Can Creditors Take Assets From a Trust?

ANSWER: OFTEN CREDITORS CAN UNLESS THE TRUST IS PROPERLY PREPARED AND ADMINISTERED.

Revocable Trusts Are Not Protected: Initially it must be understood that a trust that is revocable, in other words it can be revoked at will, or if it can be changed or modified at will, then it will never protect assets as it will be disregarded by a judge with the result that any creditor or claimant can get its assets.

Thus, only an irrevocable trust — one that cannot be revoked, changed, or modified at will — might protect assets depending on the identity of the trustee, the terms of distribution, and the state law which is applicable to the trust.

Trustee: The best trustee to use is a trustee that is an independent, professional trustee that is not related to any beneficiary in the trust or a bank trust department as it is not related to any beneficiary in the trust. If a person related to the beneficiary is trustee or if the beneficiary is trustee, then it is likely that little, perhaps no protection, will be available for the trust assets.

Properly managing this distribution of trust assets can also avoid creditor claims if the trust is set up for discretionary distributions for health, maintenance, support, and education. The distributions should also be properly timed to reduce the possible creditor claims (known by the trustee) against any beneficiary. That would involve independent counsel for the beneficiary at the expense of the beneficiary.

Terms of Distribution: Distribution designed to be made for the health, support, maintenance, and education of a beneficiary, in the discretion of the trustee, is typically used, perhaps further restricted, when any protection of the assets is desired. The longer the term for the trust the greater the possibility for the protection of the trust assets. Why? A creditor with a judgment against a beneficiary may be able to have a judge order that when the trust terminates then the creditor gets paid, with interest.

State Law Is Important: Some states have more favorable state laws that protect trusts from creditors. For example, some of the states have law that heavily restricts the ability of creditors to get money a beneficiary would receive in distributions for health, support, maintenance, and education, and it also may restrict the ability of a creditor to get money even after it is distributed to a beneficiary for those purposes. Other states may allow a creditor to get money a beneficiary would receive for health, support, maintenance, and education unless it can be shown that it is used for that purpose. Most states would likely allow a creditor to get the money a beneficiary would receive if the trust terminates perhaps at the age a beneficiary reaches as provided in the trust. It is important to both check the law of a state before creating a trust in that state, and it needs to be understood that the trustee and the trust property are best protected if they, as well as the beneficiary, are in the state whose law is desired to be used. If the trustee, the trust property, or the beneficiary are in a different state then a creditor may be successful in having the state law used in the state of the creditor. The choice of law available to a judge is not always predictable and often is dependent upon the contacts a trust has with a state.

SOURCES:
Carmack v. Reynolds, 2 Cal. 5th 844 (2017) - Creditors may reach a beneficiary's interest up to the full amount of any distributions of principal that are currently due and payable, unless the trust specifies that the distributions are for the beneficiary's support or education and are necessary for those purposes, and up to 25 percent of any anticipated payments to the beneficiary, reduced by the amount necessary for the beneficiary's and dependents' support.

Blech v. Blech, 38 Cal. App. 5th 941 (2019) - Creditors may file petitions to enforce judgments against revocable trusts when distributions are mandated.

Cal Prob Code § 15301 - Mechanism for a creditor to petition the court to enforce a money judgment against a trust beneficiary's distribution.

Cal Prob Code § 15306.5 - Allows creditors to reach up to 25% of a beneficiary's future trust distributions, subject to limitations for support needs.

Cal Prob Code § 15302 - Protects distributions intended for the beneficiary's support or education to the extent necessary for those purposes.

Cal Prob Code § 15307 - Permits creditors to access amounts exceeding what is necessary for the beneficiary's education and support.

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