Irrevocable Spendthrift Trusts — Outside the Reach of a Beneficiary’s Creditors — Not True in the Case of a Divorce

Asset protection lawyers are almost universally in agreement that assets in an irrevocable spendthrift trust established by a third party (often a parent) for the benefit of a beneficiary (typically a child) are not available to satisfy the debts and liabilities of the beneficiary. Indeed, that is one of the principal reasons for including spendthrift language in the trust. And case law is clear that settlors have every right to place their assets outside the reach of their beneficiaries’ creditors. Compare this traditional planning with the self-settled spendthrift trust – the typical domestic asset protection trust – where under laws of certain states a settlor is entitled to convey the settlor’s own assets to a trust which is not reachable by the settlor’s creditors.

In a recent Massachusetts divorce action, Pfannenstiehl v. Pfannenstiehl, the marital estate was found to include the husband’s beneficial interest in an irrevocable spendthrift trust established by his father. Because the trust was not a party in the divorce case, the husband was ordered to make 24 monthly payments to his ex-wife insuring the ex-wife received her 60% share of the marital estate which included the value of the husband’s interest in the trust.

The court found that the trustees had manipulated distributions to protect the family’s money against the wife’s claims. Particularly, the trust had for an extended period of time made monthly distributions to beneficiaries of the trust including the husband. However, once the trustees became aware of the divorce action, all distributions to the husband ceased while the trustees continued making monthly distributions to the other beneficiaries who had previously been receiving distributions. It didn’t help that one of the trustees was the husband’s brother and the second trustee, the ostensible independent trustee, had been the settlor’s attorney for over 3 decades and continued to act in that capacity.

The court explained that in the divorce realm the judge is not bound by traditional concepts of title or property. Even property not currently owned can be part of the marital estate: “When the future acquisition of assets is fairly certain, and current valuation possible, the assets may be considered for assignment.” The court did not find that the spendthrift provision kept the husband’s beneficial interest outside of the marital estate. To the contrary, the court stated that a trust, even one with a spendthrift provision, may be included in a marital estate for purposes of dividing property between the parties.

The court then reviewed the specific language of the spendthrift clause and observed that trust distributions are subject to an ascertainable standard. This allowed the court to conclude that the husband had a vested interest-a present enforceable right to distributions from the trust. Once it reached that conclusion, it was easy to find that this property right constituted a divisible asset.

Interestingly, the irrevocable spendthrift trust did work in one respect. It was not ordered by the court to make a distribution to the husband so that he could make the required payments to the wife nor was it ordered to pay the wife directly. Of course, the trust not being a party to the divorce case assured that result. So the court simply imposed the payment obligation on the husband leaving it to him to make sure he received sufficient funds from the trust. The question remains as to what will happen if the trust does not make distributions to him in the future such that he is unable to comply with the court ordered payments to the ex-wife? Is it conceivable that the ex-wife could bring an action to collect against the trust claiming an interest in the trust distributions payable to the husband? Could a court adopt the same approach as some courts have done in the offshore asset protection trust environment; namely, compelling the husband to get the money from the trust or face a contempt action. ┬áMy speculation is that if a collection action is brought against the trust in a different court (the divorce case was tried in probate court) the new court might apply a very different standard than what the divorce court used to determine the husband’s property. In such a scenario I suspect greater deference might be given to the spendthrift trust provision. Unanswered questions and much to ponder.