Michigan’s Qualified Dispositions in Trust Act: A Race to the Bottom?

For decades, the common law clearly held that an individual could not transfer his or her assets to a trust and retain the enjoyment of those transferred assets and prevent their creditors from reaching those same assets. That longstanding rule all changed with Michigan’s 2017 Qualified Dispositions in Trust Act which has, in general, received positive comments from legal commentators across the country. Others tend to view the policy that permits a trust to hold a debtor’s assets exempt from claims and collection as just one more sign of a race to the bottom.

Michigan Uniform Voidable Transfer Act: In order to understand the role of a qualified disposition trust, you first have to understand the legal context in which the trust is intended to work. That starts with the Michigan’s Uniform Voidable Transfer Act (the Act.) That Act is intended to prohibit the transfer of assets by a debtor that frustrates the debtor’s creditors who later attempt to collect a judgment. The Act authorized a court to set-aside a transfer so that the transferred asset can be used to satisfy a creditor’s judgment against the transferor-debtor. The Act’s import is that a debtor’s transfer will be deemed fraudulent, and thus the transfer can be set-aside by a court on a showing of fraud. The transfer of the asset (or the debt incurred by the debtor), whether before or after the transfer (or the debt is incurred) must either: (i) be with the actual intent to hinder, delay, or defraud any creditor of the debtor; or (ii) the debtor does not receive reasonably equivalent value in exchange for the transferred asset (or the incurred debt) and the debtor did either of the following: (a) engaged in a business or transaction when the remaining assets retained by the debtor were unreasonably small in relation to the business or transaction; or (b) the debtor intended to incur, or believed, or reasonably should have believed that he or she would incur debts beyond his or her ability to pay them as they became due.

Actual Intent and Badges of Fraud: Remedies under the Act turn on a showing of the debtor’s actual intent to defraud. But the same Act lists factors that a court can look at to presume that actual intent to defraud exists. These are called badges of fraud, and used when actual intent to defraud cannot be directly proved. This means that circumstantial evidence can be used to support a finding under the Act that the debtor actually intended to defraud creditors. Since debtors usually do not publically admit that they intended to defraud their creditors, most often a transfer will be set aside by a court upon a showing of one or more badges. Some of the badges of fraud identified include the following: Was the debtor’s transfer to an insider? Did the debtor retain possession or control of the asset after its transfer? Was the transfer disclosed or concealed by the debtor? Was the debtor threatened with a lawsuit prior to the transfer? Did the transfer consist of substantially all of the debtor’s assets? Did the debtor abscond? Did the debtor remove or conceal the assets? Did the debtor become insolvent before or shortly after the transfer? In short, a person cannot use an irrevocable trust to place their assets beyond the reach of their creditors since an intent to hinder or defraud the creditors will be presumed with the transfer of assets to the trust. But that now changes with Michigan’s Qualified Dispositions in Trust Act.

Qualified Dispositions in Trust Act Exceptions: Michigan’s new asset protection trust legislation modifies Michigan’s Uniform Voidable Transfer Act to make it clear that a transfer to a qualified disposition trust will be treated differently in two fundamental ways. First, a qualified disposition will be treated as fraudulent only with regard to those creditors whose claims arose after (not before or after) the transfer of the asset into the trust. Second, a qualified disposition will be treated as fraudulent only if the disposition was made with actual intent to hinder, delay or defraud any creditor. Thus, badges of fraud cannot be used as the basis to set aside a transfer of assets to a qualified dispositions trust by a settlor who later has creditor problems. Restated, the transfer of assets to a qualified dispositions trust can still be attacked by a judgment creditor, but the ability to set aside the transfer of assets to that trust will be difficult, as actual intent to defraud will be hard to uncover and prove to a court, coupled with other hurdles the new qualified dispositions in trust statute imposes.

Turning to the Michigan Qualified Dispositions in Trust Act, [Senate Bill 597, referred to for brevity as the Act], those additional hurdles will quickly become apparent. Most of italics which follow are my personal comments or observations that you are free to ignore.

