Interested persons nonjudicial settlement agreement

Nonjudicial Settlement Agreements: The Good, the Bad, and the Ugly

Some trusts are irrevocable as soon as they are created, which means that, in general, the grantor (the person who created and funded the trust) cannot terminate or modify it and take back the money or property that it holds. You may wonder why anyone would want an irrevocable trust, but irrevocable trusts can provide some very important benefits, particularly asset protection, tax minimization, and maintaining eligibility for government benefits. In contrast, Grantors may amend or revoke a revocable living trust at any time prior to their death, but at their death the trust becomes irrevocable.

Although irrevocable trusts generally cannot be changed, many states’ laws allow interested parties to modify a trust in certain circumstances using a binding nonjudicial settlement agreement—assuming there is no language in the trust document prohibiting their use or providing another way for the trustee and beneficiaries to consent to modifications. In the absence of a statute permitting a nonjudicial settlement agreement, the interested parties under state law, which may include the grantor, the trustee, or the current or future beneficiaries or their representatives, would have to petition a court to modify the trust or interpret unclear provisions. In states where nonjudicial settlement agreements are permitted, their use can avoid the costs, delays, and lack of privacy associated with judicial proceedings.

When May a Nonjudicial Settlement Agreement Be Used?

A nonjudicial settlement agreement is only valid if it does not violate a material purpose of the trust or terminate the trust in an impermissible manner and any modification would have been approved by a court if the parties had petitioned the court. Although there are variations in each state’s statute governing nonjudicial settlements, there are several situations in which a nonjudicial settlement agreement is typically allowed, including the following:

• Interpretation of the terms of the trust document if they are unclear
• Approval of a trustee’s report or accounting
• Authorization or prohibition of certain actions by the trustee
• Appointment or resignation of a trustee or determination of the trustee’s compensation
• Transfer of the location where the trust is administered
• Determination of the liability of the trustee for actions related to the trust

Many states’ statutes also broadly allow a nonjudicial settlement to address any matter that a court otherwise would resolve. A nonjudicial settlement must be signed by all interested persons to be valid.

Examples

1. Assume Mike creates a trust for the benefit of Marcia, Jan, Cindy, Greg, Peter, and Bobby and names Carol as trustee. The trust document does not name a successor trustee and does not specify a method for naming a replacement trustee. On a trip to Hawaii, Mike and Carol are killed in a car accident after they find a mysterious tiki idol thought to bring bad luck to whoever touches it. The beneficiaries, who are all adults, may enter into a nonjudicial settlement agreement to appoint a new trustee. In California, because the Mike (the creator of the trust is deceased), a petition to the court would be required. It will go smoothly though if the beneficiaries agree on the successor Trustee.
2. Assume Morticia creates a trust naming her husband, Gomez, as trustee, and leaving one half of the funds in her savings account to each of her children, Wednesday and Pugsley. Unfortunately, before Morticia passes away, Wednesday dies in a freak accident while trying to teach Lurch to dance, leaving three of her own adult children. The trust does not clearly state whether Wednesday’s one-half share of the savings account should go to her children; the funds should be split equally, with Pugsley and Wednesday’s three children each receiving one-fourth; or all of the funds in the savings account should go to Pugsley. Pugsley and Wednesday’s three children, who are all adults, may enter into a nonjudicial settlement agreement in which they mutually consent to an interpretation of the terms of the trust regarding distribution. It is important to note that gift tax consequences result when value shifts from one beneficiary to another. However, a settlement resulting from a bona fide dispute or litigation should be treated as a transfer for full and adequate consideration and not a gift for gift tax purposes. In this case, because Morticia is still alive, no court approval of the modification of the trust will be necessary in CA.

What Are the Downsides to a Nonjudicial Settlement Agreement?

Possible tax consequences. If a nonjudicial settlement agreement changes a trust’s distribution provisions or the beneficiaries’ interests, the change may result in transfer or income tax liability. For example, if a modification shifts a beneficial interest in the trust to a beneficiary who is a generation younger than the prior beneficiary, liability for the generation-skipping transfer tax may occur. If a nonjudicial settlement agreement involves the transfer of an interest in property to another beneficiary, for example, to settle a dispute, gift tax liability may arise. Certain modifications may also have income tax consequences. It is also important to keep in mind that some states impose their own inheritance taxes on certain transfers to relatives or third parties, which should be considered.

May be contrary to your loved one’s intentions. The Grantor may have had strong feelings about how the money and property transferred to the trust should be handled, and a modification or termination of the trust pursuant to a nonjudicial settlement agreement may not be what they would have wanted. For example, terminating a trust prior to the original termination date because the beneficiary needs the funds for daily living expenses may not violate a material purpose of the trust; but, if the grantor thought the beneficiary was too immature to handle the funds before a certain age, they would not want the trust to terminate early.

We Can Help

If you are the beneficiary or trustee of a trust with provisions that are confusing or incomplete, or if circumstances have changed since the trust document was drafted that make its application difficult or impossible, a nonjudicial settlement agreement may be able to resolve those issues. Call us today at (714) 972-2333 so we can meet to discuss these or other issues that you have encountered in the administration of a trust. Our office is located in Santa Ana, CA but we serve all of California including Irvine, Orange, Tustin, Newport Beach, and Anaheim.

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