Delaware Statutory Trusts – Trusts

Business trusts have been recognized by the common law of Delaware since 1947, however, there was no express statutory recognition of the business trust in Delaware until the passage of the Delaware Statutory Trust Act (originally called Delaware Business Trust Act), 12 Del.C. c.38 (the Act), in 1988.

The law was drafted by a committee of the Delaware State Bar Association composed primarily of practitioners who have focused their practices in the area of ​​corporate finance. The objective of the drafting committee was to increase the usefulness of the commercial trust in modern financing transactions by overriding the common law principles of trusts which were deemed disadvantageous and by including certain new provisions to statutorily permit a high degree of freedom of contract between the trustees and the trustee to determine their respective responsibilities and how the trust might be administered.

The statute expressly includes all pre-existing statutory and common laws relating to trusts, except to the extent that such law conflicts with the statute or the terms of the instrument governing a Delaware Statutory Trust (DST) constituted under the law. The success of the law is measured by the large number of DSTs currently used in asset securitizations, leveraged lease financings, mutual fund offerings, and a variety of other financing transactions.

Under traditional common law principles, the administration of a trust is vested in a trustee who is charged with broad fiduciary duties to the trust and its beneficiaries. Such obligations not only preclude the trustee from delegating some of its management discretion to the trust, but also impose a strict standard of care and limit the compensation available to the trustee for discharging those obligations. The administration of many modern business trusts, however, requires specialized knowledge outside the scope of expertise of corporate trustees. Allowing the beneficiary of a trust (or anyone else) to control the business decisions of the trustee runs the risk, under common law, of the trust being considered an agency instead of (or in addition to) a trust with several disastrous results: the beneficiary may become liable for the obligations of the trust, and the creditors of the beneficiary may be able to disregard the trust and access its assets to satisfy related or unrelated obligations of the beneficiary. Further, a Trustee who improperly delegates discretion may become personally liable for any resulting loss and may not be held liable or compensated for such losses to the extent caused by actual or imputed negligence of the Trustee. .

Under the law, however, a beneficiary of a DST has the express power to control the trustee (or even to act as a trustee himself) without running any risk of personal liability or any risk that his creditors may access the assets of the trust. Indeed, the law provides that a beneficiary of a DST will have the same limitation of personal liability as that which is extended to shareholders of private for-profit companies and that no creditor of a beneficial owner has the right to to obtain possession of or otherwise exercise any equitable rights or remedies with respect to the ownership of a DST.

In addition, the DST Act expressly provides protections for DST administrators. For example, the Act provides that to the extent that a trustee has duties (including fiduciary duties) and liabilities relating thereto, to a business trust, to another trustee, to a beneficiary thereof or to a third party, such duties and responsibilities may be extended, restricted or eliminated by the trust deed, and a trustee is not liable for relying in good faith under the terms of such trust deed . This means that the duties, obligations or liabilities of a trustee of a DST may be limited, or even eliminated, by the terms of the instrument governing the DST. (The only caveat to this limitation is that a governance instrument cannot eliminate any claim or liability arising from a fiduciary’s breach of the implied contractual covenant of good faith and fair dealing.)

Similarly, under the Act, a DST has the express power to indemnify and hold harmless the trustee, beneficial owner or other person against any claim whatsoever, subject only to the limitations set forth in the trust document.

In addition, the statute provides that, except as otherwise expressly provided in the trust instrument, a trustee “shall not be personally liable to any person other than the statutory trust or a beneficial owner for any act, omission or obligation of the trust legal entity or any trustee thereof. These provisions provide substantial protections (and comfort) to DST trustees in that the liabilities a trustee may face may be strictly limited while the protections offered by indemnification may be very broad.

Virtually all modern financings involving a DST require, in practice, that the trust be considered an entity remote from bankruptcy vis-à-vis its beneficiary. In addition to the trustee control issues noted above, under common law a single settlor/beneficiary of a trust generally has the power to terminate the trust at will, notwithstanding any agreement to the contrary set forth in the deed. constituting the trust. Such power prevents the creation of an entity remote from bankruptcy because, according to the principles of bankruptcy and insolvency, a creditor stands in the place of his debtor, and if a debtor has the power to terminate to a trust and to access the assets of the trust, then a creditor of such a debtor also has that power. Under the Act, however, except to the extent provided in its constitutive instrument, a DST has perpetual existence and cannot be terminated or revoked by a beneficial owner or any other person, or otherwise terminated by death, incapacity , dissolution, termination or bankruptcy of its beneficial owner.

In addition to modifying many common law principles such as those mentioned above, the law also makes many new legal provisions applicable to TSNs. Under the law, a DST is a separate legal entity and may engage in any legal business or activity, whether or not conducted for profit, including holding or otherwise taking title to property. Further, for purposes of taxation under Delaware law, a DST is classified as a corporation, association, partnership, trust, or other, as determined under the Internal Revenue Code. In addition, a DST may merge or consolidate with or into one or more other business trusts or other business entities, and in respect thereto, rights or title or interest in a DST may be exchanged for or converted into cash, property , rights or titles of, or interests in, any other Constituent Party to the Merger. However, in order to take advantage of the protections afforded by law, Delaware law imposes the requirement that at least one of the trustees, if not an individual resident in Delaware, have their principal place of business in the State of Delaware.

Because of the certainty of limited liability of beneficial owners and trustees and the protection of trust assets from creditors, as well as the inherent flexibility in how a business trust established under Act, DSTs are currently used not only in place of common law business trusts, but also as a replacement for other business entities in a wide variety of financing transactions. The only apparent limitation to the use of a DST in the financial field is the imagination of the drafter of the instrument governing the trust.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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