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Court-Created Trusts in Texas |
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Court-Created Trusts in Texas |
1. INTRODUCTION, SCOPE AND ACKNOWLEDGMENTS
1.1. Introduction.
1.2. Scope.
1.3. Acknowledgments.
2. HISTORY OF COURT-CREATED TRUSTS
2.1. History of Equitable Creation of Trusts.
2.2. History of Statutory Trusts in Texas.
3.1. Statutory Requirements.
3.1.1. Basis for Creation.
A. "Suit" Required.
1) Interpleader.
2) Declaratory Judgment.
3) Probate Proceedings.
4) Federal Lawsuit.
B. Beneficiary Must Be Minor or Incapacitated Person.
C. Next Friend/Guardian Ad Litem/No Legal Guardian Requirement
1) Can a 142 Trust Be Created For a Non-minor Who Is Subject to a Guardianship?
2) What About Attorney Ad Litems?
3) Parents Are Natural Guardians, Not "Legal Guardians."
4) What About Temporary Guardians And Guardians of The Person?
D. Application by Next Friend or Guardian Ad Litem.
E. Best Interests Finding.
F. Judgment Required.
3.1.2. Mandatory Provisions.
A. Must Use Corporate Trustee.
B. Sole Beneficiary Requirement.
C. Mandatory Distribution Provisions.
1) Agreed Order May Be Different.
2) Expanding Standard May Be Different.
D. Mandatory Trust Termination Provisions.
E. Trustee Compensation.
F. Distributions on Termination.
3.1.3. Optional Provisions.
A. Dribble Distributions.
B. Facility of Payment.
C. Termination at Age Other Than 25.
D. Other Optional Provisions.
3.1.4. 1997 Change Permitting Supplemental Needs Trusts.
A. 142 Trusts Created After Effective Date of SB 912.
B. Problems with the Effective Date of SB 912.
3.2. Miscellaneous Issues Regarding 142 Trusts.
3.2.1. Revocation And Modification.
3.2.2. Effect of a Guardianship Proceeding.
3.2.3. Funding 142 Trust With Only Part of Judgment.
3.2.4. Conflicts Between Tex. Prop. Code § 142.005 And The Texas Trust Code.
A. Are 142 Trusts Subject to the Texas Trust Code?
B. Jurisdictional Issues.
3.2.5. Can a 142 Trust Be a Spendthrift Trust?
3.2.6. Trustee's Duty to Account.
3.2.7. Distributions For Minor's Support, Education or Maintenance.
3.2.8. Duties And Liabilities of Next Friend or Guardian Ad Litem.
3.2.9. Potential Liability of Trustee For Administering Nonstandard 142 Trusts.
3.3. Drafting 142 Trusts.
4.1. Statutory Requirements.
4.1.1. Basis For Creation.
A. Application by a Guardian.
1) What Type of Guardian Is Required?
2) Must Guardian Qualify Before Applying for Trust?
B. Application by an Attorney Ad Litem.
C. Best Interests Finding.
4.1.2. Mandatory Provisions.
A. Must Use Corporate Trustee.
B. Sole Beneficiary Requirement.
C. Mandatory Distribution Provisions.
D. Trustee Compensation.
4.1.3. Optional Provisions.
A. 1997 Change Clarifies That 867 Trusts May Contain Extra Provisions.
B. 867 Trusts as Supplemental Needs Trusts.
C. Distributions to or for the Benefit of the Ward or Another Person Whom the Ward Is Legally Obligated to Support.
D. Paying Guardian's Compensation.
E. Trust Termination Age.
F. Distribution on Trust Termination.
4.2. Miscellaneous Issues Regarding 867 Trusts.
4.2.1. Transferring Property Into an 867 Trust.
4.2.2. Trust Amendment, Modification or Revocation.
4.2.3. Can and Should Guardian Resign When Trust Is Created?
A. Parents as the Natural Guardian of the Person.
B. Minors Attaining Their Majority.
C. When a Guardian of the Estate is Needed.
4.2.4. Texas Trust Code Applies to 867 Trusts.
4.2.5. Jurisdiction of Courts Supervising 867 Trusts.
4.2.6. Can an 867 Trust Be a Spendthrift Trust?
4.2.7. Trustee's Duty to Account.
4.2.8. Distributions For Minor's Support, Education or Maintenance.
4.2.9. Duties And Liabilities of Guardian And Attorney Ad Litem.
4.2.10. Potential Liability of Trustee For Administering Nonstandard 867 Trusts.
4.3. Drafting 867 Trusts.
5. MEDICAID (D)(4)(A) SUPPLEMENTAL NEEDS TRUSTS
5.1. Statutory Requirements.
5.1.1. Assets of an Individual.
5.1.2. Under Age 65.
5.1.3. Disabled.
5.1.4. Established by a Parent, Grandparent, Legal Guardian or Court.
5.1.5. State Repayment.
5.2. Basis for Creation of Supplemental Needs Trusts in Texas.
5.2.1. 142 Trust.
5.2.2. 867 Trust.
5.2.3. Parent-Created Trust/Court-Authorized Transfer.
5.2.4. Court-Created Trust Without Reference to Sections 142.005 or 867.
5.3. Drafting Supplemental Needs Trusts.
6. TAXATION OF COURT-CREATED TRUSTS
6.1. Taxation as Grantor Trust.
6.2. I. R. C. § 468B Qualified Settlement Funds.
6.2.1. Historical Background.
6.2.2. Statute.
6.2.3. Regulations.
6.2.4. Avoiding QSF Status.
A. Use a Guardianship And/or 867 Trust.
B. Use a Trust Created by a Relative or Other Third Party.
C. Rely on Rev. Rul. 83-25.
APPENDIX A -- Comparison of 142 Trusts, 867 Trusts and Guardianships
APPENDIX B -- Tex. Prob. Code Ann. §§ 867 -- 873
APPENDIX C -- Tex. Prop. Code § 142.005
APPENDIX D -- Application to Create 142 Trust
APPENDIX E -- Trustee's Application For Approval of Compensation (142 Trust)
APPENDIX F -- Order Creating 142 Trust
APPENDIX G -- Order Approving Trustee's Compensation
APPENDIX H -- Application to Modify Trust Regarding 1997 Legislation
APPENDIX I -- Order Modifying Trust Regarding 1997 Legislation
APPENDIX J -- Form of 142 Trust
APPENDIX L -- Attorney Ad Litem's Application to Create 867 Trust Where No Guardianship Exists
APPENDIX M -- Order Creating 867 Trust Where No Guardianship Exists
APPENDIX N -- Application to Create 867 Trust From Existing Guardianship
APPENDIX O -- Order Creating 867 Trust From Existing Guardianship
APPENDIX P -- Form of 867 Trust
APPENDIX Q -- Supplemental Needs Trust Created by Third Party
1.1. Introduction. This paper examines the history of court-created trusts, explores the statutory and nonstatutory bases for court-created trusts, offers drafting suggestions and includes forms for creation of the various types of trusts discussed. The purposes of the paper are to offer a perspective on the growing use of court-created trusts, to explore specific problems in drafting court-created trusts, to offer solutions to some of the drafting problems and to provide forms for use in Texas courts.
1.2. Scope. This paper covers trusts created pursuant to Section 142.005 of the Texas Property Code ("142 Trusts"), trusts created pursuant to Sections 867 -- 873 of the Texas Probate Code ("867 Trusts"), trusts created pursuant to 42 U.S.C.A. § 1396(d)(4)(a) ("(d)(4)(A)" trusts or Medicaid "supplemental needs" trusts), and trusts created by courts pursuant to their equitable power to do so.
The forms attached to this paper are provided as basic examples. The author does not warrant that the forms meet all legal requirements.
1.3. Acknowledgments. The author gratefully acknowledges the assistance of practitioners and judges around the state for their help in preparing this paper, including Judge Guy Herman of Austin, Pi-Yi Mayo of Baytown, Bernard Jones of Houston, Thomas Baird of Temple, Kathleen Ford Bay, Clyde Farrell, Deborah Green and Christine Larson of Austin, and Janice Torgeson of Bank One, Texas, N. A. in Dallas. In addition to the articles cited elsewhere in this paper, other excellent sources of information in this area are Bernard Jones's article, Estate Planning for Incapacitated Individuals, 33 Real Estate, Probate & Trust Law Reporter, No. 4, p. 27 (July 1995), and Robert H. Kroney's paper entitled "Court Created Trusts and Related Topics" presented to the State Bar of Texas's 20th Annual Advanced Estate Planning and Probate Course in June, 1996.
2. HISTORY OF COURT-CREATED TRUSTS
2.1. History of Equitable Creation of Trusts. In early Anglo-American jurisprudence, trusts were not recognized by the common law courts. Trusts were first enforced by the court of chancery in England in the early fifteenth century. Bogert, Trusts and Trustees, Rev. 2nd Ed. § 3 (1984). Thus, trusts have their roots in equity, and courts sitting in equity have traditionally enforced trusts. Of course, creating trusts and enforcing trusts are not the same thing.
The most common type of trust created by courts sitting in equity (and without specific statutory authority) is the constructive trust. A constructive trust is a device used by a court sitting in equity to compel one who unfairly holds a property interest to convey that interest to another to whom it justly belongs. Bogert, Trusts and Trustees, Rev. 2nd Ed. § 471 (1984). The Texas Supreme Court has stated that constructive trusts, being remedial in character, have the very broad function of redressing wrong or unjust enrichment in keeping with the basic principles of equity and justice, and that a transaction may, depending on the circumstances, provide the basis for a constructive trust where one party to that transaction holds funds which in equity and good conscience should be possessed by another. Meadows v. Bierschwale, 516 S. W. 2d 125, 131 (Tex. 1974).
Despite its name, a constructive trust typically has few of the characteristics of express trusts. A constructive trust is a means to convey title to property from one person to another. Thus, while there is a res, a trustee (albeit an involuntary one) holding legal title and a beneficiary holding equitable title, there is essentially no trust administration and, from the perspective of this paper, there is no trust instrument to draft and construe.
Another type of trust which arises in equity is the resulting trust. In resulting trusts, the intent of the party creating the trust is presumed or inferred. Resulting trusts include "purchase-money trusts" (where one party pays the purchase price to a seller and directs the seller to place title in the name of a third party, the party paying the purchase price is presumed to be a beneficiary of a trust), instances where an express trust does not exhaust the res, and cases of express trusts which fail in whole or in part. Bogert, Trusts and Trustees, Rev. 2nd Ed. § 451 (1984).
For purposes of this paper, resulting trusts hardly qualify as court-created trusts. Rather than creating the trust, a court merely presumes or infers the intent of a party to create a trust. Nonetheless, resulting trusts come into existence because of court action and involve drafting and administrative considerations similar to the other types of court-created trusts discussed in this paper.
