Asset Protection Trusts in Michigan

Take-Away: Michigan enjoys very favorable laws with regard to the protection of assets held in a trust. While settlors may take some comfort in that knowledge, less clear is how other states will treat a ‘Michigan’ asset protection trust if the beneficiary moves to a state where its laws or its public policy are not so favorable.

Qualified Dispositions in Trust Act: This Michigan statute, adopted a few years ago, authorizes a self-settled asset protection trust, contrary to common law. Generally, the only remedy for a creditor is to pursue a claim under the Uniform Voidable Transactions Act, i.e. a transfer that ‘defrauds’ creditors or which seeks to hinder or delay the collection of a judgment. A creditor may recover assets from the trust if there is proof that the transfer to the trust was to hinder, delay or ‘defraud’ the creditor. An existing creditor has two (2) years in which to seek to set aside the transfer of assets to the trust, or one (1) year after the creditor learns of the transfer to the trust. Future creditors have two (2) years from the transfer of assets to the trust in order to challenge the transfer. Claims to pay child support are excepted and not protected by the trust. Claims to pay spousal support may, or may not, be barred. A spouse can consent to the transfer of assets to the Michigan asset protection trust; if the spouse does not consent, then the trust’s assets are available in a divorce action for property distribution and spousal support purposes. If the qualified dispositions in trust is created and funded prior to the settlor’s marriage, then the trust assets are fully protected in the event the settlor is in a subsequent divorce, as the divorce judge is expressly directed by the statute to not consider the assets held in the qualified dispositions trust.

• Weaknesses: When compared to other states’ self-settled asset protection trusts, there are some perceived weaknesses to Michigan’s version. Those weaknesses include the following:

Other Creditors Can ‘Piggy-back”: The successful challenge to a transfer to the irrevocable qualified dispositions in trust by one creditor is available to be used by another creditor in a challenge to transfers to the same trust. In some states, only the specific creditor can challenge the transfer to the asset protection trust, and other creditors cannot ‘piggy-back’ onto the success of the first creditor and they must prove their own case.

Lower Burden of Proof: The burden to prove a ‘fraudulent’ transfer to the qualified dispositions in trust is by a preponderance of evidence. Other state statutes require that the challenging creditor must show a ‘fraudulent’ transfer by clear and convincing evidence, a much higher evidentiary standard.

Litigation is Not Restricted to Michigan: Unlike other state statutes, a creditor who challenges the transfer of assets to a qualified dispositions in trust must come to that state in order to pursue the litigation, i.e. more expense incurred by the creditor. With Michigan’s statute, the creditor need not come to Michigan in order to challenge the transfer of assets to the qualified dispositions in trust.

No Automatic Removal of Trustee: Other state asset protection trusts require the automatic removal of the trustee if the trustee is sued by the creditor in an attempt to force the release or distribution of assets. With Michigan’s qualified dispositions in trust statute the trustee that is sued is not automatically removed as trustee from the trust.

A qualified dispositions in trust, as noted, permits the settlor of the trust who transfers assets to it to be a discretionary beneficiary of that same trust. The positive features of such a trust can also benefit a non-settlor beneficiary of the qualified dispositions in trust who may have future creditor problems or who may find themselves in a divorce.

Discretionary Trusts at Common Law: Common law discretionary trust protection originated under English law. A discretionary trust is not related to spendthrift protection. While a spendthrift provision restrains either a voluntary or involuntary transfer of a trust beneficiary’s interest in the trust [Restatement (Second) of Trusts section 153; MCL 700.7103(j)] there are several exception creditors who may still access a trust that contains a spendthrift prohibition. [MCL 700.7504.]

