Now that Pennsylvania recognizes directed trusts, corporate fiduciaries should be aware that sharing trust responsibilities could create both legal liability and administrative burdens. The law, which went into effect late last year, gives settlors the ability to allocate trust responsibilities among trustees and non-trustees.
The terms of a directed trust give certain fiduciary responsibilities to non-trustees (referred to as “trust directors”). Often, directed trusts are used to delegate investment management to a non-trustee or provide a non-trustee the ability to modify or terminate the trust or dictate discretionary distributions. The terms must be clearly defined with respect to any fiduciary delegations to non-trustees. But even seemingly clear trust terms could create problems in practice:
Example 1: If investment management is delegated to trust director, and the trust director holds a high concentration of a particular stock in violation of the trustee’s investment management policy, the trustee must implement carveouts to its policy to accommodate the directed trust.
Example 2: If a trust document expressly delegates investment management decisions to a trust director, problems may arise if, for example, a beneficiary seeks a loan from the trust. Is the loan an investment under the purview of the trust director or a discretionary distribution under the purview of the trustee?
Liability Protection
Trustees do not make decisions in a vacuum. The totality of the trust’s circumstances may affect a trustee’s decision on a discretionary distribution, an investment, a tax disclosure or even a resignation. The statute provides liability protection for trustees complying with the actions and inactions of a trust director, but where does that liability protection end?
The term “willful misconduct” is used throughout the statute, effectively placing a high burden of proof on any party claiming breach on the part of the trustee for following the trust director. Willful misconduct is defined as “intentional conduct that is malicious, designed to defraud or unconscionable.” The statute specifically excludes negligence, gross negligence and even recklessness from the definition of “willful misconduct.” This high standard reflects an attempt to protect the trustee from being found liable for mismanaging a directed trust that is effectively controlled by non-trustees.
To avoid liability, the statute requires a trustee to take “reasonable action” to comply with the trust director’s actions or inaction unless doing so would cause the trustee to engage in “willful misconduct.” The statute does not define the term “reasonable action,” but corporate fiduciaries are likely be held to a higher standard of reasonableness here than an individual trustee, as is otherwise the case when reviewing a potential breach of duties.
Notably, a trustee has no duty to monitor a trust director or to inform interested parties of the trust director’s actions or ways in which the trustee may have acted differently. The statute says that the trustee is not liable for acting in reliance on information provided by a trust director unless the information was outside scope of the trust director's authority or if the trustee engaged in "willful misconduct" by relying on the information.
Advantages, Disadvantages and the Courts
What are the advantages of a directed trust? They can be used to streamline trust modifications or terminations by vesting such powers with a trust director and, therefore, avoiding court approval. Trust directors may also be able to assist with addressing beneficiary disputes where complex family dynamics exist.
From a corporate fiduciary perspective, the primary disadvantage is increased risk, especially when the trust document is poorly drafted. Ultimately, while Pennsylvania now recognizes directed trusts under the new statute, it will be the trust document, not the statute, that designates who is responsible for what. Clarity in drafting will be key.
Of course, anything new in the legal realm is untested by Pennsylvania courts. It’s difficult to predict how something like “reasonable action” will be defined in practice or how ambiguous trust terms may affect each party’s obligations and decisions. It may also take time for these issues to make their way through the courts, as directed trust provisions are only starting to be incorporated into newly drafted trusts or added to existing trusts.
For now, corporate fiduciaries should continue to thoroughly review all new trustee opportunities to determine if the trust is a directed trust and, if so, whether the terms define each party’s obligations in a clear and concise manner so as to reduce potential liability.
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