2.2. History of Statutory Trusts in Texas. Prior to 1979, there was no statutory authority for a Texas court to create a trust. In that year, the Legislature amended Article 1994 of the Texas Revised Civil Statutes (the predecessor to Chapter 142 of the Texas Property Code) to permit courts to place the proceeds of a judgment accruing to a minor in a trust.
Since 1893, Texas statutes have permitted minors without guardians to be represented in lawsuits by next friends and for the judgment proceeds payable to the minor to be administered outside of the guardianship system in certain cases. In 1893, the court could permit management of up to $500 on behalf of a minor without the need for a guardianship, provided the person managing the funds posted a bond of double the amount to be managed. Acts 1893, 23rd Leg., p. 3. Between 1893 and 1979, this statute was amended to permit suits by next friends on behalf of incapacitated persons (in addition to minors), to permit bonded, nonguardianship management of up to $1,500 (the precursor to Tex. Prop. Code § 142.002), to permit investment of the judgment proceeds in general investments approved by the court (the precursor to Tex. Prop. Code § 142.001), and to permit investment in federally insured accounts (the precursor to Tex. Prop. Code § 142.004). Each of these alternatives to guardianship had drawbacks. The $1,500 limit on bonded administration obviously had limited usefulness, and trial courts were reluctant to take on long-term court supervision of investments and disbursements, preferring instead to let the probate courts to perform this function in the guardianship process. See Bob Burleson and Tom Normand, Money Judgments for Minors, Texas Bar Journal, May 1981, p. 485; see also Michael J. Cenatiempo, The Article 1994 Trust for Minors -- A New Solution to An Old Problem, The Houston Lawyer, May 1981, p. 38.
In 1979, the Legislature addressed these problems in two ways. First, it eliminated the $1,500 ceiling on bonded, nonguardianship management. Second, it permitted the court to create a trust benefitting a minor, so long as a corporate fiduciary was used and so long as the trust contained certain provisions. The authority to create a trust was recodified to Tex. Prop. Code § 142.005 when the Property Code was enacted in 1983. A 1984 amendment permitted 142 Trusts for incapacitated persons (in addition to minors).
There are two significant limitations to the availability of 142 Trusts. First, 142 Trusts can be created only from litigation proceeds -- it is difficult or impossible to get other types of property, such as life insurance proceeds paid directly to a minor, into a 142 Trust. Second, 142 Trusts can be created only if there is no legal guardian for the minor -- once the guardianship is in place, the option of creating a 142 Trust for the litigation proceeds disappears. These limitations, together with a general frustration with the expense and inflexibility of traditional guardianships, were the impetus for adoption of Sections 867 -- 873 of the Texas Probate Code. These provisions, adopted in 1993 as part of the bill recodifying Texas's guardianship laws, permit the creation of 867 Trusts on application of a guardian. The Legislature made a few technical corrections and changes to the provisions regarding 867 Trusts in 1995.
In 1997, the 75th Texas Legislature amended both Tex. Prop. Code § 142.005 and Tex. Prob. Code Ann. §§ 867 -- 873. These amendments, which became effective September 1, 1997, make it clear that the court creating either a 142 Trust or an 867 Trust may vary the terms of the trust from those which would otherwise be required by Texas law in order to make the trust qualify as a Medicaid (d)(4)(A) trust. The text of Tex. Prob. Code Ann. §§ 867 -- 873 and Tex. Prop. Code § 142.005 as amended in 1997 are attached as Appendix B and Appendix C, respectively. In addition, the 1997 changes are discussed throughout this paper.
A table comparing 142 Trusts, 867 Trusts and guardianships of the estate is attached as Appendix A.
3.1. Statutory Requirements. There are specific statutory requirements for the creation and terms of 142 Trusts.
3.1.1. Basis for Creation. Tex. Prop. Code § 142.005(a) provides:
In a suit in which a minor who has no legal guardian or an incapacitated person is represented by a next friend or an appointed guardian ad litem, the court may, on application by the next friend or the guardian ad litem and on a finding that the creation of a trust would be in the best interests of the minor or incapacitated person, enter a decree in the record directing the clerk to deliver any funds accruing to the minor or incapacitated person under the judgment to a trust company or a state or national bank having trust powers in this state.This provision places six prerequisites to the creation of a 142 Trust: (1) a "suit" is required; (2) the suit must involve a minor or an incapacitated person; (3) a minor who has no legal guardian or an incapacitated person must be represented in the suit by a next friend or an appointed guardian ad litem; (4) the next friend or guardian ad litem must apply for creation of the 142 Trust; (5) the court must find that creation of the 142 Trust would be in the best interests of the minor or incapacitated person; and (6) a judgment must be entered. Only if all six prerequisites are met can a 142 Trust be created.
A. "Suit" Required. A "suit" must exist in order for a 142 Trust to be created. Typically, the suit is a personal injury or other tort action in which damages are sought and recovered, either by trial or settlement. However, Tex. Prop. Code § 142.005 is not limited to tort suits. This presents a possible planning opportunity -- how far can the term "suit" be stretched? While creative use of the "suit" requirement may seem inappropriate at first glance, remember that 142 Trusts can only be created with the approval of the court, and courts retain the right to modify or terminate 142 Trusts.
1) Interpleader. An interpleader seems clearly to be a suit. If a party (such as an insurance company holding the proceeds of a life insurance policy payable to a minor) can be persuaded to interplead the funds rather than waiting for the appointment of a guardian, the court hearing the interpleader action should be able to create a 142 Trust out of the proceeds. (A custodian under the new Uniform Transfer to Minors Act could demand that the insurance proceeds be paid to the custodian. If the insurance company so paid the proceeds, a guardianship would be avoided. If the insurance company did not, the custodian's claim could form the basis for the interpleader.)
2) Declaratory Judgment. Is a declaratory judgment action sufficient to meet the "suit" requirement of Tex. Prop. Code § 142.005(a)? Any court of record within its jurisdiction has "the power to declare rights, status, and other legal relations whether or not further relief is or could be claimed." Tex. Civ. Prac. & Rem. Code § 37.003(a). The Declaratory Judgment Act is remedial in nature and is to be liberally construed and administered. Tex. Civ. Prac. & Rem. Code § 37.002(b). Declarations related to any question arising in the administration of a trust or estate are permitted. Tex. Civ. Prac. & Rem. Code § 37.005. Further relief based on a declaratory judgment or decree may be granted whenever necessary or proper. Tex. Civ. Prac. & Rem. Code § 37.011. Perhaps a declaratory judgement action may be brought by a next friend on behalf of a minor or other incapacitated person who is either holding title to property or is entitled to hold title to property seeking a declaration of the minor's or incapacitated person's rights in the property and seeking creation of a 142 Trust.
3) Probate Proceedings. Is a probate proceeding a "suit" for these purposes? "Probate proceedings" include a matter or proceeding relating to the estate of a decedent. Tex. Prob. Code Ann. § 3 (bb). Could someone appear as next friend (or could the court appoint a guardian ad litem) of a minor in a dependent administration and ask for the creation of a 142 Trust rather than a guardianship? A dependent administration presents a easier case than an independent administration, where there is no court supervision of the administration and no court approval of distributions from the estate.
4) Federal Lawsuit. The "suit" requirement in Tex. Prop. Code § 142.005 is not limited to state court actions. Therefore, there seems no reason why a federal court could not create a 142 Trust for a Texas litigant in a federal proceeding.
B. Beneficiary Must Be Minor or Incapacitated Person. A 142 Trust is available only if the suit involves a minor with no legal guardian or an incapacitated person. For 142 Trust purposes, "incapacitated person" means:
a person who is impaired because of mental illness, mental deficiency, physical illness or disability, advanced age, chronic use of drugs, chronic intoxication, or any other cause except status as a minor to the extent that the person lacks sufficient understanding or capacity to make or communicate responsible decisions concerning his person.Tex. Prop. Code § 142.007. This differs from the definition of "incapacitated person" for purposes of creating a guardianship. Section 601 (13) of the Texas Probate Code provides that "incapacitated person" means a minor, a missing person, a person who must have a guardian appointed to receive funds due the person from a governmental source, or "an adult individual who, because of a physical or mental condition, is substantially unable to provide food, clothing, or shelter for himself or herself, to care for the individual's own physical health, or to manage the individual's own financial affairs."
In many cases where a 142 Trust is sought, this requirement is likely to present no practical impediment to creation of the trust. A party's status as a minor should be easy to prove, and a party's status as an "incapacitated person" is likely to have been resolved as a practical matter when the suit is brought by the next friend or when the guardian ad litem is appointed -- long before creation of the 142 Trust is sought. However, the next friend, the guardian ad litem and their attorneys may face liability for their actions and inactions in connection with settling the lawsuit and creating the 142 Trust. See Byrd v. Woodruff, 891 S. W. 2d 689 (Tex. App. -- Dallas 1994, writ denied). The procedural safeguards built into Texas's guardianship laws are not present in the case of a 142 Trust -- there are no requirements for personal service on and personal appearance of the allegedly incapacitated person, trial by jury on the issue of incapacity, and proof of incapacity by clear and convincing evidence. Compare Tex. Prob. Code Ann. §§ 633, 684 and 685 with Tex. Prop. Code § 142.001 et seq. All persons involved in the creation of a 142 Trust should take care that the rights of the minor or incapacitated person are considered and protected and that the terms of the trust are not adverse to the beneficiary's interests -- especially those terms relating to the term and termination of the trust.
C. Next Friend/Guardian Ad Litem/No Legal Guardian Requirement. A 142 Trust is permitted only in a suit in which "a minor who has no legal guardian or an incapacitated person is represented by a next friend or an appointed guardian ad litem." Rule 44 of the Texas Rules of Civil Procedure provides that minors and other incapacitated persons "who have no legal guardian" may sue and be represented by "next friend." Rule 173 provides that a court shall appoint a guardian ad litem when a minor or other incapacitated person is a defendant to a suit and has no Texas guardian or where a minor or incapacitated person is a party to a suit either as plaintiff, defendant or intervenor and is "represented by a next friend or a guardian who appears to the court to have an interest adverse to such minor" or incapacitated person. Other statutes permit the appointment of guardian ad litems in other cases. See, e.g., Tex. Prob. Code Ann. § 683.
There must be no legal guardian for a minor when the 142 Trust is created -- if a guardian of the estate is appointed during the pendency of the suit or even after judgment is entered but before the trust is created, the guardian is entitled to the judgment proceeds and no 142 Trust can be created. Rodriguez v. Gonzalez, 830 S. W. 2d 799, 800-1 (Tex. App. -- Corpus Christi 1992, no writ).
1) Can a 142 Trust Be Created For a Non-minor Who Is Subject to a Guardianship? Since the phrase "who has no legal guardian" in Tex. Prop. Code § 142.005 (a) apparently applies only to minors and not to other incapacitated persons, can a 142 Trust be established for a non-minor who is an incapacitated person who is the subject of a pending guardianship? The answer is apparently yes, although there are no reported cases on the subject.