Definitions: The Act provides two solid pages of definitions. Key definitions that are relevant follow:

Fiduciary qualified disposition means a qualified disposition made by a trustee that acts in a fiduciary capacity;
Qualified disposition means a disposition when the subject of the transfer is owned by one or more trustees, at least one of which is a qualified trustee and the subject property is governed by a trust instrument [or an election for that instrument to be so treated] under which the transferor possesses discrete rights powers and interests that are permitted under the Act. These permissible rights and powers are described below. However, a qualified disposition will not be: (i) a transfer at the time of which the transferor is in arrears on a child support obligation by more than 30 days [note: no mention of an alimony arrearage]; or (ii) transfer to a grantor trust for federal income tax reporting purposes. [This second exception apparently is intended to protect grantor-trust status for federal income tax reporting purposes.]
Qualified trustee means a trustee who meets all of the following conditions: a person [defined in the Estates and Protected Individuals Code (EPIC) to include corporations] (i) which is authorized by Michigan law to act as trustee and which is subject to supervision by the Department of Insurance and Financial Services, the FDIC, the Comptroller of the Currency, or the Office of Thrift Supervision; (ii) which maintains or arranges for custody of the assets in Michigan, ‘some or all of which is subject to the qualified disposition’ and which administers all or part of the trust in Michigan; (iii) whose usual place of business and some of the records that pertain to the trust’s administration are located in Michigan [For a corporate trustee, the usual place of business is the business location of the primary trust officer.]
Trust instrument means an instrument that appoints a qualified trustee that is the subject of a disposition to which all of the following apply: (i) it is subject to Michigan law; (ii) it is irrevocable; and (iii) the instrument provides that the interest of the transferor or other trust beneficiary in trust property may not be assigned, pledged, or mortgaged, whether voluntarily or involuntarily, before the qualified trustee actually distributes trust property to the trust beneficiary, and the instrument is considered a restriction on the transfer of the transferor’s beneficial interest in the trust that is enforceable under applicable nonbankruptcy law. [This last provision is added to protect the trust if the transferor/settlor later files for bankruptcy. In short, some ‘magic language’ will be required for the trust instrument to be treated as a qualified dispositions trust.]

Settlor’s Permissible Retained Rights or Interests: The Act describes the specific rights the transferor/settlor may retain in a qualified dispositions in trust. Subject to some identified exceptions, as a general rule, a transferor/settlor does not possess powers or rights with respect to the property that is subject to a qualified disposition or the income generated by that property. [No rights in the trust means that there is no property interest for the settlor’s creditors to attach.] Any agreement or understanding that purports to grant or permit the settlor’s retention of any greater powers is deemed to be void. [Section 4]

But the trust instrument can and usually does grant (or permit retention of) one or more of the following rights or powers to the transferor/settlor, none of which either standing alone, or in the aggregate, will be treated as a retained power by the transferor to revoke the trust. [If the power to revoke the trust exists, the qualified dispositions trust’s assets would be exposed to the transferor/settlor’s creditor claims.] In sum, assets can be transferred into the trust and those assets will be exempt from creditor claims, even if the transferor/settlor holds the following powers or rights in the trust:

