisdictions as probate, chancery, or surrogate court. Judicial supervision
is intended to protect the interests of minors, incompetents, unknowns, and
the deceased. The court formally appoints the fiduciary (even though perhaps
"nominated" by the will), and reviews and approves all acts of the
fiduciary. The fiduciary typically must periodically provide the court with "accountings"
of the fiduciary's activities in administering the account.
In an estate, the trust department,
as either executor or administrator, is responsible for a decedent's assets
from the time of formal appointment by an appropriate court until the
estate's final settlement is approved by the court. A fiduciary is not
responsible for events prior to its appointment. However, once appointed,
the trust department, as executor or administrator, is responsible for
protecting the estate's assets, and is held responsible for neglectful or
delayed administration. All acts in the administration of
an estate are reported to, and subject to approval by, an appropriate court.
The department's duties and responsibilities are dictated by the decedent's
will and by state and common law.
The primary duties of an executor,
administrator cum testamento annexo (c.t.a.), include the following:
assembling of decedent's assets;
preparation of an inventory of
all assets of the deceased;
taking control or custody of such
orderly conversion of certain
assets "in kind";
payment of administration costs,
taxes (including Federal estate and/or state inheritance taxes), and all other legal claims against the estate;
distribution of the net estate in
accordance with the terms of the will; and
filing of a final accounting with
the court of competent jurisdiction, if required.
Probate procedures may also require
interim accountings, but this varies between states. The duties of an
administrator are essentially the same as for an executor or administrator
c.t.a., but are dependent upon the intestacy laws of individual states.
Generally, the trust department will act in one
of the following capacities:
An executor, whether an individual
or an institution, is nominated in a will by the maker (testator) to settle
an estate and to perform in any other manner described in the will. Before a
bank acts as executor, it must have the will accepted by a court of
competent jurisdiction as the valid and final will of the deceased. The
court will then issue written authority to serve as executor, often termed
An administrator is appointed by
the court to settle the estate of a person who died leaving no valid will.
Without a will, the administrator must carry out its functions solely in
accordance with state intestacy laws. Written authority, often termed
Letters of Administration, must be received from the court to serve as
administrator of an estate.
Administrator cum testamento annexo (c.t.a.)
The court appoints an administrator
c.t.a. (i.e., with the will annexed) when there is no executor named in the
will, or when the executor named is unable or unwilling to serve. As with an
executor, the will must be accepted by a court of competent jurisdiction,
and the administrator c.t.a. must receive written authorization to settle
the estate. Settlement of the estate is made in accordance with the terms of
the will. When an executor or an administrator c.t.a. dies or is removed
before completing the settlement of the estate, the substitute fiduciary is
known as an administrator c.t.a., d.b.n. (de bonis non) (i.e., administrator
with the will annexed for assets not yet distributed).
Ancillary administration may be
necessary if an estate contains property in a state or jurisdiction (foreign
country) other than the decedent's domicile at the time of death. The
ancillary administrator represents the estate on all matters within the
alternate jurisdiction. Typically, performance in this capacity involves the
handling of real property when an estate contains property in another state.
A guardian is an individual or
institution appointed by a court to care for the property and/or the person
(referred to as the "Ward") of a minor, an incompetent, a spendthrift, or
other incapacitated person. The powers and responsibilities of the
guardian are governed by the provisions of state statutes and court
decisions. Investment limitations are often delineated by statute and
any exceptions require court approval. The guardian's duties may be limited
to the property (guardian of the estate), the person (guardian of the
person), or both (guardian). Banks generally will serve only in the
capacity of guardian of the estate and many states prohibit a
bank from serving as the guardian of a person.
Under a guardianship, the ward is
the beneficial owner of property. A guardian is an agent of the court
and has no legal or equitable title to the ward's property. The guardian of
a minor receives, holds and manages the property, renders accountings to the
court and makes a final settlement with the minor when he becomes of age. A
guardian for an incompetent or absentee performs the above duties as long as
the incompetency or absenteeism lasts. Such words as committee, conservator,
curator and tutor are used in various states to describe particular types of
Obligations of a guardian include:
Protect and preserve the assets;
Submit an inventory and appraisal
to the court;
Retain or reinvest assets as
advised by the court, or as permitted under state law;
Use income and principal to meet
the needs of the ward; and
Submit accountings (usually
annually) to the court.
C.2. Personal Trusts
A trust is a fiduciary relationship
by which legal title to property is held by one person or corporation for
the benefit of another. In trust relationships, the trustee has the
responsibility of ownership and holds legal title to the trust property,
while the beneficiary enjoys the benefit of ownership and holds
Personal trusts can be broadly
classified as either testamentary (also known as trust under will), or
living (also known as inter vivos or trust under agreement). Trusts can
further be classified as revocable or irrevocable. In a revocable trust, the
settlor retains the right to change or terminate the trust at any time and
does not relinquish control over the assets held in a revocable trust.
Therefore, under Federal estate tax law, those assets are considered owned
by the grantor. Furthermore, the revocable trust is not a public
record, and assets transferred to beneficiaries via a revocable trust remain
a private transaction. For irrevocable trusts, the trust
cannot be modified or revoked by the settlor; however, the instrument may provide that a
designated person can modify or terminate the trust. The settlor of an
irrevocable trust relinquishes control over the assets and is, therefore,
those assets are not subject to estate taxes. An irrevocable
trust may be amended or revoked under specific circumstances. For
example, one state supreme court held that a person who is both a settlor
and sole beneficiary of an inter vivos trust may revoke the trust when the
agreement specifically provides that the trust is irrevocable. As with
the revocable trust, assets transferred to beneficiaries remain a private
common law, if the instrument is silent regarding revocation, the trust is
assumed to be irrevocable.
Fiduciary powers and duties should
be clearly defined in the trust agreement. A lack of definition may
cause uncertainty, impair investment performance, and prevent the trustee
from taking actions in the best interests of the beneficiaries. In the
absence of clearly defined provisions, state statutes also contain a list of
the trustee's powers and duties. The general responsibilities of the trustee
Preservation of the assets
composing the trust;
Management of assets to provide
Distribution of income to
Accounting for all actions; and
Dealing with interested parties.
The administration of personal
trust accounts is primarily controlled by the terms of the governing
instrument. State statutes and common law technically govern only when the
instrument is silent or the provisions violate public policy. Refer to the
discussion of Account Administration
The fiduciary capacity under which
personal trusts are administered is generally that of trustee under will,
trustee under agreement, trustee by declaration, or in some circumstances,
trustee by order of the court.
C.2.a. Trustee Under Will
A trust under will (testamentary
trust) is created when the decedent's will bequeaths property to be held in
trust for the benefit of a person, corporation, or charitable organization.
The trustee receives the property from the executor or administrator and
administers the assets for the beneficiaries. A probate court usually has jurisdiction over a
testamentary trust. When the will is probated, the trust included in the will
becomes a public record. Frequently, the bank may first serve as executor (or
administrator c.t.a.), and then follow as trustee if the will establishes a
trust, and the court permits by necessary appointment.
