Whether a trustee can be required to use trust assets to pay a beneficiary’s own debt is an important question. Under California law the legal analysis involves the terms of the trust, the California Probate Code, the nature of debt involved, and even the beneficiary’s circumstances.
Under California law, a trust established by the beneficiary for him or herself is answerable for the beneficiary’s own debts.
However, a trust for a beneficary who did not establish and fund the trust can be drafted to provide certain creditor protections to limit the extent to which the trustee can be required to satisfy debts. Once assets are distributed free of trust to the beneficiary the distributed assets are exposed to collection actions by the beneficiary’s creditors.
A trust that has a restraint on alienation provision – a “spendthrift clause” – generally prevents a beneficiary from transferring his or her interest, either voluntarily or involuntarily, to creditors. The trust’s spendthrift clause prevents the trustee from directly having to pay creditor judgments unless the creditor obtains a court order. The creditor must wait until the debtor beneficiary receives a distribution. The creditor, however, can “step into the beneficiary’s shoes” and require any distributions that are mandatory and not discretionary with the trustee.
With monetary judgment creditors, up to 25 percent of what a beneficiary is entitled to receive and any discretionary distributions that the trustee decides to distribute can become subject to a court order requiring the trustee to pay a beneficiary’s creditors.
If the trustee has complete discretion over making distributions to or for the benefit of the beneficiary then it may be possible to avoid paying general creditors by not making distributions directly to the beneficiary. The trustee can instead make purchases that benefit the beneficiary — pay rent for example — and so avoid direct distributions to the beneficiary.
There is an important limitation on court ordered payments of judgment creditors. The court order cannot deprive the beneficiary what is necessary for support of the beneficiary and any of his or her legal dependents.
Next, both a “Support Trust” and a “Discretionary Trust” are asset protection trusts that provide important protection from creditor claims.
A “Support Trust” — one that requires the income or principal or both to be used for the education or support of a beneficiary — is protected, “to the extent that the income or principal is necessary for the education or support of the beneficiary.” The money judgement creditor must prove that there is excess money that is not necessary for the education and support of the beneficiary.
A “Discretionary Trust” — one where the Trustee has sole or absolute discretion over making distributions of any kind to or for the benefit of a beneficiary — also provides protection against a beneficiary’s money judgment creditors. A creditor cannot force the trustee to make discretionary distributions to the beneficiary.
The foregoing protections (the spendthrift clause, the support trust, and the discretionary trust), however, do not apply to spousal or child support, criminal restitution, and required reimbursement of public benefits debts. A court, to the extent that it finds it equitable and reasonable under the circumstances, can order the trustee to pay such debts out of all or part of any payments either to or for the benefit of the beneficiary.
The legal analysis involved with creditor collection against trust assets varies from case to case and can be complex. The foregoing is only a simplified discussion of a much more complex subject. Anyone needing advice should consult with a licensed Lake County trust attorney for specific legal guidance and not draw any premature conclusions of their own.