The Ins and Outs of Trusts: Understanding What They Are and The Key Players Involved

Trustor vs trustee. Grantor vs Grantee. Settlor. Beneficiary. With so many similar-sounding roles, it makes sense why many find the area especially elusive and confusing. While the actual design of trusts varies from person to person, there are a few key roles that are central to the creation and functioning of a trust - the trustor, trustee, and beneficiary. Through this article, we will explain how each of these roles contributes to the correct functioning of trust to hopefully bring some clarity to this elusive area.

 

 

What is a Trust?

 

A trust is a fiduciary relationship in which an individual gives the assets/ right to hold the title he owns to a third party for their benefit. 

 

Trusts are easier to understand if we first break down the various parties involved in their functioning and the roles played by those parties. Trusts involve three parties:

 

1. 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. 

2. Trustee: A trustee is a person nominated by the trustor to manage the assets that the trustor has put into the trust.

3. Beneficiary: The person or organization 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 a future date. In this case, the benefit would be that of taking 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 vs Grantee. Settlor. 

 

 'Grantor' and 'settlor' are just alternative names for 'trustor'. All of them refer to the person who creates and puts assets into the trust. 

 

 'Grantee' is another name for 'beneficiary'. It refers to the person who benefits from the trust. 

 

Trustor vs Trustee: In More Depth

 

Trustors and trustees are distinguishable based on the role they play in a trust.

 

The trustor is the person or entity that creates the trust. Trustors are the individuals that originally own the asset, put the asset into the trust, and make it the subject of the trust.

 

On the other hand, the trustee is the person or entity selected by the trustor, responsible for holding onto and managing the assets that are put into the trust. Seeing as the trustee occupies the unique position of managing one’s assets for another’s benefit – the law effectively is imposing a duty on the trustee to put the beneficiaries' interests ahead of his own. This duty is what we call a ‘fiduciary duty - and is very demanding.

 

The confusion surrounding the distinction between trustor and trustee stems from the fact that one of the same people can be both the trustor and trustee in the same trust. Here is a way in which this might happen: 

 

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, so Andy is afraid that if he gifts the painting to him now, he would sell it and mismanage the proceeds of the sale. He, therefore, 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 (original owner of the painting) and trustee. 

 

Using the above example once again, despite Andy (the same person) being the trustee and trustor, you can see he plays two distinct roles: not only is he the original owner of the painting but is also responsible for managing it in the interim before his son turns 21.

 

 

 

Why Create a Trust?

 

1. Estate Planning

 

One of the most common uses of trusts is for estate planning. Many create trusts to distribute their property to loved ones, rather than writing a will. Here are some key benefits of using a trust instead of a will to distribute your property to your loved ones.

 

(a) Avoid Probate

Firstly, using a Trust enables you to avoid probate. Probate is the process where a court confirms a will’s validity. If it is valid, the property of the deceased is collected and distributed according to the terms of the will. 

 

This can be a very costly process due to court fees. 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 immediately distribute the assets to the beneficiaries.

 

Probate is also a public process. After the assets of the deceased are collected, a record of them will 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 down to the fact that trusts don't go through probate, meaning that no account is produced for its assets.

 

(b) Reduce Estate Tax

Secondly, people often create trusts to reduce estate tax. 

 

An ‘estate’ merely describes the net assets of an individual when he dies. The 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.

 

2. Commercial uses of trusts

 

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 done through a Security Trust Deed.

 

We have created a customizable template for a Security Trust Deed. You can find it here. 

 

Alternatively, it can involve a bank holding the legal title to the goods as security, 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 done through what is called a Trust Receipt.

 

We also have created a customizable template Trust Receipt. You can find it here. 

 

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)

 

3. To protect beneficiaries from misusing or wasting assets

 

Trusts are versatile vehicles. Unlike wills, whereupon the death of an individual the asset is passed onto a beneficiary, trustors can choose to release assets after their death to beneficiaries upon meeting certain conditions. These conditions could, for example, require the beneficiary to reach a certain age or 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. 