Common types of testamentary trusts
used by modern estate planners include: the marital deduction trust and
non-marital (a.k.a. bypass trust, credit shelter, or exemption-equivalent)
trust. These two are frequently used in conjunction with one another, and
are sometimes referred to as "a-b" trusts. Another is the
(Qualified Terminable Interest Property) trust. Testamentary "support",
"education", and "health and welfare" trusts for spouses, children, and
grandchildren, are also common. Other types of trusts may also be
encountered. In each instance, the successful administration, and
supervisory review of such administration, requires an understanding of the
objectives of the trust, as well as the specific language of the trust
C.2.b. Trustee Under Agreement or by Declaration
A trust under agreement (living or
inter vivos trust) comes into existence when the creator of the trust enters
into an agreement or contract with the trustee setting out the terms of the
trust. A trust by declaration is created upon declaration by one person to
be trustee of property for the benefit of someone else. The trustee's duties
are set out in the agreement or declaration and may include a wide range of
responsibilities. The creator may have reserved the right to amend or
terminate the agreement, in which instance the trust is considered either
partially or fully revocable. Irrevocable forms of agreement are also used
and may have certain tax advantages.
The desire of individuals to obtain
favorable tax treatment under Federal income tax laws has led to the
creation of various types of special purpose irrevocable trusts. Examples of
such trusts include "Clifford
Trusts", and various gift-related estate tax reduction trusts (RPM
Grantor Retained Income Trusts, Grantor Retained Annuity Trusts, and
Grantor Retained Unitrusts)." To properly administer such trusts, trustees
must have a comprehensive knowledge of the applicable Federal income tax
laws, since a failure to satisfy all the requirements of the Federal tax
code could cause a trust to lose the favorable income tax treatment for
which the trust was created.
Other types of living trusts are
family incentive trusts, and
insurance trusts. Such trusts have a unique or limited purpose. The
successful administration of such trusts requires an understanding of the
each trust's unique objectives, including the specific provisions contained
in the trust instrument, and the laws and regulations governing such
C.2.c. Trustee by Order of The Court
A court of competent jurisdiction
may appoint a bank as trustee to receive property in trust and administer it
for the benefit of the person(s) designated. In some states, the capacity is
known as a guardianship or conservatorship rather than trusteeship. Often,
the court appoints the trustee for a special purpose arising from
litigation. In divorce proceedings or real property disputes, the court may
appoint a trustee to care for disputed property and account to beneficiaries
pending settlement. The trustee in this instance may have full or only
directed authority over the management of the disputed property.
C.3. Charitable Trusts
A charitable trust may be
established by will or agreement for religious, educational, cultural or
community-welfare purposes. It is normally exempt from Federal income tax if
it meets the requirements of the Internal Revenue Code. In many states, the
rights of the charitable beneficiary are enforced by that state's attorney
general. Some charitable trusts may last forever, while duration of other
trusts is limited by the
rule against perpetuities, which differs in important respects from
state to state. The purposes of charitable trusts depend upon the intent of
the trustors, but tax planning will usually be important.
The following sections provide an
overview of the Internal Revenue Code as it applies to charitable trusts and
of the potential adverse consequences of failing to comply with the
requirements of the Code. The discussion is general in nature and primarily
focuses on "nonexempt" activity.
C.3.a. Internal Revenue Code
The administration of charitable
trusts is governed to a significant extent by the provisions of the Internal
Revenue Code (IRC). These rules and regulations are quite extensive and
complex and it is essential that the trustee have a good working knowledge
of the applicable provisions of the Code and the requirements for
maintaining a charitable trust's favorable tax treatment. The failure to
maintain the favorable tax status may result in unfavorable tax consequences
to individual donors and the charitable organization itself. In such cases,
the trustee may be subject to losses as a result of legal actions and court
surcharges. The miscalculation of payments and distributions may also result
in surcharges and other liabilities.
The first step in the management
process for charitable trusts is determining whether a charitable
organization and the trust created for its benefit are classified as
"exempt" or "nonexempt".
Organizations are granted
tax-exempt status under Section 501(a) of the IRC. Though there are many
types of exempt organizations, the most common are found in Section
501(c)(3). These are nonprofit organizations operated exclusively for
charitable or educational purposes. Exempt organizations are then further
categorized by the Tax Reform Act of 1969, which introduced the concept of
a "private foundation". The act differentiates between two groups: public
charities and private foundations. The restrictions and requirements
imposed upon private foundations to qualify favorable tax treatment are
numerous and complex.
Additional information is available from the Department of Treasury,
Internal Revenue Service, Publication 557, "Tax-Exempt Status of Your
Organization." Publication 557 can be found on the IRS web site
Nonexempt organizations are those
that do not qualify for tax-exempt status. However, they involve certain
charitable purposes for which a contributor is allowed a deduction.
Nonexempt activity is governed by section 4947(a)(2) of the Internal
Revenue Code. There are two categories of nonexempt trust. The first are
trusts that devote all of their "unexpired interests" to charitable
purposes. The second are trusts where the unexpired interests are devoted
to both charitable and non-charitable purposes. These are also known as
"split-interest" trusts. There are three types of split-interest trusts:
Charitable Lead, Charitable Remainder, and Pooled Fund trusts. The
split-interest trusts are more fully discussed in the following sections.
C.3.b. Charitable Lead Trust
A charitable lead trust is a trust for a
fixed term of years wherein a charity is the beneficiary of an annual
annuity or unitrust payment, with the remainder interest belonging to a
noncharitable beneficiary. It is designed to provide income payments to at
least one qualified charitable organization. The fixed term may be measured
by a fixed number of years, the lives of one or more individuals, or a
combination of the two. If the life of an individual option is chosen, the
individual must be alive at the origination of the trust. After the
expiration of the fixed term, trust assets are paid to the grantor or one or
more of the noncharitable beneficiaries named in the trust agreement.
As previously noted, the trust may
be designed as either an "annuity trust" or a "unitrust".
In an annuity trust, a trust
is formed where a fixed amount is paid not less often than annually.
The fixed amount (the annuity) may be stated as a fixed percentage of the
initial net fair market value of the trust assets, as a fixed sum, or an
amount determined by a formula stated in the trust agreement. The annuity may be changed
during the term of the trust; however, there are specific criteria that
must be met. In the event that trust income is insufficient to meet the
annual annuity payment, the corpus of the trust may be invaded.
In a unitrust, a trust is
formed where a fixed percentage of the net fair market value of its assets,
valued at least annually, is distributed, not less often than annually. The
net fair market value of the trust assets may be determined under a number
of methods, provided the methodology and timing used are consistent. The
determination may be made on any one date during the taxable year, or may be
made by taking an average of the valuations made on more than one date
during the taxable year. If the trust agreement is silent, the trustee may
select the method and date.
Other key features of unitrusts include the following:
Charitable organizations are
described in IRC Section 170(c)
No minimum or maximum payout
annuity or payout rate
No five-percent probability test
No maximum term for the trust
unless required by state law
Additional contributions allowed
(Note: Adding additional monies to an annuity trust will not increase the
income paid out.)
