A Creditor’s Right Against Trust Assets

By Doug Casarella – St. Louis, MO Attorney and LegalBuffet.com writer

Creating a trust can (and should) create a sense of security that sound planning has been done and that when assets are placed into it, they will be there when needed. However, not everyone understands how safe assets are once inside a trust, particularly in regards to the rights of a creditor. This could be a creditor of a beneficiary of the trust, or the trust settlor (the creator of the trust).

The answer, like many things legal, depends upon the circumstances and details of each situation, such as the financial status of the trust settlor and the language of the trust itself. It also turns on the nature of trusts themselves. Remember that a trust creates two owners, a legal owner (the trustee) and the equitable owner (the beneficiary).

A creditor going after one of that trust’s beneficiaries (which may be the settlor as well a third-party) can get at trust assets once assets leave the trust and are solely in the beneficiary’s hands again. The language of a trust can grant the trustee a wide variety of powers over how to manage the assets it contains. Chief amongst those powers is what to do with income generated by the trust each year, as well as what to do with principal. A trust may mandate that the income each year be distributed to the beneficiaries, or it may leave any such distribution to the discretion of the trustee. If the trustee has discretion, and the beneficiary has a creditor problem, the trustee can leave the assets in the trust, and while the beneficiary cannot enjoy them, neither can the creditor.

This is not a foolproof method. For instance, if a person who is insolvent (someone who owes more than they have) creates a trust, place a lot of his assets in there, and gives the trustee discretion, the trust will not be valid. A court, seeing that the settlor created the trust as a means to avoid paying his or creditors, will deem it a fraudulent conveyance.

More often, a settlor will include language that will benefit a third-party beneficiary who may one day have creditor trouble. Many states allow what is called a spendthrift clause, which prevents an insolvent beneficiary from access to their share, even to the point where they cannot use it as collateral for a loan. If there is no such clause, a creditor has the same rights as the beneficiary in all aspects, including income distribution. This technique is useful in situations where there is concern about a potential beneficiary’s ability with money, or they have some other issue (alcohol abuse, etc.) that could lead to them squandering assets.

Above and beyond this, certain individuals who have greater exposure (medical doctors, executives, and even small business owners) may be interested in more certainty. This type of planning is called asset protection planning and it encompasses a broad spectrum of planning, but in the area of trusts, there exist asset protection trusts, which may be located in states with favorable laws or even offshore. It is important to note that no domestic court will uphold these trusts against certain creditors, such as spouses demanding alimony or, in particular, child support payments.

Trusts are a fantastic tool for estate planning. With more knowledge as to how to draft them to maximize their potential, they become even more valuable. Find the help with living trusts that you’re looking for right here.

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