Avoiding UPIA Liabilities

A trustee managing a trust with a heavy concentration in one asset (e.g. a family business) can fall into a liability trap under the Uniform Prudent Investor Act if a will puts restrictions on the trustee’s ability to diversify (diversification is a requirement under the UPIDA). Four ways a settlor can helping a trustee avoid potential liability in these situations are below:

1. Directed Trusts: These trusts allow a settlor to appoint a third party to direct the trustee’s investing. In some states, directed trusts even give trustees some legal protection.
2. Retention Clauses: The settlor of the trust can specify in writing the reasons behind his or her wish to hold on to a concentrated position. However, these clauses can be challenged in court, and the trustee will still owe an obligation to the beneficiaries to monitor the assets and diversify them if it is prudent to do so.
3. Use a “Collar”: Hedge against a depreciation in an asset’s value by using a “collar” (i.e. sell a call option on a stock held by the trust while buying a put). 
4. Charitable Trusts: A settlor can create a charitable trust and then sell to the trust heavily appreciated trust holdings.

See Lauren Foster, Warning: Too Many Eggs in One Basket, Barron’s Penta, Sep. 17, 2011.

Special thanks to Joel Dobris (Professor of Law, UC Davis School of Law) for bringing this article to my attention.