C.3.c. Charitable Remainder
A charitable remainder trust is an
irrevocable trust that provides for a specified distribution, at least
annually, to one or more beneficiaries, at least one of whom is not a
charity. The term of the trust is not to exceed the lesser of 20 years
or the life or lives of the individual beneficiary(ies). If the beneficiary
is an individual, he must be living at the time the trust is created.
The irrevocable remainder interest is held for the benefit of, or paid over
to, one or more qualified charities. The specified distribution must be
either a sum certain (annuity) or a fixed percentage (unitrust).
A Charitable Remainder Annuity
Trust (CRAT) provides
a sum certain that is paid out, not be less than 5 percent nor more than
percent of the initial net fair market value of the property placed in the
trust. The annuity amount may be a percentage of the initial
fair market value or an amount fixed in the trust agreement. Neither the percentage nor
the fixed payment may can be changed, regardless of fluctuations of portfolio
value. Therefore, additional contributions are prohibited. [Authority
under IRC 664(d)(1)]
A Charitable Remainder Unitrust (CRUT) provides for
the payment to a noncharitable beneficiary, of a fixed percentage, not less than
5 percent nor more
than 50 percent of the net fair value of its assets, valued annually.
The fair market value of the trust assets may be determined on any one
date during the taxable year of the trust, or by taking an average of the
valuations made on more than one date during the taxable year. The
valuation method must be applied consistently, although the annual payment
from a unitrust will vary, depending upon the value of trust assets. There are a number of
payout options: standard, income, net income, make-up, and flip. Each
option presents unique payout considerations that the trustee must be
familiar with to ensure that proper distributions are made. Additional
contributions are permitted. [Authority under IRC 664(d)(2)]
Charitable remainder trusts may be
constructed with many variations, and require a good understanding of the
Internal Revenue Code. Other important considerations for this type of trust
Charitable contributions are
defined in IRC Section 170(c).
To qualify as a charitable
remainder trust, the trust must meet all of the requirements set forth in
IRC Section 664. Note, the IRS no longer issues determination letters
stating that a charitable remainder trust qualifies for a charitable
income, gift, or estate tax deduction. The IRS does provide sample
documents to provide guidance.
There is a requirement called the
"10 Percent Minimum Present Value", or prequalification floor. In 1998,
the law was revised to require that the present value of the charitable
remainder interest be at least 10 percent of the net fair market value of
the property transferred into the trust on the date of transfer. If a
trust fails this test, there are additional rules to provide relief.
The transfer of trust principal
and excess income to the charitable remainderman prior to the termination
of the trust is permitted within certain limitations.
C.3.d. Pooled Income Fund
A pooled income fund is a
trust established by a charity to receive donated property and to provide
the donors with income for life. The
pooled fund maintains an investment portfolio and provides the donor a rate
of return on the donated property. The donor receives income, gift, or
estate tax deductions. Trust departments may be appointed to act as
an administrator or investment manager for pooled income funds. Refer to
Section 7, Subsection N.4,
Bank Managed "Pooled Income Funds" Organized by Outside Entities for
C.3.e. Charitable Contribution
"Clifford Trusts" for Banks
This special purpose account
combines charitable features with the customary Clifford Trust, a form of
personal trust created for a period exceeding 10 years. The grantor of such
a trust transfers assets irrevocably in trust (i.e., for the duration of
the trust) and, the income is not taxable to the grantor during the term of
the trust. It is important to note that the income may, or may not,
be used for charitable purposes. The Tax Reform Act of 1986
eliminated the 10-year or Clifford trusts exception from grantor-trust
taxation rules, thereby eliminating the establishment of such trusts. Some
older trusts may still exist.
A bank itself may have established
a Clifford Trust, primarily for income tax purposes. Under the Internal
Revenue Code, a corporation is restricted to a maximum percentage of its
taxable income that may be deducted as a charitable contribution. By
employing the trust vehicle, a bank may increase its charitable
contributions beyond the percentage limitation without subjecting the excess
amount contributed to taxation. The trust is funded with bank assets,
usually cash or prime quality securities, and all of the income is
distributed to charities, with the principal reverting to the bank upon
termination of the trust. One or more of the bank's directors and/or
officers may be appointed as individual trustee(s). In such cases, the bank
does not need trust powers. However, if the bank has a trust
department it would be preferable for that department to be named as
The trust instrument should:
provide a statement of the purpose and objectives of the trust; specifically
prohibit "insider" transactions, self-dealing and conflicts of interest;
provide for disclosure of the trust's operations to the FDIC and State
banking authority; and require periodic (at least annual) accountings to the
board of directors. The trust instrument should not include any authority to
borrow funds or permit trust assets to be mortgaged, pledged or otherwise
A bank's current and projected
liquidity, its future earnings and the adequacy of its capital are impacted
by a Clifford Trust arrangement. In light of these considerations, it seems
reasonable to expect a bank to be able to project that a Clifford Trust
will not seriously impact its capital, liquidity, and earnings during the
term of the trust.
An agency relationship is
created by an agreement under which the trust department is appointed to act
as agent for the property belonging to the principal. Many banks use
standardized language in agency agreements. The use of such
agreements eases account administration by standardizing the institution's
fiduciary duties, which also limits the potential risks that can result from
complex, non-standard agency contracts. There are two basic distinctions
between an agency relationship and a trust relationship:
Ordinarily, agents do not hold
legal title to property, while trustees hold legal title for the benefit
of account beneficiaries. (Agency assets are now registered in the name of
the bank, or its nominee, more frequently as this expedites trading
and the transfer of ownership when assets are sold.)
An agency is usually revocable at
the option of the principal, and is automatically terminated at the death
of the principal (account assets must then be turned over to the executor
of the estate or to a court appointed administrator). Trusts, on the other
hand, may be irrevocable, and continue long after the death of the settlor
and/or the original beneficiary(ies).
An example of some of the duties
performed under an agency agreement include accepting possession of the
principal's assets, collecting and distributing income, and buying and
selling investments, either at the department's discretion or as directed by
the principal. A trust department acting as an agent should always operate under a
written agreement, with the agent's authority and duties clearly defined by
the terms of the agreement. Some of the most common agency capacities in
which a trust department may serve include:
In a Custodianship, the trust
only the duties of safekeeping property and performing ministerial acts, as
directed by the principal. As a rule, investment management or advisory
duties are not exercised. For example, in the exercise of custodial duties
involving securities, the bank may be required to collect income and
principal; notify the principal of defaults, called securities, stock rights
for purchase; and execute instructions to buy and sell securities.
C.4.b. Escrow Agent
In this capacity, a bank has the
responsibility of holding the assets and other documents delivered into its
custody until the conditions for their release to a third party have been
fulfilled according to the terms of the escrow agreement. Added
responsibilities include ensuring that the conditions specified in the
escrow agreement have been fully satisfied before assets and other documents
are delivered to the third party. The bank is liable for its actions not
only to the principal, but also to the third party. The bank as escrow agent
should: assume no liability under the terms of the agreement; perform in
accordance with the duties and obligations set forth in the escrow
agreement; and not arbitrate in the case of disputes or disagreements
between the principal and the third parties to the escrow agreement.
