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History of Trusts
By Harry L. Munsinger, J.D., Ph.D.
Trusts are a widely recognized concept under American law. However, unlike intestate succession and formal wills, discussed in Parts I and II of this series, trusts have a more recent genesis as a means of transferring property to descendants.
Black’s Law Dictionary defines a trust as “[a] legal entity created by a grantor for the benefit of designated beneficiaries under the laws of the state and the valid trust instrument. The trustee has a fiduciary responsibility to manage the trust’s corpus assets and income for the economic benefit of all of the beneficiaries.” 1 A trust document must be in writing and signed by the settlor and trustee.
Ancient Roman law permitted citizens to establish trusts by will to hold property for their descendants, but these trusts only became effective after the testator’s death. By the Middle Ages, English lawyers and their clients wanted the concept of trusts to allow the Church to use and enjoy land legally, to enforce agreements between crusading knights and their trustees, and to avoid the fees associated with feudal tenure. To enforce these informal agreements, English kings established equity courts that gradually changed the common law by deciding that legal title to land could be separated from equitable use and enjoyment of land, establishing the legal right to hold land in trust for the use of others. Ecclesiastical courts were the first to uphold trust agreements, but later, chancery courts were established to resolve conflicts between ecclesiastical and common law courts and to define the fiduciary duties of trustees.
Creation of Trusts
Early English common law did not allow separation of legal title and equitable use of land. 2 This presented problems for knights who needed someone to manage their lands while they were away on crusades to the Holy Land, so they entered into informal agreements with trustees. The legal issue became acute when knights returning from the crusades discovered that some dishonest trustees were refusing to return their lands according to the informal agreements. To deal with this injustice, English kings established equity courts to resolve these cases in a just way rather than through the common law. Equity court decisions gradually developed a body of law protecting the settlor and beneficiary from a dishonest trustee, eventually creating the English doctrine of trusts.
At the same time, English common law and Norman feudal tenure placed restrictions upon the ownership and conveyance of land, which were detrimental to the Catholic Church’s interests. Under Norman feudal law, taxes on land were assessed primarily when land passed by grant or inheritance. If land could be owned by an entity that never died, the sovereign could never collect taxes on it. Therefore, religious entities, including the Catholic Church, were forbidden from owning land under the Mortmain Acts 3 passed by Parliament in the thirteenth century. Additionally, many religious orders had taken vows of poverty, and publicly owning large tracts of land was inconsistent with a life of poverty.
When parishioners bequeathed real property to the Catholic Church, the Church avoided the legal restrictions and moral contradictions by gifting title to real estate to a layman trustee for “use” by the Church, which created an informal trust arrangement. However, these informal agreements could not be enforced in a common law court, so Church leaders began looking for alternate legal ways to make a trustee adhere to his agreement.
Finally, trusts were also developed to avoid feudal taxes. Norman laws entitled the king to cash payments under the following circumstances: (1) feudal land descended from a father to his son; (2) a wardship was established for a minor; (3) a daughter married; (4) the eldest son was knighted; or (5) a lord was captured and held for ransom. By establishing a trust to hold his land, the feudal tenant hoped to avoid these financial burdens and possibly gain the right to transfer feudal land to someone outside his immediate family or to bequeath the land to someone other than his eldest son.
The English common law courts were bound by the ancient common law precepts that regarded rights in land as indivisible, meaning that the person who held legal title to the land was automatically entitled to the use and enjoyment of profits from the land. Thus, for example, when a common law court was confronted with a case where a crusading knight had transferred legal title to a trustee who had agreed to hold the land and give it back to the knight with profits when he returned from a crusade, and the trustee refused to honor the agreement, common law courts could not look beyond the fact that the trustee held legal title to the land. Consequently, ownership of the land was awarded to the dishonest trustee by the common law courts—clearly an injustice.
To correct this legal injustice, English kings gave equity courts authority to hear these cases and decide ownership based on fairness rather than rigid common law rules. Equity court judges decided that legal title to land could be separated from equitable use and enjoyment of the land, and the result was the English doctrine of trusts. In England, there were two types of equity courts: ecclesiastical and chancery. Ecclesiastical courts had original jurisdiction over cases where a trustee was not adhering to his informal agreement, but chancery courts—which were supposed to represent the King’s conscience—were created to resolve disputes between ecclesiastical and common law courts. The chancery courts sided with ecclesiastical courts rather than common law courts and ruled that legal title to land and the use and enjoyment of land could be separated.
