TRUSTS, FAMILY LAW, & THE CONTRACT-PROPERTY DICHOTOMY
HAROLD C. ZUFLACHT Higdon, Hardy & Zuflacht, L.L.P. 12000 Huebner Road Suite 200 San Antonio, Texas 78230 tel: 210-349-9933 fax: 210-349-9988 &
STEPHEN M. ORSINGER McCurley, Orsinger, McCurley, Nelson & Downing, L.L.P. 5950 Sherry Lane, Suite 800 Dallas, Texas 75225 tel: 214-273-2400 fax: 214-273-2470
State Bar of Texas M ARRIAGE D ISSOLUTION INSTITUTE 2009 April 16-17, 2008 Fort Worth Chapter 24
HAROLD C. ZUFLACHT Higdon, Hardy & Zuflacht, L.L.P. 12000 Huebner Rd., Suite 200 San Antonio, TX 78230-1209 Telephone: (210) 349-9933 Telecopier: (210) 349-9988
[email protected] EDUCATION B.A., Bachelor of Arts (Economics), Tulane University, New Orleans, Louisiana (1986). J.D., Juris Doctorate, St. Mary's University, School of Law, San Antonio, Texas (1989). PROFESSIONAL ACTIVITIES & CERTIFICATIONS Partner, Higdon, Hardy & Zuflacht, L.L.P Board Certified, Family Law, Texas Board of Legal Specialization San Antonio Family Law Association, President; Past Vice President; Past Treasurer Texas Academy of Family Law Specialists, Member American Academy of Adoption Attorneys, Fellow Texas Academy of Adoption Attorneys, Fellow American Academy of Matrimonial Lawyers, Fellow College of the State Bar of Texas, Fellow Texas Monthly Magazine – Super Lawyers: Rising Star 2004, 2005. State Bar of Texas (1990-Present): Current Member, Family Law Section. San Antonio Bar Association: Member, SABA Family Law Section. American Bar Association, Family Law Section Texas Trial Lawyers Association Charter Vice-President, Alamo Council of Termination and Adoption Attorneys District Courts Committee, Bexar County District Courts AV rated-Martindale Hubbell PUBLISHED PROFESSIONAL LEGAL ARTICLES Parentage, 1995 Advanced Family Law Drafting Course, co-author with Victor Hugo Negron, State Bar of Texas Professional Development Program, December 14-15, 1995, San Antonio, Texas Speaker, Adoptions, Law Day, St. Mary’s University (sponsored by WOAI), San Antonio, Texas Speaker, What Every Lawyer Needs to Know About Termination and Adoption (A Primer) and Ethics; Family Law Skills for General Practitioners & Legal Assistants, January 2000 Speaker, What Every Lawyer Needs to Know About Termination and Adoption (A Primer) and Ethics; Family Law Skills for General Practitioners & Legal Assistants, September 2000 Speaker, Advanced Family Law Course 2001, Legislative Update, Latest State and Federal Legislation Affecting Termination and Adoption Practice; August 2001 Speaker, Advanced Family Law Course 2003, Legislative Update, Latest State and Federal Legislation Affecting Termination and Adoption Practice; August 2003 Speaker, American Bar Association Young Lawyer’s Mid-Year Meeting, Helping the Helpless, The
ABC’S of Termination and Adoption Practice, February 2004. Speaker, Mission Organization, Extreme Divorce Practice Makeover!; Closing the File; San Antonio Bar Association Family Law Section, June 2004. Speaker, American Bar Association Young Lawyer’s Mid-Year Meeting, Helping the Helpless, The ABC’s of Termination and Adoption Practice, February 2004. Panelist Speaker, Current Trends and Problems in Family and Civil Law Litigation, Joint presentation by Civil Litigation Section and San Antonio Family Law Section of the San Antonio Bar Association; June 2005. Speaker, Advanced Family Law Course, 2005, Termination and Adoption Practice; August 2005 Speaker, San Antonio Bar Association Extreme Divorce Practice Makeover V, Mysteries of Family Law, March 2007 Speaker, State Bar of Texas Annual Meeting, Sole Managing Conservatorship and Joint Managing Conservatorship – More Than Just Titles and Other Child Related Issues, June 2007 Speaker, Corpus Christi Bar Association Family Law Section, Mysteries of Family Law, October 2007 Speaker, San Antonio Bar Association Extreme Divorce Practice Makeover VI, International Adoption, February 2008 Speaker, E. Planner Elements of Estate Planning, Family Limited Partnerships and Limited Liability Companies and Divorce, February 2008 COURT ADMISSIONS U.S. Supreme Court (1995). U.S. Court of Appeals, Fifth Circuit (1995) U.S. District Court, Western District of Texas (1995) Supreme Court of Texas (1989) PERSONAL Born May 1965, Summit, New Jersey Former member, First Community Bank, Business Advisory Board Former member, Clear Lake National Bank, Community Advisory Board Zeta Beta Tau, Fraternity Alpha Tau Omega, Board of Trustees, University of Texas at San Antonio Former member, Steering Committee, Boy Scouts of America, Keystone Chapter Guest Speaker Legal Line, KTSA AM 5500 Radio
C URRICULUM V ITAE OF S TEPHEN M. O RSINGER
[email protected]
Born:
San Antonio, Texas, May 2, 1981
Education:
St. John’s College, Santa Fe, New Mexico University of Texas School of Law, Austin, Texas
Licenses:
State Bar of Texas (2007)
B.A., 2003 J.D., 2007
CLE Articles
The Ethics of ADR Negotiation and Settlement (co-authored with Hon. Frances Harris) Marriage Dissolution Institute, Galveston, 2008 Effect of Choice of Entities: How Organizational Law, Accounting, and Tax Law for Entities Affect Marital Property Law (co-authored with Richard R. Orsinger and Patrice L. Ferguson) Advanced Family Law Course, San Antonio, 2008 Trusts, Family Law, & the Contract-Property Dichotomy (co-authored with Harold C. Zuflacht) Marriage Dissolution Institute, Fort Worth, 2009
I.
INTRODUCTION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -7-
II. BASIC PRINCIPLES OF TEXAS TRUST LAW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A. Trusts and the Four Principal Aspects. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1. Settlor. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2. Trustee. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3. Beneficiary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4. Property & Trust Property Interests. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B. Unity of the Parties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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III. THE MORPHOLOGY OF TRUSTS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -8A. Methods of Creation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -8B. Intent, Consent & Capacity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -8C. Modification & Amendment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -9D. Methods of Revocation & Termination.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -9E. Court’s Power Concerning Trusts - Orders and Interpretation. . . . . . . . . . . . . . . . . . . . . -10F. Presumption of Validity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -11IV. ADMINISTRATION & LIABILITY. . . A. Management Powers.. . . . . . . . . . . . . B. Duties. . . . . . . . . . . . . . . . . . . . . . . . . . C. Accounting. . . . . . . . . . . . . . . . . . . . . . D. Liability. . . . . . . . . . . . . . . . . . . . . . . . V.
PROCEDURAL ISSUES. . . . . . . . . . A. Jurisdiction. . . . . . . . . . . . . . . . . . B. Venue. . . . . . . . . . . . . . . . . . . . . . . C. Standing & Causes of Action. . . . D. Joinder. . . . . . . . . . . . . . . . . . . . . .
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VI. INVENTORY OF COMMONLY ENCOUNTERED TRUSTS. . . . . . . . . . . . . . . . . . . . . . . . . A. Inter Vivos (“Living”) Trust. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B. Testamentary Trust. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C. Spendthrift Trust. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . D. Crummey Trust.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . E. Simple and Complex Trusts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F. Grantor Trust. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . G. Intentionally Defective Grantor Trust. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . H. Personal Residence Trust. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I. Section 2503(c) Trust. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . J. Qualified Terminable Interest Property (QTIP) Trust. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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VII. MARITAL PROPERTY ISSUES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -14A. Acquisition of Property. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -141. Undistributed Income Earned by Separate Property Trust without Right to Compel Distribution. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -152. Undistributed Income Acquired from Separate Property Trust with Right to Compel Distribution. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -153. Undistributed Income Acquired from Separate Property Trust with Present Possessory
Interest in Corpus.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -15Distributed and Undistributed Income Acquired from Separate Property Trust with Mandatory Distribution. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -165. Undistributed Income Acquired from Trust without Interest in Corpus. . . . . . . . . . . -166. Distributed Income Acquired from Trust without Interest in Corpus. . . . . . . . . . . . . -167. Distributed Income Acquired from Trust with Interest in Corpus. . . . . . . . . . . . . . . . -16B. Tracing, Mutation, and the Community Property Presumption. . . . . . . . . . . . . . . . . . . . . -164.
VIII. CHALLENGING TRUSTS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A. Challenges to Validity of Trust. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1. No Valid Trust Was Created. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2. Rule Against Perpetuities.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3. Passive or Dry Trusts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4. Merger. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5. The Illusory Trust Doctrine.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B. Challenges to Character of Trust Property. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1. Fraud on the Community Doctrine.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2. Alter Ego. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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IX. BRIEF HISTORY OF TRUST LAW , THEORY AND DOCTRINE. . . . . . . . . . . . . . . . . . . . A. Origins of the Trust.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B. Courts of Equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C. The Statute of Uses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . D. The (First) Restatement of Trusts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . E. The Contract-Property Dichotomy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1. Scott’s Arguments for Proprietary Nature of Trusts. . . . . . . . . . . . . . . . . . . . . . . . . . . 2. Langbein’s Arguments for Contractarian Nature of Trusts. . . . . . . . . . . . . . . . . . . . . 3. The Non-Contractarian Response.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4. Applicability to Texas Marital Property Law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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T R U ST S , F A M IL Y L A W , & T H E C O N TR A CT -P R O PE RT Y D IC H O T O M Y
I.
states that the trust itself is a relationship, not an entity.2 The definition also recognizes four distinct aspects of this relationship: the settlor, the trustee (“person holding title”), the beneficiary (“another person”), and the trust property.
INTRODUCTION If we were asked what is the greatest and most distinctive achievem ent perform ed by Englishmen in the field of jurisprudence, I cannot think that we should have any better answer than this, namely the development from century to century of the trust idea.
1.
Settlor
The Trust Code defines settlor as the “person who creates a trust or contributes property to a trustee of a trust.” Tex. Prop. Code § 111.004(14). 3 The person who provides consideration for a trust is the settlor even if another person or entity nominally creates the trust. In re Brooks, 844 F.2d 258, 263 (5th Cir. 1988); see also In re Shurley, 171 B.R. 769, 778 (Bankr. W.D.Tex. 1994), rev'd on other grounds, 115 F.3d 333 (5th Cir. 1997).
