Spendthrift Clauses

October 19, 2015

Olivia R. Holcombe-Volke, J.D.

olivia@elvilleassociates.com

A spendthrift clause is a provision that protects assets or certain trusts against the creditors of a beneficiary of those trust assets.  In practice, this means that a beneficiary of a trust containing a spendthrift clause can’t buy a house using trust funds as collateral.  Nor can a creditor force a payment from a life insurance policy with a spendthrift clause to the beneficiary (or itself) to pay a debt.  In addition to protecting a beneficiary from his or her own financial improvidence, the modern concept behind a spendthrift clause is the idea that the grantor of a trust, or the owner of a life insurance policy, or the decedent of an estate, ought to be able to dictate the ultimate disposition of his or her assets.

The genesis of the spendthrift clause was the desire to protect a beneficiary from him or her self.  According to the First Edition of Black’s Law Dictionary, published in 1891, a “spendthrift” meant “[a] person who by excessive drinking, gambling, idleness, or debauchery of any kind shall so spend, waste, or lessen his estate as to expose himself or his family to want or suffering, or expose the town to charge or expense for the support of himself or family.”  Black’s Law Dictionary 1115 (1st ed. 1891).  One hundred years later, that definition had expanded to include someone “who spends money profusely and improvidently; a prodigal; one who lavishes or wastes his estate.”  Black’s Law Dictionary 1400 (6th ed. 1990).  The concept of a “spendthrift trust,” therefore, arose as a method for ensuring that a spendthrift did not, in fact, “waste his estate” or “expose the town to charge or expense for the support of himself or family.”

With the publication of the Second Edition in 1910, Black’s Law Dictionary included the term “spendthrift trust,” defined as “[a] term commonly applied to those trusts which are created with a view of providing a fund for the maintenance of another, and at the same time securing it against his improvidence or incapacity for his protection.  Provisions against alienation of the trust fund by the voluntary act of the beneficiary or his creditors are the usual incidents.”  Black’s Law Dictionary 1101 (2nd ed. 1910).  By the time of the Sixth Edition, that definition included “One which provides a fund for benefit of another than settlor, secures it against beneficiary’s own improvidence, and places it beyond his creditors’ reach.  A trust set up to protect a beneficiary from spending all of the money that he is entitled to.  Only a certain portion of the total amount is given to him at any one time.  Most states permit spendthrift trust provisions that prohibit creditors from attaching a spendthrift trust.”  Supra.

One such state is Maryland, where the strength of protection contained in a spendthrift clause has been cemented over the past 126 years, beginning with the Smith v. Towers case in 1888 (“the founder of a trust may provide in direct terms that his property shall go to his beneficiary to the exclusion of [the beneficiary’s] alienees, and to the exclusion of [the beneficiary’s] creditors.”  69 Md. 77, 90-91, 15 A. 92 (1888)).  Despite various court battles and creditor efforts to pierce its protective shield, including challenges brought by tort creditors arguing the claims of a tort victim should be allowable claims against a spendthrift clause, the protection afforded by a spendthrift provision has maintained.

Statutorily on point is Section 14.5-504 of the Estates and Trusts Article of the Annotated Code (the “Maryland Trust Act, effective on January 1, 2015), which states, in pertinent part, that “[a] spendthrift provision is valid and enforceable”, restraining “both voluntary and involuntary transfer of the beneficiary’s interest”, prohibiting “judicial foreclosure or attachment” by a creditor, and rendering “an attempt by a beneficiary to transfer an interest in a trust in violation of a valid spendthrift provision… void and of no effect.”  Section 14.5-504 goes on to provide that the protections afforded by a spendthrift provision also extend to the “use, occupancy, and enjoyment of residential real property and tangible personal property”, which “may not be transferred… by a beneficiary whose interest is subject to a spendthrift provision…,[nor] subject to enforcement of a judgment against the beneficiary.”

The exact wording of a spendthrift clause may look something like “no beneficiary may assign, anticipate, encumber, alienate, or otherwise voluntarily transfer the income or principal of any trust created under this trust.  In addition, neither the income nor the principal of any trust created under this trust is subject to attachment, bankruptcy proceedings or any other legal process, the interference or control of creditors or others, or any voluntary transfer.”  Although no specific language is statutorily required (in fact, Section 14.5-504 simply states that the protection applies where there is “[a] provision of a trust providing that the interest of a beneficiary is held subject to a “spendthrift trust”, or words of similar import…” (emphasis added)), it is advisable to have the spendthrift clause carefully worded to ensure the strength of its protection.

This does not mean that spendthrift provisions can protect against all creditors or all claims.  Section 14.5-505 of the Estates and Trusts Article delineates “[a] allowable claims” to include “a child, spouse, or former spouse of the beneficiary that has a judgment or court order against the beneficiary for support or maintenance; a judgment creditor that has provided services for the protection of the interest of a beneficiary in the trust; or a claim of this State or the United States to the extent a statute of this State or federal law so provides;” with some limitations allowed based upon the support needs of the beneficiary him or herself.  The distinction tends to fall along the lines of public policy considerations, that great determiner of what shouldn’t (equitably) be allowed.

Another important exception is that Maryland does not recognize the protection of a spendthrift provision in a self-settled trust, wherein the beneficiary is the same person as the grantor/settlor (“a person may not effectively create a spendthrift trust for his or her own benefit.”  In Re Robbins, 826 F.2d 293, 294 (1987)).  It is also advisable that there be an independent trustee for distribution purposes, to ensure one extra layer of creditor protection (versus a beneficiary who is also a trustee, and can, therefore, arguably distribute money to himself or herself whenever he or she wants to, and, therefore, can do so to satisfy a creditor’s claim).  And of course, once a beneficiary actually receives a distribution from a trust or a payment from a life insurance policy, those funds or that asset are then available for the claims of a creditor – or, at least, are no longer protected by the spendthrift clause.

Unfortunately, it is impossible to fully protect a person against him or her self.  Nor is it possible to fully control what happens to one’s assets after their distribution to another.  However, a spendthrift clause is an extremely powerful protection mechanism and an indispensable planning tool.

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