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Can a Trustee of an Irrevocable Trust Borrow Against the Equity of Property Included in a Trust?

A trustee is invested with significant responsibility over a trust’s property, since he has the legal ability to control it. That legal right is tempered by the obligation to manage the trust for the benefit of the beneficiaries. Under these two general principles, a trustee may borrow against the property in a trust, but should be hesitant to do so for his own personal benefit.

  1. Trusts in General

    • A trust is a means for a donor to transfer property for the benefit of one party, while ensuring the property is properly managed by a third. A trust is created by a document written by the donor of the underlying property, which specifies the purpose of the trust, how the beneficiaries are to benefit, and the guidelines for managing the property. Unless otherwise specified, trusts are assumed to be irrevocable. This means that the trust cannot be modified or terminated without the approval of the beneficiaries. A trust must be organized within the guidelines of the law of the state in which it is located, so standards differ. The Uniform Trust Code (UTC) has been adopted by 23 states and is being considered by three others. The widespread acceptance of the UTC, as well as its endorsement by the American Bar Association, makes it an appropriate baseline for general discussions.

    Trustees Powers and Duties

    • The person who manages trust property is known as the trustee. A trustee’s legal powers over the trust’s property are bound by his fiduciary responsibility to the beneficiaries. A fiduciary duty is a responsibility that compels a person to act in another’s best interest while carrying out certain duties. The trustee must put the interests of the beneficiaries ahead of his own when taking actions related to the trust’s property. Beyond just the general obligation to act in the beneficiaries’ best interest, the trustee must conform to the specific requirements described in the document that set up the trust. Failure to conform to these specific requirements, or to the general fiduciary standard, could leave the trustee open to a lawsuit by the beneficiaries for breach of duty.

    Borrowing Against Trust Property

    • A trustee is allowed to use trust property as collateral for loans without limitation when that loan is for the benefit of a beneficiary or beneficiaries. Allowing trust property to secure an individual’s is subject to the presence of a spendthrift clause in the trust’s underlying organization document. This clause prevents beneficiaries from mortgaging his interest in the trust to secure a short-term loan of cash, which in effect protects the beneficiaries’ long-term interest. The trustee is allowed to use the trust’s property to secure loans for his benefit in very limited circumstances. If the terms of the trust permit the trustee to use the trust property to secure a loan, a court permits him to use the assets as personal collateral, or if the beneficiary consents to allowing the trustee to use the assets, the trustee may do so. However, these standards must be balanced against the trustee’s fiduciary duty, which makes it rare for any of the first two conditions to occur. Also, if the trustee secures the beneficiary's consent, he may be susceptible to a breach of duty lawsuit if he is unable to repay the debt and the trust’s property is taken by the person who holds the debt.

    Considerations

    • If you are constructing a trust, consult with a licensed attorney in your area to ensure that you meet all state and federal requirements. While every effort has been taken to ensure that this article’s completeness and accuracy, it is not intended to be legal advice.

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