Monthly Archives: August 2015

August 17, 2015

Colorado Court of Appeals Limits Settlor’s Ability to Exercise Retained Power of Substitution

by Helen Rogers

A recent Colorado Court of Appeals decision suggests that a settlor who retains the power to substitute assets into an intentionally defective irrevocable trust (an “IDIT”) may be prevented from substituting a promissory note into the IDIT, even if the settlor retained the right to substitute assets into the IDIT without the supervision of a fiduciary. The decision, along with the District Court order that it upholds, suggests that a settlor’s retained right to substitute assets into an IDIT is more limited than the settlor might imagine or hope.

In In the Matter of the Trust Created by Mark Vance Condiotti, 14CA0969 (unpublished decision), a settlor established an IDIT (the “Condiotti Trust”) for the benefit of his son. The trust agreement gave the settlor the right to reacquire the trust corpus by substituting other property of an “equivalent value.” The agreement stated that the settlor could exercise this power in a nonfiduciary capacity, without the approval or consent of any person acting in a fiduciary capacity. This “substitution power,” also referred to as a “swap power,” is often included in IDITs because it causes the IDIT to be treated as a grantor trust for income tax purposes but does not cause the IDIT’s assets to be included in the settlor’s estate for estate tax purposes. When an IDIT is treated as a grantor trust, the settlor may pay the income taxes for the IDIT without incurring any gift taxes (thus increasing the value of the trust gift tax-free).

After funding the trust with a diversified portfolio of securities, the settlor notified the trustees of the Condiotti Trust that he intended to reacquire the entire corpus of the Trust in exchange for a promissory note. The promissory note had a face value equal to the value of the Condiotti Trust’s securities, and paid interest at the Applicable Federal Rate.

The trustees refused to accept the promissory note in exchange for the securities. The settlor threatened to sue. The trustees petitioned the District Court of La Plata County, where the trust was then administered, for instructions.

In their petition for instructions, the trustees argued that they could reject the promissory note because the trust agreement only permitted the settlor to substitute assets of equivalent value, and the promissory note did not have a value equivalent to the Trust’s securities because (1) it was unsecured, (2) it bore interest at a low rate, and (3) there was little market for promissory notes. They also argued that the settlor’s proposed substitution was actually a request for a loan from the Condiotti Trust to the settlor, which was not permitted by the trust agreement.

The settlor argued that the promissory note did have a value equal to that of the Condiotti Trust’s assets because it had a face value equal to the value of the trust’s securities, and, under Section 7872 of the Internal Revenue Code, a promissory note is valued at its face value as long as it pays interest at the Applicable Federal Rate and the Settlor is solvent.

The District Court issued an order stating that the trustees were entitled to reject the proposed substitution. First, it stated that, in the context of an asset substitution involving an IDIT, assets will be considered to be of equivalent value if they have (1) an equivalent value under the Internal Revenue Code, AND (2) an equivalent fair market value. As the settlor’s promissory note bore interest at a low rate and there is little market for reselling promissory notes, the District Court found that the note did not have an equivalent fair market value to the Condiotti Trust’s more liquid diversified securities.

Second, the District Court held that the trustees could reject the proposed substitution because it was in fact a request for a loan from the Trust to the settlor, which was not permitted under the trust agreement.

On appeal, the Court of Appeals upheld the District Court’s finding that the proposed substitution was a request for a loan from the Trust to the settlor. The Court provided four questions for courts to consider when determining whether a particular transaction is a loan: (1) do the parties stand in the relationship of debtor and creditor; (2) was a promissory note executed; (3) was interested agreed to or paid; and (4) did the parties agree that the recipient would repay the monies received?

The Court of Appeals did not address the District Court’s finding that the note was not of equivalent value to the trust’s assets.

What does this case mean for settlors who wish to exercise their retained powers of substitution?

First, a settlor should ensure that his or her proposed substitution transaction does not appear to be a loan, especially where the trust agreement does not allow the trust to make loans to the settlor. In fact, the Court of Appeals’ four questions suggest that a settlor should never attempt to substitute a promissory note for trust assets. It is difficult to imagine a scenario in which a substitution of a promissory note into a trust does not result in (1) a debtor-creditor relationship between the settlor and the trust, (2) an executed promissory note, (3) agreed-to interest, and (4) an agreement that the settlor would repay the trust.

Second, any settlor who exercises his or her power of substitution should ensure that the asset being substituted into the trust is truly of equivalent value to the assets being taken out of the trust. The District Court’s Order indicates that a trustee may scrutinize both the tax value and the fair market value of any asset that a settlor proposes to substitute into a trust, and that the trustee may reject a substitution if it determines that either of those values is too low. Additionally, the settlor risks rejection if the property being substituted into the trust could not be resold to the same extent as the property being removed from the trust.

August 3, 2015

Fiduciary Bonds – Who Needs Them?

by J. Robert Smith

As a fiduciary, you may be required, or may want, to obtain a fiduciary bond before you are permitted to serve as a fiduciary. Fiduciary bonds are also known as  probate bonds, executor bonds, administrator bonds, conservatorship bonds, guardianship bonds, and many others, depending on the nature of the fiduciary relationship. 

What is a Fiduciary Bond?

A fiduciary bond is a legal instrument that essentially serves as insurance to protect beneficiaries, heirs and creditors when a fiduciary fails to perform honestly or competently.  A court may require a fiduciary bond for any person or party that has fiduciary duty or responsibility to another. In general, a fiduciary is someone who owes a duty of loyalty to protect the interest of another.  A fiduciary may be a trustee, executor, personal representative, administrator, guardian, financial advisor, or other person exercising control over another person’s assets and/or property. 

