Using Directed Trusts to Create More Customized Estate Plans: Legislative Developments in California and Other States

So-called directed trusts have become increasingly popular in trust planning as a “team” approach to trust administration. These trusts allow designated persons to share some of the trust management responsibilities that traditionally have been reserved solely to a trustee. Many states, including most recently California, have enacted legislation specifically to address directed trusts. These state laws vary as to the ability to form directed trusts and the liability protection afforded to the trustees and others by the division of trust duties, potentially creating unexpected exposure for any friends, family members or other “nonprofessionals” acting in these roles. 

When considering directed trusts, trust settlors, trustees and others given powers to provide directions should understand the responsibilities and liabilities applicable under state laws and which rules, if any, can be modified or waived by the trust agreement. Below is a brief overview of directed trusts and the rules that apply in the following states (click on a link to go directly to a specific state summary for California, District of Columbia, Illinois, Maryland, New York and Virginia). 

What Is a Directed Trust?

With a traditional trust, a trustee is appointed to administer the trust and manage trust assets. The trustee owes fiduciary duties to the trust beneficiaries to act in their best interests and in accordance with the trust’s terms and purposes. A directed trust allows the settlor, through the terms of the trust, to divide and assign various trust powers among persons other than the trustee. These power holders (we will call them “directors,” but they also may be referred to as advisers or protectors) direct the trustee as to the exercise of the specified powers. 

For example, a directed trust may appoint an investment director solely responsible for directing the trustee on trust investments. It also may name a distribution director solely responsible for directing the trustee regarding trust distributions and/or give a trust protector a variety of other powers under the agreement, such as the power to remove and replace trustees or other directors, to terminate an uneconomical trust, to amend the trust for more tax efficiency and/or to resolve disagreements regarding the trust’s terms. The trustee remains responsible for complying with the directions of the trust directors and for ministerial duties, such as the custody of trust assets, maintenance of trust records and filing of tax returns.

Why Use a Directed Trust?

A directed trust provides the flexibility to choose people to act in the roles for which they are best suited. A financially savvy friend may be appointed as the investment director, while a trusted family member who best understands the family dynamics may be appointed as distribution director, leaving the trustee to deal with administrative tasks. For trusts that will hold difficult-to-manage or illiquid assets, such as real estate or closely held business interests, directed trusts may incentivize desired corporate or professional trustees to serve, on the basis that they act only at the direction of another person as to those assets. Appointing beneficiaries as directors or co-directors also can empower them with respect to the trust without providing them complete authority over trust distributions or burdening them with administrative complexities. 

How Is a Directed Trust Created?

Many states have enacted statutes dealing with directed trusts, but they differ significantly as to their effectiveness in dividing fiduciary responsibilities and liability protection among the trustee and directors. For example, California and Virginia have adopted comprehensive statutes based on the Uniform Directed Trust Act, model legislation issued in 2017 that generally permits the bifurcation of fiduciary responsibilities, limits the liability of any one trustee or director for acts of the others and expressly limits a trustee’s duty to monitor decisions or identify breaches of trust by directors. Other jurisdictions, such as Washington, D.C., have far simpler statutes that offer less liability protection to directed trustees in taking direction from others.  

Where there is no or a less-comprehensive directed trust statute, a state’s general trust laws may still permit a settlor to designate specific roles and duties within a trust agreement that will govern the trust’s administration. But the rules must be checked, as not all these states permit or sufficiently provide for the division of fiduciary duties and liabilities (see New York, discussed below). Further, many states, including those with directed trust statutes, impose minimum liability thresholds, even for trustees required by the trust agreement to comply with the directions of another fiduciary.

California

The California Uniform Directed Trust Act (CUDTA), under California Probate Code Section 16600 et seq., takes effect Jan. 1, 2024. Modeled after the Uniform Law Commission’s Uniform Directed Trust Act, CUDTA provides a welcome upgrade to the California Probate Code (CPC), allowing greater flexibility and potential to tailor California trusts.

