Revocable Trust is Separate Legal Entity From Its Settlor

Take-Away: A federal court will treat a revocable trust as a legal entity that is separate from its settlor. This was done in order to expose the trust’s assets to satisfy the trust’s (not the settlor’s) creditors under strange facts.

Reported Decision: JPMorgan Chase Bank, N.A. v Larry J. Winget; Larry J. Winget Living Trust, U.S. Sixth Circuit Court of Appeals, No. 18-2089 (November 7, 2019)

Facts: Big numbers were involved in this long-standing litigation in the federal court in Michigan. Mr. Winget created a revocable trust in the 1980’s. Under that trust instrument, Mr. Winget retained the right to revoke his trust, and to receive all trust income during his lifetime. Mr. Winget also served as the initial Trustee of his revocable trust (referred to here as simply the Trust.) Fifteen years ago a corporation (Venture Holdings) owned by Mr. Winget obtained a one-half billion (yes, billion) dollar loan from a group of lenders, led by JPMorgan Chase Bank (Chase.) Mr. Winget agreed to personally guaranty that loan to his corporation, but his personal guaranty was limited to $50 million. However, the Trust also provided a guaranty to Chase for the corporate loan, and unlike Mr. Winget’s personal guaranty, there was no dollar limit to the Trust’s guaranty to Chase. The corporation later defaulted on the Chase loan. Mr. Winget paid Chase $50 million to satisfy his personal guaranty of the defaulted loan. The ensuing litigation dealt with the Trust’s refusal to pay the loan guaranty to Chase on the unpaid $750 million loan. In short, Mr. Winget paid his limited personal guaranty, but his revocable Trust did not pay its unlimited guaranty of Chase loan.

Litigation Overview: While not particularly relevant to the Sixth Circuit’s actual decision, the long history of this litigation between Chase and the Trust can easily explain a few of the Court’s snarky remarks. For example, the Court’s decision ends with this final paragraph: “Two years ago, our court described a prior appeal as ‘the latest episode in a long-running saga that must now come to a close.’ [Citation omitted.] We now know better than to think that our decision today will close the book for good. But at least we’re a chapter closer.” That testy judicial observation was due to six earlier appeals that had been filed in Chase-Trust litigation, starting in 2007 through an earlier 2019 appeal.

Alter Ego Issue: This was a transaction where the settlor had limited his personal guaranty (to $50 million) but his revocable Trust had not limited its liability on its guaranty of the Venture Holdings. Usually a settlor and his trust are treated as alter egos of each other. Mr. Winget’s defense was premised on the fact that he and the Trust were alter egos, and thus his limited personal guaranty ($50 million) should also apply to the Trust’s guaranty. As a noted legal treatise has observed: “..the settlor’s rights of consumption over the subject properties [are] rights that are the functional equivalent of ownership….After all, a naked retained right of revocation enables a competent settlor to destroy the contingent equitable interests of all ostensible beneficiaries.” Loring A Trustee’s Handbook, Section 5.3.3, page 254. Thus, Mr. Winget argued that he and his Trust were one and the same. The courts said “Not so fast with that analysis.”

Trial Court Decision: The District Judge granted summary disposition, with the result that the Trust was liable to Chase on its unlimited guaranty of the Venture Holding’s unpaid loan balance. Therefore, the Trust’s assets were available to satisfy Chase’s unpaid judgment.

Issue on Appeal: The question before the Court of Appeals was whether a creditor can recover against the Trust’s property. The Trust raised a couple interesting arguments, albeit unsuccessfully, in its efforts to avoid having to pay the $750 million Chase judgment.

Appellate Court Decision: The District Judge’s decision was affirmed by the federal appeals court panel of judges.

Power to Enter into Contracts: The Court observed that the power to manage trust property typically gives the trustee the power to do many things, including the authority to enter into contracts on the Trust’s behalf. Specifically, Mr. Winget, as the sole trustee of the Trust, had the power to enter into contracts on behalf of the Trust, contracts implicitly including a loan guaranty. [See MCL 700.7817 for a litany of trustee powers provided by the Michigan Trust Code.].
Right to Recover from Trust Property: ”And when the trustee does so, he doesn’t act with impunity. (Otherwise, why would anyone make an agreement with a trust?) Rather, he makes the trust liable on the contract. Trusts usually honor their obligations from the property they hold. That saves everyone (courts included) a lot of time and expense. But if they don’t, their creditors aren’t just out of luck. That wouldn’t make much sense. Instead, the creditors can sue to recover from the trust property- just like with any other contract….So although the terminology may seem complicated, the takeaway is quite simple: a party who has a contract with a trust can recover from the property held by the trust.”

Trust’s Claims on Appeal and Court’s Response: The arguments that Mr. Winget, as trustee of the Trust, raised on appeal, and how the Court dispensed with those arguments follow. They provide some insight into how a revocable trust will be viewed by a court as a separate legal entity, apart from its settlor:

Winget – I own the Trust’s property because I can revoke the Trust at any time (and recover the trust’s assets); as a result, Chase cannot take the Trust’s assets to satisfy the Trust’s obligation- the assets are mine (and I have already satisfied my personal guaranty to Chase.)