The author attempted to have this point clarified in the 1997 amendment to Tex. Prop. Code § 142.005. However, the bill enacted by the Legislature does not address this issue.
2) What About Attorney Ad Litems? Tex. Prob. Code Ann. § 34A permits the judge of a probate court to appoint an attorney ad litem to represent the interests of a person having a legal disability, a nonresident, an unborn or unascertained person, or an unknown heir in any probate proceeding. Can an attorney ad litem apply for the creation of a 142 Trust? One can certainly argue that an attorney ad litem under Tex. Prob. Code Ann. § 34A is, in essence, a Rule 173 guardian ad litem and that there is no reason why an attorney ad litem should not be able to apply for creation of a 142 Trust. A safer solution is for the attorney ad litem to ask the court to also appoint him or her guardian ad litem pursuant to Rule 173 prior to applying for creation of the 142 Trust.
3) Parents Are Natural Guardians, Not "Legal Guardians." Parents are the natural guardians of their minor children, but are not legal guardians for purposes of Tex. Prop. Code § 142.005 (a) unless formally appointed legal guardian in a guardianship proceeding. See Tex. Prob. Code Ann. § 676 (b). It is common for a 142 Trust to be created when a minor has a living parent who has not been appointed legal guardian. See, e.g., Aguilar v. Garcia, 880 S. W. 2d 279 (Tex. App. -- Houston [14th Dist.] 1994, orig. proc.).
4) What About Temporary Guardians And Guardians of The Person? There are no reported cases on whether a minor with a temporary guardian or a guardian of the person with no guardian of the estate may have a 142 Trust created for him or her. Having a guardian of the person in place with no guardian of the estate should not prevent the creation of a 142 Trust, since a guardian of the person has no authority to manage property or represent a minor's interests in litigation. See Tex. Prob. Code Ann. § 767. Read literally, the appointment of a temporary guardian for a minor may not preclude creation of a 142 Trust for the minor, although one might argue that a temporary guardian with the powers of a guardian of the estate is, in effect, a legal guardian. See Tex. Prob. Code Ann. § 601 (10) (definition of "guardian" for Probate Code purposes includes a guardian of the person and a temporary guardian).
D. Application by Next Friend or Guardian Ad Litem. A 142 Trust can be created only if the next friend or guardian ad litem applies for it. A 142 Trust cannot be created based on the application of another party to the suit or by the court's unilateral action. See McGough v. First Court of Appeals, 842 S. W. 2d 637, 639 (Tex. 1992).
E. Best Interests Finding. A 142 Trust may be created only if the Court finds that "creation of the trust would be in the best interests of the minor or incapacitated person." Tex. Prop. Code § 142.005 (a).
F. Judgment Required. Even though 142 Trusts are a common settlement solution, a judgment with funds accruing to the minor or incapacitated person thereunder is required for creation of the trust. Therefore, as part of the settlement, the case cannot be dismissed with prejudice or otherwise settled short of a judgment in favor of the minor or incapacitated person if a 142 Trust will be used.
3.1.2. Mandatory Provisions. Once the basis for creating a 142 Trust is established, the 142 Trust must meet mandatory requirements regarding choice of a trustee and terms of the trust. Note, however, that the 1997 amendment to Tex. Prop. Code § 142.005 permits variance from these mandatory provisions to create a (d)(4)(A) supplemental needs trust for Medicaid purposes. See "1997 Change Permitting Supplemental Needs Trusts" below.
A. Must Use Corporate Trustee. To create a 142 Trust, the court must enter a decree in the record directing the clerk to deliver any funds accruing to the minor or incapacitated person under the judgment to a "trust company or a state or national bank having trust powers in this state." Tex. Prop. Code § 142.005 (a). Individuals may not be trustees of 142 Trusts. The trust must provide that the trustee serves without bond. Tex. Prop. Code § 142.005 (b) (5).
One recent trend in at least some courts is to appoint a bank or trust company and an individual as co-trustees. In the author's opinion, this is not permitted by Tex. Prop. Code Ann. §142.005. There is nothing wrong with making an individual or group of individuals "advisory trustees" and permitting them to advise the corporate trustee. Giving an individual co-equal authority with a corporate trustee appears to be contrary to the statute.
Since most 142 Trusts are established at the time a lawsuit is settled, and since often the court is presented with an agreed order and agreed form of trust, judges often do not focus on the terms of the trust to determine if the trust terms meet the statutory requirements. Thus, it is likely that some courts will create 142 Trusts with individual co-trustees notwithstanding the statute.
What should a bank or trust company do if asked to be co-trustee with an individual trustee? There appear to be two possibilities regarding liability for future breaches of such a trust that are attributable to acts of the individual co-trustee:(1) (1) It may be that, since the court ordered the co-trustee arrangement and the bank or trust company is administering the trust as drafted (i.e., as it would administer any other trust with co-trustees), the bank may not be liable for the actions of the individual co-trustee unless the bank itself breached its duties; or (2) It may be that the bank is, in effect, the guarantor of the actions of the individual co-trustee, since the individual is serving as trustee without statutory authority. Certainty the corporate trustee, if faced with a potential liability because of the malfeasance or negligence of the individual co-trustee, can make a forceful argument that the first possibility stated above should apply. However, when one considers that (a) the individual co-trustee is likely to be gone or judgment-proof when this issue arises, (b) there is no bond assuring the performance of the individual co-trustee (see Tex. Prop. Code §142.005(b)(5)), and (c) the court deciding the case is likely to be the same court who created the trust with the co-trustee arrangement, the judge of which is likely to be looking for some way to make things right, the corporate co-trustee may be in a difficult position.
Therefore, if asked in advance if it is willing to be co-trustee with one or more individuals, a bank or trust company should (a) first try to talk the parties into making the individuals advisory trustees only (there is a good chance that this is what the parties intend in the first place), (b) insist on holding the tie-breaking vote or, at the very least, a veto power, (c) ask for exculpatory and indemnity language to be included in the trust instrument, and (d) plan on administering the trust as if it is solely responsible for the actions of all co-trustees.
B. Sole Beneficiary Requirement. Tex. Prop. Code § 142.005 (b) (1) requires that the minor or incapacitated person be the sole beneficiary of the trust. It is sometimes tempting to create one 142 Trust for multiple plaintiffs in order to minimize trustee's fees and other administrative expenses. This temptation should be avoided for at least two reasons. First, Tex. Prop. Code § 142.005 (b) (1) appears to prohibit 142 Trusts with multiple beneficiaries. Second, a trust with multiple beneficiaries is more likely to be taxed unfavorably under Internal Revenue Code 468B (discussed below). Perhaps a more favorable fee arrangement may be negotiated with the potential trustee of multiple 142 Trusts and drafted into the trusts.
C. Mandatory Distribution Provisions. The trust must provide that (1) the trustee may disburse amounts of the trust's principal, income, or both as the trustee in his sole discretion determines to be reasonably necessary for the health, education, support or maintenance of the beneficiary (Tex. Prop. Code § 142.005 (b) (2)) and (2) the income of the trust not disbursed under Section 142.005 (b) (2) is added to the principal of the trust (Tex. Prop. Code § 142.005 (b) (3)).
Except in the case of a (d)(4)(A) supplemental needs trust (see below), these provisions cannot be modified or abrogated by the court. In one of the few reported cases on 142 Trusts, the Fourteenth Court of Appeals held that the trial judge could not add a provision limiting withdrawals from a 142 Trust to use for medical purposes in situations where the parents have no other means to pay for the required medical care. In Aguilar v. Garcia, 880 S. W. 2d 279, 281 (Tex. App. -- Houston [14th Dist.] 1994, orig. proc.), the court held:
The clear language of the statute requires that the trustee have the sole discretion to determine what is in the best interest of the beneficiary and make distributions for the health, education, support, or maintenance of the beneficiary. Tex. Prop. Code Ann. 142.005 (b) (2) (Vernon 1984). The statute also clearly states that this provision is mandatory. Even though the trial judge's motives were laudable, she did not have discretion to limit the mandatory powers given to the trustee. We hold that the express terms in section 142.005 (b) (2) are mandatory and the trial court abused its discretion by requiring conflicting modifications to the trust instrument.[footnote omitted]. If correct, the holding in Aguilar could severely limit the ability of a court to design a 142 Trust to meet the specific needs of the trust beneficiary. However, when considering the effect of Aguilar, one must consider the following:
1) Agreed Order May Be Different. In Aguilar, the trial court sought to impose the modifications to the mandatory statutory distribution standard over the objection of the guardian ad litem. Since only a guardian ad litem (or next friend) can apply for the trust, perhaps Aguilar can be read as restricting the ability of the trial court to force modifications of the statutory provisions onto the guardian ad litem and the beneficiaries. See McGough v. First Court of Appeals, 842 S. W. 2d 637, 639 (Tex. 1992) (trial court could not force an annuity arrangement over the objection of the guardian ad litem). Thus, in the typical case where the guardian ad litem has requested that a trust have nonstandard provisions and where all parties have agreed to the terms of the proposed trust, the trial court would not be "requiring conflicting modifications to the trust instrument" as it did in the Aguilar case.
2) Expanding Standard May Be Different. In Aguilar, the court sought to contract or reduce the distribution standard, restricting the discretion of the trustee required by the statute. Perhaps Aguilar does not apply in a case where the distribution standard (or other mandatory terms) are being expanded. For example, if, in addition to giving the trustee the statutorily required health, education, maintenance and support standard, the trust also mandated that a specific amount per month be paid to the beneficiary, Aguilar may not apply, since the court would not be "limit[ing] the mandatory powers given to the trustee."
D. Mandatory Trust Termination Provisions. The trust must provide that, if the beneficiary is a minor, the trust terminates on the death of the beneficiary, on the beneficiary's attaining the age stated in the trust, or on the 25th birthday of the beneficiary, whichever occurs first, or if the beneficiary is an incapacitated person, the trust terminates on the death of the beneficiary or when the beneficiary regains capacity. Tex. Prop. Code § 142.005 (b) (4). For minors' trusts, the ability to extend the date of trust termination beyond age 18 has been seen as one of its principal advantages over guardianships, which must terminate at age 18 unless the 18-year-old is otherwise incapacitated.
Note that Tex. Prop. Code § 142.005 (b) (4) is somewhat unclear on when a 142 Trust benefitting a minor who also is an incapacitated person must terminate. Does the trust have to terminate at age 25, or can it continue until the beneficiary regains capacity or dies? In many cases it may be difficult to predict the level of capacity an incapacitated minor will have at age 25, while in others it may be clear that the minor is unlikely to ever have capacity to manage the trust assets. If the trust for the minor is set to terminate at age 25, and if the minor appears to be incapacitated at that time, the trust may be amended or modified to continue until the beneficiary regains capacity. Tex. Prop. Code § 142.005 (d).
