Recent Massachusetts Trust Case Has Important Divorce Planning Lessons for All

Not All Trusts Are Created Equal 

Trusts are ubiquitous in planning and one of the most common motivations for the use of trusts is to minimize the risks that a future divorce of a trust beneficiary will not expose trust assets to the reach of that ex-spouse.

A recent Massachusetts case potentially undermines the use of trusts to safeguard assets from attack in divorce in Massachusetts. But the warning signs of this case should be considered by practitioners in many other jurisdictions. Whether or not the case was appropriately decided, this case highlights many practical steps practitioners should take in all jurisdictions to make trusts safer from attack by the future ex-spouse of a beneficiary.

Too often clients misunderstand this valuable benefit of trusts, and how to achieve it. Often, clients presume that, just like a “Rose is a rose is a rose is a rose,” a trust is a trust is a trust. Unfortunately, not all trusts are planned or administered the optimal way to deflect the potential ravages of a future divorce. A recent Massachusetts case highlights the risks to improperly planned and administered trusts.

BLUF (bottom line up front)

The typical or traditional trust done for a child or grandchild is unlikely to provide the desire protection.  Applying common modern trust planning and drafting techniques (summarized in a checklist at the end of the article) will place the client’s heirs in a much safer position. Typical Trust: child is a trustee of her own trust and has the right to make distributions to herself pursuant to an ascertainable standard (HEMS or health education maintenance or support), the trust is formed in the family’s home state, and the trust ends distributing all trust assets to the heir at some specified age, say 50. Modern Trust: A completely discretionary trust, with a corporate trustee, organized in a trust friendly state that continues for a long term or in perpetuity and makes irregular distributions that do not follow a particular pattern. Clients sometimes complain about the cost, complexity, duration or other aspects of a modern trust. But as this recent case makes clear, and as other cases suggest, clients that want their divorce protection goals achieved should really weigh the benefits of those negative factors against the more important goal of protecting trust assets.

What if the Beneficiary Moves to a Less Favorable Jurisdiction Then Divorces?

It is important for practitioners to also recognize the risk that clients relocate. So even if a trust is created in a jurisdiction that has more favorable law (e.g., New Jersey as discussed briefly below), if the couple relocates to a new jurisdiction and the trust is administered in that new jurisdiction, that new jurisdiction’s laws may be applied in a later divorce thereby undermining the planning, Further, there is no certainly in many states that law favorable to the protection of a trust from a later divorce will not be changed after the trust is created.

About 40 million people move annually in the US. Nearly 3/4 of the US population moves an average of once every 5 years.  Is it realistic to rely on a settlor’s home state law applying to protect a beneficiary years or decades in the future? Wouldn’t prudence suggest a more conservative or safer approach be used when a trust is first drafted to enhance the likelihood of protection in the future?

Pfannenstiehl

A recent Massachusetts case, Pfannenstiehl v. Pfannenstiehl  held that the assets of a trust would be considered as part of the marital estate. (Mass. App. Ct., Nos. 13-P-906, 13-P-686 & 13-P-1385, August 27, 2015).  Massachusetts law takes an expansive view of what constitutes a marital estate, how certain can anyone be where an heir will reside if divorced in the future or what the law of that jurisdiction will have evolved to at that time?  While the case is still on appeal, regardless of the outcome the implications of the lower two court cases should be considered in all trust planning.

The Massachusetts Appeals Court ruled that a portion of a trust created by the parents of the divorcing husband for his benefit, and for the benefit of his siblings, were to be considered as a marital asset in his divorce.

The couple had two special needs children whom the wife provided most care. Almost ½ of the income for the family came from distributions from the family trust in question. The husband’s brother and the family attorney were co-trustees of the trust. Distributions from the trust stopped just prior to the divorce filing.

The trust included a standard of distribution based on an ascertainable standard, a HEMS or health education maintenance and support standard. The court reasoned that this standard gave the husband a present enforceable right to distributions. The court also noted that the husband would receive an outright distribution of his share of the trust at a specified future date and determined that ½ of that should be distributed to the wife.

The trust had 11 beneficiaries to whom distributions could be made and the class was open in the sense that future descendants would be added. While this was a positive fact the court did not appear to restrict its holding based on this.

The dissent, consisting of two of the five judges, argued that the distribution standard was too speculative to value. The dissent was not swayed by the cessation of distributions on the eve of the divorce and argued that the focus should be on the terms of the trust not the actions taken.

As a caution to attorneys serving as trustees the Court did not view the attorney as independent in light of the business his firm did with the family.

Although the trust included a spendthrift provision, the court was influenced by the pre-divorce pattern of distributions, the cessation of distributions just prior to the divorce, and held that it was not appropriate for the husband to have benefitted from the asset then have a spendthrift provision apply to protect the trust while the husband neglects to provide for the family he has a legal obligation to support. The court also viewed the cessation of distributions on the eve of the divorce as a “machination.”

