Take-Away: A beneficiary’s power of withdrawal over a trust is normally treated as a general power of appointment. If the trustee is given the power to withhold an otherwise permissible withdrawal by the beneficiary, the trustee’s power may be viewed as a required consent to the exercise of the power of appointment, sufficient to prevent the beneficiary’s creditors from attaching trust assets.

Background: Massachusetts seems to be a fertile ground where third-party established irrevocable trust interests are treated as fair game when the trust beneficiary is in a divorce. This was initially covered a couple of years ago in the now-infamous decision, Pfannenstiehl v Pfannenstiehl, 88 Mass. App Ct 121 (2015) rev’d 475 Mass. 105 (2016), where a trial judge included in the divisible marital estate for purposes of equitable distribution a trust beneficiary’s fractional interest in a spendthrift trust that had been created by his father for the benefit of the divorce litigant and 10 other beneficiaries. That decision was subsequently overturned on appeal. The appellate court found that with so many trust beneficiaries able to receive a discretionary distribution, at most the divorce litigant held only a hard-to-value mere expectancy in the trust. In addition, while that trust instrument had referred to distributions for the beneficiaries’ health, education, maintenance and support (HEMS), that ascertainable standard was held to be not enforceable; it simply operated as a restriction on the trustee, not a right held by the beneficiary.

In yet another Massachusetts decision, the divorce judge again invaded a third-party spendthrift discretionary trust in a divorce, this time rationalizing that since there was only one current trust beneficiary, unlike Pfannenstiehl,  more than a mere expectancy was involved. Consequently, that trust interest could be valued and included in the divisible marital estate.

Court Decision: Levitan v. Rosen, Mass. App.Ct No 18-P-847 (May 6, 2019)

Facts: Decades earlier, Amy’s father created an irrevocable trust for her benefit. The trust was established under Florida law. On Amy’s death, the trust was to be held for the benefit of Amy’s five children. Amy was given the right to withdraw 5% of the trust corpus each year. The trust contained a standard spendthrift limitation that prohibited any assignment or creditor attachment of assets held in the trust. The independent trustee was given the discretion to distribute to Amy as much of the income and principal the trustee deems advisable. No HEMS standard was used in this trust- this was clearly a discretionary trust but for Amy’s 5% annual withdrawal right. The trust’s corpus was valued at $1.7 million at the time of the divorce.

Trial Court: The trial judge held that Amy’s 5% withdrawal right was not subject to the spendthrift provision, and consequently it was a marital asset- it was more than a mere expectancy. That amount was awarded to Amy as part of the divorce settlement. Amy’s husband was awarded the only other asset of their marital estate, a retirement account with a balance of $130,000. The balance of the spendthrift trust corpus was excluded from the marital estate for equitable division purposes.

Appellate Issue: The issue on appeal was whether Amy’s interest in the discretionary spendthrift trust was includible in her marital estate for purposes of equitable distribution in the divorce.

Appeals Court: The appellate court found that Amy’s interest in the discretionary trust was not speculative, was not subject to reduction (by distributions to other beneficiaries as there were none, in contrast to Pfannenstiehl) and consequently her interest in the trust was more than a mere expectancy. However, the court then held that the spendthrift provision in the trust gave the trustee the power to withhold a distribution to Amy, which required the court to sustain the award of the entire trust to Amy, i.e. no equitable division, including Amy’s 5% withdrawal right.

Michigan Comparison: As was reported a couple of months ago in an unpublished, i.e. non-binding, decision,  the Michigan Court of Appeals refused a former spouse’s efforts to access the assets held in a third-party discretionary spendthrift trust to enforce child support and alimony arrearages that the beneficiary former spouse had run up. Anton v Gualtieria, Michigan Court of Appeals, LC No. 2016-219737- TV (March 18, 2019). The Michigan court did not spend much time addressing the implications of the spendthrift clause in the trust. Rather, it focused on the fact that the trust was a wholly discretionary trust, which confers no property interest on the trust beneficiary. [MCL 700.7103(d); MCL 700.7815(1).] Despite a strong public policy, that favors the timely payment of child support and spousal support obligations, the Court refused to invade the trust in order to bring the trust beneficiary’s support obligations current.

Spendthrift Exception Creditors: It is important to not confuse the creditor protection features of a discretionary trust with the protection that is afforded with a spendthrift trust. Each state has created over time at common law and by statute its own set of exception creditors whose claims can be enforced against a third-party trust, even when there is a spendthrift prohibition. Massachusetts apparently treats the trust beneficiary’s spouse as a ‘super-exception-creditor.’  Michigan’s limited exception creditors to a spendthrift trust are identified at MCL 700.7502(2) (3) e.g. child support, spousal support, governmental agencies and taxing authorities.] There are no exception creditors, however, to a discretionary trust in Michigan.

Power of Withdrawal: As noted earlier, a trust beneficiary’s power of withdrawal is treated as a general power of appointment over the appointive assets. As was the case in Levitan, the trial judge had no problem including the assets subject to Amy’s power of appointment in the marital estate. Similarly, absent a divorce situation, creditors of the trust beneficiary could also exploit the beneficiary’s power of withdrawal to access the assets held in the trust subject to that power of appointment, to the extent of the power could be exercised i.e. not to exceed 5% of the trust assets. If the trustee’s power to withhold an otherwise permissible withdrawal by the trust beneficiary could be regarded, as the appellate court did in Levitan, as a power of appointment held by the beneficiary that is subject to the consent of the trustee, i.e. the trustee’s power to withhold distributions by virtue of the spendthrift limitation, such an arrangement [ i.e. the power of withdrawal subject to the spendthrift limitation’s trustee consent] might prevent a creditor from even reaching that portion of trust corpus that is subject to the beneficiary’s withdrawal right.

Aside: I confess that I never viewed a spendthrift provision in a trust’s boilerplate provisions as the equivalent of the trustee’s required consent to a withdrawal right, but that is apparently one court’s way of looking at the spendthrift provision- a form of required consent to the exercise of a power of appointment.

Conclusion: If long-term creditor protection is a concern to the settlor who establishes a trust, then the best protection for the trust beneficiaries is to use a discretionary trust. A spendthrift provision in the trust can provide some protection, but not like a discretionary trust. Less clear, however, is whether a court in another state will respect Michigan’s asset protection accorded to the beneficiary of a discretionary trust when that other state’s strong public policy, like enforcing child support awards, is implicated.