A Living Trust is not a legal term, but instead generically refers to a trust that is (1) revocable during the life of its creator, and (2) holds assets for the benefit of its creator. Generally, these trusts are used to by-pass probate, since the assets in the trust at the creator's death will pass to heirs via the trust, and not through any court process.
As an aside, Living Trusts are aggressively marketed by attorneys and insurance agents through advertisements in the sports pages and "free breakfast seminars", which are also often a subterfuge to sell high-commission annuities and life insurance to the seniors who show up. That doesn't have anything to do with this case, but just to let you know what's probably going on when you see those ads. And now to return to the case of today's interest . . . .
Husband and Wife entered into a Living Trust on September 10, 1986. They were the only beneficiaries of the Trust, and could request distributions from the Trustees (themselves) at any time, and in fact were required to make such a distribution to the other upon request. For the Trust to be amended or revoked required both Husband and Wife to take joint action.
The Trust Document provided that Husband, who was a lawyer and real estate developer, would be the Managing Trustee until his death, after which Wife would take over that role.
Section 4.3 of the Trust set forth its "Spendthrift Provision":
The right of any beneficiary to receive distributions under this Agreement shall not be subject to any conveyance, transfer or assignment by any beneficiary, or be pledged as security for the debts of any beneficiary, and the same shall not be subject to any claims by creditors of any beneficiary through legal process or otherwise. It is [HUSBAND]'s intention to place the absolute title to the property held in trust, together with all income, accruals and increases thereof, in the Trustees, with power and authority to pay out the same only as authorized hereby.
The Trust existed apparently happy in this form for some 22 years, and then in 2008, Husand and Wife amended the Trust to (1) provide that either of them could act as the Managing Trustee, and (2) the Trust would become irrevocable should either of them go on to their reward.
In 2012, apparently failing as a real estate developer, Husband "went banko" and filed a Chapter 7 case that listed $11 million in assets and $18 million in liabilities. On his Schedule B, Husband disclosed the existence of the Trust, but stated that the Trust's property was not property of Husband's bankruptcy estate and that the reference to the Trust was for "notice purposes only".
A Bankruptcy Trustee was appointed to Husband's case, and the Bankruptcy Trustee took issue with Husband's claim that the Trust's property was not the property of Husband's bankruptcy estate. The Bankruptcy Trustee then filed an adversary action against both Husband and Wife, alleging that as a self-settled trust (i.e., Husband and Wife created the Trust for their own benefit), the assets of the Trust became part of Husband's bankruptcy estate upon filing, notwithstanding the spendthrift clause.
Where it gets interesting is in Wife's Answer, since she contended that while Husband contributed some assets to the Trust (making it self-settled in that part as to him), he didn't contribute all of the assets to the Trust, and thus only some of the assets were includable in Husband's bankruptcy estate.
Both the Bankruptcy Trustee and Husband moved for summary judgment. The day before the hearing on the motions, Wife filed a Declaration stating that she had contributed $1.5 million to the Trust over the years, and attached a list of deposits. The Bankruptcy Court held a hearing, and then issued its Opinion as I shall now relate.
When a debtor files for bankruptcy, all of the debtor's non-exempt property comes into what is known as the debtor's "Bankruptcy Estate" (or, commonly, just "Estate") under Bankruptcy Code 541(a)(1). One of several exceptions is where the debtor has an interest in property that is not transferable, which essentially means that if the debtor could not transfer the interest to a third-party under non-bankruptcy law, then the interest would not become part of the debtor's bankruptcy estate.
Husband contended that the spendthrift provision in his Trust kept those assets from becoming part of his Bankruptcy Estate. The Bankruptcy Trust argued otherwise, and that he was obligated to take possession of all the assets in the Trust.
The Court then looked to non-bankruptcy law to see whether Husband's interest was transferable, which in this case meant Michigan law.
In 1973, the Michigan Supreme Court in Fornell v. Fornell Equipment, Inc., 213 N.W.2d 172 (Mich. 1973), recognized that spendthrift clauses are valid, since one giving property to another can restrict the property and creditors of the recipient have no right to complain that the property wasn't given to them instead. However,
A person cannot, however, create a true spendthrift trust for himself. Public policy does not permit a man to place his own assets beyond the reach of his creditors. But a settlor is not precluded from transferring his own property in trust to protect himself against his own improvidence.
