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Trust Law Update —

1999 Texas Legislature

by

Gerry W. Beyer

    This article examines legislation enacted by the 1999 Texas Legislature relating to the Texas law of trusts.  The reader is warned that not all recent legislation is presented and not all aspects of each cited statute are analyzed.  You must read and study the full text of the legislation before relying on it or using it as precedent.

I.            Delegation of Investment Decisions

    The 1999 Legislature amended § 113.018 of the Trust Code to authorize the trustee to employ an investment agent and added § 113.060 which allows the trustee to delegate investment decisions to this investment agent.  These provisions represent a significant departure from traditional trust law which viewed investment decisions as a responsibility which the trustee could not properly delegate.  These new provisions are, however, consistent with the growing trend in the United States to apply prudent investor standards to the conduct of trustees.

    A.       Notice to Beneficiary

        The trustee must send written notice to the beneficiaries at least 30 days before entering into an agreement to delegate investment decisions to an investment agent.  The notice must inform the beneficiaries of the intended delegation and the identity of the investment agent.  If a beneficiary is a minor or is incapacitated, the notice must be given to the beneficiary’s legal guardian.

    The persons considered as “beneficiaries” of the trust and thus entitled to notice include (1) persons entitled to a distribution, (2) persons who would be entitled to a distribution if the trust terminated, and (3) charitable entities as defined by Property Code § 123.001 that have an interest in the trust.

    B.       Liability of Trustee for Investment Agent’s Decision

         The general rule is that the trustee remains responsible for the agent’s investment decisions.  However, the trustee may avoid liability for the investment agent’s decisions if all of the following relatively strenuous criteria are satisfied.

    (1) The trustee selects the investment agent and establishes the scope and the terms of the delegation by exercising the judgment and care under the circumstances then prevailing that a person of ordinary prudence, discretion, and intelligence would exercise in the management of the person’s own funds.

    (2) The trustee investigates the credentials of the investment agent by (a) reviewing the agent’s experience, performance history, and financial stability, (b) verifying the agent’s professional license and registration, if any, and (c) establishing that the agent is insured or bonded.

    (3) The investment agent is subject to the jurisdiction of the Texas courts.

    (4) The delegation agreement provides that the investment agent (a) is subject to the standard of trust management and investment as prescribed by § 113.056 and (b) assumes liability for the failure to follow that standard.

    (5) The trustee periodically reviews the agent’s investment decisions to ensure compliance with the investment strategy prescribed by the trustee for the trust.

II.        Non-Judicial Virtual Representation

    Texas law has long recognized the ability of a court to bind certain individuals, such as unborn and unascertained beneficiaries, who are not parties to a trust action provided a party to the action has a substantially identical interest.  See Trust Code § 115.013.  The 1999 Legislature added § 114.032 to the Trust Code to provide the same binding effect for certain written agreements.

    A.       Subject Matter of the Agreement

         The new virtual representation provisions do not apply to written agreements that modify or terminate a trust in whole or in part unless the agreement is otherwise permitted by law.  Thus, the most common use of these provisions is likely to be for relatively minor instances of actual or perceived breach of fiduciary duties by the trustee.  The agreements may be designated by terms such as “release” or “consent” and may deal with a trustee’s duties, powers, responsibilities, restrictions, or liabilities.

    The following example from Glenn M. Karisch, Texas Legislative Update — 1999, at 9 (1999) (located at http://www.texasprobate.com), is instructive.

    Big Bank is trustee of a trust.  The trust instrument prohibits investment in foreign securities.  Through an oversight, Big Bank had invested in offshore stocks.  When it discovers its error, it sells the stock, calculates any damages which resulted from the improper investments, and pays back the trust for the damages it calculated.  Without the new statute, Big Bank could disclose to the current adult beneficiaries and obtain a release from them, but nothing short of a court action (such as a suit to settle its interim accounts) could bind unborns.  Now, with the new statute, Big Bank can make an adequate disclosure, obtain releases from the adult beneficiaries and, assuming their interests are virtually represented, bind unborns.