Technically, absent an applicable directed trust statute, a settlor may nonetheless designate specific roles and duties within a California trust instrument, and unless such terms conflict with California law, they generally will govern the administration of the trust. Prior California law, however, did not adequately address the legal implications of implementing a directed trust in California, particularly its impact on the duties of each fiduciary to oversee the acts of the others and their corresponding liability for any breach committed by other fiduciaries. In addition, before CUDTA, a trustee’s ability to delegate its powers to third parties was limited, and the trustee would continue to have oversight responsibilities over such third parties. The trust agreement also could not exculpate a California trustee for acts of gross negligence or more culpable conduct, even if, for example, the trustee simply acted at the direction of another fiduciary pursuant to the terms of the trust. Under these relatively rigid prior rules, settlors were generally limited in their ability to create California trusts with distinct fiduciary roles and to protect those fiduciaries by limiting their powers and duties within the trust agreement.

CPC Section 16608 now provides that the terms of a trust may grant a power of direction to a trust director. The term “power of direction” broadly includes any power over a trust granted to a person that is exercisable while such person is not serving as trustee, including powers over the investment, management or distribution of trust property or other administration matters. 

Director as Fiduciary. A trust director is generally subject to the same fiduciary rules applicable to trustees or co-trustees in a like position. However, certain powers set forth in CPC Section 16606 are expressly carved out of CUDTA, and accordingly should be exercisable in a nonfiduciary capacity, including (1) powers of appointment to enable a person to designate a recipient of trust property, (2) powers to appoint or remove a trustee or trust director, (3) powers of a settlor over a trust that is revocable by the settlor and (4) powers of a beneficiary to the extent that they affect the beneficial interest of that beneficiary (or another beneficiary represented by the beneficiary).

Trustee’s Compliance With Directions. CPC Section 16614 sets forth the duties and liabilities of a trustee taking direction from a trust director. The directed trustee is required to take reasonable steps to comply with the direction of a trust director unless, in complying with such direction, the trustee would engage in willful misconduct. This willful misconduct standard is prevalent in many states’ directed trust statutes, including those states that have adopted legislation based on the Uniform Directed Trust Act, but it does not go so far as to fully exculpate a directed trustee, as under Nevada’s directed trust statute. While we have yet to see how California courts will interpret the willful misconduct standard, CUDTA provides greater protection to trustees taking directions from others compared to prior law, which prohibited exculpation for acts of gross negligence, a lower threshold than willful misconduct.    

Duties To Monitor and/or Inform Others. Another important feature of CUDTA is found in CPC Section 16618, which relieves a directed trustee and a trust director from any duty to monitor the actions of the other or to inform or give advice to the settlor or the beneficiaries with respect to the actions of the other. Unlike prior law, CUDTA makes a trustee and trust director responsible only for the powers and duties granted to them under the trust agreement, without requiring that they oversee others’ actions. CPC Section 16620 permits the settlor, through the terms of the trust agreement, to extend this rule to co-trustees so that co-trustees can be relieved from the duty to monitor one another to the same extent that a directed trustee is relieved from monitoring a trust director. Pursuant to CPC Section 16616, directed trustees and directors have a duty to share information with one another to the extent such information is related to both of their powers and duties and will not be liable for a breach of trust for acting in reliance on information provided by the other unless such action amounts to willful misconduct. 

CUDTA will apply to any trust, whenever created, that has its principal place of administration in California. If any such trust was created before Jan. 1, 2024, CUDTA will apply only to decisions or actions occurring on or after that date.

District of Columbia

Washington, D.C., has a fairly limited directed trust statute (D.C. Code Section 19-1308.08), which does not offer complete liability protection to a directed trustee. 

Director as Fiduciary. The D.C. Code provides that any person other than a beneficiary who holds a power to direct the trustee is a fiduciary who must act in good faith as to the purposes of the trust and beneficiaries’ interests and is liable for any breach of fiduciary duty. Although the statute provides a carve-out from this fiduciary standard for beneficiaries, a settlor may want the trust agreement to treat a beneficiary-director as a fiduciary, at least with respect to other current or future trust beneficiaries whose interests are not the same as or represented by the beneficiary-director.  

