Surprising Self-Settled Trusts

Take-Away: Michigan now recognizes self-settled asset protection trust with its adoption of the Qualified Dispositions in Trust Act. As a bit of a surprise is the fact that other trusts can be treated by courts as self-settled, which can be a bad thing when there are creditors looking for assets to seize in satisfaction of their judgments.

Background: Traditionally, a trust with a spendthrift provision will protect the assets from being reach by creditors, unless is it determined that the trust is self-settled. When Michigan adopted its Qualified Dispositions in Trust Act, it acknowledged that the Act was a departure from the long-standing common law rule with regard to self-settled trusts. The common law of this state, and most other states, simply stated, is that one should not be able to create a spendthrift trust and transfer their assets to that trust, continue to benefit from those same assets as a trust beneficiary, and deny their creditor’s access to those trust assets to satisfy the creditor’s claim against the trust beneficiary. It may come as a surprise that some trusts can be treated as self-settled, exposing their assets to creditor claims, even when the beneficiary did not create the trust. A couple of recent examples follow where the court found the trust to be self-settled and thus subject to attack by creditors.

Divorce Setting: In a reported Massachusetts decision, Calhoun V. Rawlins, 93 Mass. App. Ct. 458 (2018),  the ex-wife of the disabled trust beneficiary husband (severe traumatic brain injury) created a discretionary spendthrift trust as part of the divorce property settlement. The wife was the trust’s settlor. After the divorce settlement and the creation and funding of the trust, the ex-husband trust beneficiary was in a serious car accident, from which the ex-husband died. A lawsuit was filed because of that car accident and a judgment was awarded against the trust beneficiary/ex-husband. The plaintiff in the auto accident claimed that any recovery could be satisfied from the assets held in the ex-husband’s discretionary trust.

• The court found that the trust was self-settled by the ex-husband. It reached this conclusion because the assets used to fund the trust were transferred by the wife in satisfaction of an obligation imposed in the divorce settlement and that the trust’s principal and income were available to the ex-husband during his lifetime. As a result, the auto accident plaintiff was able to reach the trust’s assets as if it was self-settled, even though the ex-husband neither created nor funded the trust
• The Court’s decision relied on the Restatement (Third) of Trusts, Section 58, comment f, which notes: In order for creditors to reach trust assets where a person created a trust for support or a discretionary trust for his own benefit, it is not necessary that the beneficiary shall have himself conveyed property held in the trust. It is enough that the beneficiary provide consideration. A trust is established by the person who provide the consideration for the trust even though in the form it is created by someone else.
• In  addition, the court was not impressed that many of the assets that were used to fund the trust were held in accounts solely in the name of the ex-wife, and that those traced accounts were available to satisfy the ex-wife’s obligations to her ex-husband. The court observed that the transferred assets to the trust were “not a gift” and that the ex-husband had a “legal right to the monies“held in those accounts arising from his marital rights. “The suggestion that the trust could not have been self-settled because [the ex-husband’s] name was not on the accounts during the marriage, particularly in these circumstances [the husband was receiving Medicaid benefits], is unavailing.”
• In sum, because the assets used to fund the trust were at one time subject to marital rights conferred under state law on the spouse, those assets were treated as the beneficiary’s own contributions to the spendthrift trust, thus enabling the court to find that the trust was self-settled.

Bankruptcy Setting: In a recent federal District Court case, the court held that a debtor and his wife’s transfers to a third-party irrevocable trust were considered to be in the nature of a self-settling for purposes of Bankruptcy Code Section 548 and the Uniform Voidable Transfers Act. From the facts presented, it is easy why the court reached this conclusion in In re Cyr (Rodriquez v. Cyr, 2019 WL 1495137 (W.D. Tex. April 1, 2019).

• Back in 2009, a couple by the name of Bergerund create an irrevocable spendthrift trust. The Bergerunds transferred $1,500 to that trust. The Bergeruds named Dr. Steven Cry, an orthopedic physician who owned and operated the Orthopedic & Spine Institute, LLC, and his wife as trustees and trust beneficiaries.  Between 2009 and 2017, Dr. and Mrs. Cyr transferred several millions of dollars of assets to the trust. Dr. Cyr then filed for bankruptcy.
• The litigation centered upon whether the Bankruptcy Trustee could access the assets held in the trust, either under the doctrine of illusory trusts or because the trust was the equivalent of a self-settled trust created by Dr. Cyr.
• What is interesting about this case is the court’s discussion with regard to Section 548(e) (1) of Bankruptcy Code. That Code section permits the assets held in a self-settled asset protection trust to be accessed for bankruptcy purposes if the trust was created less than 10 years before bankruptcy is filed.  Under that section, there is no focus on the settlor’s motives to defraud or frustrate creditors; simply if the trust was created and funded within 10 years of filing for bankruptcy, the trust’s assets are ‘fair game’ for the bankruptcy trustee.
• The court noted that Code Section 548(e) (1) does not strictly limit its reach only to self-settled asset protection trusts; rather, it extends its reach to “similar devices.” Thus, even if the trust was not formally treated as being self-settled [it having been created by the Bergeruds and not Dr. Cyr] it could nonetheless be viewed as a similar device and thus subject to the 10-year set-aside rule.
• The court also noted that many of Dr. Cyr’s transfers to the trust could easily be described as fraudulent transfers, but the challenge with a fraudulent transfer remedy is that the statute of limitations to set-aside a transfer that is intended to hinder and delay creditors is two years, not the longer 10 year statute of limitations used to set aside transfers to a self-settled asset protection trust. Moreover, the trustee (or creditor) must meet its burden of proof to demonstrate that the debtor’s transfers were intended to defraud creditors, a proof obligation that does not exist under the 10-year self-settled trust or similar device
• While there were still other decisions for the court to make in this case, its import is that even if the trust is technically created by a third-person, if it looks, smells, and otherwise feels like a self-settled trust, it probably is a self-settled asset protection trust, and the technical distinction that someone other than the debtor actually is the named settlor will be easily dispensed with under the Bankruptcy Code as a similar device to such a trust.

Conclusion: If someone wants to establish a self-settled asset protection trust, they should either follow the procedures outline in the Michigan Qualified Dispositions in Trust Act (or Delaware’s version) and not play games like Dr. Cyr by using a nominal third-party settlor and then insult everyone’s intelligence by transferring millions worth of assets, by gift, into that nominally settled trust and then claim it was not self-settled. Similarly, as indicated by the Massachusetts decision, courts will go to great lengths to ignore labels and look at the source of assets that were transferred to an irrevocable spendthrift trust to expose its assets to satisfy legitimate creditor claims.