– Frederic Maitland The Law of Trusts has a rich and dynamic history, both in this state and in others. This article seeks to provide an introduction to the various facets of this distinctive achievement, and how the body of trust law in Texas interacts with the community property system. Following this introduction, Part II of the article addresses the basic principles of Texas trust law found in both the Trust Code and case law. Part III describes the general form and structure that trusts may take. Part IV explains the administration of trusts and liability that may be owed thereon. Part V examines procedural aspects of suits involving trusts. Part VI lists different types of trusts commonly encountered in the practice of family law. Part VII explores several fundamental rules of Texas’ community property system and their relation to trust law. Part VIII analyzes various methods for challenging the validity and character of trusts. Finally, Part IX chronicles the history of trust law from its inception to the modern day.
2.
Trustee
The Trust Code defines trustee as “the person holding property in trust, including an original, additional, or successor trustee, whether or not the person is appointed or confirmed by a court.” Tex. Prop. Code § 111.004(18). The clause regarding additional or successor trustees was added to the original definition in 2007. A corporation may act as trustee for real and personal property when its charter power confers such right upon the corporation, and the corporation is organized under a statute permitting it to act as trustee. Port Arthur Trust Co. v. Muldrow, 155 Tex. 612, 291 S.W.2d 312 (Tex. 1956); see also Tex. Prop. Code §§ 111.004(10), 112.008(a).
II. BASIC PRINCIPLES OF TEXAS TRUST LAW A.
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Trusts and the Four Principal Aspects 3.
Title IX of the Texas Property Code, referred to as the Trust Code, governs trusts in the state of Texas. Tex. Prop. Code §§ 101.001-123.005. Section 111.004 contains nearly all of the essential definitions of terms used in the Trust Code. The term trust is defined as:
Beneficiary
The Trust Code defines beneficiary as the “person for whose benefit the property is held in trust, regardless of the nature of the interest.” Tex. Prop. Code § 111.004(2). For the purposes of all three of these parties, the term person includes an individual, a corporation, a partnership, a government, et al. Tex. Prop. Code § 111.004(10).
...a fiduciary relationship with respect to property which arises as a manifestation by the settlor of an intention to create the relationship and which subjects the person holding title to the property to equitable duties to deal with the property for the benefit of another person.
2
The common parlance of courts, commentators, and scholars alike frequently refers to trusts as if they are entities. Such usage is more likely for ease of speech than as an implicit recognition of an entity aspect of a trust. See Ray Malooly Trust v. Juhl, 186 S.W .3d 568, 570 (Tex. 2006) (Section 111.004(4) “explicitly defines a trust as a relationship rather than a legal entity.”).
Tex. Prop. Code § 111.004(4). 1 This definition explicitly
1
This definition applies only to an express trust, which does not include resulting trusts, constructive trusts, business trusts, or security instruments such as deeds of trust. Tex. Prop. Code § 111.003.
3
The terms grantor and trustor are synonymous with settlor. Id. -7-
T R U ST S , F A M IL Y L A W , & T H E C O N TR A CT -P R O PE RT Y D IC H O T O M Y
4.
imply a merger of these estates. If any beneficiary of a trust who is not a trustee retains a property interest in the corpus of the trust, even if it is only a future interest, the merger doctrine will not operate to terminate the trust. For example, if all but one of several beneficiaries transfer their interests to the trustee, who is also a beneficiary, but there remains one beneficiary with a vested remainder interest in the corpus, legal and equitable title have not fully merged and the trust will persist. See Moody v. Pitts, 708 S.W.2d 930, 934-35 (Tex. App.–Corpus Christi 1986, no writ).
Property & Trust Property Interests
The Trust Code distinguishes between the general term property and the specific term trust property. Property means any type of property, whether real, tangible or intangible, legal or equitable, including choses in actions, claims, and contract rights. Tex. Prop. Code § 111.004(12). This is the sense of the term that is used in the basic definition of trust discussed supra. Trust property, on the other hand, is defined as “property placed in trust by one of the methods specified in Section 112.001 or property otherwise transferred to or acquired or retained by the trustee for the trust.” Tex. Prop. Code 111.004(17).4 This sense of the term is coextensive with the other, and comprises any property–as generally defined in subsection (12)–that is held in a trust validly created under the Trust Code. By deduction, trust property and interest are closely related, if not identical, concepts. See Tex. Prop. Code § 111.004(2) (“‘Beneficiary’ means a person for whose benefit property is held in trust, regardless of the nature of the interest.”). Interest is defined as “any interest, whether legal or equitable or both, present or future, vested or contingent, defeasible or indefeasible.” Tex. Prop. Code § 111.004(6). Thus, any interest in property may constitute the corpus of the trust. B.
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III. THE MORPHOLOGY OF TRUSTS A.
Methods of Creation
The Trust Code lists five different methods of creating a trust, each of which comports with a single underlying principle: one party gives something to a second party to hold for the sake of a third party. Tex. Prop. Code § 112.001. The Code clarifies this principle, stating that the “giving” may occur by declaration of trust, inter vivos or testamentary transfer, exercise of a power of appointment, or contractual promise. Id. The “something” which must be given is the property defined in § 111.004(12), discussed supra, and a trust may not be created without it. Tex. Prop. Code § 112.005. The Statute of Frauds applies to trusts, so a trust in real property must be evidenced by a writing which contains the terms of the trust and the settlor’s signature. Tex. Prop. Code § 112.004. Such a writing is commonly referred to as the “trust instrument.” The settlor’s signature need not be witnessed or notarized. In re Estate of Canales, 837 S.W.2d 662, 665 (Tex. App.–San Antonio 1992, no writ). However, since the Statute of Frauds does not apply to gratuitous transfers of personalty, a trust consisting entirely of personal property is enforceable if the trustee is neither the settlor nor the beneficiary, and the settlor expresses an intent to create a trust simultaneously with or prior to the transfer of trust property to the trustee. Tex. Prop. Code § 112.004(1). A personalty trust where the settlor is also the trustee must be evidenced by a writing. Tex. Prop. Code § 112.004(2). Consideration is not required to create a valid trust, although consideration is required to create an enforceable contract to create a trust at a future time. Tex. Prop. Code § 112.003.
Unity of the Parties
The settlor and beneficiary of a trust may be the same person, as they would be in a defective spendthrift trust. See Tex. Prop. Code § 112.035(d). The settlor may also serve as trustee of the trust. Tex. Prop. Code § 112.008(c); see also Moon v. Lesikar, 230 S.W.3d 800 (Tex. App.–Houston [14th Dist.] 2007, pet. denied). However, the settlor, the sole trustee, and the sole beneficiary may not all be the same person. Tex. Prop. Code § 112.034. Additionally, the sole trustee and the sole beneficiary may not be the same person. Id. As discussed more thoroughly infra, it is a fundamental identity of trusts that the legal title to the trust property is held by the trustee, while equitable title is held by the beneficiary. See, e.g., Jameson v. Bain, 693 S.W.2d 676, 680 (Tex. App.–San Antonio 1985, no writ). When legal and equitable title are both fully held by the same person, whether at the moment of the trust’s creation or at some later time, the two estates “merge” and the trust terminates. See, e.g., Knight v. Tannehill Bros., 140 S.W.2d 552, 558-59 (Tex. Civ. App.–Amarillo 1940, writ denied). Revocation and termination of a trust both
B.
Intent, Consent & Capacity
An essential element of the creation of a trust is the intent to create one, and since a trust may only be created by a settlor, this requirement applies only to whether the settlor intended for there to be a trust. See Tex. Prop.
4
Trust property is also often referred to as the corpus of the trust, from the Latin word meaning “body.” Black’s Law Dictionary 343 (Joseph R. Nolan ed., 6th ed., W est 1990). -8-
T R U ST S , F A M IL Y L A W , & T H E C O N TR A CT -P R O PE RT Y D IC H O T O M Y
Code § 112.002. An essential element to the appointment of a trustee is the consent of the person holding that designation. A person who does not consent to the designation of trustee incurs no liability with respect to the trust, and a person designated as a trustee may act to preserve trust property without consenting to be trustee if they give notice within a reasonable time afterwards. Tex. Prop. Code § 112.009(b), (a)(1). However, it is a basic principle of trust law that a trust will not fail for lack of a trustee. Bode v. Loeffler, 540 S.W.2d 465, 470 (Tex. Civ. App.–San Antonio 1976, writ ref’d). If a trustee does not accept the trust and no alternative trustees designated by the instrument (if any) can or will accept the trust, the court shall appoint a substitute trustee, but only on the motion of an interested party. Tex. Prop. Code 112.009(c). The consent of a beneficiary to accept the equitable ownership in the trust property is presumed. Tex. Prop. Code § 112.010. A beneficiary may disclaim this interest, but only if they have not received any benefits from the trust. Id. Another essential element to the creation of a trust is the capacity of the settlor to create it. Tex. Prop. Code § 112.007. The capacity required to create a trust by any of the methods listed in Section 112.001 is the same capacity that would be required to transfer, will, or appoint free of trust. For example, a settlor’s capacity to create a testamentary trust is the same capacity that would be required to make a simple testamentary transfer of property. See Tex. Prob. Code § 57. Another essential element to the appointment of a trustee is the capacity of the person to act as trustee; the trustee must have the legal capacity to take, hold, and transfer trust property. Tex. Prop. Code § 112.008. If the trustee is a corporation, then it must have the power to act as a trustee in Texas. Id. Unlike the settlor and trustee, a beneficiary need not have any capacity to hold equitable title as beneficiary of a trust. See Tex. Prop. Code § 112.010(c)(2) (indicating that the personal representative of an incompetent, deceased, unborn or unascertained beneficiary may disclaim the beneficiary’s interest). C.
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modified if the settlor and all beneficiaries consent to the modification. Musick v. Reynolds, 798 S.W.2d 626, 629 (Tex. App.–Eastland 1990, writ denied). D.
