Discretionary Trusts, Support Trusts, Discretionary Support Trusts, Spendthrift Trusts, and Special Needs Trusts Under the Nebraska Uniform Trust Code

• Publication year: 2021

86 Nebraska L. Rev 231. Discretionary Trusts, Support Trusts, Discretionary Support Trusts, Spendthrift Trusts, and Special Needs Trusts under the Nebraska Uniform Trust Code

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William H. Lyons* and John M. Gradwohl**

Discretionary Trusts, Support Trusts, Discretionary Support Trusts, Spendthrift Trusts, and Special Needs Trusts under the Nebraska Uniform Trust Code

TABLE OF CONTENTS

I. Introduction ................................................... 232 R
II. Nebraska Law Prior to Enactment of the Nebraska
UTC ............................................................ 235 R
A. Discretionary Trusts ........................................ 235 R
1. "Discretion" - In General ................................ 236 R
2. Effect of Describing a Trustee's Discretion as
"Absolute," "Uncontrolled," or "Unconditional" ........... 236 R
B. Support Trusts .............................................. 238 R
C. Discretionary Support Trusts ................................ 239 R
1. Smith v. Smith ........................................... 239 R
2. Doksansky v. Norwest Bank Nebraska, N.A. ................. 242 R
3. Footnote on Pohlmann v. Nebraska Department
of Health and Human Services ............................. 244 R
D. Spendthrift Trusts .......................................... 244 R
1. Definition of "Spendthrift Provision" .................... 244 R
2. Nebraska Case Law on Spendthrift Trusts .................. 245 R
E. Special Needs Trusts ........................................ 253 R
1. Trusts Funded By Third Parties ........................... 253 R
2. Trusts Funded with Property of the
Beneficiary .............................................. 254 R
III. Discretionary and Spendthrift Trusts under the
Nebraska UTC ................................................... 255 R
A. Overview .................................................... 255 R

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1. Discretionary Trusts ..................................... 255 R
a. Distinctions Among Types of Discretionary
Trusts Abolished ...................................... 255 R
b. Marital Creditors and Children Afforded
Limited Right to Reach a Beneficiary's
Interest in a Discretionary Trust ..................... 256 R
2. Spendthrift Trusts ....................................... 257 R
a. Marital Creditors and Children Afforded
Limited Right to Reach a Beneficiary's
Interest in a Spendthrift Trust ....................... 257 R
b. Judgment Creditors Who Provided Services
for Protection of Beneficiary's Interest in a
Spendthrift Trust ..................................... 258 R
c. Claims of the State of Nebraska or the
United States ......................................... 258 R
B. The Conceptual Framework of the Nebraska UTC
for Discretionary and Spendthrift Trusts .................... 259 R

C. Trustee Standards of Reasonableness, Good Faith,
and a Grant of "Unlimited Discretion" ....................... 261 R

D. The Roles of the Trustee and the Court in Dealing
with Discretion ..............................................262 R

E. Pohlmann v. Nebraska Department of Health and Human Services............................................... 263 R

IV. Is the (Creditor Protection) Sky Really Falling?: A Brief
Response to the Critics of the UTC ............................. 269 R
A. The UTC and Nebraska UTC Rules on
Discretionary Trusts ........................................ 269 R
B. Special Needs Trusts ........................................ 271 R
1. Trusts Funded by Third Parties ........................... 272 R
2. Trusts Funded with Property of the
Beneficiary .............................................. 273 R

V. A Postscript on In re Trust Created by Hansen .................. 274 R

VI. Conclusion ..................................................... 277 R

I. INTRODUCTION

The Uniform Trust Code ("UTC")(fn1) includes a number of provisions dealing with the rights of creditors to reach the interests of trust bene

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ficiaries.(fn2) A few authors(fn3) in a series of articles(fn4) have raised concerns that adopting the UTC significantly undermines traditional equity rules and policies governing the protection of trust assets against claims of creditors. These articles have caused attorneys and other trust professionals to question the extent to which enactment of the UTC changes the rules in this important area of trust law. The arguments raised by these few authors provided the initial impetus for this article. To address the particular concerns of Nebraska attorneys, we extensively analyzed Nebraska law governing the protection of trust assets against claims of creditors prior to enactment of the Nebraska Uniform Trust Code ("Nebraska UTC")(fn5) which became operative on January 1, 2005. The comprehensive legislative study prior to enactment concluded that the Nebraska UTC would change prior case law on these types of trusts very little and that the changes made by the Nebraska UTC were grounded in sound legislative policy.(fn6) We then