The fiduciary bond imposes an obligation on the surety (typically the company issuing the bond or in some states, individuals agreeing to act as sureties) to pay to the court a certain amount in the event that the fiduciary breaches his/her duty.  For instance, if the fiduciary commits fraud, theft or embezzlement of the trust or estate’s assets, a fiduciary bond could help limit the amount of damage to the trust or estate by requiring the surety to cover the amount of funds unlawfully taken.  But such protection is not just limited to intentional acts committed by the fiduciary. It can also protect against a fiduciary who negligently or carelessly causes assets to be lost or depleted. Therefore, to ensure assets are protected, the bond amount is generally set at the amount of the non-real property assets under control of the fiduciary, but may be, and often is, set higher depending on state law. 

How Do I Know If A Fiduciary Bond Is Needed? 

State statutes determine when a bond is required.  The most common situation is in probate actions.  Some states require personal representatives or executors to post a bond in a probate action. This often occurs when a testator failed to include a waiver of the bond requirements in his Will, or the decedent dies intestate.  Other states give the court discretion whether to impose a bond, even if the Will specifically waives the bond requirement.

Sometimes, fiduciary bonds may be requested by beneficiaries or creditors who are concerned about the loyalty or financial status of a fiduciary.  Rather than seeking to have such fiduciary removed, the beneficiary or creditor may request the court impose a bond to ensure that the fiduciary complies with his duties and to further ensure that the assets of the trust, estate or individual will be protected.   Thus, if the fiduciary is determined to be a financial risk, or there is something in the fiduciary’s background that raises questions regarding his ability to manage the assets, a court may require such fiduciary to post a bond.

Notably, most states do not require corporate fiduciaries, such as a bank or trust company, to post fiduciary bonds.  The rationale is that there is a low risk that these entities would be unable to pay back funds that were intentionally or negligently lost.  It should also be pointed out that courts generally do not require a fiduciary bond when the assets being managed are solely real property.  Again, the rationale is that real estate is inherently fixed, and thus there is little concern that such property can be stolen.  This is also why courts generally do not include the value of real estate in its calculation determining the amount of the bond. 

How Much Do Bonds Cost?

State laws also determine the amount of the bond.  As previously explained, the amount of the bond is generally equal to the estimated amount of assets being managed, but may be, and often is, higher.  The cost/premium for the bond is generally based on a percentage of the bond amount. For instance, if the cost/premium is 1% of the bond amount, and that amount was set at $500,000, the premium will be $5,000. Significantly, if the court has ordered a fiduciary bond, the fiduciary is not going to have access to the funds of the estate or trust to pay for the bond until after the bond has been issued. Therefore, the fiduciary must personally pay for the bond.  And unless an instrument provides that the estate or trust is to reimburse the fiduciary, the fiduciary will likely bear this expense personally.  Conversely, even if the instrument does allow a fiduciary to be reimbursed, the premium will still reduce the amount that the heirs, beneficiaries and creditors will receive from the estate, trust or individual. Thus, fiduciary bonds are a hidden cost of probate, trust, guardianship and other proceedings. 

It should also be noted that the amount of the bond may fluctuate over time.  If more assets are discovered, the amount could increase.  If a distribution is made from the estate, the amount could decrease.  Fiduciaries should, therefore, monitor the amount of the bond to be sure that it accurately reflects the value of the assets at issue.

In addition, fiduciary bonds are typically renewed annually. Consequently, the longer a person remains a fiduciary, the more money they will have to pay out in premiums. 

Some states, however, allow a fiduciary to deposit the money he/she is handling into a blocked account at a domestic financial institution.  The amount of money deposited into such blocked account will allow the bond to be reduced by the equivalent amount.  As a result, to reduce the amount of the premiums, a fiduciary may want to consider having the funds placed into a blocked account. Of course, doing so would prevent the fiduciary from accessing such funds to pay other expenses that may or may not be foreseeable.  Therefore, if a blocked account is an option for the fiduciary, he/she should consider the amount and ramifications of placing such money into that account.

How Do I Get a Fiduciary Bond?

Even if the cost of the fiduciary bond is not at issue, actually acquiring the bond may be.  When a fiduciary bond is needed, the fiduciary is generally the one who has the burden of obtaining it. 

There are numerous bonding companies that offer fiduciary bonds.  The first step is contacting the bonding company, who will send the fiduciary an application to complete.  Applying for a bond is similar to applying for a loan. Bond companies will typically check the credit and background of the intended fiduciary and only issue the bond if that person meets underwriting criteria. The higher the bond amount, the more detailed the company will be in issuing the bond. And if the fiduciary does not qualify for the amount of the bond, it will not be approved. Therefore, if a fiduciary knows they are a financial risk and will not be approved for the amount of the bond, it may make sense for them to decline serving in that capacity before going through the time and expense of applying for the bond.  For instance, if the fiduciary needs a $500,000 bond, but was recently rejected for $300,000 home loan, it is unlikely that the fiduciary will be approved for the bond. The same is true if the fiduciary has a criminal record, or has filed bankruptcy in the past.  It, therefore, does not make much financial sense to apply for a fiduciary bond under these circumstances.

Moreover, even if the fiduciary qualifies for a fiduciary bond, it can take several months to be approved for such bond. So, if a fiduciary bond is required, the fiduciary should move promptly in trying to obtain the bond with the expectation that it could take a long time to be approved.  


Because the requirements surrounding fiduciary bonds can vary from state to state, whenever a fiduciary bond is required, or recommended, the fiduciary should promptly contact their counsel for help in navigating the bonding rules, understanding the associated costs, applying for the bond, and filing the proper paperwork with the court.  Doing so will help avoid unnecessary time and expense.