Decanting a Trust: Are There Public Policy Limits?

Decanting a trust is one way to eliminate or change provisions in an existing trust that are viewed as undesirable, or which are no longer workable due to changes in the law or the beneficiary’s circumstances. While there are some statutory limitations imposed on the trustee’s decanting power (e.g. the inability to decant-away the beneficiary’s right to receive trust income) few statutory constraints exist on the trustee’s ability to decant an irrevocable trust’s assets to a new trust.

An interesting Massachusetts court decision was published in mid-March that questioned the possible limits to a trustee’s decision to decant an irrevocable trust in order to frustrate the possible claims of a creditor, or more specifically, frustrate a court in the trust beneficiary’s pending divorce. That decision prompts the question if public policy limits exist on a trustee’s ability to decant a trust’s assets to a new trust.

Decanting Statute: Like 24 other states, Michigan has a decanting statute that gives the trustee of an irrevocable trust the ability to create a new trust, and to transfer the assets of the existing trust to the new trust. In fact, Michigan has two separate decanting statutes: amendments to both the Michigan Trust Code and the Michigan Powers of Appointment statute. A significant advantage of a decanting statute is that the trustee can generally decant the existing trust’s assets to the new trust without the consent of the trust beneficiaries or a probate judge. However, most decanting statutes require notice be given to the trust beneficiaries of the intended decanting, and the terms of the proposed new trust. The imposition of the notice requirement implies an opportunity for the existing trust beneficiaries to file a court petition to object to the trustee’s proposed decanting.

Common Law Decanting: Massachusetts has no decanting statute. The question was whether a trustee possessed the power to decant a trust’s assets as a matter of common law and settlor intent. The Massachusetts Supreme Judicial Court was asked by the Connecticut Supreme Court to answer questions with regard to the co-trustee’s decision pursuant to an irrevocable Massachusetts 1983 Trust to decant it’s assets to a 2011 Trust to add a spendthrift limitation, which in effect eliminated the beneficiary’s principal withdrawal rights upon attaining a specific age. The effect of the co-trustee’s decanting decision was that the 2011 Trust’s assets were deemed unavailable to be divided in the beneficiary’s pending Connecticut divorce proceeding. The spendthrift limitation was added to the trust just prior to the beneficiary attaining an age when he would possess the right to withdraw 75% of the trust corpus. Michael J. Ferri, Trustee v Nancy Powell-Ferri (published March 20, 2017).

Facts: The facts were straight-forward. A father created a trust in Massachusetts for his son in 1983 when the son was age 18. The co-trustees were given the discretion “to pay or segregate irrevocably trust assets for later payment to” the son. When the son reached age 35 the trust instrument gave him the right to withdraw trust principal up to specified percentages of the trust corpus, with the right to withdraw the entire remaining trust corpus when the son attained age 47. The son’s wife filed for divorce in 2011 when the son had reached age 35 and could withdraw 75% of the trust corpus, but he had not yet exercised that withdrawal right. The co-trustee decanted the 1983 Trust out of his concern that the beneficiary’s wife would reach the assets held in the 1983 Trust in their pending divorce. The co-trustee made the decision to decant without informing the son, his brother, and without his consent. The 2011 Trust was a discretionary trust, which contained a fairly common spendthrift limitation that prevented the beneficiary’s creditors from attaching trust assets.

Court Decision: Most of the Ferri decision centered upon whether the co-trustees held a common law power to decant the 1983 Trust. The Court found such a decanting power to exist even in the absence of any Massachusetts statute that expressly authorized a decanting of the trust’s assets. The key to the Court’s decision was language used in the 1983 Trust instrument that reflected the settlor’s intent to give to the co-trustees whatever power and authority they needed to protect the beneficiary’s interest in the trust. The Court seem to place great emphasis on the trust’s distribution phrase ‘to pay to or segregate irrevocably…for so long as the beneficiary is living.” The Court found this language to manifest the settlor’s strong desire to preserve the assets for his son’s benefit and convincing evidence that the trustee possessed the authority to decant the trust assets to another trust. While the son possessed the power to withdraw 75% of the trust assets at the time of the decanting, later increasing to a 100% withdrawal right, the Court found that the trustee’s authority to decant was a parallel, but separate power that was exercisable independent from the trust beneficiary’s power to withdraw assets from the trust. By the co-trustees exercising their decanting power immediately prior to the trust beneficiary exercising his withdrawal power over 75% of the trust corpus, the co-trustee’s effectively eliminated the beneficiary’s ability to withdraw assets from the trust.