 

 

So, how do I create Trust?

 

It should be clear by now that trusts are very useful legal vehicles and bring many benefits. But how do you create one? We will be considered common law jurisdictions and civil law jurisdictions separately as advice varies between jurisdictions. 

 

1. Common-Law Jurisdictions:

 

In common law jurisdictions, there are two steps in creating a trust:

 

(a) Declaration of Trust

(b) Constitution

 

Let’s go into each of these in some more depth:

 

(a) Declaration of trust

The first step in creating a Trust is to make a declaration to this effect. Strictly speaking, this declaration need not be written. 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 Trust is not enough. Your declaration should evince a few things:

 

(i) Certainty of intention

 

Your declaration should demonstrate your intention to create Trust as opposed to any other arrangement. Your language should suggest that you are imposing a legal obligation on the trustee to fulfill your request. Avoid using words such as “I firmly expect”, “I wish”, or “I desire”.

 

(ii) Certainty of subject

 

You should make it extremely clear what property or money is to be held in trust. It is important to try to be as specific as possible – your description should allow someone to identify that asset.

 

(iii) Certainty of object

You should make it clear who the beneficiaries of your trust are. It is important to be as specific as possible – it is ideal if you can explicitly name people. 

 

 Note that before creating your trust, you should ensure that the trustee you select:

1. • Is trustworthy

   • Knows how to manage the trust’s assets

   • Will always manage the assets to benefit your beneficiaries

 

(b) Ensure legal title is with the trustee

 

After creating a declaration of trust, the next stage is to ensure the trustee has legal title to the assets that are the subject of the trust. 

 

If the trustor has selected himself to be the trustee, nothing needs to be done.

 

If the trustor has selected someone else to be the trustee, the legal title of the assets should be transferred to the trustee. Most legal titles to assets can be transferred simply by physically giving them to the intended recipient.

 

For some types of assets, you will need to follow certain 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. We recommend you research if any such formalities exist for the assets that are to become the subject of your trust.

 

2. Civil law jurisdictions

 

Civil law jurisdictions (such as France and Germany) tend to not have a concept of trust in their law. 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. This means that 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 manages 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 favor of someone in a civil law jurisdiction, not all hope is lost! Some civil law jurisdictions recognize trusts by the Hague Trusts Convention.

 

Fourteen civil law countries have ratified this convention, including:

 

• Italy

• Luxembourg

• Liechtenstein

• Malta

• Monaco

• Netherlands

• Panama

• San Marino

• Switzerland

 

Types of Trusts:

 

 Generally speaking, trusts are categorized in three ways: 

 

• (a) Inter Vivos vs Testamentary

• (b) Revocable vs Irrevocable

• (c) Fixed vs Discretionary

 

 

(a) Inter Vivos vs Testamentary

 

Firstly, we can categorize a trust as being an ‘inter vivos’ or ‘testamentary’ trust.

 

An inter vivos trust is a trust that is created to operate during the lifetime of the trustor. It is also called a  ‘living trust’. An inter vivos trust is created through documentation distinct from the will. This type of trust can either 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 has passed away, terms of the trust cannot be altered or revoked (see below). Assets that are the subject of the trust are those assets that the settlor owns at the time of his death. 

 

(b) Revocable vs Irrevocable

 

 Secondly, trusts can be either 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. He also retains 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 the power to amend the terms of the trust or rescind the arrangement altogether.

 

(c) Fixed vs Discretionary

 

Finally, we can categorize 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 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 to decide how the trust’s assets should be distributed amongst the trust’s beneficiaries. This discretion depends on what the trustor has stipulated. It can range from giving the trustee absolute freedom to deciding how much of the assets each beneficiary should receive 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 a cross-over between these different categorizations of trusts – for instance, a trust can be a testamentary, irrevocable, or 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.