From left: Patricia L. Davidson and Leah A. Kofos
Creditors can be vultures. But in fairness, no one likes to be stiffed. A lot of people don’t pay their bills; some debtors can’t and some debtors don’t play by the rules. And some debtors may have the fortuity of a trust, including a so-called spendthrift trust. In such situations, creditors may try to recover assets from a debtor/beneficiary’s trust, including assets presumably protected by the spendthrift trust.
Under the Massachusetts Uniform Trust Code, G.L. c. 203E, § 505(a)(2), a spendthrift clause in a trust generally insulates trust assets from creditors’ claims in two ways. First, it protects a beneficiary from a creditor trying to satisfy prior debts from the debtor’s beneficial interest in a trust. Second, it protects the beneficiary from accumulating debt that otherwise could be satisfied by the debtor’s beneficial interest in the trust.
Spendthrift trusts typically give the trustees very specific guidance or limitations about how to make distributions to the beneficiary. Spendthrift provisions endeavor to preserve assets for future beneficiaries and are typically implemented when a beneficiary has a history of fiscal imprudence or other vulnerability (e.g., substance abuse, marital problems or mental health challenges) that puts trust assets at risk.
But sometimes, a spendthrift provision does not offer the protection the grantor intended. Whether or not a spendthrift trust will clip the wings of the vulture . . . er . . . creditor . . . is often a complicated, fact-specific analysis. Three recent court decisions help to explain how spendthrift trusts can and cannot work in Massachusetts.
In Levitan v. Rosen, 95 Mass. App. Ct. 248 (2019), the Appeals Court found that a spendthrift provision governing a spouse’s right of withdrawal from a family trust did not protect estate assets from inclusion in the marital estate in the case of a divorce. In this case, the wife withdrew funds from a trust established by her father in accordance with her right of withdrawal. The court determined that these withdrawals were considered distributions from the trust and were therefore subject to application of the spendthrift provision. Consequently, the spendthrift provision prohibited creditors, including her spouse, from receiving any portion of the trust. However, even though the right of withdrawal was governed by the spendthrift clause, the court found that the trust’s distributions to the wife were not a mere expectancy. As a result, the court determined that the entire value of the trust was subject to equitable distribution upon divorce, regardless of the spendthrift clause.
In De Prins v. Michaeles, 342 F. Supp. 3d 199 (D. Mass. 2018), the District Court found that the spendthrift provision of the trust did not protect the trust assets in the debtor’s self-settled, irrevocable trust. The court found that regardless of the presence of a spendthrift provision, a creditor or assignee of the settlor may reach the maximum amount that can be distributed to or for the settlor’s benefit. The court reasoned that in a self-settled trust, even though the beneficiary did not actually receive any distributions from the trust, the trustee could have distributed the full amount of the trust. Therefore, the court found that a creditor could reach the full amount of the trust.
In Calhoun v. Rawlins, 93 Mass. App. Ct. 458 (2018), the Appeals Court distinguished between a spendthrift trust and a trust funded by divorce. The court determined that a trust funded by a divorce settlement is considered a self-settled trust and is therefore reachable by that beneficiary’s creditors because the beneficiary is the person receiving distributions as a result of the settlement agreement. The trust is not a spendthrift trust created by a third party as a gift. Furthermore, like in De Prins, the Calhoun court reiterated that a self-settled or discretionary trust cannot be used to protect assets from creditors because the grantor created a discretionary trust for his own benefit. The creditors can thus reach the maximum amount, which the trustee could distribute to the beneficiary or use for his benefit.
Spendthrift provisions are useful planning devices to preserve assets and shield trust assets from creditors and, indeed, beneficiaries themselves. However, not all purported spendthrift trusts accomplish their intended goals, particularly when the settlor seeks to use spendthrift provisions to dodge his own liabilities. Drafters must take great care to consider individual circumstances — and maybe encourage settlors and beneficiaries to satisfy their financial obligations in the first place.
Patricia L. Davidson is a partner at Mirick O’Connell in the Probate, Trust and Fiduciary Litigation Group and the Business and General Litigation Group. Her practice focuses on helping families resolve issues involving wills, trusts and real estate; disputes involving family and closely held businesses; and litigation of complex business issues that arise out of breach of fiduciary duty claims, breach of contract claims, shareholder disputes, corporate dissolutions, trade secret issues and real estate matters.
Leah A. Kofos is an associate in Mirick O’Connell’s Trusts and Estates Group. She
focuses her practice in estate planning, estate and trust administration, guardianships and conservatorships, and elder law.