OLR Bill Analysis

sSB 1264

AN ACT CONCERNING SPENDTHRIFT AND DISCRETIONARY TRUSTS AND THE CLAIMS OF CREDITORS

SUMMARY:

The bill creates a claims procedure for trustees and creditors for revocable trusts after the settlor’s death, clarifies the law regarding the liability of trust assets for creditors’ claims regardless of the type of distribution standard in the trust, and authorizes spendthrift provisions in trusts. A spendthrift provision prohibits a beneficiary’s creditor from attaching his interest in a trust until the trustee actually distributes assets to him, thereby preserving the trust for the beneficiary. Thus, with spendthrift protection, creditors may attach proceeds only when a distribution is made from the trust.

Under the bill, whether or not a trust contains a spendthrift provision, a creditor of a beneficiary, other than a settlor who is a beneficiary, may not attach or compel a distribution of property that is subject to either a power of withdrawal or a power to make distributions for the beneficiary, or someone the beneficiary has an obligation to support, under certain circumstances

The bill permits a spendthrift trust that names a beneficiary as the sole trustee or as a co-trustee.

Under the bill, whether or not the trust contains a spendthrift provision, the property of a trust is subject to claims of the settlor’s creditors. A “settlor” is the person who creates, or contributes property to, a trust.

EFFECTIVE DATE: October 1, 2005

DEFINITIONS (1)

The bill defines a "beneficiary" as a person that:

1. has a present or future interest in a trust, vested or contingent, or

2. holds a power of appointment over trust property in a capacity other than that of trustee. (A power of appointment is the right to designate the new owner of property. )

A "power of withdrawal" is a presently exercisable general power of appointment other than a power exercisable only with the consent of the trustee or a person holding an adverse interest.

A trust is “revocable” if the settlor can revoke it without the consent of the trustee or a person holding an adverse interest.

The bill defines a "settlor" as a person, including a testator, who creates, or contributes property to, a trust. If more than one person creates or contributes property to a trust, each person is a settlor of the portion of the trust property attributable to his contribution except to the extent another person has the power to revoke or withdraw that portion.

A "spendthrift provision" means a term of the trust, which restrains both voluntary and involuntary transfer of a beneficiary's interest.

"Terms of the trust" means the manifestation of the settlor's intent regarding a trust's provisions as expressed in the trust document or as established by other evidence that would be admissible in court.

RIGHTS OF BENEFICIARY’S CREDITOR OR ASSIGNEE ( 2)

The bill empowers the court to authorize a beneficiary’s creditor or assignee to reach the beneficiary’s interest in a trust by attaching present or future distributions to, or for the benefit of, the beneficiary, if a beneficiary’s interest is not protected by a spendthrift provision. The court may limit the extent to which a beneficiary’s creditor or assignee may do so as appropriate under the circumstances.

SPENDTHRIFT PROVISION ( 3)

Under the bill, a spendthrift provision is valid only if it restrains both voluntary and involuntary transfers of a beneficiary’s interest.

The bill specifies that a term of a trust:

1. providing that the interest of a beneficiary is held subject to a “spendthrift trust,” or words of similar meaning, is sufficient to restrain both a voluntary and an involuntary transfer of the beneficiary’s interest; or

2. permitting the voluntary transfer of a beneficiary's interest, but only with the consent of another person or entity the trust specifies, including the trustee, is an acceptable restraint on voluntary transfer.

The bill prohibits a beneficiary from transferring an interest in a trust in violation of a valid spendthrift provision. It also prohibits, except as otherwise provided in the bill, a beneficiary’s creditor or assignee from reaching the beneficiary’s interest while it is in the trust or before the trustee distributes it.

The bill permits a spendthrift provision that names a beneficiary as the sole trustee or as a co-trustee.

CHILD SUPPORT EXCEPTION TO SPENDTHRIFT PROVISION ( 4)

Even if a trust contains a spendthrift provision, the bill allows a beneficiary’s child who has a judgment or court order for support or maintenance to obtain a court order attaching present or future distributions to, or for the benefit of, the beneficiary. The bill specifies that the term "child" includes any person for whom an order or judgment for child support has been entered in Connecticut or another state.