    B.       Formalities of the Agreement

         A written agreement between a trustee and a beneficiary must meet all of the following requirements before it can be final and binding on the beneficiary and any person represented by the beneficiary.

    (1) The beneficiary must sign the instrument.

    (2) The beneficiary must have the legal capacity to sign the instrument.

    (3) The beneficiary must have full knowledge of the circumstances surrounding the agreement.

    (4) The agreement must be entered into on or after September 1, 1999.

    C.       Effect if Beneficiary has Power to Revoke

         An agreement signed by a beneficiary who has the power to revoke the trust or the power to appoint the income or principal of the trust to or for the benefit of the beneficiary, the beneficiary’s creditors, the beneficiary’s estate, or the creditors of the beneficiary’s estate is final and binding on any person who takes in default under the power of appointment or who takes if the beneficiary does not execute the power of appointment.

    D.       Binding a Minor Beneficiary

         An agreement is final and binding on a minor beneficiary if all of the following criteria are satisfied.

    (1) The minor’s parent, including a parent who is also a trust beneficiary, signs the instrument on behalf of the minor.

    (2) No conflict of interest exists between the minor and the minor’s parent.

    (3) No guardian, including a guardian ad litem, has been appointed to act on behalf of the minor.

    E.        Binding an Unborn or Unascertained Beneficiary

         An agreement is final and binding on an unborn or unascertained beneficiary only if a beneficiary who has an interest substantially identical to the interest of the unborn or unascertained beneficiary signs the instrument.  To have a substantially identical interest, the unborn or unascertained beneficiary must be a child, grandchild, or other descendant of the trust beneficiary.

III.    Venue

    The 1999 Legislature made sweeping changes to the venue rules for trust litigation by amending Trust Code § 115.002.  The new rules went into effect on September 1, 1999.

    A.       Single, Noncorporate Trustee

         Under prior law, venue for a trust action involving one individual trustee was in the county of the trustee’s residence.  The new law provides a variety of counties which may have venue.  Accordingly, a person contemplating suing a single, noncorporate trustee now has the ability to shop for an advantageous venue.  The possible locations where venue is proper are listed below.

    (1) The county in which the trustee resides.

    (2) Any county in which the trustee has resided at any time during the four-year period preceding the date the action is filed.

    (3) The county in which the situs of administration of the trust is maintained.  “Situs of administration” means the location in Texas where the trustee maintains the office that is primarily responsible for dealing with the settlor and the beneficiaries.

    (4) Any county in which the situs of administration of the trust has been maintained at any time during the four-year period preceding the date the action is filed.

    B.       Multiple Individual Trustees or a Corporate Trustee

         Below is a list of the possible locations of proper venue if the trust has (1) multiple individual trustees or (2) a corporate trustee (that is, an entity organized as a financial institution or a corporation with the authority to act in a fiduciary capacity).

    (1) The county in which the situs of administration of the trust is maintained.

    (2) Any county in which the situs of administration of the trust has been maintained at any time during the four-year period preceding the date the action is filed.

    (3) If a corporate trustee is the defendant, in the county in which the trustee maintains its principal office in Texas.  “Principal office” is defined to mean an office of a corporate trustee in Texas where the decision makers for the corporate trustee within Texas conduct the daily affairs of the trustee.  The mere presence of an agent or representative of the corporate trustee does not establish a principal office.  The principal office may be the same as the situs of administration of the trust.

    C.       Transfer by Court

         The court may transfer an action from one county of proper venue to another county of proper venue.  The court must have just and reasonable cause to make the transfer such as the location of the trust records or the convenience of the parties and witnesses.  The following parties may request a transfer.

    (1) A defendant or joint party may make a motion to transfer provided it is filed concurrently with or before the filing of the answer or other initial responsive pleading.  The motion must be served in accordance with law.

