Beware That Your Trust May Be Treated as Your Children’s Marital Property in Divorce
Although the divorce rate has decreased (according to the The New York Times, the divorce rate is no longer 50%), the issue of what constitutes marital property continues to plague courts in many jurisdictions. One of the recent areas of contention is what aspect of a trust created by a third party (likely a parent or grandparent) will be included in the division of marital estate. While some states exclude any such interests (gifts and inheritance) from the divorce calculation, there are many states that ignore the genesis of the property for divorce purposes. In fact, there has been a trend to include aspects of a trust in the mix.
One such state is Massachusetts, which does not clearly provide that trusts created by third parties are off limits. A recent Massachusetts appeals court case, Pfannenstiehl v. Pfannenstiehl, Nos. 13-P-906, 13-P-686, & 13-P-1385, 2015 Mass App. LEXIS 123, decided August 27, 2015, held that a spouse’s interest in an irrevocable trust created by a third party with distributions subject to an ascertainable standard provided "vested beneficial interest subject to inclusion in the marital estate." The trust at issue was a spray trust for the benefit of the spouse, siblings and their descendants, with discretion in the trustee to make distributions for their “comfortable support, health, maintenance, welfare and education…” The spouse had little or no other means of support and depended on the trust for support. Lengthy testimony was provided regarding actual distributions made to the spouse-beneficiary. The spouse was ordered to make payment to the non-beneficiary spouse in 24 monthly payments.
From the language of the decision, it is not clear whether the court’s rationale is limited to trusts containing an ascertainable standard for distributions or if a pattern of regular distributions will be deemed to be ascertainable. What is also unclear is what the impact of inclusion of the trust in the “marital property” means. For example, how will the value of the spouse’s interest be valued (here the court divided the value of the trust by the number of beneficiaries and applied a 60% factor for the plaintiff spouse). It is unclear how the beneficiary-spouse, or indeed a family court, could compel a trustee to make distributions to the beneficiary-spouse other than for the beneficiary’s own support, health, maintenance and education. No doubt the case will be appealed, if not by the beneficiary, then by the trustee, who risks a claim of breach of fiduciary duty for making distributions other than as provided by the trust.
A similar case was decided in New Jersey (Tannen v. Tannen, 416 N.J. Super 248 (App. Div. 2010), aff'd 208 N.J. 409 (2011)). At the lower court the discretionary trust payments were considered marital property with the judge adopting comments made in the Restatement (Third) of Trusts (§50 comment d(2) (2003)). However, the New Jersey Appellate Division reversed, with the New Jersey Supreme Court affirming, indicating that even though actual continuous payments were being made from the trust to the spouse, the language ("health, support, maintenance, education and general welfare") did not provide the spouse with sufficient control to force payments.
Because trust donors cannot be confident that trust beneficiaries will reside in a state that treats third-party created trusts as separate property,these cases suggest that the proper drafting and administration of a trust will be necessary to avoid inclusion as marital property. Clearly, trusts that provide an absolute right to payments (such annual income) will be subject to a marital claim in many states. Likewise, language suggesting that support or maintenance are to be provided may cause inclusion, especially if there are regular ongoing payments. Naturally, one will never know in what state a beneficiary and spouse end up at the time of their divorce; therefore, the only way to protect the third party's trust is to limit distributions to the discretion of the trustee. When making distributions, the trustee will need to document the decision of why such distributions were made. Even with a fully discretionary trust, arguably having multiple beneficiaries with some independent assets of their own is better protection for other trust beneficiaries than a single beneficiary trust. Trust donors may wish to include language indicating that the donor's intent is never to have funds of the trust considered as marital assets, even to the degree of limiting or terminating distributions if there ever is a court which decrees otherwise, although donors should carefully consider whether this is what they truly intend. In addition, it may behoove the donor to create trusts in jurisdictions, such as Delaware and New Hampshire, that consider asset protection a primary purpose of their trust laws.