Trustee’s Compliance With Directions. While a trust is revocable, the trustee may follow a written direction of the settlor that is contrary to the trust terms. Otherwise, D.C.’s directed trust statute requires the trustee to follow the direction of a director unless the exercise of the power is manifestly contrary to the trust terms or the trustee knows the attempted exercise would constitute a serious breach of a fiduciary duty that the director owes to the trust beneficiaries. The statute is silent as to the minimum liability applicable to a directed trustee in following direction. While the trust agreement can specify the applicable liability standard, it cannot exculpate any trustee, directed or otherwise, for a breach of trust committed in bad faith or with reckless indifference to the trust’s purposes or interests of the beneficiaries. In other words, liability cannot be set at the lower threshold of willful misconduct. 

Duties To Monitor and/or Inform Others. The D.C. directed trust statute does not specifically address the duty of a trustee or a director to monitor the other or to provide advice regarding the actions of the other to the settlor, trust beneficiaries or other third parties. The terms of the trust agreement can seek to limit these duties, but the minimum liability standard for any breaches of trust committed in bad faith or with reckless indifference will apply.  

Illinois

The Illinois Directed Trust Statute provides protection for a trustee acting (or declining to act) pursuant to the directions of a non-trustee directing party such as an investment trust advisor, trust protector or distribution trust advisor. It applies to all existing and future trusts that provide for a directing party or are amended to provide for a directing party (whether by court order or nonjudicial settlement agreement).  

Director as Fiduciary. The Illinois Directed Trust Statute provides fiduciary authority for each of three types of directing parties—namely, investment trust advisors, distribution trust advisors and trust protectors—each of whom is subject to the same duties and standards applicable to a trustee of a trust. The default authority applies in each case only to the extent the trust agreement is silent.  If an investment trust advisor is appointed, the default authority granted under the statute includes the ability to direct the purchase, transfer, assignment or sale of trust assets; investment of principal and income of the trust assets; and to control voting power and determine compensation of advisors, managers, consultants and other counselors to the trust. If a distribution trust advisor is appointed, the default authority granted under the statute includes the ability to direct all decisions relating directly or indirectly to discretionary distributions to or for one or more beneficiaries. If a trust protector is appointed, the default authority granted under the statute includes the ability to modify or amend the trust; modify the interest of a beneficiary or a power of appointment; remove or appoint a trustee or directing advisor; terminate the trust; and change the situs of the trust.

Trustee’s Compliance with Directions. To the extent that a settlor names a directing party to act in the trust agreement, the trustee is not able to exercise any of the powers granted to the directing party and is referred to as an “excluded fiduciary” for purposes of those powers.  The excluded fiduciary will not be held liable for any action that the excluded fiduciary takes based on instructions from a directing party except in instances of willful misconduct on the part of the excluded fiduciary (a higher liability threshold than gross negligence, bad faith and/or reckless indifference).

Duties to Monitor and/or Inform Others. Unless otherwise provided in the trust agreement, the trustee has no duty to monitor, review, inquire, investigate, recommend, evaluate or warn with respect to the directing party’s exercise or failure to exercise the powers granted to the directing party by the trust agreement.  

Maryland

Maryland’s directed trust statute (Md. Estates and Trusts Code Section 14.5-808) includes a more limited liability standard for directed trustees and specifically regulates their obligations to oversee the actions of directors.

Director as Fiduciary. Maryland’s directed trust statutes provide that any person, other than the settlor of a revocable trust, who holds a power to direct, consent to or disapprove any proposed or actual decisions of a trustee is a fiduciary who must act reasonably under the circumstances with regard to the trust’s purposes and beneficiaries’ interests. As a fiduciary, the power holder will be liable for any loss resulting from a breach of fiduciary duty. A beneficiary who holds a power to direct is not treated as a fiduciary to the extent of the interests of that beneficiary and the interests of any other persons who are subject to the beneficiary’s control through the exercise of a power of appointment. 