DISCRETIONARY TRUSTS; EFFECT OF STANDARD ( 5)

Under the bill, whether or not a trust contains a spendthrift provision, a beneficiary’s creditor (other than a child with a valid support order) may not compel a distribution that is subject to the trustee’s discretion, even if (1) the discretion is expressed in the form of a standard of distribution or (2) the trustee has abused the discretion.

But if a trustee has not complied with a distribution standard or has abused a discretion, the court may:

1. order a distribution to satisfy a judgment or court order against the beneficiary for support or maintenance of the beneficiary’s child; and

2. direct the trustee to pay to the child an equitable amount under the circumstances but not more than the amount the trustee would have been required to distribute to, or for the benefit of, the beneficiary had the trustee complied with the standard or not abused the discretion.

The bill also specifies that it does not limit a beneficiary’s right to maintain a judicial proceeding against a trustee for an abuse of discretion or failure to comply with a standard for distribution, even if a creditor has no right to do so.

These provisions apply to protected powers held by beneficiaries who are also trustees (see 9).

CREDITOR’S CLAIM AGAINST SETTLOR ( 6)

Creditors’ Claims

The bill establishes certain rules that apply to the claims of the settlor’s creditors. All of the following apply whether or not the trust contains a spendthrift provision.

1. The property of a revocable trust is subject to claims of the settlor’s creditors during the settlor’s lifetime.

2. With respect to an irrevocable trust, a settlor’s creditor or assignee may reach the maximum amount that can be distributed to the settlor or for the settlor’s benefit. If a trust has more than one settlor, the amount a settlor’s creditor or assignee may reach cannot exceed the settlor’s interest in the portion of the trust attributable to his contribution.

3. After the settlor’s death, and subject to his right to direct the source from which liabilities will be paid (except as otherwise provided by law regarding pension, retirement, death benefit, and profit sharing plans), the property of a trust that was revocable at the settlor’s death is subject to claims of his creditors, costs of administering his estate, his funeral and burial expenses, and the family allowance to a surviving spouse and children as provided by existing law to the extent the settlor’s probate estate is inadequate to satisfy those claims, costs, expenses, and allowance.

Claims, Expenses, and Taxes to Settle a Trust

The bill establishes certain rules regarding claims, expenses, and taxes to settle a trust that was revocable at the settlor’s death.

1. Any creditor’s claim, which would be barred against the fiduciary of a decedent’s estate, the estate of the decedent, or any creditor or beneficiary of the decedent’s estate, is barred against the trustee, the trust property, and the trust’s creditors and beneficiaries.

2. A trustee may use the optional notice procedures in existing law for creditors in connection with decedent’s estates. (Generally, the optional procedures allow a fiduciary at any time to give notice to anyone he has reason to believe may have a claim. The notice gives such creditors 90 days from the date they receive notice from the fiduciary to make a claim. ) Upon the trustee’s compliance with these procedures, any person so notified is barred from asserting or recovering on any claim from the trustee, the trust property, or any creditor or beneficiary of the trust.

3. The same preference and order of payment of claims, expenses, and taxes apply to a revocable trust as apply to a decedent’s estate.

4. No trustee may be chargeable for any assets that a trustee may have paid or distributed in good faith in satisfaction of any lawful claims, expenses, or taxes or to any beneficiary before the claim was presented if any claim is not presented in writing to the fiduciary of the settlor’s estate or the trustee within 150 days from the date of the appointment of the first fiduciary of the settlor’s estate, or within 150 days from the settlor’s death if no fiduciary is appointed within this period. A payment or distribution of assets by a trustee is deemed to have been made in good faith unless the creditor can prove that the trustee knew about the claims when making the payment or distribution. The 150-day period may not be interrupted or affected by a trustee’s death, resignation, or removal. But the bill specifies that the time during which there is no fiduciary in office may not be counted as part of the period.

Holder of Power of Withdrawal Treated Same as Settlor

Except as the bill otherwise provides, during the period the power may be exercised, the holder of a power of withdrawal is treated in the same manner as the settlor of a revocable trust for the property subject to the power.