C.4.c. Trustee for Land Trusts or Real Estate Trusts
A land trust may be used for privacy purposes, for estate planning purposes,
or to facilitate borrowing arrangements.
The bank as
trustee acts solely as the holder of the legal title to the property.
Typically, the beneficiary(ies) retains the power of direction and control
over the trust property. In some cases, however, the trust document may
indicate that another party (not the bank) has the power to direct the
trust. This is a unique type of fiduciary relationship that is not allowed
in every state. Illinois is the state in which land trusts are most
The administration of this type of
trust, if allowed, is addressed in state statute. Typical documentation
Land Trust Agreement - This is a
document that identifies the property(ies) held in trust, the individuals
or entity that holds a beneficial interest in the trust, the manner in
which the benefit is held (tenets in common, joint tenet, etc.), the
successor beneficiary, and the individual(s) or entity with power of
direction. There should be no responsibilities assigned to the trustee
other than that of holding title to the property and recordkeeping.
Deed of Trust - This is a document that conveys property into and out
of the trust and is sometimes referred to as a "deed in trust". This
document evidences legal title to the parcel of land and the change in
ownership. State law dictates whether the deed must be recorded.
IRS filing (Notice of Fiduciary
Relationship) - This is required at the time a property is deeded into or
out of the trust.
Legal Notices - As the trustee is
the holder of legal title, it will receive all legal notices pertaining to
the property. The notices should be forwarded for further action to the
party or parties identified in the agreement. If the notice requires
disclosure of the names of the beneficial owner(s), the trustee will be
guided by state statute for direction.
Written Letters of Direction -
These are instructions to convey a property into or out of a trust. They
also inform the trustee if the property is to be encumbered with a
mortgage or with the assignment of a beneficial interest, and so on. The
direction is to be signed by the individual or entity identified in the
To appropriately administer this
type of account, management must understand applicable state law and IRS
statutes. Good recordkeeping procedures require the documentation of all
actions taken with regard to the property in the trust. Since the trustee
assumes minimal liability from holding title to the property and has no duty
to maintain the property or to defend claims against it, management may view
the administration of land trusts as a low risk activity. This is not,
however, the only risk factor to be considered. The level of risk also
depends upon the type of property held and the beneficiary. The lowest risk
is typically associated with an owner occupied single family residential
property. Administering this type of property in a land trust requires only
limited recordkeeping, basic documentation, and limited monitoring. A higher
level of risk accompanies the holding of commercial property (income
producing properties, land development, raw land) and/or beneficiaries who
are not individuals (e.g., partnerships and corporations, etc). The higher
risk results from the volume of transactions associated with commercial
property, along with the specialized documentation required. For example,
administering a land trust holding a parcel of land under development by a
corporation represents a higher level of risk to the trustee. The additional
risk results from multiple conveyances of the property, changes in legal
descriptions (as the parcel is subdivided), and changes in encumbrance. The
type of beneficiary requires specialized documentation to allow the trustee
to clearly identify which individuals are the beneficial owners.
Intermediary" for 1031 Exchange or "Like Kind Property Exchange"
In this capacity, the bank serves
as a specialized custodian identified by the IRS as a "qualified
intermediary." This is an agency relationship governed by IRC Section 1031
(26CFR1.1031(k)-1). The agreement governing this relationship is commonly
referred to as "Starker", "Exchange" or "1031 Exchange" trust. The client
typically uses this type of account as a method of deferring income tax on
the exchange of business-use property, but it may also be used to structure
a tax-free exchange. Essentially, it permits property used in a trade or
business or held for investment ("relinquished property") to be exchanged
solely for like-kind property ("replacement property") which will be used in
a trade or business or held for investment. Like-kind exchange does not mean
100 acres of farmland for 100 acres of farmland. A transaction may, for
example, be structured to exchange farmland for apartment buildings. Items
transferred in this manner may include real estate (as mentioned in the
explanation of like-kind), heavy equipment, or collectibles. The exchange is
usually a three-way transaction that is facilitated by an intermediary,
referred to as a "qualified intermediary". There are five types of
exchanges: delayed/deferred, simultaneous, reverse, improvement, and
The typical sequence of events for
a simple deferred exchange is described as follows:
- The seller sells the "relinquished" property.
Establishment of Agency
Relationship - At the close of a sale, the
proceeds go to a "qualified intermediary". The funds are held in a
"qualified escrow account" or "qualified trust" - essentially an account
for the benefit of the seller. The relationship must be set forth in a
written agreement that includes language expressly limiting the
seller's rights to receive, pledge, borrow, or otherwise obtain the
benefits of the cash or cash equivalents held in the account prior to the
consummation of the entire transaction. The "qualified intermediary" may
not have a fiduciary relationship with the seller. This means that the
"qualified intermediary" cannot give legal or tax advice. The "qualified
intermediary" must return the funds held on deposit, with any accrued
interest, to the seller if any of the timing restrictions can not be met.
The "qualified intermediary,
whose duties are set forth in the Exchange Agreement, must acquire the
"relinquished property" from the seller, transfer the "relinquished
property" (to the buyer), acquire the "replacement property", and transfer
the "replacement property to the seller (who is now the buyer).
- The seller identifies replacement property(ies) within 45 days of
the closing of the sale of the "relinquished" property. The property does
not have to be purchased or under a contract to purchase in 45 days, it
simply must be identified. The written notification must designate
the property as "replacement" property and be signed by the seller.
Identification must be unambiguous, e.g., for real estate the legal
description or legal address. The written notification must be delivered
to the "qualified intermediary" by midnight of the 45th day
following the close of the sale of the "relinquished" property.
- The seller (now the buyer) closes on the replacement
property within 180 days of the sale of the "relinquished" property. The
funds are wired from the account to the closing agent.
A "reverse exchange" occurs when
the replacement property is closed before the relinquished property is
sold. The IRS allows a bank to be a "qualified intermediary" to take title
to the property and hold it until the relinquished property is sold. As
long as the length of the holding period is 180 days or less, then the
exchange should be allowed by the IRS.
These are complex
transactions that must meet specific IRC requirements. As demonstrated by the
example, the agency agreement is specially tailored, and the bank's primary
duty is to document the chain of events required to qualify for the
favorable tax treatment afforded by the IRC. This documentation is essential
if the IRS audits the seller. To effectively supervise this type of
arrangement, management must have a fundamental knowledge of IRS
requirements, maintain sufficient documentation to prove the chain of
events, and have a method of monitoring all the triggering events (ticklers
for notification purposes and the triggering of a tax event). This
topic is also discussed in the Asset Management section of the manual.
