Denis Behan created a Trust in 1994, and into he placed his personal residence. Denis made his four children the beneficiaries of the Behan Trust, and three of the children (but not the fourth, Philip) were also made Trustees.
Each of Denis' children were given a 1/4th interest in the Trust, subject to the Spendthrift Provision which protected those interests from a child's creditors.
Critically, each child was given a withdrawal right, embodied in the following paragraph:
In addition, the Trustees shall pay to or for the benefit of such child all or so much of the principal and accrued income of such share as such child may specifically demand in writing from the Trustees so long as such child is not incapacitated at time of demand.
Each child could, through their Will and upon their death, also appoint their share of the Behan Trust assets to whomever they designated.
Four years later, in 1998, Denis passed. Apparently, the Behan Trust percolated along without difficulty for the next 14 years.
Then, Philip J. Behan filed for Chapter 7 bankruptcy on June 6, 2012.
The only significant asset listed by Philip in his bankruptcy schedules was a Power of Appointment that he had in the Behan Trust created by his father. Philip asserted that he had no control over the Trust or its assets, and that the Trust had a Spendthrift Provision that protected his interest from creditors.
Philip claimed that the Power of Appointment held little or no value, and at any rate the value was within the amounts of his creditor exemptions allowed by local law.
The Chapter 7 Trustee (which I will refer to as the "C7T" to avoid confusion with the Trustee of the Behan Trust) filed an adversary action against the Behan Trust, seeking to recover from the Trust the value of Philip's beneficial interest, and for related relief. Philip intervened in the adversary action.
The C7T took the position that the Spendthrift clause was unenforceable, because Philip had the right to demand his share of the Behan Trust assets at any time -- and the Trustee had no discretion to refuse Philip's request. Moreover, because Philip had a Power of Appointment over his share of the Behan Trust assets, the C7T argued that this amounted to control over Philip's share such that the assets became part of his bankruptcy estate, and thus available to his creditors.
Philip, of course, disagreed. Philip argued that the Power of Appointment did not override the Spendthrift Clause, and at any rate the value of the Power of Appointment was nothing like the value of his share of the assets, but some much, much lower number -- so low, Philip argued, that it was within his personal property exemption under Massachusetts law.
The Bankruptcy Court agreed with the C7T. The fly in Philip's ointment was the Power of Appointment. Because Philip had a Power of Appointment by which he could direct where his share of the Behan Trust asset would go, that Power of Appointment became an asset of Philip's bankruptcy estate and thus ended up being held by the C7T, who could exercise the Power of Appointment for the benefit of Philip' s creditors.
After a long and very technical discussion of how the Power of Appointment caused Philip's share of the Behan Trust to end up in his estate, the Court concluded:
In the present case, the Trust document unequivocally confers on the beneficiaries the right to demand their share of the principal and accrued income provided that "such child ... specifically demand in writing from the Trustees ... [their share] ... [and] ... so long as such child is not incapacitated at the time of demand." The power of appointment, although not exercised, defeats the spendthrift provision set forth in the Trust. As a property interest, the [C7T] is authorized to exercise the power of appointment for the benefit of the Debtor's bankruptcy estate, subject to this Court's determination of the [C7T]'s Objection to the Debtor's amended claim of exemption in the power of appointment.
While the Court has not yet ruled on Philip's exemption claim, suffice it to say that the value of the Power of Appointment is probably much more valuable than the amount of his personal exemption, because it gives the C7T the right to access Philip's share of the Behan Trust.
ANALYSIS
This is an older trust with older provisions, and one of the problems with legal planning is that planners can't always accurately predict which paths the law will expand down or the conclusions to be reached by judges. And some readers will doubtless just stop there in their analysis, and move on to read about the next case.
The problem created this opinion is that the rationale adopted by the Bankruptcy Court -- that a Power of Appointment can cause inclusion of a debtor-beneficiary's share of trust assets into the bankruptcy estate -- has the potential to seriously affect much more modern trusts as well.
Asset protection planners have long looked for the Holy Grail of Trusts, meaning a trust that would lawfully allow a beneficiary to control and use the trust assets, while keeping those assets from the reach of the beneficiary's creditors.
The first attempt was the Foreign Asset Protection Trust ("FAPT"), which seemed to reach this result simply because the Trust's assets were outside the U.S. and beyond the reach of creditors. But then, courts started throwing the settlor-beneficiaries in jail until the assets were returned back to with the U.S. so they would be available for creditors. This doesn't always happen, but it happens enough as to make FAPTs suspect as an asset protection planning tool, and not just a few asset protection planners have abandoned their use in all but very limited circumstances.
The second attempt was the Domestic Asset Protection Trust ("DAPT"), which attempted to rely on favorable state law to reach the same result that FAPTs were supposed to reach. However, this has so far proven to fail if the settlor-beneficiary is not resident in a state that has adopted DAPT laws. But worse, in 2005, Congress amended Bankruptcy Code 548(e) to create a 10-year Statute of Limitations for challenges to "self-settled trusts and similar devices" and which law was aimed specifically at DAPTs. It is frankly a wonder that anybody with more than a minimal knowledge of creditor-debtor law now uses DAPTs at all -- though of course the trust companies market them quite shamelessly to the unwary without revealing these trusts' very serious flaws.
Which brings us to present day, and the third attempt to create the Holy Grail of Trusts, being the so-called "Special Power of Appointment Trusts", or "SPA Trusts" for short. The idea here is that the settlor of the trust is not, repeat not, given anything like a beneficial interest in the trust, i.e., is not made a beneficiary of the trust.
However, and here is the catch, the creator of the trust (know as the "settlor", or somebody so close to the settlor that they are effectively the settlor's nominee, is given a Special Power of Attorney that at some later date they can exercise the Power of Attorney and give the themselves a share (or all) of the trust's assets.
In estate planning parlance, the SPA Trust essentially creates a "springing beneficiary", i.e., somebody who was not a beneficiary when the trust was created, but then later becomes a beneficiary at some future date, presumably when the settlor has no creditors hovering about who might try to snatch up trust assets.
Which brings us back to the Bankruptcy Court's opinion in Behan, because the Court essentially held that such Powers of Appointment can be used by C7T to access the beneficiary's share of the trust assets, even if a Spendthrift Clause says otherwise.
Another way to look at this is that Courts are looking past the language in trust documents, and seeing what might actually occur. If at some point, a debtor-beneficiary might get access to trust assets, then the Courts are basically treating that possibility as if it has already occurred -- by letting the C7T exercise whatever powers the debtor has to bring that result about.
We'll have to see in future cases involving more modern trusts how this plays out, but the Behan opinion certainly sounds a warning horn that all may not be well in Power of Appointment land.
For more on SPA Trusts, see my article "Are Special Power of Appointment Trusts And Hybrid Trusts 'Similar Devices' To Self-Settled Trusts?" at http://onforb.es/11djfUQ and http://goo.gl/RMWGn
CITE AS
In re Behan, 506 B.R. 8 (Bk.D.Mass., Feb. 25, 2014). http://goo.gl/1yBema
This article at http://onforb.es/1tuGUAg and http://goo.gl/YOGyuV