Methods of Revocation & Termination
The Trust Code establishes a presumption that a trust is revocable by the settlor unless the trust instrument indicates that the trust is irrevocable. Tex. Prop. Code § 112.051(a). While the Code states that the irrevocability must be created by the “express terms of the instrument,” the case law establishes that the instrument need only reflect the settlor’s intent to make the trust irrevocable. Austin Lake Estates Rec. Club, Inc. v. Gilliam, 493 S.W.2d 343, 347 (Tex. App.–Austin 1973, writ ref’d n.r.e.). A settlor may revoke a trust by the express terms of the trust instrument or an instrument modifying it. Tex. Prop. Code § 112.051. However, if the trust was created by a written instrument, it must be revoked in writing. Id. The revoking written instrument need only reflect the settlor’s intent to revoke the trust, and does not have to mention revocation at all. Starcrest Trust v. Berry, 926 S.W.2d 343, 353 (Tex. App.–Austin 1996, no writ). A trust instrument may provide that the trust terminates after a certain time or upon the occurrence of a stated event. Tex. Prop. Code § 112.052. The elapsing of that period of time or the occurrence of the stated event will then terminate the trust. Id. Once the trust terminates, the legal and equitable title to the trust property merge in the beneficiary, either by direct conveyance by the trustee, or automatically if the instrument indicates that upon termination the property shall vest in the beneficiary. Sorrel v. Sorrel, 1 S.W.3d 867, 871 (Tex. App.–Corpus Christi 1999, no pet.). However, the trustee retains limited powers after the termination of the trust to wind up the affairs of the trust and distribute the trust property. Tex. Prop. Code § 112.052. The beneficiaries of a trust may also consent to its termination, but only if all purposes of the trust have been accomplished. Frost Nat’l Bank v. Newton, 554 S.W.2d 149, 154 (Tex. 1977). For an irrevocable trust, the consent of the settlor and all beneficiaries is required to terminate the trust prematurely. Musick v. Reynolds, 798 S.W.2d 626, 629 (Tex. App.–Eastland 1990, writ denied). A revocable trust becomes irrevocable upon the death of the settlor, and if there are no other unfulfilled purposes of the trust remaining, the trust terminates and is enforceable by the beneficiary. Citizens Nat’l Bank v. Allen, 575 S.W.2d 654, 658 (Tex. App.–Eastland 1978, writ ref’d n.r.e.). A trust instrument may provide for the distribution of the trust property in the event of the failure,
Modification & Amendment
The settlor may modify or amend a trust that is revocable, but they may not expand the duties of the trustee without the trustee’s express consent. Tex. Prop. Code § 112.051(b) (emphasis added). The Trust Code makes no further provision for the modification or amendment of a trust by either the settlor, trustee, or beneficiary. This fact seems to suggest that an irrevocable trust cannot be modified or amended. However, an irrevocable spendthrift trust may be -9-
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termination or revocation of the trust. Tex. Prop. Code § 112.053. E.
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Regarding the interpretation of trust instruments by a court, the following analysis adapted from the San Antonio Court of Appeals’ opinion in In re Ray Ellison Grandchildren Trust, 261 S.W.3d 111, 117 (Tex. App.–San Antonio 2008, pet. denied), is instructive. Courts have the power to interpret and construe the language of a trust instrument. Eckels v. Davis, 111 S.W.3d 687, 694 (Tex. App.–Fort Worth 2003, pet. denied). The same rules of construction apply to both wills and trusts. Id.; see also Hurley v. Moody Nat'l Bank, 98 S.W.3d 307, 310 (Tex. App.–Houston [1st Dist.] 2003, no pet.). In interpreting a will or a trust, the court must ascertain the intent of the settlor. Id. The court will ascertain that intent from the language used within the four corners of the instrument. Eckels, 111 S.W .3d at 694; see Shriner's Hosp. v. Stahl, 610 S.W.2d 147, 151 (Tex. 1980). If this language is unambiguous and expresses the intent of the settlor, the court need not construe the trust instrument because “it speaks for itself.” Eckels, 111 S.W.3d at 694; Hurley, 98 S.W.3d at 310; see Frost Nat'l Bank v. Newton, 554 S.W.2d 149, 153 (Tex. 1977) The court will not focus on what the settlor intended to write, but instead on the meaning of the words the settlor actually used. San Antonio Area Found. v. Lang, 35 S.W.3d 636, 639 (Tex. 2000). A court will not redraft a trust instrument to vary or add provisions “under the guise of construction of the language” of the trust to reach a presumed intent. Id. In determining the settlor’s intent from the four corners of the trust instrument, the court must examine the words used and, if unambiguous, will not go beyond specific terms in search of the grantor's intent. Id. Thus, when the language of a trust instrument is unambiguous, extrinsic evidence may not be introduced to show that the settlor intended something outside of the words used. Id. When the intent of the settlor is unambiguous, this intent controls even if it conflicts with applicable statutes. See Vaughn v. Vaughn, 161 Tex. 104, 337 S.W.2d 793, 796 (1960). However, if the meaning of the instrument is uncertain or “reasonably susceptible to more than one meaning,” the instrument is ambiguous. Eckels, 111 S.W.3d at 694 (quoting Myrick v. Moody, 802 S.W.2d 735, 738 (Tex. App.–Houston [14th Dist.] 1990, writ denied)). Where there is an ambiguity in the trust instrument, a court may admit extrinsic evidence to show the settlor’s intent. Eckels, 111 S.W.3d at 696; In re Estate of Cohorn, 622 S.W.2d 486, 487-88 (Tex. App.–Eastland 1981, writ ref'd n.r.e.); see Stewart v. Selder, 473 S.W.2d 3, 7 (Tex. 1971). For an analysis of several additional esoteric rules of construction, see Richard Orsinger, The Law of Interpreting Contracts: How to Draft Contracts to Avoid or Win Litigation, Advanced Family Law Course 2008,
Court’s Power Concerning Trusts - Orders and Interpretation
Upon petition of a trustee or beneficiary, the court may do any of the following regarding a trust: (1) order that the trustee be changed; (2) modify the terms of the trust; (3) order that the trustee is either required or permitted to do acts that are not authorized or that are forbidden by the terms of the trust; (4) prohibit the trustee from doing acts permitted or required by the trust; or (5) terminate the trust in part or in whole. Tex. Prop. Code § 112.054. However, the court may only exercise these powers over the trust if: (A) the purposes of the trust have been fulfilled or become illegal or impossible to fulfill; (B) because of circumstances unknown to the settlor, the order will further the purposes of the trust; (C) the modification of administrative, nondispositive terms of the trust is necessary or appropriate to prevent waste or avoid impairment of the trust’s administration; (D) the order is necessary or appropriate to achieve the settlor’s tax objectives and is not contrary to the settlor’s intentions; (E) continuance of the trust is not necessary to achieve any material purpose of the trust, and all beneficiaries of the trust consent to the order; or (F) the order is not inconsistent with a material purpose of the trust, and all beneficiaries of the trust consent to the order. Id. -10-
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the beneficiary as a matter of law. Meyer v. Cathey, 167 S.W.3d 327, 330 (Tex. 2005). Trustees are prohibited from “self-dealing,” that is personally profiting from their management of the trust. Slay v. Burnett Trust, 143 Tex. 621, 187 S.W.2d 377 (Tex. 1945); Tex. Prop. Code § 113.052. The Prudent Investor Rule, which had existed in the common law, has been codified in Chapter 117 of the Property Code. Under the Uniform Prudent Investor Act, the trustee owes a duty to the beneficiary to manage the trust property as a prudent investor would, exercising reasonable care, skill and caution. Tex. Prop. Code § 117.004. The trustee also owes duties of loyalty and impartiality to the beneficiary. Tex. Prop. Code §§ 117.007, .008. If a trustee has neither any powers nor any duties related to the administration of the trust, then the trust is considered passive and thus invalid, and the trust property passes directly to the beneficiary. Tex. Prop. Code § 112.032; Nolana Dev. Ass’n. v. Corsi, 682 S.W.2d 246, 249 (Tex. 1984). This section of the Code is a recodification of the Statute of Uses, discussed infra. A trustee who has no duty except to make payments to the beneficiary as they become due is the trustee of a “passive” or “dry” trust. Daniels v. Pecan Valley Ranch, Inc., 831 S.W.2d 372, 379 (Tex. App.–San Antonio, 1992 writ denied). However, the Statute of Uses and the passive trust doctrine Section 112.032 might be nullified by other provisions of the Trust Code. The general duties that the Code establishes apply to trust instruments where the trustee has no articulated duties, and these statutory duties prevent the trust from being passive. Tomlinson v. Tomlinson, 960 S.W.2d 337, 338 (Tex. App.–Corpus Christi 1997, pet. denied) (“Appellee contends that no trust was created because no specific duties as trustee were devolved to appellant in the...beneficiary designation. Although the...beneficiary designation lacks specific detail, all necessary details are supplied by Texas Property Code [Chapters 113 & 114].”); see also Tex. Prop. Code § 113.051 (“The trustee shall administer the trust in good faith according to its terms and this subtitle.”) (emphasis added). The argument may be made that a trust cannot be passive unless the instrument explicitly states that the trustee shall have absolutely no powers or duties to perform.
Chapter 6, §§ II.B.1-21. F.
Presumption of Validity
Some commentators and practitioners argue that trusts are presumptively valid and that Texas courts favor a finding that a trust exists, citing Tomlinson v. Tomlinson, 960 S.W.2d 337 (Tex. App.–Corpus Christi 1997, writ denied). However, this case stands for the principle that an instrument which manifests an intent to create a trust, identifies trust property, names a beneficiary, and implies a purpose for the trust, will suffice to create a trust. Id. at 338-39. Other commentators claim that the burden of proving the elements necessary to establish a trust rests on the party asserting it. 72 Tex. Jur. 3d Trusts § 228 (2009). If the burden of proof on the existence of a trust rests with the party asserting that the trust exists, as the Tomlinson court implicitly acknowledged, then the “presumption” of validity exists only after the four elements necessary for the creation of a trust have been proven. IV. ADMINISTRATION & LIABILITY A.
Management Powers
Generally, a trustee may exercise any powers that are necessary or appropriate to carry out the purposes of the trust. Tex. Prop. Code § 113.002. However, all powers given to a trustee under the Trust Code may be limited by the trust instrument itself or by the court. Tex. Prop. Code § 113.001. The trustee may not delegate his discretionary powers to another, although the trustee may give authority to another to carry out ministerial or mechanical acts. See generally Tex. Prop. Code § 113.018; see also Transamerican Leasing Co. v. Three Bears, Inc., 586 S.W.2d 472, 476 (Tex. 1979). Chapter 113 of the Trust Code enumerates a number of different default powers belonging to a trustee, including real property management, leasing trust property, borrowing funds, and paying taxes. See Tex. Prop. Code § 113.003 et seq. Unless the trust instrument expressly provides otherwise, a settlor has no duty to manage trust property, and the trustee alone is responsible as a fiduciary if he allows the settlor to mismanage trust property to the detriment of the trust. Alpert v. Riley, 274 S.W.3d 277, 292 (Tex. App.–Houston [1st Dist.] 2008, no pet. h.). B.
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C.
Accounting
A beneficiary may demand an accounting from the trustee of all transactions involving the trust. Tex. Prop. Code § 113.151(a). This demand must be made in writing. Id. Additionally, an interested person in the trust, as defined by Section 111.004(7), may also request an accounting. Tex. Prop. Code § 113.151(b).
Duties
The trustee owes a general duty to the beneficiary of administering the trust in good faith according to its terms and the dictates of the Trust Code. Tex. Prop. Code § 113.051. Trustees also owe a fiduciary duty to -11-
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D.
Liability
B.
Chapter 114 of the Trust Code governs the liability of the trustee for administration of the trust. Generally, a trustee is accountable to the beneficiary for the trust property and all profits derived from it, but is not liable for any loss to that property incurred through lawful administration of the trust. Tex. Prop. Code § 114.001(a), (b). If the trustee mismanages the trust and commits a breach of trust, they may be personally liable to the beneficiary for damages. Tex. Prop. Code § 114.001(c). A long-standing rule of Trust Law is that the trust property may not be used to satisfy the personal obligations of the trustee, despite the fact that the trustee holds legal title to the property. Tex. Prop. Code § 114.0821. In certain circumstances, the beneficiary of a trust may be liable to the trust for inappropriate conduct detrimental to the trust. Tex. Prop. Code § 114.031. The trustee may offset any losses to trust property due to this inappropriate conduct against the beneficiary’s interest in the trust property. Id. V.