C.4.e. Investment Advisory Agent
As Investment Advisory Agent, the
bank may exercise a number of duties, with the primary duty being to offer
investment recommendations to the principal. Other responsibilities may
include: execution of security transactions; collection and disbursement of
funds; and other custodial duties. Generally, written approval of the
principal is needed for investment transactions or the disbursement of funds
C.4.f. Managing Agent
In a Managing Agency, the bank
normally has the same duties as an investment advisory agent, with the
additional authority to make investment selections and execute transactions
without the written consent of the principal. Managing agency agreements are
general in nature, and sometimes grant agents significant discretionary
authority. While a managing agency may appear similar to a trust
relationship, basic differences in the transfer of title and revocability,
as previously discussed, remain. However, an exception may exist in certain
conventional managing agency accounts, whereby the agreement may provide for
assets to be registered in nominee form, to
facilitate trading activities. The agency relationship terminates upon the
revocation by either party or at the death of the principal.
C.4.g. Farm Management Agent
Farm management agency account relationships are utilized for
a number of reasons. Agricultural assets are unique and require a particular
expertise to maximize income potential and enhance value.
Whether the assets are held in a trust, or in an agency capacity, the
fiduciary must exercise the requisite level of care. Some farms may be
managed as an account investment alternative, assuming farmland returns
compare favorably to other investments. An account beneficiary may be
interested in retaining ownership and operating a family farm. An absentee
owner or a retired farmer may contract for farm management because they no
longer may be able to manage the farm themselves.
Banks offering farm management services must address the
following areas: the establishment of a written agreement clearly
delineating the responsibilities of the bank (as an agent or other capacity)
and the principals; the appointment of a farm operator or manager
responsible for actual day to day operation of the farm; the execution of a
lease governing the operation of the farm; and the monitoring of the farm
operator's performance in order to identify and correct problems with farm
operations. Each of these is discussed below.
Farm Management Agreements
governing agreement should delineate the bank's responsibility for
operating, leasing, retaining, deeding, or selling the farm; making crop
planting and marketing decisions; entering into borrowing arrangements;
making major capital improvements; and selecting and dismissing tenants.
agreement should include any provisions whereby the bank must obtain the
approval of other parties to the agreement for matters cited in the
Appointment of a
Farm Operator or Manager
a. Leases with
tenant farmers should be current
and of an appropriate duration in order to facilitate the removal of poor
tenants or the alteration of lease terms.
an outside agent is used to manage farmland, they should be carefully
selected, adequately bonded, and should submit reports of their
activities to the institution.
financial statements from the farm operator may also be appropriate to
ensure their capacity to perform under the lease terms.
The types and terms of leases vary in each account, but one
type of lease arrangement may be more prevalent in a given geographic area.
Account officers should periodically determine which arrangement maximizes
the return for beneficiaries relative to the level of the risk appropriate
for the account. Leases are usually written for one year, but typically a
farm operator's tenure is considerably longer, providing the tenant
continues to perform satisfactorily. The more prevalent types of lease
arrangements are summarized below.
rent lease. Under this arrangement, the farm operator pays a predetermined
sum of cash rent for the use of the farm in a given year. A portion of the
rent is usually paid in the Spring, with the balance of the rent paid in the
Fall. The farm operator retains all of the crop production, receives the
government crop production subsidies, provides all labor and equipment, and
pays all of the cost for seed, fertilizer, chemicals, etc. The land owner
contributes the land and buildings and typically pays the real estate taxes,
insurance and maintenance expenses. Cash rental arrangements are becoming
increasingly popular because the arrangement provides a predetermined annual
return to the trust that is not subject to the significant risks of crop
production and market price variations. Cash rental rates are also readily
comparable and can allow competitive bidding by potential farm operators.
rent lease. The bushel rent lease is very similar to cash rent; however,
the rent is paid in the form of a specified number of bushels of grain, in
lieu of cash, delivered to a local market. The farm operator and land owner
pay the same respective expenses as mentioned in the cash lease arrangement.
This rental arrangement results in a moderate increase in income volatility
compared to the cash rent lease. The return is not subject to production
risk; however, the return is subject to changes in grain market prices.
share lease. Under the net share lease arrangement, the land owner's rent
is a predetermined percentage of the crop produced. Depending on the
geographic location and the crop produced, the arrangement may require 25 to
35 percent of the crop. The farm operator and land owner pay the same
respective expenses as mentioned in the cash lease arrangement. This rental
arrangement results in a moderate increase in income volatility compared to
the bushel rent lease. The return is subject to both production risk and to
changes in grain market prices.
share lease. The 50/50 crop share lease has historically been the most
prevalent farming arrangement for good quality farms in the Corn Belt. The
farm operator provides all labor and equipment, pays 50 percent of all of
the cost for seed, fertilizer, chemicals, etc., retains 50 percent of all of
the crop production, and receives 50 percent of the government crop
production subsidies. The land owner contributes the land and buildings,
pays the real estate taxes, insurance and maintenance expenses, pays 50
percent of all of the cost for seed, fertilizer, chemicals, etc., retains 50
percent of all of the crop production, and receives 50 percent of the
government crop production subsidies. This rental arrangement results in a
moderate increase in income volatility compared to the net share lease. The
return is subject to an increased share of both production risk and to
changes in grain market prices.
farming operation. Under this arrangement, the land owner pays 100 percent
of the crop production costs, real estate taxes, insurance and maintenance
expenses, retains 100 percent of all of the crop production, and receives
100 percent of the government crop production subsidies. The land owner
pays the farm operator specified "custom fees" to provide labor and
equipment to perform the planting, harvesting, etc. This rental arrangement
has the potential for a greater overall return but results in a higher level
of income volatility. The return is subject to all of the crop production
risk, along with the change in grain market prices.
farming operation. Under this arrangement, the land owner owns all of the
farm equipment and pays all of the necessary operating expenses, including
labor. A resident manager is paid by the farm operation, and the land owner
receives 100 percent of all crop proceeds. The return is subject to the
risks described in the custom farming operation; however, the arrangement
has the added risk of equipment ownership verses the elimination of "custom
Monitor the account
and the farm operator's performance.
record of farm income and expense should be available for the property under
that taxes have been paid should be maintained.
that proper insurance is in force should be maintained. Three types of
insurance should usually be required: fire and extended coverage on
buildings and improvements, public liability, and multi-peril crop
insurance. Some farm operators may only carry crop hail insurance. Hail
insurance is a private (and often expensive) insurance program that insures
only crop losses related to hail. Multi-peril crop insurance is a
very widely utilized government farm income insurance program. Government
subsidies make multi-peril insurance an affordable income management tool.
