Michigan Court Puts Kibosh on Chapter 7 Debtor’s Attempt to Shield Trust Assets from His Creditors

Background: Richard and wife Lois entered into a trust in 1986. They were the co-trustees and sole beneficiaries of the trust during their lifetimes. It contained a standard spendthrift clause. The trust could be amended or revoked only by the joint action of both Richard and Lois. Either Richard or Lois, acting alone, is considered a Managing Trustee. In other words, either one acting alone could exercise any power granted to a trustee under the trust.

Richard filed for bankruptcy in 2012. Richard disclosed the trust on his bankruptcy asset list but claimed that the trust assets were not property of the trust estate and that the spendthrift provision in the trust was effective to block a creditor from reaching trust assets. The trustee brought a summary judgment motion claiming that (i) the spendthrift provision of the trust is not enforceable under Michigan law, (ii) the trust is against public policy and unenforceable because it is a self-settled trust designed to place the assets outside the reach of the settlor’s creditors and (iii) the assets of the trust should be included in the bankruptcy estate. The trustee sought a declaratory judgment and order for surrender of the trust assets.

The court first discussed Section 541(c)(2) of the Bankruptcy Code which excludes from the estate certain types of property interests including a beneficial interest in a trust subject to a restriction enforceable under applicable non-bankruptcy law. Thus, if the spendthrift clause in the trust was enforceable under Michigan law the property of the Richard and Lois trust would be excluded from the estate. The court then turned its attention to analyzing Michigan spendthrift trust law.

It is no surprise to anyone that Michigan recognizes the validity of spendthrift trust provisions including provisions that bar a beneficiary’s trust interest from seizure in satisfaction of the beneficiary’s debts. However, Michigan common law very consistently provides that there is a public policy exception to the validity of a spendthrift trust provision where the settlor and the beneficiary are one and the same. “Public policy does not permit a man to place his own assets beyond the reach of his creditors.” The court then exhaustively reviewed the impact of the Michigan Trust Code, enacted after the establishment of the Richard and Lois Trust, to ascertain whether the MTC abrogated Michigan’s common law rule against enforcement of self-settled spendthrift trust provisions.

The MTC expressly recognizes the validity and enforceability of spendthrift trust provisions. But it is silent on the issue of self-settled spendthrift trust provisions. The Court ultimately concluded that nothing in the MTC suggested that Michigan common law, eschewing the enforcement of self-settled spendthrift trusts, was changed by the MTC. Indeed, in reviewing the legislative history it is clear that the Michigan legislature did not intend the MTC to abrogate the common law in Michigan regarding self-settled spendthrift trusts. In Mark Harder’s (Chair and Reporter) Summary of the Michigan Trust Code it is stated numerous times that the MTC preserved well established Michigan law unless a compelling public policy consideration made it appropriate to change the law. In specific reference to Article 5 dealing with creditor’s rights, the Committee recognized the case law is comprehensive and closely follows the Restatement (Second) of the Law of Trusts. The Summary states even more directly in a footnote that “the focus upon creditors of beneficiaries is important. The MTC does not authorize self-settled asset protection trusts.”

Richard also made a number of additional arguments to support his position that the assets of the trust should not be available to his creditors: (i) the trust was irrevocable, (ii) some of the assets contributed to the trust were contributed by Lois, (iii) Richard was not the sole settlor – Lois should be treated as a co-settlor; and (iv) that Lois was also a beneficiary of the trust. The court quickly rejected each argument.

And, as is typical in these cases, the facts undercut Richard’s arguments. Richard consistently and over an extended period treated the trust assets as his own. He withdrew trust funds from the trust and then deposit them into his personal accounts whenever he felt like doing so; he never sought or felt it necessary to obtain Lois’ consent. Indeed, testimony by Richard early in the bankruptcy case [when he might not have realized its impact on the potential spendthrift provision fight] made it clear that Richard considered the trust assets to be his own…accessible to him at will. Surely this is inconsistent with any standard spendthrift provision.

The case made it abundantly clear that Michigan, at this time, does not recognize self-settled spendthrift trusts. However, it is worth noting that the author has reviewed proposed statutory language drafted to present to the Michigan legislature that would authorize self-settled spendthrift trusts. Stay tuned!