Section 142.005(g), enacted in 1997, permits the trust to "contain provisions determined by the court to be necessary to establish a special needs trust." This should permit a court to continue a (d)(4)(A) trust beyond age 25. If a minor who does not meet the definition of incapacity in Section 142.007 of the Texas Property Code is the beneficiary of a (d)(4)(A) trust, and if the (d)(4)(A) trust must terminate at age 25, the trust beneficiary would be deprived of the benefits afforded by (d)(4)(A) trusts because at age 25 (1) the government reimbursement provision would kick in and (2) if more than $2,000 was left in the trust, the trust beneficiary would cease to qualified for Medicaid and SSI benefits. Therefore, it is "necessary" under Tex. Prop. Code §142.005(g) for the trust to provide that it continues beyond age 25 until the death of the beneficiary or it is otherwise terminated by order of the court.
E. Trustee Compensation. Tex. Prop. Code § 142.005 (b) (6) provides that the trust must provide that "the trustee receives reasonable compensation paid from trust's income, principal, or both on application to and approval of the court." The statute does not define "reasonable compensation," nor does it provide whether such compensation is paid monthly or quarterly as it accrues (as is the case with most express trusts administered by corporate fiduciaries) or in arrears (as is the case with 867 Trusts and guardianships). The statute also is silent on whether one application and approval is required or whether periodic applications and approvals are required.
In most cases, trustees of 142 Trusts are paid currently as fees accrue (i.e., not in arrears) for serving as trustee of 142 Trusts at their usual and customary rates. Also, in most cases, trustees make one application for payment at the commencement of their service as trustee and obtain court approval just once (unless changed facts or circumstances require as subsequent application). This makes 142 Trusts much more attractive for corporate trustees than 867 Trusts, which limit compensation to the statutory formula for guardianship compensation (unless the court otherwise orders) and which provide for payment in arrears upon the annual filing and approval of a guardianship-type accounting.
Trustees should not forget to apply for approval of their compensation. This may seem obvious, but in the typical case the creation of the trust may be handled by the guardian ad litem and counsel for the plaintiff. Since Tex. Prop. Code § 142.005 (b) (6) requires "application to and approval of the court," it is a good idea for the trustee to submit a separate application for compensation and related order for the judge to sign at the time of trust creation so that the requirement is clearly met. Appendix E is an example of such an application.
F. Distributions on Termination. In a 142 Trust which is not a (d)(4)(A) supplemental needs trust, on the termination of the trust under its terms or on the death of the beneficiary, the trust principal and any undistributed income must be paid to the beneficiary or to the representative of the estate of a deceased beneficiary. Tex. Prop. Code § 142.005 (e). 867 Trusts offer more flexibility regarding distributions on trust termination.
A (d)(4)(A) supplemental needs trust created under Section 142.005(g) enacted in 1997 presumably is permitted to have a different distribution scheme, since (d)(4)(A) trusts must provide for the reimbursement to the state of some benefits upon termination of the trust. This may present a planning opportunity for (d)(4)(A) trusts which is not there for other 142 Trusts -- in addition to including the government reimbursement provision, perhaps the trust instrument may provide for a tax-planned distribution scheme.
3.1.3. Optional Provisions. Tex. Prop. Code § 142.005 (b) and (c) permit the trust to contain provisions other than the mandatory provisions described above.
A. Dribble Distributions. The trust may provide that distributions from trust principal before the termination of the trust "may be made from time to time as the beneficiary attains designated ages and at designated percentages of the principal." Tex. Prop. Code § 142.005 (c) (1). Thus, the trust could provide for one-third of the trust principal to be distributed to the beneficiary at age 21, one-third at age 23 and the remainder at trust termination at age 25.
B. Facility of Payment. The trust may permit payments "to the natural or legal guardian of the beneficiary or to the person having custody of the beneficiary" or "directly to or expended for the benefit, support, or maintenance of the beneficiary without the intervention of any legal guardian or other legal representative of the beneficiary." Tex. Prop. Code § 142.005 (c) (2). This is not as broad as the facility of payment clauses typically used in an express trust. Can the drafter go beyond the optional statutory language to permit distributions to a custodian under the Texas Uniform Transfers to Minors Act, or to the parent of an adult beneficiary? Since 142 Trusts often are created for minors but last beyond the beneficiary's minority, trustees often find themselves faced with the problem of having to determine if payments to the beneficiary's parent may continue after his or her eighteenth birthday. Since Tex. Prop. Code § 142.005 (c) (2) is an optional provision, a more universal facility of payment clause which gives the trustee more flexibility in making distributions should fall within the court's power to impose terms of the trust that are not in conflict with the mandatory provisions. See Tex. Prop. Code § 142.005 (b).
C. Termination at Age Other Than 25. The trust may provide that it will terminate upon the minor beneficiary's attainment of an age of less than 25. For example, the trust may provide that it terminates when the minor beneficiary attains the age of 21 years. The trust cannot be extended beyond age 25 unless the beneficiary is incapacitated.
D. Other Optional Provisions. The court is authorized to determine the "terms, conditions, and limitations of the trust" that are not in conflict with the mandatory statutory provisions. Most 142 Trusts go well beyond the minimal statutory requirements. For example, many trusts expressly make the provisions of the Texas Trust Code applicable to the trust. Trusts limiting the liability of the trustee have been approved. Many trusts provide that distributions for the health, education, support, and maintenance of the beneficiary may include enhancements to the family life of the beneficiary, such as the purchase of a new family car or van or the purchase of a new house. These optional provisions can go too far, however. See Aguilar v. Garcia, 880 S. W. 2d 279 (Tex. App. -- Houston [14th Dist.] 1994, orig. proc.).
3.1.4. 1997 Change Permitting Supplemental Needs Trusts. SB 912 (Acts, 75th Legislature, Regular Session, Chapter 128), effective September 1, 1997, adds subsection (g) to Tex. Prop. Code § 142.005, which reads as follows:
(g) Notwithstanding any other provision of this chapter, if the court finds that it would be in the best interests of the minor or incapacitated person for whom a trust is created under this section, the trust may contain provisions determined by the court to be necessary to establish a special needs trust as specified under 42 U.S.C. Section 1396p(d)(4)(A).This new provision provides a means for creating (d)(4)(A) "supplemental needs" trusts for Medicaid purposes under Tex. Prop. Code § 142.005. Prior to the enactment of SB 912, there was an apparent conflict between the mandatory trust terms required by Section 142.005 and the terms needed to meet the requirements of 42 U.S.C. § 1396(d)(4)(a). Despite this apparent conflict, the policy reasons for setting up supplemental needs trusts was so strong that many courts created 142 Trusts with supplemental needs language anyway.
Tex. Prop. Code §142.005(g) refers specifically to 42 U. S. C. §1396(d)(4)(A). It does not address the other two types of trusts permitted by the Omnibus Budget Reconciliation Act of 1993 ("OBRA 93") -- trusts designed to capture excess income established pursuant to 42 U.S.C. § 1396p(d)(4)(B), commonly called "Miller Trusts," and trusts established by a non-profit corporation pursuant to 42 U.S.C. § 1396p(d)(4)(C). On the other hand, the 1997 change to Tex. Prob. Code Ann. §868 regarding 867 Trusts (discussed below) permits deviation from the statutory distribution standard if it "is necessary and appropriate for the ward to be eligible to receive public benefits or assistance under a state or federal program that is not otherwise available to the ward." Thus, while there is no statutory basis for creation of a Miller Trust or a (d)(4)(C) trust(2) under Tex. Prop. Code §142.005, an 867 Trust may be used for this purpose.
A. 142 Trusts Created After Effective Date of SB 912. New subsection (g) makes it clear that, in order to establish a new 142 Trust with supplemental needs provisions after SB 912 becomes effective, the applicant (in addition to the other requirements for establishing a 142 Trust described above) need only obtain a court finding that such provisions "would be in the best interests of the minor or incapacitated person" for whom the trust is to be created. This finding permits the court creating the trust to include whatever provisions the court determines are "necessary to establish a special needs trust" under 42 U.S.C. Section 1396p(d)(4)(A).
A proposed form of application for creating a new 142 Trust with supplemental needs language under SB 912, together with a proposed order creating the trust and the proposed trust itself, are attached as Appendices D, F and J.
B. Problems with the Effective Date of SB 912. Sadly, SB 912 gives no guidance about its effect on 142 Trusts in existence on its effective date (September 1, 1997), or litigation proceedings under way on its effective date. The author suggested changes to SB 912 which would have made it clear that new subsection (g) applied to 142 Trusts regardless of whether they were created before, on or after SB 912's effective date, but the version that was enacted is silent on this point. (Compare HB 1314, discussed below, which made a similar change for 867 Trusts and which provides that the new amendment applies to existing 867 Trusts.)
How should SB 912 be construed? There are three possibilities:
Other problems have to do with modifying existing 142 Trusts. If SB 912 is construed to apply only to 142 Trusts created on or after September 1, 1997: (1) Can existing 142 Trusts be modified to fall within the provisions of SB 912? (2) If so, how does one go about modifying an existing 142 Trust to gain the protection of SB 912? (3) Who should apply for the modification order? (4) Is the court required to appoint a guardian ad litem or attorney ad litem for the minor?
While the author would like to think that SB 912 applies to existing 142 Trusts without the need for modification, the most logical construction is (1) the new provision applies only to trusts created on or after September 1, 1997; (2) any 142 Trusts existing prior to September 1, 1997, can be modified to fall within the new law; (3) any interested party (including the trustee or a next friend for the minor) is entitled to apply for a modification order; and (4) if the modification is a non-substantive change (in other words, if the 142 Trust being modified already had supplemental needs language in it) then no guardian ad litem or attorney ad litem should be required, but if the supplemental needs language is being added to an existing 142 Trust, then a guardian ad litem or attorney ad litem should be appointed.
Therefore, the author suggests that supplemental needs trusts established prior to the effective date of SB 912 should be modified to make SB 912 applicable. This may be unnecessary, but the cost of doing so is relatively small, and the consequences of failing to make SB 912 applicable to existing trusts if modification is required are great. A proposed form of application and order to accomplish this purpose is attached as Appendix H and Appendix I, respectively.
3.2. Miscellaneous Issues Regarding 142 Trusts.
3.2.1. Revocation And Modification. A 142 Trust may be amended, modified or revoked by the court creating it at any time before its termination, but it cannot be revoked by the beneficiary or a guardian of the beneficiary's estate. Tex. Prop. Code § 142.005 (d). A beneficiary, his or her guardian, or another representative of the beneficiary can ask the court to amend or revoke the trust. If the court revokes the trust before the beneficiary is 18 years old, it can make other arrangements for the investment of the trust property under Chapter 142 of the Texas Property Code (and, therefore, keep the property out of the beneficiary's guardianship estate). If the minor has attained age 18 when the court revokes the trust, the trust property must be paid to the beneficiary "after the payment of all proper and necessary expenses." Tex. Prop. Code § 142.005 (d).
