Private Client Services Update – Trust Directors & Family-Business Succession: New Virginia Laws Warrant Careful Planning

    By Estate, Trust & Wealth Transfer, ESOPs & Employee Benefits

    Many families build their wealth by successfully operating an active trade or business (i.e., a family-run business). Often, however, a single generation (or perhaps two generations) of family members operates and manages the business. In addition, this single “generation” usually consists of only one or two family members. Thus, as those family members contemplate retirement—or if those family members pass away unexpectedly or become disabled—many questions loom regarding the future of the business. If the ownership interests in the business (e.g., stock, partnership interests, membership interests) are held in trust, additional specific questions arise including, among others: (i) is the trustee able and willing to operate and manage the business on behalf of the other family members; and (ii) if not, can someone else do so without adversely affecting the benefits of trust ownership?

    Fortunately, in 2012, Virginia’s Uniform Trust Code formalized a (quasi) fiduciary position called a “trust director,” who can direct the trustee with respect to certain matters, including the management of unique trust assets (e.g., ownership interests in a family-run business). A trust instrument must specifically incorporate by reference Va. Code Ann. § 64.2-770(E) for a trust director to be formally recognized as such. If the trust instrument does so incorporate, the trust director is deemed to be a fiduciary, who must act in good faith with regard to the purposes of the trust and the interests of the beneficiaries. The trust director is also liable for any loss that results from a breach of the trust director’s fiduciary duty. Starting July 1, 2014, the trust director may assert defenses to such liability as if he were a trustee.

    While seemingly benign—in fact, the availability of defenses was to calm fears that absolute liability would be imposed on a trust director should he breach his fiduciary duty—the above-described provisions may, without proper, thoughtful planning, cause a key problem: The person(s) best suited to provide direction with respect to trust ownership in a family-run business may not accept the position of trust director, if along with that responsibility comes heightened fiduciary duties and consideration of purposes and interests that may conflict with best business practices.

    To be sure, the July 1, 2014, changes include the ability to draft into a trust instrument provisions to alleviate this problem. The provisions cannot, however, relieve a trust director for a “breach of trust committed in bad faith or with reckless indifference to the purposes of the trust or the interests of the beneficiaries.” § 64.2-770(E)(1). The provisions are also ineffective if they arise “as the result of an abuse by the trust director of a fiduciary or confidential relationship to the settlor.” Id. Therefore, when planning for the succession of a family-run business through the use of one or more trust directors, great care must be taken with respect to the following:

    1.  Determining and clarifying the (i) purposes of the trust; and (ii) the interests of the beneficiaries, and the extent to which they may conflict with the continued purposes and interests of the business itself (and perhaps of the original owners).
    2. Selecting one or more trust directors, and determining the standard(s) of care they are required to uphold.
    3. Preparing the trust director, the (directed) trustee, and the trust beneficiaries for the trust director’s role with respect to a family-run business.
    4. Clarifying the (directed) trustee’s fiduciary duties and standards of care: (i) with respect to any directed assets; and (ii) vis a vis the trust director.

    – Chris Johnson

    The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2024.