Limited co-trustee: The power to direct investments; [the settlor can function as a co-trustee over the trust investments]
Veto power: The power to veto a distribution from the trust; [the settlor can prevent the trustee’s distributions to other beneficiaries of the same trust]
Testamentary power of appointment: A limited testamentary power of appointment that is exercisable by the settlor’s will on death; [the settlor can control who will receive the corpus of the trust on the settlor’s death]
A ‘spray’ beneficiary: The settlor’s potential or actual receipt of income, including the right to income retained in the trust; [the settlor is a permissible distribute of trust income in the trustee’s discretion, e.g. an income spray provision in the trust]
CRT: The settlor’s potential or actual receipt of income and principal from a charitable remainder trust (CRT), and the right to release the settlor’s interest in the CRT in favor of the charitable organization; [this means a CRT can be set up as a qualified dispositions trust]
GRAT: The settlor’s potential or actual receipt of income or principal from a grantor retained annuity trust (GRAT); [this means a GRAT can be set up as a qualified dispositions trust] or the settlor’s receipt of an annual unitrust amount from the GRAT if it does not to exceed 5% of the trust corpus;
Receive support or use assets: The settlor’s potential or actual receipt or use of trust principal if the potential, actual, or use of that principal would be as a result of the trustee acting under a discretionary trust, a support provision, or the direction of a trust advisor [the settlor can be either a discretionary beneficiary of a support trust or can be given the right to use assets titled in the name of the trust, g. use of an Aspen ski chalet]
Remove Trustees: The settlor can retain the right to remove and appoint a new trustee or trust advisor; [the settlor-beneficiary can ‘shop’ for friendly trustees or trust protectors]
QPRT: The settlor’s potential or actual use or real property held as a qualified personal residence trust (QPRT); [this means a QPRT can be set up as a qualified dispositions trust]
Pay Settlor’s Income Taxes: The settlor’s potential or actual receipt of income or principal to pay income taxes due on the trust’s income [like a grantor trust where the settlor pays the income tax, yet the trustee of the grantor trust is given the discretion to reimburse the settlor for the income taxes paid]
Pay Estate Taxes: After the settlor’s death the trustee is given the authority to pay the settlor’s debts, the expenses of estate administration, and estate taxes without regard to the source of payment; [the trust’s assets will be exposed to pay federal estate taxes under current IRC 2036 or 2038 depending on the retained right or power, so the assets need to be available to pay federal estate taxes and outstanding debts when the settlor dies, but that availability to pay debts after the settlor’s death will not cause the trust’s assets to be exposed to creditors while the settlor is alive] and;
Receive RMDs: The settlor’s actual or potential receipt of required minimum distributions. [Thus, the trust can function as a self-settled conduit trust. While the IRA/401k account will be exempt from creditor claims due to other protective statutes, the distributions from the retirement accounts normally are subject to creditor claims, but not if the funds are distributed to the qualified dispositions trust.]

In sum, a settlor can set up a qualified dispositions trust for their own benefit with all of these retained rights and benefits and still protect those transferred assets held by the trustee from the transferor/settlor’s judgment creditors.

Creditor Rights- Trustees and Advisors: As you would expect, a judgment creditor is not given too many rights when confronted with a qualified dispositions trust. The Act makes it clear that a creditor does not have a claim or cause of action against the trustee of a qualified dispositions trust an advisor of a qualified dispositions trust [like a trust protector] or a person who is involved with the counseling, drafting, preparation, execution or funding of a qualified dispositions in trust act [aka the lawyer’s relief from liability by revengeful judgment creditors act.] [Section 7]

Creditor Rights- the Trust: With regard to the actual qualified dispositions trust itself, a creditor possesses only those rights expressly given to it under the Act. [Section 5.] For a lawsuit filed by a creditor for attachment or any other legal remedy to apply with respect to a qualified dispositions trust, all of the following must exist:

Limited Remedies Tie a Judge’s Hands: The action can only be brought under Michigan’s Uniform Voidable Transfer Act; [No clever equitable remedies that might appeal to a judge’s sympathies or the judge’s notions of fairness or justice, just those remedies permitted under the Voidable Transfer Act!]
Prove Actual Intent: If the claim arose after a qualified disposition [e.g. after a transfer is made to the trust] the creditor’s claim must be based on a showing of the settlor’s actual intent to defraud; [No badges of fraud will be allowed to help the creditor make its case against the settlor]
High Burden of Proof: The creditor’s allegations will have to be proved by clear and convincing evidence; [which is the highest burden of proof in civil legal proceedings brought by the creditor]
No Coattails: The creditor’s claim must be based upon that creditor’s proof that only that creditor was the party who was defrauded by the settlor’s actual intent. In some court decisions, where there has been proof that one creditor had been actually defrauded, the court has permitted other creditors to bootstrap on the other creditor’s successful showing of an actual intent to defraud; [The Act makes it clear that a showing of actual intend to defraud must be of the creditor who brings the lawsuit, not just because another creditor was able to meet that actual intent to defraud burden of proof, i.e. no ‘coat-tailing’ by the creditor]
Short Statute of Limitations: A creditor who wants to pursue claim if it is able to meet all of the other conditions described, is then faced with a short statute of limitations, [albeit not as short as other state’s asset protection trust statutes require, e.g. Nevada is 1 year.] A qualified disposition is considered to be made at the time that the property that is the subject to the disposition was first transferred to the trustee; the statute refers to an unbroken succession of fiduciary ownership of the property. For the creditor whose claim arose before a qualified disposition, i.e. transfer, was made, the statute of limitations runs on the later of two years after the transfer was made (or the debt obligation was incurred) or one year after the qualified disposition (or debt obligation was incurred) was or could reasonably have been discovered by the creditor, if the person who is or may be liable for any claim, fraudulently concealed the existence of the claim or the identity of the person who might be liable for the claim. This somewhat vague reasonably discovered language that extends when the statute of limitations expires is included because not only can a Uniform Voidable Transfer Act claim be brought against the debtor, the transferee of that asset can also be sucked into that litigation and he/she may be required to turn the asset over to the creditor. Thus, the identity of the transferee is relevant and may need to be discovered; obviously, the transferee, as well as the transferor-debtor, may have an equal incentive to conceal the transfer from creditors. If the creditor’s claim arose concurrently with or after the qualified transfer to the trust, then the statute of limitations is the normal two years after the transfer was made.
Result of Voided Transfer- Limited Set-Aside and the Trustee’s Lien: If the qualified disposition is voided, i.e. successfully challenged, in that limited circumstance the ‘set-aside’ will only be for the amount necessary to satisfy the debt that is allowed to be recovered by the creditor. Restated, the entire trust does not completely blow up, just the amount necessary to satisfy the creditor’s judgment. In that limited situation where the transfer is set-aside, if the court finds that the trustee did not act in bad faith when it accepted the transferred asset or while it administered the trust, then the statute gives to the trustee a lien against the assets held in trust equal to the trustee’s entire costs, including attorney’s fees, incurred by the trustee in the defense of the lawsuit to void the qualified disposition to the trust. This trustee’s lien is given priority over all other liens against the property, even those liens that encumbered the property before it was transferred to the trust. [Section 7.]

Divorce: The Act also includes an express direction to divorce judges when the beneficiary of a qualified disposition trust is in a divorce. If the trust beneficiary is involved in a divorce action, then:

– Settlor’s divorce: If the trust beneficiary is the transferor/settlor of the qualified disposition trust, that trust beneficiary’s interest in the qualified disposition, or in the property itself, is not considered directly or indirectly part of the trust beneficiary’s real or personal estate, and it shall not be awarded to the trust beneficiary’s spouse in a judgment of divorced IF (i) the trust beneficiary transferred the property that is the subject of the qualified disposition more than 30 days before the marriage; AND (ii) the parties to the marriage agree that this act applies to the one spouse’s qualified disposition to the trust. Condition (ii) thus compels one spouse to inform the other spouse of the existence of the qualified dispositions trust to gain the other spouse’s agreement that the Act applies. [Nowhere in the statute, however, unlike premarital agreements, does that disclosure compel the transferor/settlor to reveal the value of the assets that were transferred to the qualified dispositions trust.]

– Beneficiary’s divorce: If the beneficiary of the qualified dispositions trust is not the transferor or settlor, the beneficiary’s interest in the qualified disposition trust or in the trust’s property itself, is not considered marital property, nor directly or indirectly a part of the trust beneficiary’s real or personal estate, and is not to be awarded to the trust beneficiary’s spouse in a judgment of divorce.

– ‘Directly or Indirectly’: This phrase is included in the statute to prevent a divorce judge from treating the assets held in the name of the qualified disposition trust as being ‘available’ to the beneficiary, in order to rationalize or to justify a shift of more than 50% of the marital estate to the spouse who is not the beneficiary of the qualified dispositions trust, or available to satisfy a spousal support award. [Whether a judge will follow this statutory directive remains to be seen. In my past experience, trial judges do not like to be told ‘you can’t do that!’ The judge often rises to the occasion and says in response: “Oh ya? Just watch me!’ I view these provisions dealing with a beneficiary’s interest in a qualified dispositions trust as more aspirational than realistic. Only time will tell if I am right.]