3.2.2. Effect of a Guardianship Proceeding. As noted above, a 142 Trust cannot be created for a minor with a legal guardian. If the 142 Trust is established before the guardian is appointed, however, the trust continues in force and effect until terminated or revoked, notwithstanding the appointment a guardian or the estate of the trust beneficiary and notwithstanding the beneficiary's attainment of the age of majority. Tex. Prop. Code § 142.005 (f).
In Rodriguez v. Gonzalez, 830 S. W. 2d 799 (Tex. App. -- Corpus Christi 1992, no writ), a grandmother of four minor children brought a tort suit on behalf of the children (apparently as next friend). The parties settled and entered into an agreed judgment whereby the recovered funds were placed into the district court's registry. At that time, there was no guardian of the children's estates. The grandmother then instituted guardianship proceedings, was appointed guardian of the children's estates, and filed an application for possession of the minors' funds held in the court registry. The attorney ad litem in the tort suit then filed a motion with the district court for creation of a 142 Trust. The district court granted the motion to create a 142 trust and the guardian appealed. The court of appeals held for the guardian, stating:
The provision for the creation of such a trust applies only in those cases in which the minor has no legal guardian. . . . However, once the legal guardian has been appointed and qualified, she is entitled to custody and control of the minors' estates.830 S. W. 2d at 800-1. Thus, in a dispute between a guardian of the estate and the trustee of a 142 Trust over possession of funds, the relevant date is the date of creation of the 142 Trust. If the guardian qualifies before the trust is created, Tex. Prop. Code §142.005(f) is not a bar to recovery of the funds by the guardian. If, on the other hand, the trust is created before the guardian qualifies, Section 142.005(f) prevents the guardian from recovering the funds from the trustee.
3.2.3. Funding 142 Trust With Only Part of Judgment. In many (if not most) cases, the court orders only a portion of the judgment proceeds due to be paid to a minor or incapacitated person to be held in a 142 Trust. A portion of the judgment is kept out of the trust to pay attorneys' fees. Tex. Prop. Code § 142.005 (a) requires the court to enter a decree in the record directing the clerk to deliver "any funds accruing to the minor or incapacitated person under the judgment" to the trustee of the 142 Trust. It is unclear if this means that all funds accruing to the minor or incapacitated person under the judgment must be placed in the trust. If possible, the judgment should be structured so that attorneys' fees and other items are paid out of the portion of the judgment accruing to another party (such as the parents of the injured minor or incapacitated person) so that all of the judgment accruing to the minor or incapacitated person can be transferred into the trust. Another alternative would be to have the court order the trustee to pay the attorneys' fees out of the trust upon creation of the trust. As a practical matter, however, the practice of placing only a portion of the judgment in the 142 Trust is so widespread that it is doubtful that an appellate court would construe Tex. Prop. Code § 142.005 (a) to prohibit such practice. But see Aguilar v. Garcia, 880 S. W. 2d 279 (Tex. App. -- Houston [14th Dist.] 1994, orig. proc.).
3.2.4. Conflicts Between Tex. Prop. Code § 142.005 And The Texas Trust Code. Although the statute authorizing 142 Trusts is in the Texas Property Code, it is not part of Title 9 of the Texas Property Code, also known as the Texas Trust Code. Potential conflicts exist between the provisions of Tex. Prop. Code § 142.005 and the Texas Trust Code. Unfortunately, there are no reported cases addressing these conflict issues.
A. Are 142 Trusts Subject to the Texas Trust Code? Section 111.003 of the Texas Property Code says that a "trust" for Texas Trust Code purposes is an express trust only and does not include a resulting trust, a constructive trust, a business trust or a security instrument such as a deed of trust. The methods for creating a trust enumerated in Tex. Prop. Code § 112.001 do not include court-created trusts such as 142 Trusts. Nothing in Chapter 142 expressly makes the Texas Trust Code applicable to 142 Trusts. Therefore, a strong argument can be made that the Texas Trust Code does not apply to 142 Trusts.
Except for the potential jurisdictional conflicts described below, there seems to be no reason that the provisions of the Texas Trust Code should not apply to 142 Trusts except to the extent that such provisions conflict with the terms of Tex. Prop. Code § 142.005 or the terms of the particular 142 Trust. As is the case with express trusts, the Texas Trust Code can fill in the gaps of a simply-drafted trust, addressing issues which may not be specifically addressed in the trust instrument. For example, the Texas Trust Code provides a fairly comprehensive scheme for allocating receipts and expenses to income or corpus. It is unlikely that the typical instrument creating a 142 Trust will go into the same level of detail about allocation of receipts and expenses. Therefore, when drafting 142 Trusts, care should be taken to enumerate the powers of the trustee and, unless there are unique facts which make this unnecessary, the provisions of the Texas Trust Code should be incorporated by reference, except to the extent they may conflict with Tex. Prop. Code § 142.005 or with other provisions of the trust.
B. Jurisdictional Issues. Section 142.005 of the Texas Property Code does not specify which courts may create and supervise a 142 Trust. Rather, it just states that "the court" may create, amend, modify, revoke or approve trustee compensation from a 142 Trust. Does this mean that any type of court can create, amend, modify, revoke or approve trustee compensation from a 142 Trust?
Under the Texas Trust Code, exclusive jurisdiction over proceedings concerning trusts is granted to the district court and statutory probate courts. Tex. Prop. Code § 115.001; see also Tex. Prob. Code Ann. § 5A(c). Thus, under the Trust Code, constitutional county courts, county courts at law and justice courts have no jurisdiction concerning trusts. Does this mean that a minor who recovers in a personal injury case in a county court at law cannot benefit from a 142 Trust? As a practical matter, the jurisdictional limits of a constitutional county court or a county court at law may make it impractical to utilize 142 Trusts in many cases, but there are other cases (notably probate or guardianship cases) where county courts -- in particular, county courts at law -- hear issues involving substantial sums. The author is not aware of any cases on this issue.
This statutory construction problem could be resolved in any of the following ways:
3.2.5. Can a 142 Trust Be a Spendthrift Trust? Should a spendthrift clause be added to a 142 Trust? Tex. Prop. Code § 112.035 (d) provides that, if the settlor is also a beneficiary of the trust, a provision restraining the voluntary or involuntary transfer of the settlor's beneficial interest does not prevent the settlor's creditors from satisfying claims from the settlor's interest in the trust estate. "Settlor" is defined as "the person who creates the trust." Tex. Prop. Code § 111.004 (14). Chances are, the beneficiary of a 142 Trust will be considered by the Court to be the "settlor" of the trust, and it is doubtful that a spendthrift provision will protect the trust estate from the beneficiary's creditors. However, one can certainly argue that the court, not the beneficiary, creates the trust, and the beneficiary has no right to the trust assets until they are distributed to the beneficiary. Even if the spendthrift clause does not protect the trust assets from the beneficiary's creditors, it may prohibit the beneficiary from voluntarily alienating his or her interest in the trust. Therefore, it is probably a good idea to include a spendthrift provision in the trust.
3.2.6. Trustee's Duty to Account. Section 142.005 of the Texas Property Code provides no special duty of the trustee to account. The court may impose such a duty by including a requirement to account in the trust. If the trust is silent on the trustee's duty to account, then perhaps the trustee must meet the requirements of the Texas Trust Code. In all cases, the trustee is a fiduciary and has the same fiduciary duties that other fiduciaries have. Also, as a practical matter, it probably has a duty to account to the court on request, since the trustee's compensation must be approved by the court and since the court retains the right to terminate or modify the trust.
3.2.7. Distributions For Minor's Support, Education or Maintenance. Tex. Prob. Code Ann. § 777 provides that, absent a court finding of undue hardship, "a parent who is the guardian of the person of a ward who is 17 years of age or younger may not use the income or the corpus from the ward's estate for the ward's support, education, and maintenance [emphasis added]." This provision was added to the probate code in 1993 as part of the recodification bill; there is no corresponding provision in pre-1993 statutory probate law. It is consistent with the Family Code (see Tex. Fam. Code § 151.003(a)(3) -- a parent has "the duty to support the child, including providing the child with clothing, food, shelter, medical and dental care, and education") and prior case law (see Tharp v. Blackwell, 570 S. W. 2d 154, 159 [Tex. Civ. App. -- Texarkana 1978, no writ] -- Texas law "imposes upon a parent, who has resources of his own sufficient to maintain his children, and who is also guardian of their estates, to support them out of his own means and he may not have recourse to the estates of the wards.").
Does Texas law (Tex. Prob. Code Ann. § 777 or otherwise) permit or require the trustee of a 142 Trust to withhold payments for the support, education and maintenance of a trust beneficiary under age 18 if the beneficiary's parent or parents have the resources to support the beneficiary? If Aguilar v. Garcia, 880 S. W. 2d 279 (Tex. App. -- Houston [14th Dist.] 1994, orig. proc.) is decided correctly, then the trust instrument cannot require a trustee to withhold trust distributions which would pay for expenses that fall within a parent's legal duty to support the child. In Aguilar, the following provision was included in the trust instrument approved by the trial court:
The Trustee shall pay to or apply for the benefit of the Beneficiary such amounts out of the net income and principal (if income is sufficient) of the Trust as are reasonably necessary in the sole discretion of the Trustee to provide for the health needs of the Beneficiary when it is demonstrated that the parents have no resources available, such as insurance, or other means to provide for the medical needs of the child . . . .880 S. W. 2d at 280 [emphasis added]. The court of appeals said that, while the trial court's motives in including this restriction regarding the parent's means were laudable, the court did not have the discretion to limit the mandatory powers given to the trustee under Tex. Prop. Code § 142.005(b)(2). Thus, requiring the trustee of a 142 Trust to consider parent's resources is prohibited under Aguilar.
If the trust instrument merely permits the trustee to consider other sources of support in deciding whether to make distributions, or if the trust instrument is silent regarding other sources of support and the trustee considers such sources in exercising its fiduciary duties under the mandatory health, education, maintenance and support standard, then the Aguilar rationale seems inapplicable -- the court is not limiting the mandatory powers given to the trustee by Tex. Prop. Code § 142.005. Thus, the trustee probably is justified (and may in fact breach fiduciary duties owed to the trust beneficiary if the trustee fails to do so) in withholding distributions that can be paid, and in fact are paid, by the parents pursuant to their support obligations.
What can a trustee do if it withholds distributions because of the parents' support obligation and the parents refuse or fail to satisfy their support obligations? First, and foremost, the trustee probably must assure that the support obligations are met by making distributions from the trust. Second, unlike a guardian, the trustee of a 142 Trust has no direct authority to pursue payment of support obligations by the parents. However, the trustee probably is an "interested person" under Tex. Prob. Code Ann. § 601(14) which is entitled to apply for appointment of a guardian for the trust beneficiary. If a guardian is appointed for the trust beneficiary, that guardian is empowered (and is probably required) to pursue satisfaction of the parent's support obligations on the trust beneficiary's behalf.
