The Challenges of Transactions Involving Trusts or Trust Property

Some loan transactions may involve trusts as borrowers, guarantors or pledgers of collateral. If the trust instruments permit, lenders may enter into transactions involving trusts, including those when the trustee or beneficiaries use the trust property as security for a loan. Even with permissive trust language, lenders should be careful in such transactions to ensure loan documents are properly executed and that the provisions and requirements of the Uniform Trust Code ("UTC") are complied with in order to ensure that the loan documents are enforceable and the lender receives a valid, perfected and enforceable security interest in the trust property or a valid obligation of the trust as borrower or guarantor.

The varied nature of trusts means there really is no "standard" transaction involving a trust and all such transactions merit enhanced scrutiny and due diligence and lenders should consider whether to engage counsel in the review and drafting of loan documents. This enhanced scrutiny and due diligence is necessary both for purposes of perfection of security interests in trust property and also for protection of a lender from potential liability, for example if the beneficiary and/or the trustee acts fraudulently or fails to comply with the terms of the trust.^[1]

When dealing with trusts or trust property as collateral, the traditional rules of perfection apply to the type of property being pledged. For instance, if the trust property being used as collateral is real property then the lien on the collateral must be perfected through a properly executed and recorded deed of trust. Beyond lien perfection, the key in dealing with trusts and trust property is ensuring that all of the loan documents executed on behalf of the trust have been properly authorized and executed. This is where the UTC becomes applicable.

The Uniform Trust Code

The UTC was adopted in Virginia in 2006 and has been adopted in many other states. The UTC was designed to provide uniform rules for those dealing with trusts, where different states' laws had previously diverged or the law was unclear.

An important provision of the UTC which provides protection to lenders is contained in Section 64.2-804 of the Code of Virginia. Section 64.2-804 allows lenders and others to rely on a "certification of trust" in transactions rather than requiring them to interpret the trust documents. This also protects the trust and the beneficiaries from having to reveal the whole trust instrument to third parties. A certification of trust is a written document signed or otherwise authenticated by the trustee of the trust that contains the following information:

1. That the trust exists and the date the trust instrument was executed;
2. The identity of the settlor;
3. The identity and address of the currently acting trustee;
4. The powers of the trustee;
5. The revocability or irrevocability of the trust and the identity of any person holding a power to revoke the trust;
6. The authority of cotrustees to sign or otherwise authenticate and whether all or less than all are required in order to exercise powers of the trustee;
7. The trust's taxpayer identification number;
8. The manner of taking title to trust property; and
9. A statement that the trust has not been revoked, modified, or amended in any manner that would cause the representations contained in the certification of trust to be incorrect.

Section 64.2-804 protects those dealing with a trust, providing that a person who "acts in reliance on a certification of trust without knowledge that the representations contained therein are incorrect is not liable to any person for so acting and may assume without inquiry the existence of the facts contained in the certification."^[2] This section also protects the lender by providing that a "person who in good faith enters into a transaction in reliance upon a certification of trust may enforce the transaction against the trust property as if the representations contained in the certification were correct."^[3]In addition, this section permits the recipient of a certification of trust to require the trustee to provide copies of the relevant excerpts of the original trust documents (and any amendments) that designate the trustee and confer upon the trustee the power to act in the transaction^.[4]

The protections afforded by a properly executed certification of trust make a certification of trust a very powerful and important tool for a lender because it provides a safe harbor in the transaction. Without a certification of trust, should a question arise about the transaction the lender could be left arguing good faith and fair value defenses in order to support its right to rely on the execution of the documents underlying the transaction or avoid liability.^[5]

Practical Considerations in Transactions Involving a Trust

Obtaining the certification of trust is an important step in determining the suitability of dealing with trusts as borrowers or guarantors or of relying on the trust property as collateral to secure the loan. However, lenders should be aware of potential "red flags" and more carefully scrutinize transactions that exhibit these signs. Examples of red flags are situations where:

1. the lender is dealing with a self-interested trustee: i.e. the trustee (or his family, business, business partner, affiliate, etc.) rather than the trust or its beneficiary is benefitting from the transaction;
2. the transaction disproportionately benefits one or more beneficiaries over others;
3. there is a lack of professional accounting or tax returns for the trust;
4. the trust lacks a taxpayer ID number; and
5. the trust is unable to show compliance with reporting requirements.

Lenders should also review or have their counsel review the certification of trust to ensure that it properly complies with the requirements of the UTC. Other ways to safeguard the transaction include: (i) obtaining the signature of the settlor of the trust on all documentation related to the transaction (if the settlor is still alive and competent) and (ii) having all beneficiaries of the trust (or their representatives) execute documentation acknowledging the transaction, while the trustee executes all other documents related to the transaction.^[6]

Please note that this article is not an exhaustive review of the UTC or the procedures for dealing with trusts in loan transactions and it is not intended as advice for any particular situation. Any questions on procedures, agreements or actions related to trusts or the UTC should be reviewed by the lender's counsel.

[1] This article does not address in detail the potential liability to lenders related to trust property; however, lenders need to be aware of Virginia Code Section 64.2-796(D) which provides "whenever fraud has been perpetrated in connection with any proceeding or in any statement filed under this chapter, or if fraud is used to avoid or circumvent the provisions or purposes of this chapter, any person injured thereby may obtain appropriate relief against the perpetrator of the fraud or restitution from any person benefiting from the fraud, whether innocent or not, except for a bona fide purchaser."
[2] Virginia Code Section 64.2-804(F).
[3] Virginia Code Section 64.2-804(G).
[4] Virginia Code Section 64.2-804(E).
[5] See Virginia Code Section 64.2-803, "A person other than a beneficiary who in good faith assists a trustee, or who in good faith and for value deals with a trustee, without knowledge that the trustee is exceeding or improperly exercising the trustee's powers, is protected from liability as if the trustee properly exercised the power."
[6] Lenders need to be careful not to simply demand the trust instrument in connection with the transaction as Virginia Code Section 64.2-804(H) provides, "[a] person making a demand for the trust instrument in addition to a certification of trust or excerpts is liable for damages if the court determines that the person did not act in good faith in demanding the trust instrument."