§ 10.3 Domestic Trusts—debtor as Settlor

• Library: Administering Trusts in Oregon (OSBar) (2018 Ed.)

§ 10.3 DOMESTIC TRUSTS—DEBTOR AS SETTLOR

The settlor of a trust is the person who creates the trust. The creator of a trust can also be referred to as the trustor or grantor. Usually, the settlor funds the trust by transferring funds to the trustee. When the settlor is a debtor, the rights of the settlor's creditors to reach trust property to satisfy the settlor's debts depend on the terms of the trust and how the trust was funded. See Daniel M. Schuyler, Revocable Trusts—Spouses, Creditors and Other Predators, 8th Institute on Estate Planning ¶ 74.1300 (1974). Debtor-creditor law may protect certain assets from creditors, whether or not they are held in trust. Those exemptions are beyond the scope of this chapter.

§ 10.3-1 During Debtor's Lifetime

§ 10.3-1(a) Revocable Trust

During a settlor's lifetime, creditors can reach property of a revocable trust, whether or not it contains spendthrift provisions. ORS 130.315(1). This is consistent with prior law. Restatement (Third) of Trusts § 58 cmt b (2003); Restatement (Second) of Trusts § 156(1) (1959); see Tilcon Capaldi, Inc. v. Feldman, 249 F3d 54, 59-60 (1st Cir 2001); In re West, 81 BR 22 (BAP 9th Cir 1987); In re Frangos, 135 BR 272 (Bankr ND Ohio 1992); Daniel M. Schuyler, Revocable Trusts—Spouses, Creditors and Other Predators, 8th Institute on Estate Planning ¶ 74.1300 (1974).

QUERY: Do the Oregon exemptions against creditors' claims in ORS chapter 18 protect assets that a debtor has transferred to a revocable trust because the debtor no longer owns those assets? Compare In re Bowers, 222 BR 191 (Bankr D Mass 1998) (bankruptcy homestead exemption of 11 USC section 522(d)(1) did not protect debtor's home that was owned by his revocable trust because debtor did not reside on portion of property held in trust), with Restatement (Third) § 25 cmt e (property held in revocable trust is subject to claims of settlor's creditors or of deceased settlor's estate "if the same property belonging to the settlor or the estate would be subject to the claims of the creditors, taking account of homestead rights and other exemptions"). As stated in commentary, the Oregon UTC "do[es] not supersede state exemption statutes." Valerie J. Vollmar, The Oregon Uniform Trust Code and Comments, 42 Willamette L Rev 187, 283 (2006) (general comment).

For a revocable trust with multiple settlors, a joint revocable trust may be structured so that either (1) each settlor is deemed to own one-half of all the property in the trust as a tenant in common or (2) each settlor is deemed to own separate property inside the trust. As an example, joint revocable trusts are often used with community property to preserve its character within the trust.

COMMENT: ORS 130.315(1)(b) preserves the rule that when a trust has multiple settlors, creditors can only reach the portion of the trust attributable to the debtor-settlor's contribution. See ORS 130.315 cmt, printed in Valerie J. Vollmar, The Oregon Uniform Trust Code and Comments, 42 Willamette L Rev 187, 290-91 (2006).

When multiple beneficiaries have contributed property to a trust, each beneficiary is treated as a settlor as to his or her proportionate share contributed. ORS 130.315(1)(b); Matter of Shurley, 115 F3d 333, 337-38 (5th Cir 1997). Similarly, if a beneficiary entitled to receive all of the trust's income chooses to leave the income in trust, the beneficiary is treated as a settlor of the income left in the trust. Restatement (Third) § 58 cmt g & illus 10; see ORS 130.315(1)(b).

• Separate Property. Absent an exemption under state law, creditors of one settlor should be able to reach that settlor's separate property within the revocable trust, but not the separate property of the other settlors.

• Tenants in Common. Similarly, absent an exemption under state law, creditors of one of the settlors should also be able to reach the settlor's portion of the property held as tenants in common inside the revocable trust, but not the interests of other settlors.

• Community Property. Creditors' rights against community property are often determined according to the law of the state in which the community property was created.

