Planning for the Risk of Trust Litigation with Trust Situs or Governing Law Selection

By: Timothy M. Ferges

When including trust situs and governing law provisions, estate planners often focus on tax and asset protection issues. This article describes how these provisions affect trust litigation in ways that are rarely considered at the planning stage.

When litigation arises relating to administration of a trust, the procedural law of the forum state can have a profound effect on the proceeding. Likewise, the substantive law that would govern a trust’s administration may vary significantly from state to state. As our society becomes more mobile, we are no longer so committed to one particular jurisdiction when creating a trust. But in determining where a trust will be administered or in the selection of a trust’s situs or governing law, estate planners tend to limit their focus on issues other than the potential for litigation -- such as the creditor protection available in a particular jurisdiction, the taxes that a particular state would impose on the trust’s income, or other matters.

In some cases, it could serve the grantor well to also consider the possibility of litigation and how a dispute might play out before the courts of one jurisdiction versus another. This can be particularly true where a grantor has specific concerns regarding a litigious beneficiary or family member.

As a general matter, the administration of a trust “is supervised by the courts of that state only in which the administration of the trust is located.” Restatement (First) of Conflict of Laws § 299. In the case of a testamentary trust, that is presumed to be the state of the testator’s domicile upon her death. Id at § 298, comment a; N.J.S.A. 3B:31-8(a). In re Johnston, 127 NJ Eq. 576 (Prerog. 1940), affirmed 129 N.J.Eq. 104 (E. & A. 1941).

A grantor of an inter vivos trust may specifically designate in the trust instrument the principal place of the trust’s administration. Such designation will be respected by the court of designated jurisdiction so long as: “(1) a trustee maintains a place of business located in or a trustee is a resident of the designated jurisdiction; or (2) all or part of the administration occurs in the designated jurisdiction.” N.J.S.A. 3B:31-8(a). On the other hand, if the trust instrument does not designate the site of administration, it is presumed to be New Jersey if the trust is governed by the law of New Jersey. Id.

Setting aside those jurisdictional issues, the substantive law governing a trust’s administration can vary from state to state.

Thus in addition to the state of jurisdiction, one must consider what state law will govern. Under New Jersey’s Trust Code, the meaning and effect of the trust terms are generally determined by (a) the law of the jurisdiction designated in the trust instrument or (b) the law of the jurisdiction that has “the most significant relationship to the matter at issue.” N.J.S.A. 3B:31-7.

That substantive law would govern a dispute or proceeding involving a trust’s administration even if it is not the law of the forum state that maintains jurisdiction over the dispute. That may require consideration of law of more than one state as “the procedural law of the forum state applies even when a different state’s substantive law must govern.” N. Bergen Rex Transp., Inc. v. Trailer Leasing Co., 158 N.J. 561, 569 (1999); In re May 1, 1992 Mark Family Trust, 2016 WL 4145851 (App. Div. 2016).

Thus, for example, if a trust, by its terms, were governed by the law of New York, but its principal place of administration were in New Jersey, a New Jersey court might apply New York law to construe its terms. In doing so, however, it would only consider evidence admissible under the procedural law of New Jersey. In other words if a grantor, or her trustee, has concerns about the prospect of litigation in the future, she may wish to consider both the forum of jurisdiction as well as the governing substantive law.

For example, after a grantor’s death, a family member could challenge the validity of a trust created and funded during the grantor’s lifetime under the premise that it is the product of undue influence. Once the contestant establishes the existence of a confidential relationship between the grantor and proponent of the instrument, under New Jersey law, the burden of proof is then shifted to the proponent to establish the absence of undue influence. Pascale v. Pascale, 113 N.J. 20, 31 (1988). And the proponent’s burden of persuasion will be high – she must meet her burden by clear and convincing evidence. Id. Thus New Jersey law could have a profound impact on such litigation – the proponent of the instrument may face a more challenging position in New Jersey compared to another state (albeit, there are other states that apply similar mechanisms to adjudicate such disputes).