Public Policy: The public policy implications of the Ferri decision surfaced in a concurring decision written by three Justices of the Massachusetts Supreme Judicial Court. That concurring decision phrased the public policy question as follows: “Whether Massachusetts law will permit trustees in Massachusetts to create a new spendthrift trust and decant to it all the assets from an existing non-spendthrift trust where the sole purpose of the transfer is to remove the trust’s assets from the marital assets that might be distributed to the beneficiary’s spouse in a divorce action.” It was noted that the trust beneficiary had no role in creating the 2011 Trust, nor in decanting the assets from the 1983 Trust to the 2011 Trust. Nor was the beneficiary consulted by his brother, the co-trustee, before the decanting decision was made. The concurring decision was written solely to emphasize that the questions answered by the Massachusetts Supreme Judicial Court were limited and did not address the public policy implications of decanting to a spendthrift trust for the sole purpose of depriving the trust beneficiary’s spouse of marital assets in a divorce. By implication the concurring decision seemed to imply that the decanting should be held invalid as contrary to the state’s public policy, but it not go that far.

Michigan Public Policy: Michigan, like Massachusetts, adopted a statute that provides that a trust may be created only to the extent that the trust’s ‘purposes are lawful and not contrary to public policy, and possible to achieve.’ MCL 700.7404. While Michigan’s statute does not attempt to identify what constitutes a trust’s violation of public policy, the Reporter’s Comments to MCL 700.7404 suggest that a trust is invalid if ”the settlor’s purpose is to defraud creditors or others.” Less clear under this public policy exception is when a trustee exercises its statutory authority to decant the trust (neither the settlor, nor the beneficiary), which places the trust’s assets beyond the reach of the trust beneficiary’s creditors. Specifically, an acting trustee may feel compelled to decant the trust in the belief that the exercise of its decanting power is consistent with the trustee’s statutory duties to administer the trust ‘for the benefit of the trust beneficiary’ [MCL 700.7801], ‘solely in the interests of the trust beneficiaries’ [by inference, not the beneficiary’s creditors or spouse, MCL 700.7802(1)] and to take ‘reasonable steps to take control of and protect trust property.’ [MCL 700.7810] One could easily argue that an acting trustee might be in breach of these duties if the trustee did not exercise the authority granted by statute to decant a trust without a spendthrift limitation that could otherwise be attacked by the trust beneficiary’s creditor, or in the event of the beneficiary’s divorce.

Practical Implications: If the same decanting effort had taken place in Michigan by the co-trustee in Ferri, the husband’s withdrawal rights over the trust principal could not have been eliminated in the new trust. Michigan’s decanting statute expressly provides that the second trust to which the decanted assets are transferred cannot ‘reduce a presently exercisable general power to withdraw a specified percentage or amount of trust property held by a trust beneficiary, who is the only trust beneficiary to or for the benefit of whom the trustee has the power to make discretionary distributions.” [MCL 556.115a (d)]

But there could be other ‘rights’ held by a trust beneficiary that might be taken or attached in an irrevocable trust that could be altered or eliminated by a trustee’s decanting to a new trust. For example, an irrevocable trust might give the trust beneficiary the right to use rent-free for the winter months a Naples condominium held in the name of the trust, which right of use might be awarded to the beneficiary’s former spouse in a divorce action; conceivably the existing trust could be decanted by the trustee to remove the beneficiary’s exclusive right to use rent-free the condominium in the second trust.

Or consider a Michigan support trust that is established for a beneficiary where the trust provides that ‘the trustee shall distribute income for the health, education, support or maintenance of the beneficiary and the discretion to distribute trust principal to, or for the benefit of the beneficiary as the trustee deems advisable.’ [A support trust is defined at MCL 700.7103.] The Michigan Trust Code provides that the interest of the support trust beneficiary can be reached in satisfaction of enforceable claims against that beneficiary held by that beneficiary’s child (child support) or former spouse (spousal support), or a judgment creditor who has provided services that enhanced or protected the beneficiary’s interest in the support trust. [MCL 700.7504(1)(a)(b)]. Could a support trust be converted through a trustee’s decanting power into a discretionary trust, [defined at MCL 700.7505] where there are no statutory exception creditors (other than a claimant for back child support) who can access the trust beneficiary’s interest? Would the trustee’s decanting of an existing support trust to a discretionary trust with the intent to preclude the enforcement of exception creditor claims be void as against Michigan public policy, since the purpose behind the decanting was to frustrate the beneficiary’s exception creditors, arguably contrary to public policy?

Conclusion: Michigan’s Trust Code makes it clear that a trust that is created contrary to state public policy is void. The trust’s purpose to defraud creditors is considered to be contrary to Michigan’s public policy. But a discretionary trust with a spendthrift limitation, under the same Trust Code, precludes almost all creditors from attaching the beneficiary’s interest in the trust. If the trustee’s decision to decant a trust’s assets to a new trust is intended to take advantage of the creditor protection features of the Trust Code, or the trustee decides to decant to a new trust, which complies with the new Michigan Qualified Dispositions in Trust Act (its version of an asset protection trust), will the exercise of that statutory decanting authority be treated as contrary to public policy, or just a smart trustee that fulfills its fiduciary duties to the trust beneficiary to protect trust assets, and to protect the beneficiary’s interest in the trust. Time will only tell when we will learn the limits of whether a trust, created by the trustee’s exercise of it’s decanting power, is consistent with, or contrary to, Michigan’s public policy.