This month’s Alert examines when the income of a trust may be considered available to creditors. The Alert examines a case involving the availability for purposes of determining alimony.The New Jersey case of Tannen v. Tannenhas drawn national attention. Mark and Wendy Tannen were married for nearly eighteen years. During the marriage, Wendy’s parents created and funded an irrevocable trust which was a third-party defendant in the suit. Wendy was the trust’s sole beneficiary and Wendy and her parents were co-trustees. The issue at trial was whether, for purposes of determining Mark’s alimony, it was appropriate to impute income to Wendy based on her beneficial interest in the irrevocable trust created by her parents.The trust provided that the co-trustees “shall pay over to or apply for the benefit of the beneficiary’s health, support, maintenance, education and general welfare, all or any part of the net income therefrom and any or all of the principal thereof, as the Trustees shall determine to be in the beneficiary’s best interests . . . .” The co-trustees were to take into account the other financial resources available to Wendy in exercising their discretion. The term “best interest” included payments from the trust to help meet Wendy’s educational expenses, medical expenses or other emergency needs, to enable her to purchase a home, and to enable her to enter into a business or profession. The co-trustees also had sole discretion as to the timing, amounts, manner and form of any distributions to be made.The trust further provided that, notwithstanding any other trust provision, it was the express intention of the grantors in creating the trust that Wendy was not permitted, under any circumstances, to compel distributions of income and/or principal prior to the time of final distribution. The trust also contained a spendthrift provision which stated that distribution of both income and principal were to be made as directed under the terms of the trust. Wendy had no right to alienate or encumber any distribution without first procuring the written consent of the co-trustees.
In making its ruling, the trial court applied the Restatement (Third) of Trusts to determine that the terms “support” and “maintenance” in the trust required the trustees to distribute “such sums as are necessary to maintain” Wendy’s lifestyle. The trust court determined it must consider trust benefits before computing alimony and imputed income to Wendy from the trust. In the final judgment of divorce, the trial court ordered the trustees to make a $4,000 monthly payment to Wendy and to continue making payments for shelter-related expenses that it historically had made. Based on that imputed income, the court calculated Mark’s permanent monthly alimony obligation at $4,500.
On appeal, the Appellate Division noted that the Restatement (Third) of Trusts had not been adopted by any reported decision in New Jersey and, if adopted, would operate to change the law in New Jersey. The panel recognized that pursuant to the Restatement (Third) of Trusts, Wendy would have an enforceable interest in the income of the trust. The panel determined, however, that as a court of intermediate appellate jurisdiction it would not presume to adopt the Third Restatement and suggested that such a decision would be more appropriately made by the Supreme Court. The Appellate Division held that by applying existing New Jersey law, which has incorporated various provisions of the Restatement (Second) of Trusts, Wendy’s beneficial interest in the trust was not an “asset held by” her for purposes of the New Jersey alimony statute and she could not compel discretionary distributions without the consent of her fellow co-trustees, i.e., her parents. Thus, the panel determined that no income from the trust should have been imputed to Wendy in determining Mark’s alimony obligation. The New Jersey Supreme Court affirmed the Appellate Division’s decision.
In determining whether trust income and assets are available to the creditors of a beneficiary, it must be determined whether the trust is classified as a discretionary trust versus a support trust. A discretionary trust is a trust that gives the trustee discretion over distributions to the beneficiaries. A support trust is a trust that includes a support standard for providing distributions to the beneficiary. The most widely used standard is for “health, education, maintenance and support.” This type of trust must rely on its spendthrift provision to protect its assets from the creditors of the beneficiaries. Certain classes of creditors are able to access the trust assets as “exception creditors,” either by state statute or by judicial rule. One such popular exception creditor is a divorcing spouse. A third type of trust is a “hybrid trust” which is a discretionary support trust. The trust in this case has both discretionary and support language and therefore is a hybrid trust. Despite the protections ultimately determined by the New Jersey Supreme Court, estate planning attorneys should be careful to avoid drafting support or hybrid trusts in situations where protection from creditors (including a divorcing spouse) is sought for the beneficiary. It is also important that the beneficiary not be designated as a trustee. The trial court in this case found that Wendy owed a fiduciary duty to Mark, despite the prohibition against her making a demand for distributions.
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