On the other hand, if a trust is challenged under the premise that the grantor lacked the requisite mental capacity to execute it, and the trust was revocable when it was created, the proponent need only establish that the grantor maintained a minimal level of mental capacity when it was signed (the same capacity required to sign a will). N.J.S.A. 3B:31-42; Gellert v. Livingston, 5 N.J. 65, 73 (1950). Thus it may be more difficult in New Jersey than in other states for a litigant to challenge a revocable trust on capacity grounds.

To deter litigation, a grantor may wish to include an “in terrorem” (no contest) clause in the trust instrument. The enforceability of such a clause, however, may depend upon the applicable law. In New Jersey, an in terrorem clause is unenforceable so long as the contestant had “probable cause” for instituting his or her challenge. N.J.S.A. 3B:3-47; N.J.S.A. 3B:3-33.1(b). In contrast, in terrorem clauses are generally enforced in New York, whether or not the contestant possessed probable cause to challenge the trust, subject to certain statutory exceptions. EPTL 3-3.5; Tumminello v. Bolton, 59 A.D.3d 727 (NY 2d Dep’t 2009); Matter of Stralem, 181 Misc.2d 715, 715 (NY Surr. Ct. Nassau Cty. 1999).

In addition to trust contests, disputes may arise regarding the construction of a trust, and the applicable procedural and substantive law may have an impact on such a dispute. New Jersey, for example, takes a more liberal approach than some other states when it comes to the admission of evidence. A New Jersey court may review extrinsic evidence (i.e., evidence outside the four corners of the instrument) to evaluate the probable intent of the grantor. Fidelity Union Trust Co. v. Robert, 36 N.J. 561, 573 (1962). This may be true even if the instrument appears unambiguous on its face. Id. In other states, such as New York, extrinsic evidence can only be admitted if doubt or ambiguity exists within the four corners of the instrument. In re Chase Manhattan Bank, 6 N.Y.3d 456, 460 (2006). Thus if a grantor is concerned a litigant might seek to contradict the intent that she expressed in the instrument, she may wish to consider whether she would want extrinsic evidence admissible in such a dispute.

Of course there are many other disputes that may arise in the administration of a trust. Perhaps it is more difficult to remove a trustee under the law of one state versus another. Perhaps one jurisdiction applies more stringent rules than another when evaluating the prudence of trust investments.

Other considerations may be warranted. The courts may operate differently in one state versus another. Perhaps it is easier for a plaintiff to pursue a particular claim in New Jersey versus in another jurisdiction, or vice versa. Perhaps a grantor, concerned about potential litigation, may wish to select a jurisdiction where it is procedurally more burdensome to pursue a claim or where a claim cannot be resolved expediently.

Bearing all of this in mind, in some circumstances, it may be possible to move the situs of a trust after it is created. Perhaps the trust instrument specifically empowers the trustee to move the situs (that authorization is often incorporated in modern estate planning documents). But in the absence of such affirmative authority under the trust instrument, mechanisms exist under New Jersey law, allowing one to effectuate transfer of a trust’s principal place of administration. For example, under New Jersey’s Trust Code, a trustee can potentially do so by providing notice to the “qualified beneficiaries” (as defined under N.J.S.A. 3B:31-2 and 3B:31-10) of a proposed transfer within 60 days of initiating such transfer. N.J.S.A. 3B:31-8(d).

Of course, in determining whether to create a trust that is subject to jurisdiction or governing law of a particular state or in determining whether to move the trust situs or change its governing law, there are a host of non-litigation issues and risks that should be considered. For example, the law of some states allow for significant asset protection, even if the trust is self-settled, but the majority of states do not. Some states, such as New Jersey, have eliminated the rule against perpetuities, while others have not. Perhaps most significant to many, some states impose tax on a trust’s income, while others do not.

In selecting a trust’s situs and governing law, estate planners often focus their attention exclusively on these non-litigation issues. The possibility of litigation, however, can be an equally important consideration. Thus depending on the priorities of the grantor and the risks perceived, one should consider the substantive and procedural law that might govern such a dispute and whether it makes sense to avoid or target the law of a particular jurisdiction.

Reprinted with permission from the March 22, 2021, issue of the New Jersey Law Journal. Further duplication without permission is prohibited. All rights reserved. © 2021 ALM Media Properties, LLC.

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