Venue
Generally, proper venue for an action involving a trust is the county in which the trustee resides or the situs of where the administration of the trust is maintained. Tex. Prop. Code § 115.002. C.
Standing & Causes of Action
Any interested person may bring an action permitted by Section 115.001. Tex. Prop. Code § 115.011(a). The Trust Code defines “interested person” as “a trustee, beneficiary, or any other person having an interest in or a claim against the trust or any person who is affected by the administration of the trust.” Tex. Prop. Code § 111.004(7).5 A spouse who is not a trustee or beneficiary of a trust, and who does not have a testamentary or community property interest in the trust, does not have standing to bring an action under Section 115.001. Lemke v. Lemke, 929 S.W.2d at 664-65. However, if a spouse does have a community property interest, they become an “interested person” for the purposes of Section 115.011, and does have standing bring any action permitted by Section 115.001. Id. Absent some assignment of duty to the settlor in the trust instrument, a trustee has no cause of action to sue the settlor of a trust for a breach of fiduciary duty to the trust beneficiaries. Alpert v. Riley, 274 S.W.3d 277, 292 (Tex. App.–Houston [1st Dist.] 2008, no pet. h.).
PROCEDURAL ISSUES A.
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Jurisdiction
A district court has exclusive, original jurisdiction over all proceedings by or against a trustee and all proceedings concerning trusts. Tex. Prop. Code § 115.001. These proceedings include construing the trust instrument, determining the law applicable to it, appointing or removing a trustee, determining the powers, responsibilities, duties, and liability of the trustee, ascertaining beneficiaries, requiring that the trustee provide an accounting, et al. Id. The list of proceedings under which the district court has jurisdiction is not exhaustive, but is indiciative of the general nature of proceedings that are meant to be included. Tex. Prop. Code § 115.001(a-1); In re Stark, 126 S.W.3d 635, 641-42 (Tex. App.–Beaumont 2004, orig. proceeding). The district courts have jurisdiction over all proceedings where legal and factual determinations relative to the construction of the trust are involved. Weatherly v. Byrd, 566 S.W.2d 292, 294-95 (Tex. 1978). However, actions against a trust or trustee which do not relate to the trust itself or the operation of the trust–a tort action, for example–may be heard by county courts at law. In re Stark, 126 S.W.3d at 642.
D.
Joinder
The Trust Code provides that the necessary parties to an action under Section 115.001 are (1) a beneficiary whose act or obligation is the basis for the suit, (2) any beneficiaries named in the trust instrument, (3) a person who is actually receiving distributions for the trust at the time the suit is filed (i.e. a de facto beneficiary), and (4) the trustee, if any. Tex. Prop. Code § 115.011(b). Where a suit is brought to cancel a trust instrument, the beneficiaries are considered to be adequately represented by the trustee if their interests are not in conflict with the trustee’s interest. Mason v. Mason, 366 S.W.2d 552, 554 (Tex. 1963); see also Hedley Feedlot v.
5
The Supreme Court of Georgia has recast this definition of interested person as “a person or entity with a specific financial stake in or a specific claim against the trust.” Richards v. Richards, 281 Ga. 285, 287, 637 S.E.2d 672 (2006). The Court cited one of the leading Texas cases on trusts and marital property law, Lemke v. Lemke, 929 S.W .2d 662, 664 (Tex. App.–Fort W orth 1996, writ denied), discussed infra, for this definition, although the Lemke opinion itself does not contain such a definition. -12-
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Weatherly Trust, 855 S.W .2d 826, 833 (Tex. App.–Amarillo 1993, writ denied) (“In actions adverse to a trust, if the dispute involves no conflict between the trustee and the beneficiaries, or between the beneficiaries themselves, a trustee may sue or defend in the trustee’s own name when, either by express grant or necessary implication, that power is vested in the trustee.”). In other words, beneficiaries are proper but not necessary and indispensable parties in such a case. Mason, 366 S.W.2d at 554; see also Weatherly Trust, 855 S.W.2d at 833 (“[I]n the absence of a conflict of interest, or of a pleading that they are inadequately represented, the beneficiaries who did not participate in the trial are not considered necessary parties to the case.”). This rule may impact the issue of whether or not a guardian or attorney ad litem must be appointed for minor beneficiaries to a trust that a party seeks to invalidate. See also Tex. Prop. Code § 115.014 (“At any point in a proceeding a court may appoint a guardian ad litem to represent the interest of a minor, an incapacitated, unborn or unascertained person...if the court determines that representation of the interest otherwise would be inadequate.”).
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beneficiary’s interest in the undistributed portion of the trust is shielded from the claims of his creditors. One public policy exception to this general rule is a claim for support of the beneficiary’s children from the income of the trust. See First City Nat’l Bank v. Phelan, 718 S.W.2d 402, 406 (Tex. App.–Beaumont 1986 writ ref’d n.r.e.). The settlor of a spendthrift trust may not be a beneficiary of that same trust and preserve the spendthrift nature. Tex. Prop. Code § 112.035(d). D.
A Crummey trust is one designed to allow the beneficiary to withdraw gifts made to the trust by third parties so that these withdraws qualify for the annual gift exclusion under Federal Tax Law. See Crummey v. Commissioner, 397 F.2 82 (9th Cir. 1968). E.
F.
The following is a list of some of the different types of trusts commonly encountered in the practice of family law.
Intentionally Defective Grantor Trust
Inter Vivos (“Living”) Trust An intentionally defective grantor trust is one where the settlor is considered to be the owner of the trust for federal income tax purposes, but not for estate or gift tax purposes.
An inter vivos trust is a revocable trust created during the settlor’s lifetime which provides for distribution of trust assets upon the death of the settlor. These types of trusts are specifically designed to avoid probate. An inter vivos trust may be fully-funded, partially-funded, or only nominally funded at the time of settlement.
H.
Personal Residence Trust
A personal residence trust is a trust whose sole asset is the personal residence of the beneficiary. See Treas. Reg. § 25.2702-5(a). A qualified personal residence trust may hold additional assets, but abides by different rules. See Treas. Reg. § 25.2702-5(c).
Testamentary Trust
A testamentary trust is a trust created in probate by execution of the settlor’s will. The death of the settlor is a condition precedent to the creation of the trust. Land v. Marshall, 426 S.W.2d 841, 844 (Tex. 1968). C.
Grantor Trust
A grantor trust is one where the settlor is considered to be the owner of the trust for federal tax purposes. G.
B.
Simple and Complex Trusts
A simple trust is one which is required to distribute all income earned from trust corpus at least annually. A complex trust requires no such distribution of income.
VI. I N V E N T O R Y OF COMMONLY ENCOUNTERED TRUSTS
A.
Crummey Trust
I.
Section 2503(c) Trust
This type of trust is named for Internal Revenue Code Section 2503(c). This trust is created for the benefit of a minor and terminates when the beneficiary reaches the age of 21. A gift made into this trust qualifies for the donor’s annual gift tax exclusion.
Spendthrift Trust
A spendthrift trust is one where the settlor specifically provides in the trust instrument that either corpus or income or both may not be transferred by the beneficiary until the interest is actually distributed to them. Tex. Prop. Code § 112.035. By so doing, the -13-
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J.
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in unique ways. Rules (1) & (2) are discussed in subsection A, which deals primarily with trust income acquired during marriage. Rule (3) is discussed in subsection B, which deals primarily with the corpus of the trust.
Qualified Terminable Interest Property (QTIP) Trust
The QTIP trust is a trust created by one spouse for the benefit of the other in the event that the settlor-spouse predeceases their spouse. The standard form of a QTIP trust is that the trustee distributes income on a regular basis to the surviving spouse, and upon that spouse’s death, distributes all remaining trust property to the spouses’ children. This type of trust takes advantage of the settlor’s unlimited marital deduction.
A.
Acquisition of Property
With most forms of property, acquisition of title occurs simultaneously with the acquisition of possession. However, the term “acquisition,” as it relates to marital property, extends beyond mere possession. Under the inception of title rule, the status of property is determined by the date of origin of the title to the property, and not by the date final title is acquired. See Jensen, 665 S.W.2d at 109. The date of acquiring the ownership right, rather than the date of acquiring possession or final vesting of title, is the determinative date in establishing the inception of title. Speer, Marital Rights in Texas § 388 (4th ed. 1961). The acquisition of ownership rights by a beneficiary who may not compel the trustee to distribute income derived from the corpus of the trust has a dual nature. In one sense, that beneficiary has an equitable right to the income from the corpus of the trust whenever it is earned, regardless of whether she has a right to compel distribution of that income. If the trustee mismanages the trust, he will be liable to the beneficiary for that property, both corpus and income, that was lost. Tex. Prop. Code § 114.001. One of the many definitions given by Black for the term “right” is “a demand inherent in one person and incident upon another.” Black’s Law Dictionary 1324 (Joseph R. Nolan ed., 6th ed., West 1990).6 The beneficiary’s equitable right to that income is recognized by allowing her to recover it if the trustee breaches the trust, even if she may not compel distribution of the income under the terms of the trust until the trust itself terminates. Under this interpretation, the beneficiary acquires a particular kind of right at the moment that the income is earned. But in another sense, a beneficiary who cannot compel distribution of the income earned by trust property does not have a right to that income. Another definition Black provides for “right” is a “claim to hold, use, or enjoy [property], or to convey or donate it, as he
VII. MARITAL PROPERTY ISSUES Four of the fundamental, interrelated rules of Texas’ community property regime have special significance regarding spouses and trusts: (1) Separate property is property owned by a spouse before marriage, or acquired during marriage by gift, devise or descent. Tex. Fam. Code § 3.001 (added). Conversely, community property is property, other than separate property, acquired by a spouse during marriage Tex. Fam. Code § 3.002 (emphasis added). Income arising from separate property, if acquired during marriage, is generally community property. See Moss v. Gibbs, 370 S.W.2d 452, 455 (Tex. 1963). (2) The character of property is based on the time and manner in which the inception of title to that property is acquired. See Jensen v. Jensen, 665 S.W.2d 107, 109 (Tex. 1984). Inception of title occurs when a party first has right of claim to the property by virtue of which title is finally vested. Camp v. Camp, 972 S.W.2d 906, 908 n.1 (Tex. App.–Corpus Christi 1998, pet. denied). (3) Property possessed by either spouse upon the dissolution of marriage is presumed to be community property. Tex. Fam. Code § 3.003. To overcome this presumption, clear and convincing evidence must trace and clearly identify the property as separate. See, e.g., Evans v. Evans, 14 S.W.3d 343, 346 (Tex. App.–Houston [14th Dist.] 2000, no pet.).
