Considering setting up a trust to fund your kid’s college fees or to plan your estate? These are some of the key roles, that you should familiarise yourself with, which contribute to the correct functioning of every trust.
Trustor vs trustee. Grantor vs Grantee. Settlor. Beneficiary. With so many similar-sounding roles and no obvious meaning for any, it is clear why many find the area of trusts elusive. This article will explain how each of these roles contribute to the correct functioning of a trust and will hopefully bring clarity to this elusive area.
A trust is a type of legal relationship created by an individual to ensure that assets that he/she owns can benefit someone else.
Trusts are easier to understand if we understand which parties are involved in their functioning and the roles played by those parties. Trusts typically involve three parties:
Trustor: This is the person who creates and puts assets into the trust. The asset that the ‘trustor’ puts into the trust can be anything – a large sum of money, or a dirty pair of socks.
Trustee: A trustee is a person nominated by the trustor to manage the assets that the trustor has put into the trust.
Beneficiary: The person or organisation for whom the trust is created. The beneficiary is the person who ‘benefits’ from the trust.
The 'benefit' a beneficiary receives from a trust can come in many ways. Sometimes, a trust is created such that the beneficiary can take ownership of the assets in the trust at some future date. Here, the benefit is clearly being able to take ownership of the property itself.
Other times, the beneficiary may never become an owner of the assets but may receive ‘benefit’ in the form of the trustee using the assets for the beneficiary’s ends. For example, trusts are often created by parents to pay for their children's education. In such trusts, the beneficiaries (the children) rarely get the money in their hands. Rather the benefit they receive is in the form of the trustee using the money to pay for their education.
'Grantor' and 'settlor' are just other names for the 'trustor'. All of them refer to the person who creates and puts assets into the trust.
'Grantee' is just another name for the 'beneficiary'. It refers to the person who 'benefits' from the trust.
The trustor and trustee are clearly distinguishable based on the role they play in a trust.
The trustor is the person or entity that creates the trust. This is the person that originally owns the asset, and who puts the asset into the trust making it the subject of the trust.
Meanwhile, the trustee is the person or entity, selected by the trustor, who is responsible for holding onto and managing the assets that are put into the trust. Seeing as the trustee occupies this unique position – in being required to manage one person's assets, for another person's benefit – the law imposes a duty on the trustee to put the beneficiaries' interests ahead of his own interests. This duty is called a ‘fiduciary duty’ and is very demanding.
Much confusion regarding this distinction of trustor vs trustee stems from the fact that one and the same person can be both the trustor and trustee in the same trust. This may happen as follows:
Andy, an avid art collector, wants to give one of his most expensive paintings to his son (the beneficiary). Andy’s son is only 16 years old and so Andy is afraid that if he gifts the painting to him now, he would sell it and mismanage the proceeds of the sale. So, he decides to create a trust to give his son the painting only when his son turns 21 years old and declares himself the trustee.
Here, Andy is both the trustor (as the original owner of the painting) and trustee. They are clearly the same person. Yet, if we understand the distinction between trustor and trustee in terms of the roles they play in a trust, much of this confusion is avoided.
Using the above example once again, despite Andy – the same person – being the trustee and trustor, you can clearly see he plays two distinct roles: he is not only the original owner of the asset - the painting - but is also responsible for managing it in the interim before his son turns 21.
One of the most common uses of trusts is for estate planning purposes. Many create trusts to distribute their property to their loved ones as opposed to wills. Here is a list of some of the key benefits of using a trust as opposed to a will to distribute your property to your loved ones.
Firstly, using a trust can allow you to avoid probate. Probate is the process wherein a court confirms a will’s validity. If found to be valid, any property of the deceased is then collected and distributed according to the terms of the will.
This can be a very costly process due to court and other fees. Generally, it is also a very time-consuming process meaning your kids or loved ones may have to wait years before receiving the money or property they are entitled to.
Assets in a trust do not go through probation. This means if you put your assets into a trust, you can avoid all the court and other fees otherwise incurred through probation. Furthermore, if you put your assets into a trust, upon your death, the trustee can instantaneously distribute the assets to the beneficiaries.
Probate is also a public process. Often after the assets of the deceased are collected, a record – an account – of them needs to be produced. This account is then made publicly available. In a bid to maintain secrecy as to what they own, many decide to use a trust. This is because, as trusts don't go through probate, no account is produced for its assets.
Secondly, people often create trusts to reduce estate tax.
An ‘estate’ merely describes the net assets of an individual when he dies. Estate tax is a tax imposed on the transfer of an estate if that individual’s estate exceeds a particular value.
Trusts reduce estate tax by reducing the size of an individual’s estate. This is because, as mentioned above, to create a trust, the trustor must transfer the legal title to the asset to another individual, a trustee. This property is no longer owned by the trustor and therefore does not form part of their estate upon death.
One of the most common uses of trusts is for taking security on loans. In a sale of goods context, banks often take security over goods through a trust. These arrangements often involve a borrower holding the goods purchased using a loan from the bank, on trust for the benefit of the bank (the beneficiary). This is often done through a Security Trust Deed.
DocPro offers a template for a Security Trust Deed. You can find it here: https://docpro.com/doc1317/security-trust-deed-trustee-hold-security-for-lenders
Or, it can involve a bank holding the legal title to the goods as security, of itself, for a loan. The bank can use the legal title to the goods as security by insisting that they will only transfer legal title to the borrower once the loan, used to purchase the goods, has been repaid. This is often done through a Trust Receipt.