• No Enforceable Right: Discretionary trust protection is based on whether a beneficiary has an enforceable right to compel distributions, and therefore whether a potential creditor might stand in the shoes of that beneficiary. [Restatement (Second) of Trusts, Section 155(1), Comment 1(b).] If the beneficiary has no enforceable right, then the beneficiary’s interest is not a property interest, and it is nothing more than a mere expectancy that a judgment creditor cannot attach. Nor can a judgment creditor force the trustee to make a distribution to the debtor-beneficiary. Restated, an expectancy does not have the attribute of property, and the interest to which it relates is at the time nonexistent and may never exist. The converse is also true: If a beneficiary possesses an enforceable right to a distribution, the beneficiary most likely possesses a property interest in the trust.
• Words of Discretion: Most discretionary trusts are prepared using the words sole, absolute, and/or unfettered discretion combined with a fiduciary distribution standard, like ‘health, support and education.” There is always the danger, though, that a court might look at other language in the trust and find a reason to expand the distribution standard to include terms like comfort, welfare, and happiness.
• Restatement Confusion: One of the problems with discretionary trusts is that there has been a movement over the past 15+ years to change the common law, as reflected primarily by the Uniform Trust Code. The Restatement (Third) of Trusts, reversed the Restatement (Second) of Trust’s description of a discretionary trust which is tied to the lack of any right to enforce the trust. The Restatement (Third) of Trusts, on which the UTC is based, concludes that a beneficiary of a discretionary trust possesses a right of enforcement. Under this new and controversial theory, all discretionary trusts, except one with no standards or guidelines for the trustee to follow, create an enforceable right for the beneficiary to sue the trustee to compel a distribution from the trust. Consequently, if a beneficiary could sue the trustee to reach trust assets, so could the creditor of that beneficiary ‘standing in the shoes’ of the beneficiary. Therefore a probate judge who is encouraged to read the Uniform Trust Code, or the Restatement (Third) of Trusts,  would quickly find an enforceable right in the discretionary trust beneficiary, and thus authorize that beneficiary’s creditors access to the trust’s assets.
• Trust Drafting: To protect a discretionary trust from such encroachments, it would be helpful if the trust instrument directly state that: (i) there is no distribution standard; (ii) the trust should not be interpreted to include distribution standards like comfort, welfare, and happiness; (iii) the trustee can make unequal distributions among beneficiaries; (iv) the beneficiary possesses no enforceable right to a distribution; and (v) the trust should be interpreted as a Michigan discretionary trust as defined in MCL 700.7103(d) and MCL 700.7815 (1).

Michigan Trust Code: Michigan’s Trust Code [MTC]  contains highly favorable provisions to protect a discretionary trust from the claims of the beneficiary’s creditors, capitalizing on the common law, but in a rare situation, expressly departing from the Uniform Trust Code (UTC.)

• Discretionary Trust: A discretionary trust provision is defined to mean a provision in a trust, regardless of whether the terms of the trust provide a standard for the exercise of the trustee’s discretion and regardless of whether the trust contains a spendthrift provision, that provides that the trustee has discretion, or words of similar import, to determine one or more of the following:  (i)whether to distribute to or for the benefit of an individual or a class of beneficiaries the income or the principal; (ii) the amount of income, principal, or both of the trust to distribute; (iii) who among a class will receive income or principal or both of the trust; (iv) whether the distribution is to be made from income or principal; and (v) when to pay income or principal. [MCL 700.7103(d).]

No Right of Enforcement: The MTC then provides that the transferee or creditor of the beneficiary of a discretionary trust provision does not have a right to any amount of trust income or principal that may be distributed only in the exercise of the trustee’s discretion, and trust property is not subject to the enforcement of a judgment until income or principal or both is distributed directly to the trust beneficiary. [MCL 700.7505.]

No Property Interest: A beneficiary of a discretionary trust provision as described in Section 7505 has no property right in a trust interest that is subject to a discretionary trust provision, and has no right to any amount of trust income or principal that may be distributed only in the exercise of the trustee’s discretion.

• Spendthrift Trust’s Exception Creditors: As noted above, even with a spendthrift provision in a trust, there are specific exception creditors that may access the trust’s assets to satisfy claims against the trust beneficiary. [MCL 700.7504(1)), e.g. child support, spousal support, the State of Michigan, the United States, and creditors who provide services that preserve or enhance the beneficiary’s interest in the trust. However, there are no exception creditors with regard to a discretionary trust in Michigan. “Notwithstanding that the terms of the trust include a spendthrift provision, this provision [exception creditors] does not apply to the interest of a trust beneficiary that is subject to a discretionary trust provision.” [MCL 700.7504(3.)] In short, there are no exception creditors to a beneficiary’s interest in a discretionary trust in Michigan.
• Withdrawal Rights: The MTC also provides that a trust beneficiary is not considered a settlor of a trust merely because of a lapse, waiver, or release of a power of withdrawal over the trust property. [MCL 700.7506(c)(3).] Accordingly, if the trust beneficiary possesses a right to withdraw $5,000 or 5% of the trust assets each year, and that withdrawal right lapses, the trust beneficiary will not be treated as the settlor of the trust, i.e. a self-settled trust at common law.

Conclusion: There is some protection afforded to a settlor, or the trust beneficiaries, if the assets are held in a Michigan Qualified Dispositions in Trust. Compared to other states’ self-settled domestic asset protection trusts, however, Michigan’s version is perceived by some commentators to be weak in many of its provisions, if the goal is to protect assets from future judgment creditors. Michigan’s law on discretionary trusts is much stronger when compared to other states’ laws, particularly those states that adopted, wholesale, the UTC’s provisions. Michigan’s MTC clearly states that the beneficiary of a discretionary trust possesses no rights of enforcement to compel a distribution and that due to the absence of any right of enforcement, such a beneficiary possesses no property interest in the discretionary trust. It is surprising that more settlors do not take more advantage of these favorable Michigan laws with regard to discretionary trusts if their goal is to protect their children and grandchildren’s inheritances from future creditor claims or divorces.