What role does a Delaware Statutory Trust (DST) sponsor play?

What is a DST sponsor?

To form a Delaware Statutory Trust (DST), a certificate of trust with the Office of the Secretary of State of Delaware is an indispensable document required by law. In the certificate, it must set out the name of the statutory trust and its business address. More importantly, at least one trustee must be a resident of Delaware, which can be satisfied by naming a Delaware trust company or by forming a Delaware corporation to act as the trustee (see 12 §§ 3807). So what exactly is a DST trustee?

 DST sponsor is another name for DST trustees. It is also known as the asset manager of DST’s investment. For the purpose of this article, those three titles will be used interchangeably. In general, DST sponsors are the property hunters for the investors. They are in charge of assessing and evaluating potential properties. Afterward, they will make an offer on one or multiple properties and encapsulate this property investment under the framework of DST. Finally, the sponsors will reach out to the investors for purchases. The investors can either directly cash in or join the DST via the 1031 Exchange which permits investors to defer paying their capital gains taxes resulting from the Exchange. It is important to be aware that DST possesses its own separate legal personality which is represented by the sponsor. Consequently, the loan procurement or the property purchase will be negotiated and concluded by the DST sponsor on behalf of the trust with external parties, such as banks or property sellers.

Unlike Tenants-In-Common (TIC), the limitation of one-year trusteeship does not apply to DST trustees. In other words, a trustee can hold his or her trusteeship for a DST for an unlimited time. In practice, this is a valuable advantage for a DST to secure a loan from creditors, due to the enduring certainty it provides for a loan provider to identify and record the debtor on paper. After a DST is established by a sponsor and investors, the sponsor will then act as an asset manager to maintain the value of the property on a daily basis. The property management activities that the sponsor can operate is not unlimited. For example, the sponsor can only spend money on maintaining the real estates property, such as standard repairs and minor non-structural changes. He or she is not allowed to upgrade the property like an investment. Further restrictions upon a DST trustee are as follows:

DST trustee is restricted to accept more financial contributions to the trust after the offering is closed. It is to protect the original investors’ ownerships from being diluted.

Because the investors of DST generally do not participate in the operation of the trust, the trustee is prohibited to borrow or negotiate new loans which could alter the financial liabilities of the investors (also known as beneficiaries).

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The profit gained from DST cannot be used by the trustee to reinvest. It must be distributed among the beneficiaries based on the agreement.

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In line with preventing the trustee from risking beneficiaries’ interest, the trustee is prohibited from renegotiating the existing lease or entering a new lease, unless a tenant enters into bankruptcy or insolvency.

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Another benefit of having a DST is that the relationship among the trust parties and the operation of a trust, particularly related to trusteeship, can be crafted almost freely by the investors in the trust agreement (also known as a governing document). In other words, a governing instrument may contain any provisions relating to the management of the business and affairs of the statutory trust, the rights, duties, trustee appointment procedure, and obligations of the trustees, beneficial owners, and other persons. Moreover, a trustee can follow the directions from a third-party investment or management adviser only when he or she is authorized by the governing document.

Although a DST trustee owes a fiduciary duty to the investors, the conflicts sometimes do arise in practice when investors demand the trustee to grant their access to confidential information pertinent to the trust’s management. In general, DST investors do not participate in the management of the trust itself. The trust is operated by the appointed trustee. However, subject to reasonable standards as may be established by the trustees, DST Title 12 ss 3819 provides limited rights for beneficial owners to obtain and inspect the following documents “from the statutory trust from time to time upon reasonable demand for any purpose reasonably related to the beneficial owner’s interest”:

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Copies of the governing instrument, certificate of trust, and all amendments, together with copies of any written powers of attorney.
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A current list of the name and last known business, residence, or mailing address of each beneficial owner and trustee.
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Information regarding the business and financial condition of the statutory trust; and
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Other information regarding the affairs of the statutory trust as is just and reasonable.
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However, such a right to access confidential information by a beneficial owner is not absolute. The trustee can withhold requested documents “for a period of time” as he or she deems reasonable. By withholding such documents, the trustee must act in good faith in the best interest of the statutory trust. Any demands of document access from the beneficiaries must be in writing and state the purpose of such demand.

The legal authority from the court pertaining to this right can be found in Grand Acquisition LLC v Passco Indian Springs DST, C.A. 12003- VCMR (Del. Ch. Aug. 26, 2016). It is interesting to observe that the Court resorted to LLCs and LLPs cases to interpret the rights stipulated in section 3819 of DST Title 12. In brief, the court would only apply section 3819 if the trust agreement specifies. Otherwise, the beneficiaries can access the trust’s books and records based on the terms laid out in the trust agreement. In other words, the terms in the trust agreement related to the beneficial owner’s right to inspect the trust’s records and books trump the owner’s statutory rights derived from DSTA. Additionally, the Court also affirms that the trustee bears the burden of proof if he wields “improper purpose defense”. The trustee has to demonstrate proof of probable harm to the trust by releasing requested documents to the beneficial owner.

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Finally, each investment contains some degrees of risks. DST is no exception, however, there are various ways to minimize the risks. For instance, proceeds from the real estate sale do not have to be invested fully in one DST property. It would be wise to distribute them across multiple DST properties. As a result, an investor with a diversified DST portfolio might deal with several sponsors (trustees). Depending on the kind of property, in general, DST sponsors are persons who possess professional skills in a specific type of property. There are loads of classes of properties that are available for investors to choose from, such as self-storage, medical facilities, gyms, residential apartments, and so on. It is important for an investor to conduct thorough research on the credentials of his or her potential DST sponsor. As mentioned above, because DST sponsors are the very people promote the properties to the investors based on their self-claimed expertise and sequentially, they will be the asset manager to preserve the value of the investment and safeguard the investors’ financial interests, it is critical to meticulously examine the sponsor’s past records and understand his or her strength and weakness.
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