Multi-peril insures crop yields and, depending on the policy provisions
selected, crop revenues. Multi-peril protects the landowner and/or the
tenant's crop revenue from all types of perils that could adversely impact
yields, including wind, hail, disease, frost, drought, insects, weeds, and
flooding. Multi-peril crop insurance is strongly warranted in crop share
and custom farming arrangements, i.e. arrangements where crop yield is the
deciding factor on the return realized from the farmland investment. Crop
yield coverage levels vary from 50 percent to 85 percent of a normal crop yield. The
higher coverage levels are available at higher premiums. The farm
management agent must determine what level of crop and income risk
protection is appropriate for a given account.
farm visits are essential. The type of lease arrangement dictates the
frequency and nature of on-site visits. In a custom farming or crop share
lease arrangement, two or more visits may be warranted during the
planting/growing/harvesting season to monitor the quality of the tenant and
crop conditions due to the weather, disease, insects, weeds, etc. A cash
rental lease arrangement may require only an annual visit to monitor
maintenance of the soil and any facilities. Detailed records of visitations
should include the date, purpose, persons contacted, observations made, and
any facts or opinions that were developed.
flow projections are considered a good management tool and are often
essential to obtain credit. Annual crop plans should be on hand. USDA yield
averages for the area may provide a benchmark performance measurement.
management agents marketing grain should maintain records of prices obtained
and document decisions regarding grain sales.
record should be maintained showing the quantity and storage location of
harvested crops (on the farm or stored in elevators or warehouses). When
not on the farm, detailed storage receipts should be on hand.
maps should be retained to assist in determine soil quality, soil
erodibility, and whether drainage might be a problem. Soil tests should be
performed every few years because soil fertility may be subject to depletion
over time. Lease arrangements, supported by periodic farm inspections and
soil testing, should be designed to ensure the farm operator's practices
maintain soil fertility.
Performance. A bank may encounter problems where the farm is not achieving
adequate returns or there are conditions that limit the value of the farm.
Lease arrangements may be outdated and no longer provide the risk/return
appropriate for the managed account.
Concerns. The farm management agent should have policies and procedures to
identify potentially adverse environmental conditions such as fuel storage
tanks, improper disposal of pesticide containers, dump sites, or other
hazardous conditions. Such conditions may require that an environmental
specialist or engineer review the situation and, if necessary, supervise
proper cleanup. Environmental monitoring safeguards the value of the asset
and reduces the farm management agent's potential exposure to liability.
Concerns. Problems can arise involving compliance with governmental
conservation programs. "Swamp buster" is intended to prevent the drainage
of wetlands. "Sodbuster" is intended to protect the farming of highly
redouble lands (HEL). "Conservation Compliance" provisions require an
acceptable conservation plan on highly erodible soils to prevent soil
erosion. Compliance with conservation programs by farming operations is
important because compliance usually is a prerequisite to receiving related
government income support. Financial incentives such as the Wetland Reserve
Program (WRP) and the Environmental Conservation Acreage Reserve Program
(CRP) may be attractive alternatives for enhancing the value of
environmentally sensitive cropland.
The complexities of properly monitoring, growing, and marketing livestock or
operating livestock enterprise investments within a trust arrangement could
result in relatively high risk to the account. Livestock arrangements are
highly unusual and should require a high level of expertise and monitoring.
of Interest. Banks sometimes obtain a discount for seed purchases by buying
seed in large quantity or by being a "district dealer" for seed companies.
District dealer status should be approved by a committee. These discounts
present potential conflicts of interest in the form of side commissions,
paid either to a farm manager personally or to a bank for being a district
dealer; or from a bank retaining a portion of the bulk discount obtained. A
bank, however, might be entitled to a small portion of such a discount in
return for the bank's efforts in negotiating the discount, if most of the
discount were passed on to the farm. In addition, a conflict of interest may
arise if the bank as farm management agent enters into a lease arrangement
with a farm operator that is also a borrower from the commercial side of the
bank. Policies should adequately address the conflict of interest to ensure
the farm lease arrangement is not adversely impacted.
C.4.h. Attorney-in-Fact Pursuant to an Executed Power of
A bank becomes Attorney-in-Fact
when it receives a formally executed written power of attorney. There are
various types of powers of attorney: general, special power, heath care,
"durable", and "springing." Each of these is defined in Appendix H, under
power of attorney. The durable and springing aspects may be added to any
type of power of attorney.
To limit fiduciary risk, a trust
department that accepts an appointment as attorney-in-fact should only do so
under a special power of attorney. A specialized power of attorney
can be tailored to limit the attorney-in-fact's responsibilities to those
found in a
revocable personal trust agreement. A general power of attorney provides
too broad a range of powers and the health care power of attorney addresses
issues not traditionally administered by bank fiduciaries. A general power
of attorney grants authority to the bank to do anything as attorney-in-fact
which the principal could legally do, including: the voting of stock;
signing or endorsing checks; signing proxies; collecting debts; conveying
real estate; transferring personal property; or performing similar services.
Principal is the term used to identify the person who executes the power of
The principal may wish to use a
power of attorney to manage his personal financial affairs, as it is
traditionally an inexpensive means to have another party take care of
principal's affairs when the principal is incapacitated or otherwise unable
to care for his financial affaires. It is generally less costly than a
revocable trust and provides more management options than an investment
management account. Note, in order for the power of attorney to be effective
in the event of the principal's incapacitation, it must be a "durable" or
"springing" power of attorney. Appointing an Attorney-in-Fact is typically
less costly and easier to acquire, than a court appointed conservatorship.
Regardless of the type of power of
attorney accepted, the trust department must act in the principal's best
interest, keep accurate records, keep the principal's property separate and
distinct from that of all other accounts, and avoid conflicts of interest.
Management must be aware of any state statutes governing this type of
fiduciary appointment. For example, in some states, to effect real estate
transactions the power-of-attorney must be recorded within a particular
jurisdiction, such as a county. In some states the power-of-attorney must be
notarized before becoming effective, and in some states the Attorney-in-Fact
must appear before a public official and state under oath that he
intends to give the power (knowing full well of its consequences).
C.4.i. Safekeeping Agent
A bank performs safekeeping duties
when it limits itself to the safekeeping and delivery of property (to the
principal or others as the principal may direct), with no ministerial
duties required. The safekeeping division of the trust department should
maintain adequate records and controls, together with suitable physical
security. Articles left for safekeeping should not be commingled with bank
assets, but should be properly identified and adequately insured.
D. Additional Fiduciary Capacities
In each of the aforementioned trust
capacities, the bank, in accordance with the governing instrument or
appointment, may be required to share the administration of an account with
another fiduciary, referred to as a co-fiduciary. Examples of co-fiduciary
arrangements include the following:
A court may appoint a co-guardian
to provide for special expertise over investments, or more commonly, may
appoint a separate Guardian of the Person (Ward), while the bank serves as
the Guardian of the Property.
A co-fiduciary relationship may
be requested by the testator of a will, or the settlor of a trust, to
provide for special expertise over investments, or to be assured that
certain family interests are considered when the account is being
It is not uncommon for a family
member to be appointed co-trustee with a financial institution. A
co-fiduciary may also be one or more individuals, or another bank or trust
company. If the co-fiduciary is an individual, the bank is commonly referred
to as the corporate fiduciary. Regardless of the term used, each
fiduciary has a responsibility to participate in the administration of the
It is generally held under common
law that co-fiduciaries act in unison. It is the duty of each co-fiduciary
to use reasonable care to prevent other co-fiduciaries from committing a
breach of trust, and if a breach occurs, to compel the responsible party to
correct it. Co-fiduciaries can be held responsible for a breach of trust
committed by co-fiduciaries if, by neglect or willful misconduct of its own,
it fails to protect the account from the other co-fiduciary's breach of
trust. Further, while a fiduciary is ordinarily liable only for its own
actions, a corporate fiduciary is often held to a higher standard of care
than an individual co-fiduciary. As a result, a corporate fiduciary may be
held liable if it does not compel a co-fiduciary(ies) to initiate corrective
action to cure a breach of trust.
