Asset Protection Issues and the New Michigan Trust Code

February 25, 2010

While the new Michigan Trust Code is effective April 1, 2010, it will apply to trusts created on, after or before the effective date. Thus, with limited exceptions, after April 1, 2010, all Michigan trusts will be subject to the new provisions.

We often use trusts as part of an overall strategy to provide asset protection for our clients. For example, assume we have a husband and wife and the wife has significant debts and/or contingent liabilities. We will typically have the husband create a discretionary spendthrift trust so that, upon the husband's death, the debtor wife will be the beneficiary of a trust fund which will be outside the reach of creditors. Similarly, the wealthy parents of a debtor child will not want to simply leave the debtor child's share to him outright knowing the inheritance may very well be grabbed by the child's creditors. Instead the well advised couple will set up a discretionary spendthrift trust for the child.

Until the final rules were resolved, lawyers had questions regarding the differences between support and discretionary trusts and how spendthrift provisions are applied. This was particularly troublesome in planning for asset protection and being able to provide assurances to your client that their child's creditors could not reach the assets of the trust they created. With the passage of the new Michigan Trust Code, certainty reigns.

Best practices for this asset protection strategy is for the debtor beneficiary to be a beneficiary of a discretionary trust rather than a support trust. Even though a support trust has some protections; i.e., the interest of the beneficiary is not subject to the enforcement of a judgment, the beneficiary's creditors can reach the income or principal after there has been a direct distribution to the beneficiary (but then only to the extent that income or principal is not necessary for the health, education support or maintenance of the beneficiary). One issue of concern is that the support trust requires the trustee to distribute funds for support. This provides an opportunity for creditors to reach those funds upon receipt by the debtor beneficiary. Another problem with support trusts is that there are several additional opportunities for creditors to access the trust. In the case of support and spendtrhift provisions (but notably not discretionary trust provisions) the interest of the beneficiary in the trust can be reached to pay (i) child or spousal support awarded by a court, (ii) a judgment creditor who has provided services that relates to the preservation of the beneficiary's trust interest and (iii) an enforceable claim by a state or the United States.

The discretionary trust is a much tighter structure for asset protection. With this type of trust, the trustee is not obligated to make a distribution to the beneficiary and trust property is not subject to the reach of the beneficiary's creditors. Thus, the trustee has the ability to carefully plan distributions to avoid creditor problems in many cases paying expenses of the debtor beneficiary directly.

The new Michigan Trust Code specifically recognizes spendthrift trust provisions. It restrains both voluntary and involuntary transfers and is not subject to enforcement of a judgment until actually distributed. This continues long-standing law in Michigan on spendthrift trusts.