6
This conception of “right” is an in personam right, i.e. a right which imposes an obligation on a definite person. In this case, one person–the beneficiary–has a right to demand that another person–the trustee–compensate them for damages caused by the illegitimate actions of that person.
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may please.” 7 Id. Because the beneficiary may not compel distribution of the income free of trust to herself, her right to that income is not manifested in an ability to personally use it or spend it, to convey it or donate it, as she may please. Under this interpretation, the beneficiary does not acquire a right until the income is distributed to her and she can personally control that property. 1.
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Thus, “acquisition,” for the purposes of income derived from a separate property trust, is determined by whether the beneficiary has the power to compel the trustee to distributed that income. 2.
Undistributed Income Earned by Separate Property Trust without Right to Compel Distribution
Undistributed Income Acquired from Separate Property Trust with Right to Compel Distribution
Transposing the components of the rule announced in Burns, Lemke, and Lipsey, income derived from a separate property trust where the spouse-beneficiary does have a right to compel distribution is “constructively acquired” by that spouse, and therefore is community property. Frequently, In re Marriage of Long, 542 S.W.2d 712 (Tex. Civ. App.–Texarkana 1976, no writ), is cited in support of this principle. However, as discussed infra, this case applies to different situations and relies on a different conception of acquisition.
In Texas, it is this second sense of the right which governs acquisition for the purposes of marital property law. Income derived from separate property is community property. But undistributed income derived from the corpus of a separate property trust in which the spouse-beneficiary has no right to compel distribution of that income is separate property. In re Marriage of Burns, 573 S.W.2d 555, 557 (Tex. Civ. App.–Texarkana 1978, writ dism’d); see also Lemke v. Lemke, 929 S.W.2d 662, 664 (Tex. App.–Fort Worth 1996, writ denied); Lipsey v. Lipsey, 983 S.W.2d 345, 351 (Tex. App.–Fortworth 1998, no pet.). The Burns Court concluded that, because the spouse-beneficiary did not have “a present or past right to require [the income’s] distribution so as to compel a finding that there was a constructive acquisition...neither spouse actually or constructively acquired the undistributed...income.” Id. The Court reasoned that, in such a situation, “[t]he [undistributed] income was actually acquired by the trust and estates and not by either Mr. or Mrs. Burns.” 8 Id.
3.
Undistributed Income Acquired from Separate Property Trust with Present Possessory Interest in Corpus
In In re Marriage of Long, the trust instrument provided that half of the corpus would be distributed to the beneficiary upon reaching the age of 25. In re Marriage of Long, 542 S.W.2d 712, 715 (Tex. App.–Texarkana 1976, no writ). However, the instrument also allowed the beneficiary to elect that the corpus continue to be held in trust until he reached the age of 30, at which point the trust would terminate and the entire corpus would be distributed. Id. The beneficiary turned 25 during marriage and elected that his interest in half of the corpus remain in trust, where continued to earn income. Id. The Court held that the beneficiary had a “present possessory interest” in the corpus, and therefore, the income earned on it during marriage was community property. Id. at 717.
7
This conception of “right” is an in rem right, i.e. a right which imposes an obligation on persons generally. In this case, a beneficiary does not have a right to freely dispose of the income of the trust as she wishes, and may not prevent the trustee from disposing of it in legitimate ways. 8
Not only did the Burns Court state that the trust acquired the undistributed income, it also wrote that “such income, though earned during the marriage, remained a part of the respective trust...and was not subject to division by the [trial] court.” Burns, 573 S.W .2d at 557-58 (emphasis added). This articulation seems incommensurate with a fundamental tenet of Trust Law, viz. a trust is a relationship and not a legal entity. See Ray Malooly Trust v. Juhl, 186 S.W .3d 568, 570 (Tex. 2006); Tex. Prop. Code § 111.004(4). It is axiomatic that an entity can acquire property, but a relationship cannot. Therefore, perhaps a more accurate way to articulate the Burns holding is that “legal title to the income was acquired by the trustee, and equitable title to the income was acquired by the beneficiary, but full title to the income was not acquired by either spouse during marriage, so Family Code Section 3.002 does not apply.” However, this modified notion of acquisition of title
by the 4beneficiary during marriage invalidates the principle, discussed infra, that income earned by a trust where the beneficiary has the power to compel distribution is community property. The power to compel distribution does not, under any rubric of Trust Law, alter the acquisition of the beneficiary’s equitable ownership interest in the property. But the power to compel distribution under marital property law transforms separate into community, acquisition by “the trust” into acquisition by the spouse-beneficiary. Unfortunately, the concept of “constructive acquisition” does not resolve this quandary, since that concept, as stated by Burns, perceives no acquisition by the spousebeneficiary, and instead allocates the acquisition entirely to the trust. -15-
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Unlike Burns, Lemke, an Lipsey, the character of the income in Long did not depend on the nature of the interest in the income, but rather on the nature of the interest in the corpus. The Long Court held that only income earned on one-half of the corpus from the date the beneficiary turned 25 to the date of trial was community property. Id. at 718. Furthermore, the beneficiary in Long had the right to compel retention of the property, not distribution. The Long Court concluded that the beneficiary acquired the corpus functionally free of trust when he was entitled to receive it under the terms of the instrument; the fact that he elected for the trust to nominally hold it for him was not controlling. 4.
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title of mandatorily distributed income would occur at the same time as the beneficial interest in the trust accrued. On the other hand, mandatory distributions could be viewed as simple acquisitions of property during marriage, falling squarely under the ambit of Family Code Section 3.002 and Ridgell, discussed infra. In a trust where the beneficiary had any interest at all in the corpus, such distributions would always be community property. Many courts, commentators and practitioners rely on Long and its progeny (and its progenitors) to classify this type of income as community property, so the weight of the authority supports the latter perspective. 5.
Distributed and Undistributed Income Acquired from Separate Property Trust with Mandatory Distribution
Undistributed Income Acquired from Trust without Interest in Corpus
In a situation where the spouse is an income beneficiary of the trust but has no interest in its corpus, any undistributed income earned during marriage is that spouse’s separate property. Cleaver v. Cleaver 935 S.W.2d 491, 493 (Tex. App.–Tyler 1996, no writ). Because the corpus is not the property of the spouse, income derived from it and distributed to the spouse is not “income arising from separate property,” and is therefore considered to be a gift.
Long is also frequently cited to support the principle that a mandatory distribution of income from a separate property trust is community property. See, e.g., Sharma v. Routh, No. 14-06-00717-CV, 2008 WL 5443213, at *5 (Tex. App.–Houston [14th Dist.] Dec. 31, 2008, no pet. h.).9 The same distinction between the functional distribution of corpus in Long and compulsory distributions of income also applies to mandatory distributions of income. Conceptually, mandatory distributions of income from a trust settled by a third party where the beneficiary has a separate property interest in the corpus could be looked at in two different ways. On the one hand, as in Burns, the beneficiary does not have the right to compel distribution of the income, but unlike Burns, the trustee does not have discretion to distribute it either. Instead, the settlor decided that income derived from the corpus would be received by the beneficiary at particular delineated times, and this schedule was part of the original gratuitous transfer into trust. Thus, the right to receive distributions of income could be seen to vest at the moment the trust was settled; while the amounts of those periodic, mandatory distributions were unknown at the time the right vested, the beneficiary was assured at the time of settlement that any income would be distributed upon the occurrence of a stated event, just as they were assured that the trust would terminate all trust property would be distributed upon the occurrence of a stated event. When viewed in this way, the inception of
6.
Distributed Income Acquired from Trust without Interest in Corpus
For the same reasons, in a situation where the spouse is an income beneficiary of the trust but has no interest in its corpus, any distributed income acquired during marriage is that spouse’s separate property. See Wilmington Trust Co. v. United States, 4 Cl.Ct. 6, 12 (1983), aff’d, 753 F.2d 1055 (1985) (reviewing Texas cases in which trust income to a married beneficiary is separate property). 7.
Distributed Income Acquired from Trust with Interest in Corpus
Any income earned by a separate property trust that is actually distributed to the spouse-beneficiary is community property. Ridgell v. Ridgell, 960 S.W.2d 144, 149 (Tex. App.–Corpus Christi 1997, no pet.). The applicability of rules (1) and (2) is clear in such a case; any property interest first acquired during marriage is community property.
9
Sharma also cites Ridgell v. Ridgell, 960 S.W .2d 144, 148 (Tex. App.–Corpus Christi 1997, no pet.), and Mercantile Nat'l Bank at Dallas v. Wilson, 279 S.W .2d 650, 654 (Tex. Civ. App.–Dallas 1955, writ ref'd n.r.e.) for the same principle. Neither of these cases address mandatory distributions of income.
B.
Tracing, Mutation, and the Community Property Presumption
All property owned by either spouse upon dissolution of the marriage is presumed to be community -16-
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property. Tex. Fam. Code § 3.003. Clear and convincing evidence which proves that the source of the funding of a spouse’s beneficial interest in the corpus of the trust was separate property will establish that the trust is, as it was referred to in the previous section, a “separate property trust.” Property acquired in exchange for separate property or using separate property funds is separate property. Dixon v. Sanderson, 10 S.W. 535, 546 (Tex. 1888). As noted supra, separate property is any property owned prior to marriage, or property acquired during marriage by gift, devise or descent. Tex. Fam. Code § 3.001. In Burns, the trusts were separate property because the corpi were funded prior to marriage. Burns, 573 S.W.2d at 556. In Ridgell, the trust was separate property because the corpus was funded during marriage with one spouse’s separate property. Ridgell, 960 S.W.2d at 149-50. And in Hardin v. Hardin, 681 S.W.2d 241, 242-43 (Tex. App.–San Antonio 1984, no writ), the trust was separate property because the corpus was funded by a gift to one of the spouse. If a distribution of corpus is made during marriage, the character of property is determined by the character of the corpus. Taylor v. Taylor, 680 S.W.2d 645, 649-50 (Tex. App.–Beaumont 1984, writ ref’d n.r.e.). Thus, distributions of separate property corpus are separate property, and distributions of community property corpus are community property. In other words, for the purposes of marital property law, the spouse’s property interest in the corpus is acquired at the time and in the manner the trust was settled, not at the time or in the manner that the distribution was made. Like other marital property, trusts may also have a mixed character.
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A.
Challenges to Validity of Trust 1.
No Valid Trust Was Created
As discussed supra, the settlor of the trust must intend to create a trust. Tex. Prop. Code § 111.004(4). There must also be an ascertainable beneficiary of the trust. Id. There must be some property that is held trust to comprise its corpus. Id. The settlor must have the appropriate capacity to dispose of whatever property is to be held in trust. Tex. Prop. Code § 112.007. The trust instrument must also, in many cases, be evidenced by a writing. Tex. Prop. Code § 112.004. A trust is invalid if it lacks any one of these essential elements. A trust will not fail, however, for want of a trustee or consideration 2.
