Irrevocable trust

Irrevocable Trust Might Still be Terminated by Beneficiary

Might an irrevocable trust become revocable? That was the question faced by a South Dakota probate judge and, more recently, the state’s Supreme Court. It turns out that the trust’s beneficiary may be able to insist on termination of an irrevocable trust.

A South Dakota story

Mary Novotny, a widow living near the Nebraska border, has six children. Because she became incapacitated, three of the children sought court appointment as guardian of her person and conservator of her estate. They began to manage her affairs in 2012.

The children hired a local accountant to help prepare tax returns, court reports and the like. The accountant pointed out that her estate was somewhat in excess of $2 million. He expressed concern that an estate tax could be due upon Ms. Novotny’s death.

Was the accountant’s concern well-founded? Perhaps not. The federal estate tax limit in 2012 was already over $5 million, and South Dakota had no state estate tax. Still, Ms. Novotny’s estate was considerable, and it was unlikely that she would need all of her assets to pay for her care.

Reducing the estate size

How to reduce Ms. Novotny’s estate, to ensure that there would be no estate tax liability? Easy, suggested the accountant. Simply make substantial gifts of her assets to the six children right away. Her will left everything to her children and grandchildren, so the gifts would be consistent with her estate plan. The children agreed that this approach made sense.

Under the guidance of the accountant, Ms. Novotny’s children transferred a total of $1,270,388.30 to themselves. The distribution was in equal shares. A few months later, they approached the probate court for approval of the distributions they had already made.

There was just one problem to be resolved. When they appeared before the probate judge in early 2013, they had to explain that they had lost track of one of Ms. Novotny’s children. No one knew how to get hold of Catherine. They proposed to distribute her share of the gift — $196,564.80 — into an irrevocable trust for Catherine’s benefit.

The irrevocable trust

The children’s lawyer explained to the probate judge that they had even hired a private investigator to try to locate Catherine. He proposed that the irrevocable trust be approved, naming the same three siblings as co-trustees. Just to make sure that Catherine’s interests were protected, the siblings also proposed that the court appoint someone as guardian ad litem to advocate for her. They suggested, and the court agreed, that the estate’s accountant should serve in that role.

A year later, Catherine learned that there was a trust for her benefit. She asked the court to dissolve the trust and direct distribution of its assets to her. She also alleged that her siblings had breached their fiduciary duties to her. The judge dismissed her complaint, and directed payment of her sibling’s attorneys fees and costs from her trust.

The first appeal

Catherine appealed, and the South Dakota Supreme Court reversed the fee award. That left the trust right where it had been before she was located. She filed another petition to terminate the trust, and the trustees once again objected.

This time, Catherine focused on the apparent ambiguity in the trust’s language. Had it been established for the purpose of holding her inheritance just until she could be found, or was it intended to act as a spendthrift trust for her for the foreseeable future? And how could the court interpret the intent of a woman who had been determined to be incapacitated? Was it important to consider the intent of the siblings who actually signed the trust on behalf of their mother?

Perhaps unsurprisingly, the judge again ruled that nothing in the trust document allowed her to insist on its termination. The trustees explained that they weren’t ready to address the question of who should pay for the attorneys, and so that question was put off until another day.

The second appeal

Catherine appealed again. This time, as she had done in the lower court, she argued that the trust was ambiguous. Because of that ambiguity, she reasoned, the court should consider the circumstances around its creation to determine the purpose. The appellate court agreed.

Because Ms. Novotny was not actually involved in the creation of the trust, reasoned the Supreme Court, there was no way to determine what her intentions might have been. The intentions of three of her children were not her intentions. Therefore, there was built-in ambiguity.

Considering the circumstances — and the court testimony at the time of its creation — the appellate judges could identify the trust was purpose. It was established to hold Catherine’s gift just until she could be found. That meant that the trust’s purpose had been fulfilled: Catherine had been found. The Supreme Court directed that the probate judge terminate the trust and direct distribution of its property to Catherine. Guardianship and Conservatorship of Novotny, November 15, 2017.

What is an irrevocable trust?

Assuming that the Novotny result would be the same under Arizona law (and it probably would), does that mean that any irrevocable trust can be revoked? Not exactly.

Normally, no person (or organization) has the power to revoke an irrevocable trust. That’s what the name means. That doesn’t mean no one can end the trust. Catherine didn’t have the power to revoke her trust. She could, though, insist on termination once the court agreed that its purpose had been met.

Now we can anticipate court proceedings on the more interesting question. Does Catherine’s trust have to pay the trustee’s legal fees? If not, must  Ms. Novotny’s conservatorship estate pay them? Or will they have to come from the co-trustees’ own pockets? Stay tuned.

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