The Maine Legislature recently enacted, and Governor King approved, a modified version of a uniform act which took effect on January 1, 2003 and has important implications for the trustees of trusts governed by Maine law. Officially known as the “Uniform Principal and Income Act of 1997,” it is often called NUPIA (meaning the “new uniform principal and income act”), which is the term we will use throughout this summary. In many ways NUPIA represents companion legislation to another statute, the Uniform Prudent Investor Act, which became effective in Maine in 1997. That earlier legislation adopted the so-called prudent investor rule for Maine trusts, thereby allowing the trustees of such trusts to invest for “total return” so long as such an approach is appropriate for the beneficiaries of the trust and consistent with the settlor’s objectives. The settlor is the person who created the trust, sometimes referred to as the donor or the grantor. Total return investing takes into account both earned income and capital appreciation in determining investment results.

The Problem

It is often difficult for a trustee to invest for total return and at the same time distribute a fair share of that return to the income beneficiary of a trust. The reason for this is that, according to traditional trust accounting concepts, the term “income” is limited to dividends, interest, rents, and similar items. It does not include capital appreciation or even realized capital gains. With investment yields of traditional ordinary income averaging less than 2% in recent years, trustees have been faced with a dilemma in trying to optimize their overall investment results (seeking high total returns) while at the same time distributing a fair share of “trust income” to the income beneficiaries of their trusts. NUPIA provides the trustees of Maine trusts with two new options (which are mutually exclusive of each other) to help deal with this dilemma: (1) the power to make equitable adjustments, and (2) the power to convert to a unitrust.

Power to Adjust

New Section 7-704 of the Maine Probate Code authorizes a trustee to allocate some trust principal to income, or some trust income to principal, as needed to generate a “fair share” distribution to each income beneficiary of the trust. The purpose of this section is to enable trustees to select investments using the standards of a prudent investor without the constraint of realizing a particular portion of the trust’s total return in the form of traditional trust income. In deciding whether or not (and how) to exercise this power to make such an equitable adjustment, a trustee is to consider all relevant factors, including such things as:

1. The nature, purpose and expected duration of the trust.

2. The intent of the settlor.

3. The circumstances and needs of the beneficiaries.

4. The types of property owned by the trust.

5. The anticipated effect of inflation/deflation, other economic conditions, and tax consequences.

A trustee’s decision about exercising this power to adjust is subject to judicial review, but only for abuse of discretion. The courts are not to substitute their own judgment for that of the trustee. Judges may overturn a trustee decision regarding the power to adjust only if they find there was an abuse of discretion; and in the event this is what the court concludes, then the preferred remedy set forth in the statute is restitution: restoring the income and remainder beneficiaries to the positions they would have occupied if there had been no abuse. Only to the extent this is not possible may a court require a trustee to pay an appropriate amount from the trustee’s own funds to remedy the abuse.

Power to Convert to Unitrust

New Section 7-705 of the Maine Probate Code provides a different alternative. If a trustee determines that conversion to a unitrust will enable the trustee to better carry out the intent of the settlor and the purposes of the trust, then the trustee can make that conversion after giving appropriate written notice to both income and remainder beneficiaries and receiving no objection to the conversion within a 60-day period. If there is an objection, then the trustee may seek court approval of the conversion. If a beneficiary wants the trust converted to a unitrust and the trustee refuses, then the beneficiary may request the court to direct that the conversion be made if it determines this would be consistent with the intent of the settlor and the purposes of the trust. Once a trust is converted to a unitrust, it cannot be converted back without court approval. Also, there is no trustee power to adjust when the trust is a unitrust; but if it later converts back with court approval, then the power to adjust is reinstated.

Once a trust is converted to a unitrust, the term “income” with regard to that trust will mean an amount equal to 4% of the fair market value of the trust determined on the basis of a 3-year rolling average. Distinctions between trust income and trust principal will become meaningless; and expenses normally deducted from income (to determine net distributable income) will not be taken out of the 4% distribution but instead will be paid by the trust. For income tax reporting purposes, unless otherwise provided by the trust instrument, the income beneficiary or beneficiaries receiving the 4% distribution will be receiving the trust’s ordinary income first, then short-term capital gains, then long-term capital gains, and finally tax-free principal.

In deciding whether or not to convert to a unitrust, a trustee is to consider all relevant factors, including most of those listed above with regard to the power to adjust (other than “intent of the settlor”); and as in the case of the power to adjust, the trustee’s decision is subject to judicial review, but only for abuse of discretion. The same provisions apply here as well regarding the restitution remedy and surcharge of a trustee only when restitution is not adequate to restore the trust beneficiaries to the position they would have occupied if there had been no abuse of trustee discretion.

Conclusion

Starting January 1, 2003, NUPIA will provide trustees in Maine with a choice of three (3) alternative approaches to determining a fair share allocation of a trust’s total return to the income beneficiaries of that trust: (1) continue to distribute traditional trust income as before, or (2) make an equitable adjustment between income and principal, or (3) abandon principal/income distinctions completely and convert to a 4% unitrust. There is no fiduciary duty to choose any particular option; but there is a fiduciary duty to make a conscious decision, after considering all relevant factors as set forth above, about which option best serves the interests of the beneficiaries and the purposes of the trust. This means that trustees in Maine will have to start documenting in their files the information they have considered in making these determinations. Such documentation should begin in the early part of 2003, and should be updated at least annually thereafter.

Disclaimer: Nothing in this Client Alert should be taken as legal advice for any individual case or situation. The information in these articles is intended to be general in nature and should not be relied upon for any specific set of circumstances. You should consult with an experienced attorney before applying the information in this Client Alert to your own situation.

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