When to use Nonjudicial Settlement Agreements
Tim Curtin
Estate Planning and Probate Attorney - Past-Chair of the Atlanta Bar Association Estate Planning and Probate Section
Some trusts are irrevocable as soon as they are created, which means that, in general, the trustmaker (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, trustmakers 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?
Here are 2 examples:
1. 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.??
2. Homer and Marge own a snow plow business that their son Bart has been operating for twenty years. However, Homer and Marge’s trust leaves everything, including the business, to all of their children—Bart, Lisa, and Maggie—in equal shares. The business was the main piece of property owned by the trust. After Homer and Marge pass away, Bart wants to purchase the business and fund Lisa and Maggie’s shares with the proceeds of the sale. Bart, Lisa, and Maggie, who are all adults, may enter into a nonjudicial settlement agreement agreeing to deviate from the original distribution specified in the trust document.?
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.?
May be contrary to your loved one’s intentions. The trustmaker 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 trustmaker thought the beneficiary was too immature to handle the funds before a certain age, they would not want the trust to terminate early.
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 me today at (404) 262-0290 so we can meet to discuss these or other issues that you have encountered in the administration of a trust.