The Surety and Trust Funds: Understanding Trusts
June 13, 2023
In this Surety Today Blog post we begin a multi-part series on the surety and trust funds. One of the tools that every surety claims handler needs to be familiar with are trusts. Trusts abound in statutes, indemnity agreements and contracts, and trusts can even be implied by law under certain circumstances. Developing a solid understanding of the law of trusts is essential for the surety to be able to identify and assert such rights in the myriad of circumstances in which they may be useful. The question is what rights flow from trusts and how can the surety use such rights to its advantage. Over the next few blog posts we will look at the nature of trusts in general, the nomenclature, their characteristics and elements, the duties and obligations of the parties. Next, we will focus on the various forms of trusts, such as statutory trust funds, contractually created trusts and trusts at common law. Finally, we will discuss some of the potential situations in which trusts can be helpful for a surety including in bankruptcy and priority disputes over contract funds.
A. Nature of Trusts
Generally speaking, anyone competent to create a contract may dispose of the legal title to their property as they please, may attach such conditions and limitations to the enjoyment of said property as they choose, and may vest said property in trustees for the purpose of carrying out their specific intention. One has the same power to create trusts as one has to alienate the legal title to their property. The definition of an express trust has been stated as follows: “a fiduciary relationship in which one person holds a property interest subject to an equitable obligation to keep or use that interest for the benefit of another.” From the Heart Church Ministries, Inc. v. African Methodist Episcopal Zion Church, 370 Md. 152, 181-182 (2002), cert. denied, 537 U.S. 1171 (2003). The Restatement (Second) of Trusts, has defined a trust as, “[A] fiduciary relationship with respect to property, subjecting the person by whom the title to the property is held to equitable duties to deal with the property for the benefit of another person, which arises as a result of a manifestation of an intention to create it.” In re Penn Central Transp. Co., 486 F.2d 519, 524 (3d Cir. 1973) (quoting Restatement (Second) of Trusts § 2 (1959)). A trust is not a legal entity distinct from the trustee and is not capable of legal action on its own behalf. Farris v. Boyke, 936 S.W.2d 197, 200 (Mo. Ct. App. 1996); Blue Ridge Ins. Co. v. Stanewich, 142 F.3d 1145, 1150 (9th Cir. 1998); Bracken v. Harris & Zide, L.L.P., 219 F.R.D. 481 (N.D. Calif. 2004); Coverdell v. Mid-S. Farm Equip. Ass’n, Inc., 335 F.2d 9 (6th Cir. 1964); Limouze v. M.M.&P. Mar. Advancement, Training, Educ. & Safety Program, 397 F. Supp. 784 (D. Md. 1975).
The fundamental nature of a trust is the division of legal and equitable title in the property subject to the trust. Lambley v. Diehl, 603 S.W.3d 346, 358 (Mo. Ct. App. 2020); Moore v. Moore, 111 S.W.3d 530, 533 (Mo. App. S.D. 2003). The trustee of the trust holds legal title to the trust property, while the beneficiaries of the trust hold equitable title to the trust property. There are three primary parties to a trust: the settlor, the trustee and the beneficiary. The “settlor” is the creator of the trust. Restatement (Third) of Trusts § 3(1) (2003). Generally speaking, the settlor is the party that provides the trust property, even if the form of the trust was created by someone else. William F. Fratcher, Scott on Trusts § 156.3 (4th ed. 1987); see also Lehman v. Comm’r of Internal Revenue, 109 F.2d 99 (2d Cir. 1940); In re Green Valley Fin. Holdings, 32 P.3d 643 (Colo. Ct. App. 2001). In the surety context this will usually be the principal/indemnitors. The “trustee” is the party who is “appointed, or required by law, to execute a trust, and the one in whom an estate, interest, or power is vested, under an express or implied agreement to administer or exercise it for the benefit of another.” Times of Trenton Publ’g. Corp. v. Lafayette Yard Comm. Dev. Corp., 846 A.2d 659 (N.J. App. Div. 2004), see also Restatement (Third) of Trusts § 3(3) (2003). The settlor of a trust may also serve as the trustee. The “beneficiary” is the person for whose benefit the trust property is being held. Restatement (Third) of Trusts § 3(4) (2003). The settlor and/or trustee may also be beneficiaries of the trust, but the sole trustee cannot also be the sole beneficiary because of the doctrine of merger. Under the doctrine of merger, if the equitable title and legal title are held by the same person the property is free of the trust and the property holder has full and complete title. See Restatement (Third) of Trusts § 69 (2003).