    (2) An intervening party may make a motion to transfer provided it is filed not later than the 20^th day after the court signs the order allowing the intervention.  The motion must be served in accordance with law.

    D.       Agreement of Parties

         Upon the agreement of all the parties, the court has the discretion to transfer an action from a county of proper venue to any other county, even if that county did not have proper venue over the action originally.

IV.     Charitable Trusts

    A.       Replacement of Charitable Trust Beneficiaries

         Section 113.026 was added to the Trust Code to authorize the trustee to select one or more replacement charitable beneficiaries for a failed charitable beneficiary under certain circumstances.

        1.        Requirements

            The requirements for a trustee to use this new authority include the following:

    (1) The trust must be created on or after August 30, 1999.

    (2) The trust must be in writing.

    (3) The trust must be created by an individual.

    (4) The trust must name a charitable entity (as defined by Prop. Code § 123.001) as a beneficiary.

    (5) The named charitable entity (a) does not exist at the time the charitable entity’s interest in the trust becomes vested, (b) ceases to exist during the term of the trust, or (c) ceases to be a charitable entity during the term of the trust.

    (6) The trust instrument does not provide a method for replacing a failed charitable beneficiary.

    (7) The trustee must consult with the settlor if the settlor is still alive and not incapacitated at the time the trustee is selecting a replacement.

        2.        Selection Criteria

            The trustee must select a charitable entity which is described by the Internal Revenue Code (§§ 170(b)(1)(A), 170(c), 2055(a), or 2522(a)).  This charity must have the same or a similar charitable purpose as the failed charitable beneficiary.

        3.        Procedure if Trustee and Settlor Agree

            If the trustee and the settlor agree on the replacement charity, the trustee must send notice of the selection to the attorney general.  The attorney general must make a determination regarding the appropriateness of the replacement charity not later than the 21^st day after receiving notice.

    If the attorney general agrees, no formal action is taken and the agreed upon replacements become the new beneficiaries of the trust.

    If the attorney general determines that a replacement charity does not have the same or similar charitable purpose, the attorney general must make a written request that a district court in the county in which the trust was created review the selection.  If the court agrees with the attorney general that the replacement beneficiary is inappropriate, any remaining agreed upon replacements become the new beneficiaries.  The court must select one or more replacement beneficiaries if there is no agreed upon replacement.

    If the court determines that the attorney general’s request for a review was unreasonable, the agreed upon replacement beneficiary becomes the beneficiary.  In addition, the court may require the attorney general to pay all court costs.

    The trustee must send each replacement charitable beneficiary notice of the selection by certified mail, return receipt requested.  This notice is required not later than the 30^th day after the selection is final.

        4.        Procedure if Trustee and Settlor Do Not Agree

            If the trustee and the settlor cannot agree on the replacement charity, the trustee must send notice to the attorney general not later than the 21^st day after the date the trustee determines that they cannot reach an agreement.  The attorney general must then refer the matter to a district court in the county in which the trust was created.  If desired, the trustee and the settlor may make recommendations to the court regarding charitable beneficiaries they feel would be appropriate.

    The court must then select a replacement charity and give notice to the beneficiary by certified mail, return receipt requested.  The notice must be given not later than the 30^th day after the date of the selection.

    The language of the statute is ambiguous regarding the number of charitable beneficiaries the court may select.  In one part of the relevant sentence, the statute indicates that the court must select “a replacement charitable beneficiary.”  Later in the same sentence, the statute provides for notice to “each charitable beneficiary selected” which implies that the court may select one or more replacements.  The interpretation that the court may select multiple replacements is consistent with the other provisions of the statute.

        5.        Recommendation

            The settlor should provide a clearly explained method for replacing a failed charitable beneficiary in the trust instrument.  The trustee may then follow this method and would not need to (1) comply with the new statute, (2) seek court authorization or approval, or (3) give notice to the attorney general.