If the trust instrument provides that the trustee of a 142 Trust is not required to consider (or is prohibited from considering) other sources of support available to the trust beneficiary in determining whether or not to make distributions, can the trustee (i) ignore the parents' ability to support the trust beneficiary, (ii) make support distributions from the trust and (iii) still avoid liability? Such a trust provision does not limit the mandatory health, education, maintenance and support standard; thus, the court's reasoning in Aguilar seems not to apply. It is hard to see how such a provision would be in the trust beneficiary's best interests (thus presenting potential liability for the guardian ad litem or next friend who consents to such a provision), but this may be the best way (from the trustee's perspective) to simplify trust administration and protect the trustee from liability -- the trustee simply follows the trust instrument and makes the support distributions without considering other possible sources of support.
Note that Tex. Prob. Code Ann. § 777 and Tharp v. Blackwell, 570 S. W. 2d 154, 159 (Tex. Civ. App. -- Texarkana 1978, no writ) both address the situation where the parent is the guardian (although Section 777 applies when the parent is the guardian of the person and Tharp applies where the parent is the guardian of the estate). Obviously, in the case of a 142 Trust, a corporate fiduciary, not the parent, will be trustee, although one or both parents may be the guardian of the person of the trust beneficiary. Tex. Prop. Code § 142.005(c)(2) provides that a 142 Trust may provide that "distributions, payments, uses, and applications of all trust funds may be made to the legal or natural guardian of the beneficiary or to the person having custody of the beneficiary or may be made directly to or expended for the benefit, support, or maintenance of the beneficiary without the intervention of any legal guardian or other legal representative of the beneficiary [emphasis added]." Could the situation arise where, under Tex. Prop. Code § 142.005(c)(2), the trustee of a 142 Trust may make support distributions to the guardian of the person of the trust beneficiary, but under Tex. Prob. Code Ann. § 777 the parent/guardian may not expend the trust distributions? This situation probably cannot occur because (i) the prohibition against spending money in Tex. Prob. Code Ann. § 777 applies only to "the ward's estate" and the trust distributions should not be considered part of the ward's estate (see Tex. Prob. Code Ann. § 601(8)) and (ii) Tex. Prop. Code § 142.005(f) trumps the Probate Code, providing that a 142 Trust "prevails over any other law concerning minors, incapacitated persons, or their property." Of course, the trustee of the 142 Trust can avoid this scenario by directly applying distributions for the benefit of the trust beneficiary instead of making distributions through the parent as legal guardian, but as a practical matter distributions through the parents will be used in many, if not most, cases.
3.2.8. Duties And Liabilities of Next Friend or Guardian Ad Litem. A 142 Trust can be created only if the next friend or guardian ad litem of the minor or incapacitated person applies for its creation. Tex. Prop. Code § 142.005 (a). What duties does the next friend or guardian ad litem owe to the beneficiary in connection with requesting and drafting a 142 Trust? What potential liabilities does the next friend or guardian ad litem face as a result of actions taken in connection with the 142 Trust?
It is clear that a next friend or a guardian ad litem is a fiduciary of the proposed trust beneficiary who owes that beneficiary the same duties that other fiduciaries owe, including the duty of loyalty. In Byrd v. Woodruff, 891 S. W. 2d 689 (Tex. App. -- Dallas 1994, writ denied), the court of appeals found that a guardian ad litem for a minor is a fiduciary, and that:
As a fiduciary, the guardian ad litem shall: (i) use the skill and prudence that an ordinary, capable, and careful person would use in the conduct of his own affairs, (ii) use diligence and discretion in representing the minor's interests, and (iii) be loyal to his fiduciary. Cf. Interfirst Bank Dallas, N.A. v. Risser, 739 S. W. 2d 882, 888 (Tex. App.--Texarkana 1987, no writ) (duty of trustee to manage trust property). The fiduciary duty is one of integrity, loyalty, and the utmost good faith. Coble Wall Trust Co. v. Palmer, 859 S. W. 2d 475, 481-82 (Tex. App.--San Antonio 1993, writ denied). The guardian ad litem appointed under rule 173 in a settlement hearing is bound to serve the interests of his principal, placing the interests of the minor before his own. See Crim. Truck & Tractor Co. v. Navistar Int'l Transp., 823 S. W. 2d 591, 592 (Tex. 1992).891 S. W. 2d at 706-707.
In Byrd, a 142 Trust was not created. Rather, a portion of the settlement proceeds were held in the registry of the court and/or in the plaintiff attorney's trust account until the minor turned 18, at which point the former minor agreed to the creation of an irrevocable trust to last until age 40. The guardian ad litem participated in the settlement negotiations and recommended the settlement; he did not participate in the irrevocable trust arrangement. The court of appeals refused to let the guardian ad litem out on summary judgment, holding that he owed the minor fiduciary duties and that he was not entitled to judicial immunity.
While Byrd v. Woodruff is not a 142 Trust case, one of the minor's allegations was that the guardian ad litem failed to ensure compliance with Tex. Prop. Code § 142.005 in establishing the trust. 891 S. W. 2d at 697. Also, while the Byrdcourt did not expressly hold that a next friend is a fiduciary, the minor in Byrd also sued her parents as next friends, and that part of the case was severed so that the summary judgment in favor of the guardian ad litem was an appealable final judgment. 891 S. W. 2d at 698. Thus, unlike the guardian ad litem, the parents as next friends were unable to win a summary judgment at the trial level (which summary judgment was reversed by the decision in Byrd). The Texas Supreme Court denied writ in Byrd in 1995.
Since it is clear from the Byrd case that next friends and guardians ad litem contemplating applying for 142 Trusts owe fiduciary duties to the minor or incapacitated person they represent, how can they fulfill those duties without fear of liability to the beneficiary? On the one hand, the age of majority in Texas is 18. How can they justify making the beneficiary wait until age 25 to own his or her settlement proceeds outright? On the other hand, if the guardian ad litem or next friend fails to seek a 142 Trust and the minor spends his or her settlement proceeds immaturely between ages 18 and 25, does the guardian ad litem or next friend face liability for not properly safeguarding the minor's funds?
Similarly, what liability does a next friend or guardian ad litem face if he or she asks for the creation of a 142 Trust for a person believed to be incapacitated but who later asserts that he was not and is not incapacitated? Tex. Prop. Code § 142.005 is intended to be a procedure which happens totally outside the guardianship system. Indeed, Tex. Prop. Code § 142.007 provides a special definition of incapacity for 142 Trust purposes, and a 142 Trust cannot be applied for if a guardianship exists. Nevertheless, creation of the 142 Trust is a denial of property rights to the incapacitated person without following the due process safeguards in place under Texas guardianship law.
Byrd v. Woodruff teaches a lesson that we should have known all along -- that next friends and guardians ad litem must take their duties to their minor or incapacitated person seriously. If a 142 Trust is sought, the applicant should make a record of why it is appropriate in that particular case. In some cases, the next friend or guardian ad litem should consider applying for creation of the trust and stating to the court his or her ambivalence about the creation of the trust and the proposed age of trust termination, leaving it to the court to decide. Also, the next friend or guardian ad litem should consider insisting on a form of trust that closely follows the statutory requirements for 142 Trusts.
Another way in which a guardian ad litem can limit his or her liability is to insist on being discharged by the court upon creation of the trust. The guardian ad litem should be dismissed after entry of final judgment, and the guardian ad litem may not recover fees for services rendered after resolution of the conflict for which he or she was appointed. Brownsville-Valley Regional Medical Center v. Gamez, 894 S. W. 2d 753 (Tex. 1995). It is the trustee's responsibility to administer the 142 Trust; the guardian ad litem is not responsible for supervising the trustee, nor will the guardian ad litem be compensated if he or she supervises the trustee. Therefore, the guardian ad litem should assure that the final judgment clearly discharges him or her. The guardian ad litem remains liable for his or her actions prior to that time, but he or she should be able to avoid liability for the actions or inactions of the trustee after that time.
3.2.9. Potential Liability of Trustee For Administering Nonstandard 142 Trusts. Does a trustee face potential liability administering a 142 Trust which deviates from the mandatory statutory provisions? There are no cases on this issue, but Byrd v. Woodruff, 891 S. W. 2d 689 (Tex. App. -- Dallas 1994, writ denied), and the growing number of fiduciary liability cases involving trustees should signal the need for caution. Trustees should not blindly follow a trust instrument which the trustee knows or suspects is in conflict with the statute. The trustee should consider an application for instructions under Tex. Prop. Code § 115.001 in the event of such a conflict. The availability of this procedure may depend on whether or not the trust instrument specifically makes the Texas Trust Code applicable to the trust. See "Are 142 Trusts Subject to the Texas Trust Code?" above.
3.3. Drafting 142 Trusts. When drafting a 142 Trust, the drafter must decide how far from the bare-bones statutory provisions he or she wishes to go. The trustee usually is interested in more specificity, fleshing out the distribution standard with advice to the trustee regarding what factors to consider in making distributions, whom to consult in making distributions, permissible facilities of payment, etc. The parents or other family members of the beneficiary often are interested in assuring that lifestyle-enhancing distributions, such as distributions to pay for a new or improved house for the beneficiary's family or a new car or van for the family, are permitted by the trust. The drafter may be tempted by his or her own expertise in drafting private trusts to build in greater flexibility.
This usually places the drafter in the dilemma of choosing between making the trust as bare-bones and statute-oriented as possible, which is usually the safest course, or making the trust as client-pleasing as possible, which may raise the problems addressed in Aguilar v. Garcia, 880 S. W. 2d 279 (Tex. App. -- Houston [14th Dist.] 1994, orig. proc.), or Byrd v. Woodruff, 891 S.W.2d 689 (Tex. App. -- Dallas 1994, writ denied).
Attached are the following basic forms to consider for use in drafting 142 Trusts:
4.1. Statutory Requirements. Like 142 Trusts, 867 Trusts have certain statutory requirements regarding trust creation and trust provisions which must be met. HB 1314, enacted into law by the 75th Texas Legislature (effective September 1, 1997), changed some of these requirements. The following reflects those changes.
4.1.1. Basis For Creation. Texas Probate Code 867 provides (with 1997 changes highlighted):
On application by the guardian of a ward or by a ward's attorney ad litem at any time after the date of the attorney's appointment under Section 646 of this code, the court in which the guardianship proceeding is pending may enter an order that creates for the ward's benefit a trust for the management of guardianship funds if the court finds that the creation of the trust is in the ward's best interests. The order shall direct the guardian or another person to deliver all or part of the assets of the guardianship to a trust company or a state or national bank that has trust powers in this state. The order shall include terms, conditions, and limitations placed on the trust. The court shall maintain the trust under the same cause number as the guardianship proceeding.Thus, in order to create an 867 Trust, there must be (1) an application by the guardian or an attorney ad litem after appointment under Section 646 and (2) a court finding that creation of the trust is in the ward's best interests.