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compared the Nebraska UTC provisions relating to this area with prior Nebraska law. Finally, we examined the arguments presented in the various articles. We concluded that, although the Nebraska UTC expanded the rights of certain specific creditors under limited circumstances,(fn7) there was no basis for the prophesies of doom asserted by these authors. Similar conclusions have been reached nationally and in other states enacting the UTC.(fn8)

As we prepared the initial draft, we realized that our analysis suggested a broader policy inquiry - a more extensive examination of the relationships between and among a settlor's powers to preclude or limit the claims of creditors against trust property, a beneficiary's interest in a trust, the discretionary authority of a trustee, and the rights of the beneficiary's creditors in and to the beneficiary's interest in the trust. The Nebraska Supreme Court's 2006 decision in Pohlmann v. Nebraska Department of Health and Human Services(fn9) helped crystalize our thinking about those relationships and also greatly clarified both the pre and post-UTC Nebraska trust law. The 2007 Nebraska Legislature further clarified the Nebraska statues by enacting revisions to the 2000 original text of the Uniform Trust Code made by the National Conference of Commissioners on Uniform State Laws in 2005.(fn10) Although this article addresses the arguments of the

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authors mentioned earlier, its principal purpose is to provide a framework for analysis of the broader issues under the Nebraska UTC.

II. NEBRASKA LAW PRIOR TO ENACTMENT OF THE NEBRASKA UTC

The Nebraska Supreme Court has long recognized various trust arrangements that, to a greater or lesser extent, protect the interests of a beneficiary (other than the settlor(fn11) from claims of the beneficiary's creditors. These trust arrangements include the "discretionary trust,"(fn12) the "support trust,"(fn13) the hybrid "discretionary support trust,"(fn14) and the "spendthrift trust."(fn15) In addition to these trust arrangements, the "special needs trust" (sometimes called a "supplemental needs trust") may offer a measure of asset protection.(fn16) The primary purpose of the "special needs/supplemental needs trust" is not only to provide a disabled beneficiary benefits over and above those provided by Medicaid and Supplemental Security Income ("SSI") but also to avoid disqualifying the beneficiary from receiving Medicaid and SSI benefits.

A. Discretionary Trusts

In terms of a beneficiary's right to distributions from a trust, trusts have traditionally been classified as either "mandatory" or "discretionary." This terminology has now been codified in the Nebraska UTC.(fn17) If the trustee is required to distribute income, principal, or both to a beneficiary, the trust is a mandatory trust.(fn18) If the settlor gives the trustee discretion concerning the distribution, the trust is a discretionary trust.(fn19) This seemingly clear distinction blurs when a settlor uses language such as "my trustee shall, in its absolute discretion, distribute such amounts as are necessary for my daughter's support. "

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1. "Discretion" - In general

The amount of discretion accorded to a trustee depends, in the first instance, on the settlor's language in the trust instrument. The grant of discretion may take many forms. For example, the trustee may have discretion to decide whether to pay income or accumulate it and add it to principal. The trustee may have discretion to decide which individuals from a particular group or class will receive distributions. Often, the trustee must exercise the discretion under a standard. For example, a settlor may direct that the trustee make payments only for the education of a beneficiary, or that a trustee may invade corpus only in the event of an emergency, disability or hardship affecting a beneficiary.

When a settlor grants a trustee discretion, that grant affects a ben-eficiary's right to compel a trustee to provide a benefit because the grant of discretion limits judicial review of the trustee's exercise (or non-exercise) of the discretion. As the Restatement (Third) of Trusts explains, "A discretionary power conferred upon the trustee to determine the benefits of a trust beneficiary is subject to judicial control only to prevent misinterpretation or abuse of the discretion by the trustee."(fn20) If the beneficiary's power to compel a distribution is limited, a creditor of the beneficiary has no greater power than does the beneficiary to compel a distribution.

2. Effect of Describing a Trustee's Discretion as "Absolute," "Uncontrolled," or "Unconditional"

Even if a settlor uses words such as "absolute," "sole," "unlimited," or "uncontrolled" to describe the trustee's discretion, the trustee must exercise such discretion in good faith...