Evolution of English Trust Law
Early English court decisions developed active and passive trusts. 8 If a trustee held title to property and actively managed it, the trust was called an active or special trust. For example, if A conveyed title to land to B and instructed B to manage the land and pay the profits to C, B was an active or special trustee who owed a fiduciary duty to C to manage the property, collect rents, and pay profits to beneficiary C.
In contrast, a passive trust required that the trustee hold legal title to land while the Church managed the property and enjoyed income and other benefits from the land. Trustees of passive trusts had no responsibility to administer or manage the real property. Instead, they served only to separate legal and equitable title so that a layman could hold legal title to the property and pay taxes while the Church managed and enjoyed the income from the land without breaking mortmain laws.
The Statute of Uses
In 1535, Henry VIII forced Parliament to pass the Statute of Uses to limit the availability of trusts and give them a solid legal foundation. 9 Under the common law doctrine of uses, when a person was granted property for a specific purpose, the courts would require him to carry out that purpose. The Statute of Uses sought to curb the avoidance of taxes by the Catholic Church and to stop feudal tenants from escaping fees owed to the king when the tenant died, his daughters married, or his eldest son was knighted. The Statute of Uses also reinstated the old English rule of primogeniture, under which the first-born son inherited all a lord’s land and titles. 10 The Statute of Uses did not have its intended effect, however, because common law courts interpreted the statute narrowly. As a result, equitable uses continued to exist and eventually developed into the modern doctrine of trusts.
Common law courts strictly interpreted the exact words in the Statute of Uses and continued to apply uses to personal property, because the statute only mentioned certain types of real property. Moreover, because the statute said it applied to land where title was seized (which meant legal possession of the land free from feudal tenure), common law courts held that only freeholds were affected by the Statute of Uses. Thus, the new statute was not applied to land held in feudal tenure. Additionally, the Statute of Uses did not affect active trusts and land held for life or for a term of years. According to common law court rulings, only passive trusts were subject to the Statute of Uses, which allowed the ancient doctrine of uses to evolve into the modern law of trusts. The English law of trusts was codified after 1925 by a series of Parliamentary Acts, but even today, parts of English trust law are based on judicial decisions rather than statutes.
American Trust Law
Trust law in America developed along different lines from English trust law. There were no church courts in America, so jurisdiction over trusts was given to civil courts, which initially enforced the separation of legal and equitable title to land. Gradually, American courts developed a common law of trusts premised on the recognition of the trustee’s fiduciary duties. The American Law Institute published its Restatement of the American Law of Trusts in 1935, codifying earlier common law court decisions affecting trust agreements in the United States. The Institute revised the Restatement of Trusts in 1957.
In general, trusts can be created by operation of law, by will, or through a written agreement between a settlor and trustee. The trust document usually describes the trust assets; names the trustee, settlor, and beneficiaries; and describes the disposition of assets and the parties’ rights and duties. The trustee holds legal title to trust property and manages, invests, and distributes trust assets for the support, maintenance, education, and health of beneficiaries. Often a trustee is given discretion to distribute trust funds according to the beneficiary’s needs, typical standard of living, and the availability of trust income. The trustee may be given discretion to invade trust principal to pay expenses, or the trustee may be restricted to distributing only income from the trust.
In the United States, it is possible to create trusts that are effective during the lifetime of the settlor (living trusts) as well as trusts that become effective on the death of the settlor (testamentary trusts). In the case of a living trust, the document usually (1) appoints the settlor as trustee to manage and administer trust property for his or her own benefit during the settlor’s life; and (2) names successor trustees to manage or distribute the property to successor beneficiaries after the settlor’s death.
The trustee has a fiduciary duty to carry out all terms of the trust without self-interest. The trustee must manage, invest, and distribute the trust property according to the terms of the trust. A trustee that does not do so is in breach of a fiduciary duty and can be replaced and held liable for damages.
Living trusts are used to expedite the transfer of property to named beneficiaries when the settlor dies and allow the transfer of property at the settler’s death without the necessity of probating a will. Another type of trust, called the By-Pass Trust, was used by estate planning attorneys to take advantage of a 50% marital deduction afforded the surviving spouse to avoid estate taxes. 12 Before estate and gift tax exemptions were raised in recent years, many attorneys drafted estate plans that included By-Pass Trusts. By transferring half the estate to a trust for the benefit of a surviving spouse, a couple could postpone paying estate taxes on that portion of their assets until the surviving spouse died. Because the surviving spouse was likely to spend a significant portion of the estate assets prior to death, and payment of estate taxes was postponed for the life of the surviving spouse, the By-Pass Trust could substantially lower the total estate tax bill.
