Spendthrift Provision: A Trust’s Material Purpose

Take-Away: Despite an optional provision of the Uniform Trust Code, upon which much of the Michigan Trust Code is based, a spendthrift provision  in an irrevocable trust is treated, unless the trust instrument expresses a contrary intent, as a material purpose of that trust. Consequently, the presence of a spendthrift provision in an irrevocable trust may make the trust’s termination or its modification more difficult to achieve which may be important in an era of  building ‘flexibility’ into and modifying dynasty-type trusts. You need to confirm if the settlor intends the spendthrift provision to not be a material purpose of the settlor’s trust.

Background:

• Common Law Spendthrift Provision: At common law a  trust’s spendthrift provision prohibits the beneficiary’s assignment of his or her beneficial interest in the trust to a third person. It not only prohibits the beneficiary’s attempted  voluntary assignment of his/her interest in the trust, (e.g. ‘you give me title to that car and I will assign my right to receive income from  this trust to you’)  it also prohibits a beneficiary’s judgment creditor attaching and executing on the trust’s assets  to satisfy a judgment against the beneficiary. In short,  the judgment creditor of the trust beneficiary cannot, with limited exceptions, access the assets titled in the name of the trustee.

Spendthrift provisions can be expressed in many different ways. Some states as a matter of public policy,  have carved out big exceptions to the protection otherwise afforded by a trust’s spendthrift provision, often in response to an egregious fact situation. In addition, courts sometimes surprise trustees and beneficiaries and find an exception to the prohibition of a spendthrift provision, tending to ignore the laws of the state. See In re Darrell V. Wright Trust Agreement, 2015 Mich App LEXIS 543 (March 17, 2015) where the court interpreted a protective trust provision as not foreclosing a finding that the beneficiary possessed an ‘indefeasible vested interest in the trust funds which could be attached’ by the State of Michigan.

• Trust Code Spendthrift Provision: The Michigan Trust Code defines a spendthrift provision as ‘a term of a trust that restrains either the voluntary or involuntary transfer of a trust beneficiary’s interest.’ MCL 700.7103(j). Such a clause is valid and enforceable by courts. [MCL 700.7502(1) and (2).] With a couple of exceptions, with a spendthrift provision the trust beneficiary’s interest in the trust cannot be transferred in violation of a valid spendthrift provision and trust property is not subject to enforcement of a judgment until the property is distributed directly to the beneficiary. [MCL 700.7502(3).] Nor is a trustee is liable to the trust beneficiaries for making a distribution to which a trust beneficiary is otherwise entitled pursuant to the direction of the trust beneficiary; this exoneration is part of the Michigan Trust Code which makes sure that a spendthrift provision is not violated when a beneficiary asks the trustee to make a payment or distribution directly to a third party in connection with a distribution to which the beneficiary is otherwise entitled under the trust instrument. [MCL 700.7502(4).]
• Spendthrift Provision Exceptions: Even with a spendthrift provision, the interests of the trust beneficiary can be reached in satisfaction of an enforceable claim  by a trust beneficiary’s child or former spouse who has a judgment or court order against the trust beneficiary for support or maintenance [MCL 700.7504(a)] or a judgment creditor who has provided services that enhance, preserve or protect a beneficiary’s interest in the trust [MCL 700.7504(b)] or the State of Michigan or the United States [MCL 700.7504(c).] But the court can only order the trustee to satisfy part or all of a judgment or court order only out of part or all of a distribution of income or principal “as they become due.” [MCL 700.7504(3).] Accordingly, these limited ‘exception creditors’ can only access trust assets that the trust beneficiary is entitled to receive as a distribution, no more than what the beneficiary would otherwise be entitled to receive under the trust, meaning there can be no acceleration of future distributions in order to satisfy the creditor’s judgment against the trust beneficiary- the creditor must wait for the scheduled distributions.
• Discretionary Trust: Often a spendthrift provision is confused with a discretionary trust, but they are not the same thing. You have heard from me before about discretionary trusts under the Michigan Trust Code. A discretionary trust is  broadly defined at MCL 700.7103(d). Under a discretionary trust the beneficiary is deemed to possess no property interest in the trust. At most, the trust beneficiary is viewed as holding only an expectancy.  With a discretionary trust the transferee (voluntary) or creditor (involuntary) of the beneficiary of a discretionary trust does not possess a right to any amount of trust income or principal, and trust property is not subject to the enforcement of a judgment until income or principal, or both, is actually distributed directly to the trust beneficiary. [MCL 700.7505.] The Michigan Trust Code further clarifies  that the beneficiary of a discretionary trust “has no property right in a trust interest that is subject to discretionary trust provision.” MCL [700.815(1).]Thus, the four ‘exception creditors’ to a spendthrift provision noted above do not apply to a discretionary trust. [MCL 700.7504(3).] A support trust  as defined in the Michigan Trust Code [MCL 700.7103(k)]- ‘support provision means a provision in a trust that provides the trustee shall distribute income or principal or both for the health, education, support and maintenance of a trust beneficiary, or language of similar import’ ] can contain a spendthrift provision which will be enforced, except where the judgements or court orders are asserted by any of the four ‘exception creditors.’
• Boilerplate Provision: All of which is a long-winded way of saying that you will normally find a spendthrift provision buried in the boilerplate of most irrevocable trusts, in light of the  protection that it provides to the beneficiary from most creditor claims, or how it effectively stops the beneficiary’s temptation to assign his or her interest in the trust in exchange for some other type of asset or benefit. Which brings us then to the question: is a spendthrift provision just a common boilerplate clause included in an irrevocable trust, or is its inclusion  a material purpose of the trust?