In 1991, the Michigan Court of Appeals in the case of In re Johannes Trust, 479 N.W.2d 25 (Mich.App., 1991), relied upon the Restatement (Second) Trusts § 156 (1959) as promoting
Furthermore, the rule stated in the Restatement promotes a valid public policy: A person ought not to be able to shelter his assets from his creditors in a discretionary trust of which he is the beneficiary and thus be able to enjoy all the benefits of ownership of the property without any of the burdens.
Thus, under Michigan decisional law, Husband would not be able to protect the assets in the Trust from his creditors, and thus those assets would be properly includable in his Bankruptcy Estate and subject to being taking into possession by the Bankruptcy Trustee.
Husband, however, had an alternative argument, which was that when Michigan enacted the Michigan Trust Code ("MTC") in 2010, the MTC effectively replaced prior Michigan law on the subject, and the MTC did not expressly allow creditors to invade self-settled spendthrift trusts (but did place restrictions on how much property that a creditor of a beneficiary could reach in such a trust).
The Court did not buy Husband's argument, noting that the MTC:
focuses on the rights of a creditor of a settlor, without regard to the identity of any beneficiary. This section of the statute does not either explicitly or implicitly limit the rights of a creditor of a beneficiary who is also a settlor of a trust with a spendthrift provision. It does not support the Defendants' contention that the MTC somehow permits a self-settled spendthrift trust. [Emphasis in original]
But even beyond that, the Court noted, the MTC will only recognize a trust that is not contrary to public policy in Michigan, and the MTC did not purport to change Michigan's public policy as it relates to self-settled trusts.
Husband next tried to argue that since Wife was also a settlor of the Trust, that insulated the Trust from being considered a self-settled trust. No sale, said the Court, since merely adding one's spouse to a Trust does not change the fact that Husband was both a settlor and a beneficiary of the Trust, thus making it self-settled as to him.
The Court also shot down Husband's arguments that the Trust was really now an irrevocable trust, since both Husband and Wife had to jointly agree on any action under the 2008 amendment, and that Wife had now to consent to making any distributions to him. These arguments were a "distinction without a difference", according to the Court, since at the end of the day Husband was still a settlor of the Trust and a beneficiary of the Trust, and thus the Trust was self-settled.
Finally, Husband argued that his interest in the Trust was held in tenancy by the entireties ("TBE") with Wife, and that such kept the assets in the Trust from being available to creditors. Here, the Court noted that it had previously rejected Husband's TBE claim (which ruling Husband was appealing at the time of the instant ruling), and again denied it here.
Moving to the Trustee's arguments, the Court agreed with the Trustee that:
as a matter of fact, Richard has at all times treated, used and enjoyed the property in the Trust as his own.
Here, the Court referenced numerous evidence that Husband had repeatedly treated Trust property as his own, had transferred property back and forth between his own personal accounts willy-nilly, had undocumented loans from the Trust to himself, and in signing documents had often made no distinction between his personal capacity and that as a Managing Trustee of the Trust. Moreover, the Court thought it important that Husband had simply passed through the taxable activity of the Trust to his and Wife's personal tax returns.
[This last point should justifiably raise some eyebrows, since all "grantor trusts", including some very complex irrevocable trusts that could not by any standard be called "self settled trusts", do this. Probably best to chalk this last one up to a bankruptcy judge with obviously little or no experience in tax law, and not get too bent out of shape about it.]
Thus,
Based on Richard's own uncontroverted testimony, the Court finds that he basically treats the assets of the Trust as his own personal property for all purposes, whether signing documents, receiving distributions, or simply paying his everyday expenses.
Husband retorted that, after the 2008 amendments, he required Wife's consent to his actions, and thus could not have treated the property as his own. But the Court pointed out a complete absence of evidence in the record that Husband ever sought, much less obtained, Wife's consent to his actions:
The undisputed facts show that [Husband] and [Wife] themselves have entirely disregarded any restrictions on [Husband]'s use and enjoyment of the assets in the Trust. The unfettered control that [Husband] alone exerts over the assets of the Trust, and the manner in which he uses the Trust assets, show that this is precisely the type of case that is most offensive to the public policy articulated by the Michigan Supreme Court. The Court holds that [Husband] cannot in these circumstances hide behind the spendthrift provision in Section 4.3 of the Trust nor behind his factually unsupported argument that he cannot himself reach the Trust assets without [Wife]'s permission. For the Court to conclude anything other than that [Husband]'s beneficial interest in the Trust is property of his bankruptcy estate would require the Court to completely disregard Michigan public policy.
