New Case Expands Creditors’ Access to Funds Held By a Spendthrift Trust
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A recently decided California Supreme Court case expands the ability of a creditor to access funds held in a debtor’s “spendthrift trust” – which had before only been accessible to creditors under limited circumstances.
As background, a “spendthrift trust” is a trust in which a beneficiary’s interest in the assets is generally protected from the claims of the beneficiary’s creditors, so long as the assets remain in the trust. Once an asset of a spendthrift trust is distributed to the beneficiary, however, it can be reached by creditors. A spendthrift trust has historically been a powerful tool to protect beneficiaries from their own imprudent business decisions.
Various exceptions to this general rule, however, have been expressly adopted by statute. For example, the restrictions of a spendthrift clause do not apply when, in general, the settlor puts his/her own assets into a spendthrift trust; when the judgment is based on unpaid child-support, spousal support or restitution payments to victims of a felonious crime committed by the beneficiary; and reimbursement is required to the state or a local public entity for public support furnished to the beneficiary.1
Usually, a judgment creditor can petition the court to apply the judgment to the beneficiary’s interest in the trust, but subject to a 25% limitation on the amount which the creditor can receive from the Trust in satisfaction of its judgment.2 Any amount that the court determines is necessary for the beneficiary’s or his/her dependents’ support would, however, reduce the amount which is available to be distributed to a creditor from the beneficiary’s share of the spendthrift trust.3
Yet, statutory inconsistencies have created some degree of confusion regarding when and how creditors may access a beneficiary’s funds held by spendthrift trust. Indeed, despite the exceptions to the spendthrift protections set forth in Sections 15304 through 15306, Section 15307 seems to negate any such restriction with respect to amounts to which the beneficiary is “entitled under the trust instrument or that the trustee, in the exercise of the trustee’s discretion, has determined to pay to the beneficiary…” And Section 15301(b) also appears to negate the 25% limitation set forth in Section 15306.5, “after an amount of principal has become due and payable to the beneficiary under the trust instrument[.]” Thus, the 25% limitation set forth in Section 15306.5 and the noticeable absence of any such limitation in Sections 15301(b) and 15307 has been the subject of much debtor-creditor litigation in the administration of trusts. Taken together, the two statutes have not been clear as to the rights of a general creditor to attach to a beneficiary’s distributable share in a spendthrift trust.
This issue was most recently addressed by the California Supreme Court in Carmack v. Reynolds.4 In reversing the holdings of the lower courts, the California Supreme Court held that a general creditor may reach a sum up to the full amount of any distributions that are currently due and payable to the beneficiary even though they are still in the trustee’s hands, and separately may reach a sum up to 25% of any payments that the trustee makes to the beneficiary in the future. If such amounts are insufficient to satisfy the judgment, the creditor can go back to court when the future payments become due and payable and request an order distributing the remaining 75% distribution to the creditor, until the creditor’s judgment is satisfied.
More specifically, the California Supreme Court found that spendthrift protections do not apply to Section 15301(b) assets – i.e., assets that are “due and payable to the beneficiary.”5 The Court reasoned that “because the beneficiary’s interest in those assets has effectively vested, the law no longer has an interest in protecting them.” The Court further concluded that the 25% limitation under Section 15306.5 does not apply to orders under Section 15301(b).
Carmack appears to be a departure from long-standing case law regarding protections afforded beneficiaries of spendthrift trusts. Planners should be mindful of this ruling, examine the language of their spendthrift clauses and caution clients when they choose to allow their successor trustee to make mandatory distributions to a spendthrift beneficiary.It is now up to the Legislature to determine if the California Supreme Court’s decision in Carmack accurately reflects the intent of the Legislature in enacting the spendthrift statutes.
1See Prob. Code, sections 15300-15307.
2See Prob. Code, section 15306.5(b).
3See Prob. Code, section 15306.5(c).
4Carmack v. Reynolds (2017) 2 Cal.5th 844.
5The Court made it clear that Section 15302 continues to provide protection to former trust assets where the settlor expressly intended that these trust distributions serve as support payments for the beneficiary.