Rule Against Perpetuities
The Rule Against Perpetuities applies to trusts. Tex. Prop. Code § 112.036. “Simply” stated, the Rule provides that an interest must vest, if at all, not later than 21 years after some life in being at the time of the creation of the interest, plus a period of gestation. Id. The word “vest” refers to a vesting in interest and not in possession. Kelly v. Womack, 268 S.W.2d 903, 905-06 (Tex. 1954). The court has the power to reform the trust instrument to comport with the Rule and preserve the general intent of the settlor. Tex. Prop. Code §§ 112.036, 5.043. 10 However, if the trust cannot be reformed to comport with the Rule without drastically deviating from the intent of the settlor, the trust may be held to be invalid. 3.
Passive or Dry Trusts
VIII. CHALLENGING TRUSTS As explained supra, if a trustee has neither any powers or any duties related to the administration of the trust, then the trust is considered passive and thus invalid, and the trust property passes directly to the beneficiary. Tex. Prop. Code § 112.032. However, the effects of other provisions of the Trust Code may abrogate this rule. See Tomlinson v. Tomlinson, 960 S.W.2d at 338; see also Tex. Prop. Code § 113.051.
In the Family Law context, trusts can be attacked in a variety of ways which fall into two broad categories: challenges to the validity of the trust itself, and challenges to the character of trust property. For challenges of the latter type, the bright line rules described in the previous part regarding income and corpus may all form the basis of a challenge to the character of particular trust assets. For challenges of the former type, there are several fundamental rules of Trust Law, as well as some specific doctrines developed in Family Law, which provide grounds for invalidating a trust.
4.
Merger
The settlor, the sole trustee, and the sole beneficiary may not all be the same person. Tex. Prop. Code § 112.034. Additionally, the sole trustee and the sole beneficiary may not be the same person. Id. If either of
10
This power is also referred to as the doctrine of cy-près, from the Old French meaning “as near as possible.” -17-
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these rules is violated, the legal and equitable interests in the trust automatically merge, and the trust terminates. 5.
[T]he illusory trust doctrine, as enunciated in Land v. Marshall, 426 S.W.2d 841 (Tex. 1968), is limited to instances in which a nonconsenting spouse’s property is used to fund a trust...The Marshall trust did not fail because the husband reserved too much control over his own property.
The Illusory Trust Doctrine
The illusory trust doctrine first took root in Texas in 1968 in the landmark case of Land v. Marshall, 426 S.W.2d 841 (Tex. 1968). In Marshall, the husband funded a trust using community property under his sole management and control without the consent of his wife. Id. at 842-43. The trust instrument provided for distribution of the corpus to the spouses’ children upon the death of both of the spouses. Id. However, the husband-settlor retained exclusive control over the trustee’s powers of management and distribution of the corpus during his lifetime. Id. The two essential components of this trust were (1) that it was settled with community property without both spouses’ consent, and (2) the settlor spouse retained extensive powers over trust property. The Texas Supreme Court examined this trust and announced the first clear articulation of the doctrine:
Westerfeld v. Huckaby, 474 S.W.2d 189, 191-92 (Tex. 1972). The Court upheld the validity of the Westerfeld trust. The trust in Westerfeld also had a quasitestamentary component, so the Court focused on the aspect of Marshall addressing how the trust was funded, rather than how much control was reserved by the settlor. The Court recognized that it “could not look solely to the husband’s reservation of powers over his own property but had to bring additional policy considerations to bear.” Id. at 191. The Court cited a number of cases upholding the validity of trusts even though the settlor retained extensive powers of control, and stated: Our question is whether [the settlor], dealing with her own property, could create valid trusts even though she reserved in herself broad beneficial rights, as well as the right to revoke the trusts and the right to control or manage the acts of the trustee. The trusts were not fatally defective by reason of her power to revoke them, because the Texas Trust Act has foreclosed that objection. Art. 7425b-41, Vernon’s Ann. Tex. Civ. Stats. Land v. Marshall, 426 S.W.2d at 844. The trust act also permits the settlor to hold property as trustee for another, or for himself and another. Art. 7425b-7 Vern. Ann. Tex. Civ. Stats. See Restatement (Second) of Trusts §§ 17, 28, 57 (1959); 2 A. Scott, The Law of Trusts § 127.1 (3d ed. 1967).
[U]nder the doctrine, the husband has the power to create an inter vivos trust as part of his managerial powers over the wife’s share; but when her share is involved, the wife can require the trust to be real rather than illusory, genuine rather than colorable.11 Id. at 846. The Court invoked this doctrine in order to resolve “the question [of] whether the husband can accomplish by inter vivos trust what he could not do by a will.” Marshall, 426 S.W.2d at 846. The Court applied the illusory trust doctrine, concluded that the husband may not exercise such extensive control over the wife’s community property, and held that the Marshall trust was invalid. Id. Four years later, the Supreme Court explained its holding in Land v. Marshall:
11
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Westerfeld, 474 S.W.2d at 192. Therefore, Westerfeld clarified the illusory trust doctrine first announced in Marshall: a trust may be rendered invalid if a spouse uses community property to settle a trust without the consent of the other spouse. The element of consent is emphasized, while the element of control is underplayed.
The Court explained on its use of the term colorable thus: The term ‘colorable,’ as used herein, indicates a transfer which may be absolute on its face, but which, actually, is not a transfer at all because, through some secret or tacit understanding, the parties intended that ownership is to be retained by the donor.
B.
Challenges to Character of Trust Property
The rules described in the previous part regarding income and corpus may all form the basis of a challenge to the character of particular trust assets. A few other doctrines have developed outside the realm of these bright line rules which may also impact the character of the trust.
Id. at n. 4. The “colorable trust doctrine” has not been advanced by any other Texas court since Marshall, although it may prove to be fertile ground for challenging the validity of a trust. -18-
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1.
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When the theory of recovery of the specific fraudulently conveyed property is advanced, the fraud on the community doctrine operates against the trust. When the theory of recovery is a disproportionate division because of the fraud, this doctrine instead serves as evidence to support the division and does not directly pertain to the trust at all. Depending on which theory is advanced, Trust Code Sections 115.001 and 115.011 may or may not apply. Constructive fraud is another species of fraud which may sustain a fraud against the community argument Texas Pattern Jury Charges–Family PJC 206.4 (2008). A spouse may make moderate gifts of community property to third parties. See Hartman v. Crain, 398 S.W.2d 387, 390 (Tex. Civ. App.–Houston 1966, no writ). But a gift of community funds that is capricious, excessive, or arbitrary may be set aside as a constructive fraud on the other spouse. Horlock, 533 S.W .2d at 55. In considering the fairness of the transaction, the courts may look to the relationship between the managing spouse and the person to whom the gift was made; whether there were any special circumstances tending to justify the gift; and whether the community funds used for the gift were reasonable in proportion to the total community estate. Redfearn v. Ford, 579 S.W.2d 295, 297 (Tex. Civ. App.–Dallas 1979, writ ref’d n.r.e.). As with actual fraud, constructive fraud on the community is not a separate, actionable tort. See Schlueter, 975 S.W.2d at 585.
Fraud on the Community Doctrine
A spouse commits fraud against the community if that spouse transfers community property or expends community funds for the primary purpose of depriving the other spouse of the use and enjoyment of the assets involved in the transaction. Texas Pattern Jury Charges–Family PJC 206.2 (2008); see also In re Marriage of DeVine, 869 S.W.2d 415, 421 n. 9 (Tex. App.–Amarillo 1993, writ denied) (“This jury charge is an accurate statement of the law. See Horlock v. Horlock, 533 S.W.2d 52, 55 (Tex. App.–Houston [14th Dist.] 1975, writ dism’d).”). Such fraud involves dishonesty of purpose or intent to deceive. Id. However, fraud against the community is not a typical common law fraud tort, and is not a separate action against a spouse. Belz v. Belz, 667 S.W.2d 240, 246 (Tex. App.–Dallas 1984, writ ref’d n.r.e.). The traditional elements of common law fraud need not all be shown to establish a fraud against the community. DeVine, 869 S.W.2d at 421 n. 9. Regarding the remedies available when fraud on the community can be proven, some courts and commentators cite Belz v. Belz for the principle that a successful claim of fraud on the community entitles the defrauded spouse to recover the wrongfully conveyed community property. While the Belz opinion does state that the doctrine “is a means to an end...to recover specific property wrongfully conveyed,” Belz, 667 S.W.2d at 246, the two cases it cites in support of this principle might not support such a broad articulation.12 Thus, it is questionable whether community property transferred to a separate property trust in derogation of the other spouse’s rights is itself specifically recoverable. The more common remedy for fraud on the community is the consideration of the fraud by the court in its division of the estate of the parties, establishing it as a fact which can justify an unequal division of the property. Schlueter v. Schlueter, 975 S.W.2d 584, 588 (Tex. 1998) (citing Belz, 667 S.W.2d at 247).
2.
Alter Ego
In the context of entities, an alter ego claim is founded on the principle that, if there is such unity between the entity and the spouse that the separateness of the two has ceased, and the spouse’s improper use of the entity has damaged the community estate, the distinct identity of the entity may be disregarded. See Castleberry v. Branscum, 721 S.W.2d 270 (Tex. 1986); Lifshutz v. Lifshutz, 61 S.W.3d 511 (Tex. App.–San Antonio 2001, pet. denied); see also Texas Pattern Jury Charges–Family PJC 205.1 (2008). Alter ego, by its own terms, is a claim founded upon the unity between a spouse and an entity under their control. Once again, a trust is not an entity, but a relationship. Tex. Prop. Code § 111.004(4); see also Ray Malooly Trust v. Juhl, 186 S.W.3d 568, 570 (Tex. 2006) (The Trust Code “explicitly defines a trust as a relationship rather than a legal entity.”). While there may be some similarities between the amount of control that a spouse may exercise over an entity like a closelyheld corporation on the one hand and a trust on the other, one of the bedrock principles upon which the entire edifice of Trust Law is built is the notion of a trust as a relationship between several different parties.
12
The first case cited by Belz, Mangum v. Mangum, 184 S.W .2d 338 (Tex. Civ. App.–San Antonio 1944, no writ), did not present a recovery of specific property fraudulently conveyed. In this case, the court ordered that the fraudulently conveyed real property be sold and that the proceeds would be distributed equally between the spouses. Id. at 339. The second case cited by Belz, Brown v. Brown, 152 S.W .2d 790 (Tex. Civ. App.–Galveston 1941, writ ref'd w.o.m.), also did present a recovery of specific property fraudulently conveyed. In this case, the court also ordered that a receiver sell the fraudulently conveyed real property and distribute a portion of the proceeds to the defrauded spouse. Id. at 795. In neither of these cases did the aggrieved spouse recover specific property that was wrongly conveyed. Instead -19-
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No reported appellate case has specifically endorsed the application of the alter ego theory to trusts. However, multiple cases have mentioned alter ego arguments made against trusts. See e.g. Lemke, 929 S.W.2d at 664; Burns, 573 S.W.2d at 557. The trial court in a divorce case is necessarily vested with broad powers and discretion in making a division of the community property and in adjusting the equities between the parties. Elliott v. Elliott, 422 S.W.2d 757, 758 (Tex. Civ. App.–Fort Worth 1967, writ dism’d w.o.j.). The concept of a “sham” entity is an adjunct to the “alter ego” theory, and the same arguments for and against application of the later theory apply to the former as well.
