When Asset Protection Fails

The California Supreme Court recently clarified how spendthrift trusts are treated in federal bankruptcy, and the news is not good for those who want to protect assets from creditors.  Carmack v. Reynolds, opinion filed 3/23/2017, answered a question about how much of the current and future payments of a spendthrift trust are payable to the creditors of the beneficiary of the trust.  Over the course of the opinion, the Court lays out the following formula as an interpretation of Probate Code Section 15306.5: Unless the distributions are designated for the beneficiary’s support and are actually required for support, a creditor may collect the full amount of distributions that are payable now, and in addition the creditor may collect now up to 25% of all future known payments.  The creditor may then request to be paid the remaining 75% in each year that a future payment becomes currently available.  This is despite the trust’s spendthrift provision because the Trust includes a way to calculate distributions.  Near the end of the opinion, the Court felt a hypothetical was needed.  It clears up the otherwise convoluted formula:

 

“As an illustration, suppose a trust instrument specified that a beneficiary was to receive distributions of principal of $10,000 on March 1 of each year for 10 years. Suppose further that a general creditor had a money judgment of $50,000 against the beneficiary and that the trust distributions are neither specifically intended nor required for the beneficiary‘s support. On March 1 of the first year, upon the creditor‘s petition a court could order the trustee to remit the full distribution of $10,000 for that year to the creditor directly if it has not already been paid to the beneficiary, as well as $2,500 from each of the nine anticipated payments (a total of $22,500) as they are paid out. If the creditor were not otherwise able to satisfy the remaining $17,500 balance on the judgment, then on March 1 of the following years, upon the general creditor‘s petition the court could order the trustee to pay directly to the creditor a sum up to the remainder of that year‘s principal distribution ($7,500), as the court in its discretion finds appropriate, until the judgment is satisfied.”

 

The full opinion can be found here, above section can be found on page 15:

http://www.courts.ca.gov/opinions/documents/S224985.PDF

 

What are the takeaways? For now, asset protection in California is best achieved with unspecified discretionary distribution language to be exercised by an independent trustee.  This can be achieved with the help of an estate planning attorney, and is our firm’s default version of option for asset protection trusts.  However, this area of law changes often.  Anyone with a trust that incudes asset protection should consider having it reviewed regularly.  Had Rick Reynold’s parents updated their plan to sure up the asset protection, their son would not have lost their trust to his own creditors.