Upon the lapse, release, or waiver of the power, the holder is treated as the settlor of the trust only to the extent the value of the property affected by the lapse, release, or waiver exceeds the greater of the amount in three specified provisions of the federal tax code. (Currently, under two provisions, the amount is the greater of $ 5,000 or 5% of the aggregate value of the assets under the power. Under the other provision, the amount is $ 10,000 multiplied by a specified cost-of-living adjustment. )

OVERDUE DISTRIBUTION ( 7)

Except as the bill otherwise provides, a beneficiary’s creditor or assignee may reach a mandatory distribution of income or principal, including a distribution upon termination of the trust, if the trustee has not made the distribution to the beneficiary within a reasonable time after the mandated distribution date. The rule applies whether or not a trust contains a spendthrift provision.

A “mandatory distribution" means a distribution of income or principal that the trustee must make to a beneficiary, including a distribution when the trust terminates. The term excludes a discretionary distribution, regardless of whether the terms of the trust (1) include a support or other standard to guide the trustee in making distribution decisions, or (2) provide that the trustee "may" or "shall" make discretionary distributions, including distributions pursuant to a support or other standard.

PERSONAL OBLIGATIONS OF TRUSTEE ( 8)

Under the bill, trust property is not subject to the trustee’s personal obligations, even if the trustee becomes insolvent or bankrupt.

PROTECTED POWERS ( 9)

Whether or not a trust contains a spendthrift provision, a creditor of a beneficiary, other than a settlor who is a beneficiary, may not attach or compel a distribution of property that is subject to either a power of withdrawal or a power to make distributions for the beneficiary, or someone the beneficiary has an obligation to support, under certain circumstances.

Power of Withdrawal

A creditor of a beneficiary (other than a settlor who is a beneficiary) may not attach or compel a distribution of property that is subject to a power of withdrawal held by the beneficiary if the value of the property subject to the power does not exceed the greater of the amounts specified in three provisions of the federal tax code. Currently, under two provisions, the amount is the greater of $ 5,000 or 5% of the aggregate vale of the assets under the power. Under the other provision, the amount is $ 10,000 multiplied by a specified cost-of-living adjustment.

Power to Make Distributions

A creditor of a beneficiary (other than the settlor who is a beneficiary) also may not attach or compel a distribution of property that is subject to a mandatory or discretionary power the trustee holds, including a power held by the beneficiary as the sole trustee or co-trustee, to make distributions to or for the benefit of a person who the beneficiary has an obligation to support, if the power is exercisable by the trustee only in accordance with an ascertainable standard relating to the person’s health, education, support, or maintenance within the meaning of the federal tax code.

The same rule applies to a trustee’s power to make distributions to or for the beneficiary, except if a trustee has not complied with a distribution standard or has abused a discretion, the court may order a distribution to satisfy a judgment or court order against the beneficiary for support or maintenance of the beneficiary’s child, and direct the trustee to pay to the child an amount that is equitable under the circumstances.

Beneficiary May Not Be Treated As A Settlor

A beneficiary holding a power of withdrawal or distribution may not be treated as a settlor of the trust during the period the power may be exercised or upon its lapse, release, or waiver.

LIABILITY OF INCOME OF TRUST FUND TO CREDITORS ( 10)

The bill eliminates a law that subjects to the beneficiary’s creditor’s claims, trust income from property given to trustees with direction to pay over the income to any person, without provision for accumulation or express authorization to the trustees to withhold the income, and the income has not been expressly given for the support of the beneficiary or his family. Under that law, a creditor of the beneficiary who has secured a judgment against him could institute a legal proceeding for garnishment against him and serve the trustees. In such a case, the law allows the court to direct the trustees to pay over the net income derived from the trust estate to the judgment creditor, as the income may accrue, until the creditor's debt is satisfied.

Under current law, if any such trust has been expressly provided for the support of the beneficiary or his family, a court may make any order regarding the surplus, if any, not required for the support of the beneficiary or his family, as justice and equity may require.

COMMITTEE ACTION

Judiciary Committee

Joint Favorable Substitute

Yea

40

Nay

0