Trustee’s Compliance With Directions. If the trust agreement requires the trustee to follow directions, then the trustee must act in accordance with those directions and is not liable for a loss resulting from this compliance except in the case of the trustee’s willful misconduct. Maryland’s statute also provides that the trustee may not follow the directions if the attempted exercise is manifestly contrary to the trust’s terms (unless expressly waived in writing by the settlor) or the trustee knows the attempted exercise would constitute a breach of a fiduciary duty that the director owes to the trust beneficiaries. The directed trustee is not completely exonerated from liability for compliance, although it can apply at the higher threshold of willful misconduct, rather than gross negligence, bad faith and/or reckless indifference.   

Duties To Monitor and/or Inform Others. When the trust agreement requires a trustee to follow the directions of a director, Maryland’s statute clearly eliminates any duty of the directed trustee to monitor the conduct of the director; to provide advice to the director; or to communicate with, warn or apprise a beneficiary or other third party in instances when the trustee would or might have acted differently than directed by the director. The statute specifically presumes that any actions taken by the trustee in carrying out directions are administrative in nature and do not evidence the trustee’s monitoring of or participation in the director’s decisions. 

New York

New York is one of the few states without a directed trust statute. Its general trust laws do not authorize the appointment of non-trustee fiduciaries nor the division of specific responsibilities and corresponding liabilities among co-trustees. Under N.Y. EPTL Section 10-10.7, some liability protection is offered to a dissenting trustee who joins in carrying out a decision by the majority. If the trustee’s dissent is expressed promptly in writing to the other trustees, then the dissenting trustee is not liable for the consequences of any majority decision. The dissenting trustee cannot avoid liability for failing to join in administering the trust or to prevent a breach of the trust.  

There is authority under New York case law for wills and trusts to divide responsibility among fiduciaries and to give advisers the power to direct fiduciaries, but the New York courts have invalidated the bifurcation of fiduciary liability under such arrangements. A New York Directed Trust Act has been proposed and approved by the New York City and New York State bar associations to specifically authorize directed trusteeships and provide comprehensive rules for how they should function. Until such legislation is enacted, New Yorkers wishing to create directed trusts may want to form their trusts in another state with a directed trust statute, such as Delaware.

Virginia

The Virginia Uniform Directed Trust Act, found under Article 8.2 of the Virginia Code (VUDTA), generally follows the Uniform Law Commission’s Uniform Directed Trust Act and provides a comprehensive statutory framework for directed trusts.

Director as Fiduciary. VUDTA expressly permits a trust agreement to grant a power of direction to a director. In exercising that power, the director generally has the same fiduciary duty and liability to the trust and its beneficiaries as a trustee would in similar circumstances. The trust agreement can vary these duties or the liability to the same extent permitted for trustees. VUDTA excludes certain powers from application of this fiduciary standard, including (1) powers of appointment to enable a person to designate a recipient of trust property, (2) powers to appoint or remove a trustee or trust director, (3) powers of a settlor over his or her revocable trust, and (4) powers of a beneficiary to the extent that they affect the beneficial interest of that beneficiary (or another beneficiary represented by the beneficiary).

Trustee’s Compliance With Directions. Under VUDTA, a directed trustee must take reasonable action to comply with the direction of a director unless, by this compliance, the trustee would engage in willful misconduct. Accordingly, while VUDTA does not completely exonerate directed trustees when following directions, it does provide a higher liability threshold compared to standards based on gross negligence, bad faith and/or reckless indifference.    

Duties To Monitor and/or Inform Others. Under VUDTA, unless the trust agreement provides otherwise, neither a directed trustee nor a director has a duty to monitor the actions of the other or to inform or give advice to a settlor, beneficiary, trustee or director concerning instances when the trustee might have acted differently than a director or a director might have acted differently than a trustee or another director. A directed trustee and a director are responsible only for their specified powers and duties and are not required to monitor or oversee the actions of the other. VUDTA does require directed trustees and directors to share information with one another that is related to the exercise of both of their powers and duties, although neither will be liable for acts in reliance on information received from the other unless such action amounts to willful misconduct.