The next development came as landowners wished to convey property to one for the use of another, but also wanted greater assurance that the obligations under this arrangement would be upheld by a means more binding than simply an “honourable understanding.” However, because the common law courts did not recognize the use as an enforceable instrument for conveyances, landowners placed their trust in the Church and the ecclesiastical courts. As Maitland observed, property was “given to the convent ‘to the use’ of the library or ‘to the use’ of the infirmary, and we can hardly doubt that a bishop would hold himself bound to provide that these dedications...shall be maintained.” 17 The use of this instrument took its final step towards full recognition because of the unique aspects of charitable support of Franciscan friars. 18 As a part of their faith, these mendicants abided by a strict “evangelical counsel” or vow of poverty which prohibited them from personally owning any property whatsoever. Thirteenth century English landowners wishing to provide for the friars would use the use to transfer property to a party unaffiliated with the Brotherhood–sometimes even to the community as a whole–who would have legal title and hold the property for the use of the friars. The landowner, as “feoffer,” would transfer the property or “res” to the unaffiliated party, who would hold the property as a “feoffee” for the benefit of the Brotherhood, or “cestui que use.” 19
IX. BRIEF HISTORY OF TRUST LAW, THEORY AND DOCTRINE A.
Origins of the Trust
The revered legal scholar and commentator Frederic Maitland traced the origin of the modern trust in English law to the “use,” 13 a special form of property conveyance. 14 Maitland found evidence of the first conveyances of property to one for the benefit of another in England shortly after the Norman Conquest in 1066 A.D., where, for example, a man “is going on a crusade, and wishes that his land shall be held to the use of his children, or he wishes that his wife or his sister shall enjoy the land, but doubts...whether a woman can hold a military fee.” 15 Absent all legal recognition, this primitive form of use was only enforceable insofar as there was “an honourable understanding that the trust is to be observed.” 16
17
In another paper, M aitland provides a different account of the genesis of trusts, this one founded in landowners’ attempts to circumvent the heavy restrictions and taxes on property transfers imposed by feudal lords. Maitland, Trust and Corporation, in The Collected Papers of Frederic William Maitland vol. 3, 335-36 (H.A.L. Fisher ed., Cambridge University Press 1911). This explanation, seemingly as plausible as the others described herein, has not, for whatever reason, been favored by legal scholars.
Throughout this section, the terms “use” and “trust” are used synonymously and interchangeably, even though there may be slight technical differences between the two devices. A trust, in its original sense, is a use upon a use. The term “use” is derived from the Old French os and oes, which are in turn derived from the Latin opus, meaning “need, business, employment, work.” This origin is separate from the etymology of the more frequent meaning of the English word, “to employ for a purpose, or the act or manner of being employed,” which comes from the Latin usus meaning the same thing.
19
“Feoffer” (also “feoffor”) means settlor, the person who transfers the res to one person (feoffee) for the benefit of another (cestui que use). It is derived from the same root as feoffee. “Feoffee (to uses)” means trustee, the person holding legal title, but not equitable title, to the res. Derived from the Anglo French feoff meaning an owner of property subject to feudal obligations, otherwise known as a fief or fee, terms which have their origins in ancient words for “flock, cattle, money.” “Res” means trust property, corpus, the property held in trust. Derived from the Latin res meaning “thing.” “Cestui que use (trust)” mean beneficiary, the person for whose benefit the use is created, who holds equitable title, but not legal title, to the res. Derived from the Angle French
14
Frederic W illiam Maitland, The Origin of Uses 1, in The Collected Papers of Frederic William Maitland vol. 2, 403 (H.A.L. Fisher ed., Cambridge University Press 1911). Id. at 407.
16
Id.
Id.
18
13
15
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Maitland concludes that “the first persons who in England employed ‘the use’ on a large scale were...the friars of St. Francis.” 20 B.
C.
As the developing system of actions and writs in the common law courts was ill-equipped to handle this novel form of conveyance, enforcement of uses fell to the other branch of the English courts: Chancery. In this division of the bipartite scheme of jurisprudence, the Lord Chancellor presided over the court of the King’s conscience, with jurisdiction over cases arising out of “equity” or “fairness” when justice could not be served by the established common law. Because the courts of common law lacked a formal legal basis on which to enforce uses, the more flexible Court of Chancery became the forum for their enforcement. From this allocation of uses into the realm of equity comes the severance, still present in American trust law today, between the legal ownership interest in the trust property held by the trustee on the one hand, and the equitable ownership interest held by the beneficiary on the other. Maitland acknowledged another aspect of this developmental era of trust law that would also have farreaching ramifications: the nascency of the law of contracts.21 Maitland recognized that, at this early stage in the evolution of trusts, they closely resembled contracts entered into for the sake of a third party. Maitland contended that contract law might have subsumed the use under its own ambit had that field of law been more developed. However, at that time, contract law was also in its infancy, and it would have only been able to recognize personal rights in the feoffor, rather than the cestui que use, against the feoffee. Furthermore, it was only courts of equity which recognized the remedy of specific performance, an essential feature of the cestui’s intended rights under the use. These two differences forced trusts to develop in a different direction from contracts, and the impacts of the early divergence of these two bodies of law has played an important role in shaping the modern doctrinal dichotomies of trust law.
[T]here were two Inventors of Uses, Fear and Fraud; Fear in Times of Troubles and civil Wars to save their Inheritances from being forfeited; and Fraud to defeat due Debts, lawful Actions, Wards, Escheats, Mortmains etc. Chudleigh's Case, 1 Co. Rep. 1136, 76 Eng. Rep. 261 (K. B. 1594).24 A significant portion of the King’s revenue was derived from feudal incidents attached to the traditional concept of seisin, and the severance of ownership and possession–that is, legal and beneficial title–to one piece of real property effectively nullified seisin.25 The use also allowed users to bypass the Statute of Mortmain, which forbade conveyances of real property to religious houses.26 By means of the use, the
21
Id. at 409.
22
27 Hen. VIII c. 10.
23
See n. __ above.
24
An interesting historical coincidence is that Chudleigh’s Case was not only the first common law case dealing with uses, but was also the first major case argued by Sir Frances Bacon. 25
See E.W . Ives, The Genesis of the Statute of Uses, in The English Historical Review, Vol. 82, No. 325, 673, 674 (Oct. 1967). “Seisin” means legal ownership of a real property freehold. A use insulated the cestui que use from paying feudal lords the costs associated with property ownership. The term is derived from the Old French saisine, meaning “the act of taking possession of property.” The modern English word “seize” is derived from the same root.
phrase cestui a que use le feoffment fuit fait, literally “the person for whose use the feoffment was made.” The term feoffment, derived from the same source as feoffee, means “a transfer of property subject to feudal obligations.” Maitland, The Origin of Uses at 408.
The Statute of Uses
The next milestone in the history of trust law came with the enactment of the Statute of Uses 22 in 1535 during the reign of Henry VIII. As described by Maitland, one of the key features of early trusts, and, in fact, one of the primary reasons for their creation, was the evasion of payments owed to feudal lords upon the transfer of real property. 23 Lord Coke explained in the first case that applied the Statute of Uses,
Courts of Equity
20
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26
7 Edward I. The Statute was also referred to as “Statutum de viris religiosis,” namely the Statute of Religious Men. “Mortmain” means literally “dead hand,” a reference to the practice that was prevented by the statute, whereby a landowner would convey realty to the Church and remain a tenant on the land. Because the Church was an entity that existed indefinitely, it never “died,” and therefore the land it owned would never escheat to the feudal lord and would never -21-
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passive or dry trusts, discussed supra.29
feoffee would own the legal title to the land for the use of the Church, and thus would successfully circumvent the Statute of Mortmain. The Statute of Uses was thus a direct response to such efforts to avoid fees associated with property ownership in a feudalist society. In its essence, the Statute of Uses “executed” on a use, transferring seisin in the property from the trustee to the beneficiary so that the beneficiary became seized with full title to the property. Because both legal and equitable title had been merged and were held by one person, the Statute had the immediate effect of bringing all cases involving uses under the jurisdiction of the common law courts. For a time, uses appeared to have been vitiated by the Statute, but the courts unwittingly resurrected them. A note in Sir Robert Brooke’s La Graunde Abridgement,27 one of the first reports on the law and compiled in 1576, indicates that a use in which the trustee had active duties to perform–such as managing the trust property and paying the profits to the beneficiary–was not actually a use at all, and would not be executed by the Statute of Uses.28 Such “active trusts” afforded a new haven for settlors wishing to convey property in trust and thus proliferated. But vestiges of the Statute of Uses survive today in the doctrine of
D.
The (First) Restatement of Trusts
The law of trusts followed the English Colonists to America and took root in American courts of equity. It developed haphazardly in both countries, with changes in the law of one sometimes having a great impact on the law of the other.30 Finally, in 1935, the American Law Institute published the Restatement of the Law of Trusts, reported on and written by Austin Wakeman Scott.31 Large portions of the Restatement were adopted in the Texas Trust Code and remain a part of trust law in Texas today. Scott examined the convoluted network of doctrinal veins running through the various strata of American law, and incorporated the underlying principles he discovered into the Restatement. Thus, the Restatement was more than merely a survey of the different laws of the several jurisdictions, but was instead a synthesis of
29
This theory about how the use survived the Statute of Uses and came out the other side as a trust stands in opposition to the once popular conception that the “use upon a use” was the instrument that defeated the Statute. However, Durfee rejects this explanation, pointing out that the use upon a use was recognized as invalid by both Law and Equity prior to the Statute, and for a century thereafter. Durfee, at 88; see also Percy Bordwell, The Repeal of the Statute of Uses, 39 Harv. L. Rev. 466, 472-73; see also Tex. Prop. Code § 112.032
be taxed upon transfer. From the feudal lord’s perspective, the hand of the original landowner still controlled the property long after his death, hence, “dead hand.” The converse account, advanced by Alexander and others, attributes the term to the donee, the undying Church that retained control over the land. Gregory Alexander, The Dead Hand and the Law of Trusts in the Nineteenth Century, 37 Stan. L. Rev. 1189, 1190 n. 3 (1985). Thus, there is no consensus among either the historians or the scholars about whether the term mortmain should be rendered as “dead hand” or “undying hand.”