B. Formation of Trusts
There are numerous types of trusts and trusts can be created in a variety of ways. Trusts can be either express or implied. Express trusts are created by the direct and intentional acts or conduct of the parties; by some writing, deed or words expressly evidencing the intention to create a trust. Levin v. Sec. Fin. Ins. Corp., 230 A.2d 93, 98 (Md. 1967). Trusts can also arise by statute, such as a construction trust fund statute. Ariz. Rev. Stat. § 33-1005; Colo. Rev. Stat. § 38-22-127; 770 Del. Code Ann. tit. 6, § 3502 et seq.; Ill. Comp. Stat. Ann. 60/21.02; Md. Code Ann., Real Prop. §9-201 et seq.; Mich. Comp. Laws Serv. § 570.151 et seq.; Minn. Stat. Ann. § 514.02; N.Y. Lien Law § 70; Okla. Stat. Ann. tit. 42, § 152 et seq.; Tenn. Code Ann. § 66-34-304; Wis. Stat. § 799.02. Implied trusts generally arise by operation of law and are usually categorized as “constructive trusts” or “resulting trusts.” Springer v. Springer, 125 A. 162, 166-67 (Md. 1924).
Trusts can be either “executed” or “executory.” An executory trust involves a circumstance where a trust is intended, but the transaction has not been completed and remains imperfect. It is a trust which is not fully and finally declared, but requires some other act or acts in order to perfect it and carry out the intention of the settlor. Equity will not aid in the enforcement of an executory trust unless the trust is supported by consideration. An executed trust is one fully and finally declared by the person creating it, so that nothing further remains to be done in order to make it effective.
An express trust is created when the parties affirmatively manifest an intention that certain property be held in trust for the benefit of a third party. An express trust may be created without the use of technical words; all that is necessary are words or circumstances, which unequivocally show an intention that the legal estate was vested in one person, to be held in some manner or for some purpose on behalf of another. Old Republic Nat. Title Ins. Co. v. Tyler (In re Dameron), 155 F.3d 718, 722 (4th Cir. 1998); Schloss v. Powell, 93 F.2d 518, 519 (4th Cir. 1938); In re: Southstar Funding, LLC, 2008 Bankr. LEXIS 3883 (Bankr. N.D. Ga. 2008); Woods v. Stull, 30 S.E.2d 675, 682 (Va. 1944). The words “trust” or “trustee” need not be used and the parties creating the trust need not even have an understanding of the concept of a trust. Restatement (Third) of Trusts § 5 cmt. (a) (2003). Conversely, the mere use of the words “trust” or “trustee” will not necessarily result in a trust relationship being created, if the requirements for a valid trust are not satisfied or if a trust is not intended. The Fourth Circuit has stated that, “any words which unequivocally show an intention that the legal estate was vested in one person, to be held in some manner or for some purpose on behalf of another, if certain as to all other requisites, are sufficient to create a trust.” Mid-Atl. Supply, Inc. of Va. v. Three Rivers Aluminum Co., 790 F.2d 1121 (4th Cir. 1986) (quoting Broaddus v. Gresham, 26 S.E.2d 33, 35 (Va. 1943)).
Unlike in the law of contracts, trusts do not require consideration to be valid and enforceable. The owner of property can create a trust of that property by will, declaration or transfer, whether or not consideration is received for doing so. Moreover, notice, knowledge or consent of the beneficiary to the creation of a trust is not required for the validity of the trust. Bongaards v. Millen, 768 N.E.2d 1107 (Mass. App. Ct. 2002), aff’d 793 N.E.2d 335 (Mass. 2003). Nor is acceptance or assent to the trust by the beneficiary required to create a valid trust. Morsman v. Comm’r of I.R.S., 90 F.2d 18 (8th Cir. 1937).
The party seeking to establish the existence of a trust will generally bear the burden of proving the creation of the trust. In some jurisdictions, the burden of proof for establishing any trust, whether express or implied, requires a heightened standard of proof. For example, in Maryland, clear and convincing evidence is required. In Florida, the evidence must be clear and unmistakable both as the intent to create the trust and as to the execution of that intent. The acts or words relied on must be unequivocal. In other jurisdictions, the heightened standard of proof is reserved for constructive and resulting trusts. Moreover, while it is generally recognized that a trust may be created orally in personal property, proof of such trusts must be of an “extraordinary degree” variously described as “clear,” “cogent,” “convincing,” and “such as to leave no room for a reasonable doubt” as to the existence and terms of such a trust.
C. Elements of a Valid Express Trust
The description of the elements required to create a valid trust vary from state to state, but it can generally be stated that in the strict, traditional sense, a trust involves three elements: (1) a trustee, who holds the trust property and is subject to duties to deal with it for the benefit of one or more others; (2) one or more beneficiaries, to whom and for whose benefit the trustee owes the duties with respect to the trust property; and (3) trust property, which is held by the trustee for the beneficiaries.” Restatement (Third) of Trusts § 2 cmt. (f) (2003).
One of the fundamental requirements for the creation of a trust is the intent of the settlor to create a trust. In re Kulzer Roofing, Inc., 139 B.R. 132, 139 (Bankr. E.D. Pa.) aff’d, 150 B.R. 134 (E.D. Pa. 1992); Mory v. Michael, 18 Md. 227, 240-41 (1862); Pierowich v. Metro. Life Ins. Co., 275 N.W. 789, 790 (Mich. 1937). A trust is created only if the settlor properly manifests an intention to create a trust relationship. Such intent must be manifested in some external expression of written or spoken words or conduct. The intention of the settlor may be ascertained by a consideration of their words and conduct in the light of surrounding circumstances.