Trusts are also used to support, maintain, educate, and provide health benefits to a surviving spouse, minor descendants, or disabled persons. Because a settlor relies on the good faith of a trustee to carry out the terms of a trust, courts borrowed the concept of fiduciary duty from ancient contract law to enforce good behavior on the part of trustees.
Fiduciary Duty: The Foundation of English and American Trust Law
English courts of equity relied on the ancient concepts of fiduciary duties and adapted them to find bases on which to enforce the informal agreements between landowners and their trustees. The fiduciary duties owed by the trustee continue to be the bedrock of trust law in both England and the United States.
Fiduciary duties were so important in early English common law that four chapters of the Magna Carta listed remedies for heirs against guardians who breached their fiduciary duties by withholding or wasting a ward’s inheritance. 13 Current fiduciary duties in English and American law exceed those developed earlier, but the beginnings of a trustee’s fiduciary duties were visible as early as the thirteenth century in England.
A fiduciary duty owed by one person to another can be found in the Code of Hammurabi, published during the seventeenth century B.C.E. 14 The concepts of agency and fiduciary duty developed in ancient Mesopotamia to govern situations where a merchant gave another person, called an agent, money to invest or purchase goods.
Examples of fiduciary duties can also be found in the Bible and ancient Greek writings. Perhaps the most famous Biblical example is Jesus’s warning, “No man can serve two masters: for either he will hate the one and love the other; or else he will hold to the one and despise the other. Ye cannot serve God and mammon.” 15 In his Republic, the Athenian philosopher Plato outlined the duties a philosopher king owes his subjects, which are similar to modern ideas of fiduciary duty.
Ancient Roman law also used the concept of fiduciary in contract and trust law. Romans used the term “fiduciary” to mean a person having duties analogous to a modern trustee or agent. A Roman agent who refused to account for his principal’s funds could be sent to prison until he produced an accounting or returned the money to his principal. The action of waste in a wardship was also based on the enforcement of a fiduciary duty of a guardian to account for the profits of his ward’s land. The duties of a fiduciary, which included loyalty, care, and prudence, were developed first in ancient contract law and were then applied to trustees.
The doctrine of fiduciary duty was first used by English common law judges to enforce duties owed by an agent to a merchant who gave him funds to purchase goods and have them delivered to the merchant’s place of business. English and American courts applied the idea of a fiduciary duty to the relationship between a trustee and beneficiaries to enforce trust agreements. The trustee’s fiduciary duty was to administer and distribute the property for the use and enjoyment of named beneficiaries in a fair and prudent manner without regard to the trustee’s personal interests. As English and American trust law developed, beneficiaries gained the right to sue in court to force the trustee to administer the property in accordance with the terms of the trust or to be removed, ordered to pay money damages, and replaced by a new trustee who would follow the terms of the trust instrument.
English and American fiduciary duties exceed those developed in ancient times, but the beginnings of legal fiduciary duties were clearly visible in early English common law rulings. While on the New York Court of Appeals, Justice Benjamin Cardozo wrote the most-cited words defining the duties of a fiduciary: Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the marketplace. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. 17
Conclusion
Trusts were developed by courts of equity to avoid the rigid rules of English common law which forbid different persons or entities from holding legal title and equitable use of the land. Trust law developed from equity court decisions based on fairness. Equity court judges enforced informal agreements between a trustee, who held legal title to land, and beneficiaries, who expected the trustee to hold the land for their use and return it at a later date or distribute the land to a successor beneficiary.
If a dispute arose about the rightful ownership of the land, English common law courts could only look to the legal title held by the trustee to determine who was the rightful owner and then award the land to the trustee because he held legal title. In contrast, courts of equity applied the idea of a fiduciary duty owed by a trustee to the settlor or beneficiary to enforce the informal trust agreements rather than allowing dishonest trustees to benefit unfairly.
Modern trusts and the doctrine of fiduciary duties allow decedents to assign legal title to property to a trustee for the use and enjoyment of their dependent beneficiaries. These trusts allow for the care, education, and maintenance of spouses and children after a wage-earner’s death and are useful in estate planning or for care and maintenance of dependents.
Harry Munsinger recently retired from the practice of law, in which he focused on Collaborative Divorces, Estate Planning, and Probate matters. Harry holds a Ph.D. in psychology from the University of Oregon and a J.D. from Duke University School of Law, where he was a member of the Duke Law Journal.
