Recently a California appellate court reviewed a request to compel a trustee of an irrevocable trust to satisfy a beneficiary’s child support obligations from the trust and to impose a judgment lien to satisfy a community property judgment. The trust contained both a spendthrift clause and a shutdown clause that prohibited the trustee from making certain distributions if they’d become subject to creditors’ claims.
The Trustors’ children and grandchildren were named as the beneficiaries of the Trust, which provided that upon the death of the surviving Trustor, the Trust’s assets would be divided shares for the beneficiaries, and those shares would continue to be held in trust for their benefit. As a grandchild, the wife in this case was provided with a one-sixth share of the total assets of the Trust.
Pratt (husband) and Vedder (wife) divorced, and Pratt obtained court orders requiring his ex-wife Vedder to pay child support and expenses. He filed a petition to compel the trustee to satisfy the orders from the wife’s share of the trust.
The trial judge denied Pratt’s petition because of the “shutdown clause” in the trust. Pratt’s petition also sought the imposition of a judgment lien on his wife’s interest in the trust estate to satisfy a community property judgment that he held against her. Again, the judge relied on the shutdown clause to deny the petition for a lien.
Associate Judge Richard D. Fybel of the California Court of Appeals wrote in his opinion for the panel that the parties agreed that the case was governed by California Probate Code § 15305, which reads in part:
(b) If the beneficiary has the right under the trust to compel the trustee to pay income or principal or both to or for the benefit of the beneficiary, the court may, to the extent that the court determines it is equitable and reasonable under the circumstances of the particular case, order the trustee to satisfy all or part of the support judgment out of all or part of those payments as they become due and payable, presently or in the future.
(c) Whether or not the beneficiary has the right under the trust to compel the trustee to pay income or principal or both to or for the benefit of the beneficiary, the court may, to the extent that the court determines it is equitable and reasonable under the circumstances of the particular case, order the trustee to satisfy all or part of the support judgment out of all or part of future payments that the trustee, pursuant to the exercise of the trustee’s discretion, determines to make to or for the benefit of the beneficiary.
(d) This section applies to a support judgment notwithstanding any provision in the trust instrument.
Judge Fybel noted that Probate Code § 15305 was added to reduce the ability of a general creditor to reach a beneficiary’s interest in a trust and to give greater rights to support creditors. Fybel relied on earlier court decisions which held that child support creditors were elevated to the status of “preferred creditors.” As such, they could reach a beneficiary’s interest in the trust, despite the existence of a spendthrift clause. The judge went on to state that under § 15305, a minor’s right to support may not be defeated by a spendthrift provision in a trust. In the same manner, the Court of Appeals held here that the shutdown clause can’t defeat a minor’s right to child support. Moreover, the language of the Trust shows an intent to benefit Vedder’s children.
The Court of Appeals reversed the trial judge’s decision, holding that public policy doesn’t allow the use of a shutdown clause in a trust to prohibit satisfaction of a child support judgment against the beneficiary from periodic payments of principal. Because the spendthrift clause applied only to other distributions of principal and interest, a discretionary determination was required on the amount of all distributions of income and principal to be applied to the child support obligations. The Court found that the trial judge erred in ordering that no portion of the distributions be used to pay the child support obligations. With respect to all distributions of income and principal of the Trust, Judge Fybel said that the trial court must exercise its discretion under Probate Code § 15305(b) and (c). On this issue, the Court sent the case back to the trial court to exercise its discretion to determine how much the Trustee must distribute to pay the child support arrearages and any current support obligations.
The Court went on to say that the Trustee may not exercise his discretion to avoid distributions under the Trust with the improper motive to prevent the Trust estate from being used to satisfy Vedder’s child support obligations. In exercising its discretion to make or withhold payments, a trustee may not act in bad faith or with an improper motive. Where discretion is conferred upon the trustee with respect to the exercise of a power, its exercise is not subject to control by the court, except to prevent an abuse of discretion by the trustee.
As far as Pratt’s judgment against Vedder for the community property bank account improperly taken by Vedder immediately before their separation, the Court noted that Probate Code §§ 15301(b), 15306.5, and 15307 provide exceptions to the statutes making spendthrift clauses generally applicable. Those statutes provide that when a spendthrift clause applies, the trustee may not be compelled to satisfy a judgment against the beneficiary from the trust principal. However, when the principal is paid from the trust to the beneficiary, it becomes subject to a lien. If the trustee exercises his or her discretion to make payments to the judgment debtor beneficiary, the trial court, in its discretion, may order that up to 25% of the payment to the beneficiary may be used to satisfy the judgment. Discretionary payments that the trustee makes to the judgment debtor beneficiary in excess of the amount necessary for the beneficiary’s education and support are subject to a judgment lien. In short, any amount the Trustee pays to Vedder, whether discretionary or nondiscretionary, above the amount necessary for Vedder’s education and support, is subject to a judgment lien and subject to the limitations of the statutes.
Pratt was entitled to a judgment lien on the trust to satisfy the community property judgment, pursuant to the relevant provisions of the Probate Code and the Code of Civil Procedure. As a result, this part of the trial court’s order was also reversed. Pratt v. Ferguson, 3 Cal. App. 5th 102; 206 Cal. Rptr. 3d 895; 2016 Cal. App. LEXIS 746 (Cal.App. 4th Dist. September 6, 2016).
We have yet to see how this case will affect the long-relied upon creditor protections afforded to trust beneficiaries. We may learn that this is the first of many to open the door to an analysis of bad faith or improper motives and public policy.
Contact N·M Law, APC (949-253-0000) to speak to a trust attorney. N·M Law, APC, encourages you to take advantage of our superior skill and knowledge. Contact us today to get answers to your questions about trusts and the asset protection benefits that they can provide to your beneficiaries.
Disclaimer: This article is intended to provide a general summary of the California usury laws and should not be construed as a legal opinion nor a complete legal analysis of the subject matter. June Lin is an attorney at Niesar & Vestal LLP in San Francisco, a law firm specializing in business law and corporate finance.