As a matter of sound policy, and to
protect against possible liability, management should ensure the following:
Documentation of Co-Fiduciary
Actions - Management should maintain documented
approvals from co-fiduciaries for all investment transactions and all
other discretionary actions made during an account's administration.
Approvals should be in written form and retained as permanent file
Physical Control of Account
Assets - It is generally undesirable for an
individual (i.e. non-corporate) co-fiduciary to maintain physical
possession or control over account assets. When this occurs, management
should evaluate the controls over the assets in the custody of
co-fiduciaries, as well as any bonding requirements applicable to the
Joint Responsibility for
Administration - Management should not delegate
excessive authority over investments or other matters to the individual
co-fiduciary. Examples of excessive delegation include purchasing assets
requested by the non-corporate co-fiduciary without proper research
or making a discretionary distribution requested by the non-corporate
co-fiduciary without first substantiating that the distribution meets
the needs of the beneficiary and/or the purpose of the account.
Appropriate Response to a
Disinterested or Uncooperative Co-Fiduciary -
Situations may be encountered where a co-fiduciary has become
disinterested or uncooperative and is not performing properly. Ideally,
the bank, as corporate fiduciary, should try to avoid such situations
through pre-acceptance review of the account. Failing that, special
efforts may be needed to obtain the co-fiduciary's cooperation or,
ultimately the bank may have to seek relief through a court.
The bank may be requested or
appointed to serve as successor trustee in the event the originally
appointed trustee is removed, unable, or unwilling to continue in office.
Often, potential successor trustees are specifically designated in the trust
document. Accepting an appointment as a successor trustee can entail
additional risk to the bank. Although a successor trustee is generally not
liable for acts of prior trustees, it can be held liable for actions of
predecessor trustees if: (1) the successor trustee knows, or should know, of
a breach of trust, or any other situation injurious to the account, and (2)
it fails to take action to compel its predecessor(s) to remedy the
Before acceptance, the bank should
perform a due diligence review of an account's prior administration and
require the prior trustee to furnish a complete accounting of its
administration leading up to the time the successor is formally appointed.
If the review discloses acts of improper administration, the successor
trustee should either: (1) refuse to accept the appointment, or (2) take
immediate steps to protect the account by asserting liability against its
predecessor(s). The bank may also request appropriate releases from the
court and/or all beneficiaries to further protect itself from the assumption
of liability arising from the administration of prior trustees. The bank
should maintain written documentation of both the performance of a due
diligence review and any measures that were taken to protect both the
account and the bank from potential liability arising from the actions of
Even if the due diligence review
does not disclose improper administration by the previous fiduciary, the
bank should consider other factors prior to accepting the trust, such as:
Does the beneficiary of the trust
have unrealistic expectations regarding the rate of return on investments
or level of service that can be provided?
Is the language of the trust
document overly complex or contradictory?
Are the assets managed by the
successor trustee unusual or beyond the expertise of the trust officers?
Are fees sufficient in relation
to the degree of difficulty in management of the trust?
Is the trust subject to the laws
of other states and, if so, is the trust department capable of complying
with all required regulations?
A will or trust instrument may
include an exculpatory clause, which relieves, or attempts to relieve, a
fiduciary from liability for breach of trust. However, a fiduciary is not
always fully protected by an exculpatory provision, and such provisions
do not protect fiduciaries from breach of trust or actions which are
illegal. Some states have passed statutes affording protection to the
successor fiduciary from acts of its predecessor(s).
instances, trusts are created to preserve and protect assets for beneficiaries. The most prominent attacks
against assets come from the following sources:
creditors including personal debt contracted for a variety of reasons.
resulting from court or other legal judgments.
liability imposed by government to achieve social goals. One of the most
common sources of regulatory liability is the cost of cleaning up
environmentally damaged property.
beneficiaries. Often many clients will create trusts for an immediate
family member, with the purpose of avoiding having the trust assets
included in determining eligibility for Medicaid or public assistance.
afforded Creditor Protection
are exempt or partially exempt from creditors under either federal of state
law. Many states allow an individual or married couple to retain a certain
amount of equity in their residence. ERISA and many state laws protect
qualified retirement plans from creditors. Some states also protect cash
value of life insurance and annuities from creditors.
In Re Rousey
347 F.3d 689 (8th Cir. 2003),
the debtors voluntarily filed for relief under Chapter 7 of
the Bankruptcy Code. Included in their assets were two IRA's, which were
funded as roll-overs from their previous employer's pension plans. No
additional funds were added to the accounts. The U. S. Court of Appeals for
the Eighth Circuit ruled that IRA's were not exempt under 11 U.S.C.
§522(d)(10)(E), affirming the decision of the Bankruptcy Appellate Panel.
The court found that IRA's should not be exempted from a person's bankruptcy
estate and pointed out that Congress could easily change the law if it
wanted to protect IRA's. Furthermore, the Eighth Circuit held that because
the Rousey's could withdraw money, the IRA's were similar to savings
accounts. The debtors appealed. The U.S. Supreme Court is scheduled to
hear the case in the Fall 2004 term.
See In Re Rousey 347 F.3d 689 (8th Cir. 2003), cert granted, 72
U.S.L.W. 3740 (U.S. June 7, 2004) (No. 03-1407)
established to protect assets against creditors include:
Partnerships. Under this type of partnership agreement, a limited
partner's exposure for the debts of the partnership is limited to the
investment in the partnership, and the creditor cannot attack the personal
assets of the limited partner.
Companies (LLC). The LLC limits the liability similar to other
corporations, but allows flow-through treatment of taxable income or loss.
In general, a beneficiary's
creditors cannot reach trust assets if a trust is created in good faith by an
individual other than the beneficiary. Under the English "Statute of
Elizabeth", which is embodied in the Second Trust Restatement, if a person
created a trust for his own benefit, his creditors could reach the trust
assets. Both Offshore Protection Trusts and Domestic Protection Trusts have
been designed to overcome this traditional precept.
Offshore Protection Trusts
Offshore protection trusts established in several
jurisdictions purport to offer considerable protection against creditor
claims. A key feature that generally differs from trusts established in the
United States is that a settlor is permitted to create a spendthrift trust
for the settlor's own benefit. With a few exceptions, laws in the states
require someone other that a beneficiary to create the trust.
are difficult for creditors to attack for several reasons, including:
Simply because it's
a foreign trust may deter creditors.
Legal costs may be
high. Several jurisdictions do not allow contingency fees or require
deposits to commence a proceeding.
do not recognize foreign judgments, forcing the creditor to obtain
judgments in both the United States and the foreign jurisdiction.
jurisdiction may offer anonymity with respect to wealth.
of the ability of the offshore trust to protect assets from creditors is
often dependent upon the amount of control retained by the settlor.
