Creditors' Rights in Trusts: Spendthrift, Discretionary Interest and Other Trust Terms Affecting Creditors' Rights Under Restatement (Third) of Trusts

Estate Planning Retreat June 8-10, 2006 Vail, Colorado

By: Stanley C. Kent

I. Syllabus:

A. Use of trusts in has expanded exponentially. Revocable trusts are commonlyused today as will substitutes. Irrevocable trusts are created frequently for reducing death taxes, making protectedgifis and providing supplemental care while preserving entitlement to governmental benefits. It is not surprising that creditors' issues are arising more often in the context of trust administration. What are the rights of a deceased 's creditors? When can creditors attach beneficial interests? What rights do creditors have after they have attached beneficial interests? Can creditors compel exercise of discretion? Colorado has few governing creditors' rights in these contexts. What are the Colorado rules? What are the Restatement rules and why should Colorado be familiar with them? How do the Uniform Trust Code rules compare? This program will examine creditors' rights in trusts through common fact patterns and endeavor to identify the rules applicable in Colorado. n. Fundamental Principles:

A. Beneficial Interests Are Property:

A beneficial interest in a trust may be a present or future interest; it may be subject to conditions with respect to the recipients or the extent ofthe interest. A beneficial interest may be subject to the discretionary decisions ofa trustee or of another, or it may be subject to a or a power of revocation or amendment. There is practically no limit to the. variety of interests a settlor may create. Restatement (Third) ofTrusts, section 49 cmt b.

Is a beneficial trust interest a property interest of the or is it merely a chose in action against the trustee? This question is important in the context of creditor claims. Ifa beneficial interest is property it will be exposed to the claims of the beneficiary's creditors.

1 The prevailing view in the United States and England is that a beneficiary of a trust has a property interest in the subject matter of the trust and not a mere chose in action. II William F. Fratcher, Scott on Trusts, section 130 (14th ed. 1987). In discussing whether a beneficiary has a property interest, the Scott treatise notes "....It must be remembered, however, that the chancellors at the beginning gave him [the beneficiaxy] no more than a claim against the trustee, and only gradually gave him proprietary rights. The growth of the trust has been a process of evolution. ....The principle that a beneficiary of a trust has a proprietary interest in the subject matter ofthe trust has been accepted by the Supreme Court ofthe United States." See Senior v. Brader, 295 U.S. 422, 55 S.Ct 800, 79 L. Ed. 1520 (1935) and Blair v. Comm 'rof Internal Revenue, 300 U.S. 5, 57 S.Ct. 330, 81 L.Ed. 465 (1937). Restatement (Third) ofTrusts, section 49 and Rptr's Notes of section 49.

This fundamental principle has been recognized by the Colorado Supreme Court in In re Marriage qfJones, 812 P.2d 1 152 (Colo. 1991) ("a beneficiary has an equitable interest in the subject matter of the trust").

B. Attachment By Creditors:

Except as limited by spendthrift and other restrictions imposed by the terms of the trust of resulting from the nature ofthe beneficial interest itself, creditors can attach a beneficiary's trust interest in satisfaction of the creditor's claim. Restatement (Second) ofTrusts, sections 147-149 and 162; II William F. Fratcher, Scott on Trusts, sections 147-147.3, 148, 149, and 162 (4th ed. 1 987); Restatement (Third) of