Entireties Property: The statute addresses the transfer of entireties owned property by spouses to a qualified disposition trust. The property transferred will continue to be treated as though it were held as tenants by the entirety, even though a qualified trustee is now the actual titleholder. If there is later a successful attack by a creditor on the qualified dispositions trust, the sole remedy the judge can impose is an order that directs the qualified trustee to transfer title to the asset from the trust back to the two spouses as tenants by the entireties. [This remedy is intended to continue the entireties creditor protection when only one of the spouses is the debtor against whom the lawsuit is brought, by keeping the entireties classification (and thus creditor protection) when the asset is returned to the debtor-spouses.] [Section 6]

Spendthrift Trust: The statute is clear that the beneficiary of a qualified dispositions trust does not possess any power to transfer or assign the income from the trust, or a portion of the trust, voluntarily or involuntarily, which is the statutory equivalent of a trust’s common law spendthrift provision. Equally important is the clear statement, no doubt directed to judges, that a court cannot by direction or order compel the trust beneficiary to transfer their interest in the qualified dispositions trust. [This is another situation where I can only imagine a judge’s reaction to being told by the legislature that he/she cannot take action or fashion a remedy to address a perceived wrong.] [Section 9.]

Trustee’s Affirmative Duty: More to the point is the provision of the Act that says: ‘the trustee of a qualified disposition shall disregard and oppose [that’s stated as an affirmative obligation imposed on the trustee] an assignment or other act, voluntary or involuntary, that is contrary to this section.’ [How much comfort this provides to a trustee to blissfully ignore a court order remains to be seen when it tells the judge ‘I’m free to ignore your orders because the law says so.’ I would not want to be the first case that ‘tests’ what this section means or the relief and freedom that it purports to give to a trustee.]

Trustee’s Indemnification and Exoneration: While imposing an affirmative obligation on the qualified trustee to oppose those actions that are contrary to the statute, e.g. fight a creditor’s effort to attach or levy upon the beneficiary’s interest in the qualified dispositions trust, the statute also makes it clear that the trustee is to be reimbursed for all attorney’s fees, costs, and expenses associated for carrying out the duties to disregard or oppose any assignment or ‘other act’ that is contrary to the statute. In addition, the qualified trustee is exonerated from liability, and the Act clearly provides that a trust beneficiary ‘does not have a claim or cause of action against the trustee for breach of this duty’ unless the trustee’s breach was in bad faith or a result of the trustee’s reckless indifference to the purposes of the trust or the interests of the trust beneficiaries. [I suspect that this provision that awards all costs to the trustee anticipates how a judge who is unhappy that the trustee ignored the judge’s order might indirectly take retribution against the trustee by not approving the trustee’s costs and expenses.]

Transferor’s Affidavit: The trigger for all of the perceived benefits that are intended to arise from the qualified dispositions trust is the need for the settlor to file an affidavit. The settlor’s affidavit must address at the time of the proposed transfer of the property to the trust all of the following statements that: (i) the settlor has full right, title and authority to make the transfer; (ii) the settlor will not render the settlor insolvent; (iii) the settlor does not intend to defraud a creditor; (iv) the settlor does not know or have reason to know of any pending or threatened court actions; (v) the settlor is not involved in any administrative proceedings; (vi) the settlor is not currently in arrears in child support by more than 30 days; (vii) the settlor does not contemplate filing for bankruptcy; and (viii) the property to be transferred to the trust by the settlor was not derived from any unlawful activities. [Section 6.]

This long summary does not address several other provisions in this complex statute, such as how a trustee is replaced, and what happens if the qualified trustee resigns and no successor is ready to take its place. Hopefully this summary will give you a beginning understanding why the qualified dispositions in trust statute was enacted, how it is enforced, what role and responsibilities a trustee will have to administer and defend the trust and why some feel that the existence of this trust is just one more example of Michigan’s willingness to join 16 other states in their race to the bottom.