Olivieri: Indiana directed trusts create vital role for trust director

By John Olivieri

The Indiana Directed Trust Act was enacted effective July 1, 2019, and codified in Chapter 9 of the Indiana Trust Code. The act allows for the creation of a new type of trust, typically known as a “directed trust.”

Prior to 2019, Hoosiers interested in creating a directed trust had to leave the state to do so. Now they do not, and Indiana banks and trust companies have a new product to offer customers and will be able to attract business from other states that still do not allow for directed trusts.

In essence, any trust is a vehicle for separating the “legal” ownership of property from the “beneficial” ownership. Legal ownership resides with the trustee, which means the trustee has the legal title to, and control of, the trust assets. Beneficial ownership resides with the beneficiaries, which entitles them to receive distributions of the trust assets in accordance with the parameters set forth in the trust instrument.

A directed trust differs from a traditional trust in that it requires a trustee to follow the directions of another party known as a “trust director” in the exercise of certain powers. The act defines a “trust director” as “a person that is granted a power of direction by the terms of a trust,” and defines a “power of direction” as “a power over a trust granted to a person by the terms of a trust … The term includes a power over the investment, management, or distribution of trust property.”

Accordingly, with a directed trust, the trustee still holds legal title to the trust assets, but the powers that the trustee would otherwise have over the investment and/or distribution of the trust assets are held by a trust director. A trust director can be given the power to direct investments only (leaving the trustee in charge of distributions). Alternatively, a trust director can be given the power to direct distributions only (leaving the trustee in charge of trust investments). Finally, a trust director can be given the power to direct investments and distributions (leaving the trustee only with custody of the trust assets and certain obligations of administration, such as preparing tax returns and reports of the trust’s assets and transactions).

A trust can have more than one trust director. For example, a trust can appoint one person to direct investments and another to direct distributions to the beneficiaries. The act would permit the creator of the trust (usually referred to as the “settlor” or the “grantor”) or a beneficiary of the trust to be appointed as a trust director; however, there are tax consequences to consider if either the grantor or a beneficiary has the power to direct distributions.

Dividing the responsibilities

Directed trusts are useful for those grantors who, for one reason or another, wish to divide the responsibilities typically assigned to a trustee among two or more different parties. Suppose, for example, that a grantor wishes to create a trust for his grandchildren and put his son (the grandchildren’s father) in charge of deciding how much they can receive from the trust and when, but doesn’t want to burden his son with the responsibilities of investing the trust’s assets and preparing and filing tax returns. In this situation, a directed trust with a trustee who is required to follow the directions of the grantor’s son regarding distributions would be ideal.

Suppose another grantor wishes to create a trust for her children and to put her sister in charge of the trust’s investments, but does not want to put her children in the position of having to ask their aunt for money. In this case, a directed trust with a trustee who is responsible for distributions but required to follow the sister’s directions regarding investments would achieve the grantor’s objectives. The act not only allows the responsibilities of a trustee to be divided among two or more parties, it also ensures each party is liable only for those decisions that are in his or her control.

Fiduciary duty remains

A trust director has the same fiduciary duty and liability in the exercise or non-exercise of his or her powers as a trustee would have. In other words, a trust director responsible for investments would have the same duty to the beneficiary, and the same potential liability for investment loss, as a trustee would have if the trustee were responsible for investments. However, if the trust director is the beneficiary, then the beneficiary would essentially be liable to himself or herself.

A trustee is required to take “reasonable action” to comply with a direction from a trust director and “is not liable for the action.” Consequently, a trustee who was directed to “buy Enron stock and hold it” would have no liability for doing so. However, a trustee must not comply with a direction to the extent that by complying, the trustee would engage in “willful misconduct.” “Willful misconduct” is defined as “intentional wrongdoing, and not mere negligence, gross negligence, or recklessness.”

Sharing of information

Trustees and trust directors have no duty to monitor each other’s activities or to inform the grantor, any beneficiary or any other trustee or trust director of the fact that he or she would have exercised the authority differently. Trustees and trust directors do, however, have both an affirmative and a responsive obligation to provide each other with all information that is reasonably related to the exercise of their respective powers and duties. These information-sharing requirements were intended to avoid a problem that could occur where the party responsible for distributions has no power to generate cash to distribute. Under the act’s information-sharing requirements, the party responsible for investments is required to disclose the effect that its investment program will have on the trust’s cash position, and the party responsible for distributions is required to disclose the cash requirements of its distribution plans.

These requirements, while helpful, are arguably of limited utility. As noted, the act requires the party responsible for distributions to inform the party responsible for investments of the cash required for planned distributions. The act does not empower the party responsible for distributions to require the party responsible for investments to raise the cash needed. A certain amount of cooperation is presumed by the act. But a trust instrument could ensure such cooperation by (i) requiring the party responsible for investments to raise the cash needed for distributions as soon as shall be practicable after being informed of the intent to make them, and/or (ii) prohibiting the party responsible for trust investments from investing more than a certain percentage of the trust assets in assets that cannot be quickly liquidated.

Indiana residents now can take advantage of directed trusts, which are useful because they allow the traditional responsibilities of a trustee to be divided among two or more parties in almost any way that a grantor desires.•

• John Olivieri is a partner at Barnes & Thornburg LLP and chairs the firm’s private client services group. Opinions expressed are those of the author.