The Tennessee Advantage: Directed Trust and Special Purpose Entities
June 19, 2020
Establishing, building and safeguarding a family’s legacy requires the coordination of experts and flexible tools. It requires us to help families understand the present and prepare for the future. Among top wealth practitioners, there is a consensus that families have to get structure, process, and jurisdiction right to enhance their legacy’s long-term success.
Traditionally, when families sought help in establishing and governing their future legacy, they would seek expertise and decision-making from a single trustee or trust company. Many prominent families consolidated the functions of asset management and distribution management into one individual or corporate fiduciary
However, best practices and business models have changed. Some states have become more friendly to wealth structuring and preservation. The job of being a trustee is too complex with significant liability concerns for most individuals. Most corporate fiduciaries have become too unwieldy to operate efficiently. For most trust companies with multiple business lines and profit motives, operating with the same independence, priorities and relationships a decade from now is a low probability event.
This could lead to undesirable results:
• Decisions made out of alignment with the family’s wishes,
• Irreconcilable conflicts of interest and poor interaction with advisors,
• Wasted assets,
• Damage to family and community relationships, or
• Destroyed legacies.
Over the past few decades, thoughtful stewards of wealth recognized these issues. Wealthy families and the modern estate planning community saw that not all people, institutions and jurisdictions can be good at every function. Many wealthy families now understand that structural flexibility and impartial advice is their best defense against the unknown.
To that end, in certain jurisdictions like Tennessee, “directed trusts” have become a common way for families to use the jurisdictional advantage and administrative expertise of trust companies while bifurcating the roles of:
a) asset management to those trusted individuals and firms that have unique insight into the family’s assets and
b) distribution management to those people who can put structure around the distribution process while incorporating the family’s dynamics.
The roles of asset and distribution management are functions with significant responsibility. Many wealthy families are creating committee structures to incorporate expert thinking, a diversity of viewpoints and a check and balance approach to make difficult and complex decisions around wealth.
Tennessee has developed a structure around this best practice. The Special Purpose Entity (“SPE”) is an LLC or other corporate entity formed to work in conjunction with a directed trust. It allows families to use the jurisdictional advantages of Tennessee with the administrative capabilities of a firm like Pendleton Square Trust Company, LLC. It is a flexible structure that can have a board of directors appoint members to the investment and distribution committees.
The first major benefit of a SPE involves administrative consolidation and customization. Many investment committees have to deal with unique assets and businesses and oversee traditional liquid market investments. With the SPE, a family can incorporate investment experts and executives to make decisions that are particular to the trust asset management yet integrated with the needs of the family. Similarly, distribution committees can be set up with family members and
advisors to ensure that distributions are made both within the letter and spirit of the trust instrument. For families with multiple branches, one SPE could be used for multiple trusts, thus reducing administrative hassle. In many other states with directed trust capability, there is a tension with committees and entities operating outside the purview of the law in discharging their fiduciary responsibilities around investments, distributions and oversight. Tennessee is one of the few
states to statutorily allow a SPE to exercise fiduciary powers.
Secondly, the SPE is an entity that limits liability for the decision makers by virtue of its structure as an LLC or corporation. By using an entity to house the process around fiduciary decision-making, the committee members get the benefit of liability protection at the entity level. This reduces the liability to the advisor normally found in individual trustee situations. Additionally, when liability insurance is required for the decision-makers, the SPE structure may help reduce costs.
Finally, the SPE is a useful entity when dealing with a trust’s exposure to outside state taxes. Many families want to engage advisors whose state residency outside of Tennessee could expose the trust to negative consequences. By serving on the board of an SPE in Tennessee, the participating individual should be able to act as an advisor without exposing the trust to a tax liability in the individual’s state of residence. Provided that all the SPE’s official activities occur in Tennessee and that the corporate fiduciary is in Tennessee (as is the case with Pendleton Square), the residency of the outside advisor should not subject the trust to the advisor’s resident state tax regime.
The law and best practices around wealth management, taxation and trust administration have changed significantly within the last ten years. Tennessee is a leader in establishing flexible tools like the Special Purpose Entity and the durable legal framework that prominent families need to establish their legacies, take advantage of opportunities and protect their wealth. Pendleton Square is dedicated to helping families utilize the Tennessee jurisdiction and implement the structures needed for a long and healthy family legacy.
About the author: Frazer Rice is a Regional Director of Pendleton Square Trust Company, a leading independent trust company chartered in the State of Tennessee. Nothing in this article should be construed as providing legal or tax advice regarding your specific situation.