Spendthrift Provision  as a Material Purpose:  The term material purpose  is not defined in the Michigan Trust Code, but it regularly appears throughout that Code’s provisions. It becomes relevant when a decision is made to modify or terminate an irrevocable trust. A trust  created after April 1, 2010 can be modified or terminated by a probate court upon the consent of the trustee and the qualified trust beneficiaries if the court concludes that the modification or termination of the trust is consistent with the material purposes of the trust or that continuance of the trust is not necessary to achieve any material purpose of the trust. MCL 700.7411(1)(a). A material purpose was the issue in a recent Michigan court decision,  In re Estate of Larry E. Hutchinson Living Trust, 2016 Mich App LEXIS 1311 (July 7, 2016). There,  the trust beneficiaries settled litigation under MCL 700.7411 by agreeing to terminate the trust and divide trust assets amongst themselves. However, they overlooked mineral interests held in the trust. Years later the mineral interests became the subject of new litigation. The Court of Appeals held that the beneficiaries’ prior attempt to terminate the trust was ineffective and that the trust actually continued because a material purpose of the trust remained to be fulfilled- distributing the mineral interests, which were ultimately awarded to the contingent remainder beneficiaries after the death of the trust’s life income beneficiary.

Optional UTC Provision: Uniform Trust Code Section 411(c) which the Michigan Trust Code generally follows, included an optional provision that stated that a spendthrift provision is not a material purpose of a trust. The drafters did not include this optional Uniform Trust Code provision in the Michigan Trust Code that was finally adopted and effective in 2010. The drafters felt that the settlors of most trusts consider a spendthrift provision to be material. As such, any effort to modify or terminate an irrevocable trust that contains a spendthrift provision might not be accepted, or might be impeded,  by the probate court if the proposed modification or termination would seem to alter or impact in any manner the trust’s spendthrift provision. Consequently unlike some states where the presence of a spendthrift provision will not prevent a subsequent modification or termination of an irrevocable trust, that is not the case if the Michigan trust contains such a provision.

Conclusion: If a dynasty or long-term trust is created in Michigan and the settlor contemplates the possibility of future trust modifications as the circumstances of the beneficiaries change over the years, in reliance upon the fact that most modern trusts can be modified or adapted to meet the needs of future beneficiaries,  the settlor of the irrevocable trust should make it clear in their trust instrument that the inclusion of the spendthrift provision in the trust is not intended to be a material purpose of that trust. In sum, if you note the trust contains a spendthrift provision you should also note if the settlor intends that it is not intended to be a material purpose of the trust, otherwise it will be presumed to be a material purpose which might cause future impediments to future modifications to the trust instrument.