Trustee-beneficiaries, creditors, and New York's EPTL: the surprises that result and how the UTC solves them.

• Author: Hasseler, Victoria
• Position: Powers and Trusts Law, Uniform Trust Code

1. INTRODUCTION

   A trust is established. Tracy Brown is both the trustee and the beneficiary. (1) The settlor has empowered the trustee to make discretionary distributions from the trust to the beneficiary herself without any limitation, such as an ascertainable standard. (2) Much to the dismay of creditors, this means that Tracy Brown, as the trustee-beneficiary (hereinafter "T/B"), can access the trust funds at any time, yet the funds remain protected from her creditors while held in trust. Could the New York Legislature have intended such a consequence from the seemingly benign 2003, and subsequent 2004, amendments to section 10-10.1 of the New York Estates, Powers and Trusts Law (EPTL)? (3)

   This protection against creditors occurs because the discretionary power under section 10-10.1 of the EPTL is not a general power of appointment--with the accompanying provisions for creditors--although it is tantamount to such a power. Should the Legislature act and amend the current law to prevent abuse from occurring?

   This paper begins by presenting a brief background of trust law and creditor law, including the doctrine of merger and the rights of creditors, in Section II. Section III sets forth the evolution of section 10-10.1 of the EPTL. Section IV addresses the implications of the 2003 and 2004 amendments by first discussing provisions for creditors and then discussing why the discretionary power is not a power of appointment based on the definition of a power of appointment under section 10-3.1 of the EPTL; the legislative history of article 10 of the EPTL; and the statutory heading of article 10, part 10 of the EPTL. Section V presents the possible positions of the Uniform Trust Code and considers why New York should adopt versions of articles 1 and 5 of the Uniform Trust Code. Finally, Section VI suggests feasible legislative solutions for New York's current law.

2. TRUST LAW AND CREDITOR LAW BACKGROUND

   1. The Doctrine of Merger

      Historically, a sole trustee of a trust was not entitled to be simultaneously a beneficiary of the trust. Under the doctrine of merger, (4) formerly embodied in sections 7-1.1 and 7-1.2 of the EPTL, (5) the trust automatically terminated if the individual named as the sole trustee was also named as a beneficiary since the trust would effectively be passive, and the trustee would have no duties to carry out. (6) Title of the same nature and for the same duration as the intended trust vested in the T/B. (7) Provided that the trustee was not the sole trustee, a trustee could, however, also be a beneficiary. For example, in Woodward v. James, the Court of Appeals of New York found that where, by the terms of his will, the decedent intended to leave his widow a life estate in half the income from his estate but did not expressly word the devise as a trust, "the law will got imply a trust where, in the moment of its creation, it will be invalid, and that, as the same person cannot be both trustee and beneficiary, the trust to [the widow] must fail." (8) This decision led to "the inevitable result ... that the equitable is merged in the legal estate, and the latter alone remains" so that the widow, in regard to her one-half of the income, "was not trustee, and took what was given to her by a direct legal right." (9)

      The merger doctrine, however, was not always strictly applied. In In re Phipps' Will, for example, the beneficiary was a co-trustee but became the sole trustee when the other trustee died. (10) The court distinguished cases where merger had been applied, reasoning that in those cases there was not a demonstrated "intention that the trust continue after the death of the sole beneficiary's cotrustee," and instead held that "[t]he doctrine of merger is not to be applied 'with rigidity,' and, where it appears to have been the intention of the settlor ... that the trust continue or that a successor trustee be appointed, the courts will act to prevent the extinguishment and termination of the trust." (11) A more recent example is In re Estate of Seidman, in which the testator's wife was named as trustee. (12) She was to receive the income from the trust for her life and was given a discretionary power to invade the trust principal, in addition to being given the power to appoint the remainder beneficiaries. (13) Although the wife argued that a merger of legal and equitable titles occurred because she had been given the power to withdraw the entire trust principal and no specific remainder beneficiaries, the court rejected this argument and instead held that "a cotrustee should be appointed." (14)

      In 1997, prompted by the increasing use of trusts to transfer assets and avoid probate while keeping a life estate, (15) the legislature enacted the current version of section 7-1.1 of the EPTL. (16) In effect, the legislation prevents merger from occurring in situations where the trustee is also a beneficiary, provided that another individual also holds a beneficial interest. (17) Consequently, the ability of settlors to designate the same individual as both sole trustee and one of the trust beneficiaries is codified. (18) It should be kept in mind, however, that where there is no beneficial interest other than that of the T/B, merger will still occur.