- Trust Property
As noted above, one of the basic elements of any trust is the existence of the trust property or “res.” The trust property can consist of any type of transferrable property. The Restatement defines the type of property that can be the subject of a trust as follows: “Trust property may be real or personal, tangible or intangible. It may consist of such diverse rights as undivided interests, terms of years, contingent future interests, and choses in action, even choses with respect to things that are not specifically ascertainable at the time the trust is created, or with respect to things that are not owned by the settlor or in existence at that time.” Restatement (Third) of Trusts § 40 cmt. (b) (2003). Generally, the trust property cannot be property that the settlor has a mere future expectancy or hope of acquiring an interest in at some later date without a present right, interest or consideration. The settlor must clearly identify the trust property so that it is defined, definite and reasonably ascertainable. Begier v. IRS, 496 U.S. 53 (1990); In re Stefanoff, 97 B.R. 607 (Bankr. N.D. Okla. 1989); Eychaner v. Gross, 779 N.E.2d 1115 (Ill. 2002).
Another basic element of any valid and enforceable trust is the identification of beneficiaries of the trust. A beneficiary can be any party that has capacity to take and hold property. Individuals, corporations (municipal or private), including non-profit corporations, unincorporated associations and the government can all be beneficiaries of a trust. In addition, a class or group may be designated as beneficiaries. However, the beneficiaries must be sufficiently identifiable, definite or ascertainable for a trust to be valid. While the beneficiaries must be ascertainable, they need not be specifically named in the terms of the trust, but can be designated by class terminology or by description. Further, the beneficiaries do not necessarily need to be known at the time the trust is created and in such circumstances the title to the trust property remains in the trustee until such time as the beneficiaries have been ascertained. A class is not indefinite merely because the class consists of a changing or shifting group, the number of whose members may increase or decrease. Persons who may only incidentally benefit in some manner from the performance of the trust are not beneficiaries of the trust and cannot enforce the trust unless they were specifically intended to be beneficiaries.
Finally, perhaps the defining aspect of a trust is the existence of a trustee to hold the trust property. A trustee may be any party that can hold title to property. The trustee holds mere legal title to the trust property for the benefit of the beneficiaries with certain powers and subject to certain duties imposed by the terms of the trust, equitable jurisprudence and statute. Thus, corporations and unincorporated associations may serve as trustees.
The trustee has all powers necessary or appropriate to effectuate the purpose of the trust except for those that are specifically denied to the trustee in the trust itself or prohibited by law. Restatement (Third) of Trusts § 70 cmt. (a) (2003); see also Petition of First Interstate Bank of Denver, N.A., 767 P.2d 792 (Colo. App. 1988). The trustee is obligated as a fiduciary to exercise the powers conferred. Upon acceptance of the role of trustee, the trustee has the affirmative duty to administer the trust diligently and in good faith. Restatement (Third) of Trusts § 76 (2003). The trustee’s duties are referred to as “fiduciary duties” and include the obligation to administer the trust as a “prudent” person would with “reasonable, care, skill, and caution.” Id. at § 77. Further, the trustee owes a duty of loyalty to the beneficiaries and must administer the trust solely in the interest of and for the benefit of the beneficiaries in furtherance of the purposes of the trust. Id. at § 78. “The duty of loyalty is, for trustees, particularly strict even by comparison to the standards of other fiduciary relationships.” Id. at § 78 cmt. (a). In this regard, the Supreme Court has observed:
Under principles of equity, a trustee bears an unwavering duty of complete loyalty to the beneficiary of the trust, to the exclusion of the interests of all other parties. To deter the trustee from all temptation and to prevent any possible injury to the beneficiary, the rule against a trustee dividing his loyalties must be enforced with ‘uncompromising rigidity.’
NLRB v. Amax Coal Co., 453 U.S. 322, 329-332 (1981).
As part of the trustee’s duties, the trustee is obligated to keep records and provide information regarding the trust. Finally, the trustee is under a duty to identify and segregate trust property. The Restatement provides, “[t]he trustee has a duty to see that trust property is designated or identifiable as property of the trust, and also a duty to keep the trust property separate from the trustee’s own property and, so far as practical, separate from other property not subject to the trust.” Restatement (Third) of Trusts § 84 (2003). However, the fact that a trustee does not in fact segregate the trust property from other property, while a breach of duty, does not render the trust invalid. “Trust funds do not lose their character as such because they are commingled with those of the trustee. Once a trust is created, it cannot be destroyed by the action, wrongful or innocent, of the trustee, in the absence of the intervening right of a purchaser for value without notice.” West Virginia v. Blue Cross and Blue Shield of West Virginia, Inc., 638 S.E.2d 144 (W.Va. App. 2006), (quoting Henson v. Lamb, 199 S.E. 459 (W. Va. 1938)). However, while the trust may not be held invalid the ability to recover the trust property will be impaired or even extinguished if the trust property cannot be traced.
If you have any questions regarding the issues addressed in this blog post please contact Michael A. Stover, Esq. (email@example.com) or any member of the Surety and Fidelity Practice Group.
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