Court– “It does not matter who owns the property. If ownership mattered, creditors of a trust- revocable or not- could almost never recover from the trust property.”

Winget- I pay taxes on the trust property. Revocable trusts are ‘will substitutes.’

Court- “Tax law may not treat revocable trusts as separate entities, but trust law certainly does. Revocable trusts might serve similar functions as wills, but that does not make them the same as wills. For instance, wills cannot enter into contracts with other parties or be sued when they breach their obligations.”

Winget- Several Michigan statutes, like MCL 700.7506 (1) (a) exist that deal with how a creditor can recover against a settlor’s revocable trust’s assets. [MCL 556.128; 566.131(1); 700.7506(1) (a).] Consequently, these statutes prohibit the creditors of the trust from recovering from the Trust.
Court- “The statutes cited say nothing of the sort. Under a revocable trust, the settlor usually holds the beneficial interest in the trust property (i.e. the right to receive the income generated by the property.) So these statutes merely codify the principle that creditors can recover from the beneficial interest. They do not repeal the principle that creditors of the trust can recover from the trust as well.”
Winget- Various cases say that trust property cannot be used to satisfy a trustee’s personal liabilities. (See MCL 700.7708 – “Trust property is not subject to personal obligations of the trustee, even if the trustee becomes insolvent or bankrupt.”)

Court– “The trust property here would not be used to satisfy Winget’s personal liability. Rather, it would be used to satisfy the Trust’s liability. So these cases are inapposite.”

Random Observations: This case is about the source of assets used to satisfy a $750 million judgment, juxtaposing the Trust’s unlimited guaranty with the settlor’s limited guaranty of the same debt. No reason was given why the Trust’s guaranty of the Venture Holdings loan from Chase was not limited consistent with the personal guaranty of the Trust’s settlor.

Alter Ego: Lawyers often refer to a settlor’s revocable trust as the settlor’s alter ego, e.g. “the functional equivalent of ownership.” In this case, the settlor’s personal guaranty was limited to $50 million. In contrast, the settlor’s revocable Trust’s guaranty had no dollar limit. If the settlor and his revocable trust were alter egos, as we often assert, which guaranty was applicable?: $50 million or the unlimited amount? The Court had no problem finding the revocable Trust to be a legal entity, separate from its settlor, and thus its unlimited guaranty was enforceable.
Why the Trust’s Guaranty: Chase demanded a guaranty from Mr. Winget’s revocable Trust when it learned that most of his (personal) assets were titled in his Trust. Mr. Winget negotiated his own $50 million personal guaranty. Presumably, Mr. Winget could also release his right of revocation over his revocable Trust, thus placing the Trust (and its assets) to be beyond his reach, and beyond the reach of his creditor. Probably that is why Chase decided that it needed a loan guaranty from Mr. Winget’s revocable Trust, where most of Mr. Winget’s wealth was titled.
Voidable Transfer: While not germane to the issues before the Court, after the judgment had been entered in Chase’s favor, in 2014 Mr. Winget exercised his retained right of revocation under the Trust. He revoked the Trust and withdrew all of the assets from the Trust, consistent with his retained right. (Recall that Mr. Winget had by that time personally satisfied his own personal guaranty of the Chase loan.) Chase protested the Trust’s revocation by Mr. Winget, even though there was no covenant in the Trust’s guaranty that Mr. Winget would not exercise his retained right of revocation under the Trust instrument. The District Judge found that Mr. Winget’s Trust revocation was a fraudulent conveyance. [MCL 566.35.]

A footnote in the Court of Appeals decision observed: “To be sure, this does not resolve whether Winget could revoke the Trust and simply remove all the trust property. Winget tried to do exactly that back in 2014 but later reversed course. In related proceedings, the district court held that this revocation was a fraudulent conveyance under Michigan law. [Citations omitted.] But if Winget ‘owns’ the trust property, that may affect whether the district court was correct….Our decision does not address the fraudulent conveyance issue.” Apparently, this question was not preserved for the Court on appeal, so there was no discussion whether the District Judge’s finding of a fraudulent transfer was correct.

This footnote raises an interesting question: if the settlor and his trust are alter egos, is the revocation of the Trust and the return of the assets to the settlor’s name a transfer under Michigan’s Voidable Transfer Act? If the settlor and his Trust were alter egos, the revocation of the Trust would not result in a transfer. At the same time, the Trust is treated as a separate entity for separate contractual liability purposes. This seems a bit counter-intuitive reasoning by the Court of Appeals.

Someone Dropped the Ball? Apparently, someone forgot to limit the Trust’s guaranty to the same amount as Mr. Winget’s personal guaranty, in effect making the dollar limit on Mr. Winget’s personal guaranty illusory, inasmuch as his Trust could be fully depleted to satisfy its separate unlimited guaranty of the same Chase loan.

Conclusion: This case is just one more example where the Restatement (Third) of Trusts, Section 25 (2003) and thus the courts will treat a trust, even a revocable trust, as a separate legal entity apart from its settlor. Treating the Trust as a separate legal entity is a departure from common law, which treated a trust as a special relationship, and not a contract that creates a separate legal entity between the settlor and the trustee with the trust beneficiaries as third-party beneficiaries of that contract. Hence the evolution of the law of trusts from a special relationship to a contract.