The husband borrowed money from his father to make payments as required under the divorce settlement and when those payments ran out he requested distributions from the trust. To no ones’ surprise the brother and family lawyer as trustees refused distributions.

Support versus Discretionary Trusts

For practitioners to understand the essence of many of the matrimonial decisions addressing trusts, the distinction between a “support” and a “discretionary” trust needs to be clarified. A “support” trust is a trust which directs the trustee to make distributions to support the beneficiary. A common support standard is Health Education Maintenance and Support, referred to by the acronym “HEMS.” This is the type of trust that was reached in the Pfannenstiehl case. A “discretionary” trust is one that grants the trustee the discretion to determine if, when and how much to distribute from the trust to the beneficiary.

As a generalization, if a trust were characterized as a pure support trust the court might be inclined to enforce the beneficiary’s interests in the trust in a matrimonial action. If the trust is a pure discretionary trust, the courts would be harder pressed to find an interest to enforce and the trust would be less likely to be reachable. In reality, many trusts are combinations of the two standards, and that makes the decision process murkier.

Other states take a different view of the protections afforded by a trust. For example, New Jersey reached a very different result in Tannen v. Tannen. 416 N.J. Super. 248 (App. Div. 2010), aff’d, — N.J. —,  — A.3d —-, 2011 WL 6090130  (2011). The significance of the Tannen decision is the rejection of the Restatement Third of Trusts that a discretionary trust can be enforced as a support trust (based on the notion that the trustee must act in the best interests of the beneficiary).  Instead, the decision reaffirmed that New Jersey will follow the Restatement Second of Trusts position that a purely discretionary trust will be honored as giving the trustee unfettered discretion to distribute or not distribute, regardless of the support needs of the beneficiary.

A recent Delaware case makes suggests that having a trust formed in a trust friendly will automatically assure that the courts in that jurisdiction will hear the case. The fact that a Delaware court may have jurisdiction does not mean that another court outside of Delaware cannot exercise jurisdiction over the case. Also, even if a Delaware court has primary jurisdiction over administrative issues relating to Delaware trusts courts in other states may still exercise jurisdiction over matters of trust administration so long as doing so would not constitute “undue interference” with Delaware’s primary jurisdiction.  In this case, husband was trustee of a Delaware trust. His wife sought to have the trust treated as marital property in their Kentucky divorce. The husband had served as a special trustee with distribution and investment powers. The husband resigned those positions and the Delaware trustee endeavored to have the Delaware courts rule that the Delaware courts had exclusive jurisdiction. The court declined to do so. IMO Daniel Kloiber Dynasty Trust U/A/D Dec., 2002 C.A. No. 9685-VCL (August 1, 2014).

In a Florida case the Court permitted the former spouse of a beneficiary to access distributions as they were made from a discretionary trust. Berlinger v. Casselberry, Case No. 2D12-6470 (Fla. 2d DCA Nov. 27, 2013).

Lessons from Pfannenstiehl v. Pfannenstiehl

The following is a checklist of planning suggestions based on the Pfannenstiehl case:

• Use a true independent trustee, such as a corporate trustee. If counsel serves as trustee considering adding an assuredly independent co-trustee.
• Form the trust from inception in a trust friendly jurisdiction that is less likely to undergo a possible transformation in case law, e.g., Nevada. If the trust is in a jurisdiction whose law may be less certain, evaluate whether a change of situs could be completed.
• Eliminate distributions pursuant to an ascertainable standard in favor of fully discretionary distributions held by an independent trustee. In the instant case that would have been problematic in that the brother was also a co-trustee but this could have been addressed by having separate trusts for each child or including provisions preventing an interested trustee, such as a trustee/beneficiary, from making distributions or limiting those distributions to an ascertainable standard (obviously not the optimal approach).
• If distributions are to be made avoid a pattern of regular distributions to support a beneficiary’s lifestyle and instead plan distributions to be erratic and not correlated with major life events (e.g., beneficiary buying a house, beneficiary’s child marrying, etc.).
• Use long term or perpetual trusts not trusts that end about a beneficiary attaining a specified age or at some other ascertainable time period.
• Don’t make radical changes in distributions or other theretofore consistent facts on the eve of a divorce and expect a court to be sympathetic.
• Clients should sign prenuptial agreement that disclose and exclude interests in family trusts.
• If any of the aspects of the trust are not optimal endeavor to decant the trust into a newer and more favorably structured trust well in the advance of any challenge, including divorce. The wider use and availability of decanting has post-dated many of the unfavorable matrimonial/trust decisions and presents an opportunity for practitioners to improve older client trusts that are not optimal. This recent Massachusetts decision demonstrates the importance of this.

Conclusion

Clients should be advised to have the terms of all existing trusts, and the administration of those trusts, reviewed to ascertain whether improvements can be made to enhance the likelihood of the trust withstanding a matrimonial challenge.