Placing Limits on Trust Asset Protection

Goldburn Maynard

The issue of whether trust beneficiaries should be treated differently from individuals who own their assets directly has been a central one in the trusts and estates world for centuries, and it shows no signs of disappearing. While it would be preferable to have a standard, across-the-board response to this matter, its intractable nature reveals a balancing of interests. The trust is a centuries-old fiduciary relationship that is not nefarious in and of itself. Much as they do with corporations, governments find themselves torn between respecting such voluntary arrangements according to their terms or setting them aside to prevent abuse. The purpose of look-through rules is to prevent trusts from undermining other policy goals, such as facilitating debt collection or restricting certain government benefits to individuals who demonstrate financial need.

In a forthcoming article, Professors Adam Hofri-Winogradow & Mark Bennett compare trust look-through approaches taken by five nations: the U.S. (and its states), Canada (and its provinces), England and Wales, Australia, and New Zealand. The authors’ focus is primarily on liability and means-testing avoidance by trust beneficiaries, which they argue is improper. To paint a picture of how weighty and emotion-provoking these issues can be in the real world, consider three examples featuring Gary, a hypothetical trust beneficiary of a $10 million trust set up by his mother Gwen before her death from a terminal illness. Gary’s father, as trustee, in entitled to make distributions to Gary in his sole discretion:

1. At 18, Gary applies for food stamps and Temporary Assistance for Needy Families after being kicked out of his home by his father for smoking marijuana. Should the government consider his interest in the trust when determining if he qualifies for public benefits?
2. At 21, Gary goes out drinking with friends. On his drive home he gets into an accident. Jenna, the driver of the other vehicle is left unable to walk and undergoes numerous surgeries, both lowering her quality of life. Jenna is awarded $5 million in damages for her medical costs, pain, and suffering. Should she be able to reach the trust assets to satisfy the judgment?
3. At 25, Gary goes to Vegas and gets married to his high school sweetheart, Mary. Two years later, they divorce, and Mary seeks alimony and a property settlement. Should Gary’s trust assets be considered in determining settlement and alimony amounts?

Hofri-Winogradow & Bennett’s article highlights how the answers to these questions depend on the laws of the jurisdiction which govern the trust document. For example, in the U.S., most states have allowed asset protection through the use of spendthrift and discretionary trusts. The spendthrift trust restrains voluntary alienation of trust assets by the beneficiary and involuntary alienation by his general creditors. The discretionary trust protects assets because, as distributions are subject to the trustee’s discretion, the beneficiary has no vested interest in the trust and a general creditor cannot even sue to compel the proper exercise of discretion. The authors are particularly concerned with the discretionary trust and its descendant, the massively discretionary trust, in which trustees have the discretion to add or remove individuals or entities from the class of beneficiaries and even to bring the trust to an end.¹

Each of the five jurisdictions analyzed by the authors has a set of anti-avoidance rules to prevent trust beneficiaries from escaping liability for public policy reasons. For example, if Gary lived in Australia, he would be subject to look-through rules to ascertain how much control he had over the trust. New Zealand has comparatively weaker look-through rules in this scenario. But notably, if Gary lived in Canada, the UK or U.S., the financial eligibility rules for public assistance would likely disregard the trust assets, thus allowing him to qualify for government benefits such as food stamps or Medicaid. To some extent this makes sense since he is not guaranteed any distributions. However, if the trustee were to make distributions in a given year, those would count as a financial resource of Gary when applying for public benefits.²

Jenna would probably not fare well in her claim against Gary, despite his recklessness. Although favored by some commentators, a public policy exception for tort victims seeking to reach assets contained in a spendthrift or discretionary trust exists only in a few states in the U.S.. Mary, however, would likely fare better than Jenna because most jurisdictions that otherwise recognize strong protections against creditors provide exceptions for family support claimants. Australia, for example, allows the court to disregard certain transfers in the case of divorce. Similarly, most U.S. states allow for spousal claims against spendthrift and discretionary trusts. While she would not be guaranteed success, particularly in states with domestic asset protection trusts,³ Mary would at least have a shot.

Hofri-Winogradow & Bennett argue that look-through rules should be strengthened to close loopholes that subvert public policy goals, like enhancing social equality. Their proposal is a draconian default presumption which would treat the entire discretionary trust as property of the beneficiary, in the absence of a showing that the trustee only intended to distribute a portion of the trust property. In Gary’s case this would mean that the entire value of the trust could be subject to inclusion. However, the authors do not expect that this would be the result. Instead, the default presumption would force trustees to disclose reasonable amounts that they plan to distribute and thus subject those amounts to claims by creditors. The trustee of Gary’s trust might provide evidence that he plans to distribute $200,000 per year to Gary. That part of the trust would then be subject to claims and countable as income for public benefit purposes. Such a rule would represent a massive change to current law and would certainly face strong opposition both from the wealthy and from jurisdictions that actively compete to attract trust business to their states.

1. See Lionel Smith, Massively Discretionary Trusts, 70 Current Legal Probs. 17, 26–27 (2017).
2. In the U.S. there in an exception to this rule if the trust meets the requirements of a special needs trust.
3. The rules on asset protection trusts vary by state, with some including exceptions for creditors or other anti-fraud rules.