Trusts and Divorce - Good, Bad & Ugly:* New Rules for the Treatment of a Spouse's Discretionary Trust Interests and Powers of Appointment in Divorce Under Utc Article 5 and Goodlander
| Publication year | 2015 |
| Citation | Vol. 55 No. 2 Pg. 0020 |
| Pages | 0020 |
Joseph F. McDonald, III, and Megan C. Neal.
I. INTRODUCTION
The high incidence of divorce and the popularity of trusts for asset protection, wealth transfer tax shelter and inheritance management have combined to foster considerable ferment in state domestic relations and trust laws regarding marital rights and trust interests and powers. Estate planning clients often express to their attorneys an especially keen interest in trust ownership to protect to the greatest possible extent their descendants' inheritances from diversion to non-beneficiary spouses and child support orders in the event of a divorce. The third party discretionary trust has historically been the vehicle of choice to bullet-proof trust assets from these kinds of risks. Drafting attorneys were able to give the settlor's descendants extensive powers over and interests in their discretionary trusts without jeopardizing the settlor's protective purposes. This gave the beneficiaries virtually all the benefits of outright ownership without exposing the trust property to the risks of diversion to non-beneficiaries.
Provisions of our "designer version" of the Uniform Trust Code (the "UTC") and the New Hampshire Supreme Court's decision in Goodlander[1]seemed to confirm the immunity of third party discretionary trust interests from risks associated with property settlements between a beneficiary and non-beneficiary spouse. However, a recent order, not citable as precedent, issued by a "3JX" panel of the Court in Nerbonne[2] has cast some doubt on what was thought to have been settled.
*Apologies to Sergio Leone, and Clint Eastwood (good), Lee Van Cleef (bad) and Eli Wallach (ugly), who directed and acted in the 1969 Spaghetti Western from which part of the title is borrowed. The authors thank Todd Mayo of Perspecta Trust Company, for his review of an early manuscript and thoughtful suggestions that enhanced the final product.
Further, the role and powers of the family and probate divisions of our Circuit Courts in considering a divorcing spouse's trust interests under the UTC and family law statutes in fashioning alimony and child support awards have created uncertainties that did not exist under prior law. This new legal landscape ignores long-standing New Hampshire traditions respecting freedom of disposition, creates unnecessary confusion, and requires a wasteful, inefficient circuity of action between the family and probate divisions. It undermines our state's efforts to maintain a competitive position in the inter jurisdictional trust situs wars as other progressive trust law jurisdictions offer greater protections against domestic relations risks to non-resident settlors and their advisors.
This article will survey this complex intersection of principles of trust, property and domestic relations laws. Topics addressed include: (i) the classification and proper treatment in structuring property settlement, alimony and child support awards of discretionary trust interests and beneficiary-held powers of appointment under our prior and current law; (ii) the limited subject matter jurisdictions and the relative roles of the separate Probate and Family Divisions of the ten New Hampshire Circuit Courts under applicable provisions of UTC Article 5 relating to the new vulnerability of trust interests and powers, and (iii) the preservation of the privacy rights and respect for the duties and intentions of third party trustees and settlors under the new regime. We will call for remedial amendments to Article 5 and some other UTC provisions intended to strike a policy balance favoring the free alienability of property over the interests of non-beneficiaries that is more in line with New Hampshire's strong settlor intent-serving bias and the legislature's ongoing commitment to maintain our competitive position among progressive domestic trust jurisdictions.