   2. The Rights of Creditors

      When a debtor owes money, creditors look to any and all property that the debtor owns or in which such debtor maintains an interest in order to satisfy the debt. Some property that seemingly appears beyond the reach of creditors is not, while other property that creditors want to attach promises to be more elusive.

      Section 5201(b) of the New York Civil Practice Law and Rules (CPLR) provides that "[a] money judgment may be enforced against any property which could be assigned or transferred, whether it consists of a present or future right or interest and whether or not it is vested, unless it is exempt from application to the satisfaction of the judgment." (19)

      However, section 5205(c)(1) makes this provision irrelevant for all practical purposes by providing that, with few exceptions, property held in trust for a judgment debtor is exempt from "application to the satisfaction of a money judgment," so long as the judgment debtor did not create or fund the trust. (20) In effect, the New York Legislature provided automatic spendthrift provisions for all trusts. Section 5205(d)(1) of the CPLR exempts ninety percent of the income, or other payments, from trusts. (21) When read in conjunction with section 5205(c) of the CPLR, which exempts the trust principal, only ten percent of the trust income and none of the trust principal is left for creditors of the beneficiary. (22) Section 7-1.5 of the Estates, Powers and Trusts Law places additional limits on the voluntary alienation of trust interests. Although the premise is that all trust interests are alienable, the trust instrument must expressly allow the income beneficiary to alienate this right for the interest to be transferred. (23) Thus, the only way for creditors to effectively reach the assets that the T/B can access is for the T/B's power to be interpreted as a power of appointment.

      Trust dispositions for the settlor's use are unequivocally "void as against [any] existing or subsequent creditors" the settlor may have, (24) as are dispositions in which the beneficiary is entitled to the trust corpus at will. (25) The underlying reason for these policies is that it is "'contrary to sound public policy to permit a person to have the absolute and uncontrolled ownership of property for his own purposes, and to be able at the same time to keep it from his creditors.'" (26) Thus, in such situations, the creditor can reach the property that is the subject of the trust disposition. (27) Property held by a trustee for the benefit of others, however, is not subject to the trustee's creditors. (28) This is true even if the trustee is also the settlor so long as the trustee is not a beneficiary as well. (29)

      The relative standing that the beneficiary's current creditors enjoy is decidedly murkier. Recall that only assignable or transferable property is subject to the enforcement of money judgments. (30) Consequently, if the beneficiary lacks the power to transfer or assign the property, it will be beyond the reach of the beneficiary's creditors. Although section 5201 of the CPLR generally authorizes the enforcement of money judgments against property held in trust, (31) Article 10 of the EPTL more specifically delineates the actual rights of creditors. (32)

3. THE EVOLUTION OF SECTION 10-10.1 OF THE EPTL

   Designed to address tax issues, the precursor to the statute that evolved into section 10-10.1 of the EPTL was first introduced in 1945. (33) A revised version was introduced in 1966. (34) For the next thirty years the statute remained unchanged in the following form:

   A power conferred upon a person in his capacity as trustee of an express trust to make discretionary distribution of either principal or income to himself or to make discretionary allocations in his own favor of receipts or expenses as between principal and income, cannot be exercised by him. If the power is conferred on two or more trustees, it may be executed by the trustees who are not so disqualified. If there is no trustee qualified to execute the power, its execution devolves on the supreme court, except that if the power is created by will, its execution devolves on the surrogate's court having jurisdiction of the estate of the donor of the power. (35) The next amendment came in 1997 when the Legislature added the introductory phrase "[e]xcept in the case of a trust which is revocable by such person during lifetime" and provided the surrogate's court as an alternate court, along with the supreme court, qualified to exercise the devolving power. (36) Gender neutral language was also added. (37)

   At the recommendation of the Chief Administrative Judge, based on a recommendation by the Surrogate's...