Spendthrift, Discretionary, and Support Trusts; Creditors' Rights

Spendthrift, Discretionary, and Support Trusts; Creditors' Rights

A spendthrift trust is one in which the settlor restrains the beneficiary from voluntarily or involuntarily transferring his equitable interest, protecting the beneficiary both from his own improvidence and from his creditors. The clause imposes two distinct restraints. First, a restraint on voluntary alienation: the beneficiary cannot sell, assign, pledge, or otherwise transfer his right to future distributions, so an assignment the beneficiary purports to make is unenforceable, and the trustee may disregard it.

Second, a restraint on involuntary alienation: the beneficiary's creditors cannot attach, garnish, or otherwise reach the beneficiary's interest before the trustee actually distributes it to the beneficiary. California gives full effect to both restraints. Probate Code §15300 validates a restraint on the voluntary or involuntary transfer of a beneficiary's interest in trust income, and §15301 does the same for principal, although a restraint on principal that has already become due and payable to the beneficiary is ineffective once the beneficiary is entitled to immediate distribution.

The crucial conceptual point is timing: spendthrift protection ends at the moment of distribution. Once trust funds are paid into the beneficiary's hands, they are the beneficiary's free property and creditors may reach them like any other asset; a creditor may even position itself to seize the distribution as it leaves the trust. The protection guards the stream while it is still trust property, not after it has been delivered.

A spendthrift clause need not use any magic words, but it must clearly express the settlor's intent to impose the restraint; a general statement that the beneficiary's interest is 'free from the claims of creditors and not subject to anticipation or assignment' is the classic formulation. Because the device frustrates creditors, it is strictly a creature of the settlor's intent and cannot be conjured from silence.

Even a perfectly valid spendthrift clause does not defeat every creditor; California identifies several categories of exception creditors who may reach the beneficiary's interest notwithstanding the restraint, reflecting public-policy judgments that some claims are too important to be defeated by a settlor's wishes.

The most important are dependents: a beneficiary's child, spouse, or former spouse with a judgment or court order for child or spousal support may reach the beneficiary's interest to satisfy that support, and Probate Code §15305 authorizes the court to order the trustee to satisfy all or part of such a support claim out of payments to which the beneficiary is entitled or that the trustee in its discretion has determined to pay.

A second category is government claimants: under §15305.5, the state or a public entity may reach the interest to satisfy a restitution judgment arising from the beneficiary's felony conviction; and federal and state tax claims generally override spendthrift protection. A third is the so-called 'station-in-life' creditor and providers of necessaries, and §15306 allows certain public-support reimbursement claims to reach the interest.

In addition, Probate Code §15306.5 provides a general rule that, regardless of a spendthrift restraint, a judgment creditor may petition the court to order the trustee to satisfy a money judgment out of payments the beneficiary is entitled to receive, but capped so that the order may not exceed twenty-five percent of the payment that otherwise would be made to the beneficiary, and not so as to leave the beneficiary without necessary support.

These exceptions matter constantly on the essay, because the typical fact pattern pits a spendthrift beneficiary against an ex-spouse seeking support or a tort victim holding a judgment, and the correct analysis turns on which exception, if any, the claimant fits.

A settlor cannot use a spendthrift trust to shield his own assets from his own creditors. Where the settlor is also a beneficiary of the trust — a self-settled trust — the spendthrift restraint is ineffective against the settlor's creditors to the extent of the settlor's beneficial interest.

California codifies this in Probate Code §15304: a restraint on the transfer of the settlor's own beneficial interest is invalid against the settlor's creditors, and if the settlor is the beneficiary of a trust the settlor created, the settlor's creditors may reach the maximum amount that the trustee could pay to or for the benefit of the settlor under the trust's terms.

This rule prevents the obvious abuse of a debtor sheltering wealth behind a self-imposed restraint while continuing to enjoy the property, and it is why traditional self-settled asset-protection trusts are ineffective in California (unlike a handful of states and offshore jurisdictions that permit domestic asset-protection trusts).

The rule extends to revocable trusts with even greater force: because a settlor of a revocable trust can revoke at any time and recapture the assets, the property of a revocable trust is fully subject to the settlor's creditors during the settlor's lifetime, and Probate Code §18200 confirms that the trust property is subject to claims of the settlor's creditors to the extent of the power of revocation.

After the settlor's death, the assets of a formerly revocable trust remain liable for the settlor's debts and the expenses of administering the estate to the extent the probate estate is inadequate (§19001), and a statutory claims procedure (§19000 et seq.) lets creditors reach the trust. The lesson for the essay is to separate two questions: whether a spendthrift clause protects a third-party beneficiary (often yes, subject to exceptions) versus whether it protects the settlor himself (no).

Spendthrift protection is one technique; the structure of the beneficiary's entitlement is another, and the examiners often combine them. In a pure discretionary trust, the trustee has discretion over whether and how much to distribute, and the beneficiary has no fixed right to any distribution until the trustee chooses to make one.

Because a creditor can reach no more than the beneficiary himself could compel, and the beneficiary can compel nothing while the trustee withholds, a creditor of a discretionary-trust beneficiary generally cannot force any payment; the creditor stands in the beneficiary's shoes, and those shoes are empty until the trustee acts.

There is an important wrinkle: if the trustee, with notice of the creditor's claim or court order, nonetheless decides to make a distribution, the creditor may be able to intercept that distribution as it is made, and a child- or spousal-support claimant enjoys enhanced rights under §15305 to reach amounts the trustee has determined to pay.

A support trust directs the trustee to distribute only so much as is necessary for the beneficiary's support, education, health, or maintenance; the beneficiary's interest is limited to that purpose, and the beneficiary cannot demand more nor assign the interest because doing so would frustrate the support purpose. Creditors who supplied the very necessaries the trust exists to provide — food, shelter, medical care, education — may reach the interest to be paid for those goods and services, but general creditors who furnished non-necessaries cannot.

Many real trusts blend these features — a discretionary support trust with a spendthrift clause — and the analytic key is to identify each feature, ask what the beneficiary could compel, and then ask whether the particular creditor is an exception creditor who can do better than the beneficiary.

Creditor Access at a Glance

• Spendthrift trust (third-party beneficiary): creditors generally cannot reach the interest before distribution; protection ends once funds reach the beneficiary's hands.
• Exception creditors (child/spousal support, restitution judgments, certain government and tax claims): may pierce a spendthrift clause; support claimants may reach amounts the trustee is or has decided to pay.
• Self-settled spendthrift trust: ineffective against the settlor's creditors, who reach the maximum the trustee could pay the settlor (Prob. Code §15304).
• Revocable trust: fully reachable by the settlor's creditors during life to the extent of the power to revoke (Prob. Code §18200).
• Discretionary trust: creditor stands in the beneficiary's shoes and can compel nothing until the trustee elects to distribute.
• Support trust: providers of necessaries (support, education, health) may reach it; general creditors cannot.