Delaware Statutory Trusts

Statutory trusts have been recognized by the Delaware common law since 1947, however, there was no express statutory recognition of the statutory trust in Delaware until the passage of the Delaware Statutory Trust Act, 12 Del. C. 3801 et. seq. (the "Act"), in 1988.  The Act was drafted to increase the utility of the statutory trust in modern financing transactions by overruling those principles of the common law of trusts which were deemed disadvantageous and including certain new provisions to statutorily authorize a high degree of freedom of contract between the trustor and the trustee in determining their respective liabilities and the manner in which the trust could be administered.  The Act expressly includes all pre-existing statutory and common law with respect to trusts, except to the extent otherwise provided in the Act or in the terms of the governing instrument of a Delaware statutory trust formed under the Act.

Under traditional common law principles, the administration of a trust is vested in a trustee who is charged with broad fiduciary obligations to the trust and its beneficiaries.  Such obligations not only prevent the trustee from delegating any of its discretion any authority with respect to the management of the trust, but also impose a strict standard of care on, and limit the indemnity available to, the trustee in fulfilling such obligations.  The administration of many modern statutory trusts, however, requires specialized knowledge outside the scope of expertise of corporate fiduciaries.  Under common law theories, allowing anyone other than the trustee to control the business decisions of a trust may lead to the trust being deemed to constitute an agency instead of (or in addition to) a trust.  Classification as an agency relationship may have disastrous results including, without limitation, that a trust beneficiary may become liable for the obligations of the trust, and that a creditor of the beneficiary may be able to disregard the trust and reach its assets to satisfy related or unrelated obligations of the beneficiary.  In addition, a trustee who improperly delegates its discretion may become personally liable for any resulting losses and may not be able to be held harmless against, or indemnified for, such losses.

Under the Act, however, to the extent provided in the governing instrument, a beneficiary shall be entitled to direct the trustee of a statutory Delaware statutory trust without the risk of personal liability for the debts of the trust or the risk that the creditors of the beneficiary could reach the assets of the trust itself.  Indeed, the Act provides that a beneficiary of a Delaware statutory trust shall have the same limitation of personalliability as is extended to a stockholder of a private corporation for profit organized under Delaware law and that no creditor of a beneficial owner has any right to obtain possession of, or otherwise exercise legal or equitable remedies with respect to, the property of a Delaware statutory trust.  Moreover, the Act expressly provides that to the extent that, at law or in equity, a trustee has duties (including fiduciary duties) and liabilities relating there to to a statutory trust or to a beneficiary thereof, such duties and liabilities may be expanded or restricted by the trust's governing instrument, and a trustee shall have no liability for its good faith reliance on the terms of such governing instrument.  Likewise, under the Act, a statutory trust has express authority to indemnify and hold harmless the trustee, beneficial owner or any other person from and against any and all claims whatsoever, subject only to such restrictions as are set forth in the trust's governing instrument.

Virtually every modern financing involving a statutory trust requires, as a practical matter, that the statutory trust be deemed a bankruptcy remote entity vis-a-vis the beneficiary thereof.  Apart from the trustee control problems noted above, under the common law, a sole settler/beneficiary of a trust generally has the power to terminate the trust at will, not withstanding any agreement to the contrary set forth in the trust's governing instrument.  Such a power prevents the creation of a bankruptcy remote entity because under bankruptcy and insolvency principles, a creditor stands in the shoes of its debtor, and if a debtor has the power to terminate a trust and reach the trust's assets, then a creditor of such debtor also has such power.  Under the Act, however, except to the extent provided in its governing instrument, a statutory trust has perpetual existence and may not be terminated or revoked by a beneficial owner or any other person, or otherwise terminated by the death, in capacity, dissolution, termination or bankruptcy of its beneficial owner.

In addition to modifying many principles of common law, the Act also includes many provisions that increase the desirability of the statutory trust format.  For instance, the Act specifically provides that a Delaware statutory trust is a separate legal entity and may carryon any lawful business or activity, whether or not conducted for profit, including holding or otherwise taking title to property.  In addition, the Act allows the drafter of the trust instrument flexibility with respect to the tax classification of the trust in that it permits the drafter to select which of the four so-called "corporate characteristics," to include or exclude depending upon the desired tax treatment.  Similarly, for purposes of taxation under Delaware law, a statutory trust is classified as a corporation, an association, a partnership, a trust or otherwise, as determined under the Internal Revenue Code.  Furthermore, a Delaware statutory trust may merge or consolidate with or into one or more other statutory trusts or other business entities, and in connection there with, rights or securities of, or interest in, a statutory trust may be exchanged for or converted into cash, property, rights or securities of, or interests in, any other constituent party to the merger.

As a result of the certainty with respect to the limited liability of beneficial owners and trustees and the protection of trust assets from creditors, as well as the inherent flexibility with respect to the manner of administration of a statutory trust formed under the Act, Delaware statutory trusts are currently being used not only in place of common law statutory trusts but also as replacements for other business entities in a wide variety of financing transactions.