Just Because You Live in California Doesn’t Mean Your Trust(s) Have To!

Dear Clients, Colleagues, and Friends,

Divorce Attorney Smith has a job to do, and it's not an easy one... breaking bad news never is.

Over lunch, Smith takes a deep breath, readying himself for the next half-hour of rage that is sure to come from his client Bill. The rage will be justified because the outcome certainly isn't.

Bill caught his soon-to-be ex-wife Laura having an affair with his best friend. Instead of remorse and apologies, Laura announced she was leaving Bill and taking him for everything he's got.

Because Laura enjoys a lifestyle that would make any wealthy retiree envious, including a full-time, live-in nanny and private school for their child, in large part because of the support trust Bill's parents established for him before their death. Smith was initially concerned that she could make a case for unusually high levels of spousal and child support due to the large income distributions from this Trust. But Bill believed the well-funded spendthrift trust would protect him against creditors -- including vindictive ex-spouses. Smith felt that the spendthrift provisions of the Trust would limit financial damage to Bill's bottom line.

But now, brand new California case law will make it easier than ever for Laura to get what she wants. It's Smith's job to deliver the bad news.

The law is an elastic thing, and the erosion of California's family trust protections stems from the State's public policy of ensuring child support payments. Probate Code Section 15305 provides that a trial court has discretion in ordering a Trustee to make payments for the benefit of a beneficiary, clarifying that this applies to support judgments "notwithstanding any contrary provisions in the trust instrument."

Then, Ventura County Dept. of Child Support Services v. Brown (2004) held that a trial court can order a trustee to satisfy child support judgments. The case also held that a spendthrift clause could not be used by a trustee to avoid child support judgment.

In 2016, yet another case expanded the court's discretion. In Pratt v. Ferguson (2016), Cynthia Vedder was beneficiary of a trust set up by her grandparents in which she was entitled to 1/6th of the total assets and income of the trust, which included a "shutdown clause" where distribution would "become inoperative" when subject to the beneficiary's creditors' claims.

Pratt and Vedder's divorce settlement included a $50k community property interest that Vedder failed to pay. By April 2014, Vedder owed Pratt over $93k, which included the community property interest and "unpaid child support and child care expenses." As a result, Pratt filed a petition for an order requiring the Trustee to pay child support and expenses, and to impose a judgment lien on Vedder's share of the trust estate to satisfy the community property judgment. The trial court denied this petition based on the shutdown clause in the original trust, and Pratt appealed.

Surprisingly, the appellate court reversed the trial court's decision, arguing that when creating Probate Code section 15305, the Legislature had the intent of ensuring the payment of child support obligations.

In applying Probate Code section 15303, and the precedent set in the Ventura case, the appellate court determined that the shutdown clause did not cover all distributions by the Trust nor to discretionary distributions from the principal for Vedder's needs. Only a spendthrift clause could apply to these types of income and principal distributions, but because the Ventura case established that a Trustee cannot use a spendthrift clause to avoid child support judgment, this opened the trust to invasion. Then, the appellate court held that the trial court ought to use its discretion to impose the judgment lien, citing Code of Civil Procedure section 709.010. Any amount that the Trustee pays to Vedder that is above the amount necessary for her education and support would be subject to the judgment lien. The appellate court ordered the trial court to compel the trustee Ferguson to make these distributions.

For California residents who have or who are considering establishing a trust for the support of children and grandchildren -- who want to protect them from a divorcing spouse laying claim to assets placed in the trust -- this recent case is very troubling.

As Smith explains to Bill how this new case law could affect his divorce, Bill's heart sinks into his stomach. He realizes his trust's assets could be up for grabs.

With Probate Code Section 15305, the California legislature overturned centuries of common law precedent, formally adopting public policy that trust assets held for the beneficiaries of a trust created by another (a non-self-settled trust) are not protected from child support obligations. These assets belonged to the trust creator, not the creator's beneficiary, and thus, the creator should be able to decide who gets and more importantly, "who doesn't get" access to the trust creator's assets. Therefore, this case now makes California just about the worst place to establish a non-self-settled spendthrift trust because it opens up the trust's assets for invasion.

Smith watches Bill process this information, his face getting redder by the second. Bill asks what California residents are supposed to do in such an impossible situation. Unfortunately, it's too late for Bill to do anything as his trust has been long-established by his parents, but that doesn't mean all California residents must suffer the same fate.

Just because you reside in California doesn't mean your trust has to. Its called "choice of law" or "forum shopping." Selecting a jurisdiction like Nevada or Alaska which have no "exception creditors"1 will give the creator of a trust far more peace of mind that their legacy can remain intact and protected when it comes to certain types of future unknown creditors, like child support creditors. Choosing the law of the proper situs of a trust is extremely important to its long-term protection, and an experienced asset protection and estate planning attorney can help guide such decisions.

If you have already established your trust in California and want to shore up the protections for your heirs' assets against unforeseen creditors -- including judgments for child support, give us a call.

 

1 Exception creditors would include child support in most states.