II. THE ROLE OF THE UNIFORM TRUST CODE.
RSA Chapter 564-B contains our nuanced version of the UTC. It was initially enacted in 2004, substantially rewritten in 2005 and 2006,[3] and amended several times since then to make our laws more user-friendly and accessible to non-resident settlors. This article will often refer to pertinent provisions of RSA 564-B by "UTC" section numbers without the "RSA 564-B" prefix (e.g., "UTC §1-101"). References to the uniform state law from which many of the provisions of our UTC are drawn will be to the "Model Act."[4]
III. BASIC TRUST LAW PRINCIPLES AND TERMINOLOGY.
A. The Parties to a Private Trust Relationship and Their Rights, Responsibilities, Liabilities and Powers.
Each private trust involves the participation of at least three parties: the trust's settlor, the trustee and one or more beneficiaries. The same person can occupy one, two or even all three of these categories simultaneously. The relative rights, responsibilities, powers and liabilities of the settlor, trustee, beneficiaries and certain third parties, including creditors of beneficiaries, their spouses and former spouses, and their dependent children, are defined generally first in the trust agreement,[5] and secondarily in the pertinent default statutory and common law rules of the state whose laws govern the trust and its administration. A trust is self-settled' when the settlor retains a beneficial interest in the trust. This is to be contrasted with a third-party trust created for beneficiaries other than the settlor him or herself.
Any given trust may have one or more trustees and other non-trustee participants. The non-trustee participants may serve the trust by performing certain trust-related administrative and substantive functions in fiduciary or non-fiduciary capacities as trust advisors, protectors and agents.[6] One or more trustees may be the trust's settlor, a third party or one or more of the trust's beneficiaries.
Legal title to the trust's assets is vested in the trustee. The equitable interests held by the beneficiaries and the trustee's fiduciary duties to protect and serve those interests are enforced by the remedies available to the beneficiaries for a trustee's breach of trust. Those remedies include petitioning a court of competent jurisdiction to compel the trustee to make a required distribution to the beneficiaries under the terms of the governing instrument. The rights and remedies available to third parties to reach a beneficiary's trust interest to satisfy claims against the beneficiary are largely dependent on the terms of the trust agreement and the law that governs the trust's validity, construction and administration.
B. The Treatment of Third Party Discretionary Trust Interests and Beneficiary-Held Powers of Appointment Under Traditional Common Law Principles.
1. Discretionary Trusts: Support, Extended Discretion and Hybrid Trusts.
A discretionary interest in a third party trust is created by provisions in a trust agreement that grant the trustee some level of discretion over the payment or accumulation of either income or principal or both to one or more current discretionary beneficiaries. A sprinkle trust or spray trust is one that allows a trustee to make distributions of the trust's net income, principal or both among multiple concurrent discretionary beneficiaries.
A trustee's discretion over distributions may be limited by an objective or ascertainable standard, such as "amounts as are necessary to provide for the health, education, maintenance and support of the children of the settlor." Trusts creating these interests are often referred to as support trusts.
Alternatively, the trustee may be given unlimited or extended discretion over distributions. One common example: "the trustee may in its sole, uncontrolled and absolute discretion distribute so much of the trust's net income and principal, or both, whether the whole or a lesser amount, to or for the benefit of such one or more persons as such trustee may, in its sole and absolute discretion, select among a class of persons consisting of the settlor's descendants who are living from time to time."[7] These are sometimes referred to as extended discretion trusts. Trustees often petition for instructions or a beneficiary may challenge a trustee's distributions or refusal to make distributions. In resolving these issues, probate judges are often faced with difficult legal questions in construing the trust agreement language to ascertain the intended scope of the trustee's discretion[8] .
A discretionary support trust or hybrid trust combines an expression of broad discretion with a support language such as "such amounts as the trustee shall, in the trustee's sole and uncontrolled discretion, determine is necessary to support the settlor's children in the style of living to which they are accustomed."[9] The question: did the settlor intend some or all of the above-italicized language to be precatory or mandatory in nature?[10] As discussed later in Section VI.A. infra, such in artful drafting can present issues concerning the content and enforcement of alimony and child support awards under our current UTC Article 5 that may not be within the jurisdiction of a family division judge to resolve.
Modern trust drafting practices tend to favor the greater flexibility and creditor-safety of extended discretion trusts. Trust agreements creating mandatory interests, such as a current beneficiary's right to receive distributions of a trust's net income, are less popular and infrequently used unless required to achieve tax-related objectives.[11] Discretionary trusts offer greater distributional flexibility by allowing the trustee to adapt distribution patterns to unforeseen circumstances. The availability...
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