DocPro offers a template Trust Receipt. You can find it here: https://docpro.com/doc1644/security-trust-agreement-trust-receipt
Other uses of trusts in a commercial context include:
Trusts can be created for investment purposes (e.g. employee benefit trusts; pension fund trusts etc)
Trusts over loan monies (Quitsclose Trust)
Trusts are very versatile vehicles. Unlike wills, where upon the death of an individual, the asset as a whole is passed onto a beneficiary, trusts can be engineered by trustors to release assets, after their death, to beneficiaries, if certain conditions are met. These conditions could require that the beneficiary should have reached a particular age or could require that the money should only be used for a particular purpose.
For example, a mother could create a trust for the benefit of her son (the beneficiary) of $100,000. She can stipulate in the trust agreement that the property can only be released to her son after he has turned 21 when he will have a better idea of how to invest and manage the money. Even if the mother dies, and the son has only become 18 years old, the assets will not be released by the trustee to the son until he has turned 21.
Clearly, trusts are very useful vehicles. So how do you create them? To answer this question, we will consider common law jurisdictions and civil law jurisdictions separately.
In common law jurisdictions, generally speaking, there are two steps to create a trust:
Let’s go into each of these in some more depth:
The first step to creating a trust is to make a declaration to this effect. Strictly speaking, this declaration need not be written and can be oral. However, oral trusts are rare, and most prefer to document the arrangement in some form or another.
Simply making a declaration to the effect that you are creating a trust is not enough. Your declaration should evince a few things:
Your declaration should clearly demonstrate your intention to create a trust as opposed to any other arrangement. In short, your language should clearly suggest that you are imposing a legal obligation on the trustee to fulfil your request. Avoid using words such as “I firmly expect”, “I wish” or “I desire”.
You should make it extremely clear as to what property or money is to be held on trust. It is important to try to be as specific as possible – your description should allow someone to clearly identify that asset.
You should make it extremely clear as to who the beneficiaries of your trust are. It is important to try to be as specific as possible – if you can explicitly name people, this is the best.
You may want to think about and include the following information on your declaration of trust:
Who is your trustee? You may want to ensure that the trustee you select:
Has knowledge of how to manage the trust’s assets
Will always manage the assets to benefit your beneficiaries
After creating a declaration of trust, the second stage is to ensure the trustee has legal title to the assets that are to be the subject of the trust.
If the trustor has selected himself to be the trustee, then nothing needs to be done.
If the trustor has selected someone else to be the trustee, then legal title to the assets should be transferred to the trustee. Most legal title to assets can be transferred simply by physically giving it to the intended recipient.
For some types of assets, it is necessary to follow certain specified formalities to successfully transfer legal title. For instance, in many common law jurisdictions, the transfer of legal title to land must be done by deed. Thereby, we recommend you research if any such formalities exist for the assets that are to become the subject of your trust.
Civil law jurisdictions – such as France and Germany – generally speaking, do not have a concept of trusts in their law. Without getting into too much detail, this is because civil law jurisdictions have a completely different conception of what it means to ‘own property’.
The ownership of property is conceived of as absolute – if you hold legal title to property you should be entitled to do as you please with it without any restriction. The concept of a trustee, who holds legal title to assets, but must manage these assets in the best interests of another person (the beneficiary) is incompatible and foreign.
Nonetheless, if you are in a common-law jurisdiction and are seeking to make a trust in favour of someone in a civil law jurisdiction, not all hope is lost! Despite civil law jurisdictions not having a concept of trusts, some civil law jurisdictions, recognise trusts by virtue of the Hague Trusts Convention.
So, you can guarantee that if you create a trust in favour of someone in the following civil law jurisdictions, it will not be deemed invalid.
Fourteen civil law countries have ratified this convention, including:
Generally speaking, it is possible to categorise trusts based on three dimensions:
Firstly, we can categorise a trust as an ‘inter vivos’ or ‘testamentary’ trust.
An inter vivos trust is a trust which is created to operate during the lifetime of the trustor. As it operates during the lifetime of the trustor, it is also called a ‘living trust’. An inter vivos trust is created through documentation that is distinct from the will. This type of trust can be ‘revocable’ or ‘irrevocable’.
A testamentary trust is created to operate after the death of the trustor. A trustor can create a testamentary trust by including terms to this effect in his will. This type of trust is ‘irrevocable’ - the trustor being dead, obviously has no capacity to alter the terms of the trust or revoke it completely (see below). Assets that are the subject of the trust are those assets that the settlor owns at the time of his death.
Secondly, we can categorise a trust as a ‘revocable’ or ‘irrevocable’ trust.
In a revocable trust, the trustor retains the ability to amend or change the terms of the trust whenever he/she wants. They also retain the power to end and rescind the trust arrangement, wherein the assets that are the subject of the trust will return to their ownership.
In an irrevocable trust, the trustor does not reserve such a power to amend the terms of the trust or rescind the arrangement altogether.
Finally, we can categorise trusts as ‘fixed’ or ‘discretionary’.
A ‘fixed trust’ is a trust in which the trustee has no discretion as to how to distribute the trust assets to its beneficiaries. The trustor, in creating the trust, will clearly stipulate what property has to go to which beneficiary. The trustee, in a fixed trust, must follow these instructions issued by the trustor.
A ‘discretionary trust’ however, affords some freedom for the trustee in deciding how the trust’s assets should be distributed amongst the trust’s beneficiaries. Such discretion depends on what the trustor has stipulated. It can range from giving the trustee absolute freedom, to decide how much of the assets each beneficiary should receive if any, to requiring the trustee to give each beneficiary some property, yet leaving it to the trustee to determine how much each beneficiary should receive.
There can be cross-over between these different dimensions – for instance, a trust could be created which is a testamentary, irrevocable, fixed trust.
Disclaimer: Please note that this is a general summary of the position under common law and does not constitute legal advice. As the laws of each jurisdiction may be different, you may wish to consult your lawyer.
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