• Tenants by the Entirety. In Oregon, real property that a husband and wife own as tenants by the entirety offers certain protections from creditors. If a judgment is entered against only one spouse, then creditors ordinarily can reach only that spouse's interest (including the spouse's share of any income earned by the property) and cannot force a sale or partition of the property. Stanley v. Mueller, 222 Or 194, 209-10, 350 P2d 880 (1960); Schafer v. Schafer, 122 Or 620, 626-27, 260 P 206 (1927). However, this creditor protection has its limits. The debtor-spouse's conveyance of his or her interest in a tenancy by the entirety can amount to a fraudulent transfer. Oregon Account Sys., Inc. v. Greer, 165 Or App 738, 745-46, 996 P2d 1025 (2000). The IRS may have the power to force a sale of the entire interest, keeping the debtor-spouse's share of the proceeds while remitting the other spouse's share of the proceeds. In re Pletz, 225 BR 206 (Bankr D Or 1997), aff'd, 234 BR 800, 99-1 US Tax Cas (CCH) ¶ 50,206 (D Or 1998), aff'd, 221 F3d 1114, 2000-2 US Tax Cas (CCH) ¶ 50,660 (9th Cir 2000). Furthermore, a federal tax lien against property held as tenants by the entirety will attach to the debtor-spouse's interest in the property, and will allow the IRS to reach proceeds from the sale of such real property. United States v. Craft, 535 US 274, 288, 122 S Ct 1414, 2002-1 US Tax Cas (CCH) ¶ 50,361, 152 L Ed 2d 437 (2002). The creditors may be able to obtain the judgment spouse's right of survivorship if the nonjudgment spouse dies first. Brownley v. Lincoln Cnty., 218 Or 7, 11, 343 P2d 529 (1959). If the debtor-spouse dies first, a creditor of that spouse has no claim against the property, and the surviving spouse holds that property free from creditors' claims. Ganoe v. Ohmart, 121 Or 116, 126-27, 254 P2d 203 (1927).

• Effect of Transfer to Joint Revocable Trust on Real Property Held as Tenants by the Entirety. Oregon lawyers disagree about whether real property held as tenants by the entirety retains that character after it is transferred to the couple's joint revocable trust. Most likely, title to the property converts to a tenancy in common between the cosettlors, especially if the creditor's claim arises after the transfer to the trust. See Sec. Pac. Bank Washington v. Chang, 80 F3d 1412 (9th Cir 1996) (criticizing Bolton Roofing Co., Inc. v. Hedrick, 701 SW2d 183 (Mo Ct App 1985)).

§ 10.3-1(b) Irrevocable Trust

An irrevocable trust is one that, by its terms, cannot be revoked. Under the Oregon UTC, a trust is revocable unless the trust expressly provides it is irrevocable. ORS 130.505(1). This supersedes prior Oregon law. See Stipe v. First Nat'l Bank of Portland, 208 Or 251, 268, 301 P2d 175 (1956).

No Oregon cases have specifically reviewed the ability of a creditor of a settlor of an irrevocable trust to satisfy the settlor's debt out of property the settlor transferred to the trust. However, in Johnson v. Commercial Bank, 284 Or 675, 681-82, 588 P2d 1096 (1978), the court suggested that creditors may reach irrevocable trust assets to the extent of the settlor's retained interest. This view is codified in ORS 130.315(1)(b). Thus, if the settlor retains a general power of appointment over trust assets, creditors may reach those assets. If the settlor retains only a right to income, that is all the creditors may reach. See Matter of Marriage of McGoldrick, 85 Or App 412, 736 P2d 622, rev den, 304 Or 55 (1987) (wife awarded half of husband's trust income in divorce proceedings); Restatement (Second) of Trusts § 156(2) (1959). It is unclear how the court in Johnson would have treated a limited power of appointment reserved by the settlor.

EXAMPLE: Settlor establishes an irrevocable trust but retains the right to income. Creditors may be able to reach the income interest retained by settlor, but not the principal.

Various cases in other jurisdictions have enabled creditors to reach spendthrift trust assets to the full extent the trustee could distribute those assets to, or for the benefit of, the settlor-beneficiary. See, e.g., Tilcon Capaldi, Inc. v. Feldman, 249 F3d 54, 60 (1st Cir 2001) (creditor may reach maximum that trustee of self-settled trust could pay, even if trustee chooses to not make any payments to debtor-beneficiary to protect trust principal from creditors); Markham v. Fay, 74 F3d 1347, 1356, 96-1 US Tax Cas (CCH) ¶ 50,118 (1st Cir 1996) (creditors could reach entire assets of trust when settlor-beneficiary had power to eliminate other beneficiaries' interests); In re Morris, 151 BR 900, 906-07 (CD Ill 1993) (creditors could reach entire corpus when trustee had discretion to apply entire corpus for debtor's support); In re Schultz, 324 BR 712, 716 (Bankr ED Ark 2005) (settlor of trust may not effectively create spendthrift trust for himself); In re Landry, 226 BR 507, 510-13 (Bankr D Mass 1998) (creditors could reach debtor's life interest and one-third interest in remainder); In re Spenlinhauer, 182 BR 361, 364 (Bankr D Me 1995), aff'd, 195 BR 543 (D Me 1996), aff'd, 101 F3d 106 (1st Cir 1996). When the debtor is settlor only for part of the trust assets, creditors may reach the settlor's interest only to that extent. ORS 130.315(1)(b); Matter of Shurley, 115 F3d 333 (5th Cir 1997).

EXAMPLE: In one successful "Hail Mary pass," the husband arguably indirectly created a creditor-proof settlor irrevocable trust. The husband and his wife held property as tenants by the entirety. The husband, with judgment creditors, transferred his interest in the property to his terminally ill spouse, without consideration. The next day, she wrote a will leaving the real property in a testamentary spendthrift trust for her husband. She died 60 days later. Under Maryland law, the husband's transfer to his wife was not

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