    B.       Allocation of Principal and Income

         The 1999 Legislature added § 113.1021 to provide special rules for the allocation of principal and income in charitable trusts.  This purpose of this new section is to make “it easier for net income makeup charitable remainder unitrusts (NIMCRUTs) to employ the so-called spigot technique — a substantial portion of the NIMCRUT is invested in deferred annuity contracts, yielding no income in years when the noncharitable beneficiary needs no income and permitting the trustee to generate lots of make-up income in years when the noncharitable beneficiary wants lots of income.”  Glenn M. Karisch, Texas Legislative Update — 1999, at 9 (1999) (located at http://www.texasprobate.com).

        1.        Application of Special Rules

            The following conditions must be satisfied before the new rules apply.

    (1) The property involved is either (1) a deferred annuity before annuitization or (2) a life insurance contract before the death of the insured.

    (2) The trust instrument does not provide for the method of allocation.

    (3) The principal and income became subject to allocation on or after September 1, 1999.

        2.        Allocation Rule

            The increase in value of the property (that is, the deferred annuity before annuitization or the life insurance contract before the death of the insured) over the value at the time the trust acquired the obligation is income.

        3.        Additional Rules

            The increase in value of the property is available for distribution only when the trustee receives cash on account of the obligation.  If the obligation is surrendered or partially liquidated, the cash received must be attributed first to the increase.  The increase in the value of the obligation is available for distribution to the income beneficiary who is the income beneficiary when the cash is received and, if different, not to the income beneficiary who was the income beneficiary at the time the income actually accrued.  This latter rule applies notwithstanding the rules contained in Trust Code § 113.103.  Once annuitization occurs, Trust Code § 113.109 applies to the allocation of principal and income for a deferred annuity.

        4.        Limited to Charitable Trusts?

            This new Trust Code provision “is supposed to be limited to charitable trusts.  However, the restriction is only set out in the heading of the statute.  It is unknown whether it would apply to a trust that has an incidental charitable beneficiary, such as an inter vivos trust which is the primary testamentary document and has a small bequest to a charity.”  Jerry Frank Jones, Probate, Guardianship & Trust, 62 Tex. B.J. 766, 771 (1999).

    C.       Protection From Suit for Improperly Engaging in Trust Business

         Article 2.31 of the Texas Non-Profit Corporation Act permits charitable corporations to serve as the trustee of a trust which benefits the corporation itself or another charitable type organization.  The 1999 Legislature amended this section to protect these corporations from claims that they are engaging in the trust business without a state charter as required by the Texas Trust Company Act.

    The statute provides that any corporation (or person or entity assisting the corporation) is immune from suit as to any claim alleging that the corporation’s role as trustee constitutes engaging in the trust business.  This immunity from suit applies to both a defense to liability and the right not to bear the cost, burden, and risk of discovery and trial.  An interlocutory appeal may be taken if a court denies or otherwise fails to grant a motion for summary judgment that is based on an assertion of this immunity.

V.         Conversion of Trust to Nonprofit Corporation

    Section 112.058 was added to the Trust Code to authorize community trusts, as described by 26 C.F.R. § 1.170A-9(e)(11), to convert to nonprofit corporations after complying with specified requirements and obtaining court approval.

    A.       Requirements to Convert

         A community trust may transfer the assets of the trust to a nonprofit corporation and terminate the trust if all of the following requirements are satisfied.

    (1) The nonprofit corporation must be organized under the Texas Non-Profit Corporation Act.

    (2) The nonprofit corporation must be organized for the same purpose as the community trust.

    (3) The charter of the nonprofit corporation must describe the purpose of the corporation and the proposed use of the assets to be transferred using language substantially similar to the language used in the instrument creating the community trust.

    (4) The governing body of the trust must file a petition in a probate, county, or district court requesting (a) the transfer of the assets of the trust to a nonprofit corporation established for the purpose of receiving and administering the assets of the trust and (b) the termination of the trust.