Husband's arguments having gone down in flames, the Court then turned to Wife's argument that she contributed $1.5 million to the Trust and that at least this amount should be off-limits to the Trustee.
Unfortunately, Wife waited to file her Declaration until the day before the hearing on the summary judgment motions, which was too late:
Neither the Federal Rules of Bankruptcy Procedure nor the Court's Local Bankruptcy Rules permit the filing of the Declaration one day prior to the scheduled hearing and, for that reason alone, the Court disregards it.
But, the Court noted, even if it had considered Wife's Declaration, that would not have changed things, since all it showed was that she made deposits into certain accounts over a six-year period, without showing that those accounts were owned by the Trust or not. If anything, it just further proved to the Court that Husband was running the Trust willy-nilly without attempting to discern between Trust property and his personal property, which facts furthered the public policy of allowing creditors to invade the Trust.
The Court thus granted summary judgment to the Trustee, and overruled Husband's own motion and objections. The Trustee was allowed to take possession of all the Trust's assets, which were includable in Husband's Bankruptcy Estate.
ANALYSIS
It is probably important to distinguish this case from one involving an "asset protection trust", which is a self-settled spendthrift trust that is formed in a jurisdiction whose laws do expressly protect the assets of such trusts from creditors. Michigan is not such a jurisdiction, and the Court in footnote 1 was careful to point out that "self-settled asset protection trusts" are not part of either the Uniform Trust Code or the Michigan Trust Code.
I will similarly leave for another day a discussion of whether if this Trust were an asset protection trust formed in another jurisdiction whether its assets would have been included in the Husband's bankruptcy estate under Bankruptcy Code § 541(a)(1) -- except to say "probably", since it is likely that Michigan law would have applied to a Michigan debtor regardless of where the Trust was formed (see Huber).
Of more immediate importance are the issues which the Court did decide, which is that one cannot protect the assets of a Living Trust from creditors simply by adding another settlor, or by requiring the consent of the other settlor to certain actions. As the Court here states, none of that make any difference since the only analysis is whether the debtor is a settlor and a beneficiary -- if that is the case, then you have a self-settled trust and the assets of the trust are available to the debtor's creditors (and includable in the debtor's bankruptcy estate).
That the assets of the Living Trust were commingled with Husband's personal assets was obviously a bad fact, but, truthfully such commingling is often the case with Living Trusts. Most Living Trusts are accompanied by what is known as a "pour over will", which is a will that simply says that whatever assets the settlor has that are not already in the Trust at the settlor's death will become part of the Trust at the settlor's death. Such provisions are common, because a lot of people who set up Living Trusts either don't fund them fully (or at all), or because -- as here -- they treat the Trust property as their own and commingle it.
This commingling doesn't have that much downside as far as the transfer on death is concerned if there is a pour over will, but it can have disastrous consequences in creditor-debtor situations such as these where one wants a trust to fulfill an asset protection goal.
In fact, giving a beneficiary control over the trust is usually a really bad idea as it relates to the asset protection features of all trusts, and not just Living Trusts.
Here is the problem: Many folks who create a trust want to give up title to the trust's assets for some reason or another, such as taxes or creditors, but they don't want to give up control of those assets for fear that the assets will be embezzled or mismanaged. Thus, trust planners have come up with all sorts of structural gimmicks to try to give such folks the best of all worlds, such as (here) making them the "Trust Manager" or whatever.
Unfortunately, these arrangement threaten to upset the trust applecart since question arise as to whether there is a bona fide trust arrangement in place, regardless of what the documents say, or whether the trust is instead simply the alter ego of the person who created it, such as was found to be the case by the Ninth Circuit in Schwarzkopf. This is where trust structuring becomes more art than science, since there is a fine line to be walked between the too little control which client fears and the too much control that will void the trust under an alter ego or similar analysis.
Finally, the Trustee may have missed an argument under Bankruptcy Code § 548(e) as to the amendment of the Trust in 2008, since, arguably, the attempted conversion of the trust from a revocable trust to an irrevocable trust was a "transfer" or the Husband's right to revoke but without any consideration, and thus potentially was a fraudulent transfer of Husband's right to revoke.
But, hey, the Trustee here hit a home run so who cares if he didn't swing at an earlier pitch.
CITE AS
In re Lewiston, 2015 WL 3894609 (Bk.E.D.Mich., June 24, 2015). Full Opinion at http://goo.gl/asPoYK
This article at http://onforb.es/1IC0rns and http://goo.gl/dtA2CP