Generally, the more control that is retained by the settlor, the
less protection is provided by the trust against creditors.
provisions frequently found in offshore protection trust designed to
increase protection against potential creditors include:
Foreign Trustees or Other Fiduciary to Change Situs of Trust Assets.
The trust can be given power to change the situs of the trust assets to
another jurisdiction if an action against the trust is threatened in the
original jurisdiction. This can increase the costs of and time consumed
by the creditor.
Letter of Wishes.
The settlor can provide nonbinding written guidelines to the trustee,
covering the settlor's intent regarding investment of assets and
This clause directs a trustee to ignore direction of a U. S. trustee, if
such direction is given under duress, including court compulsion.
No Benefits Term.
The trust might include a provision that provides for a term in which the
beneficiaries are persons other than the settlor. The term could
correspond with the limitations period applicable to claims of creditors
in the foreign jurisdiction governing the trust.
Beneficial Interests. The trust can provide that the settlor is only
one of several permissible beneficiaries with the trustee having the power
to choose among them or remove one or more. This trust can also provide
upon the occurrence of certain events, the settlor's beneficial interest
in the trust may either be terminated or held in abeyance for a specific
period of time.
have not proved impenetrable from state or Federal court actions; in fact,
court decisions have order repatriation of assets to U. S. jurisdictions.
Courts are generally unkind if evidence indicates a fraudulent transfer or
attempts to avoid payment of alimony or child support. Creditors can often
force bankruptcy or make it very difficult for a beneficiary to obtain the
use of the assets of an offshore protection trust.
Domestic Protection Trusts
Domestic Protection Trusts (also known as Dynasty Trusts) are
attempts by several states to provide spendthrift protection for trusts in
which the settlor is the beneficiary (self-settled
trusts), similar to offshore protection trusts. States that have
adopted Domestic Protections Trusts include Nevada, Rhode Island, Delaware,
and Alaska, and other states are considering adopting similar measures. Two
effects of a discretionary self-settled trust are:
Any gift made by the
settlor to the trust in which the settlor retains an interest causes the
trust to be incomplete for federal gift tax purposes.
interest in the trust will continue to be part of the settlor's gross
estate for federal estate tax purposes.
permit exceptions of Domestic Protection Trusts which allow creditors to
reach the trust assets of self-settled trusts include:
Creditors can reach
the assets if the transfer of assets into the trust was intended to
hinder, delay or defraud creditors, that is, it was a fraudulent
The claim resulted
from an agreement or a court order for child support, or at the time of
the transfer of assets, the settlor was delinquent in child support
payments. Some states also include court orders arising out of divorce
of the trust must take place in the state where the trust was created.
During 2003, the State of Alaska
modified its trust statutes allowing substantial protection for beneficiaries
from creditors desiring to attach assets of self-settled trusts. Major provisions of the
statute include the following:
The statute provides
protection for the trust assets against claims for spousal support,
alimony, child support, providers of necessities, and claims for tort
liability. Note, however, that a settlor cannot be delinquent in a child
support obligation when the trust is settled.
The statute prohibits an
order or attachment against the beneficiary's assets held in trust.
A non-resident beneficiary is now
allowed to act as co-trustee with distribution authority without
compromising creditor protection.
Claimants of pre-existent
creditors must demonstrate evidence that a specific claim was made prior
to assets being transferred to the trust or file an action within four
years of an asset transfer asserting a specific cause of action based on
an act of omission prior to the transfer, such as negligence. Most other
states have unlimited statutes of limitations for actions that occurred
prior to the asset transfer.
The definition of a "fraudulent
conveyance" has been modified, hampering the ability of a creditor to
assert that an asset transfer was fraudulent. The phrase "hinder or
delay" has been removed from the statute, so now a claim of fraud must
prove that the transfer was intended to defraud a creditor. The higher
standard in the new statute will make it significantly more difficult
for a creditor to attach the assets of the trust.
Should other states follow the
example of Alaska and loosen the restrictions on self-settled trusts, the
effects could be far-reaching and substantially inhibit creditors and other
claimants from reaching the assets of these trusts.
self-settled trusts reduce the ability of creditors to attach trust assets,
several limitations restrict their ability to protect trust assets. Some of
these limitations include:
Since states cannot
exempt themselves from Federal law, the state cannot hinder the IRS, a
Federal court, or some other Federal body from reaching the trust assets.
The effectiveness is
usually limited to the state where the trust is administered. Since a
state cannot impose its regulations upon assets located in other states,
the trusts can provide only limited ability to protect assets located in
other states, even if these assets are administered by the trusts.
States are required
to recognize the judgments of other states, so judgments ordered in one
state can be enforced in the state where the trust is administered,
despite the terms of the trust.
While an offshore
protection trust can maintain some degree of confidentiality and secrecy,
a domestic protection trust is subject to subpoena or discovery either
through Federal courts or the regulations of another state.
Most states will
allow claims that originated prior to the transfer of assets. Claimants
usually are unable to transfer assets into dynasty trusts after claims
have been presented.
Signs of Fraudulent Transfer of
managers must be wary of trusts being used for fraudulent transfers. Most
states have adopted legislation similar to the
Transfer Act which defines several factors, called Badges of Fraud,
which are indicators that the transfer of assets to a trust may be
fraudulent. These factors are:
the transfer or
obligation was to an insider;
retained possession or control of the property transferred;
the transfer or
obligation was concealed;
transfer was made or obligation was incurred, the debtor had been sued or
threatened with suit;
was of substantially all the debtor's assets;
removed or concealed assets;
the value of
the consideration received by the debtor was reasonably equivalent to the
value of the asset transferred or the amount of the obligation incurred;
the debtor was
insolvent or became insolvent shortly after the transfer was made or the
obligation was incurred;
occurred shortly before or shortly after a substantial debt was incurred;
transferred the essential assets of the business to a lienor who
transferred the assets to an insider of the debtor.
Rule Against Perpetuities
In order to
compete with states with liberal trust laws, many states have recently
passed regulations abolishing or severely modifying the "rule against
perpetuities." The "rule against perpetuities" is the rule originating in
common law that prohibits the grant of an estate unless the future interest
granting that estate vests within 21 years after the death of someone alive
when the interest was created. In other words, the estate must distribute
assets no later than 21 years after the death of someone now living.
purpose of the rule was to strike a compromise between allowing an owner of
assets to exercise his will over his assets at death and, on the other hand,
tying up assets in such a way and for an indeterminate time so as to prevent
the workings of a free market.
have created innovative methods of using trusts in states that have
abolished the above rule. In one instance a trust was created in order to
perpetuate and grow a business. This was accomplished through the use of a
defective trust, so income taxes were paid outside the trust, allowing
the trust and the business to continue to grow for future generations.
review of trusts designed to protect assets should insure that the transfer
of assets was not fraudulent and did not violate any state regulation,
including the "rule against perpetuities". Furthermore, most states have
passed a version of the Uniform Fraudulent Transfers Act,
designed to ensure transfers are not made into trusts to avoid an immediate
claim by creditors, or avoid child support or alimony.