Chapter 29 - § 29.6 • SPENDTHRIFT TRUSTS

• Jurisdiction: Colorado

§ 29.6 • SPENDTHRIFT TRUSTS

§ 29.6.1—Introduction

If one establishes a trust for the benefit of others, and if the trust contains a spendthrift clause, then the trust may be referred to as a spendthrift trust. A sample spendthrift clause is as follows:

No beneficiary of the trust estate shall have any right, power, or authority to sell, assign, pledge, mortgage or in any other manner to encumber, alienate, or impair all or any part of his or her interest in the trust estate or in the principal or income thereof. The beneficial and legal interest in, and the principal and income of, the trust estate and every part of it shall be free from interference or control of any creditor of any beneficiary of the trust and shall not be subject to the claims of any such creditor, including claims for the payment of alimony, nor liable to attachment, execution, bankruptcy, or any other legal or equitable process. The income and principal of the trust estate shall be paid over to the beneficiary directly, or, in the event of the minority or incompetency of any beneficiary, to the legal representative of that beneficiary, or in any form allowed by law for gifts to minors, or to or for the benefit of that beneficiary, in such manner as the Trustee in the Trustee's sole discretion deems advisable, at the time and in the manner provided by the terms of the trust, and not upon any written or oral order nor upon any assignment or transfer by the beneficiary nor by operation of law.

A trust can often shield the transferred assets from creditors of the trust's non-settlor beneficiaries. A spendthrift trust is usually created to provide a fund for the maintenance of a beneficiary and at the same time to secure the fund against the beneficiary's improvidence or incapacity and to place the fund beyond his or her creditors' reach.

It is, in a real sense, a trust set up to protect a beneficiary from spending all of the money to which he or she is entitled. Black's Law Dictionary 1400 (6th ed. 1990). It is also a trust that by its terms or by statute constitutes a valid restraint on the voluntary and involuntary transfer of the interest of the beneficiary. Restatement (Second) of Trusts § 152. A spendthrift provision is simply a provision in a trust document that expressly prohibits beneficiaries from transferring, encumbering, or pledging their respective beneficial interests in the trust. It also typically expressly prohibits any creditor of a beneficiary from attaching, levying against, or seeking a forced sale of the beneficiaries' respective beneficial interests. Estate of Sowers, 574 P.2d 224, 228 (Kan. App. 1977).

Although there is some erosion of this concept, see the Mississippi case of Sligh v. First National Bank,³ generally, spendthrift provisions are enforced by U.S. courts when the debtor-beneficiary is someone other than the transferor of the sought-after property. See Scott's Abridgement of the Law of Trusts §§ 151-152.1 (Little, Brown & Co. 1960); Scheffel v. Krueger, 782 A.2d 410 (N.H. 2001). As a result, except for a potential application of fraudulent conveyance laws to "avoid" the transfers, in theory the beneficiary's creditors would be unable to access the transferred assets.

§ 29.6.2—Federal Bankruptcy Code with Respect to Spendthrift Trusts

The Federal Bankruptcy Code recognizes the validity of spendthrift trusts. Section 541(c)(2) provides, "A restriction on the transfer of a beneficial interest of a debtor in a trust that is enforceable under applicable non-bankruptcy law is enforceable in a case under this title."

Therefore, if the restriction on the transfer is not enforceable under applicable non-bankruptcy law, it is not enforceable in the bankruptcy proceeding, and therefore, the restriction will not be honored by the court.

§ 29.6.3—Modern Trend of Spendthrift Trusts

Section 503 of the Uniform Trust Code evidences the modern trend with respect to whether a creditor can access a non-grantor tortfeasor's interest in a spendthrift trust. The comment to this section indicates that the drafters declined to create an exception for tort claimants. Further, § 59 of the Restatement (Third) of Trusts (2003) also refuses to create an exception for tort creditors. In fact, the Restatement (Third) takes a stronger position than Restatement (Second) because the comment to Restatement (Second) of Trusts § 57 states that a tort claimant may be able to reach the tortfeasor's beneficial interest in a trust.

At issue in Duvall v. McGee, 826 A.2d 416 (Md. 2003), was whether a spendthrift trust's principal that was held for a tortfeasor's benefit could be used to satisfy the tort judgment. The Maryland Court of Appeals resolved this issue in the debtor's favor.

In Duvall, James McGee was convicted of felony murder for his participation in a robbery that resulted in the decedent's death. The personal representative of the decedent's estate settled a civil suit against McGee for...