A. Application by a Guardian. One party who may apply for the creation of an 867 Trust is a guardian.
1) What Type of Guardian Is Required? Does Tex. Prob. Code Ann. § 867 require a guardian of the estate, or may a temporary guardian or a guardian of the person apply for creation of an 867 Trust? Prior to September 1, 1995, the answer was unclear. Since September 1, 1995, any type of guardian should suffice. The following definition of "guardian" was added to the Probate Code effective September 1, 1995:
"Guardian" means a person who is appointed guardian under Section 693 of this Code, or a temporary or successor guardian. Except as expressly provided otherwise, "guardian" includes the guardian of the estate and the guardian of the person of an incapacitated person.Tex. Prob. Code Ann. § 601 (10). Therefore, a guardianship of the estate, a guardianship of the person, and a temporary guardianship should meet the requirement in Section 867 that a guardian of the ward may apply for creation of an 867 Trust.
2) Must Guardian Qualify Before Applying for Trust? If creation of the 867 Trust is based on the application of a guardian, must the guardian be appointed and qualify as guardian before applying for creation of the trust? The answer appears to be yes -- the guardian must qualify before formally applying for creation of an 867 Trust. Thankfully, however, most courts permit the applicant to ask for creation of the guardianship and creation of the 867 Trust at the same time. If the guardian is not appointed, or if he or she fails to qualify as guardian, the 867 Trust cannot be created. However, the combined application permits the court to hear the entire matter at one hearing, cutting down on the time and expense associated with creation of the 867 Trust. If a combined application is used, it is a good idea for the guardian, upon qualification, to file another, formal application for creation of the trust so that the literal terms of Section 867 are met.
If it would be difficult or expensive to bond the guardian for the short time between his qualification as guardian and the creation of the 867 Trust, the guardian can request that his powers as guardian over the property which will pass into the 867 Trust be limited to directing the third parties holding such property to deliver such property to the trustee of the 867 Trust once it is created. The guardian also should obtain an order from the court directing the holders of the ward's property to transfer it directly to the trustee. See "Transferring Property Into an 867 Trust" on page 19 below.
B. Application by an Attorney Ad Litem. Prior to the 1997 amendment to Section 867, for an 867 Trust to be created when no guardianship existed, the "Texas two-step" was required: First, a guardian had to be appointed and qualify (since only a guardian could apply for the creation of a management trust). Second, the guardian then would have to apply for the creation of the trust. As a practical matter, most judges would allow applicants to prove up the guardianship and the trust in one hearing, but it was impossible to get an 867 Trust unless a guardian was appointed and qualified. This was always inconvenient and often a problem, since a non-corporate trustee had to post a bond in order to qualify as guardian. Often this problem was solved by appointing the soon-to-be-named corporate trustee as guardian of the estate (since corporate guardians are not required to post a bond), but this was a cumbersome process which arguably required the filing of an inventory, etc.
In 1997, Section 867 was amended to read as follows [language added by amendment is underscored; author's emphasis is boldfaced and italicized]:
On application by the guardian of a ward or by a ward's attorney ad litem at any time after the date of the attorney's appointment under Section 646 of this code, the court in which the guardianship proceeding is pending may enter an order that creates for the ward's benefit a trust for the management of guardianship fundsif the court finds that the creation of the trust is in the ward's best interests. The order shall direct the guardian or other person to deliver all or part of the assets of the guardianship to [the trustee of the 867 Trust]. . . .The 1997 amendment eliminated the need for the Texas two-step, so long as the attorney ad litem appointed under Section 646 of the Probate Code thinks the 867 Trust is a good idea and is willing to apply for it. If the attorney ad litem asks for the creation of the trust, then the court can create the trust without waiting for the guardian of the estate to qualify.
This should mean that an 867 Trust may be created without there ever being a guardian of the estate. In order to have an 867 Trust created without a guardian under the amended Section 867, the following must occur:
The forms attached to this paper as Appendix K, Appendix L and Appendix M are, respectively, a combined application for appointment of a guardian and creation of an 867 Trust (normally a prerequisite to the appointment of an attorney ad litem under Section 646), an application by the attorney ad litem for creation of an 867 Trust, and an order creating the 867 Trust without the need for a guardian to be appointed.
If a guardian of the estate is appointed prior to creation of the 867 Trust, it is possible to have the guardian discharged, but it may be necessary for a guardian of the person of the ward to continue to serve. The 1997 amendment added new Section 868A, which reads as follows:
On or at any time after the creation of a trust under this subpart, the court may discharge the guardian of the ward's estate only if a guardian of the ward's person remains and the court determines that the discharge is in the ward's best interests.This provision was included at the request of some of the statutory probate judges, who wished to assure that there was someone to keep an eye on the trustee and to act on behalf of the beneficiary of the trust should the need arise. See "Can and Should Guardian Resign When Trust Is Created?" below for more discussion of the effects of new Section 868A.
C. Best Interests Finding. An 867 Trust may be created only if the court finds that "creation of the trust would be in the ward's best interests." Tex. Prob. Code Ann. § 867.
4.1.2. Mandatory Provisions. Like 142 Trusts, 867 Trusts must meet mandatory requirements regarding choice of a trustee and terms of the trust. Many of the mandatory provisions are based on the requirements for 142 Trusts and, therefore, are similar or identical to the requirements of Tex. Prop. Code § 142.005. Some of these mandatory provisions may be varied by the court in order to create a supplemental needs trust. See "867 Trusts as Supplemental Needs Trusts" below.
A. Must Use Corporate Trustee. The order creating an 867 Trust must direct the guardian or another person to deliver all or part of the assets of the guardianship to "a trust company or a state or national bank that has trust powers in this state." Tex. Prob. Code Ann. § 867. Individuals may not be trustees of 867 Trusts. The trust must provide that the trustee serves without bond. Tex. Prob. Code Ann. § 868 (a) (4).
As noted above, some courts are creating 142 Trusts with individuals serving as co-trustee with a bank or trust company. The author is not aware of any 867 Trusts with individual co-trustees. Given the guardianship orientation of 867 Trusts, it seems unlikely that a probate court would agree to a co-trustee arrangement. Individual co-trustees clearly are not permitted by the statute.
B. Sole Beneficiary Requirement. Tex. Prob. Code Ann. § 868 (a) (1) requires that the ward be the sole beneficiary of the trust (except in the case of supplemental needs trusts -- see "867 Trusts as Supplemental Needs Trusts" below). Notwithstanding the mandatory sole beneficiary requirement, Section 868(b) permits distributions "for the health, education, support, or maintenance of the ward or of another person whom the ward is legally obligated to support." (emphasis added). Presumably this possible conflict can be reconciled by recognizing that, if the ward/beneficiary is legally obligated to support someone, payment for that person's needs benefits the ward/beneficiary.
C. Mandatory Distribution Provisions. Except in the case of supplemental needs trusts (see "867 Trusts as Supplemental Needs Trusts" below), the trust must provide that the trustee may disburse an amount of the trust's principal or income as the trustee determines is necessary to expend for the health, education, support or maintenance of the beneficiary. Tex. Prob. Code Ann. § 868 (a) (2). The trust also must provide that the income of the trust that the trustee does not disburse under Section 868 (a) (2) must be added to the principal of the trust. Tex. Prob. Code Ann. § 868 (a) (3). This distribution standard is virtually identical to the one required in 142 Trusts. Does this mean that the reasoning of the court of appeals in Aguilar v. Garcia, 880 S.W.2d 279, 281 (Tex. App. -- Houston [14th Dist.] 1994, orig. proc.), which was a 142 Trust case, applies with equal force to 867 Trusts? Obviously, the same bases for distinguishing Aguilar in the case of 142 Trusts apply as well in the case of 867 Trusts. In addition, one may argue that Aguilar does not apply directly to 867 Trusts and, at most, applies only by analogy, so that until a similar appellate decision is reached with respect to an 867 Trust, practitioners and courts are free to structure 867 Trusts as if Aguilar did not exist. Finally, one may argue that Tex. Prob. Code Ann. § 867 imposes a less stringent requirement on the trial court regarding varying from the "mandatory" provisions -- while Tex. Prop. Code § 142.005 provides that the court may provide for the terms, conditions and limitations of the trust "that are not in conflict with" the mandatory provisions in the statute, Tex. Prob. Code Ann. § 867 contains no such statement restricting the court's ability to include conflicting provisions in the trust.
The requirement of Section 868 (a) (3) that income not distributed under Section 868 (a) (2) must be added to principal presents a potential problem for 867 Trusts, since distributions from the trust may be made under Section 868 (b) as well as under Section 868 (a) (2). Section 868 (b), which is discussed in more detail below, permits distributions benefitting those persons who the ward is legally obligated to support (such as the ward's spouse and minor children). Does Section 868 (a) (3) prohibit a distribution of income to benefit the ward's spouse or minor child, since that distribution cannot be made under Section 868 (a) (2)? Perhaps. Section 868 (a) (3) is an unnecessary provision that should be deleted from the statute. However, until that happens, the best solution probably is: (a) continue to include the Section 868 (a) (3) provision in the trust, since the statute says it is mandatory and since the court in Aguilar suggests that the mandatory requirements must be taken seriously; (b) include the optional provision permitting distributions benefitting the spouse and minor children if desired; and (c) assure that any distributions benefitting the spouse or children are made from the principal of the trust.
Ironically, the inclusion of the useless and apparently contradictory requirement about adding income to principal in Tex. Prob. Code Ann. § 868 (a) (2) may actually bolster arguments that more flexible distribution standards are permitted in an 867 Trust. Notwithstanding Aguilar and the "mandatory" statutory provisions, it is not uncommon to see 142 Trusts and 867 Trusts with additional distribution provisions. One may argue that these additional distribution provisions are permitted by the general terms of Tex. Prop. Code § 142.005 (b) and Tex. Prob. Code Ann. § 867, so long as they do not conflict with the mandatory statutory provisions. However, if these additional distribution provisions permit incomedistributions, they may conflict with Tex. Prop. Code § 142.005 (b) (3) and Tex. Prob. Code Ann. § 868 (a) (3), which require income not distributed in accordance with the mandatory provisions to be added to principal. In the case of 867 Trusts, one may argue that the legislature must have anticipated that distributions that go beyond the mandatory distribution standard are permitted since the statute expressly permits other, optional distributions pursuant to Tex. Prob. Code Ann. § 868 (b). Therefore, other custom-drafted distribution provisions should not be considered inconsistent with the mandatory provisions and should be permitted in an 867 Trust. (The same argument is unavailable in the case of a 142 Trust, since Tex. Prop. Code § 142.005 does not permit distributions to persons whom the beneficiary is legally obligated to support.)