    (5) The governing body of the trust must send by first class mail to each settlor and each trustee of each component trust of the community trust who can be located by the exercise of reasonable diligence a copy of the governing body’s petition and a notice specifying the time and place of the court-scheduled hearing on the petition.

    (6) The governing body of the trust must publish a proper notice in a newspaper of general circulation in the county in which the proceeding is pending.  This notice needs to be published only once.  The notice must read substantially as follows:

TO ALL INTERESTED PERSONS:

    (NAME OF COMMUNITY TRUST) HAS FILED A PETITION IN (NAME OF COURT) OF (NAME OF COUNTY), TEXAS, REQUESTING PERMISSION TO CONVERT TO A NONPROFIT CORPORATION.  IF PERMITTED TO CONVERT:

    (1) THE (NAME OF COMMUNITY TRUST) WILL BE TERMINATED; AND

    (2) THE ASSETS OF THE TRUST WILL BE:

        (A) TRANSFERRED TO A NONPROFIT CORPORATION WITH THE SAME NAME AND CREATED FOR THE SAME PURPOSE AS THE (NAME OF COMMUNITY TRUST); AND

        (B) HELD AND ADMINISTERED BY THE CORPORATION AS PROVIDED BY THE TEXAS NON-PROFIT CORPORATION ACT (ARTICLE 1396‑1.01 ET SEQ., VERNON'S TEXAS CIVIL STATUTES).

    THE PURPOSE OF THE CONVERSION IS TO ACHIEVE SAVINGS AND USE THE MONEY SAVED TO FURTHER THE PURPOSES FOR WHICH THE (NAME OF COMMUNITY TRUST) WAS CREATED.

    A HEARING ON THE PETITION IS SCHEDULED ON (DATE AND TIME) AT (LOCATION OF COURT).

    FOR ADDITIONAL INFORMATION, YOU MAY CONTACT THE GOVERNING BODY OF THE (NAME OF COMMUNITY TRUST) AT (ADDRESS AND TELEPHONE NUMBER) OR THE COURT.

    B.       Court Proceedings

         The court must schedule a hearing on the petition.  The hearing must be held at least ten days after the later of the date the notice is (1) deposited in the mail or (2) published in a newspaper.  The hearing must be held at the time and place stated in the notice unless the court postpones the hearing for good cause.  If the court postpones the hearing, a notice of the rescheduled hearing date and time must be posted at the courthouse of the county in which the proceeding is pending or at the place in or near the courthouse where public notices are customarily posted.

    If the governing body of the community trust makes a request, the court may require approval from the I.R.S. before the asset transfer takes place.  If the court orders that I.R.S. approval be obtained, the asset transfer may occur when the governing body of the community trust files a notice with the court indicating that the I.R.S. has approved the asset transfer.  This notice must be filed on or before the first anniversary of the date the court’s order approving the asset transfer is signed.  If the notice is not timely filed, the court’s order is dissolved.

    A court order transferring the assets of and terminating a community trust must provide that the duties of each trustee of each component trust fund of the community trust are terminated on the date the assets are transferred.  However, this order does not affect the liability of a trustee for acts or omissions that occurred before the duties of the trustee are terminated.

VI.     Management Trusts

    The 1999 Legislature amended Probate Code § 868(f) to authorize the trustee of a management trust to invest trust funds in the Texas Tomorrow Fund, a college tuition payment program, if the trustee determines that the investment is in the best interest of the ward.

VII. Foreign Banks and Trust Companies as Trustees

    The 1999 Legislature amended Probate Code § 105A which governs the appointment and service of foreign banks and trust companies in a fiduciary capacity to bring it into compliance with the restructured banking laws.

    In publishing this article, the author is not engaged in rendering legal, accounting or other professional service. If legal advice is required, the service of a competent professional should be sought.