30
One example was the rule announced in the English case of Brandon v. Robinson, 34 Eng. Rep. 379 (1811), forbidding a settlor from creating what amounted to a spendthrift trust that restrained the beneficiary’s ability to assign or transfer unreceived distributions of either principle or profits. This rule was followed in most American jurisdictions and persisted for seventy years until it was widely abandoned by American courts at the end of the nineteenth century. Alexander, 37 Stan. L. Rev. at 1199, 1202. In other situations, the law of one country had neither a direct nor an immediate impact on the other. For example, while the spendthrift trust was widely recognized in America as late as 1895, its English analog–the protective trust–was not firmly established until the Trustee Act of 1925, 15 & 16 Geo. 5. c. 19.
27
Robert Brooke, La Graunde Abridgement, 2 vols (n.p. 1576), Feoff, al Uses, 52. 28
See Edgar N. Durfee, The Statute of Uses and Active Trusts, 17 Mich. L. Rev. 87 (1918) for a thorough explanation of the theoretical underpinnings of this doctrine. In essence, Durfee hypothesizes that a passive trust in which the trustee merely held legal title for a beneficiary who actually had possession of the property was the most common and indispensable type of trust, and comprised the most important component of ownership, namely possession. The active trust, on the other hand, was much less common, lacked the element of beneficiary possession, and contemplated only a right to an accounting for the beneficiary. Therefore, the active trust was considered separate and distinct from the type of trust the Statute of Uses was designed to execute upon, and was thus insulated from it.
31
Austin W akeman Scott (1884-1981) graduated from Rutgers University in 1903 and took classes at the Rutgers School of Banking before attending Harvard Law School, from which he graduated in 1909. That same year, Scott took over Dean James Barr Ames’ class on Pleading & Equity at Harvard Law and became a full profession in 1914. He taught at Harvard for 51 years, the longest tenure of any professor there before or since. In addition to being reporter for the Restatement of the Law of Trusts, Scott was also co-reporter for the Restatements covering Restitution and Judgments. -22-
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those laws into a unified canon of comprehensive definitions, general rules and specific exceptions. One of the best illustrations of this synthesis is Scott's definition of the trust itself. The prevailing articulation of the essential nature of these instruments prior to the Restatement was made by Lord Coke in 1606:
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Scott's theory of the proprietary basis that found its way into his Restatement of the Law of Trusts. As Scott wrote, “[t]he creation of a trust is conceived of as a conveyance of the beneficial interest in the trust property rather than as a contract.” 34 This debate has been revived in recent years, and is still being discussed today. E.
An use is a trust or confidence reposed in some other which is not issuing out of the land but a thing collateral annexed in privity to the estate of the land and to the person touching the land....32
The Contract-Property Dichotomy
It would be a monumental task, far beyond the scope of this article, to catalogue the different arguments and responses for interpreting trusts under contract law or property law. Instead, the focus of this paper is on the ramifications that these theories have on the treatment of trusts by marital property law, and what novel approaches to family law rules regarding trusts may be proposed. As such, only a cursory treatment of the contract-property dichotomy is necessary here.
Scott examined the cases interpreting this definition, which had been in service for over three hundred years, and derived the following restatement of the nature of a trust: A trust...is a fiduciary relationship with respect to property, subjecting the person by whom the property is held to equitable duties to deal with the property for the benefit of another person, which arises as a result of a manifestation of an intent to create it.33
1.
Scott raised four separate arguments for the proprietary nature of trusts in The Nature of the Rights of the “Cestui Que Trust.” 35 First, he observed that it was disputed whether the beneficiary of a third party contract had the right to enforce the obligation against the promisee, whereas the beneficiary of a trust axiomatically could enforce the her rights under the trust. 36 Second, Scott points out that an action at law for breach of contract will not lie against one who holds subject to trust.37 Third and finally, he argues, in essence, that a settlor of a trust may also serve as trustee, but a promisor may not also be a promisee.38 In response to Maitland’s arguments about the contractarian nature of trusts, Scott explained that the “internal” elements of trusts–such as duration, transmission, and alienation are proprietary. 39 Scott also addressed four other contractarian arguments. He rejected the contractarian claim that the beneficiary
Scott's definition highlights many of the important components of trust law that existed in the case law at the time and recur throughout the Restatement, among them fiduciary relationship, equitable duties, and intent. This definition also reflects which elements of the theory of trusts Scott personally chose to emphasize, and which he chose to underplay. Another element of trust law that Scott chose to emphasize was a particular nature of the beneficiary’s rights. In the years leading up the Restatement, a debate had been seething in academia over whether a beneficiary has merely an in personam–that is, contractual, against a person–right against the trustee, or an in rem–that is, proprietary, against the property–right in the res itself. In essence, this debate centered around whether trust law should be viewed as more akin to contract law or property law: the “contract-property dichotomy.” Scott advocated the proprietary basis for trust law, while several other scholars, including Lord Coke, Maitland, Ames and Langdell, supported the contractarian basis. Not surprisingly, it was, in the end,
34
Id. at § 197 cmt b.
35
17 Colum. L. Rev. 269 (1917)
36
Id. at 270. This argument has subsequently been rendered obsolete, however, by Restatement (Second) of Contracts § 302(1); 311 (1981).
32
Sir Edward Coke, Releases, Part 20, Selected Writings of Sir Edward Coke vol. 2, § 464 nota (Steve Sheppard ed., Indianapolis: Liberty Fund 2003) (citing, among others, Chudleigh’s Case). 33
Scott’s Arguments for Proprietary Nature of Trusts
Restatement of Trusts § 2 (1935). -23-
37
Id.
38
Id.
39
Id. at 271.
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cannot have a property interest in the res because the trustee has a clear and definite property interest, and there can be no conflicting ownership interests over the same property. Scott responded that Law, on the one hand, recognizes the interest of the trustee, but Equity, on the other, recognizes the interest of the beneficiary.40 Scott also criticized the doctrine that judgments in Equity always acts upon the person, while judgment in Law tend to acknowledge a particular right. Scott observed that this delineation between remedies in the two different realms of the court did not strictly persist. 41 The third contractarian argument relied on the principle that duties which correlate to in rem rights are always negative, while the duties which correlate with the beneficiary’s rights are not merely negative, but also positive. Scott answered that any positive duties that are owed to the beneficiary are in the nature of in personam rights, but the some of the negative duties owed are in rem rights. 42 Thus, Scott recognized that the rights held by the trustee were of a dual nature. The final contractarian argument that Scott addressed is the rule that a bona fide purchaser for value without notice of the trust takes the property free and clear of the trust; if the beneficiary’s right were in rem, it would follow the property to its new owner and be enforceable against him. Scott responded that a bona fide purchaser rule, if adopted in general property law, would not transform the in rem rights of property owners into merely in personam ones. 43 Furthermore, Scott acknowledges that bona fide purchaser rules cut a wide swath across all branches of law, and therefore cannot be said to be either in rem or in personam in nature.44 2.
Langbein’s Argum ents Contractarian Nature of Trusts
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secondary characteristics of trust law and contract law. Observations of this type include the fact that both trust law and contracts law are made up of default rules;46 contract law has increasingly adopted equitable remedies such as specific performance; 47 contracts of long duration with more discretionary future obligations have become more frequent;48 and trust law relies heavily upon the law of fiduciary obligations, which is itself heavily contractual.49 Langbein also relied on two of the fundamental characteristics of trust law and contract law which appeared to be either similar or identical. The relationship between the settlor and the trustee on the one hand, and the promisor and promisee on the other, are both consensual relationships. 50 This consent extends, in both fields of law, to the formation of the relationship and the terms of the instrument.51 Because these essential components are the same, the resulting fields of law will be fundamentally similar. 3.
The Non-Contractarian Response
Henry Hansmann and Ugo Mattei took a different approach to understanding the contract-property dichotomy in The Function of Trust Law: A Comparative Legal and Economic Analysis.52 Acknowledging many of the points of similarity that Langbein described, Hansmann and Mattei applied the default law of trusts to the default law of contracts to determine whether trusts could survive in substantially the same form in the absence of Trust Law. They found that the common law of contracts provided a efficacious and efficient law for creating obligations that behaved like trusts in all respects except for the interaction between the three principal parties of the relationship and their creditors:
for
In sum, it appears that the important contribution of trust law lies not in its ordering, via default rules of contract, of the relationships among the three principal parties
Nearly 80 years later, John H. Langbein, a law professor at Yale University, advanced the opposing interpretation of trust law and examined Scott’s proprietary arguments in his influential article The Contractarian Basis of the Law of Trusts. 45 Essentially, Langbein’s argument relied on the similarity of many 46
Id. at 650.
40
Id. at 276.
47
Id. at 653.
41
Id. at 277.
48
Id. at 654.
42
Id.
49
Id. at 657-60.
43
Id. at 278-79.
50
Id. at 650.
44
Id. at 279-80.
51
Id. at 629.
45
105 Yale L.J. 625 (1995).
52
73 N.Y.U. L. Rev. 434 (1998).
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trust doctrine does not recognize the contractarian interpretation of the settlor retaining no rights in the trust property. Instead, the illusory trust doctrine relies on a distinctively proprietary interpretation of trust law. Thus, an advocate may use contractarian arguments, like those of Langbein and others, to attack the illusory trust doctrine and assert that it relies on a faulty interpretation of the nature of a trust.
to a trust-like relationship–the Transferor, the Manager, and the Recipient–but rather in its ordering of the relationships between those persons and third parties with whom they deal. It is the latter relationships that, owing to high transaction costs, cannot be rearranged easily by contractual means.53 In other words, trusts are not contractarian insofar as they impact the rights of the settlor, trustee, and beneficiary with regards to creditors. Hansmann and Matei’s important finding was that under the common law of trusts, trust property is not available to satisfy the personal debts of the trustee, while under the common law of contracts, the trustee’s legal title in the corpus of the trust would subject it to levy by his creditors absent language in each and every contract entered into by the trustee that trust property may not be used to satisfy his debts. 54 Based on this finding, the authors concluded that the essential rule of the trust is to perform a proprietary, rather than a contractarian, function.55 4.
Applicability to Texas Marital Property Law
The rules discussed under Parts VII and VIII above pertaining to the character and validity of trust assets can be supported or denounced doctrinally by arguing either the contractarian or proprietary nature of trusts. First, the particular rule in question must be analyzed to determine whether, in its essence, it views trusts doctrinally as either contractarian or proprietary, and whether it recognizes the in personam or the in rem rights of the beneficiary. Then, the corresponding arguments for or against that doctrine may be used to support or denounce that rule. Take, for example, the illusory trust doctrine. Hansmann and Matei concluded that, when a trust is interpreted as protecting the trust corpus from the settlor’s creditors, it is performing a contractarian function.56 However, under the illusory trust doctrine, the aggrieved spouse, acting as creditor with regards to her community property non-consensually used to fund the trust, is permitted to invade trust corpus to satisfy her claim against the spouse-settlor. Therefore, the illusory
53
Id. at 465.
54
Id. at 455-57.
55
Id. at 434.
56
Id. at 454.
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