D. Trustee Compensation. One of the most controversial statutory provisions regarding 867 Trusts is the mandatory trustee compensation provision. The trust instrument must provide that:
the trustee, on annual application to the court and subject to the court's approval, is entitled to receive reasonable compensation for services that the trustee provided to the ward as the ward's trustee that is:
(A) to be paid from the trust's income, principal, or both; and
(B) determined in the same manner as compensation of a guardian of an estate under Section 665 of [the Probate Code].Tex. Prob. Code Ann. § 868 (a) (5).
Corporate trustees who administer 142 Trusts are used to getting their compensation approved when the trust is created and being paid "reasonable" compensation, which is usually based on their fee schedules and is paid currently (in other words, as services are rendered and not in arrears at the end of the year). Section 868 (a) (5) requires them to use the "5% in, 5% out" formula that guardians use (unless they can convince the court that such formula produces an unreasonably low fee). In addition, Section 868 (a) (5) and Section 871 require them to file an annual guardianship-style accounting with the court and obtain the court's approval thereof before being compensated.
A bill backed by the Texas Bankers Association in the 1995 legislative session would have allowed corporate trustees of 867 Trusts to charge their fee schedules and to use its trust accounting statements as the statutory accounting requirement unless the court otherwise ordered. This bill received strong opposition from statutory probate judges and did not pass. No similar bill was introduced in 1997. Therefore, the current scheme for compensating trustees of 867 Trusts appears likely to stay.
While the trustee compensation provisions have caused some corporate trustees to be reluctant to take on 867 Trusts, there clearly are trustees who are willing to serve, especially on larger trusts. Even in the case of small guardianship estates, it may be possible to use 867 Trusts if the drafter, the trustee and the ward's family are willing to be creative. The author participated in one proceeding in which the trust provided that the trustee's fees were to be paid by a family member of the ward. This enabled the trust to be created, which in turn kept the trust principal out of the soon-to-be-18-year-old ward's hands until the ward was a little older.
4.1.3. Optional Provisions. Like 142 Trusts, 867 Trusts may include certain optional provisions in addition to the mandatory provisions discussed above.
A. 1997 Change Clarifies That 867 Trusts May Contain Extra Provisions. Many practitioners incorporate additional provisions in 867 Trusts which address issues which are not addressed by the statute. Prior to September 1, 1997, the only bases for including these provisions were (1) common sense and (2) two cryptic provisions in the statutes -- first, a provision in Section 867 stating that the court's order creating an 867 Trust "shall include terms, conditions, and limitations placed on the trust," and, second, a provision in Section 869 (a) stating that the court may amend or modify the trust.
HB 1314, effective September 1, 1997, but applying to trusts existing on that date by its own terms, adds subsection (e) to Section 868, which reads as follows:
The court may include additional provisions in a trust created or modified under this section if the court determines an addition does not conflict with Subsection (a) and, if appropriate, Subsection (d) of this section.Subsection (a) contains the mandatory provisions of an 867 Trust and subsection (d) contains the new exception for supplemental needs trusts. This new subsection goes a long way toward justifying the additional provisions which are often routinely included in an 867 Trust.
Does subsection (e) require a finding that the additional provisions do not conflict with Tex. Prob. Code Ann. § 868 (a) or (d)? Prudence dictates that the order creating the trust should include such a finding. For example, routinely including the following phrase among the findings in the order should do the trick:
that the additional provisions of the trust do not conflict with Tex. Prob. Code Ann. § 868 (a) or (d);In light of the Aguilar case, supra, subsection (e) of Section 868 gives 867 Trusts an advantage over 142 Trusts as a flexible tool to be used in unusual situations. The trial court's determination that the additional provisions do not conflict with the mandatory provisions, coupled with new subsection (e), should go a long way toward avoiding an Aguilar-type problem with 867 Trusts.
The provisions of HB 1314 and its legislative history make it clear that the changes made by HB 1314 apply to 867 Trusts created before September 1, 1997, without the need for modifying the trusts. However, the order creating existing trusts may or may not include a determination that the additional provisions are not in conflict with the mandatory provisions. Can one assume that there was an implied finding that the additional provisions were not in conflict? Perhaps it is a good idea for trustees to review the orders creating 867 Trusts to see if the determination of no conflict is implicitly or explicitly stated. While the author suggests that it should be unnecessary to go back and obtain such a determination for existing 867 Trusts with nonstandard language, it would be a simple matter to include a request for clarification from the court that such a determination was made in the order approving a future annual account.
B. 867 Trusts as Supplemental Needs Trusts. Perhaps the most notable change in 1997 to the statutes governing 867 Trusts is the addition of subsection (d) to Section 868, which reads as follows:
When creating or modifying a trust, the court may omit or modify terms required by Subsection (a)(1) or (2) of this section only if the court determines that the omission or modification:
(1) is necessary and appropriate for the ward to be eligible to receive public benefits or assistance under a state or federal program that is not otherwise available to the ward; and
(2) is in the ward's best interests.This provision was added to make it clear that 867 Trusts may be established as supplemental needs trusts under 42 U.S.C.A. § 1396(d)(4)(a). All that is required is a court determination that (1) omission or modification of a mandatory term is "necessary or appropriate" for the beneficiary to qualify for government benefits and (2) the omission or modification is in the ward's best interests.
The 1997 amendment, HB 1314, is effective September 1, 1997, and expressly applies to "all trusts created under Section 867, Texas Probate Code, as amended by this Act, regardless of the date on which the trusts were created." The legislative history of HB 1314 makes clear that the legislature intended that existing supplemental needs trusts created under Section 867 prior to the effective date of HB 1314 need not be modified for the terms of HB 1314 to apply. Nevertheless, since trustees must submit annual accounts each year anyway, counsel for trustees should consider obtaining in the order approving the annual account a clarification that HB 1314 applies to the pre-existing 867 Trust and that all required determinations have been made.
C. Distributions to or for the Benefit of the Ward or Another Person Whom the Ward Is Legally Obligated to Support. In addition to the mandatory distributions provided for in Section 868 (a) (2), the trust instrument may provide that a trustee may:
make a distribution, payment, use, or application of trust funds for the health, education, support, or maintenance of the ward or of another person whom the ward is legally obligated to support, as necessary and without the intervention of a guardian or other representative of the ward, to:
(1) the ward's guardian;
(2) a person who has physical custody of the ward or another person whom the ward is legally obligated to support; or
(3) a person providing a good or service to the ward or another person whom the ward is legally obligated to support.Tex. Prob. Code Ann. § 868 (b).
In the 1993 version of Section 868 (b), distributions were permitted only for the benefit of the ward or for the support, maintenance and education of the ward's children if the ward was an incapacitated adult.
In 1995, this section was amended to permit distributions for the health, education, support and maintenance of persons whom the ward (regardless of age) is legally obligated to support. Presumably the persons whom the ward is legally obligated to support include the ward's spouse and the ward's minor children. Thus, it is clear that the legislature intended to enlarge the pool of potential recipients of trust benefits beyond the ward and an adult ward's minor children. Unfortunately, this clear intent nonetheless left a confusing statute to construe and a confusing trust provision to administer.
In 1997 the legislature made further repairs to this section. As a result, the statute is much clearer. The 1997 changes make it clear that "facility of payment" distributions for the benefit of a ward (or a person the ward is legally obligated to support) may be made directly to persons providing goods and services -- it is not necessary for the payment to go through the hands of the guardian or the person having physical custody of the ward. While this 1997 change makes it less important to include an additional facility of payment provision in the trust, a broad facility of payment provision seems to be permitted by the statute and is probably a good idea.
D. Paying Guardian's Compensation. Consider including a provision in the trust instrument requiring the trustee to pay court-approved fees of the guardian of the person and/or guardian of the estate of the ward. Since most, if not all, of the guardianship assets will be in the trust, this prevents later conflicts between the trustee and the guardians regarding how they are to be paid.
E. Trust Termination Age. Tex. Prob. Code Ann. § 870 (a) permits the court to provide for a trust for a minor to terminate as late as the ward's twenty-fifth birthday. If the court does not otherwise provide in its order, the trust for a minor will terminate on the earlier of the minor's death or the minor's eighteenth birthday. Thus, while the court may order the trust to continue beyond the minor's eighteenth birthday, the trust will terminate at age 18 if the trust instrument is silent. This is different from 142 Trusts, where the statute provides that the trust will terminate at age 25 unless the court otherwise orders. Tex. Prop. Code § 142.005 (b) (4).
Should a court routinely extend the trust termination age to age 25? Many practitioners would argue that it should, since the statute permits it and since most 18-year-olds are too immature and uneducated to handle large sums of money. However, some judges are reluctant to set the trust termination age at age 25 when the ward is young, preferring instead to wait until close to the ward's eighteenth birthday before deciding whether to continue the trust. The statute does not require the court order creating the trust to be the court order that extends the trust beyond age 18; therefore, an order amending or modifying the trust to extend it beyond age 18 can be entered after the trust is created.
As discussed above with respect to 142 Trusts, in order for a (d)(4)(A) trust established for a minor who does not meet the Tex. Prob. Code Ann. §601(13) definition of "incapacitated person" (other than because of his or her minority) to properly benefit that minor, it must not terminate at age 25. If the trust terminates at age 25, the trust beneficiary would be deprived of the benefits afforded by (d)(4)(A) trusts because at age 25 (1) the government reimbursement provision would kick in and (2) if more than $2,000 was left in the trust, the trust beneficiary would cease to qualified for Medicaid and SSI benefits. Therefore, it is necessary for the trust to provide that it continues beyond age 25 until the death of the beneficiary or it is otherwise terminated by order of the court. However, the wording of Section 868(d), enacted in 1997 to permit 867 Trusts to be (d)(4)(A) trusts), arguably only permits the distribution standard of an 867 Trust to be modified (found in Section 868(a)(2)), not the trust termination provisions (found in Section 870). (The author of this paper suggested a broader provision enabling (d)(4)(A) trusts that would have covered the termination issue, but the bill that was introduced was more restrictive.)(4) Since altering the termination age is necessary for the (d)(4)(A) trust to accomplish its purpose, and since the legislature clearly indicated its intent that 867 Trusts be adaptable to be (d)(4)(A) trusts, the statute should be construed to permit trusts to last beyond age 25.
F. Distribution on Trust Termination. Unlike Tex. Prop. Code § 142.005, which requires the trust on termination to be distributed to the beneficiary or to the personal representative of the beneficiary's estate, Tex. Prob. Code Ann. § 873 permits greater flexibility. As amended in 1995, Section 873 provides:
Unless otherwise provided by the court, the trustee shall:
(1) Prepare a final account in the same form and manner that is required of a guardian under Section 749 of this Code; and
(2) On court approval, distribute the principal or any undistributed income of the trust: