Parents who want a child’s inheritance to pass to a trust, rather than outright, often seek to prevent the child’s former spouse from reaching such assets in the event of divorce. Unfortunately, under the laws of some states, regardless of whether a trust has a spendthrift provision or is a discretionary trust (or both), a beneficiary’s children and/or a former spouse may have rights to reach trust assets that are otherwise protected from creditors. When clients are concerned about these issues, attorneys should consider creating the trust in a state where the law is clear that no creditor, including children, spouses and former spouses, will have access to trust assets.
Let’s explore discretionary and spendthrift trusts under Article 5 of the Uniform Trust Code (UTC)1 and compare the exposure of both to claims of creditors holding a judgment against a beneficiary with respect to payments required under a divorce decree. State laws differ significantly, even among the states adopting the UTC, with respect to the power of a former spouse or child to enforce his rights against a spendthrift and/or discretionary trust created by a third party.2
Each of the 24 states (and the District of Columbia) that adopted the UTC had an opportunity to modify or delete portions of the law. (See “Treatment of Exception Creditors by UTC States,” http://wealthmanagement.com/estate-planning/treatment-exception-creditor....) Many states, including Florida, modified Article 5, titled “Creditor’s Claims; Spendthrift and Discretionary Trusts.”3 Florida’s experience in adopting Article 5 of the UTC serves as an example of the type of issue that may arise should a former spouse or child with a judgment for support try to enforce the judgment against an irrevocable spendthrift trust and/or a discretionary trust.
As described below, many states make it easy for a former spouse or child having a judgment for support to reach assets in a spendthrift trust when mandatory distributions are provided, as compared to discretionary trusts. States providing for exception creditors typically have a public policy of protecting former spouses and children holding a judgment and, in furtherance of that policy, give them additional rights to attach or reach certain trust assets. Some states give these rights to children, but not to a spouse or former spouse. The law is less clear as to whether: (1) a former spouse or child with a judgment for support can reach, attach or garnish assets in a discretionary trust, regardless of spendthrift provisions, before the trustee actually distributes trust funds to the intended beneficiaries; and (2) the trustee of a third-party-created trust can make distributions for the benefit of a beneficiary known to be subject to a judgment for support.
Example: Trust for Divorced Son
Mark, a domiciliary of State X, has suffered serious financial difficulties and has no assets or income to satisfy his obligation to his former spouse. Mark’s wealthy father, Jack, consults his advisor and asks whether the testamentary trust Jack intends to create for Mark at Jack’s death could be reached by Mark’s former wife, who has received a judgment for support payments. Jack says that when Mark was financially secure, Mark was making timely payments to his former wife. However, like many others, Mark’s ability to satisfy his debts was significantly curtailed when the value of his real estate vanished, as did his capacity to earn a living as a developer. Jack is helping to support Mark (hopefully temporarily) and wants to know that when Jack dies, Mark, and not Mark’s former wife, will benefit from assets left in a testamentary trust that will be established for Mark after Jack’s death.
Jack inquired about the benefits of using a spendthrift trust and/or a discretionary trust. He was advised that Mark’s former wife would be considered an “exception creditor” and could reach Mark’s trust if it was a spendthrift trust. Jack was advised that Mark needed a discretionary trust with a spendthrift provision. Jack asked his advisor to explain the difference between a spendthrift trust and a discretionary trust and whether either of them would protect Mark against his former wife’s judgment. If State X’s laws didn’t provide protection, should another jurisdiction be considered?4
Spendthrift v. Discretionary
The UTC addresses spendthrift and discretionary trusts.
Spendthrift trusts. Sections 501 and 502 of the UTC5 address spendthrift trusts. If a beneficiary’s interest in a trust isn’t subject to a spendthrift provision, a court may authorize a creditor or assignee of the beneficiary to reach the beneficiary’s interest in the trust by attachment of present or future distributions to or for the benefit of the beneficiary or other means. The comment to
Section 501 of the UTC states:
This section does not prescribe the procedures (“other means”) for reaching a beneficiary’s interest … leaving those issues to the enacting state’s laws on creditor’s rights. The section does clarify, however, that an order obtained against the trustee, … may extend to future distributions whether made directly to the beneficiary or to others for the beneficiary’s benefit. By allowing an order to extend to future payments, the need for the creditors periodically to return to court will be reduced.
A spendthrift trust is a trust:
‘[C]reated with a view of providing a fund for the maintenance of another, and at the same time securing it against his own improvidence or incapacity for self-protection...’ [quoting Croom v. Ocala Plumbing & Elec. Co., 57 So. 243, 244 (Fla. 1911)]. When a trust includes a valid spendthrift provision, a beneficiary may not transfer his interest in the trust, and a creditor or assignee of the beneficiary may not reach any interest or distribution from the trust until the beneficiary receives the interest…6
Comments to UTC Section 502 state:
[A] settlor has the power to restrain the transfer of a beneficiary’s interest, regardless of whether the beneficiary has an interest in income, in principal, or in both. Unless one of the exceptions under this article applies, a creditor of the beneficiary is prohibited from attaching a protected interest and may only attempt to collect directly from the beneficiary after payment was made.
UTC Section 503(b) provides: “a spendthrift provision is unenforceable against: (1) a beneficiary’s child, spouse, or former spouse who has a judgment or court order against the beneficiary for support or maintenance…”
UTC Section 503(c) provides that “a claimant against which a spendthrift provision cannot be enforced may obtain from a court an order attaching present or future distribution to or for the benefit of the beneficiary…”
Comments to UTC Section 503 state:
The exception . . . for judgments or orders to support a beneficiary’s child or current or former spouse is in accord with Restatement (Third) of Trusts . . . and numerous state statutes. It is also consistent with federal bankruptcy law, which exempts such support orders from discharge.
Discretionary trusts. UTC Section 504(b) provides that, other than as provided in UTC Section 504(c), regardless of whether a trust has a spendthrift provision, a creditor of a beneficiary may not compel a distribution that’s subject to the trustee’s discretion, even if: (1) discretion is expressed in the form of a standard of distribution, or (2) the trustee has abused the discretion. UTC Section 504(c) states if a trustee hasn’t complied with the standard or abused his discretion, a court can order a distribution to satisfy a judgment or court order against the beneficiary for support or maintenance of the beneficiary’s child, spouse or former spouse, and the court shall direct the trustee to pay the child, spouse or former spouse such amount as is equitable, but not more than the amount the trustee would have been required to distribute to the beneficiary if the trustee had complied with the standard or had not abused discretion.
The comments to UTC Section 504 state that the power to force a distribution due to an abuse of discretion or failure to comply with the standard belongs solely to the beneficiary, unless it’s on behalf of a spouse, former spouse or child having a judgment or order against a beneficiary for support or maintenance. The court must direct the trustee to pay the child, spouse or former spouse such amount as is equitable, but not to exceed what the trustee is required to pay the beneficiary. Similar to the law for spendthrift trusts, the UTC doesn’t provide a procedure to enforce a judgment against the trustee of a discretionary trust.